Monday, 23 November 2020

Is this the crucial flaw in fractional reserve banking?



In a “base money only” system, i.e. under full reserve banking, people and firms would lend to each other, sometimes on a peer to peer basis, and sometimes via banks. And under that system there is no obvious reason why the rate of interest established would not be some sort of genuine free market, or “GDP maximising” rate: after all in such a market there’d be millions of borrowers and hundreds of lenders all competing for business, just as in the real world right now. I.e. in that scenario, it is difficult to set up monopolies or cartels to rig the market.

Note that under that system, banks would lend only base money. That is, letting private banks create their own home made money would not be allowed.

However, if commercial banks are allowed to create their own home made money (as under fractional reserve banking), they can lend at BELOW the above rate because they do not to attract deposits to cover 100% of the monies they lend out: they can simply print some of it, at no cost to themselves. (Joseph Huber alludes to this process on p.31 of his work “Creating New Money”). That obviously increases the total amount of lending and debts.
That might seem beneficial. Or at least the increased lending might seem beneficial. Only trouble is that, as just intimated, debts rise as well, and there’s an army of do-gooders who witter on about the allegedly excessive amount of debt we as a society have. So to that extent, the latter increased amount of lending and debt is not quite the boon it might seem.

But that’s not the basic point I wish to dwell on here, particularly since I have somewhat jaundiced views about the latter do-gooders.

The more important point is that it’s a widely accepted default assumption in economics that the free market price for anything is the GDP maximising price for reasons given in the economics text books: i.e. it is up to those who want to claim a particular market is flawed to prove their case. Ergo the default assumption must be that money printing by private banks is not beneficial: it will not maximise GDP.

Of course it can well be argued that given the disastrous environmental effects of more GDP, raising GDP should not be an objective. But the answer to that is simply to replace “maximise GDP” with “maximise output per hour”. That is, there clearly isn't any harm to the environment in raising output per hour by X% if the average number of hours worked per person per week is CUT BY X%.

Indeed, there are campaigns aimed at cutting the working week to four days, and partially on the grounds that while total number of hours worked declines, productivity increases more or less compensate for that.


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