This page has been archived and commenting is disabled.
Prominent Economists Call for End to Fractional Reserve Banking
Excessive leverage by the banks was one of the main causes of the Great Depression and of the 2008 financial crisis.
As such, lower levels of “fractional reserve banking” – i.e. how many dollars a bank lends out compared to the amount of deposits it has on hand – the more stable the economy will be.
But economist Steve Keen notes (citing Table 10 in Yueh-Yun C. OBrien, 2007. “Reserve Requirement Systems in OECD Countries”, Finance and Economics Discussion Series, Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board):
The US Federal Reserve sets a Required Reserve Ratio of 10%, but applies this only to deposits by individuals; banks have no reserve requirement at all for deposits by companies.
So huge swaths of loans are not subject to any reserve requirements.
Indeed, Ben Bernanke proposed the elimination of all reserve requirements for banks:
The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.
Economist Keen informs Washington’s Blog that about 6 OECD countries have already done away with reserve requirements altogether (Australia, Mexico, Canada, New Zealand, Sweden and the UK).
But there is a growing recognition that this is going in the wrong direction, because fractional reserve banking can destabilize the economy (and credit can easily be created by the government itself.)
It was big news this week when one of the world’s most prominent economics writers – liberal economist Martin Wolf – advocated doing away with fractional reserve banking altogether… i.e. requiring that banks only loan out as much money as they actually have on hand in the form of customer deposits:
Printing counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and should – be terminated.
***
What is to be done? A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt. I discussed this approach last week. Higher capital is the recommendation made by Anat Admati of Stanford and Martin Hellwig of the Max Planck Institute in The Bankers’ New Clothes.
A maximum response would be to give the state a monopoly on money creation. One of the most important such proposals was in the Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher. Its core was the requirement for 100 per cent reserves against deposits. Fisher argued that this would greatly reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff suggests this plan could work well.
Similar ideas have come from Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, and Andrew Jackson and Ben Dyson in Modernising Money.
***
Opponents will argue that the economy would die for lack of credit. I was once sympathetic to that argument. But only about 10 per cent of UK bank lending has financed business investment in sectors other than commercial property. We could find other ways of funding this.
Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.
(The IMF study is here.)
In fact, a lot of experts have backed this or similar proposals, including:
- Bank of England Chief Mervyn King
- Prominent conservative economist Milton Friedman
- Prominent liberal economist Irving Fisher
- Prominent conservative economist Lawrence Kotlikoff
- Prominent liberal economist James Tobin
- Prominent conservative economist John Cochrane
- Prominent liberal economist Herman Daly
- Prominent conservative economist Murray Rothbard
- Prominent British economist John Kay
- Conservative Spanish economics professor Huerta de Soto
- German economist Thorsten Polleit
- Conservative French economist Jörg Guido Hülsmann
- Head economics writer at the Guardian Ambrose Evans-Pritchard
- Bloomberg columnist Matthew C. Klein
Interestingly, the Chicago Plan for full reserve banking came very close to passing in 1934. But the unfortunate death of one of its main Congressional sponsors – Senator Bronson M. Cutting – in a plane crash reversed the momentum for the bill.
As Wikipedia notes:
Cutting played a key role in the political struggles over the reform of banking which Roosevelt undertook while dealing with the Great Depression, and which resulted in the Banking Reform Acts of 1933 and 1935. As a supporter of the Chicago Plan proposed by economist Irving Fisher and others at the University of Chicago, Cutting was among a handful of influential Senators who might have been able to remove from the private banks their ability to manipulate the money supply by enforcing a 100 percent reserve requirement for all credit creation, as stipulated in the Chicago Plan. His unfortunate death in an airliner crash cut short what may have been his most enduring legacy to the nation.
