Why should taxpayers support money printed by private banks?

 

Prior to the days when governments and their central banks (i.e. “the state”) created fiat money, money creation by private / commercial banks made sense. But now that states create money, the question arises as to which is better: state created money or private / commercial bank created money (henceforth just “banks”). After all, full employment is easily attained in “state money only” system simply by creating and spending state issued money into the economy up to the point where households have enough money to induce them to spend at a rate that brings full employment.

Well the first big advantage of state money is that it costs nothing to create and distribute, whereas banks have to check up on the credit worthiness of those they supply money to, obtain collateral / security off them etc. That all costs a significant amount.

Of course people can hold state money in the form of physical central bank notes, e.g. $100 bills, but precious few people want to store their money in the form of wads of $100 bills under the mattress.

Pro cyclicality.

A second drawback of bank money is that those banks create and lend out that money like there’s no tomorrow during a boom, thus exacerbating the boom. I.e. they act in a pro cyclical manner. That means that states have to take counter cyclical measures: mainly by issuing or withdrawing state issued money from the economy in a COUNTER cyclical manner. In short, given the availability of state created fiat money, bank money is just a nuisance.
 

Duplication of effort.

A third drawback of bank money, is that it has a nasty habit of going up in smoke unless it is backed by states (via deposit insurance and bank bail outs). That money “goes up in smoke” when a bank fails.

But that means that the state is in effect creating TWO FORMS of money: first state created money, and second, bank money which the state then stands behind. As Martin Wolf said, bankers are simply the most highly paid civil servants we have. Or as Steve Waldman put it, "Jamie Dimon is just a poorly supervised public servant who’s fibbed his way into exemption from the General Services pay scale."

That smells like duplication of effort: i.e. one of those two forms of money must be better than the other. And given the pro cyclical characteristics of bank money, which helped cause the biggest economic disaster in living memory, the 2007/8 bank crisis, it looks very much like it’s state created money which is better.

 

Conclusion.

State backing for bank money should cease, i.e. deposit insurance and bank bail outs should cease. The only form of totally safe money should be state created money. That’s not to say ALL FORMS of privately issued money (e.g. Bitcoin) should be banned, but where there is the remotest chance of the public getting the impression that those forms of money are safe, there should be clear health warnings on all relevant literature and web sites to the effect that the state will not give assistance to those who lose out where a bank, stablecoin outfit or similar fails and depositors’ money vanishes – except for accounts at private banks which are 100% backed by reserves, i.e. state created money.

That health warning would hopefully keep the market for risky money relatively small, as is currently the case with Bitcoin. Though obviously if the popularity of privately issued risky money grows too much and that form of money poses systemic risks, there would be a need to re-think that point.

Loans would cost more under full reserve banking?

 

A popular argument against full reserve banking is that funding bank loans via equity rather than deposits (which is what full reserve involves) would raise interest rates too much because equity holders charge for the risk carried, whereas depositors do not. That sort of argument was put by the UK’s “Independent Commission on Banking” para 3.21 and by Frances Coppola in her article “Full Reserve Banking, the largest bank bail out in history” (2012).

The first flaw in that argument is that where depositors fund loans, there is still a charge for risk: it’s just that the government’s deposit insurance system carries the risk and charges for it (or at least it s*dding well should do – though given the revolving door that exists between banksters and politicians, it is clear that politicians have offered banks sweetheart rates on deposit insurance premiums in the past). Indeed, if the latter equity holders and deposit insurance system gauge the risk correctly, then in theory they’ll charge the same amount!

Second, the latter “charge the same amount” conclusion is backed by empirical evidence. That is, there is a ready market for mortgage backed securities, particularly in the US, and those securities amount to funding loans (to mortgagors) via equity! So both the theory and evidence support full reserve.

As for Frances Coppola’s idea that full reserve is a bank bailout, that’s a bit rich given that she made that claim four years after the biggest bank bailout in history: just after the 2007/8 bank crisis. And that bailout was a bailout of the FRACTIONAL RESERVE system, not a FULL RESERVE system. Indeed, there is no reason for a full reserve bank system EVER to be bailed out, and for the simple reason that banks cannot fail under full reserve.

Why was interest ever paid on instant access accounts?

