Tony Miller's Finance Blog’s blog

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The review below was found the most useful by the most people.

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This book is well written. It is very well organised and structured, engaging, easy to read, clear and interesting.

According to the author, one can hold one of 3 views:
1) one can think that the markets are efficient (auto-equilibrating) and believe the central banks are required (mainstream thinking). According to the author, this is logically untenable because if the markets are efficient, then logically one would not need a central bank to correct desequilibria as they would not occur.
2) one can think that the markets are efficient and therefore no central banks are required (Friedman). According ot the author this is more logical but empirically false as reality shows that markets are inefficient and severe crisis do occur on such a regular basis as to invalidate the theory of automatic auto-regulation of the markets
3) one can think that the markets are inefficient and that we needed an interventionist central bank. This is the point of the author. In one chapter, the author recommend a strategy of "monetary regulation" copied from Maxwell's "governors" in physics: this is required precisely because (again according to the author) markets are as inherently instable as the Eurofighter plane is (the plane though is this way by willful design for manoeuvrability purpose and the instability is corrected electronically by a "governor").

There can be little argument against discarding 1).

So the difficult part is deciding on between 2) and 3).

Let's say we go along with the author and choose 3). Then we are facing with a nightmarish situation. You would need to have always a very competent (actually a genius) economist to direct the "governor" of the central bank. Although it needed not be perfect (and the author make it seem almost easy to design), most people can express doubt about this and the actual result. And then consider what happens when one day a president names his loyal (but incomptetent) friend (of course, this could never happen in the real world!) at the helm of the central bank and this friend is seated on the cockpit to pilot the "inherently unstable" eurofighter/economy! You guess it... we might not enjoy a soft landing but a terminal crash! Scary prospect. No wonder there is a market for gold, even nowadays.

Let's now consider option 2). Like another reviewer I was stunned when the author discarded the option by merely writting (p. 55):

"It soon became apparent through repeated waves of financial crisis, that this new credit generation system was highly unstable. However it was equally apparent that this new system was also leading to dramatic economic expansion, wealth generation and improving living standards. Going backward to a world before depository banks and credit creation was not an option. The process of credit creation had opened up a whole new channel for economic growth and prosperity. Venture capital in the truest sense of the word was now possible. Equally the new banking system permitted channels by which risk could be pooled and shared; larger ventures became feasible."

Wow! We are to take this at face value! Lots of details follow as to why the instability occurs but zero further explanation why the credit generation system is required and is the actual cause of the prosperity. It is supposedly "self-evident". This is like my mathematical teacher would say: the weak point in an argument is always the line where someone writes the disputed "obviously formula xyz applies in all case" and then spend all the rest of the article explaining, at great length, the obvious. In this case, the author spend virtually the entire book trashing the efficient market hypothesis, and zero line defending the most contentious point!

Indeed, there is a growing number of very knowledgeable economist who do believe that the central bank is not necessary and that fractional reserve banking not only is the no 1 source of instability of the system, but should be abandonned.

Now let's respond to the author point by point:

1) "venture capital in the truest sense of the word was now possible". Hummm. It ALWAYS had been possible. People have always pooled their money and give it to an adventurer going to India or America; people have always pooled their money to give to the inventor to create a new machine. You don't need a fractional reserve bank AT ALL to do this.
MOREOVER, without a fractional rerve banking system, you remove the main instability: if the endeavor/project fails, only the venture capitalist lose and they had themselves accepted the risk, no surprise. In a fractional reserve system, either the bank disappear (about 9,000 failed in the 30's in the USA...) destroying hard-earned savings of people who never thought their money was used for risky endeavor, or, the central bank is used to save the bank (2008 situation) and its risk-takers (or plain gambling as it now the case with derivatives the extent of which I doubt not even 0.1% of the population is aware of) at the expense of the entire unwitting population.

2) "the new banking system permitted channels by which risk could be pooled and shared": this is almost the dictionary definition of an insurance company! You don't need any fractional banking system for this! Again, with an insurance company in a world of fractional banking system it only worsens: they are rendered more instable and can only be resuscitated by a central bank otherwise the entire economy will collapse (think AIG). In a non-fractional banking reserve system, only the insurance company collapse - it is isolated from the rest of the economy penalising only its imprudent shareholders and customers.

Fractional reserve banking leads to instability and require a central bank. I think everybody agrees on this.
THE controversial point is: can the author show us why we NEED the (inherently unstable) fractional reserve banking? Why?

I am quite open to contrary viewpoint and could even change my mind about the subject.

Indeed I'd be delighted (and without a doubt, many others would also be) to purchase and read a book from the author titled "Why we need a fractional reserve banking system and its ensuing economic instability that can then only be rendered rendered stable by a eurofighter style "governor" piloted by a agile central bank".

It would especially be a delight reading that new book because I do enjoy the author's clear and well organised writing style. And I would love to write a review of that new book on Amazon!


I'll be patiently waiting...

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