The Bank of England has declared the end of the banks. Well, sort of – and certainly not immediately. To be completely accurate, the UK’s central bank is publicly musing on the consequences of digital money. In a somewhat subversive recent blog, the bank explores what could happen if something like bitcoin was taken under the control of national authorities.
Money is to economics what quantum mechanics is to physics. If you claim to understand either then you are probably delusional. One mistake is to think that central banks control the money supply. This is not true. Ordinary banks determine how much money is in the system (it depends on how much they lend). We used to think that if central banks bought trillions of dollars, yen, pounds and euro government bonds we would get rising inflation. The fact that we have no inflation at all is testament to the fact that money is a bit like Dark Matter: physicists are convinced that it’s there but they are not quite sure what or where it is. Economists are similarly searching for ways to define and measure money. And just as quantum physicists talk about “weird entanglement” there is a peculiar and ironic link between unprofitable banks and the current wave of populism.
The advent of digital currencies means that we can imagine a world without cash and banks. If central banks implement a digital currency regime they will gain control over the money supply and ordinary retail banks would become redundant. Our individual accounts will exist in the cloud in one big digital ledger, controlled, maybe, by entities such as the Bank of England. Crucially, the role played by banks as payment intermediaries disappears in a puff of digital smoke.
Banks might still exist but only with drastically changed roles: they could still make loans but only with 100 per cent reserves (as opposed to the funny money system that operates today). More likely will be the separate disruption facing traditional lending activities:fintech (peer-to-peer lending). Banks risk becoming like the music industry, utterly blown away by technology. Traditional banks could be caught in a classic pincer move: fintech on one side and digital currencies on the other.
All this lies in the future, a rather dystopian one for bankers. While that might bring deep joy to those who blame those bankers for all modern ills, we still need the commercial banks. And trouble is brewing, again. Most obviously, the Italian banking system is doing a passable imitation of our own, circa 2008, needing some kind of bailout. Europe’s banks are not in such bad shape as Italy’s but they are still far from being restored to health. Sad as it may seem for the ordinary punter, retail banks are not making enough money.
At its most simple, bank profitability relies heavily on sales (loans) and profit margins (called net interest margins). Both aspects of profitability are struggling. Near zero central bank interest rates are part of the problem: these are helping to compress profit margins. Banks could make more money by lending more but this is both risky and difficult against a background of mediocre economic growth: even if they wanted to make loans there isn’t much private sector appetite for them.
The policy contortions currently under way at all central banks is a result of them not being in control of the money supply. They must wish that digital currencies were in existence today. In such a world they could make the money supply anything they wanted it to be and could easily get the inflation (and growth) that is notably absent.
Central bank failure to get inflation and growth up has led to them being blamed for the global populist wave. Their response is to point to the extraordinary things they have done already and to the limits to how much more than they can do. Some central bankers still speak in code but their words are, properly interpreted, quite clear: “We have done what we can; lack of economic growth is a prime driver of populist unrest. If politicians want to combat populism they have to play their part on the economy. That means the end of austerity. Get on with it: borrow and spend more to boost growth (and bank profits).”
It will be interesting to see who listens. The new government in the UK is clearly moving in this direction. It seems likely that the new US president will also be amenable – with, ironically, Donald Trump the most likely big spender. Japan is on the road to even more government spending. Will Europe – Germany – also listen?
