Positive Money’s odd claim that full reserve banking is different from their “Sovereign Money” proposal.

PM make that claim in an article entitled “Sovereign Money and full reserve banking proposals aren’t one and the same.” Author of the article is Frank van Lerven.

The crucial passages of the article, which I’ve put in green italics are as follows.

Sovereign Money proposals are often mentioned alongside FRB proposals. And they do indeed have a same goal; that is to stop banks creating money in the process of making loans (or buying assets). However, the method is different – and there happens to be a number of other goals and benefits of implementing a Sovereign Money system.

In the case of FRB it is done by forcing banks to hold reserves against their deposits. As the Bundesbank correctly notes, this doesn’t necessarily stop banks creating money – that is, it is quite possible for there to be money creation by the banking sector with 100% reserves.

Now wait a moment. According to Milton Friedman, one of the most heavy-weight advocates  of full reserve, money creation by private banks IS PROHIBITED under full reserve. He refers in this paper to “A reform of the monetary and banking system to eliminate both the private creation or destruction of money…”. (Title of his paper is “A Monetary and Fiscal Framework for Economic Stability”.)

On the subject of why full reserve allegedly does not stop private banks creating money, Van Lerven continues…

Simply put, banks create money and look for the reserves later. Central banks always accommodate private banks’ demand for reserves. So even in an FRB system, private banks could create new money through the process of lending, and then get the required reserves from the central bank.

Well under the EXISTING bank system banks may “create money” and get supplied with reserves later, but that would not happen under full reserve! What would happen under full reserve is as follows.

First, banks are informed that they are not supposed to create money: i.e. if they wish to grant loans, they must first obtain the necessary base money needed to make the loan, and that money must be VOLUNTARILY placed by relevant depositors in accounts specifically advertised as being for those who want their money loaned out or invested (which PM calls “investment accounts”). Plus holders of those accounts buy into what are in effect unit trusts / mutual funds, where the value of their stake in such funds can rise or fall dependent on the performance of the relevant loans or investments.

However, it is of course possible a miscreant bank or two would disobey the latter rule, and simply fire ahead and try to create and lend out money. But such a bank and the private bank system as a whole would then face a problem, namely that a proportion of the recipients of that new money would want it put into safe accounts (accounts which are supposed to be backed by reserves at the central bank). So relevant banks would need to come up with reserves.

But they wouldn’t get anywhere asking the central bank for reserves because the reaction of the central bank would be (on the simplifying assumption that no stimulus was needed): “The amount of base money in circulation is just fine, thankyou very much. We have no intention of supplying you with reserves. You’ll just have to rein in your activities and thus reduce your need for reserves. But to get you out of difficulties for a while, we’ll supply you with reserves, but at Bagehot’s “penalty rate” of interest. That will concentrate your mind no end, and get you do what we want you to do, i.e. rein in your activities.”


Conclusion.

There may be some small differences between full reserve and Positive Money’s “Sovereign Money”, but essentially they’re the same thing. Indeed, every advocate of full reserve promotes a different variation on the basic full reserve theme. But they all have some basics in common, and Positive Money’s “Sovereign Money” shares those basics.