Sunday, 15 November 2015
Adair Turner’s flawed criticisms of full reserve banking.
Adair Turner is a former head of the UK’s Financial Services Authority. I agree with much of the thrust of his recently published book “Between Debt and the Devil.” But his criticisms of full reserve banking (in his Chapter 12) leave room for improvement to put it politely.
The paragraphs below deal just with that Chapter 12, and one of Turner’s criticisms of full reserve (FR) runs as follows.
“Moreover, any risks of private credit creation need to be balanced against the risks that would arise if we instead relied entirely, as the Chicago Plan proposed, on fiat money creation to increase nominal demand. For if we allow governments to run money-financed fiscal deficits, there is a danger that they will do so in excess or will allocate the spending power inefficiently for short-term political advantage.”
What – so politicians never boost demand before elections under the EXISTING system? The phrase “pull the other one” springs to mind.
A second criticism Turner makes of FR is that even if money creation by private banks is banned, “..near-money equivalents and new credit and purchasing power can be created outside banks. If promissory notes are believed to be low risk, they can be used as a money equivalent…”.
Well the first answer to that that is that advocates of FR don’t advocate a complete ban on non-state issued money. For example, most supporters of FR in my experience have no objections to local currencies like the Bristol pound.
Second, what FR advocates do propose is that money creation by the ten or twenty largest banks (regular banks AND shadow banks) should be banned, and that represents a HUGE CUT in the amount of private money creation.
Third, money is defined in economics dictionaries as something like “anything widely accepted in payment for goods and services”. Now every high street shop accepts central bank notes (e.g. Bank of England £10 notes) and credit and debit cards issued by well-known private banks and card issuers.
However, high street shops certainly won’t accept Turner’s “promissory notes”. And those promissory notes are no use when buying a car or house.
Thus while Turner’s promissory notes arguably count as a form of money in financial centres, like the City of London, they’re not much use anywhere else in the country. Thus those notes are not a fully fledged type of money.
A third criticism that Turner makes of FR is thus.
“…the development of shadow banking illustrates the remarkable ability of innovative financial systems to replicate banklike maturity transformation and thus the creation of near-money equivalents outside the formal banking system. The challenge of constraining credit and money creation would not be wholly resolved by requiring the formal banking sector to hold 100% reserves.”
That point is partially answered above: i.e. while promissory notes are a form of “near-money”, they certainly are not what might be called “100% proof” or “genuine” money.
Another answer was spelled out very eloquently by Turner himself when he said in reference to shadow banks which up to now have avoided some of the regulations that apply to regular banks, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards…”.
If some drug is deemed harmful, then it makes no difference who makes or sells it – a lone individual or a multinational corporation – any such manufacture or sale should be banned.
However, in a sense, stopping private money creation is easier than stopping dangerous drug production. That is, dangerous drugs are indeed produced by individuals and families, and it’s clearly difficult to keep tabs on all those small producers. In contrast (to repeat), the smaller the organisation that tries to issue money, the less money-like is its so called money.
Indeed, someone who lends £10 to his next door neighbour is acting like a bank. There is clearly no need to regulate that sort of lender.
A fourth criticism of FR made by Turner relates to debt jubilees. That is, Turner casts doubt the idea put by Messers Benes and Kumhoff, namely that some sort of debt jubilee should be or has to be implemented when FR is first set up. That idea is indeed nonsense: there may be arguments for debt jubilees, but there is no need whatever to lump the introduction of FR and debt jubilees together. Plus I don’t know of any other advocates of FR who agree with that “lump together” idea.
Thus that weakness in Benes and Kumhoff’s argument is not a weakness in the overall argument for FR.
Turner also backs the existing bank system because of the maturity transformation it involves. As he puts it, “…banks can play a useful role in mobilizing capital investment that would not otherwise occur. Maturity-transforming banks enable long-term investments to be funded with short-term savings..”
I’ll deal with that point in a separate post in a day or two because this post is already long enough, plus the maturity transformation point is complicated.
Full reserve reduces debts.
A final irony about Turner’s criticisms of FR is that (as the title of his book more or less implies) he argues that one of the causes of the crisis was excessive private debts. As the opening sentence of Part II of his book puts it, “The most important reason the 2008 crisis was followed by such a deep recession and weak recovery was excessive private credit creation in the preceding decades.”
But one of the effects of FR is to REDUCE DEBTS! Indeed, the world is awash with people who deplore the size of private sector debts in one breath, and in the next, they advocate lots of lovely bank lending (which funds investments that “would not otherwise occur”) because that allegedly promotes economic growth.
FR forces banks to fund loans just from equity or equity like liabilities rather than from deposits. To the extent that that disposes of bank subsidies, that will clearly raise the cost of loans. The result will be a rise in interest rates and hence a reduction in loans and debts.
However, there is no reason to assume any reduction in aggregate demand or numbers employed because of any cut in demand stemming from FR. Any such cut can easily be countered with standard stimulatory measures: the stimulatory measure preferred by several FR advocates being to simply have the state print money and spend it into the private sector (and/or cut taxes). Plus the removal of unjustified subsides ought to increase GDP, not reduce it.
As for any idea that a rise in interest rates is some sort of problem, mortgagors in the 1980s were paying up to THREE TIMES the rate of interest that they pay nowadays. I don’t remember that being a huge problem.