Tuesday, 31 August 2021

The argument against fractional reserve banking is very like the argument against artificial interest rate adjustments.


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 or similar. 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 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, or to be more accurate privately created and state backed money (backed via deposit insurance and bank bail outs) would not be allowed. (Privately created UNBACKED money, e.g. Bitcoin, is a different matter).

However, if commercial banks are allowed to create their own home made state backed money (as under fractional reserve banking), they can lend at BELOW the above free market rate. Reason is that they then have additional funds to lend, which will inevitably result in the rate of interest falling. Apart from an artificially low rate of interest, another effect is that there is then an artificially high level of debt.

But that fall in interest rates stems from preferential treatment for private banks: that is, there is no more reason for those banks to be allowed to create money (in particular state backed money) than for steel producers or restaurants to be allowed to. Indeed if steel producers or restaurants had the right to create money, that would cause the price of steel and restaurant meals to fall.

As Irving Fisher said in the 1930s, there is no reason why firms which LEND money should also create the stuff.

The latter point about state backing for privately issued money is important. That state backing makes the relevant privately issued money as good as base money. In contrast, there is non state backed money, e.g. Bitcoin. It is assumed here that the latter form of relatively risky money, while it will always occupy a niche market, will never be popular with the vast majority of households and small and medium size businesses, as long as totally safe state issued or state backed money is available, and thus that it can be ignored, though obviously things are developing in this area and need watching.

A final point here is that the above argument dealt with the relatively simple case of where, initially, the only form of state backed money is central bank issued money and privately issued and state backed money is then allowed. That argument can actually be made more general in the sense that having allowed a small amount of privately issued and state backed money, there are no good arguments for allowing even more privately issued state backed money and for the reasons suggested above, i.e. that any such move would simply INCREASE the preferential treatment accorded to private money issuers.

Put another way, given a need for stimulus, having the state create and spend more money into the economy is preferable to artificial inducements to private banks to create and lend out more money.

And that of course amounts to saying that where stimulus is needed, the best form of stimulus is to simply create and spend more base money (and/or cut taxes) as advocated by Ben Dyson, Richard Werner etc (p.10) here for example, rather than cutting interest rates.

Does that amount to saying that fiscal stimulus is preferable to monetary stimulus in the form of interest rate adjustments? Well not quite, if by fiscal stimulus you mean having government borrow $X and spend it. The latter Dyson/Werner form of stimulus is really a combination of monetary and fiscal stimulus, a form of stimulus with which Ben Benanke is actually sympathetic (see his para starting “A possible arrangement....”).


Market forces.

It might be claimed that a weakness in the above argument is that the importance attached to market forces is rather called into question by the fact that having the state issue money is not in the nature of a free market either. The answer to that is that as anthropologists and historians have discovered, in most civilisations, money comes into existence because of the desire by a king or ruler to collect taxes more efficiently, not as a result of market forces. i.e. while the market is good at some things, it is not good at setting up a form of money. As Abba Lerner put it, “Money is a creature of the state”.

Moreover, the idea that we can do without state created money is just delusional. The reality is that nowadays states are expected to do something about recessions, and the only way they can do that is by creating and spending state created money, something they have actually done on an unprecedented scale since the 2008 bank crisis.

To summarise, while money itself is arguably not a free market phenomenon, having accepted that the state should create money, it is then reasonable to make the assumption, widely made in economics, namely that the free market produces the best solution, unless there are clear reasons for thinking it doesn't.

Saturday, 28 August 2021

Article by Megan Green on CBDC in the Financial Times.


Title of the article is “Central banks need to go slow on digital currencies”. 

FT articles are normally behind a paywall, but this one does not seem to be: at least I looked it up on a computer which does not have a subscription to the FT, and I could see the entire article.

Anyway, an important argument for “going slow” she doesn't mention is that the ACTUAL ADMINISTRATION of accounts which are 100% backed by reserves can perfectly well be farmed out to private / commercial banks. Indeed advocates of full reserve banking have been advocating the latter for DECADES.

Under full reserve (aka “100% reserves” aka “narrow banking”) depositors have a choice between two types of account. First, as just mentioned, accounts which are 100% backed by reserves, and second, accounts which are not. The former are of course totally safe, whereas if anything goes wrong with the latter, there is no help available from taxpayers, e.g. in the form of deposit insurance or bank bail outs. The latter accounts pay a higher rate of interest to reflect the additional risk.

Of course the SPEED at which money is transferred via “farmed out” accounts might be slower than under genuine CBDC accounts, but the speed offered by traditional high street banks is good enough for a large majority of account holders. Have you ever had cause to complain about the speed at which commercial banks transfer money via debit cards? I haven't.

