Virtual Consumer Mar-Apr 2013

Smart money

Virtual Consumer column from Ethical Consumer magazine Mar-Apr 2013

Is ethical finance possible? That was the theme of a discussion organised by Ethical Consumer and The Co-operative in Manchester recently. The Co-operative Bank says it has turned down £1.2bn worth of business on ethical grounds since it went ethical in 1992, which is pretty convincing. Someone in the audience posed an interesting question however: can a bank that uses fractional reserve banking (they all do) possibly be ethical? Fractional reserve banking gets some people very worked up because it looks like a gigantic con. When you deposit money with a bank it is allowed by law to lend most of it out again, just so long as it keeps a minimum reserve to pay people who demand their money back. This works fine so long as everyone doesn’t ask for their money back at the same time - like they did with Northern Rock. However if the money lent out is then deposited with another bank, then it too can lend most of it out. The same money can be lent out several times to different people. Money is created out of thin air. Money created this way has been steadily increasing over the years as the volume of financial transactions has increased. If the banks hold back on lending money out, as they have done recently, the air money disappears again, which is why governments have been desperately pumping their own air money back into the system.

Some people think this is immoral and want to return to the gold standard where every pound is backed by gold reserves. This limits the amount of money in circulation because there is only so much gold. As the economy expands, prices - and wages - have to go down. Most economists think this would be a mistake.

But what if we had a currency that wasn’t backed by anyone, that simply had the value that all its users agreed it should have? That is the promise of Bitcoin, a decentralised peer-to-peer digital currency. Bitcoin is an astonishingly clever system that allows you to send money in a simple email, in a way that is very very hard to cheat. It uses open source software that anyone can inspect, and there is a public shared record of all the transactions. The proponents of Bitcoin argue that it could do to the banks what file sharing did to the record companies: cut them out of the system.

As with other currencies, a Bitcoin has a value and can be exchanged for dollars or pounds at a rate that varies. Some people have pointed out that - since there is a (deliberate) mathematical limit to the total number of Bitcoin there can ever be (21 million), deflation is built in, just like the gold standard. Bitcoin enthusiasts modestly respond that it’s not designed to replace ordinary money, just offer an alternative. Meanwhile the exchange value of Bitcoin goes on increasing - currently trading at just under $15 with some $100m in circulation.