Guiseppe Fontana and Malcolm Sawyer’s claim that full reserve advocates are “cranks”.

Guiseppe Fontana and Malcolm Sawyer (F&S) published a paper in the Cambridge Journal of Economics in 2016 entitled “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’”.

The paragraphs below are quick summary of reasons for thinking that if any group of people are cranks, its Fontana and Sawyer rather than advocates of full reserve banking (FRB).

I’ve actually dealt with Fontana & Sawyer’s ideas on FRB before on this blog (Google: Ralphonomics..Sawyer….full reserve). But I thought I’d do a proper paper in the new year and place it at the Munich Repec. The draft of that paper is proceeding nicely, but I thought I’d do a quick summary or “taster” of it meanwhile. Some of the points below are repetitions of points made in the latter blog articles and some are new. So here goes….

1. F&S accuse FRB advocates of “disregarding established theoretical literatures”.

Well now that’s an odd claim given that the main target of F&S’s criticisms are works authored by  Ben Dyson (founder of Positive Money) and co-authors, and the fact that Ben Dyson and Andrew Jackson wrote a book entitled “Modernising Money” which contains around 160 works in its list of references.

Being moderately well acquainted, if not intimately acquainted with 160 works on a particular topic, does not equal “disregarding established theoretical literatures” on that topic in my books. But what do I know?

2. One of the main arguments for full reserve was put by Joseph Huber in his work “Creating New Money” (p.31), which is that the right of commercial banks (aka money lenders) to simply create the money they lend out from thin air is a subsidy of those money lenders.

F&S however do not deal with Huber’s point. Plus Huber does not appear in F&S’s list of references. That rather raises the question as to exactly who is guilty of “disregarding established theoretical literatures”.

Another point which calls into question F&S’s grasp of “established theoretical literatures” is they seem to be unaware that several Nobel laureate economists have backed FRB, e.g. Milton Friedman, Maurice Allais and Merton Miller.

F&S do mention Friedman, but not his support for FRB. As for Miller and Allais, they are not mentioned at all.

3. F&S devote between a quarter and a third of their paper to criticising an idea put by some advocates of FRB, including Dyson & Co, namely what is sometimes called “overt money creation” (OMC).  That’s the idea that the state (i.e. government and central bank), when stimulus is needed, should simply create new base money and spend it (and/or cut taxes).

The problem with that criticism of FRB is that OMC is not an inherent characteristic of FRB: it’s simply for the form of stimulus favoured by SOME FRB advocates. To illustrate, Ben Bernanke and Adair Turner have made approving noises about OMC without at the same time advocating FRB. (For Bernanke, see passage starting “So, how could the legislature….” here)

Put another way, it would be perfectly possible to implement FRB while sticking with the existing methods of adjusting demand, like interest rate adjustments.

4. In their section 2 sub-section 4, F&S challenge the claim made by FRB advocates that “The new supply of bank loans creates an equal increase in the amount of outstanding debt in the economy.”

Well the first problem there is that it’s not just FRB advocates who make that claim: it’s a fairly widely accepted truism in economics that commercial bank created money “nets to nothing”. I.e. that for every dollar of such money there is a dollar of debt owed to a commercial bank.

For an example of an economist who is not an FRB advocate but who nevertheless supports the latter “nets to nothing” point, see articles entitled “Deficit spending 101 – Part 3” and “Money Multiplier and other Myths” by Bill Mitchell.

Thus it rather looks like F&S have not got to grips with the basic book-keeping entries that commercial banks make when granting loans.

5. F&S’s section 2, subsection 5 starts with the bizarre claim that “The current accounting of money as a debt–credit relationship is a relic of the past, when banknotes were backed by and redeemable for gold.”

Well that will be news to Bill Mitchell. It will also be news to the authors of numerous economics text books. For example Armen Alchain and William Allen in their book “University Economics” Ch29 say “A possibly surprising idea is that debt is money, provided the debt is a particular kind owed by a commercial bank….”.

6. Another indication that F&S do not understand the basic book-keeping entries done by central and commercial bank comes in this passage of theirs.