Examples of advocates of full reserve who also advocate the farmed out arrangement include Milton Friedman. See Ch3 of his book “A Program for Monetary Stability” (published in 1960) under the heading “How 100% reserves would work”. See also “Towards a twenty first century banking and monetary system”, p.7. See also the book “Modernising Money” by Ben Dyson (founder of Positive Money).

The big advantage of farming out is of course that commercial banks already have the staff and expertise needed to deal with millions of accounts held by households and small firms. Central banks do not.

Less intermediation.

Next, Megan Greene says, “With CBDCs, businesses and individuals could hold accounts directly with the central bank. While that could provide efficiency, it would end the role of banks in financial intermediation.”

The phrase “financial intermediation” is a bit vague, but presumably she means CBDC reduces the extent to which bank loans are funded via deposits: i.e. it it cuts down on that PARTICULAR FORM of “financial intermediation”. In contrast it does not cut down on loans funded via equity, which is what many mutual funds do – some of which are incidentally run by banks.

She then says in relation to the latter decline in lending that “Fewer loans would be made, a drag on overall growth. To make up for the lost fees, banks might charge more for payment services and accounts.”

She makes a mistake there that dozens of others have made. It is obvious that less lending means less demand and less growth ALL ELSE EQUAL. But there is a very simple and zero cost solution to that, which is to implement more stimulus. As Milton Friedman said, it costs nothing in real terms to create more money and spend it into the economy, something that central banks and governments have done on an unprecedented scale since the 2008 bank crisis.

So the net effect of less intermediation combined with more stimulus would be GDP remaining about the same, but with less debt based economic activity and more non-debt based activity. Given the weeping and wailing that comes from the great and the good about the allegedly excessive amount of private debt, it is no clear why that would be particularly bad outcome.

Moreover, it is PRECISELY funding loans via deposits (I.e fractional reserve banking) which has been responsible for hundreds of bank failures thru history and for the 2008 bank crisis, which had catastrophic economic consequences. Thus her idea that disposing of the “deposits fund loans” system would be a “drag on growth” is a joke.

In other words, Megan Green's idea that funding loans via deposits promotes growth is true AS LONG AS IT WORKS. But inevitably at some point it won't work, at which point the whole “funding loans via deposits” idea comes crashing down.


Running to safety.

Next, she says “Since CBDCs are backed by the central bank, they are safer. In a crisis, that might lead to a run on banks as customers switch out of cash.”

Well the first bit of evidence that that would not happen is that personal accounts at high street banks are ALREADY PROTECTED by deposit insurance. There is of course a limit to that deposit insurance cover: it's €100,000 in the EU. But a wild guess that's sufficient for 99% of households.

Secondly, in the UK (and doubtless some other countries) people have actually been free FOR DECADES to open accounts with state run savings banks. In the UK there is “National Savings and Investments”.

NSI certainly does not offer the speed and flexibility of CBDC or of a traditional high street bank. But for anyone who wants to flee to safety, NSI would be ideal. But there was no large scale dash for NSI during the 2008 crisis.

And of course there is no reason to be inconvenienced by the latter lack of flexibility of NSI: to gain the advantages NSI for the bulk of your money, while retaining the flexibility you need for day to day transactions, all you need do is keep enough for day to day transactions in a traditional high street bank account, while placing the rest with NSI.

Another attraction of the NSI is that those with accounts there are not limited to the UK £80,000 deposit insurance limit: they can deposit up to £1million in complete safety.

Tuesday, 24 August 2021

The Financial Times gets to grips with MMT.


Seems the Financial Times has now got to grips with MMT, i.e. the idea that given any sort of recession, government and central bank should simply create money and spend it up to the point where inflation looms. Plus the actual amount of money printed (or, pretty much the same thing, the resulting increase in the national debt) is irrelevant.

My only criticism of that FT article (written by the “editorial board” of the FT) is the popular claim (para starting "Recent QE programs...") that it is hard to unwind QE and revert to the higher interest rates that prevailed prior to the 2007 bank crisis. Actually the latter is easy to do: just raise the deficit to a level higher than it need be and counter the resultant excess increase in demand with higher interest rates. I look forward to the economics profession tumbling to that one.

But the MMT response to the latter idea is that the optimum rate of interest on government debt is zero. Milton Friedman thought likewise – see his para starting “Under the proposal…” in his American Economic Review article ("A Monetary and Fiscal Framework...")

So on that basis, it would not even be a good idea to return to the pre 2007 set up. At least that's certainly the correct conclusion assuming all government spending is CURRENT rather than CAPITAL spending.

