Home > Uncategorized > Is the EuroArea marching towards a system of private ‘free’ banking?

Is the EuroArea marching towards a system of private ‘free’ banking?


It looks as if the Euro Area is, unintendedly, changing into an ‘Austrian’ style  ‘free banking’ area where every bank issues its own money, the central bank is no lender of last resort anymore, government money does not exist  and exchange rates between bank moneys are variable. A Banco Santander Euro will be another Euro than a Deutsche bank Euro. Yanis Farouvakis gives us a taste of how this works:

“Greece today (and Cyprus before it) offers a case study of how capital controls bifurcate a currency and distort business incentives. The process is straightforward. Once euro deposits are imprisoned within a national banking system, the currency essentially splits in two: bank euros (BE) and paper, or free, euros (FE). Suddenly, an informal exchange rate between the two currencies emerges.”


Why do I think this trend might gain strength?


  1. A) At this moment there is a lobby to abolish cash. Not just the 500,– Euro note but essentially all cash. Cash is money issued by the government. The government promises that Euros created by whatever money creating bank (the so called MFI’s) has a guaranteed 1:1 exchange rate with cash. This ensures that Euro’s created by Banco Santander have the same nominal value as Euro’s created by Deutsche Bank or RABO. Without cash this promise is empty and there is no guarantee anymore that all bank moneys have equal value.


  1. B) Bank moneys are of course indistinguishable. Nobody can tell if an electronic deposit Euro in a bank has been issued by RABO or Banco Santander. However, there is a lobby (not the same as the first one), led by mister Schauble, minister of finance of Germany, to roll back the ‘whatever it takes’ promise of Mario Draghi. The ‘whatever it takes’ promise of ensures that all government debt (except Greek debts, which are exempted) is nominally risk free. Which, as banks own quite a bit of these debts, means that all banks can use it as high quality collateral. Schauble wants to end this. This might, when Spain has to impose a haircut on its debt, hamper the possibilities of Banco Santander (a Spanish bank) to issue money to, for instance, provide short term financing for commercial transactions. In extreme cases (which, as the attempts of mister Schauble might trigger bank runs, might become a lot less extreme) this might lead to the situation described by Farouvakis.


  1. C) There is also a distinct and strong lobby to bail in bank creditors instead of citizens when banks run into trouble: no more ‘Irelands’.


The lobbies mentioned are distinct movements. I, for example, am a very minor part of the last lobby but not of the first two. But the point: if all lobby’s succeed banks are on their own in a cashless world, issuing their own distinct electronic money, which will or will not be accepted (and as is well known, the change from ‘will’ to ‘will not’ is in reality never a gradual one). It will be essentially a system of free banking. And banks will possibly hoard not gold but billions of physical dollars, guaranteeing the USA a whopping seigniorage profit

  1. Peretz
    February 16, 2016 at 9:37 am

    I think you are quite right. That means we have to change the U.E system and break (gently) the treatises.

  2. February 16, 2016 at 11:03 am

    I can’t see anyone benefits from such a change except the banks and the reference cash currency (the real money). So why do it?

    • merijnknibbe
      February 16, 2016 at 11:05 am

      Good question. But it seems to be happening…

    • February 17, 2016 at 1:13 am

      Probably to destroy the idea of sovereign money and fully privatise it. So that money can’t be a policy instrument and only reflects market outcomes.

      • Otto Barten
        February 22, 2016 at 12:57 pm

        It sounds a lot more cumbersome and inefficient than the original separate sovereign currencies

  3. visitor
    February 16, 2016 at 12:40 pm

    “Greece today (and Cyprus before it) offers a case study of how capital controls bifurcate a currency and distort business incentives. […] Suddenly, an informal exchange rate between the two currencies emerges.”

    This is something I had been wondering ever since the resolution of the Cyprus crisis. But rather than a value discrepancy between cash and bank accounts, I was suspecting that Cypriot exporters (or tourist enterprises) might grant discounts to those foreign customers who paid them in an account at a foreign bank (e.g. a German bank outside Cyprus) instead of a Cypriot bank. The discount would provide a figure for the “exchange rate” between European € and Cypriot € — correlated to the lack of liquidity of Cypriot account money.

    I was never able to find out information to confirm or disprove my hunch.

    As for returning to a free banking system: wasn’t it the situation in many countries in the 19th century, and with pretty dismal results (balkanisation of currency, loss of confidence in banks, bank runs, plenty of difficulties in commerce because of friction due to the lack of a uniform currency)? Wouldn’t the abolition of cash lead to the informal adoption of a foreign currency (dollar, yuan, whatever) to replace € banknotes?

  4. February 17, 2016 at 12:16 am

    Yes, discrete currencies started to exist as soon as different national banks faced different risk premia. These manifest in the slow bank run, from south to north, preceding the SYRIZA election and the dramatic events in the summer of 2015. Risk premia and discrete currencies are synonymous. How were they possible? Because tax regulations, inconvenience, and norms acted as soft capital controls deterring all EU citizens from banking in Germany. Given the risk premia, de-facto different exchange rates and officially pegged 1:1 convertibility the slow bank run was an inevitable arbitrage effect.

    Europe, not the US, is moving towards the free libertarian model where each bank, not each sovereign issues its currency and has to float that currency in an exchange. The key question dividing Europe is whether money is a political quantity that the sovereign can compel to flow and guarantee solvency at the expense of inflation, or it’s an accounting quantity subject to bankruptcy. Schauble says bankruptcy is good for you, for some reason. Draghi for now and reasonable people everywhere accept the benefits of inflationary circulation.

    If the transition from sovereign to private bank currencies became advanced it would be chaotic or at least veering on libertarian dystopia. Every bank would have a floating rate, like US dollars around 1900 before the Fed. Worse, savers would bear the whole risk of each bank’s currency (liabilities) exceeding investment collateral and there would be wild swings in risk perception and constant bank runs. Or “bank swarms” as savers move deposits to perceived safer banks en masse, instantly and electronically.

    We can’t expose risk to bondholders (depositors) while maintaining the illusion of parity and thus riskless money. Privatised floating money would work if the assumption of “riskless” is dropped and money is allowed to vary in value by a lot, including aggregate swings not just inter-bank exchange fluctuations. Money in effect becomes share stock on each MFI’s collateral, turning banks into giant funds as per Paul Wooley. Well it’s a systematically sound proposal. Would it be stable enough and acceptable to people in practice? I don’t know.

    Incidentally while visiting Holland last year I thought it vulgar that bakeries and supermarkets would refuse Euro currency. Cards only. It’s a Euro, how can the businesses choose not to accept it? The whole point of sovereign currency is that traders are compelled to accept it.

    Also last year I asked Yannis in his blog before he became minister what Greece would look like with hard Euro currency and soft GR-Euro or drachma bank accounts running in parallel. A sort of dollar/peso system, certainly easy for the ATMs to handle. “Terrible”, he said. In the light of later events, I’m not sure it’s that terrible or different from what actually happened.

    • February 18, 2016 at 12:13 am

      Oops, wrong reference, not Wooley. Laurence Kotlikoff’s Limited Purpose Banking. He advocates a Chicago style plan where banks become funds that the bondholders own.

  5. Douwe Meijer
    February 22, 2016 at 10:42 pm

    Worrying. We must leave the fractional banking system anyway and move towards a full reserve banking system. The ECB should be and stay monopolist of money creation. And there should be free non debt-based money in circulation. Private banks are the source of instability and crises.

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