The expansion of $100 through fractional-reser...

The expansion of $100 through fractional-reserve banking with varying reserve requirements. Each curve approaches a limit. This limit is the value that the money multiplier calculates. (Photo credit: Wikipedia)

I think I know enough about banking to say that debt creates very little wealth or value. I have often wondered what makes banks better at accessing risk than anyone else. It is even scary to think that people who work for banks take risk with someone else’s money with the illusion that they understand the risk. Time and time again we trust the banks to do the right thing and it leads to bigger and bigger financial calamities, I have written about why I think this problem exists. The whole banking system is built around a ponzy scheme and it continues to give the privilege of creating money to private banks and hope they will spur the economic progress of the city, or state or country. It is romantic thought process but it is flawed from the outset. I believe the way out of this financial mess the world is in is through equity, i.e let Entrepreneurs lead! We had the dot com bubble and it left fantastic value after its collapse like the Internet, Google, Amazon, Ebay, Apple etc but I am not saying that is the only business we need to create all I am saying is give Entrepreneurship a chance. Let us cut the fractional reserve system that disproportionately allocates capital to “Risk-Free” assets which is an oxymoron because you cannot have Return without Risk associated with it. If someone is selling you “Risk-Free” drug, please ask why they are doing that. I believe Iceland has the opportunity to redefine how the Banking System can be restructured. Here is a link to a Paper by Jaromir Benes and Michael Kumhof from the IMF, with the title “The Chicago Plan Revisited“. The abstract of the paper is given below:

At the height of the Great Depression a number of leading U.S. economists advanced a
proposal for monetary reform that became known as the Chicago Plan. It envisaged the
separation of the monetary and credit functions of the banking system, by requiring 100%
reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this
plan: (1) Much better control of a major source of business cycle fluctuations, sudden
increases and contractions of bank credit and of the supply of bank-created money.
(2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt.
(4) Dramatic reduction of private debt, as money creation no longer requires simultaneous
debt creation. We study these claims by embedding a comprehensive and carefully calibrated
model of the banking system in a DSGE model of the U.S. economy. We find support for all
four of Fisher’s claims. Furthermore, output gains approach 10 percent, and steady state
inflation can drop to zero without posing problems for the conduct of monetary policy.

One of my favorite authors, Nicholas Nassim Taleb has written a lot about it and we don’t need complicated models to explain the fallacy of Debt or Leverage on Securities (which includes Mortgages, Government Bonds etc). I blogged about it in my personal blog and I think it is about time we looked for a better way. I think the above plan can be implemented in Iceland. It could pave the way for defining the right way for financial systems to work in an economy. I am sure it is not simple but necessary to debate and review otherwise we will be stuck in this Ground Hogs Day of Leverage if we don’t change something about this system. I wanted to leave you with a couple of documentaries about Debt and leverage.

Inside Job:

Overdose: The Next Financial Crisis