Apologists for the existing bank system keep putting their foot in it.

I dealt with about forty mistakes made by supporters of the existing bank system here. But the blunders just keep coming.

A new one I just stumbled across was made by Tim Worstall (who I actually agree with much of the time). He claims in this article that fractional reserve banking is indeed fraudulent, but that it’s what he calls a “useful fraud”. (Title of his article: “There’s An Obvious Answer To Fractional Reserve Banking…”)

His first claim is that fractional reserve gives us so called “maturity transformation”, which indeed it does: that is, and to put it in plain English, it makes various assets more liquid, i.e. more like money.

Well the answer to that is that if maturity transformation (i.e. fractional reserve) was abolished, the initial effect would, as TW implies, be deflationary (in the sense of reducing demand). But that problem is of course easily dealt with by having government and central bank create and spend more money into the economy.

Moreover, government and central bank do not need to engage in any sort of fraud to do that.

Plus, government / central bank created money does not run any sort of risk of bank failures. As Messers Douglas and Rajan put it in the abstract of this paper of theirs, in order for banks to perform their basic function under the existing system, they have to have “a fragile capital structure, subject to bank runs…” – which is hardly glowing praise for the existing system. (Title of their paper: "Liquidity risk, liquidity creation and financial fragility....")

In view of the latter point, I’d describe the existing system as “raving bonkers”, but perhaps other words would be more appropriate.


Funding thirty year mortgages.

Second, TW makes the absurd claim that under full reserve (the alternative to fractional reserve) depositors would have to deposit money for thirty years if people are to be able to get thirty year mortgages.

Well that’s not consistent with the fact that a fair amount of industrial investment is funded via shares, i.e. equity, and shareholders can sell out any time, but the investments they fund can easily last thirty years, and sometimes longer.

Of course the latter bit of magic relies on not too many shareholders all wanting to sell out at once. But about 99% of the time, there is no mad rush for the exit, or put another way, the number of potential shareholders wanting in is normally matched approximately by the number wanting out.

Indeed had TW actually studied the works of those who promote full reserve, in particular Positive Money and Lawrence Kotlikoff, he’d have discovered that under full reserve, mortgages are funded in much the same way as the latter industrial investments. Thus TW’s “30 year” criticism is not valid.