Scott Fullwiler thinks Neil Wilson has “nailed it”.

Neil Wilson thinks he’s spotted flaws in full reserve banking, one being that under FR, commercial banks would still need central bank support and Scott Fullwiler thinks Neil has “nailed it”.

I wouldn’t put it quite like that. I’d say that Neil hasn’t bothered to get to grips with even the basics of full reserve and thus constantly puts his foot in it. My reasons for saying that are set out below. And the basics are simple enough: I could explain them to a 15 year old in ten minutes.

If you’re one of the very few people who likes getting to grips with the basics of a subject before mouthing off, I’ve put a list of introductory material at the end below, which you’ll probably be able in read in less than an hour. Or if you want an ultra-brief 35 word explanation it is as follows (in green itlaics).

The bank industry is split in two. One half offers totally safe accounts where money is simply lodged at the central bank. The other half does normal bank loans, but that half is funded only by shares.

Bank runs.

Anyway, one of Neil’s illuminating “nail it” ideas is that under full reserve “At any point in time there will be 7, 30 and 90 day deposits maturing, so yes there can still be bank runs.”

No, sorry. Under full reserve (to repeat the point made in green above) the only deposits in the normal sense of the word “deposit” that are ever made under FR are made at totally safe institutions or in totally safe accounts. The latter are totally safe because the relevant money or “deposit” is simply lodged at the central bank (or possibly, as advocated by Milton Friedman (an advocate of full reserve), invested in short term government debt which to all intents and purposes is as safe as sums lodged at the central bank). So barring war, revolution or similar disasters, there is no chance of “7, 30 or 90 day depositors” losing their money. I.e. no chance of “bank runs”.

Incidentally, by “deposit in the normal sense of the word” I mean plonking $X somewhere on the understanding that the guardian or holder of that money has an obligation to return the $X at some stage and not one cent less (bar any amounts the holder might charge for administration costs.)  

I’m not entirely sure if that is one of the reasons Neil thinks commercial banks would still need central bank support under full reserve, but regardless of whether it is or not, the “7,30,90” point is obviously invalid.

Liquidity.

Second, Neil claims “On the liquidity side the central bank will still need to offer short term liquidity operations when the interbank gums up. Otherwise you will get banks failing for cash flow reasons, rather than lack of equity reasons.”

Now it’s a bit hard to see how any “liquidity” problems can ever arise for lending entities under full reserve, because those entities just don’t owe any money to anyone! That is, their creditors (so called) are just shareholders or others who are effectively shareholders (like those with a stake in mutual funds which lend as under Laurence Kotlikoff’s full reserve system).

The nearest thing to “gum up” that might occur could be as a result of a repetition of the pre 2008 crisis behaviour: that is lending entities making too many silly loans. When those loans were revealed for what they were, there would certainly be a general reluctance to lend to non-bank entities. But that’s not a “gum up” in the sense of a potential collapse of the entire banking industry which is what would have happened but for trillions of subsidised loans given to banks four or so years ago.

You choose what’s done with your money.

Moreover, under FR, those who want their money loaned on HAVE A CHOICE as to what is done with their money. That’s in contrast to the existing system where banks can use grandma’s savings to bet on dodgy derivatives or NINJA mortgages.

Now I’d guess that most of those who want their money to be loaned on are not going to go for mortgages supplied to those with “No Income, No Job or Assets”. I.e. they’ll go for relatively safe mortgages: e.g. house buyers who have a minimum 20% or so stake.

But that’s not to say booms and busts would be totally eliminated under full reserve: obviously the sudden discovery that large numbers of silly loans had been made would have a deflationary effect. And clearly given that deflationary or recession inducing effect, there’d be a need for stimulus. But concentrating that stimulus on banks would’nt make much sense. Reason is that the sudden discovery that a particular sector of the economy has been over-optimistic is not a reason to subsidise it or give it any special preference.

To illustrate, suppose it suddenly transpires that too many houses have been built (more or less what actually happened around five years ago), is that a reason to subsidise house building? Obviously not . Certainly no special assistance was offered to house builders five years ago, and quite right.

In short, if banks suddenly find they’ve overestimated the amount of viable loans, that IS A REASON FOR general stimulus. In contrast, IT IS NOT a reason for special assistance for banks.

Interest rate rise.

A possible result of a sudden discovery that too many silly loans had been made COULD BE a rise in interest rates. It’s not certain that would be a result, as that sudden discovery might reduce the DEMAND FOR loans just as much as it did the SUPPLY OF LOANS.

But even if short term rates did shoot up, it’s not clear that LONG TERM rates would. And I see no reason for taxpayers to subsidise the chancers who like playing the spot market: that is, people who like taking risks by borrowing SHORT TERM.

So I wouldn’t TOTALLY RULE OUT the possibility that interest rates might be seen (on social grounds) to be rising too precipitously given full reserve and given a re-run of the irresponsible lending we saw 5 -10 years ago. But I think that’s unlikely for reasons given above. Plus, to repeat, any such intervention would be for SOCIAL reasons, e.g. to help mortgagors. It would not be to rescue banks, as suggested by Neil. In contrast to social matters, as far as brute free market considerations are concerned, I see nothing wrong with interest rates rising and falling in line with supply and demand just as occurs with coal, iron ore, you name it.

For a quick intro to full reserve, see:

1. Laurence Kotlikoff’s version of FR.

2. John Cochrane’s ideas.

3. Milton Friedman’s book “A Program for Monetary Stability”, Ch3, under the heading “How 100% reserves would work”.

4. My own 400 word summary. See p.4 under the heading “Full Reserve Banking in Brief”.