Two of the main advocates of full reserve banking in recent
years are, first, Laurence Kotlikoff (K) and second the three co-authors
“Richard Werner, Positive Money and the New Economics Foundation”. The work
produced by the latter three will henceforth be called “W” (short for
“Werner”).
However, there are slight differences between W and K, and
this article is an attempt to pick the best from each.
The similarities and differences.
Under both systems, depositors must choose between two types
of account which are not a hundred miles from the two basic types of account
already offered by banks, namely deposit accounts and current accounts
(“checking” accounts in the U.S.). Under W, money in current / safe accounts is
not invested at all, while under K., the money is invested only in very safe
securities, as occurs with U.S. money market funds. Indeed, under K, current
accounts are actually run by unit trusts or money market funds.
And then there are deposit accounts (called “investment”
accounts by W). Under W, money in such accounts IS LOANED ON or invested, but
depositors have limited access to their money. They can deposit their money for
varying periods, or choose from varying periods of notice before withdrawal.
Plus they can choose varying levels of risk, i.e. commit themselves to losing
for example 20% or 40% of their money if the underlying loans or investments go
bad.
In contrast, under K, money to be invested is all placed in
unit trusts (“mutual funds” in the U.S.). As is normal with unit trusts,
depositor / investors stand to lose a portion of their money, and (extremely
unlikely) ALL THEIR MONEY.
Current accounts: W or
K?
Re K’s idea that current accounts be hived off to unit trusts
or money market funds, I don’t see the point of that. Existing banks are used
to, and have experience in running current or checking accounts, so they might
as well continue with that activity. Or put another way, after the switch to
full reserve, K’s desire to see unit trusts run instant access accounts could
be fulfilled by simply giving banks a new name: “unit trusts”. But that is
clearly just semantics.
As to whether banks (or other institutions) running safe /
current accounts should even be allowed to invest in supposedly safe securities
like government debt (in the same ways money market funds in the U.S. do) my
answer is: “definitely not”. Reason is that government debt is not 100% safe:
it rises and falls in value. Indeed one money market fund failed during the
recent crisis or “broke the buck” as the saying goes. And if there is the
slightest chance of a supposedly safe institution failing, that implies a
taxpayer funded bail out, which in turn equals a taxpayer funded subsidy for
the institutions in question. And a subsidy, however small, for an industry
which is supposed to stand on its own two feet is a straight self
–contradiction: it involves a mis–allocation of resources.
Moreover, the idea that Eurozone periphery government debt is
safe at the time of writing is a joke.
So that’s fifteen love to W so far.
Invested money.
As to money that is going to be loaned on or invested, there
is a problem with W, as follows.
W involves vastly less taxpayer exposure than our current
banking system, which in turn means that W (and indeed K) involve far less
taxpayer funded subsidies for banks.
However, notwithstanding the relatively large amount of loss
absorbing that depositors are exposed to under W, there is still a finite
chance of all the underlying loans and investments for a particular bank
turning out to be worthless or near worthless. And that means taxpayer
exposure, or a taxpayer funded subsidy for banks.
And there is no excuse whatever for even the smallest subsidy
for an industry that is supposed to pay its own way - which is supposed to be
commercially viable.
In contrast, under K, there is no theoretical limit to the
loss that depositor / investors can make: i.e. in theory they can lose their
entire investment. And that in turn completely disposes of taxpayer funded
subsidy (at least as far as investment accounts are concerned).
Moreover, bank insolvency or failure is impossible under K’s
system.
Money creation.
Next, there is one respect in which W fails to achieve its
own objectives, namely preventing the creation of money by commercial banks.
Reason is thus.
W allows maturity transformation or “borrow short and lend
long”. For example those running investment accounts can make a loan designed
to last say five years, and fund that with deposits where depositors commit
their money for no more than say three months. No doubt there is a good chance
that when a portion of those “three month” depositors withdraw their money,
they’ll be replaced with another lot of “three monthers”. But there is always
the possibility they WON’T BE REPLACED. And in that case the relevant bank will
have done a classic bit of money creation: it will have loaned out money it
doesn’t have.
Werner offers
flexibility?
One ostensible merit of W as far as investment money goes, is
that depositors have a choice as to what risk they take. Howerver under K they
actually have much the same flexibility. That is, a depositor who wants to play
it relatively safe under K can put a relatively large portion of their money in
a safe account and a small portion in an investment account (or into unit
trusts).
Another way in which K provides flexibility is that
depositor’s aiming for interest or a dividend on their money can actually have
near instant access to their money in the same way as those who invest in stock
exchange quoted securities have near instant access. That is, those who invest
in unit trusts as per K, or those who invest direct in the stock exchange (or
indeed in anything else, like a buy to let property), can cash in their
investment whenever they want. Of course, in the middle of a recession the value
of those investments may easily be less than the investor initially paid for
them. But that’s a risk that all investors take.
Conclusion.
In this W versus K tennis match, it looks like fifteen all.
That is, as regards current accounts, W is better than K. And as regards
investment accounts it’s the other way round. To expand on that…..
Re safe / current accounts, the relevant money, as per W’s
recommendations, is exposed to NO RISK WHATEVER. That is, the money is not be
invested or loaned on at all. That way, no taxpayer funded subsidy of the
banking industry is involved.
Plus existing banks might as well continue running those
accounts: that is, there is no need (as per K) to hive off current accounts to
unit trusts, money market funds, etc.
As regards money which depositors want invested or loaned on,
K is better than W for the following reasons.
1. There is absolutely no taxpayer exposure and thus no
taxpayer funded subsidy whatever for an industry (banking) which is supposed to
be commercially viable.
2. While W is far simpler than Vickers or Basel III or
Dodd-Frank, W is nevertheless more complicated than K. And banks JUST LOVE
complexity. It gives them wriggle room. It makes it easier for them to use the
obscene sums of money they devote to lobbying to getting their way with
regulators and politicians.
To quote Walter Bagehot, "The business of banking ought
to be simple; if it is hard it is wrong."
3. K offers those who want a dividend or interest on their
money flexibility in that they can cash in their investment (albeit at a loss)
whenever they want.
4. In allowing maturity transformation, W may fail to achieve
one of its own objectives: stopping the creation of money by commercial banks.
An interesting analysis which clearly distinguishes the proposals. I will dispute one point, however. Under the W system, when a depositor withdraws money from the investment fund, that is money which either has not yet been lent out by the bank, or which has been repaid by the borrower and is no longer out on loan. It is not the case, therefore, in the event that no other lender makes up for the withdrawal, that the bank "will have loaned out money it doesn't have."
ReplyDeleteHi Graham,
ReplyDeleteI was referring to the situation where $X is lent out long term, and then the relevant depositors who originally funded that loan withdraw their money. In that scenario, the money being withdrawn is not as you put it money that has “not yet been lent out by the bank, or which has been repaid by the borrower”.