Very simple economies illustrate the merits of full reserve banking.

If you can show that an idea works in a very simple economy, that clearly supports the idea. In the case of the fractional versus full reserve banking argument, considering how best to run a very simple economy indicates that full reserve rather than fractional reserve makes sense and for the following reasons.

First, let’s assume the ruler or government of the economy decides to set up a form of money. That assumption ties up with the historical reality, namely that at least half the time, money has come into existence in different civilisations and societies throughout history, as a result of a ruler deciding to set up a form of money, rather than as a result of market forces. The ruler’s motive for doing that is often that money helps the ruler collect tax.

Second, let’s assume the government or ruler issues enough money to bring about full employment, but not so much that excess inflation ensues.

Third, we’ll assume that people in the hypothetical economy lend money to and borrow from each other. Plus we’ll assume that some people act as intermediaries between lenders and borrowers, i.e. those people effectively become banks.

Next, the question arises as to whether, in the event of a bank failing, government ought to bail it out, or whether depositors (i.e. those who have loaned to others via the bank) should carry the loss.

Well when anyone lends DIRECT to another person, and the second cannot repay the money, the lender carries the loss. That applies in the real twenty first century world and there is no obvious reason that shouldn’t apply in our hypothetical economy.

So why should people who lend to others via a bank be any different? Well I’m darned if I know. Do you?

Put another way, a bank is simply a middle-man between lenders and borrowers. What’s so amazingly virtuous or beneficial about middle-men that they deserve government support?

In contrast to those who want to lend to others via a bank and thus earn interest, there are those who deposit money at a bank PURELY for safe-keeping, and to enable them to transfer money to others, sometimes a considerable geographical distance away. Banks in the real world do that electronically, e.g. via debit and credit cards nowadays. But let’s assume banks do something similar in the simple hypothetical economy.

It could of course be argued that a bank is a purely commercial operation, and that if anyone entrusts their money to a bank, if only for the purposes of safe-keeping the money and transferring it as requested by depositors, that depositors should carry the loss there as well.

However, I think most would agree that having a totally safe method of storing and transferring money is a basic human right: certainly there is a difference between depositing money at a bank with a view to having the bank lend on the money, which is a blatantly commercial activity, and second, depositing money just for safe-keeping and transfer purposes.

So the conclusion is that taxpayers in our hypothetical economy should certainly not bail out those who are into COMMERCE:  those who want their money loaned on by a bank are into commerce just as much as if they get a mutual fund, unit trust, private pension scheme or stockbroker to lend on or invest their money.  As for those who just want their bank to safe-keep their money and transfer it as requested, they probably have a right to that service / facility, and government should organised such a “safe-keeping and transfer” system, perhaps with some of the relevant work being sub-contracted to commercial banks. (But that’s not to suggest that service should be provided for free: i.e. it would be legitimate to charge depositors for that service.)

And what do you know. That’s full reserve banking!