Thursday, 13 December 2018

Guiseppe Fontana and Malcolm Sawyer’s claim that full reserve advocates are “cranks”.


Guiseppe Fontana and Malcolm Sawyer (F&S) published a paper in the Cambridge Journal of Economics in 2016 entitled “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’”.

The paragraphs below are quick summary of reasons for thinking that if any group of people are cranks, its Fontana and Sawyer rather than advocates of full reserve banking (FRB).

I’ve actually dealt with Fontana & Sawyer’s ideas on FRB before on this blog (Google: Ralphonomics..Sawyer….full reserve). But I thought I’d do a proper paper in the new year and place it at the Munich Repec. The draft of that paper is proceeding nicely, but I thought I’d do a quick summary or “taster” of it meanwhile. Some of the points below are repetitions of points made in the latter blog articles and some are new. So here goes….

1. F&S accuse FRB advocates of “disregarding established theoretical literatures”.

Well now that’s an odd claim given that the main target of F&S’s criticisms are works authored by  Ben Dyson (founder of Positive Money) and co-authors, and the fact that Ben Dyson and Andrew Jackson wrote a book entitled “Modernising Money” which contains around 160 works in its list of references.

Being moderately well acquainted, if not intimately acquainted with 160 works on a particular topic, does not equal “disregarding established theoretical literatures” on that topic in my books. But what do I know?

2. One of the main arguments for full reserve was put by Joseph Huber in his work “Creating New Money” (p.31), which is that the right of commercial banks (aka money lenders) to simply create the money they lend out from thin air is a subsidy of those money lenders.

F&S however do not deal with Huber’s point. Plus Huber does not appear in F&S’s list of references. That rather raises the question as to exactly who is guilty of “disregarding established theoretical literatures”.

Another point which calls into question F&S’s grasp of “established theoretical literatures” is they seem to be unaware that several Nobel laureate economists have backed FRB, e.g. Milton Friedman, Maurice Allais and Merton Miller.

F&S do mention Friedman, but not his support for FRB. As for Miller and Allais, they are not mentioned at all.

3. F&S devote between a quarter and a third of their paper to criticising an idea put by some advocates of FRB, including Dyson & Co, namely what is sometimes called “overt money creation” (OMC).  That’s the idea that the state (i.e. government and central bank), when stimulus is needed, should simply create new base money and spend it (and/or cut taxes).

The problem with that criticism of FRB is that OMC is not an inherent characteristic of FRB: it’s simply for the form of stimulus favoured by SOME FRB advocates. To illustrate, Ben Bernanke and Adair Turner have made approving noises about OMC without at the same time advocating FRB. (For Bernanke, see passage starting “So, how could the legislature….” here)

Put another way, it would be perfectly possible to implement FRB while sticking with the existing methods of adjusting demand, like interest rate adjustments.

4. In their section 2 sub-section 4, F&S challenge the claim made by FRB advocates that “The new supply of bank loans creates an equal increase in the amount of outstanding debt in the economy.”

Well the first problem there is that it’s not just FRB advocates who make that claim: it’s a fairly widely accepted truism in economics that commercial bank created money “nets to nothing”. I.e. that for every dollar of such money there is a dollar of debt owed to a commercial bank.

For an example of an economist who is not an FRB advocate but who nevertheless supports the latter “nets to nothing” point, see articles entitled “Deficit spending 101 – Part 3” and “Money Multiplier and other Myths” by Bill Mitchell.

Thus it rather looks like F&S have not got to grips with the basic book-keeping entries that commercial banks make when granting loans.

5. F&S’s section 2, subsection 5 starts with the bizarre claim that “The current accounting of money as a debt–credit relationship is a relic of the past, when banknotes were backed by and redeemable for gold.”

Well that will be news to Bill Mitchell. It will also be news to the authors of numerous economics text books. For example Armen Alchain and William Allen in their book “University Economics” Ch29 say “A possibly surprising idea is that debt is money, provided the debt is a particular kind owed by a commercial bank….”.

