A Golden Opportunity:
How a planned revamp of the BOT could help lead Thailand out of the economic crisis.

By Jeff Powell *)

On August 27, an article appeared in The Nation outlining MR Chatu Mongkol's proposal to remodel the Bank of Thailand (BOT) after the US Federal Reserve, or 'Fed'. This, followed theas recommendationsed byof a commission headed by the Chairman of the US investment bank, Goldman Sachs. The proposal, to be tabled in October, is, presumably, an attempt to 'professionalise' the BOT and prevent a re-occurrence of the central bank bungling which featured so prominently during the July 1997 collapse of the baht. Most people probably believe that such decisions should be left to experts in the field, namely economists, bankers and finance officials. This could not be further from the truth.

If gone ahead with, this decision will mark Thailand's entry into the ranks of permanently indebted governments whose social and political agenda are determined by bankers rather than the democratic process. For this reason, it is critical that Thai citizens have a greater understanding of the issues involved.

The 'Fed'

It is probably worthwhile to provide some background information regarding the structure of the 'Fed'. It is an institution whose agenda is dictated by commercial banks..

Power in the Fed is divided into two levels. The twelve regional banks are privately owned by member commercial banks who chose its officers. Regional banks are allowed to make nominal profits and to distribute a dividend to member banks. In contrast, the Washington Fed is owned by a branch of the federal government. The seven members of its Board of Governors are appointed by the President with the consent of Senate. Usually, nominees to the Board of Governors are commercial bankers. Virtually all of the profits of the Fed are paid to the US Treasury, for eventual use by the US government.

Two other organisations play a key role in the establishment and execution of Fed policy--the Federal Open Market Committee (FOMC) and the Federal Advisory Council (FAC). The FOMC is comprised of the seven members of the Board of Governors, the President of the New York Regional Bank and the presidents of four of the other eleven regional banks chosen on a rotating basis. Each of the regional banks chooses one member to sit on the twelve member FAC. These representatives of the regional banks are almost exclusively former executives of the larger commercial banks.

The Fed has been variously described as an 'autonomous branch of government', a 'semi-autonomous agency of government' and 'independent within government, not independent of government'. Two statements are certain--the Fed is autonomous of the influence of farmers, entrepreneurs, labour and debtors; while it is not autonomous of the agenda of the banking industry.

Fiscal policy is, quite rightly, determined by the elected officials of Congress. Monetary policy, (the power to determine the size of the money supply, interest rate levels and financing of government expenditure), however, is in the hands of administrators who are strongly biased in favour of creditors. To be effective, fiscal and monetary policies must be co-ordinated. Compare this with the conflicting aims of an American electorate who want job creation and US Federal Reserve Chairperson, Alan Greenspan's obsession with zero inflation.

Why is control of the money supply so crucial?

To answer this question, we must first look at the meaning of money. Most people are firm in their belief that the word money refers to the bills and coins that are issued by the government. They are largely mistaken.

Here, a distinction should be made between money and legal tender. On Thai bills are printed the words 'this bank note is money which can be used to pay debts following the law'. This means that these pieces of paper must be accepted for the repayment of all debts and are, therefore, legal tender. In contrast, cheques, credit cards and transfers may be rejected by the creditor. Though not legal tender, these secondary forms of money serve the purpose of exchange in most of the transactions that occur every day. In fact, less than 10% of the total US money supply ("M3", as defined by economists) in the US is currency held by the public. The remaining 90% is created by commercial banks. In Thailand, **less than 8% of the total money supply is currency held by the public, down from over 12% only a decade ago. The remainder--over 90% of the money supply--is created by commercial banks.

This last statement may be surprising to some. How do commercial banks create money? According to eminent economist, John Kenneth Galbraith, "the process by which banks create money is so simple that the mind is repelled."

There is a long-held misunderstanding that, first, individuals make deposits in banks and that, subsequently, banks loan out this money to borrowers. This is incorrect. Banks create money as they create deposits in the process of making loans. After subjecting debtors to the prerequisite credit check (or not, as the case may be), the bank loan officer writes a balance in a computer ledger. The customer may then draw upon this amount to pay for their expenses, whereupon the money becomes a deposit in another individual's account. Since the money supply is defined as currency held by the public plus bank deposits, the money supply has now been increased by the amount of the loan. For this nothing, banks collect interest. (More space would be required to explain how this absurdity phenomenon came about. See John Kenneth Galbraith's very lucid Money: Whence it Came, Where it Went.)

To repeat, overapproximately 90% of the US money supply is created out of thin air by commercial banks--for this privilege, banks collect interest on loans to individuals, businesses and government. In the last respect, it is crucial to rememberpoint out that the overwhelming burden of US government spends more on interest payments on the US government--leading to calls for cutbacks in all areas ofon its debt than it does on all social services combined. In turn, successive American administrations have cut education and health care expenditures in order to pay back interest owed to commercial banks (both domestic and foreign). In effect, this amounts to an enormous transfer of wealth from US taxpayers to the holders of debt and equity instruments of the commercial banks.

