Wednesday, 2 January 2013

Adair Turner’s odd reasons for opposing full reserve.

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.
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?


  1. Ralph,

    Thanks 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

  2. Ralph,

    A 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.

    Mike Ellwood

    1. I'd be interested to see what Coventry BS say.


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