- advertisements -


Unfortunate plane crash (Senator Cutting) for society- fortunate for the bankers. Several democratically elected South American leaders were killed by the CIA using this method too. Back to the article's intention-you can have a ton of PhDs and individuals with a national platform but I plan on getting rid of the Fed by standing outside Wal-Mart and handing out some fliers. These fliers will show how the their dollar's buying power has shrunk with this entity at the helm. Until the masses awake all dialouge regarding this will be just that. I am still in planning stages but hope to get a website up with the information. I am going to try to get college students to help. It would be great to do this grassroots money education across the country.
Personally speaking, I'd be pretty pleased with myself if my 'family' was making a cool 6% on trillions I could order up with a few keystrokes.
Beats working in the coalmines.
Truly a wolf in sheep's clothing. Here is the key part of Wolf's essay that explains his "conversion":
Of course, Wolf isn't interested in fully reserved banking as much as he is interested in giving politicians the power to spend whatever the "printing presses" can produce. Now, if Wolf wants to combine fully reserved banking with an absolute requirement that all government spending be financed with taxes, we can take him seriously.
"The haircut of deposits, will allow major shareholders of Cypriot banks to reduce the legally required capital in cash, through the fractional reserve rule, while a large part of the bailout package will be returned to the banks for the sake of "stabilization" of the banking system."
http://failedevolution.blogspot.gr/2013/03/the-new-big-trick-of-neoliber...
"The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system."
The Federal Reserve is a distortion of the banking system.
Accidenting people does have a way of influencing events.
credit is money, credit should be strictly in the private sector, but credit is money, and the congress, no, the federal reserve, controls the money supply. so if the private sector goes on a credit binge, the fed has no choice but to print the money, and therefore they have no control over inflation (ben is lying)
before the 2008 crash private sector money creation was ramping up. the market was crashed in order to restore the feds control and authority. with the private sector debt creation at zero the fed has had to resort to pumping asset values and money is not moving. i can't wait for NEGATIVE money velocity. its coming
"i can't wait for NEGATIVE money velocity. its coming"
And towing "economies of scale in reverse" right behind it...
wow. I really am at a loss as to how anyone, especially posting here can support fractional reserve lending.
In a nutshell, because someone stores the money in a 'safe' location (debatable since most is digital now), they get to lend out more money than they have and collect interest on it, because why? Because if they keep enough in 'reserve' they won't get caught that they actually lent out more than they have?
Does this work with car rentals? Groceries? Anything that isn't non tangible?
To me it just seems like getting something for nothing. I can understand why TPTB don't want to give it up, but ordinary individuals?
fractional reserve banking is completely natural and typically human, as credit
Ghordius, Midas and hundred others live on an island. G has lots of sheep, M has a gold mine and all the others are fishers
Ghordius has always a stock of wool. Which becomes the unit of account on the island
therefore it's perfectly acceptable by all that Ghordius can issues IOUs in excess of his stock of wool
ta-dah! fractional reserve banking
The only natural thing here is gullability of humans to fall for false promises (because we like to be "hopeful and positive") which ponzi schemes are. They work great at first and who gets in early, they may even look "stable" for quite a while, but they always, ALWAYS, end in tears.
Yup.
And the "ALWAYS" part is shored up by the fact that the System guarantees it by way of assuming that there will be "perpetual growth." Perpetual growth is the carrot, attaining it is not possible. So, yeah, it's on big fucking Ponzi, but people don't see where they all really originate from... (so we cook up another great plan to "fix" the "failure" of the last great plan, only we don't change the flawed premise-> Deja Vu).
Now a wave of sheep flu kills Gordius's sheep and he has no wool to replace those iou's on nonexistent wool.
Those empty bag holders now realize how foolish they were to allow Gordius to hornswoggle them into accepting a piece of paper for something he did not have.
They kill him and bury them in the mine and go back to trading the miners gold. Even if the mine runs out of gold, they still have a unit of accounting that cannot be falsified with ease.
It works like this.
My neighbor is on vacation.
Want to rent his car from me?
Collecting rents from property you don't own.