F&S start by quoting a passage from one FRB advocate, Herman Daly which is thus. “With 100% reserves every dollar loaned to a borrower would be a dollar previously saved by a time account depositor (and not available to the depositor during the period of the loan), thereby re-establishing the classical balance between abstinence and investment. With credit limited by saving (abstinence from consumption) there will be less lending and borrowing and it will be done more carefully.”

F&S then say…

“The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources. More importantly, the quote above indicates an inherently deflationary bias of FRB proposals, which is likely to produce recessions and financial instability.”

Well for anyone who understands how banks, commercial and central, actually work, the question as to where the latter “prior savings” come from is not too difficult. It is thus. Under present arrangements, governments engage in fiscal stimulus which consists of their borrowing $X, spending $X back into the private sector and giving bonds  worth $X to those they have borrowed from. The result is that private sector paper assets rise by $X. Hey presto: we have uncovered a source of “prior savings” (of a sort, anyway)!

Of course central banks can then create base money and buy back those bonds as they see fit (with a view to cutting interest rates and/or implementing QE). In that case, the latter bonds in the hands of the private sector are converted to dollars. But that just alters the nature of the “prior savings” a bit. But note that those dollars have been created WITHOUT a commercial bank making a loan, which according to F&S is impossible.

And moving on to OMC (where the state by-passes the latter bonds and simply creates money and spends it), if the state simply creates $X and spends it, then private sector “prior savings” rise by $X. And that’s just a slightly different way of creating those allegedly “impossible to create” dollars.

To summarise, that all makes a nonsense of F&S’s claim that “It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount.”

7. In section 3 (and in their abstract), F&S accuse FRB of having a “deflationary bias”.

Well it’s certainly true that lending and borrowing are more difficult under FRB, i.e. that interest rates would be higher. But any deflationary effect of that is easily countered by standard stimulatory measures, the one favoured by most FRB advocates being OMC. Magic: problem solved!

Moreover, as Milton Friedman rightly said, stimulus dollars cost nothing in real terms. So the solution to F&S’s alleged problem is costless.

Plus it is far from clear that the low interest rates that obtain at the time of writing are an unmixed blessing: they have resulted in record levels of debt and an unprecedented rise in house prices.

8. In their section 3, F&S make the revelatory pronouncement that “However, one of the main lessons from the work of Minsky and other Post Keynesian economists is that the demand for and supply of bank loans via the financing of the production of goods and services (investment) are an integral aspect of the operation of real-world economies.”

Good heavens – so bank loans are an essential part of 21st century economies? You learn something every day, don’t you?

I suspect we’d all be aware that bank loans are a good idea without any assistance from Minsky or Post Keynsian economists. I mean was no one aware that bank loans are good idea BEFORE Minsky and Post Keynsians appeared on the scene?

And another flaw in the latter F&S claim is that bank loans do not suddenly become impossible under FRB: all that happens (to repeat) is that interest rates rise a bit.

9. In their section 4, F&S claim that the difference between the transaction accounts and investment accounts under FRB is sufficiently small that banks would be able to turn investment accounts into what are effectively transaction accounts and thus get instant access money to fund loans.

Well that depends on exactly how the two types of accounts are structured. Clearly it would be POSSIBLE to have the difference between the two so small that there is effectively no difference.

On the other hand under the type of FRB system advocated by Laurence Kotlikoff, investment accounts simply take the form of unit trusts (mutual funds in US parlance), no different from the hundreds of unit trusts already available. Far as I know, no one has claimed that such unit trusts constitute instant access money. Certainly if anyone putting £X into a unit trust tried to claim they had a right to have their £X back when the trust performed poorly, they’d be laughed at.

10. F&S make the tired old claim that under FRB, the cost of transaction (aka instant access) accounts would rise for bank customers.

Well true: costs certainly would rise. But costs (aka bank charges) are only as low as they are at the moment because instant access accounts are subsidised by banks’ money lending activities. 

There is no particular merit in cross subsidisation: e.g. there is no particular merit in apple growers subsidising potato growers. Indeed, cross subsidisation is normally frowned on in economics.