 
Reason for asking is that interest is earned for two reasons. First, the lender undertakes risk: the risk that the borrower may not return the money loaned. Second, the lender forgoes the right to spend the relevant sum of money.

But wait a moment: holders of instant access accounts undertake no risk in that they are protected by deposit insurance. And as to foregoing access to their money, they DO NOT forgo it: that’s why the accounts are called “instant access”!!

Of course it could be argued that holders of instant access accounts get next to no interest nowadays because of interest rates being at record lows. But that’s actually debatable: it can well be argued that interest earned by banks does actually cross subsidise or defray the cost of administering instant access accounts. So holders of those accounts do in effect still get a significant amount of interest.

But whatever the truth of the latter point, the above initial point that it’s curious that “holders” ever got any interest needs answering – unlike 95% of the human race, I have a nasty habit of asking fundamental questions…:-)

Well I suggest the explanation was set out (sort of) by David Hume 300 years ago when he said in his essay “Of Money” that politicians are always tempted to spend too much with a view to ingratiating themselves with voters, while collecting insufficient tax (for the same “ingratiating” reason). The result is that they have to borrow to make up the difference, and that forces up interest rates in general.

And that’s my provisional explanation for why holders of instant access accounts used to (and may still) get interest. But I’m not entirely sure I’m right.  

Odds and sods – installment No.1.

 

 

The system for adding to and editing the right hand column on this blog where I normally put short notes has gone haywire. Many others using this blog system have this problem periodically. So I’ll collect these short notes together and put them in this centre column for the time being. 

 

9th Aug 2021. Chinese archaeologists find the remains of a foundry in China dating from around 600 BC which was used to produce coins – coins which looked like spades as per above image.

  __________ 

9th Aug 2021. Good article on the history of money by Pavlina Tcherneva: written in 2016, but I’ve only just come across it.

Bank regulation is a farce.

 
 

The basic objective of bank regulation is to ensure banks are reasonably safe, i.e. that they are unlikely to do a repeat of the 2007/8 bank crisis.

The first questionable aspect of that whole effort is that the chairman of the main UK investigation into banks in the wake of the latter crisis, Sir John Vickers said that regulations are still nowhere near good enough. See article of his article entitled “Storm is coming….”.

But a more fundamental and nonsensical aspect of bank regulation is as follows.

The main element of those regulations consists of trying to ensuring that banks have enough capital to withstand a crisis, i.e. the objective is to ensure they do not take their “borrow short and lend long” activity too far. Borrow short and lend long is also known as “maturity transformation” (MT).

MT is profitable for banks because they can charge a higher rate of interest on “long loans” (e.g. mortgages) than they themselves have to pay to borrow funds short term (e.g. from bog standard bank depositors).

But MT allegedly has a merit, namely that it creates liquidity / money, as pointed out by Messers Diamond and Rajan in the abstract of their NBER working paper No. 7430.   So banks and bank regulators spend tens of thousands of hours arguing about how much of a constraint there needs to be in MT to give us reasonable safety without cutting too much into the apparent merit of MT, namely money / liquidity creation.

But wait a moment: it’s not only private / commercial banks that can create money / liquidity. Governments and their central banks (henceforth “the state”) can do that. Indeed, the state can create and issue whatever amount of money is needed to give us full employment! Plus that’s exactly what states have had to do in reaction to the latter crisis and Covid. So why bother with private / commercial banks’ money creation activities at all!

I.e. why not go for TOTAL AND COMPLETE SAFETY by simply banning all money creation by private banks? Put another why not adopt full reserve banking where loans are funded 100% by equity rather than deposits?  Moreover, private banks’ money creation efforts are basically just a nuisance: they create and lend out money like there’s no tomorrow in a boom, thus exacerbating booms. Then come a recession, they cut down on the latter activity, or even call in loans: again, exactly what is not wanted.

And that simply increases the amount of counter cyclical activity that states have to engage in.

As the Nobel Laureate economist, Merton Miller, put it reference to and in support of full reserve, “Think how much national economic welfare could rise . . . . . when thousands of no longer needed bank regulators (and hundreds of academic banking economists) find themselves forced at last to seek more socially productive lines of economic activity.”.

For more on the above points, see this recent article of mine.

Feeble criticisms of CBDC by Stephen Cecchetti and Kim Schoenholtz.

