Two of the main advocates of full reserve banking in recent years are, first, Laurence Kotlikoff (K) and second the three co-authors“Richard Werner, Positive Money and the New Economics Foundation”. The work produced by the latter three will henceforth be called “W” (short for “Werner”).However, there are slight differences between W and K, and this article is an attempt to pick the best from each.
The similarities and differences.
Under both systems, depositors must choose between two types of account which are not a hundred miles from the two basic types of account already offered by banks, namely deposit accounts and current accounts (“checking” accounts in the U.S.). Under W, money in current / safe accounts is not invested at all, while under K., the money is invested only in very safe securities, as occurs with U.S. money market funds. Indeed, under K, current accounts are actually run by unit trusts or money market funds.
And then there are deposit accounts (called “investment” accounts by W). Under W, money in such accounts IS LOANED ON or invested, but depositors have limited access to their money. They can deposit their money for varying periods, or choose from varying periods of notice before withdrawal. Plus they can choose varying levels of risk, i.e. commit themselves to losing for example 20% or 40% of their money if the underlying loans or investments go bad.
In contrast, under K, money to be invested is all placed in unit trusts (“mutual funds” in the U.S.). As is normal with unit trusts, depositor / investors stand to lose a portion of their money, and (extremely unlikely) ALL THEIR MONEY.
Current accounts: W or K?
Re K’s idea that current accounts be hived off to unit trusts or money market funds, I don’t see the point of that. Existing banks are used to, and have experience in running current or checking accounts, so they might as well continue with that activity. Or put another way, after the switch to full reserve, K’s desire to see unit trusts run instant access accounts could be fulfilled by simply giving banks a new name: “unit trusts”. But that is clearly just semantics.
As to whether banks (or other institutions) running safe / current accounts should even be allowed to invest in supposedly safe securities like government debt (in the same ways money market funds in the U.S. do) my answer is: “definitely not”. Reason is that government debt is not 100% safe: it rises and falls in value. Indeed one money market fund failed during the recent crisis or “broke the buck” as the saying goes. And if there is the slightest chance of a supposedly safe institution failing, that implies a taxpayer funded bail out, which in turn equals a taxpayer funded subsidy for the institutions in question. And a subsidy, however small, for an industry which is supposed to stand on its own two feet is a straight self –contradiction: it involves a mis–allocation of resources.
Moreover, the idea that Eurozone periphery government debt is safe at the time of writing is a joke.
So that’s fifteen love to W so far.
As to money that is going to be loaned on or invested, there is a problem with W, as follows.
W involves vastly less taxpayer exposure than our current banking system, which in turn means that W (and indeed K) involve far less taxpayer funded subsidies for banks.
However, notwithstanding the relatively large amount of loss absorbing that depositors are exposed to under W, there is still a finite chance of all the underlying loans and investments for a particular bank turning out to be worthless or near worthless. And that means taxpayer exposure, or a taxpayer funded subsidy for banks.
And there is no excuse whatever for even the smallest subsidy for an industry that is supposed to pay its own way - which is supposed to be commercially viable.
In contrast, under K, there is no theoretical limit to the loss that depositor / investors can make: i.e. in theory they can lose their entire investment. And that in turn completely disposes of taxpayer funded subsidy (at least as far as investment accounts are concerned).
Moreover, bank insolvency or failure is impossible under K’s system.
Next, there is one respect in which W fails to achieve its own objectives, namely preventing the creation of money by commercial banks. Reason is thus.
W allows maturity transformation or “borrow short and lend long”. For example those running investment accounts can make a loan designed to last say five years, and fund that with deposits where depositors commit their money for no more than say three months. No doubt there is a good chance that when a portion of those “three month” depositors withdraw their money, they’ll be replaced with another lot of “three monthers”. But there is always the possibility they WON’T BE REPLACED. And in that case the relevant bank will have done a classic bit of money creation: it will have loaned out money it doesn’t have.
Werner offers flexibility?
One ostensible merit of W as far as investment money goes, is that depositors have a choice as to what risk they take. Howerver under K they actually have much the same flexibility. That is, a depositor who wants to play it relatively safe under K can put a relatively large portion of their money in a safe account and a small portion in an investment account (or into unit trusts).
Another way in which K provides flexibility is that depositor’s aiming for interest or a dividend on their money can actually have near instant access to their money in the same way as those who invest in stock exchange quoted securities have near instant access. That is, those who invest in unit trusts as per K, or those who invest direct in the stock exchange (or indeed in anything else, like a buy to let property), can cash in their investment whenever they want. Of course, in the middle of a recession the value of those investments may easily be less than the investor initially paid for them. But that’s a risk that all investors take.
In this W versus K tennis match, it looks like fifteen all. That is, as regards current accounts, W is better than K. And as regards investment accounts it’s the other way round. To expand on that…..
Re safe / current accounts, the relevant money, as per W’s recommendations, is exposed to NO RISK WHATEVER. That is, the money is not be invested or loaned on at all. That way, no taxpayer funded subsidy of the banking industry is involved.
Plus existing banks might as well continue running those accounts: that is, there is no need (as per K) to hive off current accounts to unit trusts, money market funds, etc.
As regards money which depositors want invested or loaned on, K is better than W for the following reasons.
1. There is absolutely no taxpayer exposure and thus no taxpayer funded subsidy whatever for an industry (banking) which is supposed to be commercially viable.
2. While W is far simpler than Vickers or Basel III or Dodd-Frank, W is nevertheless more complicated than K. And banks JUST LOVE complexity. It gives them wriggle room. It makes it easier for them to use the obscene sums of money they devote to lobbying to getting their way with regulators and politicians.
To quote Walter Bagehot, "The business of banking ought to be simple; if it is hard it is wrong."
3. K offers those who want a dividend or interest on their money flexibility in that they can cash in their investment (albeit at a loss) whenever they want.
4. In allowing maturity transformation, W may fail to achieve one of its own objectives: stopping the creation of money by commercial banks.