Is this fair?


Can this be changed?

It certainly has not always been this way. The percentage of the money supply created by commercial banks has risen steadily since the turn of the century when the US government issued 25% of the money supply compared to less than 10% today.

To understand why this has happened, it is necessary to explain the concept of fractional reserve banking. If, for example, according to government law, banks must hold $10 in reserve for every $100 in deposits, the reserve rate is 10%. Reserve requirements serve two purposes: they provide security in the case of bank runs, such as those that occurred at the Bangkok Bank of Commerce on August 13 and 14 of this year; secondly, they allow the Fed to influence (not control) the money supply. If the Fed lowers the reserve requirement (say, from 10% to 8%), this allows banks to make more loans, thereby increasing the money supply as explained above. If the Fed raises reserve requirements, the opposite effect is achieved. Since 1940, when memories of the Great Depression were still fresh in policymakers' minds, the Fed has lowered the reserve requirement from 30% to 6.5% in 1970 to 2.5% today. This means that approximately 1/40 of total deposits are backed by reserves. Not very good odds in the increasingly likely scenario of a global financial meltdown. A similar reduction in reserve requirements has occurred in Thailand; from 25% shortly after the Bank of Thailand's establishment in 1942, to 10% in the 50's and 60's, to current levels of 7%.

To review, despite the considerably smaller role taken by government in the creation of money, the entire money supply has increased exponentially since the Second World War due to the relaxing of reserve requirements. In the last 30 years with pressure to decrease corporate taxes, the US government has had to turn increasingly to loans from commercial banks, both domestic and foreign. This, far more than the rhetoric about wasteful government spending, is responsible for the inability of the US government to fulfil its promises on issues such as welfare reform.

With MR Chatu Mongol's proposal to reform the BOT comes the opportunity to hand greater control over the money supply to all the Thai people--farmers, entrepreneurs, and labourers--and not just the banking community and those who benefit from their profitable operation. With Thai banks on their backs, now is the ideal time to assert greater democratic control.

What is needed is for the government to take greater control of the money supply by either printing more money or crediting government accounts. This could be done in gradual stages. Surely, remarks the sceptic, the subsequent increase in the money supply would be inflationary. But, unlike other proposals to simply crank up the printing presses, this legislation would be introduced hand in hand with a corresponding increase in reserve requirements. The total amount of money created by the commercial banks would decrease by the same amount as government created money is increased. Note that during a credit crunch such as the one we are currently experiencing, this would put more power to 'spend the economy back to health' in the hands of the government, rather than leaving it completely in the hands of profit-maximising, risk-averse bankers.

The sceptic would then continue, even if such a policy would not be inflationary, you simply can not trust politicians with greater control of the money supply and, therefore, resource allocation. To this, we could respond in two ways. The first, and obvious response, is that by rejecting the right of democratically elected officials (as flawed as the democratic system may be) to make such decisions, you are unconsciously putting unwarranted stock in unelected profiteers--such as those at the Bangkok Bank of Commerce, (or those at finance companies such as Finance One, General Finance and SITCA)--to look after social interests. Certainly, precautions would be needed to prevent pre-election increases in the money supply.

Secondly, it could be arranged that the increase in government created money be partially (or completely) channelled through commercial banks. These banks would pay interest to the government for the privilege of holding liquid funds rather than the other way around. Bank pProfits would come from the difference between this rate and the rate paid by bank debtors. These profits would compensate the banks for playing their vital role of allocating resources in free markets.

Stop and think for a moment. It is insanity for a national government to pay interest to banks, both domestic and foreign, to borrow the funds it needs whenwhich it has theat power to create itself. In the boom years, Thailand's government consistently ran budget surpluses. This is about to change. Interest will have to be paid on 17.2 billion US$ of IMF funds, World Bank 'social funds', and a 300 billion baht bond issue to bail out the banking sector. Interest costs associated with bank restructuring operations alone are to hit 4% of Gross Domestic Product (following optimistic projections).

For the next decade, policy makers and economists will scream the dangers of the 'debt monster'. They will successfully convince the government that expenditures on social programmes must be curtailed. This will come at a time when the ranks of the unemployed will swell to previously unheard-of levels and when emerging efforts to protect the environment will be scrapped as Klaus Topfer, Executive Director of the UN Environmental Programme confirmed last week. In essence, this will come at a time when, instead of belt-tightening, a government should be asserting its sovereign right to look after its citizens.

Following the lead of the Fed will ensure that Thailand will become a vassal of the feudal banking lords, in step with the United States, Canada, Australia, New Zealand and most of Europe before it. There is, however, an alternative to servitude or default. It is imperative that the government reclaim greater control over the creation of money. The Bank of Thailand has a history of resisting predatory foreign influence--first the British and then the Japanese. We urge MR Chatu Mongkol to create a BOT which responds to the needs of all Thai citizens and not just the globalits banking elite.