Money supply, banks and the economy

The banking sector is configured to be very conservative: not only in its origins, where people left their gold for a receipt, and received nothing in exchange except the feeling that their gold was secure and well kept, but also currently by all the government regulation. In the very same moment the public institutions are setting limits to the elasticity of the money, they are pushing all the industry to that edge.

Otherwise we would expect a more diverse range of strategies by the banks in their natural competition, i.e.: some more risk averse and less profitable for its customers, and others less risk averse and capable of offering better conditions* in response to the riskier situation for its customers –those different strategies as normal ways for individuals to compete in a society that Darwin describes holds perfectly for companies in a market with competition.

In that Darwinian scenario, the interest rate would be the price at which supply and demand meet each other (much tighter than current conditions), thus, a deflationary trend would be the standard situation for the economy, (e.g.: Smith describes it so some hundred of years ago.

The current conditions are pretty different. Maybe we are more intelligent and can obtain more profits for society and the banking sector thanks to ... Maths 2.0 or thanks to the backing support of the governments, or maybe .... It is only that we have too much money around, too cheap to borrow, and too low banking requirements.

That would better explain the great benefits of the banks ... and the skyscraper in Dubai.

The problem though, is that with this configuration, the banks shrink at the same time as the economy does. They are not neutral, but pro-cyclical, digging deeper into the economic pain. So, what should be changed in order to avoid messy situations like the current? What to change so that the financial sector doesn’t make the problems worse?

The thing that I am not an economist may help make clear I am not going to solve it, but the fact that I don't understand the subterfuges of the government’s agencies, should help to understand that there is something wrong when the system is that complicated.

How is possible that the government can do it all: borrow money (government per se), and lend it to himself (through the SEC? From my point of view, the government should only be able to borrow money (and that is another topic, in politics, but... somehow it should be limited by an international agency: it is too cheap for any current "x" government to borrow money, win elections today, and even get some dark money extra), and leave the bill for the next government...

A first step (the libertarian step) should drive us to sounder money, therefore we would avoid expensive excesses of the system (dot com bubble, Real Estate bubble, Dubai, etc. That solution sounds good to “gold bugs” and “austrians”.

A second step (the keynesian’s) could intend to have the government helping the economy. Of course not spending what they don’t have as it’s common strategy for ex post crisis situations, but spending the money (when the aggregate demand shrinks or when the economy enters recession) they have previously saved.

That strategy would be twofold beneficially:
Saving in the good times and getting that money out of the stream, helps to cool down the peace of the economy. Even better, you can diversify and invest it abroad (as SWFs already do).

Then, when the economy is overheated and starts to fall (recessions are natural in economics, and they even have a good side too), that money that has been saved by the government can be invested better: getting it back to work in infrastructures, in IT projects and hardware to improve the technology of the public workers, etc.* -> Bearing in mind that it is a recession, and the government will face higher spending (e.g. unemployment subsidies) and lower incomes (e.g. less taxes from consumer spending, from companies profits, etc.

Regarding the financial regulation, William Wild has a good paper about the topic, advocating for a high-cost, low-return form of capital.link.
... that may get the banks out of the stock markets (a truly conservative banking strategy is not able to cope with the equity risk premium of the stock markets.