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"It's a strange argument, because 100% reserve banking is like nationalising the asset side of commercial banks' balance sheets."

Not really, Nick.

If you look at the Chicago Plan, and the rest of those types of 100 per cent proposals, the idea is that existing commercial bank assets (e.g. corporate loans) must be funded by matching non-money commercial bank liabilities (i.e. bank debt or allowable term liabilities of some sort), rather than by money-liabilities that may previously have been in place to fund those assets. As a result, existing bank assets are then entirely funded by matching term liabilities (or by equity) with liquidity risk immunization.

This can be implemented if the CB does a one-time amount of OMO in the same amount as the money liabilities. That allows the banks then to issue non-money liabilities in the same amount. The money liabilities then get matched to the new reserves created, and the new non-money liabilities now fund the assets previously funded by the money liabilities.

The result is that the overall commercial bank balance sheet expands by the amount of that OMO/term funding.

Alternatively, the CB can just seize that part of the commercial bank balance sheet that reflects the matching of reserves and money liabilities.

But that doesn’t nationalize the rest of the commercial bank assets.

JKH: fair point. I have a simplified model of banks, where all their liabilities are monetary liabilities. But part of banks are mere financial intermediaries.

"It's a strange argument, because 100% reserve banking is like nationalising the asset side of commercial banks' balance sheets"

It is like nationalising the asset side of *payments banks*. Commercial banks are a mongrel breed of a

1. payments/settlements network - properly a utility, but can be outsourced to a private system for operational efficiency just like other utilities
2. liquidity facilitator - related to the 'elasticity' of bank balance sheets. Can be properly private (with an 'ultimate' sovereign backstop, w/o any TBTF type arrangements)
3. maturity transformation - public good, historically outsourced to a private system (and then extracted back partially through such measures as a Cash Reserve ratio and 'seigniorage') because sovereigns did not quite have the requisite commercial legitimacy or werewithal. Almost irrelevant these days with ample long term wealth pursuing long term returns. The key to the insight that a 100% reserve (short term government debt) backed banking system could work.
4. a credit investment fund - private function, ample examples of fully functioning non-bank models exist and thrive.

The modern 100% reserve argument would basically be - given that we are finally able to drill down to the public good essence of 3 as it is not a seemingly insurmountable challenge requiring financial magicians anymore, a sustainable approach to 1 + 3 would be to go the way of electric utilities and unbundle. Let the profits come from superior operational efficiency (ala distribution) and the public function be nationalised (ala transmission).

One challenge would be that on account of 2, should the range of assets be expanded from just s.t. sovereign debt to all 'real bills' (working capital, inventory finance, trade credit) - why discriminate against high quality and often more easily source-able private assets. That would be a good challenge. One could solve it using the exact opposite of the single-payer Obamacare philosophy. Let pvt banks discount all real bills, have a public bank network as an option that only uses s.t. government debt.


Also, minor aside. But my IOU does not get used as a medium of exchange; my friend will not use it to buy lunch at Tim Horton's" is an incomplete argument. The mirror is not symmetrically true. Most likely, you can get your friend to buy you lunch somewhere trading a Tim Horton's IoU (coupon) in return.
You're not much of a bank. But Tim Horton's is more of a bank than you are.

Nick,

“But part of banks are mere financial intermediaries.”

That is remarkably true – perhaps more so than you imply.

A certain kind of “heterodox” thinking bends itself out of shape trying to deny that banks are financial intermediaries, suggesting that “loans create deposits” makes it so.

But this is myopic, simplistic, and essentially wrong as a kind of exclusionary reasoning. Individual banks compete for deposits in a variety of ways, including the specific case where a 100 per cent reserve system forces them to seek out new types of funding. And they manufacture the type of liability that is required in the circumstances, in order to attract the money they are looking for according to the purpose they need it for. That’s financial intermediation - matching liability type to asset type as appropriate.

"But my IOU does not get used as a medium of exchange; my friend will not use it to buy lunch at Tim Horton's. I am not creating money."

Well, you are creating something that is on the money spectrum. Some of your students might accept your IOU as money, and then might pay it to you in exchange for tutoring. Your IOU might not circulate as long or as widely as BOC notes, but while it circulated it would be part of the money supply. Now, if Tim Horton's or Walmart were to issue IOU's...