11. A  final indication that F&S have little grasp of basic central bank and commercial bank transactions and book-keeping entries is that in their section 5 they say “Another controversial aspect of FRB proposals is the claimed relationship between the money creation process and budget decisions. Currently, the government decides the level of expenditure, and then the Treasury finances it through a loan from either commercial banks or the central bank.”

That quote should cause your jaw to drop, or to cause you to fall off your chair laughing.

First, governments do not finance expenditure, at least in the first instance, “from either commercial banks or the central bank”.  The reality is that government spending is financed mainly via tax.

Next, to the extent that income from tax is not enough to cover spending, governments resort to borrowing, though in some years there is no need to resort to borrowing because tax covers spending.

Next, where borrowing does take place, governments do not borrow primarily from “commercial banks or the central bank”. What they actually do is offer to borrow, with absolutely ANYONE being entitled lend, i.e. to purchase government bonds. The main purchasers (contrary to F&S’s suggestions) are pension funds, insurance companies and foreign entities of one sort or another (e.g. foreign governments). E.g. this source gives the proportion of government debt purchased by domestic commercial banks as just 4%.

https://www.justfacts.com/nationaldebt.asp
Next, government spending is not covered in the first instance by loans from central banks. To repeat, governments borrow from all and sundry. Relevant central banks may or may not subsequently create money and buy back some of the bonds issued by government (i.e. in effect, lend to governement ). Central banks will do that if they think interest rate cuts or QE is needed, but not otherwise.


Conclusion.

I do not wish to suggest that advocates of FRB never make mistakes. Indeed F&S do correctly identify one or two. But, to put it mildly, Fontana and Sawyer are not exactly up to speed on the subject of full reserve banking: if anyone is a “crank”, it’s Messers Fontana and Sawyer.

As for whether I’ll submit my paper to the Cambridge Journal of Economics, I certainly won’t. They appear to be more interested in pseudo intellectual wind and waffle than actually solving economic problems.









Guiseppe Fontana and Malcolm Sawyer’s claim that full reserve advocates are “cranks”.
Guiseppe Fontana and Malcolm Sawyer (F&S) published a paper in the Cambridge Journal of Economics in 2016 entitled “Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’”.

The paragraphs below are quick summary of reasons for thinking that if any group of people are cranks, its Fontana and Sawyer rather than advocates of full reserve banking (FRB).

I’ve actually dealt with Fontana & Sawyer’s ideas on FRB before on this blog (Google: Ralphonomics..Sawyer….full reserve). But I thought I’d do a proper paper in the new year and place it at the Munich Repec. The draft of that paper is proceeding nicely, but I thought I’d do a quick summary or “taster” of it meanwhile. Some of the points below are repetitions of points made in the latter blog articles and some are new. So here goes….

1. F&S accuse FRB advocates of “disregarding established theoretical literatures”.

Well now that’s an odd claim given that the main target of F&S’s criticisms are works authored by  Ben Dyson (founder of Positive Money) and co-authors, and the fact that Ben Dyson and Andrew Jackson wrote a book entitled “Modernising Money” which contains around 160 works in its list of references.

Being moderately well acquainted, if not intimately acquainted with 160 works on a particular topic, does not equal “disregarding established theoretical literatures” on that topic in my books. But what do I know?

2. One of the main arguments for full reserve was put by Joseph Huber in his work “Creating New Money” (p.31), which is that the right of commercial banks (aka money lenders) to simply create the money they lend out from thin air is a subsidy of those money lenders.

F&S however do not deal with Huber’s point. Plus Huber does not appear in F&S’s list of references. That rather raises the question as to exactly who is guilty of “disregarding established theoretical literatures”.

Another point which calls into question F&S’s grasp of “established theoretical literatures” is they seem to be unaware that several Nobel laureate economists have backed FRB, e.g. Milton Friedman, Maurice Allais and Merton Miller.

F&S do mention Friedman, but not his support for FRB. As for Miller and Allais, they are not mentioned at all.

3. F&S devote between a quarter and a third of their paper to criticising an idea put by some advocates of FRB, including Dyson & Co, namely what is sometimes called “overt money creation” (OMC).  That’s the idea that the state (i.e. government and central bank), when stimulus is needed, should simply create new base money and spend it (and/or cut taxes).