6. Another indication that F&S do not understand the basic book-keeping entries done by central and commercial bank comes in this passage of theirs.

F&S start by quoting a passage from one FRB advocate, Herman Daly which is thus. “With 100% reserves every dollar loaned to a borrower would be a dollar previously saved by a time account depositor (and not available to the depositor during the period of the loan), thereby re-establishing the classical balance between abstinence and investment. With credit limited by saving (abstinence from consumption) there will be less lending and borrowing and it will be done more carefully.”

F&S then say…

“The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources. More importantly, the quote above indicates an inherently deflationary bias of FRB proposals, which is likely to produce recessions and financial instability.”

Well for anyone who understands how banks, commercial and central, actually work, the question as to where the latter “prior savings” come from is not too difficult. It is thus. Under present arrangements, governments engage in fiscal stimulus which consists of their borrowing $X, spending $X back into the private sector and giving bonds  worth $X to those they have borrowed from. The result is that private sector paper assets rise by $X. Hey presto: we have uncovered a source of “prior savings” (of a sort, anyway)!

Of course central banks can then create base money and buy back those bonds as they see fit (with a view to cutting interest rates and/or implementing QE). In that case, the latter bonds in the hands of the private sector are converted to dollars. But that just alters the nature of the “prior savings” a bit. But note that those dollars have been created WITHOUT a commercial bank making a loan, which according to F&S is impossible.

And moving on to OMC (where the state by-passes the latter bonds and simply creates money and spends it), if the state simply creates $X and spends it, then private sector “prior savings” rise by $X. And that’s just a slightly different way of creating those allegedly “impossible to create” dollars.

To summarise, that all makes a nonsense of F&S’s claim that “It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount.”

7. In section 3 (and in their abstract), F&S accuse FRB of having a “deflationary bias”.

Well it’s certainly true that lending and borrowing are more difficult under FRB, i.e. that interest rates would be higher. But any deflationary effect of that is easily countered by standard stimulatory measures, the one favoured by most FRB advocates being OMC. Magic: problem solved!

Moreover, as Milton Friedman rightly said, stimulus dollars cost nothing in real terms. So the solution to F&S’s alleged problem is costless.

Plus it is far from clear that the low interest rates that obtain at the time of writing are an unmixed blessing: they have resulted in record levels of debt and an unprecedented rise in house prices.

8. In their section 3, F&S make the revelatory pronouncement that “However, one of the main lessons from the work of Minsky and other Post Keynesian economists is that the demand for and supply of bank loans via the financing of the production of goods and services (investment) are an integral aspect of the operation of real-world economies.”

Good heavens – so bank loans are an essential part of 21st century economies? You learn something every day, don’t you?

I suspect we’d all be aware that bank loans are a good idea without any assistance from Minsky or Post Keynsian economists. I mean was no one aware that bank loans are good idea BEFORE Minsky and Post Keynsians appeared on the scene?

And another flaw in the latter F&S claim is that bank loans do not suddenly become impossible under FRB: all that happens (to repeat) is that interest rates rise a bit.

9. In their section 4, F&S claim that the difference between the transaction accounts and investment accounts under FRB is sufficiently small that banks would be able to turn investment accounts into what are effectively transaction accounts and thus get instant access money to fund loans.

Well that depends on exactly how the two types of accounts are structured. Clearly it would be POSSIBLE to have the difference between the two so small that there is effectively no difference.

On the other hand under the type of FRB system advocated by Laurence Kotlikoff, investment accounts simply take the form of unit trusts (mutual funds in US parlance), no different from the hundreds of unit trusts already available. Far as I know, no one has claimed that such unit trusts constitute instant access money. Certainly if anyone putting £X into a unit trust tried to claim they had a right to have their £X back when the trust performed poorly, they’d be laughed at.