Ritwik and Mike: the classic Canadian example is Canadian Tire "money". Notes of various denominations, that can be redeemed for goods at Canadian Tire. Borderline legality, according to my sources. Very rarely used apart from at Canadian Tire stores.

"It's a strange argument, because 100% reserve banking is like nationalising the asset side of commercial banks' balance sheets."

Presently however we have fractional-reserve banking with government deposit insurance, which is in turn backed by the printing press. (Where we should also take into account all asset classes that are theoretically not covered but no government could realistically resist the pressure to bail them out.) This means that when you deposit cash, you're effectively exchanging it for a government-issued printing press voucher, while at the same time the bank borrows the same amount from the government, which it can use however it wants (subject of course to minimum reserve and other regulations), with no concern at all to you. From the standpoint of everyone involved, the ostensible market transaction between you and the bank in fact represents two separate transactions with the government. (Moreover, when put this way, it also shows that we have a rather odd government program that issues and calls loans to banks in proportion to how many customers they've managed to attract and keep by sheer quality of customer service.)

(I'm not doing advocacy for full-reserve banking with this comment, just pointing out that the above remark, while correct, is far from the whole story if we are to evaluate which side on the FRB question is more "free-market." One can of course also advocate FRB without deposit insurance, but that has historically shown to be very unstable, and there would always be irresistible political pressure for government intervention whenever a bank run would hit.)

Writing in the late nineteenth century, the great English economist W. Stanley Jevons warned of the dangers of this kind of "general deposit warrant," where only a certain category of good is pledged for redemption of a receipt, in contrast to "specific deposit warrants," where the particular chair or watch must be redeemed by the warehouse. Using general warrants, "it becomes possible to create a fictitious supply of a commodity, that is, to make people believe that a supply exists which does not exist." On the other hand, with specific deposit warrants, such as "bills of lading, pawn-tickets, dock-warrants, or certificates which establish ownership to a definite object," it is not possible to issue such tickets "in excess of goods actually deposited, unless by distinct fraud."

In the history of the U. S. grain market, grain elevators several times fell prey to this temptation, spurred by a lack of clarity in bailment law. Grain elevators issued fake warehouse receipts in grain during the 1860s, lent them to speculators in the Chicago wheat market, and caused dislocations in wheat prices and bankruptcies in the wheat market. Only a tightening of bailment law, ensuring that any issue of fake warehouse receipts is treated as fraudulent and illegal, finally put an end to this clearly impermissible practice. Unfortunately, however, this legal development did not occur in the vitally important field of warehouses for money, or deposit banking.

Murray N. Rothbard -- The Case Against the Fed

... also ...

A crucial question to be asked is this: why did grain warehouse law, where the conditions — of depositing fungible goods — are exactly the same, and grain is a general deposit and not an earmarked bundle — develop in precisely the opposite direction? Why did the courts finally recognize that deposits of even a fungible good, in the case of grain, are emphatically a bailment, not a debt? Could it be that the bankers conducted a more effective lobbying operation than did the grain men?

There is a much longer history going back to Roman law (which recognized three distinct cases "Mutuum", "Commodatum" and "Depositum", or the special case of "Depositum Irregulare" for fungible goods such as grain or money). The Christian efforts to put an end to usury, led to contracts disguised as some other type of contract, thus confusing the issue. Modern banking law talks about deposits (sounds a bit like "Depositum" don't it?) but treats the contract as if it were "Mutuum"... and we no longer have any legal banking equivalent to the "Depositum Irregulare" contract for money (but as Rothbard points out, we do it for grain).

Well, you are creating something that is on the money spectrum. Some of your students might accept your IOU as money, and then might pay it to you in exchange for tutoring. Your IOU might not circulate as long or as widely as BOC notes, but while it circulated it would be part of the money supply. Now, if Tim Horton's or Walmart were to issue IOU's...

Most retailers do issue IOU notes, they call them "gift cards" and you buy them with cash. I should point out that the cash has a faster turnover than the gift cards (i.e. the retailer tends to quickly spend the cash, while the holder of the gift card usually waits a while before spending)... thus the total quantity of "money" does increase slightly.

How much these gift cards circulate independently would be an interesting thing to study, I would guess not much, but then again why not?

