Thursday, 17 July 2014

Milton Friedman on full reserve banking.

This is a section from his book “A Program for Monetary Stability”. The section is from Ch3 and is entitled “How 100% reserves would work”. I’ve put it green below. He sets out the basic characteristics of full reserve banking, namely:
1. The existing banking industry is split in two.
2. One half is totally safe and to achieve that total safety, depositors’ money is lodged in a totally safe manner: e.g. at the central bank. Though Friedman actually advocated also investing the money in short term government debt.
3. The other half lends to mortgagors, businesses, etc, but it is funded just by shareholders, or stakeholders who are in effect shareholders.
4. Neither half creates money.
The effect of this proposal would be to require our present commercial banks to divide themselves into two separate institutions. One would be a pure depositary institution, a literal warehouse for money. It would accept deposits payable on demand or transferable by check. For every dollar of deposit liabilities, it would be required to have a dollar of high ­powered money among its assets in the form, say, either of Federal Reserve notes or Federal Reserve deposits. This institution would have no funds, except the capital of its proprietors, which it could lend on the market. An increase in deposits would not provide it with funds to lend since it would be required to increase its assets in the form of high-powered money dollar for dollar. The other institution that would be formed would be an investment trust or brokerage firm. It would acquire capital by selling shares or debentures and would use the capital to make loans or acquire investments. Since it would have no power to create or destroy money, monetary considerations would not demand any special control over its activities. Hence, it need be subject to no more governmental supervision than other financial institutions.
Incidentally “high powered money” is a synonym for “base money” or Positive Money’s “debt free money”.
Just after the above section, Friedman claims the transition to full reserve can be done “speedily” and “easily”.
He also correctly identifies one important reason full reserve has not been implemented: what he calls the “vested political interests” wouldn’t like it. Personally I’d use the phrase “bankster / criminals and the politicians they’ve bought” instead of “vested political interests”, but “chacun a son gout” as they say in France.
(Reproduced with permission from the publishers, Fordham University Press.)

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