Virg Bernero, the mayor of Lansing, Michigan, just won the Democratic nomination for governor of his state, making a state-owned Bank of Michigan a real possibility. Bernero is one of at least a dozen candidates promoting that solution to the states' economic woes. It is an innovative idea, with little precedent in the United States. North Dakota, currently the only state owning its own bank, also happens to be the only state sporting a budget surplus, and it has the lowest unemployment rate in the country; but skeptics can write these achievements off to coincidence. More data is needed, and fortunately other precedents are available from other countries.
One of the most dramatic is the Commonwealth Bank of Australia, which operated successfully as a government-owned bank for most of the 20th century, until it was privatized in the 1990s. The Commonwealth Bank's creative founders demonstrated that a government-backed bank can make loans without capital. Denison Miller, the Bank's first Governor, was fond of saying that the Bank did not need capital because "it is backed by the entire wealth and credit of the whole of Australia."
The Commonwealth Bank's accomplishments were particularly remarkable considering that for its first eight years, from 1912 to 1920, it did not have the power to issue the national currency --unlike the U.S. Federal Reserve, which acquired that power in 1913. The Commonwealth Bank was thus in the same position as a state of the United States or a member country of the European Union (think Greece), which also lack the power to issue their own currencies. Operating without that power and without startup capital, the Commonwealth Bank funded both massive infrastructure projects and the country's participation in World War I. According to David Kidd, writing in a 2001 article titled "How Money Is Created in Australia":
"Australia's own government-established Commonwealth Bank achieved some impressive successes while it was "the peoples' bank', before being crippled by later government decisions and eventually sold. At a time when private banks were demanding 6% interest for loans, the Commonwealth Bank financed Australia's first world war effort from 1914 to 1919 with a loan of $700,000,000 at an interest rate of a fraction of 1%, thus saving Australians some $12 million in bank charges. In 1916 it made funds available in London to purchase 15 cargo steamers to support Australia's growing export trade. Until 1924 the benefits conferred upon the people of Australia by their Bank flowed steadily on. It financed jam and fruit pools to the extent of $3 million, it found $8 million for Australian homes, while to local government bodies, for construction of roads, tramways, harbours, gasworks, electric power plants, etc., it lent $18.72 million. It paid $6.194 million to the Commonwealth Government between December, 1920 and June, 1923 - the profits of its Note Issue Department - while by 1924 it had made on its other business a profit of $9 million, available for redemption of debt. The bank's independently-minded Governor, Sir Denison Miller, used the bank's credit power after the First World War to save Australians from the depression conditions being imposed in other countries. . . . By 1931 amalgamations with other banks made the Commonwealth Bank the largest savings institution in Australia, capturing 60% of the nation's savings."Harnessing the Secret Power of Banking for the Public Good
The Commonwealth Bank was able to achieve so much with so little because its first Governor, Denison Miller, and its first and most ardent proponent, King O'Malley, had both been bankers themselves and knew the secret of banking: that banks create the "money" they lend simply by writing accounting entries into the deposit accounts of borrowers.
This banking secret was confirmed by a number of early banking insiders. In a 1998 paper titled "Manufacturing Money," Australian economist Mike Mansfield quoted the Rt. Hon. Reginald McKenna, former Chancellor of the Exchequer, who told shareholders of the Midland Bank on January 25, 1924, "I am afraid the ordinary citizen will not like to be told that the banks can, and do, create and destroy money. The amount of money in existence varies only with the action of the banks in increasing or decreasing deposits and bank purchases. We know how this is effected. Every loan, overdraft or bank purchase creates a deposit, and every repayment of a loan, overdraft or bank sale destroys a deposit."
Dr. Coombs, former Governor of the Reserve Bank of Australia, said in an address at Queensland University on September 15, 1954, "[W]hen money is lent by a bank it passes into the hands of the person who borrows it without anybody having less. Whenever a bank lends money there is therefore, an increase in the total amount of money available."
Ralph Hawtrey, Assistant Under Secretary to the British Treasury in the 1930s, wrote in Trade Depression and the Way Out, "When a bank lends, it creates money out of nothing." In his book The Art of Central Banking, Hawtrey expanded on this statement, writing, "When a bank lends, it creates credit. Against the advance which it enters amongst its assets, there is a deposit entered in its liabilities. But other lenders have not the mystical power of creating the means of payment out of nothing. What they lend must be money that they have acquired through their economic activities."
Banks can do what no one else can: "create the means of payment out of nothing." The Commonwealth Bank's far-sighted founders harnessed this guarded banking secret to serve the public interest.The Bank Collapse of 1893 Spawns a New Public Banking Model
The Commonwealth Bank was founded under conditions like those prevailing today: the country had just suffered a massive banking collapse. In the 1890s, however, there was no FDIC insurance, no social security, no unemployment insurance to soften the blow. People who thought they were well off suddenly found they had nothing. They could not withdraw their funds, write checks on their accounts, or sell their products or their homes, since there was no money with which to buy them. Desperate people were leaping from bridges or throwing themselves in front of trains. Something had to be done.
The response of the Labor government was to pass a bill in 1911 which included a provision for a publicly-owned bank that would be backed by the assets of the government. In a rare move for the time, the bank was to have both savings and general bank business. It was also the first bank in Australia to receive a federal government guarantee.
Jack Lang was Australia's Treasurer in the Labor government of 1920-21 and Premier of New South Wales during the Great Depression. A controversial figure, he was relieved of his duties after he repudiated loans owed to the London bankers. In The Great Bust: The Depression of the Thirties (McNamara's Books, Katoomba, 1962), Lang described the Commonwealth Bank's triumphs and tribulations in revealing detail. He wrote:
"The Labor Party decided that a National Bank, backed with the assets of the Government, would not fail in times of financial stress. It also realised that such a bank would be a guarantee that money would be found for home building and other needs. After the collapse of the building societies, there was a great scarcity of money for such purposes.
". . . Chief advocate of the cause of a Commonwealth Bank was King O'Malley, a colorful Canadian-American . . . Before coming to Australia, he had worked in a small New York bank, owned by an uncle. . . . He had been much impressed by the way that his uncle had created credit. A bank could create the credit, and at the same time manufacture the debit to balance it. That was the big discovery of O'Malley's banking career. A born showman, he itched to try it out on a grand scale. He started his political career in South Australia by advocating a State Commercial Bank. In 1901 he went into the first Federal Parliament as a one-man pressure group to establish a Commonwealth Bank, and joined the Labor Party for that purpose."
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