Keynes spends many pages in the Treatise dealing with bank money — not surprising given that, as Keynes makes clear, bank money was much larger than state money in 1930. Well, not much has changed since then. Today, bank money accounts for 82% of the total broad money measure, M4.
So bank money is the elephant in the room. Anything that affects bank money dominates the production of money, broadly measured. And changes in money and credit set the course for economic activity.
We have prepared the stage – now for the play. For politicians, as well as central bankers, the name of the game is to blame someone else for the world’s economic and financial troubles.
In the wake of the 2008 crisis, their accusatory fingers pointed at banks and bankers. The establishment asserted that banks were too risky and dangerous because they were “undercapitalized” and “underregulated.” It is, therefore, not surprising that the Dodd‐Frank Act passed with flying colors, and that banks are now burdened with more than 22,000 pages of new regulation — and counting. This resulted in a damaging pro‐cyclical policy stance in the middle of a slump — just what U.S. did not need. Indeed, all this anti‐bank regulatory zeal created a credit crunch.
The U.S. monetary stance has been wrongheaded and schizophrenic. When it comes to the big elephant in the room – bank money – the stance has been very tight. But when it comes to state money, the stance has been ultra‐loose. The end result has been one in which state money exploded after the crisis while bank money initially contracted and then stagnated. In consequence, broad money (Divisia M4), which is the fuel for the economy, is growing at a modest 4.8% annual rate.
What makes the post‐crisis regulatory zeal so absurd is that it is based on a myth — one identified by John Allison, one of the country’s top bankers. Indeed, in his book The Financial Crisis and the Free Market Cure (McGraw‐Hill, 2013), Allison shines a light on the myth that the banking industry was deregulated during the administration of George W. Bush and that this was a major cause of the financial crisis. As Allison documents, this argument is nonsense. There was a massive increase in regulations that affected banks during the Bush years. The financial industry was not deregulated, but misregulated, with the likes of the Privacy Act, the Sarbanes‐Oxley Act, and the Patriot Act, to name but three.
If we return to the regulatory madness associated with Dodd‐Frank, we see that, while all financial institutions were put in a vise, community banks were put in a super‐squeeze.
Just what constitutes a community bank? For the answers, there is no better source than a Harvard Kennedy School working paper, “The State and Fate of Community Banking,” by Marshall Lux and Robert Greene (February 2015):