How full reserve stops private money creation.

Money creation by private or commercial banks takes place, first when a bank lends on money deposited at the bank. To illustrate, when $X is deposited and loaned on, both the borrower and the depositor then possess $X, thus $X has been turned into $2X.

Second, the commercial bank system can create money from thin air by lending without reference to whether it has enough deposits to “fund” that lending. That is banks simply credit borrowers with $Y, and that $Y is then deposited by whoever receives that money.

Under full reserve, all lending entities (whether they call themselves banks or not) have to be funded just by shareholders rather than by depositors, loans from the wholesale money market, bonds, etc.

Now money is a liability of a bank which is FIXED IN VALUE (inflation apart). That is, a dollar issued by a central bank or commercial bank is guaranteed to be worth very nearly the same 48 hours later. (Or to be more accurate, if inflation is anywhere near the 2% target, then that dollar’s value will not fall by more than about 0.01%)

But shares different. Shares rise and fall by significant amounts. Thus shares are never counted as part of a country’s money supply anywhere in the World. So if someone buys $Z of shares in a bank and the bank lends on $Z, no money creation takes place.

Thus enforcing full reserve (or at least the above aspect of full reserve) is easy compared to the Byzantine complexity that is Dodd-Frank and similar forms of recent and near useless bank regulation in other countries. All the authorities need do is keep an eye on the balance sheets of banks and make sure there aren’t any depositors there.

As to those who don’t want to “risk losing value”, i.e. those who want to lodge a given sum and ensure that they get exactly that sum back (in real terms) under full reserve, they’re catered for by entities or accounts where relevant sums are simply lodged at the central bank and/or (as advocated by Milton Friedman) some of that money is invested in short term government debt. Obviously that money (unlike shares) is totally safe, or as near totally safe as it is possible to get.

Bitcoin changes value.

An obvious exception to the idea that money is not money if it changes significantly in value is Bitcoin, which has changed value dramatically over recent years. My answer to that is that Bitcoin types of money will just never take off in a serious way until they’re guaranteed to keep their value. The vast majority of individuals and firms are not interested in seeing the contents of their bank accounts suddenly halve in value.

Moreover, if an when a Bitcoin type of money DOES become more or less fixed in value, it is then performing the same function as a central bank. And the idea that governments and central banks are going to stand for anyone intruding on their territory in any big way is just nonsense. Bitcoin has already been banned in Russia.

Anyone can create money?

The above method of curtailing private money creation might seem ineffective in that, as Minsky amongst others pointed out, anyone can create money. And indeed they can – in theory. For example INDIVIDUAL PEOPLE can try issuing IOUs. Unfortunately money is defined in economics dictionaries and economics text books as “anything widely accepted in payment for goods and services” or words to that effect. And the idea that an individual person can buy weekly groceries or a car by giving the shop or garage a bit of paper inscribed with the words “I owe the bearer of this bit of paper $A” is pure fantasy. Even small firms would have difficulties doing that.

Thus under full reserve, the authorities just wouldn’t need to keep an eye on individual people, small firms or even the smallest shadow banks. It’s only the larger firms and corporations that would need watching.

But that’s not to say that under full reserve there would ever be a 100% watertight ban on private money creation, especially since there is no sharp diving line between money and non-money. For example short term government debt is sometimes used in the world’s financial centres in lieu of money. Or you can try using bottles of whiskey as money if you want. The latter might work to a very limited extent in a few cases. (I actually pay a friend of mine who helps me with my PC with whiskey, strange to relate, because he won’t accept money. Computer geeks are normally a bit odd.)

Banks would try to circumvent the rules.

It’s a 100% certain that banks would try every trick in the book to circumvent the rules of full reserve. But then it’s a 100% certain they’ll try to circumvent ANY RULES or laws. Banks are quasi criminal organisations. J.P.Morgan was recently fined $20bn for various crimes. Yes, billion not million.

But to repeat, at least the rules of full reserve are simple. So to that extent they’re easy to enforce.

Portraying shares as money.

One trick that banks would try is to have just shareholders on the liability side of their balance sheets, while arranging for the value of those shares to remain constant, and allowing “depositor / investors” to draw checks on or do debit card transactions based on depositor / investors’ accounts at the bank.

Arranging for the value of shares to remain constant is relatively easy where depositors’ money is loaned out only to safe borrowers, e.g. mortgagors who have a minimum 20% or so equity stake in their homes.

However that ruse is easily dealt with. First it can be made illegal to draw checks on a stake in a bank which consists nominally of shares. Indeed under the full reserve system advocated by Positive Money, checks and plastic card transactions can only be funded by the above mentioned totally safe accounts.

Second, it would be easy to stipulate that any literature or web sites relating to bank shares make it abundantly clear that there is no FDIC type insurance for the relevant “money”. Indeed that sort of stipulation has been in force in the UK for years in that ALL LITERATURE relating to shares and mutual funds (“unit trusts” in the UK) says something in bold print about the possibility of the relevant stake possibly falling in value. (That applies of course just to non-money market mutual funds. Money market mutual funds (assuming they invest in nothing more risky than short term government debt, would be classified as “totally safe” under full reserve.))

The UK’s National Savings and Investments.

Anyone who thinks there is a problem in running totally safe accounts should ponder the fact that accounts of this sort already exist in the UK: supplied by “National Savings and Investments”. And doubtless some other countries have something similar. NSI is a government run savings bank which invests only in government debt. It does not issue check books or plastic cards, but it DOES TRANSFER depositors’ money within 24 hours to any other bank account the depositor wants. And of course it’s a very small step from that to a system which  also issues check books and debit cards.