Sunday, 24 September 2017

The basic principles that support full reserve banking.

Principle No.1.    Everyone has a right to a totally safe bank account in the same way as everyone has a right to enough food, a roof over their head and so on. Plus many employers find a totally safe bank account useful.

Principle No.2.     The fact that everyone has a right to something is not necessarily an argument for supplying the item to them for free. For example the way food is delivered to everyone is normally to ensure everyone has sufficient cash income; then people are free to choose the food they want and they pay for it, using that cash.

Principle No.3.     Various basic essentials are supplied to everyone for free in many countries, e.g. health care and education for kids. The argument for that, rather than having people to pay cash for those items is that some people would choose not to purchase those items, and instead would spend the relevant cash on luxuries. That would impose costs on the community at large, for example the failure by some to purchase health care could promote the spread of contagious diseases, and the costs of not teaching kids the three Rs are heavy for society at large later in those kids’ lives: they are unlikely to find jobs, which means society as a whole has to support them.

Principle No 4.     There are no particularly heavy costs for society at large that derive from someone NOT HAVING a bank account (i.e. letting them deal just in cash). Therefor there is nothing wrong with requiring people to PAY FOR the privilege of having a bank account.

To that extent, the argument that it is important to let banks lend on depositors’ money so as to earn interest and thus defray the cost of administering bank accounts is not valid. Moreover, cross subsidization (e.g. having money lending subsidise the cost of administering a bank account) is generally frowned on in economics. Indeed, subsidies in general are frowned on unless there is a good social case for subsidies.

Of course the possible withdrawal of physical cash in the next few years might seem to weaken the latter argument. However, even if physical cash is withdrawn, there would still be a few people happy to go without a bank account: for example one member of a husband and wife couple who was happy for their partner to do all the financial transactions for the family. Same applies to children not considered by their parents to be responsible enough to have a bank account.

Principle No.5.
     Where anyone wants interest on the money they’ve deposited at a bank, there is only one way the bank can supply that interest, which is to lend on relevant monies. I.e. anyone who wants interest in effect is a lender. That is, they are into commerce, and it is a widely accepted principle that it is not the job of governments or taxpayers to stand behind commercial transactions. Thus there should be no taxpayer deposit insurance where a depositor wants their money loaned on, any more than there is taxpayer backed insurance for people who deposit money at a mutual fund / unit trust, or who deposit money with their stock broker with a view to that money being invested or loaned on.

Principle No.6.     The argument that if deposits ARE INSURED BY TAXPAYERS, that banks will lend more and thus boost GDP does not stand inspection. Clearly if deposits where relevant monies are loaned on ARE INSURED by taxpayers, there would SEEM TO BE a rise in GDP. However, governments (assisted by their central banks) have complete control of aggregate demand, and can thus raise demand and GDP any time they want. To that extent, the additional above mentioned demand stemming from extra private bank lending is irrelevant: i.e. given inadequate demand stemming from deposits no longer being insured by taxpayers, government can easily make good that deficient demand with conventional stimulus, fiscal or monetary.

Thus given that keeping demand at the full employment level is not difficult in principle, the question than arises as to what the GDP maximising banking set up is.

Well it’s widely accepted in economics that GDP is not maximised where anything is subsidised for no good reason. And taxpayer backed insurance for money which is deposited at banks and loaned on is an unjustified subsidy for reasons given above.

Ergo taxpayer backed deposit insurance reduces GDP. Put another way, bank loans should be funded via equity. Or put another way, where X lends to Y and Y does not repay the money, X should foot the bill, not the taxpayer.

A second weakness in the argument that taxpayer backed insurance for lenders increases lending and thus GDP and/or investment is that exactly the same argument applies to lending in the form of the purchase of corporate bonds and even corporate shares. For some strange reason, advocates of the above “taxpayer backing for lenders increases GDP” argument apply that argument to bank deposits, but never to corporate bonds or shares. That is a clear inconsistency.

Principle No.7.     Taxpayer backed insurance is subsidised insurance because everyone knows the “insurance company” cannot possibly fail, unlike private sector insurance companies. Of course taxpayer backed insurance could take account of the artificial privilege that taxpayer backing brings by making an extra charge for its insurance. However the reality is that over the last hundred years or more, bankers have regular as clockwork bribed or persuaded politicians into doing the exact opposite: i.e. bankers have induced politicians to grant private banks special privileges rather than make sure banks and their customers PAY FOR special privileges, like taxpayer backed insurance. Thus the idea that an extra charge for the privilege of taxpayer backing would ever be made, or the idea that if it were made, the extra charge would last any length of time, is a joke.