UPDATE 3-CME mulls price fluctuation limits for gold, silver futures
http://www.reuters.com/article/2014/04/29/cme-group-precious-idUSL2N0NL1...
GW, you do a wonderful job. yet in this I disagree violently, so much that I have to make a third post re
"Excessive leverage by the banks was one of the main causes of the Great Depression and of the 2008 financial crisis."
It's not "excessive leverage" by the banks. this is a meme that is being used for other purposes in the current banking "wars" among themselves
imho there is nothing wrong at all with fractional reserve banking as long as banks are kept small, regional, tightly regulated, "know their customers", "know their collateral" and are allowed to fail
and, most important of all, are kept separate from investment (aka merchant) banking
some evidence for that: between 1945 and 1971 there were practically no banking crises. I know, this is taken as evidence that either the "Bretton Woods System" worked or that the "Nixon Shock" changed the rules again
yet there is the clinch in all this: whenever we talk about the past, we easily forget that banks then were not the same thing as banks now
I remember a time when "bank" was the label people gave to small affairs like the savings and loans associations, or any of the 30'000 small banks that were operating in the First World. nowadays, we talk about monstrosities that have swallowed thousands of them. the megabanks, the chimeras with dozens of investement banking heads and hundreds of business/retail banking feet
just note this criticism in your blog article:
"Investment banks (1) leveraged their balance sheets to stratospheric levels by using short-term wholesale financing (like repurchase agreements and commercial paper) (2).Meanwhile, some entities regulated as bank holding companies (BHCs) used off-balance-sheet entities (3) to warehouse risky assets, thereby evading their regulatory capital requirements. These entities’ reliance on short-term debt to fund the purchase of oftentimes illiquid and risky assets made them susceptible to a classic bank panic. The key difference was that this panic wasn’t a run on deposits by scared individuals, but a run on collateral by sophisticated counterparties(4)."
1) investment banks: I remember when in London they were called "merchant banks", or even "jobbers", were small affairs and... run by the shareholders, who often were liable with all their own assets, making them very, very cautios
2) repos? see regulation. or, better, utter lack of intelligent regulation
3) off balance sheet vehicles? we have the Great DeRegulation to thank for them
4) sophisticated counterparties who have no skin in the game, being only managers with the chance of reaping great bonuses in their megabanks by picking dimes (who thanks to leverage make lots of money) in front of steamrollers while using for this other people's money
I repeat: we don't have a banking problem. we have megabanks. the problem is that we allow megabanks to exist
you want to forbid fractional reserve banking? fine. forbid it for banks above a certain level of balance sheet size
You propose economic rule by regulators. The regulators then decide what is an acceptable asset. Whatever the regulators value as an asset will probably be invested in more heavily than assets that would be bought in a free market system.
So how do you make the system that is regulated by the billions of economic actors.
You get the government out of currency.
If the billions choose gold, then it becomes the currency. People can deposit wages and income in either a deposit bank that is a utility for storing and transacting, or people can deposit income and wages in an investment bank, taking risk.
Each entity can issue receipts for the gold it has. The receipts are redeemable at each institution.
The people as economic actors then can decide on the validity of each banks receipts.
This is where GW is just plain wrong. Money is not a necessary domain of government.
Of course all these institutional receipts for gold are a bit complicated.
Thus comes The LordShatoshi.
Now you have a convenient money that is automatically guaranteed to be the real deal. You don't need to trust that the bank has the gold. You know that your coin is your coin, and it's guaranteed by a network that hasn't gone wrong and certified any coin that was actually a fraud.
I did not start this to talk about Bit Coin, or whatever coin ends up as currency , but it sure does simplify things.
"You propose economic rule by regulators" No, I don't. Read again
example: "The regulators then decide what is an acceptable asset." No. The lender/bank decides what is an acceptable asset. With an assessment made by a credit officer. And this loan stays on the bank's balance sheet. And this credit officer knows the borrower, and knows the asset, and does not get a megabonus out of it. And the bank goes into bankruptcy if it fails to be cautious.
