Carswell leads on bank & money reform

by Steve Baker MP September 13, 2010

[NOTE: House of Commons debate posted at foot of this page]

There is a doctrine which creates wealth and spreads it around. It is just and moral. It works. It is called capitalism and, today, in practice, there is very obviously something wrong with it.

If one were to summarise the doctrine of capitalism in one word, it would be "property". It is property which enables human social cooperation through production, exchange and consumption. The voluntary exchange of property has rules and these are known as contract.

These two concepts, property and contract, are fundamental to capitalism and yet, in relation to money held on demand in bank accounts, they are applied at best inadequately.

On Wednesday, immediately after Prime Minister's Questions, Douglas Carswell MP will be introducing a moderate and conservative ten-minute rule bill which would introduce sound property rights and contract to monetary deposits. It is potentially of profound importance and I am delighted to support him.

Allow me to explain.

If you deposit securities at the bank, they are held in safe custody, ready for immediate use. They are your property, not the bank's. If you wish to increase the yield of your securities by lending them, then you enter into a securities lending agreement with the bank, which borrows your shares for a period, lending them on at a premium. You have forgone your shares for a term in exchange for a fee. The bank is contractually obliged to return your property at the end of the term.

In other words, you either deposit your securities on demand or you save them by lending them to the bank for a term.

I was once intimately involved in the design of a securities lending system for a major international prime broker. There was no requirement to take securities held in safe custody and lend them while maintaining a liability to return them on demand. Lending securities not contractually designated for the purpose would have been an infringement of property rights in breach of trust, that is, a fraud.

While banks maintain clear property rights in securities on deposit, the same cannot be said of monetary deposits. Thanks to a base of judicial decisions, when you deposit your money on demand at the bank, ready for immediate withdrawal without penalty, it is not your property, but the bank's. Banks can lend money held on demand and of course they do so.

This is fractional reserve banking and it may not be the good thing most bankers think it is.

Fractional reserves on demand deposits allow banks to extend credit in excess of real savings. That leads to the creation and destruction of fiduciary media: claims on money for which there is insufficient money to meet all claims. It is what makes bank runs possible. It means that, as the great economist Irving Fisher wrote in 1935,

our national circulating medium is now at the mercy of loan transactions of banks; and our thousands of checking banks are, in effect, so many irresponsible private mints.

As I explained in my maiden speech:

Unlike the situation in respect of any other commodity, in the case of money, price controls do not drive the product off the market. Artificially lowered interest rates increase the demand for credit, and decrease the supply of savings, but the legal privilege granted to banks means that they can meet demand by extending credit that is unbacked by real savings. There is a good argument to say that that causes the boom-and-bust cycle, the misdirection of resources in the capital structure of production, and over-consumption by consumers.

And since the money supply contracts when banks lend less, we find central banks injecting new money through QE, further distorting an economy already distended by excess credit expansion, in an attempt to cope with the anarchy of money creation and destruction caused by fractional reserve banking.

To repeat: demand deposits of money are not subject to the same principles of property and contract as any other commodity. Banks enjoy the legal privilege of open access to money which they are liable to return on demand. In concert with the central planning of interest rates and a range of government interventions, this is what is wrong with capitalism.

It is around this point that scholars of banking theory begin disagreeing, often with very great passion. However, it is a fact that various economists of the three great traditions - Keynesian, Monetarist and Austrian - have, at various times and for various reasons, proposed ending the system of fractional reserve banking.

Douglas's Bill would assert property rights over demand deposits. Real savings - term deposits - would be loaned to entrepreneurs, delivering an economy built on save and invest.

There is a great deal to communicate on this subject, some of which you can find through the links below. In the meantime, I will conclude with some remarks by Nobel Laureate James M Buchanan at the Mont Pelerin Society in 2009:

The market will not work effectively with monetary anarchy. Politicization is not an effective alternative. We must commence meaningful dialogue with acceptance of these elementary verities. Moreover:

Let us not waste this set of crises by exclusive recourse to jerry-built efforts to patch up the failed monetary anarchy we have witnessed.

