Human, all too human

Our financial system needs to work with human nature, says John Stepek - not against it.

I think history has proved pretty well by now that if you try to govern your economy or your population with systems that go against the grain of human nature, you're on to a loser.

The collapse of the Soviet Union and the shift of China towards a highly-controlled form of capitalism showed that whatever you thought of the ideals of communism, in practice, it didn't work ownership and profiting from your own work is important to people.

In the West, we're also waking up to the futility of trying to buck human nature with the creeping retreat from the war on drugs'. Prohibition of booze didn't work, and we're realising it doesn't work for narcotics either. With the US steadily legalising the use of marijuana, it's hopefully only a matter of time before these very lucrative criminal markets are shut down for good.

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Now, it seems, the race is on to seriously rethink the financial system. This week, Martin Wolf wrote a piece in the Financial Times, calling for an end to fractional reserve banking.

Before you start thinking the FT has gone all Austrian economics' on us, Wolf was suggesting that money creation should be strictly controlled by the state, not outlining plans for a gold-backed currency or a system of competing versions of Bitcoin.

His basic point is that the most money creation is actually done by the commercial banks, not the central bank. By reining in their power to print money almost at will, we'd avoid destabilising financial crises like the one we endured in 2008.

I'd agree something needs to be done. But I think Wolf's argument misses the point. It's not so much the process of money creation that's the issue. It's human nature, and the failure of our system to work with it.

During the boom, banks weren't forcing credit onto investors investors were desperately chasing yield. The banks were just creating products to meet demand. The real problem is that old chestnut, moral hazard' if you create an environment where you protect people from the consequences of their actions, then they'll take full advantage. And that boils down to the very central banks that Wolf would like to see monopolise credit creation.

Long experience had taught both banks and investors to expect the Federal Reserve and other central banks to step in with lower interest rates to prop up asset prices. Until the financial system basically choked on dodgy debt, there was virtually limitless demand for credit.

If the Fed hadn't been as accommodating through the 1990s and early 2000s, then perhaps investors would have been warier of the downsides of capitalism bankruptcy and the 2008 crisis would never have happened.

Instead, we're perpetuating the moral hazard with money printing, and governments are reduced to introducing ad hoc credit controls, such as the Mortgage Market Review. But perhaps we shouldn't be surprised as Bill Bonner notes, nobody really wants capitalism.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.