Disposing of debt based money won’t benefit debtors much.

The popular idea that disposing of debt based money will signficantly reduce debts is a superficially attractive argument. Unfortunately it does not stand inspection and for the following reasons.

Under full reserve banking (FR), the industry is split in two. One half just lodges depositors’ money in a totally safe fashion, while the second half lends to businesses, mortgagors etc, but that half is funded just by shareholders, or by creditors who are effectively shareholders. In practice, those wanting their money loaned on to businesses or mortgagors buy in to unit trusts (mutual funds in the US) which do the lending.

Shares or unit trusts units are not counted as money in any country, amoungst other reasons because shares vary in value (in contrast to money which is fixed in value – bar inflation). As to Positive Money’s FR system, the stake that investors have IS FIXED IN VALUE, but investors don’t have access to their funds / investment for a number of months. And it’s common practice round the world for so called money in accounts to which account holders don’t have access for a month or two not to be counted as money.

Ergo, on introducing FR the money supply declines.

Thus on introducing FR, some sort of boost to the money supply is required to make up for the above REDUCTION in the money supply. And that boost comes from expanding the stock of a form of money that already exists in significant amounts: that’s CENTRAL BANK created money (aka “debt free” money aka “base money”).

Safe accounts.

When FR is introduced, clearly a proportion of existing depositors’ money will be put in safe accounts and some will be put into unit trusts (or “investment accounts” to use Positive Money parlance).

To the extent that money is put into safe accounts, the amount of money available for loans will decline. That means a cut in debts / loans, but it also means a rise in interest rates. (Demand remains constant while supply declines, ergo the price rises). Thus on balance debtors probably won’t gain much.

And anyone who thinks that a rise in interest rates is some sort of disaster should bear in mind that the rate of interest paid on a typical mortgage at the end of the 1980s in the UK was up to THREE TIMES the current rate. Yet curiously economic growth was better then than over the last five years during which we have had record low rates.

Obviously a SUDDEN trebbling of interest rates would be too disruptive, but if the switch to FR was done gradually, any consequent gradual rise in interest rates would not be a problem.

Investment accounts / unit trusts.

To the extent that existing depositors’ money goes to unit trusts / investment accounts, there’d be no decline in loans / debts. It’s just that those debts no longer constitute money.

Conclusion.

Introducing FR is not a bonanza for debtors: total debts / loans decline, while interest rates rise. And that prompts the question: what then is the advantage of FR? The answer is:

1.  FR disposes of bank subsidies (an objective that Dodd-Frank and other bank regulators agree is desirable, but which they’ve totally and completely failed to achieve).

2. FR would probably ameliorate the boom bust cycle.

3. It’s virtually impossible for banks / lending entities to go bust under FR, which pretty much rules out credit crunches, which also helps ameliorate the boom bust cycle. The reason was nicely set out by George Selgin in his book “The Theory of Free Banking”,  “For a balance sheet without debt liabilities, insolvency is  ruled out…” (which is not to suggest that Selgin supports FR, by the way).