First
though a brief introduction to full reserve (FR). FR banking is very simple. It
consists of the following (in blue). Skip if you like.
The bank industry is
split in two. One half offers totally safe accounts where money is simply
lodged at the central bank, or maybe also invested in government debt. The
other half offers normal bank loans, but that half is funded only by
shareholders, or people who are effectively shareholders. For example the
latter half can take the form of mutual funds (unit trusts in the UK) with
investors having a choice as to what is done with their money, i.e. a choice as
to which particular fund they put their money into. The advantages of that set
up are:
1. The first half
cannot fail. As to the second half it cannot suddenly go insolvent, though a
slow decline and consequent takeover by another bank is certainly possible.
2. That means no more
credit crunches and subsequent recessions. It also means an end to bank
subsidies, an objective which those in charge of reforming bank regulations
have set themselves, but which they’ve largely failed to achieve.
3. There’d be no
reason under FR for the current limits on how much of depositors’ money is
guaranteed (£85,000 in the UK at the time of writing). That is because offering
that guarantee under the existing system, where the guarantee is taxpayer funded (as
is the case in the UK) is a GENUINE liability for governments (i.e. taxpayers).
In contrast, safe accounts under FR are GENUINELY SAFE. Thus there is no reason
to limit the guarantee. Moreover the guarantee can be extended from INDIVIDUALS
to firms and corporations.
Frances’s
article.
As
to Frances’s article, its only merit is that she criticises an IMF paper by
Messers Benes and Kumhof
which advocated full reserve (FR). Agreed. I don’t think much of that paper
either.
Next
she makes the point (and indeed repeats the point throughout the article) that
FR means the end of banking as we know it, hence the title of her article no
doubt. (E.g. see her paragraph starting “But there is a problem”)
Well
the simple answer to that is that advocates of FR are PERFECTLY WELL AWARE that
FR involves a change to banking which is so large and fundamental that
successor entities or institutions can arguably no longer be called banks. To
illustrate, Matthew Klein penned a Bloomberg article
which explains Laurence Kotlikoff’s ideas on FR, and the title of the article
is “The Best Way to Save Banking is to Kill It”. That implies a pretty big
change.
However,
the fact of advocating reform of something that is so fundamental that previous
definitions of relevant words like “bank” no longer apply is NOT AN ARGUMENT
against such reforms.
Payments
systems.
Next
she makes the absurd charge against Kotlikoff (and indeed Bennes and Kumhof)
that they “completely ignore the crucial role of banks in facilitating payments”.
Messers Bennes, Kumhoff and Kotlikoff would have to be mentally sub-normal not
to be aware that it is necessary for people and firms to make payments to each
other. And I suspect those three individuals are not mentally sub-normal.
Interest.
In
the next two paragraphs (starting “The third proposal..”) she addresses the
point that under FR, those who want a return on their money put their money in
special accounts which actually amount to mutual funds (unit trusts in the UK).
But
she doesn’t like that, and says, “But once again, there is a problem. Banks are
not fund managers.” Well under the EXISTING SYSTEM banks’ main job is not fund
management, but under FR that is their main job!
To
object to banks becoming fund managers is a bit like objecting in the 1800s to
ships being powered by steam on the grounds that “ships are powered by sail”.
To repeat, the fact that a reform is fundamental is not an argument against the
reform.
Incidentally
the above claim that banks are not fund managers is not correct for another
reason: banks already manage hundreds of mutual funds with billions invested in
them!
Bank desposits.
Next,
she tells us that “People put money in banks for two reasons: because they want
safety AND a return” and seems to bemoan the fact that people can no longer get
that combination, i.e. safety and return.
Well
that’s for a VERY GOOD REASON. And this goes right to heart of the basic
argument for FR which Frances doesn’t seem to get. So I’ll explain.
Lending
or investing money INEVITABLY involves risk, and for the blindingly obvious
reason that borrowers sometimes don’t repay loans, and investments sometimes go
wrong. And SOMEONE SOMEWHERE has to carry that risk. If it’s not the person
lending the money then it’s . . . wait
for it . . . .probably the taxpayer!
Frances
may or may not have notice the TRILLIONS of dollars of taxpayers money needed
to rescue banks over the last few years: certainly everyone else noticed.
In
short, if you want that much vaunted “safety and return” then you are asking to
be subsidised. FR disposes of that subsidy. The UK’s Vickers commission backed
the idea that bank subsidies should be removed, as did Dodd-Frank (though both
Vickers and Dodd-Frank failed miserably so far as subsidy removal goes, in contrast to FR which succeeds in that
respect).