Douglas is attempting to begin the process of correcting capitalism by asserting sound property rights and contract in banking. I hope Parliamentary colleagues and activists will hear him out, particularly those who wish us to have an economy built on the investment of real savings.

Further information


London School of Economics, 28 October, 18:30-20:00: Professor Jesús Huerta de Soto, this year's Baxendale Distinguished Hayek Visiting Professor, will deliver the 2010 Hayek Lecture, Financial Crisis and Economic Recession. In his 1998 book Money, Bank Credit and Economic Cycles (PDF), Huerta de Soto predicted the economic crisis and comprehensively set out its primary cause: credit expansion unbacked by real savings. Huerta de Soto is a passionate and convincing advocate of capitalism and bank reform - I highly recommend this lecture.

The Cobden Centre, of which I am a director, has a developing events programme, including an annual lecture, a Christmas reception and a series of monthly private dinners. Contact us for more information.

Articles and speeches

I gathered together ten plans for financial reform here.

The Earl of Caithness condemned fractional reserve banking and said "the fault that really needs correcting is our whole banking system" in his speech on the Banking Bill debate, 2009. The noble lord introduced the Safety Deposit Current Accounts Bill in 2008 with similar intent to Douglas. In my maiden speech,

"I condemned fractional reserve banking, central planning of interest rates and the socialisation of risk as the cause of the banking and economic crisis."

James Tyler, Chief Executive of Tyler Capital, explains how the banking system hurts the little guy in The violation of Mr Smith, tells us that Money is not working and sets out How to avoid future encounters with financial meltdown.

Financial engineer Gordon Kerr advocates sound property rights in banking at the European Parliament, explains How To Destroy the British Banking System and asks you to Imagine that the Crisis was a Shortage of Bread.

Entrepreneur and Cobden Centre founder Toby Baxendale describes A day of reckoning: how to end the banking crisis now, developing the next stage of Huerta de Soto's proposals.

Sean Corrigan, Chief Investment Strategist at Diapason Commodities Management, condemns fractional reserve banking and provides a reform in Improper Fractions.


The Cobden Centre has gathered together a selection of literature from a number of traditions here with downloads available here. Our primer is here.

House of Commons debates, 15 September 2010, 1:28 PM
Motion for leave to bring in a Bill (Standing Order No. 23 )

Bill Presented — Savings Accounts and Health in Pregnancy Grant Bill

1:33 pm

Douglas Carswell (Clacton, Conservative)

I beg to move,

That leave be given to bring in a Bill to prohibit banks and building societies lending on the basis of demand deposits without the permission of the account holder;
and for connected purposes.

Who owns the money in your bank account? That small question has profound implications. According to a survey by Ipsos MORI, more than 70% of people in the UK believe that when they deposit money with the bank, it is theirs-but it is not. Money deposited in a bank account is, as established under case law going back more than 200 years, legally the property of the bank, rather than the account holder. Were any hon. Members to deposit £100 at their bank this afternoon or, rather improbably, if the Independent Parliamentary Standards Authority was to manage to do so on any Member’s behalf, the bank would then be free to lend on approximately £97 of it. Even under the new capital ratio requirements, the bank could lend on more than 90% of what one deposited. Indeed, bank A could then lend on £97 of the initial £100 deposit to another bank-bank B-which could then lend on 97% of the value. The lending would go round and round until, as we saw at the height of the credit boom, for every £1 deposited banks would have piled up more than £40-worth of accumulated credit of one form or another.

Banks enjoy a form of legal privilege extended to no other area of business that I am aware of-it is a form of legal privilege. I am sure that some hon. Members, in full compliance with IPSA rules, may have rented a flat, and they do not need me, or indeed IPSA, to explain that having done so they are, in general, not allowed to sub-let it to someone else. Anyone who tried to do that would find that their landlord would most likely eject them. So why are banks allowed to sub-let people’s money many times over without their consent?

