DeAngelo and Stulz’s strange argument against full reserve.

I dealt with no less than 38 flawed arguments against full reserve banking here recently. But the daft arguments just keep coming – nearly always from people who clearly haven’t grasped the basics of full reserve. And a paper by Harry DeAngelo and Rene Stulz is in the latter genre. The title is “Liquid-Claim Production, Risk Management, and Bank Capital Structure: Why High Leverage is Optimal for Banks”.

Essentially the paper just makes the point that commercial banks perform a useful service in issuing what the authors call “liquid claims” - commonly known as “money”.

Well advocates of full reserve banking have grasped that point. But they’ve grasped another point as well, namely that having liquid liabilities which are FIXED IN VALUE on one side of the balance sheet and ILLIQUID assets on the other side which moreover can fall in value (when silly loans are made) is risky. And every now and then, the risk (as is entirely predictable) goes wrong, and chaos ensues.

Of course the latter problem can be solved by having the state or taxpayer stand behind banks, but that equals a subsidy of private banks. And it’s widely accepted that banks should not be subsidised.

Thus – so argue the advocates of full reserve – it would be a good idea to just ban private money creation, and leave money creation to the state or central bank, which issues a significant proportion of the money supply ANYWAY: a type of money sometimes called “base money” or “high powered money” or “monetary base”. That proportion is normally around 5% of the money supply, though at the moment and thanks to QE, it’s more like 20% in the US far as I can see.

But DeAngleo and Stulz have clearly missed the latter simple basic points, as is demonstrated by the fact that the following words and phrases just don’t appear in their paper: “central bank”,  “base money”, “high powered money”, “monetary base” and “subsidy”.