That’s in their Financial Times article, 28th July 2021, entitled “Now is not the time for central bank digital currencies”.

One of their arguments is that “By their nature CBDCs risk disintermediation…”. Well what of it? In other words what’s so wonderful about intermediation?

For example anyone can buy bonds in a corporation or alternatively they can buy a stake in a mutual fund which invests in those corporate bonds, in which case the mutual fund acts as an intermediary between them and the corporation. Now there’s nothing inherently wrong with mutual funds: they suit some people rather than buying bonds or shares DIRECT, i.e. without intermediation. But if there is a general move away from intermediation, what of it? That’s a choice which consumers / savers are fully entitled to make.

Next, Cecchetti and Schoenholtz say “Suppose there’s a bank run. It’s not hard to imagine that uninsured deposits would flee from private banks to the central bank, exacerbating the strains on the financial system.”
 

Now wait a moment. One of the promises that commercial banks make to their depositors,  with a view to making depositing money at a bank a more attractive proposition, is that those banks will turn deposited money into central bank issued money whenever those depositors so wish. Indeed, you exercise your right to turn money in your bank account, or some of it, into central bank issued money whenever you go to an ATM and withdraw £10 notes, $100 bills etc.

What on earth is wrong with people exercising a right they have under any contract they have with a bank or any other entity? Absolutely none! If banks want to make themselves less prone to runs, they are always free to place restrictions on withdrawals: there is no obligation on government to skew public policy in such a way as actually help commercial banks in that process.

Of course the result of a mass exodus from commercial bank accounts into CBDCs could well “exacerbate strains on the financial system” as the FT authors say. But that’s the fault of commercial banks for allowing customers a quick exit.

Next, the FT authors claim a big inflow of funds to CBDCs would tempt central banks to LEND OUT funds. Well that’s a strange argument. Central banks do not normally lend to private sector entities, and as for central banks buying up GOVERNMENT bonds, central banks only do that when they think stimulus is needed (which equals QE of course).

Next, they say “Finally, there’s the issue of privacy. As using CBDC means everything we do becomes traceable, it poses serious threats to personal liberty. In theory, outsourcing compliance to “narrow banks” holding CBDC could secure privacy, but that wouldn’t stop authoritarian states.”

Well the latter “outsourcing”, as the authors rightly say, does stop states having immediate access to details of account holders’ accounts – indeed, that sort of system where accounts fully backed by central bank money are actually administered by commercial banks has long been advocated by supporters of full reserve banking, e.g. Positive Money and Lawrence Kotlikoff.

But what on earth is the very vague phrase “that wouldn’t stop authoritarian states” supposed to mean? Obviously technical adjustments to how the bank system works does not stop some sort of Stalin or Hitler coming to power. Is that what they mean? Darned if I know.

The important point surely is that “outsourcing” makes CBDC similar to existing bank accounts where, at least in most countries, government or its agencies can spy on people’s bank accounts, though the state has to get permission first from a judge or magistrate and provide a good reason for wanting that access, e.g. a suspicion that the account holder is engaged in tax avoidance.
 
And the FT authors last sentence is “In our view, that means stopping well short of issuing universal, unlimited, interest-bearing CBDC.” Er – whence the assumption that CBDC accounts pay any interest? MMTers and Milton Friedman argued that ideally the state should pay NO INTEREST on its liabilities. I agree.
 

Government borrowing raises interest rates?

 

Numerous economists are less than entirely as to when government borrowing raises interest rates and when it doesn’t, for example the four economists pictured above in this SUERF article (2019). The economists are Elga Bartsch, Jean Boivin, Stanley Fischer, Philipp Hildebrand. They claim that “With global debt at record levels, major fiscal stimulus could raise interest rates…”. (Article title: “Dealing with the next downturn….”)

Perhaps I can clarify matters.

If a government relies exclusively on fiscal stimulus, a scenario the above authors consider, then it might seem that the extra borrowing needed “could raise interest rates”. But wait: if extra stimulus is needed then the central bank is not going to let interest rates rise!!!  Put it another way, it will simply QE most if not all the extra government bonds.

And what do you know? Since the above article was published, Covid has arrived and governments have done even more borrowing than the above authors probably envisaged. Lo and behold: central banks have QEd most of, indeed pretty much all of the additional government bonds!