Saturday, 6 May 2017

Jo Michell’s criticisms of Positive Money and full reserve banking.

Michell teaches economics at the University of the West of England. I follow him on social media because he is a constant source of ideas.

I agree with some of his criticisms of Positive Money (PM) in this article of his. Title of the article is “Full reserve banking: the wrong cure for the wrong desease”. But on balance he doesn’t seriously dent the case for full reserve banking (FR). Reasons are thus.

1. Michell starts by criticising the popular and fallacious “continuous growth” argument. That’s the idea that when private banks make loans, the economy has to expand otherwise it will not be possible to pay interest on the loan. Ergo, so the argument runs, the existing bank system requires continous growth, which in  turn degrades the environment.

The flaw in that argument is that anyone borrowing from a bank can perfectly well pay interest on a loan, despite their income being constant if they cut down on some other form of spending. Simple.!!! Put another way, if person X saves money and lends it to Y at interest instead of making product Z and selling it to Y, Y will then pay money to X in the form of interest instead of giving money to X as payment for product Z.

However the fact that the continuous growth argument is nonsense is not a good criticism of FR because PM is nowhere near the only advocate of FR: at least four economics Nobel laureate economists have supported the idea, e.g. Milton Friedman and James Tobin. Those economists (and others) do not cite the environmental or continuous growth arguments far as I can see – and I’ve read large amounts of their material.

2. In the para starting “To the average person…” Michell’s accuses PM of using psychological tricks to make people feel uneasy about the existing monetary system. Well fair point: but then PM is a pressure group, not an economics text book. Other pressure groups, political parties etc use psychological tricks.

That’s normal. Plus most supposedly impartial “objective” economists use emotive language. They shouldn’t. But I don’t abstain from emotive language, so I can’t complain.

3. Michell’s then criticises an idea long pushed by PM along the lines that private banks create money when they make loans (on which interest is paid) ergo privately created money forces people to pay interest to private banks for the simple privilege of having money with which to do daily business. (See para starting “The ‘real’ (non-financial)…”)

I agree with  Michell:  i.e. where banks charge interest, they do so in respect of loans. And to the extent that they simply supply customers with money with which to do daily transactions, it would not make sense for them to charge interest, though it does make sense to charge for administration costs. I set out detailed reasons on that point in section 7 of an article of mine entitled "Privately issued money reduces GDP".

4. Michell then deals with PM’s claim that stimulus should come in the form of the state simply printing new money and spending it, and/or cutting taxes. See paragraph starting “Oddly, despite the environmental argument…”.

Michell says, “Further, the conflation of QE with the use of newly printed money for government spending is another example of sleight of hand by Positive Money. QE involves swapping one sort of financial asset for another – the central bank swaps reserves for government bonds. This is a different type of operation to government investment spending – but Positive Money present the case as if it were a straight choice between handing free money to banks and spending money on health and education.  It is not. It should also be emphasised that printing money to pay for government spending is an entirely distinct policy proposal to full reserve banking – which do would nothing in itself to raise infrastructure spending – but this is obfuscated because PM labels both proposals ‘Sovereign Money’.”

I agree with Michell there. About the only excuse I can offer for PM’s error there is that numerous other people have fallen for what might be called the “green / infrastructure QE” illusion. One is Richard Murphy.

5. Give £7,000 to everyone instead of traditional QE?

£7,000 is approximately the total amount of QE done per household, and Michell says “Further, the conflation of QE with the use of newly printed money for government spending is another example of sleight of hand by Positive Money.” I agree. Indeed PM have published material suggesting the average household would have enjoyed spectacular increases in income if the £7,000 (or a significant fraction of it) had been paid direct to households or spent on infrastructure or similar.  Reason why that’s a sleight of hand is that QE has little effect on demand, whereas spending £7,000 for every UK resident on infrastructure or helicopter drops or similar would have a HUGE EFFECT on demand: indeed it would be positively inflationary. I.e. PM should make it clear that the alternative to £7k of QE is not £6k or £5k going straight to households. At a wild guess, it’s probably more like £1k

6. Small banks, shadow banks, etc.

Next, in a para starting “The same is true..”, Michell makes a criticism of FR which has been made dozens times before, and demolished an equal number of times. It’s the idea that FR would deal only with large regular banks, while failing to deal with the smaller unregulated banks or quasi banks.

The answer to that was given by Adair Turner when he said “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards…”. I.e. no organisation which acts like a bank should be excused obeying bank regulations. Building firms, whether they employ three or three thousand people have to obey similar rules, e.g. as regards health and safety. There is no reason why banks cannot be regulated similarly.

Moreover, even if the smallest shadow banks are not regulated, that does not matter too much: if say the hundred largest banks, regular and shadow, ARE REGULATED, that cracks the problem basically.

7. Seigniorage.

Michell then criticises the claim by PM that money creation by private banks enables them to enjoy seigniorage profits. As he puts it, “There is simply no reason why the act of issuing money generates profits in itself.”

Well strikes me there is a very simple and obvious reason why money creation results in profits: to the extent that banks simply lend out “home made” money, the borrower and the bank obtain a valuable asset (e.g. a house) in exchange for mere bits of paper or book-keeping entries. Nice work if you can get it.

