100% reserve banking
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It seems ‘positive money’ and other banking reformists are calling for a 100% reserve i,e cash to loan ration.
Now if that where it means that all that commercial banks could lend would be the extra currency issued by the central bank. Or have I missed something?
The ‘New Economics Foundation’ have a book out called ‘Where does money come from?’Here’s a video about it:
And here’s eccentric Tory MP Douglas Carswell trying to explain how to abolish “fractional reserve banking”, ie to turn banks into safe deposits. Well, actually, he’s just proposing allowing people who deposit money in a bank to choose not to receive interest on it (coming out of the bank lending it) but to instead pay the bank for storing it for them. As if many would.
As member and reader of many lists i often come across “banks are bad – lets make them good” arguments naturally debt fractional reserve and the Fed are the targets. In America a campaign is being waged for the North Dakota State-type bank, particularly vociferous on the web is a Ellen Brown. http://www.yesmagazine.org/new-economy/the-north-dakota-miracle-not-all-about-oili would appreciate up to date info on banks, referring to 1931 and the MacMillan report tends to make me seem very old and it is bit UK parochial to be easily accepted by Americans. Maintaining a data base woldbe usefuli have tried to post on banking on my personal blog since have no confidence in its accuracy so i err on the side of caution and avoid our own SOYMB bloghttp://mailstrom.blogspot.com/2011/08/banking-myths.htmlhttp://mailstrom.blogspot.com/2011/09/on-banks-again.html
I know it’s boring but I think we do have to deal with the various arguments and misunderstandings about banking and money as they are so widespread these days amongst critics of society.The first point to be clear on is the definition of “money”. Up to WW2 there was more or less agreement that money was “currency” (notes and coins). Since then “bank loans” have been regarded as money. This is ok as long as the same definition is kept to throughout the analysis. But it should be noted that, even today, conventional economics has felt the need to distinguish between M0 (mostly currency) and M1 (which is M0 + bank loans) (M2, M3 and M4 are M1 plus various other types of loan).So, when as in the New Economics Foundation video and in all economics textbooks, people say “banks create money” this is true (by definition) if money is defined as M1. But it wouldn’t mean that banks create all money, as M0 is created by governments and/or central banks. Having said this, it is true that only 3% of M1 is currency and 97% bank loans.The case against regarding both bank loans and currency as money is that they come into being and behave differently. Currency circulates. Bank loans don’t. In fact, although M0 is only only about 3% of M1 it can be used to make payments, etc (including bank deposits and bank loans) of many times its face value.But even accepting that bank loans are money, banks do not create it out of thin air (as is often claimed, though not in economics textbooks). No bank can lend more than it has, either as deposits or what it has itself borrowed. In fact, because they have to keep some of what they have as cash, they can only lend less than they have. In the past, in Britain, they had to keep about 8% of their assets as cash. Now it’s down to about 3%. This is the “fraction” of assets they have to keep as a “reserve” against withdrawals. Hence the “fractional reserve banking” that currency cranks make such a fuss about. But all lending institutions do this (building societies, savings clubs and credit unions too). If they didn’t, all they would be would safe deposits. It’s what lending other people’s money involves.The first mistake that currency cranks make about this is that they assume that, with a fractional reserve of 10%, if someone deposits £100 in a bank this means that the bank can then lend out a sum of which this is 10% (less a £100), ie £900. In fact, it means only that the bank can lend out £90 as it has to keep 10% (£10) as cash.It is true that economics textbooks do teach that the banking system as a whole (but not a single bank on its own) can, with an initial deposit of £100, eventually make loans totalling £900. The assumption is that the first bank makes a loan of £90, which is then deposited in a second bank which can then lend 90% of this (£81), which is then deposited in a third bank which can then lend out 90% of £81, until eventually total loans of £900 will have been made.There is nothing wrong with this theoretical model as such, only with the claims that are made about it. Even the textbooks claim that the £900 has been created by the banks together, but in fact it depends on the money from loans being repeatedly re-deposited in the system. So, it could just as logically be claimed that it was the depositors