We know that on the surface it may not seem like a big deal, but it should give you reason to pause for some thought about the global banking system.
Last week we wrote about Commonwealth Bank’s online Netbank service being offline intermittently for two days.
But perhaps more than anything this electronic stuff-up should get you thinking about where your money is.
We all know that when you deposit $100 cash into your bank account it doesn’t sit in the vault waiting for you to collect it. You pay the cash over the counter, the teller frantically clicks a few buttons and there you have it, your balance increases by $100.
The $100 cash goes into the cashier’s drawer.
After your account has been credited with the $100, and the $100 note is in the cashier’s drawer, another customer enters the bank and is given the $100 note that you just handed over.
Their account is debited by $100 after some frantic tapping away by the cashier and everyone is square.
But what if you change your mind and you want your $100 back? Do you need to chase after the other customer to ask them for it? Of course not, you go to the cashier and they’ll give you a bank note someone else has paid in.
That’s all fairly easy to comprehend. But aside from the cash in the cashier’s drawer, and the cash in the safe, most of the money we have in the bank isn’t really ‘there’ at all.
When we get paid it goes electronically from your employer’s bank account to your bank account. You pay bills using the internet or phone banking. You buy groceries using your EFTPOS card.
Every now and again you’ll get some cash from the ATM, but chances are 90% of your transactions are electronic rather than physical notes or coins.
Still with me?
OK, here’s the thing, – and our point – under the current banking system it has to be that way.
Simply put, there is not enough currency in circulation, or held with the banks, or created by the central bank to meet all the deposit demands in the banking system.
Mark Thompson explained this recently in a guest essay for Money Morning titled “Inflation (The Hidden Tax) Part II.”
He gave this example of how what is called the ‘fractional reserve’ banking system works:
“Bank A receives $1000 deposit….lends out $900, and keeps $100 in reserve
Bank B receives $900 deposit….lends out $810, and keeps $90 in reserve
Bank C receives $810 deposit….lends out $729, etc…
Till finally the original $1000 grows to about $10,000″
It might be a hard concept to get your head around, but it simply means if I deposit $1,000 in the Commonwealth Bank, the CBA will keep $100 in reserve (a cash float if you like) and then lends out $900 to someone.
That ‘someone’ can take the $900 and deposit the money at the ANZ Bank, the ANZ keeps $90 in ‘reserve’ and can lend out $810.
In effect there is only $1,000 cash deposited, yet you have three people with a claim over a total of $2,710.
It’s for this reason that a seemingly small default rate can have a much larger knock-on effect on the economy. If you picture these three people as lending money directly to each other rather than through a bank you can see the problem.
In order for the first person to reclaim their $1,000 they have to rely on the second person being able to recover $900 from the third person. The third person can only pay back the $900 if the fourth person can repay him/her the $810… and on it goes.
In any other type of investment apart from banking, using one person’s money to pay returns to someone else is labeled a Ponzi scheme. It’s what Bernie Madoff received a sentence of 150 years for.
In the world of banking it’s an everyday occurrence.
Think about that the next time your online banking system is ‘unavailable’!
If You Can’t Beat Them, Join Them
Don’t panic/rejoice (delete as applicable), we haven’t joined the throngs of financial commentators and analysts who have given up on free markets to join their comrades in the world of centrally planned economies.
Far from it. We’re actually referring to the chance that policy makers are about to re-embrace free market ideas.
Which is a bit surprising seeing as we’ve been told free markets were “out of control,” “extreme,” and “broke.”
In actual fact yesterday afternoon we were stunned when we read the 20-page document on the Treasury website called “Urban congestion – why ‘free’ roads are costly.”
We were even more stunned when we saw that it got column space in today’s Australian Financial Review (AFR). Not tucked away in some unread ‘special report’ but prime print real estate on page 3.
Could it possibly be true that while business leaders, commentators and economists abandon the notion of free enterprise that the boffins in government are eagerly embracing it?
We won’t bank on it just yet.
In fact, we won’t bank on it at all. Because more likely than anything, the concept of charging for road usage will be based on the amount of tax revenue the government could receive rather than the benefits of a user pays system.
Maybe we’re being too cynical, but it’s hard to see any government imposing a charge on a road that was previously ‘free.’ Sure there are isolated examples such as the Tullamarine Freeway in Melbourne that became the Tullamarine Tollway. And London has its congestion charge.
And we’re sure there are plenty of other examples worldwide. But there’s a big difference between imposing a charge on one road out of thousands, than imposing a charge on every single road.
Don’t get me wrong, we’re in favour of user pays. After all, why should someone who drives two kilometers from home to the train station pay the same vehicle registration as someone who drives 100 kilometres every day?
Of course, the second person is paying more for petrol, which is about 40% tax, but there’s no guarantee that money is being spent on the road network. It just goes in to a big pot to be swirled around and spat out the other end.
Providing a user-pays road charge is based on a competitive free market then we’re in favour of it. It makes a lot of sense, not just to road users but to other forms of transport as well.
But the key is to make all forms of transport subject to free market competition.
Any attempt to provide a subsidy to cars means you are punishing train, bus and motorbike users. And if you subsidise train passengers then you are punishing the others. And so on…
In reality there’s little reason why every single road shouldn’t have a fee for using it. But it needs to be market based rather than set artificially by government or some other public body.
You only have to look at the public transport system to see that government agencies have no idea about setting prices, and no idea how to provide paying customers with a suitable service.
Other Stuff on the Markets
The S&P/ASX200 fell 1.16% yesterday, while overnight on Wall Street the Dow Jones Industrial Average added 44 points. In Europe the FTSE100 lost 0.98% and the CAC40 dropped 1.20%.
The price of gold in Australian dollars is trading at $1,162.44, while in US Dollars it trading at $925.20.
The Aussie dollar remained steady versus the US dollar and Japanese Yen, trading at USD$0.7962, and JPY75.85.
Further strength for Crude oil overnight, closing at USD$64.36.
For the biggest movers on the market yesterday click here…
And today on the economic calendar we have the Reserve Bank of Australia interest rate decision.
{ 1 comment… read it below or add one }
His was 23 years ago, in a much different time. ,