Principle No.8.      Funding bank loans via equity rather than deposits might seem to raise the cost of loans because equity holders demand a higher return than depositors. That apparent difference is largely or  entirely an illusion: reason is that once the cost of deposit insurance is taken into account, the total cost of funding via deposits is in theory no different to the cost of funding via equity. Reason is that the risks of bank funders losing a given proportion of their money is determined by the nature of the bank’s ASSETS (e.g. NINJA mortgages versus safer mortgages) not by the nature of its funding.

Put another way, the extra return demanded by equity holders as a percentage of their total stake in a bank should be equal to or related to the risk they run. But the risk run by depositors is the same. Ergo the insurance premium, as a percentage of the sum insured for depositors, ought to be the same or at least very close to the latter percentage in the case of equity holders (i.e. the amount equity holders charge for “self-insuring”).

Moreover, the return on bonds (which are similar in nature to deposits) in the US is currently HIGHER than the return on equity!


The best bank system is one where people can have totally safe accounts if they want, but those accounts are inherently safe because relevant money is not loaned on. Alternatively, if they want interest, they themselves carry the risk of having their money loaned out, not the taxpayer. Under such a system it is plain impossible for banks to fail: to illustrate, if a bank’s assets (i.e. the loans it has made) turn out to be worth only 75% of book value, then the stake in the bank held by those who have chosen to have their money loaned on drops to about 75% of book value. The bank as such does not go bust.

That system is full reserve banking.

Friday, 22 September 2017

Nonsensical conventional wisdom on banking.

Sir John Vickers on the left  (I think) sits under a slide, the heading of which is complete nonsense: that’s the idea that there is a trade-off between growth and risk when it comes to bank regulation.

That trade off APPEARS TO BE the case for an apparently very plausible reason, namely that the lighter is regulation, the more banks will lend and at a lower rate of interest. And of course more bank lending means more demand, all else equal.

The flaw in that argument is that governments have complete control of aggregate demand via stimulus (monetary and or fiscal), thus any fall in demand stemming from less commercial bank activity is easily compensated for via stimulus. Ergo there is no reason for tighter bank regulation to have any effect on demand or numbers employed.

Thus the KEY question is: what’s the OPTIMUM or GDP maximising amount of bank regulation. As I’ve pointed out time and again on this blog, the concept “optimum” seems to be beyond the comprehension of the simple folk who make up much of the economics profession. Certainly a failure to understand that concept would explain falling for the above “trade-off” fallacy.

Well there is a simple and widely accepted principle in economics namely that subsidies do not result in GDP being maximised, and that applies to banks. Thus there is a big problem with the idea that lighter bank regulation raises GDP which is that the lighter the regulation, the more the banking industry has to be backed by, i.e. subsidised by taxpayers. For example, the riskier banks are, the more expensive will deposit insurance be – never mind the half dozen other subsidies that banks get, like the TBTF subsidy.

So…how do we bring about a entirely subsidy free bank industry? Well it’s quite easy: just make sure that banks and those who have any sort of relationship with banks carry the full costs of bank failures when they occur, rather than have taxpayers foot the bill.

And that’s easily done by stipulating that anyone who wants to have a bank lend on their money with a view to earning interest carries the cost when those loans go wrong. After all, anyone who wants their money lending out is into commerce, and IT IS A WIDELY ACCEPTED PRINCIPLE THAT IS IS NOT THE JOB OF TAXPAYERS TO STAND BEHIND COMMERCIAL TRANSACTIONS.

In short, having banks fund loans via deposits is plain straightforward fraud. It involves telling depositors their money is totally safe, when the mere fact of lending it on by its very nature means that money IS NOT SAFE.

Ergo loans should be funded via equity or similar. And having done that, there is no need for deposit insurance because banks do not promise equity holders they’ll get $X back for every $X placed with the bank.

Taxpayers do not stand behind people who start up a small business or who invest in the stock exchange. There is no reason for taxpayers to stand behind a slightly different form of commercial activity: having a bank lend on your money.

Tuesday, 19 September 2017

The Wolf, Balls, Boait debate at the Royal Society of Arts on bank reform, London, 18th Sept 2017.


Martin Wolf is the chief economics commentator at the Financial Times. Ed Balls is a former UK politician who worked under Martin Wolf at the FT for a few years. Fran Boait is director of Positive Money.

The latter three gave speeches in the order in order given above, i.e. Martin Wolf went first. Wolf’s speech was much the most technically competent, as might be expected. I didn’t disagree with anything he said.

I’ve set out a summary of their speeches below. I’m not guaranteeing my summary is accurate or fair. Listen to the debate if you want a total accuracy and fairness.

Times given are APPROXIMATE: certainly not accurate to the nearest second or even the nearest 30 seconds.