It is of course often claimed that governments should borrow to fund capital spending, but Friedman didn’t seem to go along with that idea, and I criticised the idea yesterday on this blog.

Incidentally my above claim that government debt is pretty much the same as simple straightforward cash needs qualifying. Certainly SHORT TERM government debt which pays a near zero rate of interest is very close to cash. In contrast, longer term debt which pays significantly above zero is not the same, and I do not favour a deficit which is so large that government and central bank then have to counter the resultant excess demand by artificially raising interest rates to an excessive extent.


P.S. 26th Aug 2021.  On second thoughts, my above claim that it is easy  to revert to the higher interst rates that existed prior to QE would be easy, is not too clever. At least that would be difficult for an INDIVIDUAL country to do since all sorts of problems would arise from its intereset rates being out of line with that of other countries. In contrast, if every country or at least a majority of large countries went for that higher interest rate policy, that would be more manageable.

Monday, 23 August 2021

Government should not borrow to fund capital spending.



The idea that government should borrow to fund capital spending, like a bridge, is a popular one. After all, households and private sector employers often borrow to fund such spending, so it might seem that government should do likewise.

However, one weakness in the latter argument is that private sector entities DO NOT always borrow to fund capital spending. For example if you want a new car and happen to have enough cash to pay for it, why borrow?

So borrowing, it would seem, only makes sense if you’re short of cash. But governments ARE NEVER short of cash in the sense that they can grab near limitless amounts of cash from taxpayers any time, plus they (along with their central banks) can print and spend a certain amount of money most years.

As for how much government SHOULD CHARGE those who use government funded capital projects, like a bridge, there is no question but that the charge should be enough to pay for whatever interest a private contractor would have had to pay to build the bridge or whatever the item of capital investment is.

Of course sometimes it is not feasible to charge those using a particular publically owned investment in the same way as people are sometimes charged at toll bridges. But in that case, the amount that a private contractor would have had to pay by way of interest should still be taken into account when deciding what bridges or other items of public investment are worthwhile and which are not.

To summarise, in the ideal world, the amount people are charged for using publically owned assets should not be influenced by whether those assets were originally funded via tax or government borrowing: i.e. they should be charged an amount that covers interest REGARDLESS of whether interest was actually paid or not.

And that in turn means that if government DOES TRY to borrow to fund capital projects, the only net effect is to enable the cash rich to lend to the less well off. But the rich can lend to the less well-off anytime ANYWAY!!! So what’s the point of government facilitating or encouraging the latter process, i.e. encouraging the less well-off to go into debt?

All government is doing there is in effect acting as a banker – a banker which is artificially powerful in the sense that government bonds are artificially secure because government has the right to grab near limitless amounts of money from taxpayers anytime if any government funded projects go wrong. Normal private sector bankers do not enjoy that luxury.



My provisional conclusion is that government should not borrow to fund capital spending, though others may well spot a flaw in the above argument.!!


Sunday, 22 August 2021

The market won’t deal with global warming? You don’t say!


Can you spew out a torrent of sophisticated sounding words which boil down to statements of the blitheringly obvious? Then you’d do well as a journalist.

One of the central points in this long article in the Financial Times entitled “Kim Stanley Robinson: a climate plan for a world in flames” is the above alleged “insight”, namely that the market won’t deal with global warming – see section entitled “And don’t think that the market.”

Well I have news. Economists are famous for disagreeing with each other, but if there’s one thing they agree on, it’s that free markets do not deal well with what are called “externalities”, i.e. the temptation for firms in a free market to load costs onto the community at large. A factory which pours pollutants into a river is a classic example. So Robinson’s “insight” is actually no insight at all.

But with a view to trying to making his non-insight look super  sophisticated (remember that’s important if you’re to get your article published), Robinson says “That whole notion of rule by market was a catastrophic example of monocausotaxophilia, “the love of single causes that explain everything”, Ernst Pöppel’s joke neologism for a tendency very common in all of us.”

Well there’s a teensy flaw in Robinson’s mockery of “monocausotaxophilia”, namely that science actually attaches HUGE IMPORTANCE to monocausotaxophilia. Why were Einstein’s theory of relativity or Newton’s laws of motion held to be important? Reason (much to the disappointment of Robinson) is that those laws were SIMPLE explanations for a LARGE VARIETY of different phenomenon.!!!

Looks like Robinson is talking thru his rear end, at least on the subject of monocausotaxophilia.

Incidentally Ann Pettifor seems to be impressed by Robinson’s take on monocausotaxophilia. But no big surprise there: as regular readers of this blog will know, I don’t have a high opinion of Ann Pettifor, though she is of course brilliant at appearing plausible.

