Saturday, 26 April 2014

Warren Mosler tries to criticise full reserve.

Warren criticises Wolf’s recent Financial Times article on full reserve banking (aka 100% reserve banking). Basically Warren doesn’t say anything that seasoned advocates of full reserve like cannot demolish. So here goes…
Warren’s first criticism is that Wolf “has not yet defined ‘money’ for the purposes of this analysis”. Well the simple answer to that is that when no SPECIFIC definition of a word is given, the normal assumption is that the word is being used as per dictionary definition.

Bank subsidies.
Next, in the passage starting “Banking is not a normal market activity….”, Wolf correctly points to the fact that banking is not “normal” in that it is subsidised: he cites two subsidies, namely deposit insurance and the lender of last resort facility provided by central banks.
Incidentally, it’s important here to distinguish between different deposit insurance regimes, some of which constitute a subsidy, and some not. In the US, there’s the Federal Deposit Insurance Corporation which covers small banks and is funded by insurance premiums paid by small banks. Clearly that is not a subsidy. In contrast, deposit guarantees for larger banks in the US and all banks in the UK are funded by taxpayers. So that definitely IS A SUBSIDY.
Anyway, Warren clearly does not get the above subsidy point. That is, he does not answer Wolf’s valid criticism of the existing banking regime, namely that it is subsidised.

Next, Wolf makes the point that bank failures are destabilising, to which Warren answers “How about aggressive fiscal adjustments to sustain aggregate demand as needed?”
Well the answer to that is that “aggressive fiscal adjustments” can certainly do much to counter the effect of large scale bank collapses, but we’re still better off without those gyrations, aren’t we? If your kid suddenly jerks the steering wheel of your car in one direction you can probably compensate quick enough to avoid disaster, but you’re better off not letting the kid anywhere near the steering wheel.

Aggregate Demand.
Next, Warren says, “Yes, a 100% capital requirement, for example, would effectively limit lending. But, given the rest of today’s institutional structure, that would also dramatically reduce aggregate demand…”.
Well hang on: Warren said just above that the demand reducing effect of bank collapses don’t matter because “fiscal adjustments” can compensate. Now all of a sudden he’s implicitly saying fiscal adjustments can’t compensate for a drop in demand.
Moreover, there’s a difference between a sudden and unexpected collapse in the banking system, and a pre-planned rise in capital requirements up to 100%. In the first case, fiscal policy can perhaps avoid the worst effects of the banking collapse, but there are still dislocations. In contrast, the switch to full reserve can be done at any speed we like. For example the requirement could be raised by just 10% a year, which would mean the adjustment too place over a ten year period approximately (though personally I think, as does Positive Money, and as did Milton Friedman, that the switch can be made in much less than 10 years).

Types of money.
Next, Warren deals with this sentence of Wolf’s: “A maximum response would be to give the state a monopoly on money creation.” To which Warren responds, “The state is already the single supplier/monopolist of that which it demands for payment of taxes.”
False logic from Warren there. It’s true that taxes must be paid in the state’s money, but the state’s money is not the only form of money!!! Indeed, at the start of his post, Warren agrees that the vast majority of money (he cites 97%) is created by commercial banks, not the state.
Next, in relation to Irving Fisher’s claim that full reserve would “greatly reduce business cycles”, Warren repeats his point that full reserve would reduce demand. To repeat, as Warren himself correctly points out, the government / central bank machine can increase demand by any amount any time it likes.
And a few sentences later, Warren repeats (for the third time) his claim that full reserve reduces demand. He refers to a “vicious deflationary spiral to lower ‘real wages’..”. Now this is getting boring.
Advocates of full reserve are well aware of the fact that the INITIAL EFFECT of full reserve is to reduce demand. 

