When Entire Economies are Held Hostage

Written by Spencer Veale (Guest Author) on August 20, 2015.

The recent dramatic events surrounding the Greek debt crisis had many of us on the edge of our seats as we witnessed history unfolding before our eyes. From the calling of the referendum, to the landslide No vote, to Tsipras’ subsequent capitulation under pressure from the Troika– for many of us it was as gripping as it was occasionally demoralising (like watching the finals except the outcome actually matters). What I’m sure is lost on most, obscure as the mechanics of the monetary system are, is the crucial role of fractional reserve banking both in precipitating the crisis and in using it to strip the Greek people of their democratic sovereignty.

The Ultimate (Yet Unmentioned) Twin Reasons Why the Creditors’ Position is Not Valid

Don’t get me wrong, there are plenty of far less obscure reasons why the creditor’s position should not be persuasive to anyone, which have been well-articulated by many prominent economists in the media. However, for me the ultimate two, which go hand in hand, go unsaid, probably largely because of their obscure and inherently technical nature. In the simplest terms possible, the first of these reasons is because the Greek debt is illegitimate as it was incurred under a system in which the privilege of creating the public currency (the Euro) is almost entirely reserved for private banks. That this is how our banking systems work throughout the world has been acknowledged by the authorities themselves, most recently by the Bank of England(1). The Greek government was originally bailed out so that it could repay various private European banks(2). Yet (for simplicity’s sake it is accurate enough to say) it only borrowed from these private banks in the first place because they were the only institutions endowed by the monetary system with what amounts to the power to create the public currency.
For those familiar with the idea of a Sovereign Money System, the contrast between it and our current system makes clear an important reality of today’s power structure. This reality is that the privilege of private banks to create for profit the public currency represents a massive implicit subsidy to some of the world’s most powerful financial institutions at the expense of sovereign governments everywhere, and the people they represent. It is a lot like if your neighbourhood mafia chief dropped into your produce shop and informed you that all your inventory now belonged to him, and you now had to borrow it back from him in order to stay in business.
If this analogy seems harsh, consider that our public currencies are valuable because of the confidence they enjoy as a result of being the public currency. Therefore they are essentially a form of public infrastructure. To allow private banks to charge us and our governments for creating this public infrastructure (on their keyboards) is essentially the same as allowing private corporations to charge us for driving on our own roads and bridges (without even first selling them this infrastructure). In both analogies, the common theme is that we are being charged by private interests who have no legitimate claim of ownership to use something which is rightfully ours. This is the essence of the illegitimacy of our current monetary system. The only reason we tolerate this arrangement is because not enough people realize that this is what the system amounts to– after all, the mechanics of the monetary system are nothing if not excessively convoluted, which preserves their obscurity. In the meantime a self-destructive austerity has been imposed across Europe(3) in the name of fiscal responsibility. If Europe’s governments have been profligate, their greatest extravagance has been in subsidizing their banks in this discreet manner– the same banks Greece was bailed out in order to repay. Europeans living under austerity bear the burden of funding this subsidy largely without knowing it, let alone consenting to it.
The second of these twin reasons that the creditors’ position should be viewed as less than credible is that it was this very system of fractional reserve banking, which delivers this subtle yet massive subsidy to the banks, which necessitated that Greece be bailed out in order to repay the banks. It is only because of the banks’ inherent fragility and their “systemic importance” under the fractional reserve system that Greece did not simply default on its debts when it became insolvent. After all, to do so would have caused a wave of bank failures and likely brought down the entire global economy.
To recap, Greece, to a significant extent, only had to borrow in the first place to make up its budget shortfall that results from subsidising (largely) the very same banks it borrowed from. Then on top of this, the reason it had to accept bailout money (and austerity measures) in order to repay these banks was because of their fragility and the threat they pose to global economic stability. The banks only have this leverage as a result of the same system which grants them this massive and widely unrecognized subsidy. European harmony, the highest stated objective of the European project, has been sacrificed in order to bail out Europe’s already heavily subsidised banks. All of this is a direct consequence of our needlessly dysfunctional monetary system.