Saturday, 21 August 2021

Do-gooders push for central banks to cut loans to polluters.



I’m all for dealing with carbon dioxide emissions in realistic as opposed to totally unrealistic ways. E.g. I’m all for subsidising wind turbines and solar power generation, plus high taxes on fossil fuels are a good idea.

Unfortunately it has become fashionable in think tank circles over the last year or two to push for central banks to limit lending to polluters, like coal mines. The logic or should I say “false logic” is all too appealing. It seems to go something like “central banks are powerful institutions, and something needs to be done about global warming, ergo central banks would be able to do plenty about global warming.”

The big flaw in that argument is that if a corporation is prevented from borrowing money to fund itself, it can easily fund itself via equity.  And indeed, the debt/equity ratios of different corporations are all over the place, which indicates there is not much difference between the cost of funding via borrowing and via equity.

For example, Google is funded almost entirely by equity: i.e. it borrows very little. If the do-gooders’ idea that curbing borrowing to corporations that pollute was valid, Google would be a disastrous flop. Far as I know Google has done extremely well ever since the day it was founded.

Thursday, 19 August 2021

Tim Worstall on fractional reserve banking.


Tim is a productive individual: he writes one article PER DAY, (Saturdays and Sundays included) for the Adam Smith Institute, which I invariably look at, though don’t necessarily read right thru.

I just stumbled across a Forbes article of his from around ten years ago entitled “What caused the great financial crash.”

He rightly says that the big weakness in fractional reserve is the fact that it engages in “borrow short and lend long” (BSLL) which is risky. But he then makes the common mistake of claiming that to abandon BSLL would cut growth, and quotes Adam Smith in support of that view.

The mistake there is that Adam Smith lived in the days before we had a flexible monetary base: i.e. the money creation that results from BSLL certainly did assist growth in Adam Smith’s day. But we now have a flexible base, i.e. government and central bank can create whatever amount of money they need to bring about the desired amount of stimulus. Ergo, as I explain here, there is no need to run the risk that is inherent to BSLL.


Monday, 16 August 2021

Richard Murphy claims the multiplier matters.

He makes that claim in an article entitled “The multiplier shows that not all government spending is equal.”

I normally agree with Murphy, particularly since he started backing MMT. But his ideas on the multiplier leave room for improvement.

One of his main points seems to be that if government raises spending by £Xpa, and if the multiplier is large enough, then the increased economic activity will raise tax paid to government by roughly £Xpa, in which case that extra government spending may pay for itself, which is allegedly a plus. Incidentally that's a point to which Ann Pettifor has attached importance in some of her articles.

But suppose the multiplier is relatively small, and extra public spending DOES NOT pay for itself in the above sense. Why would that matter? All government and central bank need do is create and spend more base money so as to raise demand by the required amount. And creating base money (i.e. central bank issued money) costs nothing in real terms as Milton Friedman pointed out.  

As I explained in a Ralphonomics article entitled “The multiplier is totally irrelevant” over ten years ago, the multiplier, contrary to Richard Murphy’s claims, is irrelevant, at least as far as the above "pay for itself" point is concerned. 

Sunday, 15 August 2021

Why should taxpayers support money printed by private banks?


Prior to the days when governments and their central banks (i.e. “the state”) created fiat money, money creation by private / commercial banks made sense. But now that states create money, the question arises as to which is better: state created money or private / commercial bank created money (henceforth just “banks”). After all, full employment is easily attained in “state money only” system simply by creating and spending state issued money into the economy up to the point where households have enough money to induce them to spend at a rate that brings full employment.

Well the first big advantage of state money is that it costs nothing to create and distribute, whereas banks have to check up on the credit worthiness of those they supply money to, obtain collateral / security off them etc. That all costs a significant amount.

Of course people can hold state money in the form of physical central bank notes, e.g. $100 bills, but precious few people want to store their money in the form of wads of $100 bills under the mattress.

Pro cyclicality.

A second drawback of bank money is that those banks create and lend out that money like there’s no tomorrow during a boom, thus exacerbating the boom. I.e. they act in a pro cyclical manner. That means that states have to take counter cyclical measures: mainly by issuing or withdrawing state issued money from the economy in a COUNTER cyclical manner. In short, given the availability of state created fiat money, bank money is just a nuisance.

Duplication of effort.

A third drawback of bank money, is that it has a nasty habit of going up in smoke unless it is backed by states (via deposit insurance and bank bail outs). That money “goes up in smoke” when a bank fails.

