At last – I’ve stumbled across a moderately intelligent set of criticisms of Positive Money’s version of full reserve banking. Van Dixhoorn’s criticisms contain numerous errors, but that’s better than other criticisms I’ve dealt with here recently and which are PURE nonsense.
Anyway, let’s run thru her criticisms, some of which I actually agree with.
Her paper consists of thirteen sections. The first is an introduction. The second deals with the full reserve system advocated by the IMF authors Benes and Kumhoff. I dealt with the latter paper here myself, and regard it as flawed, so I’ll ignore Van Dixhorn’s criticisms: they may well be valid.
However, I WILL DEAL with her section 3 which considers Positive Money (PM), and her section 8 which summarises the pros and cons of full reserve. I might deal with her other sections at a later date.
Criticisms of Pos Money.
Dixhoorn’s first criticsm of PM is that PM claims central bank created money is debt free, whereas, according to Dixhoorn, ALL MONEY is a form of debt (her p.21).
Well in a minor and near irrelevant sense she is right: that is, base money or central bank created money is NOMINALLY a debt owed by the central bank to the holder of that money. Indeed British £10 notes and other notes actually state “I promise to pay the bearer on demand the sum of £10”.
But of course that “promise” is a farce. That is, if anyone tried to get £10 of gold (or anything else) from the BoE in exchange for their £10 note, they’d be told to go away (assisted by the police if necessary). Thus Dixhoorn’s claim that central bank created money is a debt does not stand inspection.
Do way pay interest on privately created money?
Next (on the same page) Dixhoorn says “One could also question the claim that we pay interest on our money supply because it is commercial bank debt; the interest is paid on the loan that is received in return and not the money that is created in the process.” Agreed. To be more accurate, as I argued here, commercial banks DO CHARGE FOR CREATING AND SUPPLYING MONEY, but those charges are strictly speaking ADMINISTRATION costs, not interest. Interest, as Dixhoorn rightly points out is a cost that banks have to pay depositors, and which they have to pass on to borrowers.
Second criticism.
This is that under full reserve a la PM “availability of credit will be limited.” Well of course! Full reserve requires those who fund loans and investments to carry the risk involved. And that means the cost of funding loans and investments will rise a bit. But that rise in the cost of borrowing simply reflects the removal of a subsidy: that’s the current practice of letting people have their money loaned on or invested, with the taxpayer carrying the ultimate risk. Dixhoorn doesn’t get that point.
She then jumps to the conclusion that in order to make good the demand reducing effect of that restriction on lending, the central bank will need to offer loans at favourable rates to private banks. Well the answer to that is “no they won’t”. All the central bank and government need do is implement general stimulus (the form of stimulus favoured by full reservers being the printing and spending of new money into the economy, and/or cutting taxes).
The transition to full reserve.
Dixhoorn’s third criticism involves alleged problems involved in the TRANSITION from fractional to full reserve. Well the answer to that is that assuming a country benefits from full reserve and continues to benefit for the next century or two, then transition costs are probably near irrelevant compared to the long term benefits. Moreover, as one advocate of full reserve (Milton Friedman) put it “There is no technical problem of achieving a transition from our present system to 100% reserves easily , fairly speedily, and without serious repercusstions on financial or economic markets”. (Ch3 of his book “A Program for Monetary Stability”).
The independence of committees.
Dixhoorn’s fourth criticism (p.22) is that “..there are concerns about the independence and feasibility of the MCC.” (That’s the Monetary Creation Committee).
Well as regards “independence” there is no reason why the “concerns” should be any more or less than over EXISTING committees that determine stimulus. For example there is the Bank of England Monetary Policy Committee which has a HUGE INFLUENCE on stimulus (via interst rate adjustments, quantitiative easing, etc). Other countries obviously have similar committees.
As regards the above mentioned “feasibility”, Dixhoorn is worried about the fact that the “central institution” (i.e. the central bank) “would also have the task of ensuring that the information provided by commercial banks about their loans is correct”.
Well of course the central bank would have to do a fair amount of auditing of commercial banks to make sure they were obeying the rules (as indeed they already do). But compare that with the rules which make up the Dodd-Frank regulations. Those stand at 10,000 pages and counting. And then there’s the near incoherent ring-fence proposals put by the UK’s Independent Commission on Banking. Comared to that lot, full reserve is simplicity itself.
Equality and the environment.
Dixhoorn’s fifth criticism is that “it is questionable whether a single reform as such can have such wide spreading consequences such as reducing inequality and improving the quality of the environment”.
