Friday, 4 January 2013

Hopeless criticisms of full reserve by Messers Wolf, Diamond, and Dybvig.

Martin Wolf claims full reserve would mean an end to monetary policy. 
He assumes that full reserve banks would hold only very safe assets like government debt. That assumption is actually debatable: that is, it can well be argued that where depositors want 100% safety, the relevant bank should back that simply with monetary base, not government debt. But there isn’t a huge difference between debt and base, so let’s run with Wolf’s assumption.
He then claims that full reserve would “eliminate monetary policy” because “Public debt held by banks would set the money supply.”  I’m baffled.
The proportion of public debt held by commercial debt is small (2% in the US and 11% in the UK). So quite why the fact of commercial banks holding a small proportion of debt would stop a central bank buying or selling debt with a view to influencing interest rates is a mystery.
My source of the 2% and 11% figure is here.
Moreover, even if full reserve DID MEAN an end to monetary policy, that outcome would be enthusiastically embraced by the authors of at least one of the leading works advocating full reserve: the submission to Vickers by Richard Werner, Positive Money and the New Economics Foundation. That submission was very explicit on the deficiencies of monetary policy and why we should rely on fiscal policy alone (or to be more accurate, why we should merge monetary and fiscal policy).

Full reserve would cut funds available to borrowers or investors?

The above is silly criticism because it is so obvious. It’s a bit like telling a bicycle manufacturer that bicycles are inherently unstable, so we’d be better off with tricycles.  
Advocates of full reserve, along with bicycle manufacturers and users, have tumbled to the above blindingly obvious apparent problems, and have solutions. They’d be verging on mentally deficiency if they hadn’t noticed those very obvious apparent problems.
Martin Wolf makes the above criticism when he says “the supply of funds to riskier, long-term activities would be greatly reduced if we did adopt narrow banking”.
Wolf concentrates (to repeat) on what he calls “long-term activities”, while Diamond and Dybvig (DD) concentrate on shorter term loans (p.65-6). But that difference is unimportant. The important point is that implementing full reserve would, at least initially, constrain bank activities and thus reduce lending (probably both long and short term).
But that’s no problem because any deflation stemming from such reduced lending can be countered by having government and central bank create and spend new money into the economy. And one side effect of that is that everyone would have more money, thus people and firms would NOT NEED TO borrow so much. I.e. total debts would decline.
So the crucial question is: which system gives us an optimum or nearer optimum allocation of resources: a “high debt, high lending” system under which bank lending is underwritten by, and thus subsidised by taxpayers, or a lower lending / lower debt system (full reserve) which requires no subsidy?
Well that’s an absolute no-brainer for anyone who has got as far as GCSE in economics. That is, subsidies of so called “commercial” entities are completely and wholly unjustified. Period. Full stop. End of. Finito.
Forgive me for flogging a dead horse, but the mere fact that fractional reserve cannot do without a taxpayer backing means that fractional reserve is kaput. It’s in check mate. In the words of Monty Python, “Look, matey, I know a dead parrot when I see one, and I'm looking at one right now.”
Incidentally, the reason why it’s virtually impossible for a full reserve bank to fail is that, first, as regards money which depositors want to be 100% save, that is not invested at all – or is only invested in ultra-safe securities, like government debt. And second, as to money which depositors want loaned on or invested, depositors carry most of or all the costs if and when those loans or investments go wrong.

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