However, the latter is an over-simple view of what banks do. It is more realistic to say that banks’ freedom to create money enables them to lend at an artifically low rate of interest, and that’s where the profit lies. I.e. the latter seignorage profit is actually shared by all mortgagors and by those who fund banks (shareholders, bond-holders, etc).

Joseph Huber in his work “Creating New Money” alluded to the latter interest rate point. As he put it:

“Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves.”

In short, strikes me that what’s wrong with the existing bank system is the latter point of Huber’s rather than seignorage in the standard sense of the word and I enlarge on that in the above mentioned article of mine.

8. Milton Friedman.

Michell ends with a short discussion of Friedman’s ideas, which is of relevance since Friedman backed FR. But Michell makes the following strange claim about Friedman, “Like PM, he favoured a simple monetary solution: the Fed should print money to counteract the effect of bank failures.”

Well I’ve just looked at Friedman’s 1948 paper “A Monetary and Fiscal Framework for Economic Stability” in which Friedman advocates full reserve and money printing by the state. The phrase “bank failure” does not appear. Moreover, while the word “bank” appears about fifteen times, there is no suggestion that Friedman wants to have the state print money so as to rescue banks.

Indeed Friedman is quite clear that when entities in the half of the bank system which lend make poor lending decisions, shareholders take a hit or get wiped out.
That’s very much in line with Friedman’s pro-free market outlook.  In contrast the ACTUAL PURPOSE of money creation by the state as far as Friedman is concerned is exactly as envisaged by PM: it’s to provide general STIMULUS. Friedman is not bothered about the extent to which banks or “lending entities” benefit from that stimulus, and quite right too. Incidentally Friedman also advocated FR in his book “A Program for Monetary Stability” (mainly in the 2nd half of Ch3).

9. Financial instability.

Finally, there is an omission from Michell’s article as follows.

He says quite rightly that one of PM’s central claims is that FR reduces “financial instability”. But he does not say whether he thinks PM is right or wrong there.

In fact FR brings a HUGE INCREASE in financial stability in that it’s plain impossible for a bank to fail under full reserve. Reasons are simple and as follows.

As regards the half of the bank industry which simply accepts deposits, it cannot go bust because all those deposits are lodged at the central bank. And as to the half of the industry which makes loans, it cannot go bust because it is funded by shareholders (or something similar like bonds which can be bailed in). Thus if (to take an extreme scenario) a bank makes a series of seriously stupid loans, and the bank’s assets (i.e. those loans) become worthless, then the value of its shares and bonds become worthless as well. But the bank is not bust in the sense that its liabilities exceed its assets.

10. Conclusion.

Having set out the flaws in several of PM’s and Michell’s arguments, some readers may be left wondering what, if any, are the arguments for FR. The answer is, basically, the one alluded to in the above quote from Joseph Huber. I.e. the right that commercial banks have to print money is effectively a subsidy of those banks. I go into that point in more detail in the above mentioned article of mine.

Incidentally PM themselves also cite that “subsidy” argument in this short video. Thus PM’s basic error is what might be called their “scattergun” approach. I.e. they cite too many arguments against private money creation. Some of those arguments, as Michell rightly points out, are flawed.


  1. You, and Jo Michell, are dead right - PM scatter too many arguments, many of which are flawed. This detracts from the case for Full Reserve banking.

    You are also right (in your sections 6 and 9 above) that Jo Michell misunderstands the financial instability argument for FR. He correctly states that FR would move risk-taking activity away from the more regulated retail banking system to the less regulated sector, but he fails to realize that this is a good idea.
    Sadly, none of us is perfect, even Ralphanomics. In contrast to your sections 7 and 8, Jo Michell is very clear and correct regarding the arguments regarding seigniorage and Friedman.
    Even worse, your concluding section 10 claims that the flawed seigiorage arguments of yourself and Huber are “basically” the case for FR.
    To my mind this, like PM scriptures, is a distraction from and betrayal of the original primary purpose of the 1933 Chicago Plan, viz. financial stability:
    “That guarantee of bank deposits be undertaken only as part of a drastic program of banking reform which will certainly and permanently prevent any possible recurrence of the present banking crisis”

  2. “Sadly, none of us is perfect, even Ralphanomics.”?? My self confidence has been shattered….:-) Anyway, moving on…

    Re Friedman, if you’re saying that Friedman thought one of the main purposes of stimulus was to prevent bank failures, where does Friedman say that? Nowhere that I know of. Of course, stimulus will normally save a finite part of the bank industry, but likewise it will normally save part of the engineering, building, farming, and you name it industry. Friedman never claimed banks should get preferential treatment, far as I know.

    Re the Chicago Plan etc, I think it is taken as read nowadays that would be bank depositors must have some sort of totally safe bank account available to them. That element is included in full reserve. So there is no argument about that. I.e. when I said the “basic” merit of FR is that it disposes of bank subsidies, what I meant is that apart from fulfilling the “safe account” requirement, the other main merit is disposing of bank subsidies.

    Thanks for the dailykos link: there’s some interesting stuff there.

  3. Amazing post….You have shared nice information. Thank you for sharing.


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