Full reserve won’t reduce poverty or help solve environmental problems.

I  favour full reserve banking, but I’m not under the illusion suffered by what I think are the more naïve and evangelical full reserve advocates, namely that full reserve will solve every other problem on planet Earth, including environmental problems, poverty, the alleged national debt problem, the alleged personal debt problem. 

The national debt.

Full reserve has no bearing on the alleged national debt problem, because that debt is easily reduced at any time. Don’t know how? Try this.

First, have the central bank print money and buy back the debt (exactly what several countries have been doing big time in recent years under the guise of QE).

Second, to the extent that the latter QE type policy is too inflationary, raise taxes (and/or cut public spending) by enough to give a deflationary effect that cancels out the inflationary effect of QE, which frankly isn’t of astronomic proportions. I.e. if the recent and massive amounts of QE have had a huge stimulatory or inflationary effect, where is the evidence? The large numbers of people currently trying to find work would  doubtless also like to know.

National debts exist, amongst other reasons, because of a desire by the private sector (pension funds in particular) to hold paper assets.  That desire won’t vanish just because we convert from fractional to full reserve.Indeed, there are currently concerns about a SHORTAGE of quality paper assets. Also of some relevance, see David Beckworth’s five facts here.

Put another way, it is the easiest thing in the world for a country that issues its own currency to substantially reduce its national debt. But all that happens is that former debt holders end up holding monetary base. And the latter is also (at least nominally) a debt owed by government to those “holders”. Or put that another way, if a country has a national debt that is of such a size that creditors demand any significant rate of interest, such a country can simply buy back enough of the debt until the interest on that debt nears zero, which makes the debt little different in nature to monetary base.

Now that amounts pretty much to saying that national debts are pointless and that the only liability issued by the government / central bank machine should be MONEY, or monetary base to be exact. And what do you know? That’s exactly what Milton Friedman advocated in a paper entitled “A Monetary and Fiscal Framework for Economic Stability”. He said:

“Under the proposal, government expenditures would be financed entirely by either tax revenues or the creation of money, that is, the issue of non-interest-bearing securities. Government would not issue interest-bearing securities to the public….”

Another authority on these matters, Warren Mosler, said much the same. He said:

“I would cease all issuance of Treasury securities. Instead any deficit spending would accumulate as excess reserve balances at the Fed. No public purpose is served by the issuance of Treasury securities….”

And if you want some more detailed arguments (put by me) as to why national debts are pointless, see here.

Personal debts.

Re the idea that fractional reserve increases the amount of personal debt, I largely demolished that idea here. However, a further point needs making in that connection, as follows.

Borrowing and lending takes place for the very simple reason that the cash that households, firms and other entities have at their disposal does not tie up with the cash REQUIREMENTS of those entities. E.g. some people have surplus cash, while others want cash for buying a house. Some people want cash to start up or expand a business, but don’t have the cash to hand.

Now that mismatch between cash available and cash required or wanted is not affected one iota by a switch from fractional to full reserve. Thus a switch to full reserve will not greatly change the total amount of borrowing and lending.

Interest rates.

There is however, one route via which full reserve reduces personal debts which is thus.

Assuming the full reserve system implemented is something along the lines advocated by Kotlikoff or Werner, it involves lenders taking a hit where relevant loans go bad (instead of banks or taxpayers taking a hit). And lenders will want extra interest for taking that risk: i.e. interest rates will rise.

The effect of that on its own would be deflationary, thus government would need to create and spend extra monetary base into the economy, which in turn would mean debtors and creditors having a bigger stock of cash. And that in turn would bring a reduced need for borrowing.

So on balance, does full reserve bring instant nirvana for debtors? Hardly. They’d borrow less, but they’d pay more interest on whatever they did borrow. And those two effects might well cancel out. I.e. debtors might continue paying exactly the same total amount of interest. And it’s the affordability of the interest that is one of the main problems for debtors.

Environmental matters.

The full versus fractional reserve argument is entirely separate from the question as to how to deal with environmental problems. To illustrate, we could perfectly well carry on with the existing fractional reserve banking system and implement substantial annual increases in the price of carbon based fuels starting tomorrow. Plus we could spend twice as much on solar, wind and tidal power generation starting next week. There is nothing about fractional reserve banking that stops us implementing the latter sort of environmental measures.