The problem with that criticism of FRB is that OMC is not an inherent characteristic of FRB: it’s simply for the form of stimulus favoured by SOME FRB advocates. To illustrate, Ben Bernanke and Adair Turner have made approving noises about OMC without at the same time advocating FRB. (For Bernanke, see passage starting “So, how could the legislature….” here)

https://www.brookings.edu/blog/ben-bernanke/2016/04/11/what-tools-does-the-fed-have-left-part-3-helicopter-money/
Put another way, it would be perfectly possible to implement FRB while sticking with the existing methods of adjusting demand, like interest rate adjustments.

4. In their section 2 sub-section 4, F&S challenge the claim made by FRB advocates that “The new supply of bank loans creates an equal increase in the amount of outstanding debt in the economy.”

Well the first problem there is that it’s not just FRB advocates who make that claim: it’s a fairly widely accepted truism in economics that commercial bank created money “nets to nothing”. I.e. that for every dollar of such money there is a dollar of debt owed to a commercial bank.

For an example of an economist who is not an FRB advocate but who nevertheless supports the latter “nets to nothing” point, see articles entitled “Deficit spending 101 – Part 3” and “Money Multiplier and other Myths” by Bill Mitchell.

http://bilbo.economicoutlook.net/blog/?p=381
http://bilbo.economicoutlook.net/blog/?p=1623
Thus it rather looks like F&S have not got to grips with the basic book-keeping entries that commercial banks make when granting loans.

5. F&S’s section 2, subsection 5 starts with the bizarre claim that “The current accounting of money as a debt–credit relationship is a relic of the past, when banknotes were backed by and redeemable for gold.”

Well that will be news to Bill Mitchell. It will also be news to the authors of numerous economics text books. For example Armen Alchain and William Allen in their book “University Economics” Ch29 say “A possibly surprising idea is that debt is money, provided the debt is a particular kind owed by a commercial bank….”.

6. Another indication that F&S do not understand the basic book-keeping entries done by central and commercial bank comes in this passage of theirs.

F&S start by quoting a passage from one FRB advocate, Herman Daly which is thus. “With 100% reserves every dollar loaned to a borrower would be a dollar previously saved by a time account depositor (and not available to the depositor during the period of the loan), thereby re-establishing the classical balance between abstinence and investment. With credit limited by saving (abstinence from consumption) there will be less lending and borrowing and it will be done more carefully.”

F&S then say…

“The second inconsistency is that it is not clear where the prior savings alluded to by Daly and other advocates of FRB have come from. It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount. Therefore, at least initially there must have been a process of credit creation in the economy, which was completely unconstrained and unrelated to pre-existing resources. More importantly, the quote above indicates an inherently deflationary bias of FRB proposals, which is likely to produce recessions and financial instability.”

Well for anyone who understands how banks, commercial and central, actually work, the question as to where the latter “prior savings” come from is not too difficult. It is thus. Under present arrangements, governments engage in fiscal stimulus which consists of their borrowing $X, spending $X back into the private sector and giving bonds  worth $X to those they have borrowed from. The result is that private sector paper assets rise by $X. Hey presto: we have uncovered a source of “prior savings” (of a sort, anyway)!

Of course central banks can then create base money and buy back those bonds as they see fit (with a view to cutting interest rates and/or implementing QE). In that case, the latter bonds in the hands of the private sector are converted to dollars. But that just alters the nature of the “prior savings” a bit. But note that those dollars have been created WITHOUT a commercial bank making a loan, which according to F&S is impossible.

And moving on to OMC (where the state by-passes the latter bonds and simply creates money and spends it), if the state simply creates $X and spends it, then private sector “prior savings” rise by $X. And that’s just a slightly different way of creating those allegedly “impossible to create” dollars.

To summarise, that all makes a nonsense of F&S’s claim that “It is technically impossible for banks as a whole to collect deposits without at the same time granting loans for the same amount.”

7. In section 3 (and in their abstract), F&S accuse FRB of having a “deflationary bias”.

Well it’s certainly true that lending and borrowing are more difficult under FRB, i.e. that interest rates would be higher. But any deflationary effect of that is easily countered by standard stimulatory measures, the one favoured by most FRB advocates being OMC. Magic: problem solved!

