A guest post by Benjamin Cole
If one spends enough time in econo-blogland, one becomes saturated in a repeating meme, or trope: Savers are entitled to returns.
Sometimes there is a prologue or addendum that the Fed or other central banks are practicing “financial repression” on savers, by “artificially” holding down interest rates. Usually, these tropes righteously wave the free market and free banking flags, and genuflect to gold.
That savers are virtuous is perhaps true.
But in free markets, savers are “entitled” to jackdoodle.
Indeed, in truly free markets savers might be entitled to 100 percent losses, and more if they left their money in the hands of a money manager who leveraged up. In that case, perhaps creditors would be entitled to seize the savers’ other assets and attach future income.
Oddly enough, the fiction that savers are entitled to a return is a creation of modern state-backed banking, and state-imposed distortions on free markets. The only reasonable means of assuring savers of a return is government TIPS bonds, or a central bank guarantee on bank deposits and perhaps artificially high interest rates.
Now, it is true, if free markets came to banking, we would see private deposit insurance, and that might lead to higher reserve standards, and better underwriting. But that is not a given, not is it given such an arrangement would mean returns for savers.
Consider what happened to American bond markets in 2008. These were institutional markets, of sophisticated sellers and buyers.
Not only that, the private sector developed ratings agencies, such as Moody’s or Standard & Poor’s that rated corporate and mortgage-backed bonds.
Not only that, then bonds were privately insured by AIG.
So, some sophisticated buyers bought AAA bonds backed by AIG—all private transactions.
Of course, 2008 was a rout, a debacle, a catastrophe for the private bond markets, and savers took heavy losses, and would have taken even heavier losses except government stepped in and backed up AIG.
So, after the wrenching experience of 2008, private-sector dominance in bond markets would result in reforms, right?
After 2008, bond-buyers would not trust a rating agency hired by the issuer anymore, and bond buyers would only buy bonds where the rating agency was independent, hired at random through a pool system—right?
Sadly, the markets have gone right back to bond-issuer hired ratings agencies. The private-sector, free market correction has not happened. I find this inexplicable, but it is what it is.
Would free banking and a gold standard work out better?
There is no reason to suppose that lending out gold is risk-free, or that banks that operate without a central bank backstop will not collapse sooner or later. In some ways it is Murphy’s Law that will inevitably ruin banks, in other ways it reflects the character type of people attracted to finance. Let’s just say the people who work Wall Street do not inspire boundless trust.
And in other ways it reflects on the grasping for yield that afflicts savers.
And, as we saw from the bond markets, the private-sector idea of deposit insurance could be a house of cards when push came to shove.
With free banking, there is the constant possibility of catastrophic disintermediation, bank runs and near-complete losses for investors, or long-term minor depreciation on deposits (that is, bank fees could more than eat up interest income. Buying real insurance and physical security for bars of gold could be expensive).
In general, in free markets savers can only receive returns if the process of intermediation throws off enough profits to sustain returns. It may, or may not.
Why then, would people save, if they received negative returns and faced risks? Many reasons. For retirement, for unexpected health care, for college, to start a business, or buy a house, for cultural reasons, for any and all types of financial security.
The rate of savings, without guarantees of security and returns, might be less, and we would probably see less capital formation.
And the occasional catastrophic collapse?
Maybe that too.