Stores could leverage this factor by issuing gift cards with some time factor included plus a discount factor (egats! time preference!!) so you buy the $100 card at a discount, perhaps $95 in cash, but you cannot spend it until a set date printed on the card. Now I think of it, I should Patent that idea and sell it to Walmart.

Tel,

"Now I think of it, I should patent that idea and sell it to Walmart."

In essence your plan would be for Walmart to borrow money outside of the regular banking channels. I don't think you would be able to patent a method of borrowing.

Also, there are provisions in U. S. law that prevents private corporations / industries from operating as banks (industrial banking). This precludes companies like Wal-Mart from offering bank like activities (deposits, check clearing, etc.).

In essence your plan would be for Walmart to borrow money outside of the regular banking channels. I don't think you would be able to patent a method of borrowing.
I wasn't entirely serious about the patent, else I would not have just published. However, you would be very surprised what can be fitted into a business method patent. You would be very surprised. Possibly even shocked :-)
Also, there are provisions in U. S. law that prevents private corporations / industries from operating as banks (industrial banking). This precludes companies like Wal-Mart from offering bank like activities (deposits, check clearing, etc.).
What's a few harmless gift cards? Come on bub! See, see, we offer a discount, it's helping the community. Low low prices.

This is nothing to do with banking man, and we don't do any check clearing... naaa it's just gift cards. Calm down a little, M'kay?

===

There's an excellent specific use case too: which would be around the Christmas / Thanksgiving time, offer cards with a discount and specify they must be redeemed AFTER the Christmas rush. This reduces pressure before Christmas, but better than that, it also keeps prices slightly higher during the after-Christmas sales, and thus offset the discount. Plus, there's the borrowing factor that you mentioned, probably doesn't add up to much over two months, but maybe offer more generous discounts at slack times mid-year. Think of it as a lay-buy in reverse.

Tel,

Yeah, I know you weren't totally serious. But honestly, I don't think enough thought is given in economic discussions to the legal underpinnings of monetary policy and banking. For instance, why are industrial banks prohibited?

Nick often goes to great pains to discuss what is special about the medium of exchange compared to other goods. But I haven't seen much discussion here about what is special about banking compared to other industries.

Why is anything prohibited? Well, politics of course.

I grant you that Walmart don't have a top notch profile amongst the "Progressives" right this minute, but they might not be the first adopter. If it was Costco selling after-Christmas gift cards at a discount... seriously dude, throwing banking regulation at them? Naaa, that won't work.

What's more, my gift card scheme expands the money supply, and in a nice and stealthy manner too. You can imagine Yellen: "We get to expand the money, and I can still look hawkish on rates? I say yes!!!! That's a very good idea!" She ain't gonna beat up Costco over non-existent checking accounts. Come on. Not on the eve of a very knife-edge election.

After the election, under President Trump, what happens? I really don't know, but the sale of gift cards could right be off his radar. Trump, the man who banned gift cards... just can't see it happening.

I just bounced this off a friend and seems that iTunes already has a system of buying vouchers at a discount and then redeeming then later.

It's really difficult to think of a new idea these days. Anyhow, there's value in the Costco application for after-Christmas (unless Apple have a patent already).

Nick,

Your article is plain bizarre. For example you say “It's a strange argument, because 100% reserve banking, or the abolition of commercial banks, does not make monetary policy impotent.” So who said 100% reserves DOES MAKE monetary policy impotent? No one, far as I know.

“The central bank buys the commercial banks..”. Whaaat? I’ve never come across any variation on the 100% reserve theme that advocates that. Certainly Milton Friedman (who advocated 100% reserves) did not advocate that. Nor does Lawrence Kotlikoff. Nor does Positive Money.

Homepage of the Swiss Campaign for full reserve banking (Vollgeld).

http://www.vollgeld-initiative.ch/english/

Loons, if you ask me. Although I admit I never quite got my head around full reserve banking. Maybe someone can help me along, even if it's slightly off topic:

Full reserve is the requirement to match all liabilities that require reserves (say deposits) with reserves on the asset side 1:1.

Starting from scratch, and looking at the system as a whole, an initial expansion of a bank's balance sheet will entail making a new loan (acquiring a new asset) and creating a corresponding deposit (new liability).
By the end of the reserve maintenance period, the bank will have to have either had the loan paid back, written down, transformed the deposits into liabilities that carry no reserve requirements, borrowed reserves through the discount window or sold its assets to the central bank in exchange for reserves. The latter would amount to not only a one-time nationalisastion of bank assets but essentially having the central bank underwrite each and every new loan willy nilly. Sounds like the worst possible combination of private entrepreneurship and communism to me and probably is not what these 'reformers' have in mind.

