Friday, December 28, 2012

Clint Ballinger — Modern Monetary Theory & Full Reserve Banking: Connected by Fiat

The fourth of a series of posts on MMT, ‘The Chicago Plan Revisited’, and related issues...

There are actually two concerns most advocates of Full Reserves have:
1. Solvency – there are few solvency issues with full reserves; not surprisingly a major concern in the 1930s for Simons, Fisher, The Chicago Plan etc.
2. (Endogenous) money creation
The second is much the more important, but the two are often confusingly conflated.
Partly this is because the significance of the fact that the loanable funds model is wrong and there is no money multiplier is not always fully appreciated by Full Reservers.
Banks do not make loans based on reserves or loanable funds but based on demand, perceived profitability, and the capital they hold. The government covers reserve requirements later. Raising reserve requirements can raise costs but does not stop money creation. Even the focus on sight deposits (i.e., PositiveMoney) misses the point – not only do reserve requirements not stop money creation, neither does stopping lending based on sight deposits. Banks loans pull money from the central bank, with the limit being the ratio of capital to risk-weighted assets.
So, unless Full Reservers are only worried about bank solvency, which is doubtful, they are really addressing concerns that have their root in endogenous money.
Clint Ballinger
Modern Monetary Theory & Full Reserve Banking: Connected by Fiat


12 comments:

Anonymous said...

Endogenous private money creation is good (I say "private" because only Caesar should create Caesar's money and it should only be inexpensive fiat to avoid government waste and to avoid arbitrary limits on the amount of government money created such as a gold-standard would impose).

But endogenous private money creation to be truly private and thus ethical must not enjoy government privileges such as the banks now enjoy - such as government deposit insurance and a legal tender lender of last resort.

David said...

endogenous money adds fuel to the “FIRE”

It amounts to a subsidy which, if not directly "paid for by the taxpayer," accrues to rent and comes out of the Mr. Taxpayer's hide in the form of higher housing prices. The latest news is that housing is going up, even though wages are still going down. And this is greeted as good news! Henry George noticed over a hundred years ago that wages seemed to be high when land prices were low and vice versa. It's just the law of rent in operation. We have a system whose main function seems to be to prop up the price of real estate, and yet we look for the sources of income inequality everywhere else except where it obviously lies if one understands the law of rent.

Ralph Musgrave said...

Frlbane,

I agree that all forms of subsidy for private banking should be removed – in particular the lender of last resort privilege and the TBTF subsidy. (Deposit insurance (e.g. FDIC) is actually OK with me as long as it’s genuinely self-funding). However, the very fact of removing those subsidies or privileges means an inevitable move to full reserve, or an exogenous money only system. Reasons are as follows.

As regards money that depositors want their bank to lend on or invest (so that depositors can earn interest) the costs involved when those loans go wrong is currently born to some extent by taxpayers. So to remove that subsidy, it’s just depositors and bank shareholders who must carry the cost when loans go wrong. But in that case, what depositors hold when putting money into a bank is no longer money: it’s more in the nature of a shareholding in the bank or in the loans / investments made by the bank.

Indeed Laurence Kotlikoff, who advocates full reserve, SPECIFICALLY ADVOCATES that where depositors want interest, they have to buy into mutual funds. I.e. they no longer hold money: they hold a stake in a mutual fund.

Ergo no endogenous money creation takes place there.

As distinct from money that depositors want their bank to lend on or invest, there is money that depositors want to be 100% safe and/or instant access. Now the only way of keeping money 100% safe is not to lend it on or invest it at all. And private banks create money when they lend. So in the latter 100% safe scenario, no endogenous money creation takes place EITHER.

I’ll actually be putting a paper online hopefully in January which will probably be entitled “Removing bank subsidies leads inexorably to full reserve banking.”

There is a SLIGHT weakness in the above argument, as follows.

You could argue that in an economy with no central bank (i.e. just commercial banks) and no subsidies for commercial banks, that the latter would nevertheless obviously create a form of money. However, that form of money for reasons given above, would amount to a stake or shareholding in the relevant commercial bank. And that is not an ideal form of money - as millions of people in the early 1930s and earlier discovered when the savings they put into failed commercial banks vanished. In fact it was the latter robbery of millions of small savers that was one of Irving Fisher’s main motives for advocating full reserve.

