Monday, October 15, 2012

Krugman’s flawed criticism of full reserve.

I normally agree with Krugman, but not with this article where he criticises full reserve banking. He is obviously not up to speed on the subject.

On the subject of money market funds, he claims these represent some sort of quandary for advocates of full reserve, and on the grounds that those depositing money in such funds can write cheques on the funds.

There is actually no quandary there at all because money market funds pretty much obey the rules of the “full reserve game” already.

The basic rule of full reserve is that banks, or any organisation acting like a bank, cannot create money. To that end, where a depositor wants instant access to their money, that money cannot be lent on or invested, else two parties then have a legitimate claim to the same tranche of money: the money has so to speak been doubled. Money creation has taken place.

Now when someone writes a cheque on a money market fund and the fund immediately sells investments of the same value, which is more or less what these funds do, then no money creation takes place. No problem.

Of course there might in some cases be a few days delay between honouring the cheque and selling the relevant investments, which strictly speaking is breaking the rules, but that does not make money market funds the sort of big time creators of money that fractional reserve banks are.

Keeping tabs on money creators.

Krugman then says, “So would a Ron Paul regulatory regime have teams of “honest money” inquisitors fanning across the landscape, chasing and closing down anyone illegitimately creating claims that might compete with gold and silver? How is this supposed to work? OK, I don’t expect a serious answer.”

Well here’s a serious answer.

First, whether the monetary base consists of a rare metal or is in fiat form, as in almost every country nowadays, makes no difference to the basic principles involved. I’ll assume a fiat monetary base.

Creating money or “claims” that constitute money is not easy. IN THEORY anyone can do it in that anyone can write an uncrossed cheque in payment for something, and the recipient can endorse the cheque, and pass it on, in the same way as bills of exchange were passed from hand to hand in the 1800s. But that phenomenon is almost unheard of nowadays.

To all intents and purposes the only organisations that can create BIG quantities of money are BIG organisations (surprise, surprise). That is because no one trusts the paper money produced by tin-pot unheard of organisations. Plus it’s very difficult to set up a bank of any size, or anything that acts like a bank, without being noticed by the authorities. That is, if the income tax authorities can spot self-employed plumbers or electricians who are trying to avoid being noticed, the authorities shouldn’t have too much trouble noticing organisations with a turnover a hundred or a thousand times that of the average plumber or electrician.

So there is no need, as Krugman puts it, to “fan across the landscape”.

There are of course local currencies, like Bristol pounds, and supermarket loyalty points, Airmiles, Bitcoins, etc. But if you look at these carefully, you’ll find that no money creation takes place, and if it is, it’s on a very small scale.

In short, getting full reserve to work would not be difficult.

And finally, the authorities in different countries actually impose reserverequirements on banks, varying from 30% to 0%. If 30% can be imposed, then presumably so can 70% and 100%.

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