Britain’s move to ‘capitalism with Chinese characteristics’

We’ve written here several times over the last few years about the way in which money is created in the West. So regular readers will understand that the supply of money is not created in the main by central banks, but by commercial banks –  they create it out of thin air every time they make a loan.

This isn’t the kind of thing that the authorities much like to talk about – it is hard to maintain the idea that central banks are in absolute control of monetary policy when everyone knows that commercial banks print 97% of the new money every year as and when they feel like it.

So we have been interested to see the subject making its way into the mainstream. First, in the first quarter of this year came the the Bank of England Quarterly Report, which described the process pretty clearly: “In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”

Then came FT columnist Martin Wolf. A few weeks ago he too described the way in which money is really created, and then last week he suggested a few improvements to the current system. Why, he asks, should the ability to print money rest to such a large degree in private hands? Is it this that gives us boom and bust? And if so what should we do about it?

These are big questions – and ones we will be discussing at length at the MoneyWeek Conference on Friday (there are a few tickets left). But there is definitely a growing sense in government that things aren’t quite as they should be.

Douglas Carswell, among others, reckons that taking away the government guarantee on deposits would sort things out pretty well (see our interview with him and this roundtable discussion), while Martin suggests that only the government should have the right to print money, create inflation and pocket the proceeds of doing so.

However in the short term the most likely move will be towards credit controls – whereby the Bank of England puts restrictions on how much banks may lend out, and how. There is a little of this about at the moment (banks have to hold less capital against mortgages than business loans for example, something that encourages them to make more mortgage than business loans). But there are more precise ways to do it.

The Japanese have long used something called “window guidance” as a way of telling the banks exactly how much may be lent to any one sector at any one time. And if you look at the restructured Bank of England, you will see, as I discussed a few months ago, that the Financial Policy Committee has the ability to control the supply of credit to different sectors at different times, something  CLSA’s Russell Napier calls “capitalism with Chinese characteristics”, and we could also call “capitalism with Japanese characteristics”.

What it means is that the Bank already has the power, should it choose to use it, to fully direct and control the creation of money inside the UK economy.

Will it use it? Hard to tell. But the much-discussed mortgage market review, whereby the banks have to make sure that borrowers can afford to repay their loans before they make them, might give us a hint.

The Bank of England, via the FCA, is telling the commercial banks how they may lend. It isn’t a particularly stringent credit control, but it is still a credit control.

Banks have been creating money without much in the way of controls since the 17th century. Is this the beginning of a revolution?