Three Sheffield University department of economics authors, Sheila Dow, Guðrún Johnsen and Alberto Montagnoli, published a paper a year or two ago entitled “A Critique of Full Reserve Banking.”
The first seven pages simply describe full reserve are perfectly OK. However, the authors’ criticisms of full reserve start in their section 3.1 (p.8) and the mistakes from that point onwards come thick and fast.
For example the authors say at the end of the first para of section 3.1, that bank crises tend to destroy trust in commercial banks, but, apparently unbeknown to advocates of full reserve, trust can actually be maintained via taxpayer backed deposit insurance.
Well I have news for the Sheffield authors: advocates of full reserve and indeed everyone else has actually tumbled to the fact that the trillions dished out or loaned by central banks during the 2008/9 crisis did actually save the system. Plus the entire country, is aware that governments (i.e. taxpayers) stand behind private bank accounts.
But the Sheffield authors miss the crucial point here, namely what are taxpayers doing backing a commercial operation: money lending etc? Taxpayers do not back money lending when it’s done in a slightly different form, namely lending to friends and relatives or the purchase of corporate bonds by unit trusts / mutual funds.
The history of money.
Then at the start of the next para, the authors say “…money in practice has always been created by private sector institutions and has involved a token of credit extended by some and received by others…”
If the authors studied the history of money they’d discover that money in most civilisations stems from a desire by kings and rulers to make tax collection more efficient. So the King or ruler pays for what he wants using his home made money, while at the same time demanding that taxes be paid in that form of money – else you’re in trouble. That threat gives the ruler’s money plenty of clout.
Thus it is quite untrue to say that “money has always been created by private sector institutions..”.
Later in the same para, the Sheffield authors say that “the availability of safe assets would be reduced” as a result of implementing full reserve.
Well simply saying that the supply of something is reduced is not a brilliant criticism. The crucial question is whether the supply is reduced to (or increased to) some sort of GDP maximising amount. If the supply of apples is not at its GDP maximising amount, e.g. because apple growers have formed a cartel, then the supply and GDP can potentially be increased by breaking up the cartel.
In the case of full reserve, the supply of totally safe and very liquid assets, i.e. money, would very definitely at its optimum level, at least in the following sense.
Given an inadequate stock of money, the population would tend to try to save with a view to acquiring its desired stock. That would cause Keynes’s “paradox of thrift” unemployment, which in turn would induce government to print and spend extra money into the economy, thus bringing the stock up to its “GDP maximising” or optimum level.
Next, the Sheffield authors say in relation to implementing full reserve, “Savings accounts would now carry risk about which the general population would need to take an informed position. But even financial experts in the run-up to the crisis failed to price in risk adequately – the effect of unreasonable conventional judgements arrived at under uncertainty. It is totally unreasonable to expect the general public to undertake this kind of assessment and bear the consequences of a financial failure without deposit insurance.”
The answer to that is first that the majority of the savings of the average household are ALREADY difficult to “price” in the sense that it is not clear what they will fetch when they are eventually turned into cash. The biggest chunk of saving for the average household is their house, and given that house prices in Britain have doubled in real terms over the last twenty years (compared to Germany where they have remained constant in real terms), there is plenty of scope for that big chunk of household savings to fall dramatically in value.
Another big chunk of saving comes in the form of private pension schemes. But they are normally related to stock market performance, and it’s impossible to say where the stock market will be in ten or twenty years time.
Third, under full reserve, and as explained just above, people are free to stock up on whatever amount of base money (i.e. totally safe money) they want if they are keen to have a stock of savings the value of which is totally clear.
Subsidized bank accounts.
Then at the end of the same paragraph, the authors object to the fact that if depositors’ money is not loaned out (thus earning interest), banks might have to charge for transaction accounts.
Well one answer to that is that banks ALREADY charge for transaction accounts. I pay about £12 a month for my high street bank current account and get next to nothing by way of interest.
But doubtless if depositors’ money is not loaned out, banks would charge MORE FOR current / checking accounts. But charging the full cost of supplying goods and services is hardly unusual. When you buy baked beans, cabbages or a car you pay the full cost of acquiring those items.
A system under which the income from money lending is used to defray the cost of running a current / checking account is simply a form of cross subsidisation, and subsidies are frowned on in economics: they reduce GDP unless there is a good social justification for the subsidy.
The precautionary motive.
Next (para starting “It seems to be assumed…”), the Sheffield authors say there is demand for money not just for transaction purposes, but also for the well-known “precautionary” motive, and that under full reserve, the authorities would need to take that into account in deciding how much money to create.
Well as just explained, any tendency to increased saving by households and businesses, with a view to increasing their stock of safe money would tend to cause paradox of thrift unemployment, and the authorities would need to react to that by increasing the amount of money created and spent. But the authorities need to do that ANYWAY!!! That is, it is not just under full reserve, that gyrations in the private sector’s desire to save money is a source of instability!
