Good Critical Thinking On Critical Reflection On The Article “How Money Is Made”

The financial crisis of 2008 has revealed that the banking sector is insecure in terms of financial market collapse. Many key financial institutions went bankrupt; others were financially supported by authorities. Some of notorious cases of bankruptcy have revealed severe violations of financial security measures from key market players. This encouraged the world governments to strengthen the measures of monetary and fiscal control.
In the article “How money is made” Karl-Theodor zu Guttenberg and Richard Werner stress that the imperfection of the banking system has eventually lead to the crisis and its role in the economy has to be reconsidered. The authors treat banking system as the money making institution that has to be strictly regulated by the government in order to contribute to the growth of real GDP. The article provides the number of ways to improve the government regulation of banking system.
The money-creating role of the banking system is commonly known. The classical economic theory explains the role of banking sector in money multiplication process through interest rates. Shostak (2008) in his work discusses the classical economic approach designed by Friedman in which central bank should “aim at a fixed rate of growth of the money supply”. The central bank can influence the short-term interest rates and rate of banks’ internal reserves to maintain the money multiplication.
However, in recent decades money multiplication through credit extension has reached 97 percent, granting banks the role of main money creators in economy. This compromises the classical theory as much as the U.S. mortgage market breakdown of 2008, revealing incapability of standard monetary measures to control the money supply.
The growth of money supply has to correspond with the growth of GDP in ideal economic model. In this way the economy is protected from inflation and other negative consequences. However, banks as independent market units do not operate according to what is best for economy. The extensive money creation is explained by speculative peculiarity of market transactions performed by the banks. Jackson & Dyson (2012) in their research underline that “banks currently direct the vast majority of their lending towards non-productive investment, such as mortgage lending and speculation in financial markets”. This causes the uncontrolled rise of prices on speculative assets and thus creates the financial bubble that can burst any moment. Therefore Guttenberg and Werner in their article mention that banks should be restricted from granting loans that do not contribute to GDP. They advise a number of measures that can be implemented in order to limit non-productive lending and partly offset the negative effects of banks’ activity on modern economy.
One of such measures can be government sector borrowing from banks instead of issuance of bonds. It can direct the borrowed funds into GDP generating sectors of economy given that wise fiscal policy is followed. However, government bond is a safe financial instrument that can be traded on financial market and thus banks prefer it to lending. Moreover, on practice it is the government who usually lends funds to banks in terms of financial crisis as the banks’ deposit portfolio is insufficient to grant loans and they face liquidity shortages. Besides, mortgage loans and other popular non-productive lending cannot be reduced to minimum as such loans carry an important social aspect. In lights of customer-directed economy these loans provide a certain level of welfare to the customers. Restriction of asset-purchase loans can have heavy social consequences and political instability.
The banking sector has become a powerful financial institute with significant players represented by international corporate banks. The financial collapse of 2008 has revealed that most of major banks were involved in the financial machinations. Some of them went bankrupt (e.g. Lehman Brothers); others were hardly shaken and received government financial aid. Large multinational banks are basically the main reasons of uncontrolled money multiplication. Fathi’s discovers (2010) indicate that large foreign banks usually win the competition with local banks. This usually leads to money outflow from the national economy and creates additional multiplication effect. Still it has to be accounted for that such banks will oppose every government decision that can diminish their role or decrease their profitability.

Conclusion

The article “How money is made” reveals fundamental economic issues in the world’s banking system. The existing means of monetary and fiscal control are inefficient to neutralize the financial disproportions caused by the defects of banking system. As the role of banking sector has been transformed in recent decades, new regulation instruments have to be developed. In our opinion, the ways to reform the banking sector presented by the authors are unevident and can have hidden consequences. The approach to solving this problem has to be more systematic and probably involve international summits on the highest levels of government officials.

References

Jackson, A., & Dyson, B. (2012). Economic Consequences of The Current System. In Modernising money: Why our monetary system is broken and how it can be fixed (p. 336). Positive Money.
Shostak, F. (2008, November 12). Can Friedman's Money Rule Stabilize the Economy? Retrieved January 29, 2015, from http://mises.org/library/can-friedmans-money-rule-stabilize-economy
Wilcox, J. (2011, September 1). The Increasing Importance of Credit Unions in Small Business Lending. Retrieved January 30, 2015, from https://www.sba.gov/sites/default/files/files/rs387tot.pdf
Fathi, B. (2010, November 10). Consequences of The Foreign Bank Implantation in Developing Countries and Its Impact on the Local Bank Efficiency: Theoretical Analysis and Empirical Tests on International Data. Retrieved January 30, 2015, from http://www.ccsenet.org/journal/index.php/ijef/article/download/7698/5961.