10. F&S make the tired old claim that under FRB, the cost of transaction (aka instant access) accounts would rise for bank customers.

Well true: costs certainly would rise. But costs (aka bank charges) are only as low as they are at the moment because instant access accounts are subsidised by banks’ money lending activities. 

There is no particular merit in cross subsidisation: e.g. there is no particular merit in apple growers subsidising potato growers. Indeed, cross subsidisation is normally frowned on in economics.

11. A  final indication that F&S have little grasp of basic central bank and commercial bank transactions and book-keeping entries is that in their section 5 they say “Another controversial aspect of FRB proposals is the claimed relationship between the money creation process and budget decisions. Currently, the government decides the level of expenditure, and then the Treasury finances it through a loan from either commercial banks or the central bank.”

That quote should cause your jaw to drop, or to cause you to fall off your chair laughing.

First, governments do not finance expenditure, at least in the first instance, “from either commercial banks or the central bank”.  The reality is that government spending is financed mainly via tax.

Next, to the extent that income from tax is not enough to cover spending, governments resort to borrowing, though in some years there is no need to resort to borrowing because tax covers spending.

Next, where borrowing does take place, governments do not borrow primarily from “commercial banks or the central bank”. What they actually do is offer to borrow, with absolutely ANYONE being entitled lend, i.e. to purchase government bonds. The main purchasers (contrary to F&S’s suggestions) are pension funds, insurance companies and foreign entities of one sort or another (e.g. foreign governments). E.g. this source gives the proportion of government debt purchased by domestic commercial banks as just 4%.

https://www.justfacts.com/nationaldebt.asp
Next, government spending is not covered in the first instance by loans from central banks. To repeat, governments borrow from all and sundry. Relevant central banks may or may not subsequently create money and buy back some of the bonds issued by government (i.e. in effect, lend to governement ). Central banks will do that if they think interest rate cuts or QE is needed, but not otherwise.


Conclusion.

I do not wish to suggest that advocates of FRB never make mistakes. Indeed F&S do correctly identify one or two. But, to put it mildly, Fontana and Sawyer are not exactly up to speed on the subject of full reserve banking: if anyone is a “crank”, it’s Messers Fontana and Sawyer.

As for whether I’ll submit my paper to the Cambridge Journal of Economics, I certainly won’t. They appear to be more interested in pseudo intellectual wind and waffle than actually solving economic problems.









Guiseppe Fontana and Malcolm Sawyer’s claim that full reserve advocates are “cranks”.
Guiseppe Fontana and Malcolm Sawyer (F&S) published a paper in the Cambridge Journal of Economics in 2016 entitled “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’”.

The paragraphs below are quick summary of reasons for thinking that if any group of people are cranks, its Fontana and Sawyer rather than advocates of full reserve banking (FRB).

I’ve actually dealt with Fontana & Sawyer’s ideas on FRB before on this blog (Google: Ralphonomics..Sawyer….full reserve). But I thought I’d do a proper paper in the new year and place it at the Munich Repec. The draft of that paper is proceeding nicely, but I thought I’d do a quick summary or “taster” of it meanwhile. Some of the points below are repetitions of points made in the latter blog articles and some are new. So here goes….

1. F&S accuse FRB advocates of “disregarding established theoretical literatures”.

Well now that’s an odd claim given that the main target of F&S’s criticisms are works authored by  Ben Dyson (founder of Positive Money) and co-authors, and the fact that Ben Dyson and Andrew Jackson wrote a book entitled “Modernising Money” which contains around 160 works in its list of references.

Being moderately well acquainted, if not intimately acquainted with 160 works on a particular topic, does not equal “disregarding established theoretical literatures” on that topic in my books. But what do I know?

2. One of the main arguments for full reserve was put by Joseph Huber in his work “Creating New Money” (p.31), which is that the right of commercial banks (aka money lenders) to simply create the money they lend out from thin air is a subsidy of those money lenders.

