Last night I attended an event organised by my friends at positive money, discussing the question of money creation and what to do about it. Martin Wolf and Ben Dyson both made the case for some form of full reserve banking, an Icelandic Parliamentarian kind of agreed with them and an alderwoman of the city of London was there to vaguely carp about how such a move could hurt jobs in the city. Not the most balanced event, but I enjoyed it a great deal (in spite of the inevitable ‘I have a question, and a very long comment’ prize cretins speaking from the floor!).To be transparent, this is an idea I support, and have done for some time. My reasons for this are best expressed without any technical exposition – it’s clear to me that financial institutions in the UK, and especially the large ‘clearing’ banks, have an enormous amount of power to shape our society and economy, and its equally clear that their essentially unconstrained ability to collectively control the amount of money in the economy is a big part of this power. I therefore support the removal of this power.
That was my position before last night, and it remains my position, but I’d like to recap a couple of conversations around it that I think are important. Firstly, a general observation. There is a tendency amongst finance folks like me, although I try to avoid falling into this trap, to abstract from a particular set of institutional arrangements around money and say that ‘This is how it works’. Yes it’s true that on a given date, risk limits in place at a given institution prevent the loan officer issuing unlimited loans. Yes it’s true that the money market, on a given day, can’t support unlimited size. The question is do those constraints matter, and clearly, in the long run, they don’t. The broad money is expanding exactly as one would expect if banks were broadly unconstrained in their money creation – it’s growing exponentially. It may be locally true that one bank can’t make infinite loans on a given day, but I think to argue that saying that ‘banks create money’ implies this is reduction ad absurdum at its finest. This is social/institutional ‘science’ – it ain’t physics. Saying that banks don’t create money out of nothing because they aren’t locally, entirely unconstrained obscures the broader truth that over time, the system as a whole can and does. I hope this is clear, I think it’s important so if it’s not, post a comment!
So, generalities aside, a specific criticism: by far the most commonly cited and for me most coherent objection to the idea of full reserve banking came from those worrying about near money. I’ll put their argument in the most common form I heard:
“Full reserve banking aims to have a state monopoly over the creation of money, but this is impossible because private agents always find a way to create new types of near monies that do exactly the same thing, so full reserve is pointless at best”
Firstly, I think it’s important to recognise a key characteristic of the current system, which is that the state already fully guarantees the deposit liabilities of the clearing banks. It’s unthinkable that a large bank in the UK could be forced to wipe out depositors, not just up to the 85k covered by explicit state protection, but the whole lot. As Mr Wolf said memorably last night, the deposit liabilities of major institutions are just too important. By taking responsibility for the creation of most of our money, the banks effectively have the government over a barrel. I definitely think it’s possible to rank money like things in terms of importance to the economy, and the detail of Positive Money’s proposals (which this near money criticism is a reaction to) is that only the most important kinds of money would be the purview of the state. This effectively formalises the implicit guarantee these liabilities currently enjoy. This I think is the crucial flaw in this argument. By transforming demand deposits at financial institutions into effectively electronic tokens, the economy is provided with a large, fully state guaranteed set of liabilities to use in transactions. Any money that’s created outside of that system in the ‘wild west’ of near moneys that are out there will look a lot less attractive. It’s not an asset you’d want to own that’s for sure, much as the financial system might try and force it on you, and they’d have no real excuse for so doing because so long as the stock of money available was managed appropriately (yes I understand that’s a big if, but I’d argue that the current system poses bigger ifs!), why would there be demand for such instruments? It’s impossible to get more convenient than ‘100% state backed, fully electronic money available to everyone’ and convenience is typically where ‘near moneys’ tend to creep in because the official system is too cumbersome (think paper claims on gold supplanting physical holdings). Also, I don’t understand what’s so legally complicated about simply extending the law on paper banknotes to cover electronic deposits. We allow shops to print gift vouchers, but not banks to print banknotes. It’s not that all paper promises are illegal, just certain types – and the aim of the exercise is not to restrict all types of money like things, only demand deposits that are instantly redeemable for cash. We wouldn’t want to restrict anything else.
In short, it’s true that you wouldn’t completely neuter the financial system’s ability to create things that look a bit like money. But I don’t think that’s particularly desirable or important. I’m happy to restrict the ability to create state backed money to the state only – which is exactly what PM proposes.