Incidentally,
the word “subsidy” does not appear in Frances’s article: obviously existing
bank subsidies are a big defect in the existing bank system, so if you’re
defending the existing system, what do you do about that defect? Well it’s
easy: just don’t mention it! But Frances is nowhere near the only defender of
the existing bank system to omit the word “subsidy” from articles and papers.
Messers Diamond and Dybvig were guilty of the same omission in a paper in 1986
entitled “Banking Theory, Deposit insurance and Bank Regulation”.
The second reason for depositing.
The
second reason she cites for “people putting money in banks” is “because they
need liquidity (including access to payments systems)”. You don’t say?
Notwithstanding her charge against Benes, Kumhof and Kotlikoff, namely that
they apparently aren’t aware that payments need to be made, FR offers accounts
which are the basis for making payments with cheques, debit cards, etc in
EXACTLY THE SAME WAY as the existing banking system (e.g. the safe accounts
proposed by Positive Money). So quite why she comes out with the revelation
that people put money in banks because they want “liquidity and access to
payments systems” is a bit of a mystery.
The morning mist.
Next
she criticises the half of the bank industry funded by shares (non-money market
mutual funds in the case of Kotlikoff’s system and “investment accounts” in the
case of Positive Money) on the grounds that:
“I
fear that the “investment accounts” Kotlikoff and Positive Money envisage would
disappear like the morning mist once the deposit insurance that time and sight
deposit accounts currently enjoy is removed. Positive Money UK's proposal
therefore probably means the end of commercial banking, unless they could find
other sources of funding.”
Now
the phrase “morning mist” is wonderfully evocative, and it will impress
simpletons and pseudo intellectuals. As for cold logic, the simple fact of
saying you “fear” something will disappear is a hopeless argument.
There
is actually a very good reason why there would be demand for the shares in the
share funded / equity funded / mutual fund half of the bank industry, and
that’s that the people ALREADY invest billions (or perhaps it’s a trillion or
two) in stock exchange shares. They do that both as individuals and as
subscribers to pension funds: i.e. large numbers of people opt for pension
schemes where the eventual payout is stock market related.
Lending and debts decline under FR.
Having
said that there would be significant demand for shares in lending entities,
that is not to say that the volume of lending (and hence debts) under FR would
be EXACTLY THE SAME as under the existing system: it would certainly be a bit
less.
But
that’s for the very good reason that, to repeat, FR removes a subsidy from the
borrowing / lending process. That is it forces lenders to foot the entire bill
for their little enterprise: lending in the hope of making a profit. And in
that a subsidy is removed, the result ought to be increased GDP.
Funding lending entities.
The
first sentence of the next paragraph reads “But it is perhaps more likely that
commercial banks would find ways of lending without relying on customer
deposits for funding.” More likely? What? It’s not “more likely” that “banks
would find ways of lending without relying on deposits”: they’d sodding well be
FORCED TO DO THAT! The law under FR
would stipulate that that’s what they have to do, else its fines or prison
sentences.
Responsibility
for lending decisions
Next,
she says “Completely eliminating fractional reserve lending means removing
banks’ responsibility for lending decisions.” Whaaat?
Under
FR (for the umpteenth time) lending entities are funded just by equity, by
shares. Why on God’s name does that “remove” their “responsibility for lending
decisions”?
If a
garage is funded just by shares in the garage held by the person running the
garage and relatives (and doubtless that’s how many garages ACTAULLY ARE
FUNDED) does that “remove the garage’s responsibility for car repair
decisions”?
The committee.
Next,
she says, “Wolf’s idea amounts to replacing a demand-driven money supply
creation mechanism with central planning of the money supply by a committee. Central
banks’ record on producing accurate forecasts of the economy is dismal….”.
Now
wait a moment. Under the EXISTING SYSTEM, central banks do a lot of forecasting
and determine stimulus (e.g. by adjusting interest rates, QE, etc). So in
criticising central banks incompetence, Frances is as much criticising the
EXISTING SYSTEM, as FR!!!!
Moreover,
under the EXISTING SYSTEM, central bank committees adjust the MONEY SUPPLY when
they implement QE. Indeed, fiscal stimulus followed by QE comes to exactly the
same as the form of money creation advocated by Positive Money!
And
the first sentence of her last paragraph reads “Personally I would prefer the
money supply to respond to demand rather than be decided by a committee…” Well
now that’s truly hilarious and for the following reason.
Prior
to the credit crunch the money supply was very much being determined by supply
and demand. And what do you know? Banks were creating and lending out money
like there’s no tomorrow, i.e. in a totally irresponsible manner. (See chart
below). Then came the crunch, and as always happens, commercial banks suddenly
stopped their money creation activities (exactly what we don’t want them to do
in a crunch).
Frances’s
claim that there are big merits in having the money supply determined by supply
and demand is patent and obvious nonsense.
No comments:
Post a Comment
Post a comment.