Later in the same paragraph, the Sheffield authors say “But the build-up to the crisis demonstrated the widespread capacity for conventional expectations to be unreasonable and, in particular, to underestimate risk. As a result high expected returns on market assets could entice society into treating assets as safe which are in fact much less safe than current bank assets.”
Well frankly it’s a bit odd to claim that if the supply of stuff with characteristic X is reduced, people will make believe that other commodities normally regarded as NOT POSSESSING characteristic X will all of a sudden acquire characteristic X. Does his strange new theory apply anywhere else?
If the supply of alcoholic drinks is reduced, would people start trying to make believe that milk or orange squash contained alcohol? Or if the supply of petrol was reduced, would people trying filling up the tanks of their vehicles with water?
The shadow banking sector.
Next in the same paragraph, the authors trott out the old criticism that if money creation is suppressed in the regular bank sector, then money creation will just migrate to the shadow sector. Well clearly that will happen to some extent. But there are several answers to that problem.
First, illicit money creation has been going on since the dawn of time in the form of counterfeiting central bank notes. The fact that counterfeiting has never been TOTALLY suppressed and never will be as long as we have physical money, is not a reason for not suppressing counterfeiting.
Second, there is a simple way of dealing with shadow banks: regulate them the same was a regular banks. As Adair Turner, former head of the UK’s Financial Services Authority put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”
Of course it will never be possible to regulate every single small shadow bank. Indeed most of us are a bank in the sense that most of us have loaned money to friends or relatives at some time. However, that does not matter. Reason is that money is defined as anything WIDELY ACCEPTED in payment for goods and services. And while I can write out IOUs on the back of envelopes and while those IOUs might be accepted by a very small number of people, my “envelope money” clearly does not constitute money as per the above definition.
Same goes for small shadow banks: their liabilities scarcely qualify as money.
Third, the private sector only produces its own money where government fail to produce an adequate supply, as indeed the Sheffield authors themselves say. But if government / the state issues enough to give us full employment, it is hard to see why private sector entities would want a further supply of money, at least for transaction purposes: at full employment, further transactions just ain’t possible.
Of course there may well be a desire by some people to have government (i.e. taxpayers) provide some sort of guarantee that sundry assets will never lose value. But if taxpayers are going to do that in the case of bank liabilities, why not also in the case of non bank corporation liabilities, e.g. bog standard stock exchange shares or bonds?
The latter is clearly not a justifiable use of taxpayers’ money: there are whole string of more pressing uses for taxpayers’ money, like spending more on health and education.
The first paragraph of this section tries to cast doubt on the idea that stimulus can be effected by having central bank and government vary the amount of money created and spent. The authors say:
“But even if these judgements about the feasibility and merits of central bank independence are accepted, it is much more problematic to judge the work of a central banker or a committee whose job would be to inject money into the banking system and to place a limit on the amount. The performance would have to be based on a counterfactual, but it is difficult to envisage how this would be chosen and estimated.”
“Problematic to judge the work..”? What on Earth does that mean?
Moreover, having government and central bank create money and spend it amounts to exactly the same thing as traditional fiscal stimulus followed by QE, which is what we’ve done and big time over the last five years or so. (Traditional fiscal stimulus equals “government borrows £X, spends it and gives bonds worth £X to lenders”. While QE equals “central bank prints £X and buys back those bonds”. That all boils down to “the state (i.e. government and central bank) prints £X and spends it (and/or cuts taxes)”.
The Sheffield authors next para (starting “These issues..”) casts doubt on the Positive Money claim that in addition to the state effecting stimulus by creating money and spending it, the state should also keep an eye on whether enough is being loaned to allegedly “productive” activities.
I agree with the Sheffield authors there: the decision by households and firms as to how they allocate additional money that comes their way strikes me as being their business, not the business of bureaucrats in London who think they have better ideas on how resources should be allocated.
The authorities need the “correct” economic model?
In the next para (starting “Even if we accept…”), the authors argue that if the central bank is to inject the right amount of money into the economy, the CB needs the “correct” economic model of the economy in order to get that decision right.
Basically that’s nonsense, though obviously it would be nice to have some sort of model which is a perfect replica of the real world economy. The reason that idea is nonsense is that all the CB needs to do when determining the suitable amount of stimulus is very much what CBs and fiscal authorities do at the moment: make a guess at how much stimulus is needed and see if the guess works out.
In other words what monetary and fiscal authorities do at the moment is “suck it and see”. And under the slightly different way of imparting stimulus advocated by Positive Money and the New Economics Foundation, they’d adopt the same “suck it and see” ploy.
“Suck it and see” is not ideal of course, but at least the PM/NEF system is no worse in that respect than the existing system.
Well I’m now half way through the Sheffield paper and I think I’ve established that the authors are not too clued up. I do not have time to deal with the rest of their paper, and I imagine readers will not be too interested either.