F&S however do not deal with Huber’s point. Plus Huber does not appear in F&S’s list of references. That rather raises the question as to exactly who is guilty of “disregarding established theoretical literatures”.

Another point which calls into question F&S’s grasp of “established theoretical literatures” is they seem to be unaware that several Nobel laureate economists have backed FRB, e.g. Milton Friedman, Maurice Allais and Merton Miller.

F&S do mention Friedman, but not his support for FRB. As for Miller and Allais, they are not mentioned at all.

3. F&S devote between a quarter and a third of their paper to criticising an idea put by some advocates of FRB, including Dyson & Co, namely what is sometimes called “overt money creation” (OMC).  That’s the idea that the state (i.e. government and central bank), when stimulus is needed, should simply create new base money and spend it (and/or cut taxes).

The problem with that criticism of FRB is that OMC is not an inherent characteristic of FRB: it’s simply for the form of stimulus favoured by SOME FRB advocates. To illustrate, Ben Bernanke and Adair Turner have made approving noises about OMC without at the same time advocating FRB. (For Bernanke, see passage starting “So, how could the legislature….” here)

https://www.brookings.edu/blog/ben-bernanke/2016/04/11/what-tools-does-the-fed-have-left-part-3-helicopter-money/
Put another way, it would be perfectly possible to implement FRB while sticking with the existing methods of adjusting demand, like interest rate adjustments.

4. In their section 2 sub-section 4, F&S challenge the claim made by FRB advocates that “The new supply of bank loans creates an equal increase in the amount of outstanding debt in the economy.”

Well the first problem there is that it’s not just FRB advocates who make that claim: it’s a fairly widely accepted truism in economics that commercial bank created money “nets to nothing”. I.e. that for every dollar of such money there is a dollar of debt owed to a commercial bank.

For an example of an economist who is not an FRB advocate but who nevertheless supports the latter “nets to nothing” point, see articles entitled “Deficit spending 101 – Part 3” and “Money Multiplier and other Myths” by Bill Mitchell.

http://bilbo.economicoutlook.net/blog/?p=381
http://bilbo.economicoutlook.net/blog/?p=1623
Thus it rather looks like F&S have not got to grips with the basic book-keeping entries that commercial banks make when granting loans.

5. F&S’s section 2, subsection 5 starts with the bizarre claim that “The current accounting of money as a debt–credit relationship is a relic of the past, when banknotes were backed by and redeemable for gold.”

Well that will be news to Bill Mitchell. It will also be news to the authors of numerous economics text books. For example Armen Alchain and William Allen in their book “University Economics” Ch29 say “A possibly surprising idea is that debt is money, provided the debt is a particular kind owed by a commercial bank….”.

6. Another indication that F&S do not understand the basic book-keeping entries done by central and commercial bank comes in this passage of theirs.

F&S start by quoting a passage from one FRB advocate, Herman Daly which is thus. “With 100% reserves every dollar loaned to a borrower would be a dollar previously saved by a time account depositor (and not available to the depositor during the period of the loan), thereby re-establishing the classical balance between abstinence and investment. With credit limited by saving (abstinence from consumption) there will be less lending and borrowing and it will be done more carefully.”

F&S then say…

“The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources. More importantly, the quote above indicates an inherently deflationary bias of FRB proposals, which is likely to produce recessions and financial instability.”

Well for anyone who understands how banks, commercial and central, actually work, the question as to where the latter “prior savings” come from is not too difficult. It is thus. Under present arrangements, governments engage in fiscal stimulus which consists of their borrowing $X, spending $X back into the private sector and giving bonds  worth $X to those they have borrowed from. The result is that private sector paper assets rise by $X. Hey presto: we have uncovered a source of “prior savings” (of a sort, anyway)!