I fully agree. Quite why the switch to full reserve has any big consequences for the environment is a mystery. One can subsidise windfarms (or not) under fractional reserve, and ditto for full reserve. Thus the environment is irrelevant to the full versus fractional reserve argument.
As for inequalities, same applies. Full reserve ought to ameliorate the boom / bust cycle a bit, which in turn would reduce the periods of high unemployment that come after the bust. And that clearly reduces inequalities SOMEWHAT. But certainly Dixhorn is right to suggest that equality is not an issue that is closely related to the full versus fractional reserve argument.
Sixth criticism.
Dixhorn’s sixth and final criticism in her section 3 comes in two parts. First she says “Finally, there are concerns about the viability of banking under this reform. Money is fully removed from bank balance sheets. These will shrink, and likely so too will their business. Given the value of banks, this can be claimed to potentially reduce economic efficiency.”
As astute readers will notice, that is essentially a repetition of her second criticism: i.e. that full reserve restricts lending. So I don’t need to answer that part of her sixth criticism.
The second part of her sixth criticism is, “Furthermore, while placing money in a transaction account may reduce the risk of losing the money in its entirety to zero, it does impose losses upon the accountholder as inflation reduces the value of the money. The money cannot be invested under this form of full reserve banking, so no return can be obtained in order to counter this inflationary pressure. Unfortunately nothing is said about this hidden cost by Jackson and Dyson (2012).”
Well obviously “losses are imposed” on those who are used to the luxury of having their money loaned on or invested with the taxpayer carrying the ultimate risk. But the latter is a totally unwarranted “have your cake and eat it” subsidy.
If restaurants had been subsidised for the last century and that subsidy was removed, then “losses would be imposed on” those eating at restaurants. That would not justify continuing to subsidise restaurants would it?
A final criticism appears in Dixhoorn’s conclusion namely that full reserve a la PM makes “… it difficult to predict what the ultimate effects on output and inflation would be”.
Well the answer to that is that there is NO NEED WHATEVER to predict what the effect on output or inflation would be because the latter two can be adjusted (just as they are under the existing system) by adjusting stimulus. That of course is done under the existing system by adjust interest rates, quantitative easing, the size of the deficit, etc. In contrast, stimulus adjustment is done a bit differently under PM’s version of full reserve. But that’s a minor technical point.
Moreover, under the EXISTING SYSTEM, governments have only the haziest ideas as to what inflation and unemployment will be doing five years from now: e.g. we might have another credit crunch, or we might not. I.e. Dixhoorn’s criticism applies to the EXISTING SYSTEM as much as it does to full reserve.
The important point, to repeat, is that there is no need to predict what the effect on output or inflation is. Moreover, it is widely accepted in economics that subsidies misallocate resources, i.e. reduce GDP (unless very good social reasons can be given for a subsidy). And since full reserve removes bank subsidies, the assumption must be that full reserve RAISES GDP all else equal.
Section 8.
The first criticism of full reserve in Dixhoorn’s section 8 is under the heading “No Transition to Full Reserve Banking Because”. She says “First of all, the creation of a safe public payments system and money, assumes that the State is a ‘safe’ entity. However, the State is not 100% safe…”. And the next sentence but one says “The value of money will always remain dependent on the issuer – 100% safe or risk free assets do not exist, nor does a store of value.”
Well that’s not a criticism which is specific to full reserve. To illustrate, Robert Mugabe was at one stage a totally irresponsible “issuer”. The result was that a large proportion of his population turned to using other currencies.
In contrast, there are countries where the population regards its government (rightly) as being responsible and more reliable than commercial banks. So in those countries, full reserve has a clear role to play.
Dixhoorn’s second criticism is that “‘Public money’ will reduce the amount of innovation in the payments system…”. I’m baffled.
Under the EXISTING SYSTEM, commercial banks introduced debit and credit cards because those cards are more efficient for many transactions than cash or cheques. Any bank that had ignored those innovations would have lost customers. And exactly the same would apply under full reserve. That is, under full reserve, commercial banks would open current / checking / safe accounts for customers. And as to the EXACT WAY in which payments are made, that would be up to individual banks. And competitive forces would induce banks to adopt any sort of new technology (e.g. payment by mobile phones) just as those forces induce them to adopt new technology under the existing system.
Money creation.
Dixhoorn’s third criticism is that commercial banks will do everything they can to turn the stakes that depositor / investors have in PM’s investment accounts or Kotlikoff’s non-money market mutual funds into “near-monies” as she puts it. Well my answer to that is “sure they will”. In fact advocates of full reserve in the 1930s were well aware of that potential problem as is PM.