Martin Wolf.

7.30 Martin Wolf started with the interesting point that money can be defined (to paraphrase him) as the stuff you hold which is supposed to be totally safe and which you can use in times of trouble. Yet it is precisely privately issued money which has a habit of disappearing into thin air in times of trouble.

The crisis was not just a shadow banking crisis: virtually all banks were involved.

UK banks’ capital ratio HAS BEEN improved, but not by nearly enough. In fact ratios have simply been returned to where they were around 1970.

17.00  Quote: “a bank is about as unsound a financial structure as you can imagine” (produced laughter)

Ring fencing will help, but it’s not the basic solution.

Risk weighting doesn’t work: banks claimed their assets were totally risk free just before the 2007 crisis.

20.0 Banks have a big incentive so subvert the regulations, and essentially they will succeed in demolishing all the new regulations passed since the crisis.

Wolf likes Mervy King’s “pre-positioned collateral” idea.

21.00  Wolf likes Positive Money’s “Sovereign Money” proposal.

Quote: “Money consists of the liabilities of unsound financial institutions”.

25.0  Wolf’s ends by saying that the existing bank system is a huge nonsense. That reminds me of Mervyn King’s famous quip: “Of all the many ways of organising banking the worst is the one we have today”

Wolf says there will be another bank crisis. It’s not a question of if: it’s a question of when.

Ed Balls starts at 25.0.

In his first ten minutes he explains how he, and the then governor of the Bank of England and others in early 2007 had a “war game” to mimick a bank crisis. The war game was accurate for the UK in that it envisaged a crisis sparked off by a building society / bank in the North of England in trouble – that was good foresight given the Norther Rock fiasco that happened a few months later. But the war game did not forsee the extent to which the real crisis was international.

35.0  Claims Friedman’s monetarism was an example of Chicago School thinking. Strange claim. Balls gets Keynsianism, Chicago School, monetarism and other stuff very muddled.

Balls claims there are three question marks to be put over full reserve banking. The first is whether we can pin down what is used as money?

Well my answer to that is we do not need to “pin down” in order to reap the benefits of full reserve. Indeed, after the introduction of full reserve, people will certainly continue to use a variety of forms of money other than that nation’s official currency. Plus many advocates of full reserve don’t even object to some of those alternative forms of money (e.g. local currencies like the Lewis pound in the UK or Ithaca dollars in the US).

The important point is that full reserve makes available to everyone a form of money which is totally safe. If people want to take risks and stock up on strange forms of money like Bitcoins or Krugerands, that’s their business.

38.0. Balls says (rightly) that under a sovereign money / full reserve system there is some sort of committee of economists that decides how much money to create per month (a point which Positive Money would not disagree with) but that the job of that committee is incredibly hard. Reason is that the committee has to foresee crises. That’s his second point.

Well the simple answer to that is that crises would not occur at all because it’s impossible for banks to go bust under full reserve!!!!! Of course that’s not to say economies would be 100% stable under full reserve, but advocates of full reserve never claimed they would be 100% stable. But the solution to a downturn under full reserve is much the same as under the existing system: stimulus. The main difference is that the FORM OF stimulus advocated by Positive Money amounts to a merge of monetary and fiscal policy: that is, given a need for stimulus, the state simply creates money and spends it (and/or cuts taxes).

His third point is that full reserve is much better introduced world-wide than being introduced by just one country. True. But then there are numerous organisations around the world pushing for full reserve.

Balls is a bit clueless. He claims that the above mentioned money creation committee has to take all sorts of decisions, like what constitutes worthwhile investments!!! Total nonsense.

Balls claims that avoiding bank crisis is not the most important issue we face.

Well I dare say it isn’t, but that’s not an argument for not tackling the issue. Sprained ankles or flue may not be the most important issues facing the National Health Service, but if we can find a way of halving the time taken to cure sprained ankles or flue, why not go for it? False logic there by Balls.

Fran Boait starts around 42.0.

She says she won’t talk much about stripping private banks of their powers to create money. And launches forth about inequalities, climate change, and other issues. She attacks “neoliberalism”.

Well neoliberalism is a favourite gripe of lefties. Be nice if they defined it!!!! Also it should be remembered that neoliberalism, at least in the UK, was a reaction to what preceded it, namely the Labour government throwing taxpayers’ money at clapped out loss making industries so as to “save jobs”. At least that was the excuse. “So as to buy votes” might be nearer the mark.

Many reacted to that episode with something like, “S*d taxpayer funded subsidies: let’s just have the free market rip.” Can’t say I totally disagreed with the latter “let market forces rip” philosophy.

