Is transforming liquid savings into long-term loans important?

Mark Carney, governor of the Bank of England thinks so. At least in this speech of his (p.3), he says, “Success would be a global financial system that maximises its full potential to ensure that…..  liquid savings are transformed into long-term loans…”

The UK’s so called “Vickers commission” report on banking makes the same claim (sections 3.20 and 3.21).

Well now, the most “liquid” of all assets or savings is money, so I assume that’s what Carney is referring to, or at least I assume it’s ONE OF the types of saving he is referring to. As to Vickers, money is quite clearly what is being referred to.

So, does it matter whether as much “saved money” as possible is transformed into loans?

Well as viewed from a micro economic perspective, i.e. as viewed by an individual household or firm, there’s much to be said for maximising the proportion of savings that are loaned out rather than   taking the form of pound notes or dollar bills stuffed under the proverbial mattress.

But as anyone who has got half way through an introductory economics text book knows, it is very dangerous to extrapolate from the microeconomic to the macroeconomic. More often than not, that doesn’t work. The currently fashionable tendency by twits in high places to treat government, and in particular government debt, in the same way as a household’s debt is a classic example of this mistake.

In contrast to savings as viewed by households (microeconomics), there are savings as viewed by the country as a whole (macroeconomics). Here, “liquid savings”, are not (as Carney and Vickers seem to think) some sort of valuable asset which must if possible be used. Money is simply a book-keeping entry, and banks (both commercial banks and central banks) can create such “entries” in infinitely large amounts any time. I.e. those “entries” are as inherently worthless as $100 bills and £10 notes.

Far from straining ourselves to ensure that every unit of money saved is loaned on, there are some very good reasons for NOT LENDING MONEY ON. E.g. throughout history, banks have gone bust precisely because they have loaned out too much, with the result that when depositors’ form queues outside such banks wanting their money back, the money isn't there: a “bank run”.

So how do we ensure bank runs don’t take place? Well it’s easy: forbid banks from lending out money unless relevant depositors have specifically given permission for their money to be loaned out, and for a longish period. Or alternatively, have lending funded just by shares in the lending entity. That’s different from the existing system under which banks can lend out the large majority of the contents of depositors’ checking or current accounts without permission from depositors.

Of course requiring the above “permission” would reduce the proportion of deposits that were loaned on, which might cause grief for Carney and Vickers. But actually things are not that simple.

The latter reduced amount of lending would certainly cause a decline in total amounts loaned – at least initially. But that would cause a decline in aggregate demand, and government and/or central bank would have to react to that. And a very good way of returning demand to its initial level would be exactly what we have in practice done over the last three years or so. That’s fiscal stimulus followed by QE. And the latter amounts to printing new base money and spending it into the economy (and/or cutting taxes).

(By “fiscal stimulus”, I mean having government borrow and spend, and/or cut taxes. Then comes QE, which consists of the central bank printing money and buying back those government bonds. Net effect comes to the same thing as the government / central bank machine simply printing money and spending it, and/or cutting taxes.)

So, the latter money creation would result in everyone having a larger stock of money, some of which they’d let their bank lend on. Thus the above INITIAL reduction in amounts loaned out would be partially reversed by the latter money creation.

But it probably wouldn’t be TOTALLY reversed. I.e. the net effect would be (assuming the economy remains at capacity) less lending based activity and more non-lending based activity. That is, a proportion of households and firms would be able to do whatever they wanted to do (e.g. buy property) WITHOUT borrowing rather than WITH THE ASSISTANCE of borrowing. Now is that some sort of disaster?

To summarise, trying to maximise the proportion of “liquid savings” loaned on is a badly flawed objective. A better objective is to treat lending just like any other commodity: maximise output (without output being subsidised) and to the point where the marginal unit sold is only just profitable.

And what do you know? That’s what full reserve banking consists of. That is, under full reserve, there is no sort of subsidy or rescue available to lenders (unlike the existing system where we have a host of subsidies for banks, TBTF, etc).

As to the total amount of money saved, that needs to be whatever induces the private sector to spend at a rate that brings full employment, i.e. keeps the economy at capacity. If that results in everyone having $10,000 in savings which is not loaned or (or which is stuffed under mattresses) what’s the problem? Printing that $10,000 costs nothing. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”