Thursday, 7 May 2015
What if just one country implements full reserve banking?
A common objection to full reserve (FR) is that if just one country implements it, that is likely to raise the cost of borrowing in that country which means that unless one has draconian capital controls, borrowers in that country will seek loans from foreign banks.
The answer is as follows. The REASON that full reserve may increase borrowing costs is that under FR all taxpayer funded bank subsidies and guarantees are very definitely removed. That’s distinct from the situation at the time of writing where the authorities make NOISES about the desirability of removing bank subsidies but fail in practice to do so. A classic example is the UK, where government currently actually ADVERTISES the fact that depositors are protected gratis the taxpayer.
Put another way, if just one country implements FR, then in effect all other countries would have subsidised banks, while banks in the country with FR would not be subsidised. So would the latter country lose out? Well the answer was given recently by Tim Worstall in a Forbes article, when he explained a point that has been obvious to more clued up economists for a long time. That’s that if some other country wants to supply you with subsidised goods and services, far from being discouraged, they should arguably be ENCOURAGED.
Some other country wants to make and send you cars at half the cost of making them? Fine: tell them to go a stage further and make that a QUARTER the cost of manufacturing the cars. In fact you could persuade them to go even further and tell them to just GIVE YOU the cars for free!
Seriously though, if I was in charge of the UK economy and implemented FR, and other countries wanted to supply the UK with banking services at a subsidised rate, I wouldn’t be too bothered. I would actually point out to them that subsidies do not result in an optimum allocation of World resources and that it might be an idea if they re-thought their policy of subsidising banks or any other industry. But I wouldn’t lose nights of sleep over it.