Moreover, as Milton Friedman rightly said, stimulus dollars cost nothing in real terms. So the solution to F&S’s alleged problem is costless.

Plus it is far from clear that the low interest rates that obtain at the time of writing are an unmixed blessing: they have resulted in record levels of debt and an unprecedented rise in house prices.

8. In their section 3, F&S make the revelatory pronouncement that “However, one of the main lessons from the work of Minsky and other Post Keynesian economists is that the demand for and supply of bank loans via the financing of the production of goods and services (investment) are an integral aspect of the operation of real-world economies.”

Good heavens – so bank loans are an essential part of 21st century economies? You learn something every day, don’t you?

I suspect we’d all be aware that bank loans are a good idea without any assistance from Minsky or Post Keynsian economists. I mean was no one aware that bank loans are good idea BEFORE Minsky and Post Keynsians appeared on the scene?

And another flaw in the latter F&S claim is that bank loans do not suddenly become impossible under FRB: all that happens (to repeat) is that interest rates rise a bit.

9. In their section 4, F&S claim that the difference between the transaction accounts and investment accounts under FRB is sufficiently small that banks would be able to turn investment accounts into what are effectively transaction accounts and thus get instant access money to fund loans.

Well that depends on exactly how the two types of accounts are structured. Clearly it would be POSSIBLE to have the difference between the two so small that there is effectively no difference.

On the other hand under the type of FRB system advocated by Laurence Kotlikoff, investment accounts simply take the form of unit trusts (mutual funds in US parlance), no different from the hundreds of unit trusts already available. Far as I know, no one has claimed that such unit trusts constitute instant access money. Certainly if anyone putting £X into a unit trust tried to claim they had a right to have their £X back when the trust performed poorly, they’d be laughed at.

10. F&S make the tired old claim that under FRB, the cost of transaction (aka instant access) accounts would rise for bank customers.

Well true: costs certainly would rise. But costs (aka bank charges) are only as low as they are at the moment because instant access accounts are subsidised by banks’ money lending activities. 

There is no particular merit in cross subsidisation: e.g. there is no particular merit in apple growers subsidising potato growers. Indeed, cross subsidisation is normally frowned on in economics.

11. A  final indication that F&S have little grasp of basic central bank and commercial bank transactions and book-keeping entries is that in their section 5 they say “Another controversial aspect of FRB proposals is the claimed relationship between the money creation process and budget decisions. Currently, the government decides the level of expenditure, and then the Treasury finances it through a loan from either commercial banks or the central bank.”

That quote should cause your jaw to drop, or to cause you to fall off your chair laughing.

First, governments do not finance expenditure, at least in the first instance, “from either commercial banks or the central bank”.  The reality is that government spending is financed mainly via tax.

Next, to the extent that income from tax is not enough to cover spending, governments resort to borrowing, though in some years there is no need to resort to borrowing because tax covers spending.

Next, where borrowing does take place, governments do not borrow primarily from “commercial banks or the central bank”. What they actually do is offer to borrow, with absolutely ANYONE being entitled lend, i.e. to purchase government bonds. The main purchasers (contrary to F&S’s suggestions) are pension funds, insurance companies and foreign entities of one sort or another (e.g. foreign governments). E.g. this source gives the proportion of government debt purchased by domestic commercial banks as just 4%.

https://www.justfacts.com/nationaldebt.asp
Next, government spending is not covered in the first instance by loans from central banks. To repeat, governments borrow from all and sundry. Relevant central banks may or may not subsequently create money and buy back some of the bonds issued by government (i.e. in effect, lend to governement ). Central banks will do that if they think interest rate cuts or QE is needed, but not otherwise.


X Conclusion.

I do not wish to suggest that advocates of FRB never make mistakes. Indeed F&S do correctly identify one or two. But, to put it mildly, Fontana and Sawyer are not exactly up to speed on the subject of full reserve banking: if anyone is a “crank”, it’s Messers Fontana and Sawyer.

As for whether I’ll submit my paper to the Cambridge Journal of Economics, I certainly won’t. They appear to be more interested in pseudo intellectual wind and waffle than actually solving economic problems.