Thursday, November 17, 2011

A hopeless defence of fractional reserve banking in the Financial Times.

Ben Dyson of Positive Money authored an article in the Guardian earlier this week attacking fractional reserve banking. This blog article at the Financial Times authored by Izabella Kaminska responded. The latter’s attempt to demolish Dyson’s arguments are hopeless.

Dyson argues against the right of private banks to create money. The first five or so paragraphs of Kaminska’s article respond by pointing out that economists realised a century or more ago that private banks do this. Thus Dyson’s point, according to Kaminska is old hat.

The answer to that is that Dyson does not claim to be revealing anything that most economists are not already aware of. As Positive Money’s literature points out time and again, the object is to educate the PUBLIC. (I could cite ignorant economists who quite clearly DO NOT get Dyson’s point, but I don’t want to be cruel.)

Second, in the paragraph starting “Having staggered…” Kaminska claims that Positive Money “plans to end evil debt everywhere”. Wrong again. The advocates of full reserve banking (including Positive Money) are well aware that borrowing and lending will always take place. What advocates of full reserve object to is (amongst other things) the fact that fractional reserve exacerbates instabilities.

That is, during a boom, asset prices rise. It was primarily property prices in the run up the recent credit crunch, and in the late 1920s it was primarily share prices. This price rise makes assets better collateral to back further lending. That further lending boosts asset prices still further. And so on.

Third, and credit where credit is due, Kaminska claims that the whole full versus fractional reserve argument is complex. Agreed.

And finally, Kaminska makes the bizarre claim that “Without debt, after all, you can’t have money.” Oh yes? What about a commodity based currency, like gold coins? If I have some gold coins, exactly where is the “debt” associated with these gold coins? Answer: the debt does not exist!

And it’s not only commodity based money systems that involve debt free money. In our existing fiat money system, monetary base is effectively debt free. Of course monetary base IN THEORY has an associated debt: a debt owed by the central bank to holders of monetary base. Those £20 notes (which are part of the monetary base) have imprinted on them the phrase “I promise to pay the bearer on demand the sum of £20”. But of course that is meaningless: try going along to the Bank of England and demanding £20 of gold (or anything else) in exchange for your £20 note. You’ll be told to shove off.

In short, there is no debt associated with monetary base.


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