The Current Monetary System Allows Entire Economies to be Held Hostage by their Central Banks, in this Case the ECB

Greek Prime Minister Alexis Tsipras has openly admitted that he himself did not even believe in the agreement he signed with the Eurogroup (4), and has now pushed through parliament. Yet he did so anyway in order to restore emergency lending (of reserves, which are different from the electronic deposit money created by private banks) to the Greek banking system and avert a disorderly “Grexit”. The recent closure of the Greek banks was the result of the ECB reducing the Greek banking system’s access to this emergency lending. The dependence of the Greek banks, and therefore the Greek economy, on this lending from the ECB once again is entirely a byproduct of the current fractional reserve banking system. It is exactly because our banks are required to hold only a fraction of the total amount of their deposit liabilities in reserves (Note: in UK, there’s 0% reserve requirement) that banks are vulnerable to this kind of bank run which can require emergency lending to avert.
To illustrate why this is the case– if a bank only holds, for instance, 10% of its deposit liabilities in reserves, and its depositors attempt to withdraw more than that, the bank needs to be able to borrow the difference or it goes bankrupt. As a result of the Syriza government’s stated intention to reverse austerity in Greece, Greek banks found themselves unable to borrow, both from other banks as well as the ECB’s normal facility, in order to cover such shortfalls (5). This, in turn, is why the ECB’s emergency lending has become so indispensable to the Greek banks. By reducing the Greek banks’ access to emergency lending, the ECB pushed the Greek government to limit the amount of money that depositors can withdraw, so as to avert (for the time being) the bankruptcy of Greece’s banks. Next, it informed Tsipras that higher levels of emergency lending would not be restored until an agreement was made with Greece’s creditors(6). This of course with time running out before Greek depositors withdrew the last of their banks’ reserves, pushing the banks to the verge of collapse. With his country’s banks held hostage, the economy itself was effectively held hostage as well. Unwilling to dare the Troika to do its worst, Tsipras signed on to an agreement worse than the one his voters bravely rejected (with his encouragement) in the recent referendum. The hashtag that was trending on Twitter in the wake of the agreement, #ThisIsACoup, is not hyperbolic. It is a sound diagnosis which should be taken very seriously.

Monetary Reform Offers a way to Restore Democratic Sovereignty and Reverse Austerity in Europe

In short, what a Sovereign Money System would do is eliminate each of the major flaws of the current system described above. Banks would no longer be able to create money, restoring this prerogative instead to the democratic state, which is responsible for the value of the currency in the first place. Governments would therefore be much better funded, and could then afford (without taking on further debt) to reverse the downward spiral inflicted by austerity. The fact that money would be created by spending it into circulation in the public interest as opposed to being lent into circulation by private banks for profit, would alleviate the economy of the massive weight of the illegitimate debt burden we are forced to bear under the current system. This would further promote economic recovery.
Finally, revoking the banks’ privilege of fractional reserve lending (banks would have to hold in depositors’ accounts all money that could be withdrawn on demand at all times), would mean that they could be allowed to fail when too many of their loans went bad, as deposits would be safe. As a result, governments would no longer be forced to bail them out. The prohibition of fractional reserve lending and the resulting safety of deposits would also mean that banks would no longer be in danger of becoming dependent on emergency lending in order to avert collapse. The central bank would therefore no longer be able to hold entire economies hostage in order to overrule the democratically elected government’s sovereignty.
The past month has provided as vivid an illustration as we could possibly ask for as to why monetary reform is so startlingly necessary. Democratic sovereignty itself is at stake. This is not the first time we have seen such a coup (7), nor will it be the last. Only when enough of us understand the weapons this technocratic power wields against us will we have a chance of disarming it.

1. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
2. http://www.nakedcapitalism.com/2015/07/dan-davies-greek-banks-were-bigger-beneficiaries-of-the-2010-bailout-than-french-and-german-banks.html
3. http://www.theguardian.com/business/2014/oct/01/austerity-eurozone-disaster-joseph-stiglitz
4. http://www.telegraph.co.uk/finance/economics/11740527/Alexis-Tsipras-on-Greek-bailout-I-signed-a-text-I-do-not-believe-in.html
5. http://www.bloomberg.com/news/articles/2015-02-04/emergency-liquidity-assistance-for-greek-banks-an-explainer
6. http://www.marketwatch.com/story/ecb-to-greece-no-deal-no-more-emergency-aid-for-banks-2015-07-08
7. http://www.economist.com/blogs/charlemagne/2014/11/trichet-letter