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The Money Reform Party

Personal Debt

Are the Banks out of Control?

At the time of writing (2005), personal debt in Britain has reached the trillion pound mark (£1,000,000,000,000), which amounts to some £16,000 of debt for each of the country's 60 million inhabitants - £16,000 for every man, woman and child.

Not everyone has this level of indebtedness. Most people probably have no debts at all, but this just means that the amount of debt borne by those who have them is even greater. Much of this debt is in the form of mortgages at very low rates of interest, but much is in the form of unsecured loans, at much higher rates of interest. These are reckoned to average out at some £7,000 per household.

To the uninitiated in money matters, this high level of borrowing may also be indicative of a high level of saving. After all, people can only borrow what other people have deposited as savings. True?

False. It is no coincidence that the upsurge in personal borrowing in recent decades coincided with banks getting more involved with mortgage lending, with the demutualisation of many building societies and with the spread of the use of credit cards, which are, of course, backed by the major high street banks.

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The Fractional Reserve Banking System

The privately owned high street banks do not lend out their saver's deposits as loans to those customers who wish to borrow. They never have. Instead these deposits act as a reserve on any calls that banks have on their money over and above the normal in-flow of funds. It is called their fractional reserve.

Instead of lending actual cash money to borrowers, the banks have only ever lent 'credit'. However, this credit is used by individuals to buy homes and to spend through their credit cards, overdraft facilities and arranged loans. It is also used to run businesses, to pay employees and suppliers, who further use it to run their own finances. Governments borrow it for public spending when income from taxation is insufficient.

This bank-created credit now forms some 97% of the British money supply (with similar ratios affecting all the world's major economies), and it has effectively become money. If a person borrows, say, £100,000 from a bank to buy a house, they regard that sum as money. It gets paid into the vendor's own bank account and they also regard it as money and spend it as money.

The amount of credit lent as a proportion of money held on deposit has always been a matter for nice judgement by the individual banks. The more they lend the more profit they make, but the more exposed they become, if too many customers want their money back in the short term. During the 18th and 19th centuries, private banks often collapsed due to a 'run on the bank'. Nowadays, the banking system as a whole tends to rally round to prevent any one bank collapsing, if only because they are all so bound up with each other.

So by the 20th century a figure of 15% was established as a suitably 'safe' exposure - the prudent fractional reserve. This meant that for every £100 that a bank had out on loan, it had £15 of savings held on deposit to cover the loan. This was the equivalent of a bank lending out each of its saver's deposits six times over. This was a fabulously profitable way of working, but it did at least impose a degree of constraint upon bank lending.

Bank de-regulation in the 1980s and the decline of the use of cash has ended even this modest constraint.

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No Reserve

The use of cash has declined from 46% of the money supply in 1946, to 21% in 1972 and now down to 3% today, making this 15% 'safety' figure cease to have relevance. A reduction of cash to just 3% of the money supply suggests that the 'fractional reserve' of most banks has also fallen to a similarly low level. In other words, banks can and do lend to the amount of over 30 times their depositors' savings. To all intents and purposes, with such a tiny amount of reserve required and as cash is now so little used, there is virtually no restraint upon the amounts that banks may lend.

There certainly is no government control upon bank lending. The only influence by statutory authority is an increase in base interest rates by the Bank of England's Monetary Policy Committee when inflation rises, indicating too much money within the economy.

In recent years, despite the growth in the money supply, both interests rates and inflation have been at a very low level. This may be because, despite there being so much money in circulation, a large proportion is in use simply to pay the interest on the high level's of borrowing. It is therefore not available, as historically it would have been, to allow high levels of inflation to occur with 'too much money chasing too few goods'.

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Bad Debts Rising

This natural curb on both inflation and interest rates, caused by the straight-jacket of high levels of borrowing, should not allow us to be complacent, however. The level of bad debts is rising steadily. At the time of writing it is estimated to be in the region of 20%. In other words, the banks are losing about £20 for every £100 they lend.

Given that the money that they lent was created out of thin air in the first place, it is money that they can afford to lose. It just means that their profits are a few billion pounds less each year than they would otherwise have been.

For the individual borrowers concerned, however, this difficulty with indebtedness is not so easily dismissed, for the banks do not allow them to walk away from their commitments without difficulty. Homes are repossessed; businesses go bankrupt; county court judgements are imposed; debt-collectors are set onto people; sleepless nights become common; marriages break-down; spouses and children become the subjects of physical and emotional abuse; suicide is contemplated and even attempted.

All this is because the culture of thrift has been swept a away in an orgy of irresponsible lending. Everywhere, lenders are falling over themselves to push borrowing down people's throats. People are urged to sign loan agreements that they do not understand, proffered by people whom they do not know, to borrow money that they cannot afford, to buy things that they do not need.

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A Topsy-Turvy System

We have the most topsy-turvy credit rating system, wherein people with large amounts of debt are given good credit ratings and permitted to borrow more, whereas those who have a history of prudence, who have scarce ever borrowed before are given poor ratings and are penalised by high rates of interest!

This cavalier attitude on the part of the banks would be entirely curbed by the simple expedient of making it illegal for them to create money. Then they would have to very careful with the money that they lent out, as it would not have been created out of thin air. They could fulfil a useful and profitable role within the economy, but it would end their capacity to lend irresponsibly.

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The Solution is Money Reform

The purpose of the Money Reform Party and its sole policy is to promote, by any legal means, the abolition of the power to create state-backed money (sterling) by private individuals or companies for private profit, and the investment of that power in national or local government for the benefit of the public purse.

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Personal debt: Are the banks out of control?

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