Tuesday, 1 July 2014

Marsall Auerback’s flawed ideas on full reserve.

I left a comment after this article by Marshall 48 hours ago. The article is entitled “The payments system is what matters”. But it looks like he doesn’t want to publish my comment, so I’ve reproduced his article below (in green) interspersed with my comments. He starts…
In a recent paper, ‘Money creation in the modern economy’[2] Bank of England staff explained that:
‘[B]anks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits … Commercial banks create money, in the form of bank deposits, by making new loans.’
Because there is widespread confusion about the role of banks in creating money, it did not take long for the Bank of England’s report to ignite debate on the comment pages of the Financial Times. In his regular column, Martin Wolf called for private banks to be stripped of their power to create money.
Wolf’s proposals are radical, and would give a small committee – independent of the state – a monopoly on money creation. His ideas are based on the Chicago Plan, advanced among others by Irving Fisher in the 1930s, and shared today by the UK NGO, Positive Money. They agree that all ‘decisions on money creation would … be taken by a committee independent of government’.
Furthermore, Wolf argues, private commercial banks would only be allowed to:
‘…loan money actually invested by customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are.’
I have no issue with nationalizing the banks……

Nationalising banks.
Oops. Advocates of full reserve ARE NOT for or against nationalising banks. Certaintly Positive Money very clear about having no opinion on that matter. What they favour is nationalising the MONEY CREATION SYSTEM. Or in the words of Irving Fisher (an advocate of full reserve in the 1930s), “We could leave the banks free, or at any rate far freer than they are now, to lend money as they please, provided we no longer allowed them to manufacture the money which they lend.” (To be strictly accurate, that sentence of Fisher’s doesn’t SPECIFICALLY say anything about nationalising banks, but I think it’s fairly obvious that Fisher is not in favour of nationalisation.) Anyway, Marshall continues….
I have no issue with nationalizing the banks, but a safe payments system could easily be solved via a narrow banking model.  The problem with the 100% reserve banking model is that it doesn’t deal with the kinds of exogenous shocks we had in 2008.  100% reserve banking simply replaces deposit insurance–it doesn’t stop private money creation.

The boom bust cycle.
Well first, advocates of FR don’t claim that FR totally abolishes the boom bust cycle. However, the indisputable fact is that commercial bank created money in the UK was expanding like there’s no tomorrow in the years prior the recent crisis. Then the expansion ground to a halt come the crisis (as it always does in a bust).
Indeed, in some busts, the stock of privately created money goes into reverse. As Fisher put it, “The most outstanding fact of the last depression is the destruction of eight billion dollars-over a third-of our "check-book money"-demand deposits.”  That’s probably something like $80bn in today’s money. (The quote is from Fisher’s book, “100% Money and the Public Debt”.)
That disappearance of $8bn would presumably have been accounted partly by banks going bust and telling ordinary households, “Sorry, we’ve lost your money”. And partly the “disappearance” would have been accounted for by the repayment of debts to banks.
Second, and contrary to Marshall’s above point, FR actually does ameliorate his “exogenous shocks”. Reason is that under the existing system where banks are funded about 3% by shareholders and 97% by depositors and other types of creditor whose stake in the bank is fixed in terms of dollars, banks’ assets only have to decline by about 3% (due to silly loans being made or whatever) and the relevant banks are technically insolvent. Hey presto: we get a Northern Rock, a Lehmans, etc.
In contrast, under FR banks or lending entities are funded just by shareholders, it is thus virtually impossible for them to suddenly go insolvent. And that ought to bring a HUGE REDUCTION in “exogenous shocks”.  Marshall continues…
Further, you could nationalize all the banks to at least get rid of private “deposit” creation in name, but there will still be essentially the same thing (albeit more like investment bank “shares” through the “back door” of providing the non-bank FIs with lines of credit, which you MUST do).  The AMI and positive money folks think that the non-nationalized FIs–whether banks or not–wouldn’t be able to create credit endogenously under their proposals, and they’re just wrong.
Now I’m not entirely sure what Marshall means there, but it looks like he is saying that if lending entities are barred from funding themselves from traditional deposits and similar, then they’ll resort to funding themselves via the “shares” to which Marshall refers. And my answer is: “quite right, and that’s exactly what advocates of FR propose”. That is, FR (to repeat) advocates that lending entities be funded just by shares.
Impossible to ban private money?
And Marshall’s final paragraph is:
Private endogenous credit creation predates capitalism by 1000s of years–you can’t get rid of it, and you really don’t want to; but you can and should regulate it a la Minsky.
Now the word “credit” is too vague. For example there is “trade credit”, i.e. the debt that arises  when one person or firm supplies goods or services to another, and which is extinguished when payment is made. Advocates of FR have no objection that that sort of credit. What they do object to is turning private debts into a form of money.
As to Marshall’s claim that “you can’t get rid” of privately created money, that’s true in that there is no sharp dividing line between money and non-money. It’s also true in that there is nothing to stop INDIVIDUAL PEOPLE or small firms trying to issue IOUs in payment for goods and services, and trying to persuade the supplier of those goods and services that the IOU is as good as a dollar bill. However, they’d be wasting their time 99.9% of the time. The bald fact is that my local supermarket or garage is never going to accept an IOU from me in payment for groceries or a new car. (Me using a credit card is different: that amounts to the credit card issuer, which will be an entity with assets well into the billions, issuing the IOU.)
Thus it’s only relatively large firms / lending entities / banks that the authorities need to keep an eye on if FR is to be implemented. Moreover, I’m personally not even in favor of even trying to ban every single form of privately created money. I’d be happy to leave local currencies in place: they’re a bit of fun, and can’t do much harm. 
However, since local currencies are not accepted outside the locality concerned, it's debatable as to whether they constitute money. Remember that the definiton of money is something like "anything WIDELY ACCEPTED in payment for goods and services". And local currencies are obviously not accepted over a very wide geographical area. Plus they're not even guaranteed to be accepted WITHIN the relevant area.