The IMF.
Next, Wolf says “A 2012 study by International Monetary Fund staff suggests this plan could work well.” to which Warren replies “No comment”.
That’s fair enough. Warren is a leading advocate of Modern Monetary Theory, and the IMF is widely regarded as incompetent in MMT circles. I had a look at the full reserve system set out by two IMF authors here, and wasn’t too impressed.
Next, Wolf refers to the fact that full reserve is supported by Laurence Kotlikoff, Ben Dyson and Andrew Jackson. Wolf could have added Milton Friedman and Hyman Minsky to that list.
Warren’s answer is the single sentence: “None of which have any kind of grasp on actual monetary operations.” That’s a totally useless sarcastic remark which I’m not going to bother answering. The above list of leading economists may be wrong, but the idea that you can write off their ideas with one single sarcastic sentence is ridiculous.
Next, in the passage starting “Today, state spending…” Warren makes the bizarre claim (for the second time) that base money is the only form of money. To repeat, has Warren himself pointed out at the start of his post, the vast majority of money  is commercial bank created money, not central bank created (i.e. base money).
Next, in the passage starting “So anyone who got paid…” and ending “Deficit spending does that.” Warren objects (for the FOURTH time) to the fact that full reserve reduces demand. For the FOURTH TIME, the answer was given by Warren himself: government and central bank can make good any deficiency in demand.
Plus Warren seems to object to the fact that Wolf’s advocacy of deficit spending as a means of dealing with the deflationary effect of introducing full reserve is not original. Well sure: the idea that deficit spending boosts demand is not original.
All the advocates of full reserve are saying (to repeat the point for the umpteenth time), is that introducing full reserve has a deflationary effect, and that can be countered with deficit spending.
Go back and re-read the latter paragraph sixteen times or a hundred and sixteen times if you like.

Too Big to Fail.
Next, in response to Wolf’s claim that full reserve would “end too big to fail”, Warren says, “That’s just a matter of shareholders losing when things go bad which is already the case.”
Whaaaat? Just shareholders losing?? Hasn’t Warren noticed the trillions of dollars of taxpayers’ money diverted into banksters’ pockets over the last four years?

Next, Warren objects to Wolf’s claim that full reserve “would also transfer seignorage – the benefits from creating money – to the public.” And that’s the first point that Warren gets right and Wolf gets wrong. Reasons are thus.
When the state creates $X and spends it on let’s say roads, the benefit of that money printing accrues just to the state or the citizenry (assuming the printing is not so excessive as to cause excess inflation). However, when a commercial bank lends $Y into existence, that does not boost bank profits by $Y: nowhere near. The bank charges interest of course, but it has to cover staff costs, paying for bad debts, etc. All in all, the bank may make a profit out of the loan, or may make a loss.

Permanent zero interest rates.
Next, in the passage starting “In any case…”, Warren points to the fact that, if as argued by full reserve advocates, the state simply creates and spends money into the economy when stimulus is needed (without paying interest to holders of that new money), then that comes to much the same as his own “permanent zero interest rate” policy. And Warren ends the passage by saying “But that doesn’t require any of the above institutional change, just an announcement by the cb that zero rates are permanent.”
Well it’s perfectly true that a zero interest rate policy does not require full reserve. Indeed that point is pretty obvious: several large Western countries have actually had a zero or near zero rate policy for the last four years or so without implementing full reserve.
However, it is false logic to argue, as Warren does, that because policy A involves B, and B can be achieved without A, that therefor A is devoid of merits. Travelling northwards from somewhere South London will get you across the river Thames. But crossing the Thames can be achieved in other ways. Ergo the London Underground is pointless?


  1. First of all:

    "Warren’s first criticism is that Wolf “has not yet defined ‘money’ for the purposes of this analysis”. Well the simple answer to that is that when no SPECIFIC definition of a word is given, the normal assumption is that the word is being used as per dictionary definition."

    You also have not specifically defined the "money" you are talking about. If you are referring to the textbook definition of money as "a unit of account, store of value, and medium of exchange", then you are not be specific enough at all.

    Lets demonstrate with this quote:

    "False logic from Warren there. It’s true that taxes must be paid in the state’s money, but the state’s money is not the only form of money!!! Indeed, at the start of his post, Warren agrees that the vast majority of money (he cites 97%) is created by commercial banks, not the state."

    No, Warren DOES NOT agree that that 97% of money is created by banks.

