Tuesday, 10 November 2015

Bloomberg publishes an article on 100% reserve banking.

And it’s hopeless. I’ll run through the arguments, most of which I’ve seen a dozen times before.

First, the author (Leonid Bershidsky) describes the change to 100% reserve with the emotive word “cataclysmic”.  That’s in stark contrast to what Milton Friedman said on the subject. He said “There is no technical problem in achieving a transition from our present system to 100% reserves easily, fairly speedily, and without any serious repercussions on financial or economic markets.” (That’s from Ch3 of Friedman’s book “A Program for Monetary Stability).

Next, even if a change is “cataclysmic”, that is not a good argument against the change. The change from the feudal regime in Europe of the Middle Ages to present day democracy was arguably “cataclysmic”. The changes brought by the industrial revolution were arguably “cataclysmic”.  That’s not an argument against democracy or industrialisation.

Next, Bershidsky says “a process whereby banks would gradually repay the central bank for the 100 percent reserves, would be immensely complicated.”

The first answer to that point is much the same as the answer to the above “cataclysmic” point. That is, if a change is complicated, that’s irrelevant: the important point is how the ULTIMATE BENEFITS stack up against the cost or “complexity” of the change. I’m 99% sure that Bill Gate’s found his first operating system “complicated” to set up. The ultimate benefits have been ASTRONOMIC.

Second, the above “repayment” system far from being complicated is simplicity itself. All that happens is that the central bank takes over some of the assets of existing banks (e.g. mortgages) and collects interest and capital repayments for the next 20 years or so. Where’s the “complexity” is there?

There would of course scope for argument as to what a mortgage is worth in the case of dodgy NINJA mortgages. But a few hours haggling would sort that out. As to bog standard UK mortgages, they aren’t in the NINJA category. That is the value of those mortgages will be within 1% of book value.

100% reserve is deflationary?

Next, Bershidsky makes a claim I’ve seen a dozen times before. As he puts it: “Then, if banks are only allowed to lend money they have made from commissions and interest, borrowed from the central bank or from depositors, they will probably provide less funding to the economy than they are providing now.”

Well they wouldn’t “probably provide less funding”: they’d DEFINITELY provide less funding. Reason is that under 100% reserve, banks can only lend on money that relevant depositors are prepared to put at risk. That’s  as distinct from the existing system under which banks can lend on money which is insured by governments (i.e. taxpayers). That featherbedding of the “borrow and lend” process is wholly unjustified.

As the cut in demand that would result from less bank funding, that’s easily dealt with by standard stimulatory measures. Moreover, less “bank funding” means less debt, and half the world is having a nervous breakdown over the size of private sector debts. Assuming those nervous breakdowns are justified, then less debt won’t do any harm.

Next, Bershidsky makes the bizarre claim that having just the central bank create money is “a tiny step removed from central planning”.

Central planning actually consists of government bureaucrats, rather than market forces, deciding the amount of almost every product to be produced in the next five years or whatever. That includes the amount of steel, aluminium, sulphuric acid and ten thousand other items.

In contrast, there isn't one single advocate of 100% reserve banking I know of who proposes anything remotely like that. In particular, it would be very odd of the arch proponent of free markets, Milton Friedman, advocated 100% reserve (which he did) if 100% reserve bore any resemblance to central planning.

The only “centralising” that takes place under 100% reserve is that the state decides how much new money to issue with a view to determining how much stimulus should be implemented. But the state (i.e. central bank and government) ALREADY DECIDE how much stimulus to put into effect. It’s just that they do it in a slightly different way under the existing system.

Thus it is debatable as to whether 100% reserve would give us any more “centralising” than we already have.


  1. I note he is Russian,so fear of centrally contolled anything is understandable.But it is blinding him against a perfectly reasonable solution,that is as far from Communist ideals as I can think.Pity,as he seems almost slighty in favour toward the end of the article.The Swiss are not uniquely positioned to do this however ,the Icelanders are considering it too...so should we.

  2. The debate on reserve ratio (between 0 and 100 percent) is interesting, but IMHO not very fundamental.

    See post "No more free money for the banks" on my blog


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