An alternative account, and probably the one they do have in mind, is that one starts out with an initial endowment of reserves which defines a purported upper limit of total system reservable deposits. Banks would be expected to manage this pool such that marginal additions of loans / deposits would have to be counter balanced by an equal transformation flow of existing deposits to non-reserved liabilities, say term deposits.

But, for the upper limit to be effective without being disruptive, I imagine banks would have to find ever more innovative ways to circumvent reserve requirements at will so as to maintain leeway in their lending activities. Or the central bank would have to either provide a buffer pool of excess reserves or continue to lend freely through the discount window, as is the case now, in any case effectively nullifying the upper limit.

So, whichever way you turn it, you end up more or less with the account above, i.e. either the problem is innovated away so that nothing much changes or you end up with communism. Most likely a potent combination of the two. It seems to me like another misguided attempt to address qualitative issues through quantitative measures with the sad side effect of lowering overall quality instead of raising it.

Nick says, “….100% reserve banking is like nationalising the asset side of commercial banks' balance sheets. The central bank buys the commercial banks…” That’s not an accurate description of 100% reserve banking. Certainly the 100% reserve systems advocated by Milton Friedman, Lawrence Kotlikoff and Positive Money don’t bear much resemblance to “nationalising….”.

What those three all advocate is that the bank industry is split in two. One half lends to mortgagors, small businesses etc, and that half is funded just by equity or equity like liabilities, e.g. bonds (rather than deposits). There’s nothing there that resembles nationalisation.

The second half accepts deposits (i.e. money that is supposed to be totally safe). And that money really is totally safe: it’s simply lodged at the central bank and/or invested in short term government debt. That second half gives customers cheque books, debit cards etc.

Whether those accounts are actually at the central bank and run by the central bank, or are administered by private banks acting as agents for the central bank is a matter of choice. The above three advocate leaving actual ownership in private hands. In contrast, William Hummel who also backs 100% reserve banking says those accounts should actually be at the central bank and be run by the central bank. So the Hummel option WOULD AMOUNT to nationalising entities that run checking accounts.

Note that failure of banks under full reserve is impossible, or as near impossible as it’s possible to get in this world.

It's not just that the failure of fully-reserved banks is impossible. It's also that "animal spirits" in the credit markets have no effect on the stock of money.

For what it's worth, Euro Pacific Bank Ltd. claims to operate at 100% reserves.

It's Schiff, so the reserves are gold and silver (he no doubt would consider government bonds unsafe) and the account denomination is split so you have your 100% backed long-term account denominated in the metal of your choice, plus a small working cash account presumably denominated in USD. There's a debit card available, and conversion from your working account in USD to local currency from the ATM happens by the standard banking transaction network.

Apparently he manages to find some customers.

https://europacbank.com/products/metals-backed-account/


So it is perfectly possible to have a private bank with 100% reserves, no nationalization involved, just because at least some customers want it that way.

There's also a small percentage fee when you convert between the cash working account to the long-term storage account (effectively buy and sell the metal) and there's storage fees only for silver, so that's a very small negative interest rate (but most governments inflate their fiat currency most of the time, so on average you may well come out ahead after the storage fee... at least some people think that way). Might be good for well off retirees who are nervous about inflation.

Ralph: "So who said 100% reserves DOES MAKE monetary policy impotent? No one, far as I know."

No advocate of 100% reserves said so, to my knowledge. But when I hear people say that monetary policy is impotent because banks won't expand loans, that is exactly what those people are saying, whether they realise it or not.

You keep getting caught in the spam filter.

But when I hear people say that monetary policy is impotent because banks won't expand loans, that is exactly what those people are saying, whether they realise it or not.


Yeah well 100% reserve deposits would be one possible reason why banks don't lend out... not the entire exhaustive list of reasons, I can imagine other possibilities. In this case I suspect there's several other reasons in play, because clearly the USA does not have 100% reserve deposits and yet still banks are declining to lend their excess reserves. Ergo, there must be at the very least one other reason to refrain from lending.