    Warren block quotes Wolf's statement:

    "In the UK, such deposits make up about 97 per cent of the money supply."

    and replies:

    "Yes, with ‘money supply’ specifically defined largely as said bank deposits."

    If you are defining money as commercial bank deposits (Which Wolf is doing" then yes 97% of bank deposits are created by private banks.

    But thats 'not the only type of money!'

    CB Balances are Govt currency. Entries in reserve accounts are obviously counted as a type of "money", but every security ever purchased was with reserves that were repo'd into existence by the Fed. Securities are simply term reserves that pay a higher interest. Exactly like CD's, which are included in broad money aggregates.

    Once we correctly account for the values of all monetary aggregates, we find that in the USA, $42 T in private debt created bank deposits and $17 T in accumulated Govt deficits. So private bank money only accounts for only 71% of the entire money supply.

  2. A couple questions Ralph:

    How does PM plan on getting the required reserves into the system?

    Would the CB simply do QE to add reserves, debiting securities accounts and crediting reserve accounts?
    This would only account for $17T out of the $42T in the USA, where would the other $25T come from?

    Would the Govt stop issuing securities? So that when it deficit spent, it would add that many reserves to the system? In that case, the US money supply has grown by an average of $2T every year between 2000 and 2008. If banks could no longer add to the growing money supply, then that $2T would have to come from deficits. I personally have no problem with that, but is this what PM advocates?

    1. Hi Auburn,

      I answered that point in my response to your Daily Kos article. See below.

    2. Auburn,

      Here is a hopefully better answer. (But note that I’m not an official spokesman for PM).

      As to how PM proposes getting base money into the economy (more or less the same as reserves) they propose having government and central bank simply create such money and spend it (and/or cut taxes) when stimulus is needed. That’s actually not much different to what’s happened recently in that fiscal stimulus followed by QE equals the above PM “print and spend” policy.

      Next there are reserves (if any) that banks are required to hold, and bear in mind that full reserve splits the banking industry into two halves: one half simply accepts deposits and organises check books, debit cards, etc. And the second lends, but it’s funded just by shareholders or quasi-shareholders.

      As to the first half, every dollar deposited must be backed by a dollar of reserves (or short term government debt). As to the second half, personally I see no need for any reserve requirements, a policy that has been adopted in several countries for decades. However PM have a rather complicated formula for determining the size of those reserves which I don’t like. So I part company with PM there (not that I’m 100% sure I’m right and they’re wrong).

    3. Ralph- You are missing my point.

      In the USA, there is roughly $42 T in outstanding bank debt.

      How in the world can you get $24T in reserves through deficit spending to get up to the 100% reserve requirement?

      QE can only be good up to $18T. Deficit spending on the scale of 150% of GDP is not some small thing that can be overlooked.

  3. “If you are defining money as commercial bank deposits, which Wolf is doing" then yes 97% of bank deposits are created by private banks.”

    Wolf gives no definition of money and nor do I. So by implication we are using the standard definition which is something like “anything widely accepted in payment for goods and services”. And the bank deposits are accepted in payment for goods and services (e.g. where I draw a check on my bank deposit). So bank deposits are “money” on the standard definition, aren’t they?

    Next, you say “But that’s not the only type of money!'” Agreed. But the fact that there are other types of money doesn’t stop deposits at commercial banks being money. Conclusion: I don’t see that Wolf’s arguments fall to pieces because he doesn’t define money.

    Re your claim in your last sentence that the relevant figure is 71% rather than 97% I have no quarrel with that. I actually drew attention to the flawed arguments behind the 97% figure 18 months ago here:

    Plus as a result of QE, there’s been a big increase in the amount of base money sloshing around which I drew attention to here:

    To judge by the chart shown at the latter post, the percentage looks like 80%. But obviously that’s a rough and ready way of calculating the percentage.

  4. Ralph-

    Its so weird, every time I read your posts and comment because I disagree with something, your respond in the comments in such a way that I then agree with your comments. Weird.

    I must say that I do agree with just about everything you responded with, sans the fact that you never acknowledged misquoting Mosler about the 97% part. But thats a minor quibble.

