A Forex View From Afar

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Government Private banks

Written by A Forex View From Afar on Wednesday, October 15, 2008

With the recent developments in the financial markets, it seems more and more banks will become nothing more than a government subsidiary, while the others left “free” will have the government as one of the biggest shareholders.

In the short term, this does not have major implications. Eventually, it will help banks build up their balance sheets and create a desire to lend to each other, at least this is what is being said right now. However, in the long run, the effects of having the government deep inside the shareholders structure, is not such a good thing.

A company’s job is to maximize its profits, which does not match too much to the government’s task list. The government would rather aim at full employment and a strong housing market.

Full employment means banks are likely to increase the number of workers, or simply not fire anyone. However, this would put additional pressure on the bank’s balance sheets. Furthermore, having control on the financial system, the government cannot only influence the bank’s decision, but the business cycles too.

The central banks control the money supply throughout the financial system; having the government owning an important part of it will end up with a duality that is not too healthy in the long run. If for example the central bank would want to raise the interest rates (choking growth), while the government would not want this to happen, it will just “suggest” that banks lend more. This way, the government will ensure a large number of people will keep their jobs, even if it is not the healthiest thing to do.

A second consequence is that the government will try to do everything possible to keep the housing market in an upward trend. Banks would be encouraged to lend to (no income) Average Joe, so he can afford a new house just like his neighbor. This is exactly what led to today’s credit crunch, and probably would be even stronger because banks (which are half state owned) will officially know that they will not be let to fail.

To put it more simply, history shows an impressive number of times that the government is one of the worst decision-makers when it comes to companies; Just think of the huge Federal Deficit, and all the money that is spent world-wide on bad state owned investments and initiatives. As a short period decision (referring to a few years), state owned banks are a good decision, but the government should also know when to pack his things in and make room for the capitalism, or the children of the free-markets.

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