Saturday, March 8, 2014

Andrew MacLeod objects to the Friedman / Positive Money banking system.

I was at a meeting recently at which Andrew MacLeod made two objections to the Milton Friedman / Positive Money banking system. His first objection was that the increased cost of running banks would mean increased bank charges which would dissuade some of the less well off from having bank accounts. The answers to that point are as follows.
First, over recent decades, there has always been a small proportion of the population who don’t want bank accounts, i.e. who are paid cash and deal only in cash. That “way of life” doesn’t seem to involve insuperable problems.
Second, it is however possible that with the digitalisation of money (debit and credit cards etc), a bank account will become a basic essential, like food or fuel to heat homes.
Now there are two basic ways of providing people with basic essentials. One is to provide the entire population with the relevant basic essential and free at the point of delivery (e.g. the National Health Service and education for kids in the UK). And that policy is adopted where we think the relevant basic essential is best provided by a publically owned monopoly.
But (and second) we don’t adopt that policy where we think the relevant basic essential is best provided by competing private sector firms (e.g. food, fuel for heating homes, and . . . bank accounts). The policy adopted in respect of the latter basic essentials is to ensure everyone has sufficient income to AFFORD basic essentials, and leave it to individuals to allocate their income as they wish.
And that policy makes sense in that the default assumption in economics is that GDP is maximised where prices are set at free market prices (unless someone can explain why the market has gone badly wrong).
Now under the current fractional reserve banking system, banks are SUBSIDISED (e.g. the TBTF subsidy). Thus current arrangements do not maximise GDP. In contrast, under the Friedman / Positive Money full reserve system, banks would  NOT BE SUBSIDISED, therefore the F/PM system is Pareto efficient. It maximises GDP. Ergo MacLeod’s above objection is invalid.
Objection No.2.
Andrew MacLeod’s second objection was to the effect: “Why go to all the upheaval involved in switching to the Friedman / Positive Money system when we’d get the same benefits from decent bank regulation?”
Well my first, and perhaps flippant answer to that is that the F/PM system IS A FORM OF improved bank regulation. But a better answer is thus.
MacLeod’s above second objection does contain some truth. That is, if we raised bank capital ratios to about 25% (as advocated by Martin Wolf, Anad Admati and others), that would make banks about 99% safe, from which you might deduce that raising the ratio to 100% as is involved in the F/PM system is overkill. Well I gave an answer to that point here and here (and in earlier posts referred to in the latter posts).

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