Of course central banks can then create base money and buy back those bonds as they see fit (with a view to cutting interest rates and/or implementing QE). In that case, the latter bonds in the hands of the private sector are converted to dollars. But that just alters the nature of the “prior savings” a bit. But note that those dollars have been created WITHOUT a commercial bank making a loan, which according to F&S is impossible.

And moving on to OMC (where the state by-passes the latter bonds and simply creates money and spends it), if the state simply creates $X and spends it, then private sector “prior savings” rise by $X. And that’s just a slightly different way of creating those allegedly “impossible to create” dollars.

To summarise, that all makes a nonsense of F&S’s claim that “It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount.”

7. In section 3 (and in their abstract), F&S accuse FRB of having a “deflationary bias”.

Well it’s certainly true that lending and borrowing are more difficult under FRB, i.e. that interest rates would be higher. But any deflationary effect of that is easily countered by standard stimulatory measures, the one favoured by most FRB advocates being OMC. Magic: problem solved!

Moreover, as Milton Friedman rightly said, stimulus dollars cost nothing in real terms. So the solution to F&S’s alleged problem is costless.

Plus it is far from clear that the low interest rates that obtain at the time of writing are an unmixed blessing: they have resulted in record levels of debt and an unprecedented rise in house prices.

8. In their section 3, F&S make the revelatory pronouncement that “However, one of the main lessons from the work of Minsky and other Post Keynesian economists is that the demand for and supply of bank loans via the financing of the production of goods and services (investment) are an integral aspect of the operation of real-world economies.”

Good heavens – so bank loans are an essential part of 21st century economies? You learn something every day, don’t you?

I suspect we’d all be aware that bank loans are a good idea without any assistance from Minsky or Post Keynsian economists. I mean was no one aware that bank loans are good idea BEFORE Minsky and Post Keynsians appeared on the scene?

And another flaw in the latter F&S claim is that bank loans do not suddenly become impossible under FRB: all that happens (to repeat) is that interest rates rise a bit.

9. In their section 4, F&S claim that the difference between the transaction accounts and investment accounts under FRB is sufficiently small that banks would be able to turn investment accounts into what are effectively transaction accounts and thus get instant access money to fund loans.

Well that depends on exactly how the two types of accounts are structured. Clearly it would be POSSIBLE to have the difference between the two so small that there is effectively no difference.

On the other hand under the type of FRB system advocated by Laurence Kotlikoff, investment accounts simply take the form of unit trusts (mutual funds in US parlance), no different from the hundreds of unit trusts already available. Far as I know, no one has claimed that such unit trusts constitute instant access money. Certainly if anyone putting £X into a unit trust tried to claim they had a right to have their £X back when the trust performed poorly, they’d be laughed at.

10. F&S make the tired old claim that under FRB, the cost of transaction (aka instant access) accounts would rise for bank customers.

Well true: costs certainly would rise. But costs (aka bank charges) are only as low as they are at the moment because instant access accounts are subsidised by banks’ money lending activities. 

There is no particular merit in cross subsidisation: e.g. there is no particular merit in apple growers subsidising potato growers. Indeed, cross subsidisation is normally frowned on in economics.

11. A  final indication that F&S have little grasp of basic central bank and commercial bank transactions and book-keeping entries is that in their section 5 they say “Another controversial aspect of FRB proposals is the claimed relationship between the money creation process and budget decisions. Currently, the government decides the level of expenditure, and then the Treasury finances it through a loan from either commercial banks or the central bank.”

That quote should cause your jaw to drop, or to cause you to fall off your chair laughing.

First, governments do not finance expenditure, at least in the first instance, “from either commercial banks or the central bank”.  The reality is that government spending is financed mainly via tax.

Next, to the extent that income from tax is not enough to cover spending, governments resort to borrowing, though in some years there is no need to resort to borrowing because tax covers spending.