In short, I'm advocating for small banking. In the US and the UK there was such banking in great numbers, and we still have 3'000 such banks in europe
This is stupid. Even in a classical gold standard you have fractional lending and it works if the banks are regulated for solvency. This is what the Suffolk Bank did in the New England states from 1816 to 1858. Over that time, fewer than a handful of their member banks failed, while thousands when under in the rest of the US. These 42 years represents the most stable form of banking in the recorded history of the world. Wake up Sheople. www.electanewcongress.com and www.electfawell.com SERFS UP AMERICA!
You are exactly right. The Suffolk Bank was well regulated. But there were no regulators.
It worked because gold was money. The receipts for the gold were currency. Each bank issued receipts. Individuals and other banks could take the receipts, or leave them depending on how much they trusted the issuing bank.
Suffolk solved a big problem. It was difficult to have knowledge about how much gold was actually there for each issuing bank, especially if the bank was far away.
Suffolk would make a market in country bank receipts and use it's expertise in evaluating the actual solvency of the country bank receipts. Sometimes it sent agents to demand the gold for receipts, but generally , it made more polite arrangements to gain knowledge as to country bank solvency.
Suffolk prospered by providing a valuable service to it's customers. It was able to provide the best price for far away and small bank receipts.
People brought far flung bank receipts and small unknown bank receipts fo Suffolk because Suffolk , through superior knowledge, was able to give then the best price for receipts that Suffok deemed solid. Everybody benefitted fro this arrangement.
The lesson is that we don't need no stinking gmen to ban fractional reserve banking. We don't even need them to regulate it. We just let people acting in self interest regulate it. Nobody wants to take a bad note. Caveat emptor will ensure that in genral , bad money will be rejected.
You merely point out that the "Gold Standard" cheated too. The real gold standard, the one used for the first 5,000 of human civilization, was an implicit 100% reserve. And those caught fudging were impaled, beheaded, eviscerated, etc. Only when the great nations got together and formalized their club, did Sir Issac N. propose a 40% reserve ratio as a perk to all the members. That was in the 1700s; 200 years of that "classical" gold standard pales in comparison to the rest of history.
But hey, let's compromise. Why don't we have the banks track TWO types of deposits: customer's money, and customer's funds that are explicitly designated to be lent, where the banks and the customers expect to split earned interest. If there is a simple requirement that "lent" money must be repaid before it can be redeemed, then we have a simple 100% reserve system across the board, where banks can make money by fees for safekeeping, and doing a bang up job spotting investment opportunities, customers can still lend and borrow as well, but no new money is created by the fiction of fraud. You get your lending, I get my 100% reserve, the banks have a way to make money; everybody but the government is happy.
You kind of glazed over the part where nations diluted their coins by gradually reducing the amount of gold and silver in the coins, while maintaining the same face value.
And there's a question of why that happened. Yes, "greed" is a convenient scapegoat, but it all eminates from the system's predication on perpetual growth: interest, inflation and even greed are pretty much given the playground to run on when the game is understood to be "perpetual growth."
I don't like the Fractional Reserve because of the probabilist gambling it fosters among banks. At least in conjunction with the bank guarentees. I think it also puts stress on the FDIC since supposedly when the bank runs that are not supposed to happen, happen, they have to come in and pay up.
I am guessing that the argument against removing it is that growth would be far less.
If banks don't loan money they don't have, then why would you need a central bank?
<cough> government excess <cough> <cough> monetizing debt <cough> <cough> hidden theft from the masses <cough>
I think that it maps back to "banker excess," no matter which is the cart and which is the horse, we're being tag-teamed.
Prominent, no matter. They will be rounded up by the oligarchs for orderly disposal.
Sorry, budget cuts have done away with all "reprogramming" and "rehabilitation" options.
