Two IMF authors,
Benes and Kumhof, set out their ideas on the changes to the consolidated
balance sheet of commercial banks that would take place on converting to full
reserve banking.
I expressed
reservations about their ideas here. Now for something more positive: some
ideas as to what the balance sheet changes WOULD look like.
A brief
introduction to full reserve.
Full reserve
is a system under which commercial banks do not “lend money into existence” as
the saying goes. The only source of money is the central bank. Commercial banks
are then free to continue borrowing and lending as under fractional reserve,
but they cannot lend money they haven’t got (i.e. they just lend money they’ve
obtained from depositors, shareholders or bondholders).
If
depositors want their money to be 100% safe, such money cannot be put at risk
by being loaned on or invested by a bank. And if such money is not loaned on,
no money creation takes place. Also no interest is paid on such money.
In contrast,
and where depositors want interest, they are acting in a commercial fashion,
and there is no obligation on taxpayers to underwrite that commercial activity.
That is, depositors bear any losses due to poor performance by the underlying
loans or investments. Thus in effect such depositors become shareholders rather
than depositors.
For a more
detailed explanation of full reserve, see this work by Richard Werner and
co-authors.
Werner &
Co suggest that depositors who want their money invested put their money into “investment
accounts” at their bank.
In contrast,
Laurence Kotlikoff, another advocate of full reserve advocates that those who
want their money investing put their money into unit trusts (“mutual funds” in
US parlance).
Effectively there
is not much difference between those two above ways of implementing full
reserve. Thus I’ll refer to “investment accounts” and “unit trusts”
interchangeably.
Also, note
that the investment accounts / unit trusts are essentially different entities
from safe accounts. To illustrate, if ALL THE MONEY put into investment
accounts / unit trusts for a particular bank is lost, that shouldn’t have any
effect on “safe” money.
On their
page 64, Benes & Kumhoff (B&K) show a consolidated balance sheet which has
assets and liabilities equal to 200% of GDP. Let’s stick with that 200% figure.
(All numbers henceforth are percentages of GDP).
Next, let’s
ignore bank shareholders and bondholders since they form a relatively small
part of bank balance sheets (and actually form a small part of the balance
sheets shown by B&K.).
So prior to
the change, commercial banks’ consolidated balance sheet would be thus.
Assets.
Liabilities.
200 loans and investments. 200 Depositors.
On
announcement of the change, depositors then have to choose how much of their
money they want to have in safe accounts and how much in investment accounts or
unit trusts. Let’s say depositors go for a 50:50 split. The new consolidated
bank balance sheet for safe accounts would then be thus:
Assets. Liabilities.
100 reserves. 100 Deposits.
As to
investment accounts / unit trusts, they are essentially separate entities. And
their initial balance sheet would be thus:
Assets. Liabilities.
100 loans
and 100 Deposits.
Investments.
The two
balance sheets look very similar, there is a fundamental difference. For safe
accounts (the first balance sheet) the number next to “deposits” and “reserves”
is always exactly equal to the amount lodged by depositors (net of
withdrawals). In contrast, for the investment account / unit trust balance
sheet, the numbers fluctuate with changes in the value of the underlying loans
and investments.
Note that
there has been a drastic reduction in the amount lent by and invested by banks,
which would have a deflationary effect. That would need to be countered by
having the government / central bank machine print and spend monetary base into
the economy. Let’s say (to keep things simple) that depositors continue to
split their money 50:50 as between safe and investment accounts / unit trusts.
It might seem
that government would need to print and spend an extra 200 into the economy so
as to return the amount lent and invested by banks to its original figure.
However, that would be too much because the NET EFFECT would be to expand
private sector net financial assets by 200, and that would have too much of an
inflationary effect (assuming the economy was at capacity BEFORE the change to
full reserve).
As to
EXACTLY HOW MUCH money government would need to print and spend into the
economy, that is impossible to know with any accuracy. And for that reason, it
would be inadvisable to try to effect the change within just a year or so. That
is, it would be better to raise commercial banks reserve requirements by
perhaps 20% a year until they had reached 100% after five years.
But let’s
assume that at the end of that five year period, the total amount of new money
required is 100. In that case, the new balance sheets would be thus.
Safe accounts:
Assets Liabilities
150 reserves 150 deposits
Investment accounts / unit trusts
Assets Liabilities
150 Loans
and 150 deposits.
Investments.
The reduced
amount of lending by banks (150 instead of 200) would mean, first, an overall
reduction in investment, i.e. there’d be more labour intensive economic
activity. Second, the proportion of investment funded by equity rather than
lending would rise.
No doubt a
number of simple folk will react to the latter by claiming that any reduction
in investment must be “bad” because investment is “good”, “virtuous” and all
the rest.
The answer
to that is that it is very naïve to think that a simple increase or decrease in
investment (or anything else) is beneficial or harmful. The IMPORTANT QUESTION
is: what’s the OPTIMUM amount of investment (or anything else)?
And investment
funded by a banking system that needs subsidising (as is the case with
fractional reserve) is probably not optimum: on the face of it, the amount of
investment brought about that way will be excessive.
Other
changes.
Another
overall or “macro” change that takes place on conversion to full reserve is
that private sector entities have a bigger stock of cash, and thus do not need
to borrow so much.
As to GOVERNMENT
DEBT, that is drastically reduced in the B&K scenario, which has got me
baffled. Under the scenario set out just above, there is no effect on
government debt.
No comments:
Post a Comment
Post a comment.