Next, where borrowing does take place, governments do not borrow primarily from “commercial banks or the central bank”. What they actually do is offer to borrow, with absolutely ANYONE being entitled lend, i.e. to purchase government bonds. The main purchasers (contrary to F&S’s suggestions) are pension funds, insurance companies and foreign entities of one sort or another (e.g. foreign governments). E.g. this source gives the proportion of government debt purchased by domestic commercial banks as just 4%.

https://www.justfacts.com/nationaldebt.asp
Next, government spending is not covered in the first instance by loans from central banks. To repeat, governments borrow from all and sundry. Relevant central banks may or may not subsequently create money and buy back some of the bonds issued by government (i.e. in effect, lend to governement ). Central banks will do that if they think interest rate cuts or QE is needed, but not otherwise.


X Conclusion.

I do not wish to suggest that advocates of FRB never make mistakes. Indeed F&S do correctly identify one or two. But, to put it mildly, Fontana and Sawyer are not exactly up to speed on the subject of full reserve banking: if anyone is a “crank”, it’s Messers Fontana and Sawyer.

As for whether I’ll submit my paper to the Cambridge Journal of Economics, I certainly won’t. They appear to be more interested in pseudo intellectual wind and waffle than actually solving economic problems.









Saturday, 8 December 2018

Banking in the North East of England 200 years ago.




This is an interesting work: especially for me since I live in the area. I’ve only dipped into it and skimmed thru a few pages, but there are plenty of stories about “enterprising” bank related activities in the area long ago, some more honest than others. There are stories about coin clipping, highway robberies, forged bank notes, bank raids and so on, all of which took place on streets and in localities I know well. This makes the Wild West look positively tame.

This work is available here for free. Hat tip to my friend Gerard who lives in Newcastle and supports full reserve banking / Sovereign Money, and who alerted me to this work.

Friday, 7 December 2018

Richard Fuld tried to wheedle money out of Warren Buffet 24 hours before Lehmans collapsed.


I like this story on the above topic told by “J.Hughes” in the comments here. The story goes thus.
 

“Mr. Buffett tells a great story about Lehman Brothers. He was travelling in Canada, incognito, when, to his surprise, he got a phone call from Fuld while he was at his hotel. He was surprised that Lehman's CEO tracked him down but took the call.

He was less surprised when Fuld asked for money. He asked him to summarize the situation in a fax and send it to his hotel. When he returned later that evening there was no fax. He went to bed and found out the next day that that Lehman had declared bankruptcy.

About six months later his daughter was using his ancient flip cell and informed him there was an old message on it. It was Fuld asking for the number of the fax where he could be reached.

When asked if Lehman would have survived if he had gotten the message Mr. Buffett stated that he had reviewed their financials six months prior and concluded there was nothing to be done. He asked for the fax out of politeness.

If Mr. Buffett could see what was obvious six months in advance it is because he uses common sense and is leery of "geeks bearing charts".

It probably explains why he is not involved with GE.”


Friday, 30 November 2018

Great news: the US can help itself to limitless riches!


Stephanie Kelton and co-authors have a great new economic theory which is set out in this Huffington article. (Article title: “We can pay for a green new deal.”)

As they put it, “Here’s the good news: Anything that is technically feasible is financially affordable.” Well that is indeed good news. It’s even better “good news” than the “good news” that Jehova’s Witnesses try to broadcast.

Lets think about this.

It would be “technically feasible” for the US to have a UK style National Health Service. It would also be “technically feasible” for the US to build a nice six bedroom suburban house for every family in the US. Plus it would be “technically feasible” for the US to build 20 new aircraft carriers. So why doesn’t the great US of A go right ahead  and order up all those goodies and more? I’m baffled, as I’m sure you are (ho ho).

Sunday, 25 November 2018

Permanent zero interest rates.


The idea that the central bank base rate should be kept permanently at zero is very much an MMT idea. At least the two co-founders of MMT, Warren Mosler and Bill Mitchell both advocated the idea. Mosler’s exposition of the idea (co-authored by Matthew Forstater) is in a paper entitled “The Natural Rate of Interest is Zero”.