The criminals operate "wide open" now, in full view since 2008
"liberal economist Martin Wolf – advocated doing away with fractional reserve banking altogether…"
sure. but what is Mr. Wolf advocating? Public credit / Money creation by the state/CBs
in short, moar "central planning"
in detail, he offers a solution advocated by Andrew Jackson and Ben Dyson in Modernising Money.:
"1) the state, not banks, to create transactions money, just as it creates cash today. Customers would own the money in transaction accounts, and would pay the banks a fee for managing them.
2) banks to offer investment accounts, which would provide loans. But they could only loan money actually invested by customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are. Holdings in such accounts could not be reassigned as a means of payment. Holders of investment accounts would be vulnerable to losses. Regulators might impose equity requirements and other prudential rules against such accounts.
3) central banks would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as now, be taken by a committee independent of government."
note that the mainstay of what modern fractional reserve (retail) banking is supposed to be, i.e. the prudent loan (which creates credit) based on quality collateral, good standing of the debtor and careful previous analysis by the banking officer... is thrown out the window by that
reminds me of the great US drive towards homogenization of housing zones and securitization of said zones into great packages, to be then "sliced and diced" into various CDOs for great synthetic debt instruments to be then thrown into the furnace of shadow banking
in short, I smell investment bankers trying to further kill small/retail banking
Wth, ghordo?
"note that the mainstay of what modern fractional reserve (retail) banking is supposed to be, i.e. the prudent loan (which creates credit) based on quality collateral, good standing of the debtor and careful previous analysis by the banking officer... is thrown out the window by that"
They were already thrown out the window. These principles were ignored by the banks and even the regulatory agencies themselves leading up to 2007, and some of those agencies were predicated on compliance alone. Remember how christopher cox refused to accept any accountability with the crash and blamed it on everything from market greed to the failure of capitalism, but not the sec under his oversight? Wolf's idea of a credit based system thats accountable and transparent seems worth a shot to me, eliminating the labyrinthed out of control leveraging that ensues in a frb based system. It also minimizes the fed res role. There will always be some level of government involvement in the creation of a sound banking system, or 'central planning' as you so pejoratively use the term, but i would take a crack at what wolf has outlined over further dependancy on the fed res anytime. Its worth a try.
doppel
https://www.youtube.com/watch?v=e1A_vdXntEY
Complete bullshit. The financial system is unstable because it has no regulator of quality, thus value. Reserve requirements merely meet day to day redemption requirements.
Fractional reserve banking does not create money. It creates credit. Unfortunately the existence of fiat money has clouded the difference, because in debt-based fiat there is no real money, it is ALL credit.
I Disagree.
Money was 'real' when it was redeemable in gold and silver. The fact that it was severed from that anchor only means that the subsequent fiat money/ credit is fraudulent.
Real money is like energy. Once created by the Big Bang of capital invested and the labor of the miner, refiner and the minter, it cannot be destroyed but merely transferred.
If fiat gold/ silver disappeared tomorrow, the true value of gold/ silver money would immediatly become apparent in a free market.
It would take a far larger pile of phoney paper promises to convince someone to trade for an ounce of gold.
Maybe it's me, but I'm sense there's a bit of a conflict going on that I think is because we're mixing "money" and "currencies?"
Currencies MUST be allowed to be defined by the market(s). I tend to think/feel that it is govt's (perhaps manipulated by banks or other?) meddling with currencies that is messing things up.
Gold and Silver were created by a Big Beautiful Star; far away in a Galaxy. For some reason, I like this better than "money" created by politicians. I guess I'm just old fashioned. But it's hard not to be when you look at how well money performed it's necessary functions in the nineteenth century during an enormous explosion of technology and growth and increase in standard of living.
and further, solar metallicities are pretty standard for stars with planets. which means the aliens 1000 light years away might also be using gold (perhaps silver but it gets used up in industry) as money.
a counterpoint tho is that henry ford seems not to have liked gold as money. he thought it could be hoarded and manipulated by the financial powers. he seems to have favored barter / money backed by productive assets like land, etc.