But it doesn’t take a genius to think up a set of rules that deal with that problem. For example it would be easy to require that all literature and web sites dealing with non-money market mutual funds declared in bold type something to the effect that “You are not guaranteed $X back for every $X you invest in this fund.” In fact legislation in the UK actually requires those selling unit trusts and other stock exchange investments to declare something very similar: a sentence to the effect that “the value of these investments can fall as well as rise”.
Moreover, one has to wonder why those selling mutual fund units (“unit trusts” in the UK) seem to make NO EFFORT whatsoever to portray their liabilities as money. A possible answer to that is that the existing system supplies the economy with as much money as it needs, so there is no inducement for mutual fund operators do the latter. Nevertheless, as Dixhoorn rightly points out, portraying one’s liabilities as money gives those liabilities an added attraction. But it is striking there are PRECISELY ZERO attempts by non money market mutual funds / unit trusts to pull that trick under the existing system.
Anyone can create money.
Dixhoorn then says “Furthermore, since money is simply an accepted liability, any party can still create money, in the same way that firm and trade credits currently also exist.”
Now wait a moment. She seems to have forgotten the definiton of the word money, which is something like “anything widely accepted in payment for goods and services”.
Now the liabilities of banks are “widely accepted” because they are SPECIFICALLY DISIGNED to be easily transferrable. In contrast, it is quite untrue to suggest, as Dixhoorn does, that an ordinary trade credit is a form of money. To illustrate, if firm A delivers goods to firm B worth $X, B is then indebted to A to the tune of $X. And B could issue an IOU in payment. But is that liability likely to be of any use to A for the purposes of “paying money” to some third party? Pretty unlikely I’d say. Thus an ordinary trade credit just isn't money.
Full reserve is not concerned just with retail banks.
Dixhoorn’s third criticism is that most bank liabilities do not come in the form of retail deposits, which is what (so she claims) advocates of full reserve are concerned with. As she puts it, “The amount of money associated with today’s current accounts and the small saver, which these plans focus on, is also far too small to cause bank runs and an irrelevant problem in the current financial system”
Well the quick answer to that is “what about Northern Rock?”. That was a bank which concentrated on retail banking.
But in any case, advocates of full reserve are not concerned PURELY with retail banking (at least they certainly shouldn’t be given that the crisis in the US was largely a run on shadow banks). That is, there is a FUNDAMENTAL principle involved here which ANY ENTITY that attracts funds and lends them on or invests them should abide by. It’s as follows.
To promise someone you’ll return $X to them while investing or lending on their money is basically fraudulent because it’s a near certainty that sooner or later the loans or investments go wrong, and you won’t be able to return the $X. Indeed the fact is that throughout history banks have gone bust regular as clockwork.
Banning the latter fraud is an important element in full reserve, and it makes no difference what sort of bank is concerned: investment bank, shadow bank, etc. Nor does it matter whether the relevant entity sees itself or portrays itself as a bank. The above “anti-fraud” principle should apply to all lending / investing entities. At least it should certainly apply to all lending / investing entities above some given size. (That’s because harmful systemic effects tend not to come from the smallest banks or “lending entities”).
Central bank would lend to full reserve banks?
Dixhoorn’s fourth criticism is that full reserve fails to eliminate government guarantees or taxpayer support if government lends to the lending half of the banking industry. As she puts it. “Any funding of commercial banks by the central institution retains the risk of ‘bad loans’ with the taxpayer as upon bank failure they have indirectly funded the bank. Furthermore, bank runs on the credit institutions and in near-monies may still occur.”
But where does this idea that under full reserve banks are funded by the “central institution” come from? That’s not full reserve as I understand it. As I understand it, under full reserve, there is the 100% safe half of the industry and secondly the lending half which is funded just by shareholders or loss absorbers who are effectively shareholders. And if silly loans are made by one of the entities in the lending half, then the value of its shares declines and that’s it. There is no crying need for government to bail out that entity. Of course (as already mentioned) there may be a deflationary or demand reducing effect stemming from that incompetence, that that’s leasily dealt with by general stimulatory measures.
To bolster her claim that central funding may be needed, Dixhoorn says earlier in her paper that “To avoid a credit crunch, the public institution may also lend funds to banks beyond money saved by the general public.” Now wait a moment. A credit crunch is where numerous banks have doubts about the SOLVLENCY of other banks and refuse to lend and/or there is a run on banks. But under full reserve, the INSOLVENCY of banks / lending entities is plain impossible because they are funded just by shareholders.
As George Selgin put it in his book on banking, “For a balance sheet without debt liabilities, insolvency is ruled out….”.
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