Bill Mitchell’s exposition is in an article entitled “There is no need to issue public debt”.

The idea that interest rates should be kept permanently at zero comes to the same thing as saying that neither government nor central bank should borrow anything: i.e. the only liability they should issue should be zero interest yielding base money.

I found Mosler and Forstater’s paper unnecessarily complicated – or perhaps it’s just me being stupid. Mitchell’s is more common sense and contains numerous good points. Mitchell criticises some of the defective arguments put for government borrowing, but he does not deal with all of those defective arguments.

Milton Friedman also advocated a zero government borrowing regime in a paper entitled “A monetary and fiscal framework for economic stability” (American economic review). But he does not go into much detail.

In short, I think the above three articles leave room for a bit of improvement, so I’ve just turned out my own attempt to argue for a permanent zero interest rate. That’s in a paper entitled “The arguments for a permanent zero interest rate.”

Friday, 23 November 2018

A simple reason to ban private money printing.


Under the existing bank system, a private / commercial bank, when granting a loan, does not need to get the relevant money from anywhere: it can simply produce the money from thin air. See Bank of England article, entitled “Creating Money in the Modern Economy” for confirmation of that point.

If you think that amounts to counterfeiting, then you’re not the first to think that: the French Nobel laureate economist Maurice Allais thought likewise (see article entitled “Credit Markets and Narrow Banking” by Ronnie Phillips).

There is however another reason for banning money creation by commercial banks which seems to have been largely or totally overlooked in the literature, which is as follows.

When a commercial / private bank creates new money and lends it to sundry borrowers, that money gets spent: after all, there’s not much point in borrowing money unless you spend it on something. For example when someone borrows money to buy a newly built house, their money ends up, at least initially, in the pockets of the construction workers, brick and cement manufacturers etc.

On the simplifying assumption that those workers and manufacturers simply bank their newly acquired money and don’t spend it, then in effect, those workers etc have granted a loan to the house purchaser. And those workers will earn interest on that money, especially if they put it into term accounts.

Of course in the real world the latter workers and manufacturers will spend their money fairly quickly, thus the money quickly gets dispersed among THOUSANDS of people. But the above point remains: those thousands of depositors have made a loan (via a bank) to the house purchaser. In short, those depositors are money lenders: they are into COMMERCE.


Should taxpayers back commercial transactions?

But wait a moment: there’s a widely accepted principle that it is not the job of taxpayers or governments to stand behind COMMERCIAL ventures. So when a bank goes bust, what’s the justification for taxpayers / governments rescuing depositors who have deposited money at banks so as to earn interest? There is NO JUSTIFICATION at all!!

Indeed, if you place money with a stock-broker or mutual fund (“unit trust” in UK parlance) or with any other investment intermediary and with a view to earning interest or dividends, there is no taxpayer / government insurance for you, and quite right. So what’s the justification for such insurance in the case of an investment intermediary that happens to call itself a “bank”? I can’t see one.

So if we’re going to to dispense with the latter glaring inconsistency or preferential treatment for banks, we need to have two distinct types of account. First, there need to be totally safe accounts for those who are not into commerce, i.e. who do not aim to have their money loaned out so as earn interest. After all, having a totally safe way of storing and transferring money is a basic human right, I suggest.

Second, there needs to be a category of bank account where depositors want their money loaned out by their bank so as to earn interest, but no taxpayer backed insurance is available.

And what d’yer know? That’s exactly what full reserve banking (aka “Sovereign Money”) has always consisted of!

But strange as it might seem, the above very simple reason for adopting full reserve does not seem to appear in the literature. And I am moderately well acquainted with the literature: I wrote a book on full reserve banking. At the very least, references to the above simple idea are rare, thus the idea needs to be given greater prominence.

So I’ve just published a paper which explains the above simple reason to back full reserve, and which argues for the idea to be given greater prominence. The title of the paper is “A new justification for full reserve banking?”