  1. The Canadian colonies (pre-1867) had a shortage of "official" money, and tokens were heavily used as currency. Practically any business of any size issued tokens. I'm not an expert othat period, but that was a situation I doubt that a modern state would want to end up in.

    The shadow banking system would rapidly take over the role of financing if a 100% reserve policy was implemented. There is very little the regulators could do about it, given the flexibility of contract law of the English legal system. Within a decade, the economy would be dependent upon the new shadow banking systems, and the government would be forced to ratify the private sector arrangements when a crisis hit.

    In other words, exactly what happened to the banking system.

    Beyond creating a Postal banking system, I doubt that reforms of this nature would have anything other than a cosmetic effect.

    1. Brian,

      Yes, and in the 1800s, metal bashers in Britain turned out their own coins because government didn’t supply enough. Plus bills of exchange were a common form of quasi-currency (issued by rich individuals and larger firms). But assuming the authorities supply enough money to keep the economy at full employment, that reduces the incentive for anyone else to create money.

      Also its plain impossible for INDIVIDUALS and small firms to issue IOUs and have them widely accepted. You yourself won’t have tried paying for food in a supermarket or paying for a car using home made IOUs because you know you’d be wasting your time.

      As to larger firms and banks (including shadow banks) they’re easy to keep any eye on. If the tax authorities can trip of self employed plumbers earning $50,000 a year and not declaring their income, then the authorities shouldn’t have a problem keeping an eye on shadow banks with a turnover of $5million a year, which is minute by the standards of shadow banks.

  2. ". It’s also true in that there is nothing to stop INDIVIDUAL PEOPLE or small firms trying to issue IOUs in payment for goods and services, and trying to persuade the supplier of those goods and services that the IOU is as good as a dollar bill. However, they’d be wasting their time 99.9% of the time. The bald fact is that my local supermarket or garage is never going to accept an IOU from me in payment for groceries or a new car."

    Actually, there was a shortage of "official" money in the Canadian colonies pre-1867. To compensate, there was widespread issuance of tokens by businesses, both large and small. Although that situation is entertaining for coin collectors, it is a rather embarrassing situation for a modern economy.

    Minsky pointed out that you should not make economic policies that are running counter to powerful economic forces and expect them to be successful. A 100% reserve lending policy would just push lending to the shadow banking sector. Given the flexibility of contract law, this would be effectively impossible to stop.

    The economy would become dependent upon the shadow banking systems that are in place, and regulators would have no choice but to ratify those systems in a crisis.

    Which is exactly how the formal banking system evolved.

    1. Brian,

      I accept that when there is a shortage of government issued money, private money issuers go into overdrive. But to repeat the point I made above, under full reserve (as under the existing system) government attempts to supply enough money to keep the economy at full employment.

      Re Minsky’s point, his point is not 100% valid. E.g. there are “powerful economic forces” inducing people to steal. Senior bankers are particularly good at that. But that’s not an argument against laws that forbid theft.

      Still on Minsky’s point, I suppose it’s a case of weighing all the costs against all the benefits. Re the costs of auditing or “keeping an eye” on banks, the authorities ALREADY spend millions doing that. So I’m not sure that there’d be any increased cost there - especially since the rules of full reserve are simplicity itself compared to the Byzantine complexity of Dodd-Frank and the equally complex and useless rules proposed by the UK’s Vickers commission.

      Another cost of the existing system is the catastrophic loss of GDP over the last 5 years: GDP in the US and UK are about 5% below trend. Full reserve would not totally do away with booms and busts, but it should ameliorate that problem.

  3. Brian,

    Another point . . Minsky’s reference to “powerful economic forces” was a reference to FREE MARKET forces. I’m basically pro-free market, and agree with Minsky there. However, the idea that a banking system underpinned by taxpayers is a free market phenomenon is a joke.

    As for the idea that a banking system that has to be rescued by $29trillion of subsidised loans is a free market phenomenon, that’s an even bigger joke. (I got the $29trillion figure from Randy Wray and it refers to banks worldwide – not just in the US).

    The “forces” at work here are not market forces. What’s going on is an attempt by banks to take bigger risks than they would in a genuinely free market with the idea of keeping the profits when all goes well, and forcing Uncle Sam to foot the bill when it doesn’t. And to achieve that, banks devote HUGE efforts to lobbying and corrupting politicians. That’s not “free market”.


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