that created the loans as they provided the banks with the money to lend. In fact this refutes the second mistake that currency cranks make: saying that all money (bank loans) comes into being as “debt”. They don’t. They come into being as previous deposits. What is happening is that money is circulating throughout the banking system, but there’s nothing mysterious about that as circulating is what money does.The currency cranks mistake what the economics textbooks say about the whole banking system as applying to an individual bank. Hence their mistaken conclusion that, if someone deposits £100 in a bank, that bank can then immediately lend out £900.There is one bank that can create money out of thin air and that is the government-owned or controlled central bank. It does so by mere decision, by creating more “fiat” (“let it be”) money and introduces it into circulation by using it to buy government bonds off commercial banks (“quantitative easing” is a variety of this).Ironically, one of the solutions proposed in the New Economics Foundation video, that the government itself should issue money, already happens, even if indirectly. It could do it directly of course as the video says it did during WW1 and as the US government did during the Civil War (as “greenbacks”) … or as the government of Zimbabwe has been doing.What we need to ask is why people today tend to blame banks rather than capitalism as a whole. In his 1935 pamphlet Economics for Beginners (which has an interesting section on the currency crank theories of his day, some of which have been revived today) John Keracher attributes funny money theories to indebted small farmers, shopkeepers and businessmen who want to monkey about with the currency to reduce the value of their debts. I don’t think this applies today. It seems to be rather that because money so dominates people’s lives and that they associate money with banks that people’s resentment at their money problems is aimed at banks.Of course no banking or monetary reform is going to stop money dominating people’s lives. This is where we come in.
alanjjohnstone wrote:referring to 1931 and the MacMillan report tends to make me seem very old and it is bit UK parochial to be easily accepted by Americans.Maybe but that New Economics Foundation video starts with a quote for Sir Reginald McKenna, dating from 1924, when he was chairman of Midland Bank (now HSBC) though it gives the impression that it dates from 1915-6 when he was Chancellor of the Exchequer, which is all over the internet on Monetary Reform sites including US ones. And he was a member of the 1931 Macmillan Committee.Type “I am afraid” + “Reginald McKenna” into a search engine and 93,000 results come up. A measure of how widespread currency crank and funny money ideas are.On the other hand, the quote from another banker of the time, Walter Leaf, chairman of Westminister Bank (now the NatWest, part of RBS) that:
Quote:The banks can lend no more than they can borrow – in fact not nearly so much. If anyone in the deposit banking system can be called a ‘creator of credit’ it is the depositors; for the banks are strictly limited in their lending operations by the amount which the depositors think fit to leave with them. (Banking, Home University Library edition, 1926, p. 102)can virtually only be found on our and related sites (only 95 come up).Of course, exchanging quotes settles nothing but those who support McKenna’s position ought at least to be aware of his contemporary Walter Leaf’s opposing view.
I guess the problem is that ‘money’ has come to mean more than M0. The Bank of England even stopped publishing M0 data in 2006Perhaps a better approach today is to talk about ‘credit’ and ‘wealth’?An expanision in bank loans is an expansion of the money supply (in terms of M1, M2, M3 and M4). But is this necessarily an expansion of wealth? Obviously not.Definitions of money are here
The Bank of England still publishes a weekly return showing, amongst other things, the total value of notes and coins in circulation. It’s here. This week the figure is £50,007,649,295.But you’re right. It is partly a question of definition, with the definition of money changing over the years. In the past it used to be “can the banks create credit?”. Now it’s become “can the banks create money?” The answer is the same but the issue was less confusing when the claim was just about credit not money.Obviously banks can supply credit (even if not out of nothing), but they can’t create money unless this is defined as including bank loans (in which case they do so by definition). Money, in its original sense of coins and notes, can only be created by the government via the central bank. These days out of nothing.
Good to know data is still available. This series is the one that stopped in 2006, there is a slight difference in that the old series includes ‘banks operational deposits’. What theoretical problems this posses I’m not yet quite sure.
