World Economics Association article on full reserve banking.

This article on full reserve by Mark Joób published by the WEA has the merit of being clear and brief, which is in contrast to the wind and waffle that makes up much economics literature. But apart from that, the article is defective.

Joób starts with six points, the first of which is the claim, popular with advocates of full reserve (FR) namely that “debt based money” increases debts. I demolished that argument here.

2. “Social desirability”.

Joób’s second point which I’ve put in green is:

“However, commercial banks decide which customers are granted loans and which investments are made according to their interest in maximizing their own profits. Whether an investment is socially desirable is not the decisive criterion for commercial banks. This way, investments serving the common good but not being profitable enough are not supported by the banking system and have to be financed by government spending that depends on tax revenues and public debt creation.”

Now there’s a big confusion of issues there, and as follows.

The above objection to maximising profits is strange in view of the fact that advocates of FR have no big objections to free markets and the profit motive, bar the following point. Advocates of FR go along with the widely accepted view that the free market will not produce an adequate supply of various items, which therefor have to be supplied by government (education for kids, law enforcement, etc).

So if going for investments which make the maximum profit is OK for butchers, bakers, candlestick makers and every other non-bank entity, why isn't it OK for banks? Plus if having government supply the items that the profit motive fails to supply solves that particular problem than “that particular problem” is “solved”, if you’ll forgive a statement of the obvious. In short, the above point made by Joób and other advocates of FR does not stand inspection.

Are non-mortgage loans productive?

One argument put by advocates of FR against the profit motive being involved in loan decisions by banks is that banks have a tendency to prefer supplying mortgages as opposed to lending to businesses, and mortgages are allegedly “unproductive” whereas business are allegedly “productive”.

Now the problem there is that businesses fail to repay loans about twice as often as mortgagors. To that extent, the idea that businesses are “productive” compared to mortgagors just won’t wash.

Moreover, the above “businesses are productive” argument seems to imply that production is somehow more worthy than consumption (and mortgages and housing are indeed consumption items). However, production is pointless without consumption, thus it is really meaningless to argue that production is more worthy than consumption or vice versa.

3. Bank runs.

Joób’s third point is that commercial banks in their present form are brittle: they’re liable to runs. Quite right. The solution, as explained by John Cochrane, is to have just non-runnable items (i.e. shares) on the liability side of banks’ balance sheets. And that amounts to FR. And indeed, the FR systems advocated by Milton Friedman and Laurence Kotlikoff include the latter feature: that is having non-runnable liabilities on the liability side of bank balance sheets.

4. Cyclicality.

Joób’s fourth point is that traditional or “existing” banks exacerbate the boom bust cycle. True, though of course human beings, herd animals that they are, will never be totally free of bouts of irrational exuberance, tulip mania and so on. So while FR certainly ought to ameliorate booms and busts, it will not totally dispose of them.

5. Private money promotes inflation?

That’s Joób’s fifth claim. That’s a difficult one - at least I find it difficult. People have been arguing over that since the early 1800s, and that’s one of the ideas that prompted the ban in Britain in 1844 on private banks issuing their own notes.

^{6. Subsidies.}

This is entitled “The privilege of creating money is a subsidy to the banking sector”, and he starts:

“Since money is debt, it carries interest. Therefore, interest has to be paid on all the money in circulation and virtually nobody can escape paying interest. Interest is primarily paid by customers who take loans from commercial banks and thereby ensure the money supply.”

Wrong, and for reasons I set out here.

But that’s not to say private banks are not subsidised under the existing system. Indeed, it’s widely accepted that they are: there’s the Too Big to Fail Subsidy, second, taxpayer funded deposit insurance and third, lender of last resort facilities provided by central banks to commercial banks, but not made available to non-bank entities. And the beauty of FR is that it disposes of the latter subsidies, a merit in FR not mentioned by Joób.

So to summarise, Joób’s sixth point is defective. The alleged subsidy he points to is not a subsidy, while he fails to mention subsidies which are widely accepted as such, and widely seen as undesirable, even by those who don’t advocate FR.