47.0 She disagrees with Carney’s claim that the UK needs a much bigger financial sector.

She claims lots of people think markets are perfect!! Well about 95% of economists realize (apparently unbeknown to Fran Boait) that markets are highly IMPERFECT. She claims “markets are people” – meaningless phrase, but the phrase will go down well with lefties.

51.0  Complains that QE and interest rate cuts (almost the same thing) makes the rich richer by increasing asset prices. Problem with that is that as Positive Money itself has said, INTEREST RATE INCREASES can also be argued to increase inequalities in that debtors have to pay more interest to the rich (i.e. creditors).

She wants the Treasury committee inquiry into monetary policy to be re-opened.

52.0 She ends by saying she wants to “democratize” the Bank of England and the financial system. What does that mean? Democratize is one of those words like “neoliberal”, “radical” or “progressive”: fashionable at the moment, but their exact meaning is not clear.

Monday, 18 September 2017

Random charts - 39.

Text in pink on the charts below was added by me.

Tuesday, 12 September 2017

Random charts - 38.

Text in pink on the charts below was added by me.

Friday, 8 September 2017

Taxpayer backed deposit insurance is a nonsense.

If bank deposits are not insured, as was the case in several countries prior to WWII, then so called deposits are not actually deposits: that’s “deposit” in the sense of “a totally secure holding of $X”. Those so called deposits are more akin to shares or bonds, i.e. so called depositors are not guaranteed to get their money back.

So that system, it can be argued, amounts to full reserve banking: a system where bank loans are funded by equity, not deposits.

Alternatively, if deposits are insured by taxpayer backed deposit insurance, that amounts to a subsidy of banks and depositors. Reason is that taxpayer backed insurance is artificially cheap or “good value for money” because everyone knows the state has limitless powers to grab money off taxpayers to rescue depositors should there be a series of large bank failures.

That’s similar to the “too big to fail” phenomenon: that is, if everyone knows taxpayers will come to the rescue of a large bank when it gets into trouble, that knowledge in itself means the relevant bank can borrow at an artificially low rate of interest, even if the bank never actually gets into trouble and taxpayers never actually need come to the rescue of said bank.

But subsidies for banks or indeed any other type of corporation are not justified, unless it can be shown there are overwhelming social considerations involved.

Ergo taxpayer backed deposit insurance for fractional reserve banks is not justified. Accounts at banks should be split into two basic types: first, accounts where deposited money is not loaned on. Those accounts are totally safe because they are INHERENTLY totally safe and do not need any significant amount of insurance.

The second type of account is where deposited money IS LOANED ON, but it’s made abundantly clear to depositors that they may not get all their money back.

And apart from the latter arrangement making sense logically, an additional bonus is that it’s plain impossible for banks to fail: for example if it turns out that the loans made by a bank are worth only half of their book value, the bank does not go bust. All that happens is that depositors will get only around half their money back if they want to cash in their deposits immediately. Alternatively they can hold on in the hopes that things improve.

And as for the idea that funding loans via equity will be much more expensive than funding them via deposits, that’s rather contradicted by the fact that at the time of writing the return on equity in general is (bizarrely) less than the return on bonds, and bonds are of course nothing more than long term deposits.

But even if funding via equity does turn out to be more expensive, the important point is that that system is subsidy free. Ergo it approximates a genuine free market better than funding via deposits. Ergo GDP ought to be higher under that subsidy free system.

Wednesday, 6 September 2017

How to deal with debt ceiling numpties.

First, the Fed carries on doing QE: i.e. printing money and buying up government debt (Treasuries).

That will probably raise inflation too much, so the Fed announces that taxes need to be raised or public spending cut so as to deal with that inflation. That would be music to the ears of right wingers (Republicans) seeing as they’re always keen to cut the deficit.

If that process goes on for long enough, there’d be little or no debt left: it will be turned into base money paying a zero rate of interest.

Debt ceiling numpties (Republicans) would then be hit in the face with the realization that the debt had been replaced with base money: i.e. that debt and money are virtually the same thing. That would be a big improvement in Republican’s grasp of economics.

A further benefit would be that the US would no longer be paying interest to China, Japan and other foreign countries.

What’s not to like?

As for how to regulate demand, just continue with the above idea: i.e. the Fed suggests to numpties (I mean “Congress”) that the deficit needs raising or reducing a bit – and possibly, given a serious outbreak of irrational exuberance, that a surplus is in order.

The only slight drawback with that idea is that the reduction in interest yielding investments in the US would induce some investor / savers to take their money elsewhere in the world, and that would cause the dollar to decline relative to other currencies, which in turn would reduce US living standards for a while. But that’s a purely temporary effect.

I really deserve a nobel prize for that idea, but I’m far too modest to nominate myself.