A picture can tell a story. How banks work http://geographyfieldwork.com/HowBanksWork.htm “I think that people have learned that money is not made in banks. It is made by real people working hard at real jobs. Actually, deep down we knew that all along. We just have to learn it again.” Asbjorn Jonsson, an Icelandic fisherman, in a week when Iceland was effectively a bankrupt state. Its banks owed the world an astonishing £35billion – 12 times the size of Iceland’s gross domestic product and £116,000 for every man, woman and child.
admin wrote:Good to know data is still available. This series is the one that stopped in 2006, there is a slight difference in that the old series includes ‘banks operational deposits’. What theoretical problems this posses I’m not yet quite sure.Actually the weekly returns do include these as “reserve balances”, ie interest-bearing deposits by commercial banks and building societies with the Bank of England. So, M0 could be reconstituted if it was wanted, but breaking it into its two components is more useful as “reserve balances” are not part of the currency that is actually in circulation, which is the more relevant statistic.
admin wrote:Good to know data is still available. This series is the one that stopped in 2006, there is a slight difference in that the old series includes ‘banks operational deposits’. What theoretical problems this posses I’m not yet quite sure.Actually the weekly returns do include these as “reserve balances”, ie interest-bearing deposits by commercial banks and building societies with the Bank of England. So, M0 could be reconstituted if it was wanted, but breaking it into its two components is more useful as “reserve balances” are not part of the currency that is actually in circulation, which is the more relevant statistic.
If anyone’s interested Positive Money’s proposals can be read here
Should be meeting some people who are impressed with these ideas tonight. I feel a standard article is in the pipelineJust finished reading the book of that New Economics Foundation video. Here are some of its more ridiculous claims:
Quote:private banks can really create money by simply making an entry in a ledger.and not just money but real wealth too:
Quote:Those with the power to create new money have enormous power — they can create wealth simply by typing figures into a computer.But it’s not just banks:
Quote:Building societies and credit unions also have the right to create money through issuing credit.Tell that to the management committee of a credit union.But not only that. Banks (and presumably credit unions too) create money and wealth not just when they make a loan but whenever they spend any money even to cover their own expenses, including on the salaries of their staff:
Quote:the bank creates new money when it buys assets, goods or services on its own account, or pays its staff salaries or bonuses.They can even create their own capital (though why they need any when they can create money simply by making an entry in a ledger and then spending it is unclear):
Quote:in aggregate, banks are not constrained by capital, as they create the money that circulates and can be used to increase capital.With banks’ possessing such magical powers it’s surprising that any capitalists invest in the non-banking sector. And why don’t we all set up credit unions and pay ourselves the money we need instead of going to work for an employer?And there’s this:
Quote:It is the ability of banks to create new money, independently of the state, which gave rise to capitalism.Marx tells a rather different story in the section of Capital on “So-called Primitive Accumulation”. Earlier of course he had explained that the only way wealth can be produced is by humans applying their mental and physical energies to materials that originally came from nature.
ALB wrote:that New Economics Foundation video starts with a quote for Sir Reginald McKenna, dating from 1924, when he was chairman of Midland Bank (now HSBC) though it gives the impression that it dates from 1915-6 when he was Chancellor of the Exchequer, which is all over the internet on Monetary Reform sites including US ones.I have now checked the quote with how the Times of the time (26 January 1924) reported what he said. The passage in question is :
Quote:I am afraid the ordinary citizen will not like to be told that the banks can, and do, create and destroy money. The amount of finance in existence varies only with the action of the banks in increasing or decreasing deposits and bank purchases. We know how this is effected. Every loan, overdraft, or bank purchase creates a deposit, and every repayment of a loan, overdraft, or bank sale destroys a deposit.This passage is not in the Times report (maybe it was left out, as is possible) but this is:
Quote:While banks have this power of creating money it will be found that they exercise it only within the strict limits of sound banking policy. Anyone who studies the monthly statements of the London Clearing Banks will find that these banks keep a reserve of cash fairly constant in relation to their deposits. If banks increased their loans and investments the result would be to increase the aggregrate amount of their deposits, but to add nothing to their cash resources. The proportion of cash to deposits would be reduced, and, in the judgement of those responsible for the management of the banks, would be less than sound banking principles dictated. Thus a limit is placed on a bank’s power of lending by the amount of its cash and, so long as the canons of conservative banking are conformed to, additional loans can only be made if this cash is increased. Banks lend or invest up to the full amount by their cash resources, but they do not go beyond that point.Which gives a rather different interpretation as to what he meant than has been suggested.Another dodgy quote from the currency cranks hits the dust.
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