    Anyways, I have some questions about the PM proposal. Would you mind taking a look and giving your perspective? You don't have to reply at DKos, but thats where I've written all this up:

    1. Auburn,

      Herewith a comment. I was going to leave it on your site, but couldn’t see the “leave comment” facility: probably my browser being silly. Anyway, copy and paste the following to your site if you want.

      My only disagreement is with this passage:
      “In the Positive Money proposal, instead of bank lending increasing first and the level of reserves second. The reserves would have to come first through deficit spending, and then banks could make loans up to that amount of reserves.”

      Under full reserve (as set out by Positive Money, Laurence Kotlikoff and other advocates of full reserve), the existing banking industry is split in two. One half just accepts deposits and lodges the money at the central bank, or perhaps invests in short term government debt. The second half (funded by shareholders or people who are effectively shareholders) does the lending. Thus the total amount of lending is not much influenced the total amount of reserves or base money.

      The total amount of lending is determined by the desire / need to borrow and lend and by interest rates. Positive Money regards interest rates as a poor method for regulating demand (as do I). I.e. I assume PM believes simply in leaving interest rates to find their own free market level – a policy I support.

  5. Ralph-

    My comment this morning was a little sloppy. And I admit that the $42 T number is simply a reference to the FRED series, "Non-Financial Sectors; Total Credit Market Instruments" and that this is most likely not a 1 to 1 representation of the # of outstanding bank loans that would need reserves to cover them.

    So that leads to 2 questions:

    1) How would YOU define the number of bank loans in need of reserve creation to reach 100% backing? For example, would you use the $14T number in the "Bank Assets" table at the Fed? Does that represent the entirety of all bank loans?

    2) What mechanism would you advocate for using to meet the necessary $Trillions of reserves? Expanded QE? All Deficit spending without securities issuance?

    1. Auburn,

      Re your first question, remember that under full reserve, the bank industry is split in two. The half that holds the vast majority of reserves is the safe half: that’s the half where deposits must be backed by base money / reserves. Though possibly the deposits can be backed mainly by short term government debt, which is much the same as reserves.

      As to the second half, that does the lending. But personally I don’t think there is any need for a reserve requirement there, just as there is no reserve requirement imposed on banks in many countries right now. Positive Money thinks otherwise there. Indeed the difference between me and PM mirrors the difference between different countries that exists right now on the reserve requirement point.

      Re your question No 2, the answer is deficit spending. But there is a potential problem there for full reserve banking (I’m not sure if this is a serious problem) and it’s thus. What happens if the economy is at full employment and a significant number of depositors want extra money in safe accounts, but the relevant reserves just aren’t there?

      One answer is that the above extra saving is deflationary, so govt and central bank would automatically feed more base money into the economy to overcome that deficient demand.

      Second, banks could borrow reserves. That would cut the rewards for depositors holding safe accounts, which would cut demand for safe accounts and reserves. So there’s a sort of supply / demand thing there: should sort itself out, but I’m not 100% sure.

  6. Ralph-

    again, you are totally ignoring the questions. Your first response paragraph has absolutely nothing to do with what I asked. Yes, once we GET to 100% reserve, Money supply growth would be restricted to the deficit or net reserve injection.

    Lets try this again:

    1) How many reserves do you think need to be created to reach 100% loan backing and your source?

    2) What is the mechanism you plan to use to get there? We cant just deficit spend $14T worth of reserves into existence.

    100% backing has nothing do with deposits themselves. It has to do with making loans = creating money.

    Please respond to my actual questions.

    1. Auburn,

      I think I answered your points in two posts about two weeks ago. See: and

      But if that doesn't answer your points, fee free to come back to me.

  7. I don't agree with the assumptions nor with the conclusions of the advocates of full reserve banking.
    The 4 points mentioned by Ralph Musgrave of why he supports PM are, in my opinion, paralogisms.
    Furthermore, any kind of financial system can create instability if there's no proper asset side discipline (regulations) and not the proper macro fiscal policy in place to support the private credit structure.
    Also, no major country has fractional reserve banking!
    PS: A question for opponents of fractional reserve banking.


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