But that means that the state is in effect creating TWO FORMS of money: first state created money, and second, bank money which the state then stands behind. As Martin Wolf said, bankers are simply the most highly paid civil servants we have. Or as Steve Waldman put it, "Jamie Dimon is just a poorly supervised public servant who’s fibbed his way into exemption from the General Services pay scale."

That smells like duplication of effort: i.e. one of those two forms of money must be better than the other. And given the pro cyclical characteristics of bank money, which helped cause the biggest economic disaster in living memory, the 2007/8 bank crisis, it looks very much like it’s state created money which is better.



State backing for bank money should cease, i.e. deposit insurance and bank bail outs should cease. The only form of totally safe money should be state created money. That’s not to say ALL FORMS of privately issued money (e.g. Bitcoin) should be banned, but where there is the remotest chance of the public getting the impression that those forms of money are safe, there should be clear health warnings on all relevant literature and web sites to the effect that the state will not give assistance to those who lose out where a bank, stablecoin outfit or similar fails and depositors’ money vanishes – except for accounts at private banks which are 100% backed by reserves, i.e. state created money.

That health warning would hopefully keep the market for risky money relatively small, as is currently the case with Bitcoin. Though obviously if the popularity of privately issued risky money grows too much and that form of money poses systemic risks, there would be a need to re-think that point.

Friday, 13 August 2021

Loans would cost more under full reserve banking?


A popular argument against full reserve banking is that funding bank loans via equity rather than deposits (which is what full reserve involves) would raise interest rates too much because equity holders charge for the risk carried, whereas depositors do not. That sort of argument was put by the UK’s “Independent Commission on Banking” para 3.21 and by Frances Coppola in her article “Full Reserve Banking, the largest bank bail out in history” (2012).

The first flaw in that argument is that where depositors fund loans, there is still a charge for risk: it’s just that the government’s deposit insurance system carries the risk and charges for it (or at least it s*dding well should do – though given the revolving door that exists between banksters and politicians, it is clear that politicians have offered banks sweetheart rates on deposit insurance premiums in the past). Indeed, if the latter equity holders and deposit insurance system gauge the risk correctly, then in theory they’ll charge the same amount!

Second, the latter “charge the same amount” conclusion is backed by empirical evidence. That is, there is a ready market for mortgage backed securities, particularly in the US, and those securities amount to funding loans (to mortgagors) via equity! So both the theory and evidence support full reserve.

As for Frances Coppola’s idea that full reserve is a bank bailout, that’s a bit rich given that she made that claim four years after the biggest bank bailout in history: just after the 2007/8 bank crisis. And that bailout was a bailout of the FRACTIONAL RESERVE system, not a FULL RESERVE system. Indeed, there is no reason for a full reserve bank system EVER to be bailed out, and for the simple reason that banks cannot fail under full reserve.

Tuesday, 10 August 2021

Why was interest ever paid on instant access accounts?

Reason for asking is that interest is earned for two reasons. First, the lender undertakes risk: the risk that the borrower may not return the money loaned. Second, the lender forgoes the right to spend the relevant sum of money.

But wait a moment: holders of instant access accounts undertake no risk in that they are protected by deposit insurance. And as to foregoing access to their money, they DO NOT forgo it: that’s why the accounts are called “instant access”!!

Of course it could be argued that holders of instant access accounts get next to no interest nowadays because of interest rates being at record lows. But that’s actually debatable: it can well be argued that interest earned by banks does actually cross subsidise or defray the cost of administering instant access accounts. So holders of those accounts do in effect still get a significant amount of interest.

But whatever the truth of the latter point, the above initial point that it’s curious that “holders” ever got any interest needs answering – unlike 95% of the human race, I have a nasty habit of asking fundamental questions…:-)

Well I suggest the explanation was set out (sort of) by David Hume 300 years ago when he said in his essay “Of Money” that politicians are always tempted to spend too much with a view to ingratiating themselves with voters, while collecting insufficient tax (for the same “ingratiating” reason). The result is that they have to borrow to make up the difference, and that forces up interest rates in general.

And that’s my provisional explanation for why holders of instant access accounts used to (and may still) get interest. But I’m not entirely sure I’m right.  

Monday, 9 August 2021

Odds and sods – installment No.1.



The system for adding to and editing the right hand column on this blog where I normally put short notes has gone haywire. Many others using this blog system have this problem periodically. So I’ll collect these short notes together and put them in this centre column for the time being. 


9th Aug 2021. Chinese archaeologists find the remains of a foundry in China dating from around 600 BC which was used to produce coins – coins which looked like spades as per above image.


9th Aug 2021. Good article on the history of money by Pavlina Tcherneva: written in 2016, but I’ve only just come across it.