Steve Keen’s objections to full reserve banking.

Steve Keen does not deny that full reserve would work, but thinks the change would not be worthwhile. He gives three reasons, all of which are a bit shaky.

First, he claims that under full reserve, government’s ability to fine tune the economy would not be perfect. He says, “I am sceptical about the capacity of government agencies to get the creation of money right at all times.”

Well now, failure to achieve perfection is not a desperately strong criticism, is it? Has anyone, or any system ever been perfect?

No advocate of full reserve to my knowledge has ever claimed that fine tuning would be vastly better under full reserve, although there is one respect in which it would be slightly better, set out below.

Short memories.

Second, he claims that if full reserve brought a period of “tranquillity”, people would forget the reasons for imposing full reserve, and fractional reserve would re-assert itself. No doubt the latter process would be assisted by a multi-million pound lobbying effort by banks. (In Britain, the finance industry spends £93 million a year on lobbying.)

As a historian, Keen clearly has some insight. Fractional reserve might easily re-assert itself. That has close parallels with the way in which Glass-Stegall was imposed, and then removed.

But we’ve learned from that episode haven’t we? In ten or twenty years’ time when the criminals and the filth that run the banking industry try to get bank regulations relaxed, we might be a bit more wary.

Instabilities.

Keen’s third point is that there are ways of dealing with instability other than full reserve. And he cites two examples, both of which are his own creations, and both of which have come in for a fair amount of criticism: Jubilee shares and “the pill”.

The pill is a system under which the amount that can be borrowed to purchase a house is limited. Well the problem there is that if someone has a secure and decent income, and wants a 100% mortgage, that can be a perfectly viable and safe proposition for a lender. Why ban it?

In contrast, full reserve tends to counter a much more fundamental cause of instability (which Keen himself has rightly drawn attention to) namely the feed-back loop that is inherent to fractional reserve: an asset price rises, which makes the asset a better form of collateral, which in turn allows more money creation and borrowing based on that collateral, which in turn boosts the asset price still further, etc etc.

In contrast, under full reserve, the amount of money is more stable, which means that given a rise in demand for money to fund property speculation, interest rates rise, which ameliorates the speculation.

And finally, the latter instability point is not the CENTRAL merit in full reserve, or the central flaw in fractional reserve. The central flaw in fractional reserve is that it just cannot operate without a taxpayer funded subsidy.

There is no more of an excuse for keeping fractional reserve alive, than there was for keeping the loss making car manufacturer British Leyland alive.