The greatest flaw in our financial system

As a comment on my posting “When Economics becomes sensible again” a reader has written:

” You say, ‘There is a vast imbalance of debt’. I wonder how you come to even think of the possibility of imbalance?  Wherever there’s a debt there’s always a balancing credit, by definition – whether you’re dealing with money or anything else.  But I’m sure you must have an answer . . .”

I replied: “Yes, I do have an answer and it is a very obvious one. A debt immediately starts acquiring a running penalty — interest payments — until it — and they — are all paid off.”

The reason why I’m also making this a separate post is that this actually puts the finger on what has been the greatest weakness in our financial systems both during the gold-standard years before World War I and afterwards — especially afterwards.

The Bank of England saved a major bank from bankruptcy in the mid-19th century but such was the furore afterwards — that it contradicted the terms of the Banking Act of 1844 — that it never did so again.  When Overend, Gurney & Company, the largest commercial bank in the world, collapsed in 1866 the Bank of England did not save it.  This caused a great deal of suffering among shareholders, depositors and bank workers  but it was all over and done with well within two years and it had no repercussions at all in other countries.

But after World War I, especially after 1931 when this country left the gold standard, the Bank of England began helping finance houses and banks.  After World War II, by which time hundreds of banks in the country had become the Big Six, they were deemed TBTF (‘Too big to fail’).  After the 2008 Great Recession — as it is increasingly being called — the government fell over itself to save the Big Five.  But it was one thing giving them enough cash over the fateful September weekend when the cash machines had to be ready for the Monday, it was quite another to then start feeding the banks with massive amounts of Quantitative Easing in order to get them to start lending again.

They didn’t do so — and are still not doing so — and although eminent and experienced advisors — e.g. Paul Volcker in America and Sir John Vickers in this country — have been calling for banks to  be treated he same as every other  business, it still hasn’t happened.  The banks remain a ‘Moral Hazard’.  And, as most advanced governments are themselves also deeply in debt, they won’t make an honest job of it until the debt imbalance is so great that it can’t be ignored any longer and the world financial system is in danger of crashing — again !

2 thoughts on “The greatest flaw in our financial system

  1. Dear Keith,

    I think I must take you to task a bit on your terminology.
    Interest payments and interest on interest taken over a period of 300+ years, in a fractional reserve system (the origins of which, by the way, were long before the 1930s), has an effect which successively expands the money supply and automatically skews its distribution towards return on financial capital, in relation to earned income and creation of real wealth. On an exponential curve. I think it may be adverse effects of this that you are wanting to point to?
    But this represents today not a ‘debt imbalance’, simply an increase in debt/credit/quantity of money with no corresponding creation of real wealth, feeding fears of inflation. At the same time mini crashes cause debts to be written off on a massive scale, causing for the moment even bigger fears of deflation. Scylla and Charybdis, with the channel between them getting narrower and narrower.
    The flaw in the financial system if there is one is not in the original design, which was fit for purpose at the time and very successful, but in the failure to be conscious enough when the ‘turnaround’ occurred (in ca. 1970) and intelligent enough to adapt it for current global purpose and needs. That’s the challenge today!
    Exceptional human beings will be required to bring this about. Maybe you have some ideas, or at least fantasies, how they might come into being?


    1. Peter, As to needing “exceptional human beings” . . . well, they’re desirable in any subject ! Although I criticise economists in general in my posts I’m also aware that there are a number of exceptionally bright people among them. The trouble is that highly intelligent individuals can be quite as susceptible to the cultural norm as lesser mortals and this, in the financial world these days, includes the notion that governments are the progenitors of money. Keith

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