Turner is head of the UK’s Financial Services Authority and
he often promotes thoughtful and radical ideas. But he went right off the rails
in this speech. He very eloquently set out some of the defects in fractional
reserve banking. (For some relevant quotes, see here.)
But he ends (p.16) by giving some utterly feeble and
laughable reasons for RETAINING fractional reserve. And I think I know why.
This is part of a pattern. Mervyn King did the same: set out
some well thought out criticisms of fractional reserve while in the end backing
the Vickers commission’s very timid changes to bank regulation (which will be
watered down to nothing within 5 years thanks to bank lobbying).
The pattern is that people in high places cannot openly
oppose the conventional wisdom or the consensus establishment view too strongly
(at least not if they want to keep their jobs and/or get gongs). Also members
of the establishment don’t want to be seen to be too openly squabbling with
each other.
Anyway, Turner’s first reason for retaining fractional reserve
is (in green italics):
. . . that some private credit and money creation
may be essential to the effective mobilisation of savings and that this
requires a role for fractional reserve banks.
What?
Take an ultra-simple economy in which the money supply is fixed.
Some people save and plonk their money in banks. Others want to borrow, so they
borrow from banks.
Now unless I’ve temporarily gone round the twist, that system
“mobilises” savings doesn’t it? Why on Earth is it necessary for banks to
create money out of thin air for the above “mobilisation” to take place. I’m
baffled.
Turner continues:
Banks perform risk pooling, enabling
the funds of multiple savers indirectly to finance multiple borrowers: in theory
at least this function could be performed by non-bank loan funds, but how truly
practical that is, particularly in SME sectors, remains unclear.
Well the word “unclear” is ust a euphemism for “I don’t
know”. I.e. if something is unclear to Turner, why doesn’t he just keep quite
on the point? Any normal person who wants to make a useful contribution to this
world says what they think where they have definite views, while in contrast,
they keep quiet when they aren’t sure. In fact even drunks in pubs up and down
the land normally obey that rule: that is they let everyone know in no
uncertain terms what they think when they have a view, while in contrast they
keep quiet when they aren’t sure about something.
In contrast, academics, intellectuals, pseudo-intellectuals,
quangocrats, etc. when they aren’t sure – well they just carry on talking,
while interspersing their hot air with the occasional “remains unclear” sort of
phrase.
As to why it should be difficult for “non-bank loan funds” to
gauge the creditworthiness of SMEs or anyone else is a mystery. Creditworthiness
appraisal nowadays is very automated: unlike in the days of “Captain
Mainwaring” banking where personal relationships were more important. And in as
far as personal relationships ARE RELEVANT, there is no conceivable reason why
those relationships should be any harder to build up in a non-bank / borrower
relationship than in bank / borrower relationship.
In fact UK building societies used to work in a full reserve
manner: that is they didn’t lend out money till they’d got the requisite funds
in the kitty. Indeed some mutual building societies may still work in this full
reserve manner, but whether they still do is beside the point. The real point
is that building societies which work on full reserve principles had / have no
trouble arranging for “funds of multiple
savers indirectly to finance multiple borrowers”.
And then there are credit reference agencies: organisations
that gauge the credit worthiness of people and firms. But those agencies are
not banks. How on Earth do those agencies do their job and make a living? I’m baffled
(not).
Turner continues:
But more fundamentally, banks perform
maturity transformation, enabling households and businesses to hold shorter
term financial assets than liabilities. And that is likely to enable greater
long term investment than would otherwise be supported. As Walter Bagehot
argued persuasively, the development of joint stock fractional reserve banks
may well have played an important role in the development of the mid-nineteenth
century British economy, giving it an advantage over other economies where
maturity transforming banking systems were less developed.
OMG. Not the tired old “maturity transformation” argument.
It’s blindingly obvious that maturity transformation (MT)
enables more lending to take place – but it’s risky! It is precisely MT (i.e.
“borrow short and lend long”) that has brought down hundreds of banks
throughout history.
And how is that risk covered nowadays? Well it’s the taxpayer
that carries much of the risk. In other words the additional lending that MT
brings only comes about thanks to the astronomic subsidies that banks get. And
an industry (or any part or aspect of it) that needs subsidising does not make
economic sense. Subsidies (unless there is a very good reason for them) reduce
GDP.
In short, the fact that MT increases investment DOES NOT
prove that that investment increases GDP. If that investment takes place
partially or wholly because of a subsidy, the result will be more than the
optimum amount of investment, which in turn will REDUCE GDP.
As to the reference to Walter Bagehot, that is COMPLETELY
IRRELEVANT. In Bagehot’s day the gold standard prevailed, that is the money
supply (or monetary base to be exact) was fixed. Or at least it was very
inflexible. And that in turn meant that it made sense to maximise the use of
money.
However we are no long in a gold standard environment: i.e.
the monetary base is infinitely flexible. Indeed (and perhaps Adair Turner
hasn’t noticed) the base has expanded by astronomic and unprecedented amounts
recently thanks to QE.
And that all means that any deflationary effect that comes from
banning MT can be countered by simply creating and spending new money into the
economy. Which in turn means we can get rid of the risks involved in MT at zero
real cost! What more do you want?
As Milton Friedman put it in his book “A Program for Monetary
Stability” (which advocated full reserve), “It need cost society essentially
nothing in real resources to provide the individual with the current services
of an additional dollar in cash balances.”
Now for the next “Turnerism”:
The second is that quite apart from
mobilising savings and allocating them to alternative investment projects, the
creation of credit and private money can support life cycle consumption
smoothing (with e.g. mortgage debt and matching deposit savings lent to and
borrowed from people at different points in their life cycles), and that this
can be welfare enhancing even if it has no necessary impact on growth rates.
Why in God’s name does allowing “private money” creation
enhance “life cycle consumption smoothing”?
Turner’s “mortgage debt and matching deposit savings” would take place
perfectly OK in the above hypothetical economy where total money supply is
fixed. Or have I (again) gone round the twist?
Ralph,
ReplyDeleteThanks for this very convincing hatchet job on Adair Turner's "defence" of fractional reserve banking.
Your analysis is very convincing. Yes, establishment figures are incapable of going the whole way and saying that the Chicago Plan really would be very beneficial.
Cheers Simon
Ralph,
ReplyDeleteA small point, but I think the Coventry BS still aims to only lend out of deposited funds. However, I need to check on this, and will report back if I get any sensible reply from them.
Thanks for a great article.
Regards,
Mike Ellwood
I'd be interested to see what Coventry BS say.
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