This gets me back to the analogy of the economy as a car, and the driver puts her foot down on the accelerator, but strangely the car barely picks up speed. Scott Sumner jumps up and says, "You were too soft on the accelerator! Get in there and push it harder." Never mind that the accelerator is down to the floorboards already, they are planning to push it right through the floorboards any minute now.

Think of what a normal driver would say in that situation, "Hmmm, I wonder if this engine is OK? Maybe I should get it checked out or something..."

So when you have a machine coming off the assembly line, all of the fully working engines are all the same.

However, the broken engines can be broken down for a whole lot of reasons:
* Fuel running out
* Oil is leaking
* Old oil hasn't been changed in a while
* Filter clogged
* Worn clutch

... etc ... etc ... etc ...

Let's look at this a different way. You see Keynesians like Krugman draw an expected economic growth curve (basic linear extrapolation) and then calculate an "output gap" which is the bit that the real economy needs to meet up with the theoretical growth. What is the meaning of this methodology in physical terms? What it says is that regardless of any government policy, regardless of any socio-political situation, regardless of whatever else is happening in the whole world... the economic growth should be linear, and any deviation is fixable by Fed policy (of which there are only a very few levers). Imagine that was a car... would anyone think that way?

An economy is more complex than a car, not less complex.

Tel: I know. Quoting myself: "I'm a very amateur auto mechanic, and a professional macroeconomist. I wish I knew as much about fixing macroeconomies as I know about fixing cars."

But you missed my point about banks not making loans.

Nick, I am well aware that increasing the statutory reserve requirements on banks would curtail lending and diminish the "money multiplier". In other words it would be deflationary.

Back in 1936 the Fed did this exact thing (supposedly to bring inflation under control), probably causing contraction in 1937. Of course the 1936 policy was closing the door after the horse had bolted during the great expansion of the roaring 20's, and they were a bit heavy handed doubling the reserves in one hit.

China did similar reserve ratio adjustments in the previous decade to control their credit expansion (we can argue about how successful that was, and how much the shadow banking system bypassed the limitation anyhow).

To say this type of thing "DOES MAKE monetary policy impotent" is a bit silly in a way, because it used to be accepted that tweaking the reserve ratios WAS monetary policy. Since then we moved to a preference for setting interest rates instead... anyhow it's all part of monetary policy.

And yes of course 100% reserve would be an extreme example of this same throttle on credit... no one disputes that.

"But when I hear people say that monetary policy is impotent because banks won't expand loans, that is exactly what those people are saying, whether they realise it or not."

That's what I thought too when I was reading your post. Zimbabwe's banking system was probably the sickest banking system in the world; that didn't prevent the Reserve Bank of Zimbabwe from having a profound impact on aggregate demand.

JKH: "This can be implemented if the CB does a one-time amount of OMO in the same amount as the money liabilities. That allows the banks then to issue non-money liabilities in the same amount."

How does this work, unless the CB is literally just buying the newly-issued commercial bank debt?

I don't understand how 100% reserve banking would not cause a massive contraction in the economy. The only way to get there without a contraction, is by depositors converting deposits into long-term debt or equity. Why would they do that? Depositors are keeping their assets as deposits for a reason -- what would make them change their mind just because someone says "100% reserve banking"?

Deposits, debt and equity exist for a reason: firms hold long-term assets. The investors that fund them have disparate investment horizons, liquidity needs, and risk appetites. Preventing banks from doing the maturity transformation of deposits into long-term loans is not going to eliminate the economy's need for that maturity transformation. Even if investors directly invested with firms, there will still be 30-day commercial paper, medium-term and long-term debt, and equity. The economy will still collapse without central bank intervention if the 30-day commercial paper investors decide not to roll over. On the investor side, first, all the small depositors would get stiffed -- they can't afford to invest long-term and they will have to be charged higher fees to keep their deposits in money. The depositors with larger deposits would all have to start accepting much more risk, or much lower returns. An individual depositor needs a much higher cushion than the pool of all depositors -- the fractional reserve banking system is a liquidity insurance system for the depositors.

The fact that in a fractional reserve system, the maturity transformation function is concentrated in banks, is a good thing, because it allows the central bank and other regulators to concentrate their regulatory focus on the banks. In a system with full reserve banking, they would have to spread their oversight across every single industry.

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