My Bill would give account holders legal ownership of their deposits, unless they indicated otherwise when opening the account. In other words, there would henceforth be two categories of bank account: deposit-taking accounts for investment purposes, and deposit-taking accounts for storage purposes. Banks would remain at liberty to lend on money deposited in the investment accounts, but not on money deposited in the storage accounts. As such, the idea is not a million miles away from the idea of 100% gilt-backed storage accounts proposed by other hon. Members and the Governor of the Bank of England.

My Bill is not just a consumer-protection measure; it also aims to remove a curious legal exemption for banks that has profound implications on the whole economy. Precisely because they are able to treat one’s deposit as an investment in a giant credit pyramid, banks are able to conjure up credit. In most industries, when demand rises businesses produce more in response. The legal privilege extended to banks prevents that basic market mechanism from working, with disastrous consequences.

As I shall explain, if the market mechanism worked as it should, once demand for credit started to increase in an economy, banks would raise the price of credit- interest rates-in order to encourage more savings. More folk would save as a result, as rates rose. That would allow banks to extend credit in proportion to savings. Were banks like any other business, they would find that when demand for what they supply lets rip, they would be constrained in their ability to supply credit by the pricing mechanism. That is, alas, not the case with our system of fractional reserve banking. Able to treat people’s money as their own, banks can carry on lending against it, without necessarily raising the price of credit. The pricing mechanism does not rein in the growth in credit as it should. Unrestrained by the pricing mechanism, we therefore get credit bubbles. To satisfy runaway demand for credit, banks produce great candy-floss piles of the stuff. The sugar rush feels great for a while, but that sugar-rush credit creates an expansion in capacity in the economy that is not backed by real savings. It is not justified in terms of someone else’s deferred consumption, so the credit boom creates unsustainable over-consumption.

Policy makers, not least in this Chamber, regardless of who has been in office, have had to face the unenviable choice between letting the edifice of crony capitalism come crashing down, with calamitous consequences for the rest of us, or printing more real money to shore up this Ponzi scheme-and the people who built it-and in doing so devalue our currency to keep the pyramid afloat.

Since the credit crunch hit us, an endless succession of economists, most of whom did not see it coming, have popped up on our TV screens to explain its causes with great authority. Most have tended to see the lack of credit as the problem, rather than as a symptom. Perhaps we should instead begin to listen to those economists who saw the credit glut that preceded the crash as the problem. The Cobden Centre, the Ludwig von Mises Institute and Huerta de Soto all grasped that the overproduction of bogus candy-floss credit before the crunch gave rise to it. It is time to take seriously their ideas on honest money and sound banking.

The Keynesian-monetarist economists might recoil in horror at the idea, because their orthodoxy holds that without these legal privileges for banks, there would be insufficient credit. They say that the oil that keeps the engine of capitalism working would dry up and the machine would grind to a halt, but that is not so. Under my Bill, credit would still exist but it would be credit backed by savings. In other words, it would be credit that could fuel an expansion in economic capacity that was commensurate with savings or deferred consumption. It would be, to use the cliché of our day, sustainable.

Ministers have spoken of their lofty ambition to rebalance the economy from one based on consumption to one founded on producing things. A good place to begin might be to allow a law that permits storage bank accounts that do not permit banks to mass-produce phoney credit in a way that ultimately favours consumers and debtors over those who create wealth. With honest money, instead of being the nation of indebted consumers that we have become, Britons might become again the producers and savers we once were.

With a choice between the new storage accounts and investment accounts, no longer would private individuals find themselves co-opted as unwilling-and indeed unaware-investors in madcap deals through credit instruments that few even of the banks’ own boards seem to understand.

Question put and agreed to.


That Mr Douglas Carswell and Steve Baker present the Bill.

Mr Douglas Carswell accordingly presented the Bill.

Bill read the First time; to be read a Second time on Friday 19 November and to be printed (Bill 71).