The key being free to choose. Mandated is the problem. There would be a diversification across multiple forms and uses.
Money is a direct proxy for productivity. Credit depends upon the inherent honesty of the individuals involved, and upon whether those individuals are also lucky.
It gets a little more complicated and less predictable when the unit of exchange for the credit system is constantly changed in value by the "authorities".
exactly
further, there is one component in the creation of this credit - in the current setup this public credit - that a lot of those people above forget:
that it's the debtor that creates it - facilitated by a bank
if I want to buy a piece of land and build a house or a business on it, I can go to the bank and immediately offer all this as collateral for a mortgage
hell, in a very few countries I can even pledge my future increased wages for my university education
so whatever you want to say about fractional reserve banking, remember that it's not strictly speaking a central planning shebang per se. it only becomes such a thing through banking regulations
and whatever you want to say about banking regulations, remember how many of them - old, tested ones - were scrapped in the 90's
so for me all this talk about fractional reserve banking... deviates from the real problem: that we allow too big banks to exist
"deviates from the real problem: that we allow too big banks to exist"
"deviates from the real problem: that we allow BAD too big banks to exist"
Fixed! (it's not that they're too big, though I am no fan of "big," it's that they are BAD, and all BAD things need to find their rightful resting spot)
Too big to prosecute. BAD enough?
Im with you on your 'too big to fail' rant though, ghordo. Problem is, the u.s. status quo loves things big, with evryone forced to participate, and hell or highwater if no
You're correct, of course. Deregulation became a religous dogma to be applied blindly to everything. In the real world one has to be pragmatic, not dogmatic. Banking has to be regulated, effectively, and dependably. Also the difference between an investment bank that's owned by it's partners, who will lose their own money, and their standing in their community, when they behave foolishly, and a "Bank" financed by the stock market, playing with other peoples money, is enormous.
Or fully deregulate banking, and be prepared for frequent collapses. If you have a deposit insurance scheme, it must pay for itself, and if the bank collapses, the customers should have their deposits replaced at another bank, and let the failed bank go under instead of getting a bailout.
Precisely why maintaining Faith is so important. Prosecute the fucking fraud, execute white collar criminals (stop rewarding them with government positions).
"Full faith and credit"
Simply put, no more faith means no more credit motherfuckers...
I disagree with the idea that money is a natural function of government. History shows that government cannot be trusted with the power to create money. There should be a free market for private money with the government restricted to a referee to enforce contracts. That is, if Wal-bucks advertise as containing .75 oz of .999 pure silver then the state has a role in making sure they don't water that down. When they are in charge of enforcing that contract against themselves, guess what, in 100 years we go from a dollar that is 1/35th an oz pure gold to one that is Benny Clownbux.
I also disagree with the idea that fractional reserve banking was the problem here. The article practically admits as much. The problem is that there are no reserves! What is going on here is not "fractional reserve banking" because that would require some adequate reserves to be in place. There are no reserves. It is re-hypothecation to infinity counting on everything on the way always maintaining or growing in value. That is why those on the top, who got there by rehypothecating to infinity, can't afford to let the free market do its thing and weed out the losers. These concepts are discussed in more depth in an e-book here http://www.amazon.com/Localism-A-Philosophy-Government-ebook/dp/B00B0GAC... There is a hard cover out there somewhere too, but its hard to find.
As private bankers cannot be trusted with the power to create money then it should be created by governments. As the power to create money is the ultimate power in society then the group with this power controls the government and Mayer Rothschild acknowledges this. So if you believe in true democracy then by implication you believe that the state should control the right to create money rather than private individuals. Furthermore there is a massive conflict of interest in giving the right to create money to a private group as they can be expected to abuse this power for their own profit rather than acting in the public interest. Stark proof of this was provided by Vitali Glattfelder and Battiston (2011) who found that a singlle secret entity linked to the private individuals that control the right to issue money had managed to accumulate around 80% of the wealth in the western world. For you to argue that this is ok is ridiculous.