Minsky’s absurd objections to full reserve banking.

Jan Kregel wrote an article on Minsky’s views on full reserve banking entitled “Minsky and the narrow banking proposal..” (Public Policy Brief, No.125, published by the Levy Economics Institute of Bard College). “Narrow banking” as defined by Minsky is the same as what is normally called “full reserve banking”.

I actually tackled this article of Kregel’s five years ago in 2012, and set out some flaws in it. However, on re-reading Kregel’s article, it struck me there are even more flaws to be exposed. This present article runs thru some of the flaws I set out in 2012 and in addition deals with two or three new ones.

The first objection to full reserve cited by Kregel is one not actually raised by Minsky, but rather by Neil Wallace, whose objection is that full reserve “eliminates the banking system”  (p.5, 2nd column).

Well the answer to that is that advocates of full reserve are well aware that full reserve is such a fundamental change to the bank system that it is perfectly fair to describe that change is “eliminating the banking system” as we know it.

Indeed Matthew Klein penned an article, published by Bloomberg, in support of full reserve entitled “The Best Way to Save Banking is to Kill It”.

You could say the internal combustion engine is inherent to the definition of the word “car”, and thus that banning internal combustion engines and replacing them with electric motors and batteries equals the end of the motor car. That, however, is just semantics. The important question is whether fundamental changes to banking or cars make sense.


Stability.

The next objection to full reserve cited by Kregel and made by Minsky is: “such a system could neither ensure the stability of the real economy nor assure stability of the capital financing institutions…”. The answer to that is as follows.

The advocates of full reserve never claimed that full reserve would actually bring the above “stability”. For example a work by Positive Money and co-authors which advocates full reserve and is entitled “Towards a Twenty-first Century Banking and Monetary System” specifically says that demand management under full reserve is needed just as under the existing system.

Moreover, the implication in the above “stability” quote from Kregel’s article that the EXISTING bank system brings stability is hilarious. As readers may have noticed, we had a major bank crisis in 2007/8 which gave rise to a ten year long recession.


Return on investments.

The above “stability” quote from Kregel’s article continues as follows.

“First, the real investments chosen could still fail to produce the anticipated rate of return; and second, sectoral over-investment and financial bubbles could still exist if there were herding behavior by the investment advisers of the trusts that produced pro-cyclical financing behavior. There would always be a risk of investors calling on the government to save them from financial ruin.”

First, as regards “investments” which “fail to produce the anticipated rate of return”, that’s hardly unusual under the EXISTING system!!!! Ford’s disastrous Edsel car did not cause the sky to fall in.

As regards the idea that investors might “call on government to save them from financial ruin”, investors under the existing system do not normally go running to government for help when faced with ruin,  and they normally get short shrift when they do. There is no general expectation that government comes to the rescue when there’s a stock market crash.  Exactly the same would apply under full reserve.

Of course there are well known cases of where governments HAVE STEPPED IN under the existing system: e.g. General Motors and Chrysler were given government assistance in 2008. And then there were the trillions loaned to banks at sweetheart rates of interest during the recent crisis. Thus the charge by defenders of the existing bank system that under full reserve there’d be instances of taxpayer funded assistance is a joke: the words pot, kettle and black spring to mind.


Demand management.

The next objection to full reserve has to do with demand management, and is in effect just a repetition of the above mentioned demand management objection.  Kregel says “In such a system it is evident that total private saving would exceed investment by the private sector’s holdings of narrow bank deposits and government currency, creating a tendency toward deflation or recession.”

Well the quick answer to that is that, as already pointed out, advocates of full reserve are well aware that demand management is still needed under full reserve.


Large government sector needed?

Next, Kregel says “In the absence of a large government sector to support incomes, liabilities used to finance investment could not be validated in a narrow bank holding company structure.”

I’ve no idea what that’s supposed to mean. But the claim that a “large government sector” is needed is nonsense. What IS NEEDED as already pointed out, is demand management, i.e. deficits (and maybe the occasional surplus). But deficits are easily arranged even given a government sector half the present size.

To illustrate, public spending as a percentage of GDP in the US is near 40%. If that were halved, that would mean a deficit equal to about 20% of GDP would be no problem at all: that could be done by government ceasing to collect any tax and continuing to spend at a rate that equalled 20% of GDP. And of course a deficit equal to 20% of GDP is truly massive: it’s unheard of, thus the “large government sector” alleged problem mentioned above is nonsense.


Innovation.

Next, Kregel says, “But, even more important, it would be impossible in such a system for banks to act as the handmaiden to innovation and creative destruction by providing entrepreneurs the purchasing power necessary for them to appropriate the assets required for their innovative investments. In the absence of private sector “ liquidity” creation, the central bank would have to provide financing for private sector investment trust liabilities, or a government development bank could finance innovation through the issue of debt monetized by the central bank.”

Frankly this is getting more absurd with each succeeding paragraph. It is also not entirely clear whether the latter objection to full reserve is Minsky’s or Kregel’s.

At any rate, as Kregel himself explains earlier in his article, under full reserve, all funds supplied to non-bank corporations come effectively via equity and bonds rather than via bank loans which themselves are funded via deposits. Thus the idea that under full reserve, non-bank corporations and firms have no way of obtaining “purchasing power” is pure, unadulterated nonsense. They just get their purchasing power in a slightly different way.

Indeed, some corporations under the EXISTING SYSTEM choose to fund themselves mainly via equity rather than bank loans: for example Google is funded 90% by equity, and Google is hardly a failure when it comes to “innovative investments”.


Conclusion.

Minsky and Kregel’s criticisms of narrow / full reserve banking are hopeless.