I.e. as soon as government / central bank produces money, that form of money becomes the dominant and preferred form of money. While the interest earning deposits in commercial banks are revealed for what they really are: a shareholding in the bank or in the underlying loans / investments.

Anonymous said...

I get the feeling Warren has been misinterpreted.

I get the feeling that Clint is saying endogenous money is a crock and we can do without it.

Endogenous money is one of the several foundations of Modern Monetary Theory. Remove it from MMT and you have something other than MMT.

I've seen much of the same confusion I used to have with endogenous money elsewhere too - indicating only banking/horizontal money is endogenous. This could not be more wrong.

I think it is time to revisit this post by Peter Cooper http://heteconomist.com/verticalhorizontal-vs-exogenousendogenous/

Anonymous said...

Funny, I go back to read Clint's other posts and he makes this exact same point in the comments on his first post. Something is missing here.

My point and Peter Cooper's point is horizontal money is not the only form of endogenous money and endogenous money exists regardless.

I wish I could define "regardless" better in the context I mean it as it seems to leave it a bit open. Hopefully my intent is clear.

Anonymous said...

I'm not real clear on Full Reserve Banking and am beginning to understand the intent reading these posts and it does seem to suggest it will close of one form of endogenous money from bank lending, however not what people choose to do with their money which affects the federal budget outcome, so that remains endogenous. This needs to be clarified in the posts Clint Ballinger has made.

Personal Opinion: Also strikes me FRB will not allow new banks to emerge and will operate like most markets gravitate to major centres and leave more distributed centres in the lurch.

Anonymous said...

I'm so glad that my thinking process led to the same conclusion as Bill Mitchell's:

There would be the equivalent of a gold standard imposed on private banking which could invoke harsh deflationary forces.

And that only reinforces my theory of how FRB would be distributed into existence. It is little more than a power play.

Anonymous said...

Indeed Laurence Kotlikoff, who advocates full reserve, SPECIFICALLY ADVOCATES that where depositors want interest, they have to buy into mutual funds. I.e. they no longer hold money: they hold a stake in a mutual fund. Ralph Musgrave

Actually, I consider common stock to be an ideal private money form since it requires no reserves, no usury, no government privileges and is democratic (at least per share).

Anonymous said...

There would be the equivalent of a gold standard imposed on private banking which could invoke harsh deflationary forces. modernmoney

Not necessarily. If new fiat were distributed equally to the entire population at the same rate as the repayment of existing credit debt until all deposits were 100% backed by reserves then a ban on FRL would not cause deflation (or inflation for that matter).

Anonymous said...

(Deposit insurance (e.g. FDIC) is actually OK with me as long as it’s genuinely self-funding). Ralph Musgrave

If deposit insurance could be made self-funding then no involvement by the monetary sovereign would be necessary; private insurance companies would happily take that business. But the banking cartel is prone to system-wide failure and panic so no insurer but the monetary sovereign is credible. But then, why not have the monetary sovereign itself provide a risk-free fiat storage and transaction service and avoid subsidizing the "private" banks?

Anonymous said...

FRLBane,

You'll never get 100% Reserves ever that way unless you have a ban on lending until FR is reached which would likely create deflation as the economy is driven to a halt.

It seems to me Full Reserve Banking no matter the transmission mechanism to get to FR is merely analogous to a fixed exchange rate.

History speaks for itself on that.

Clint Ballinger said...

modernmoney said...
"I get the feeling that Clint is saying endogenous money is a crock and we can do without it."
Hear hear

"Endogenous money is one of the several foundations of Modern Monetary Theory. Remove it from MMT and you have something other than MMT."
MMT can address operational realities or analyze a Chartalist system. But it cannot do both

Peter Cooper - don't see the relevance. Call it more correctly inside money; fiat money is outside money, and it is what chartalism is about.


On the comment by Bill Mitchell - he is just wrong with a gold standard comparison. Indeed, the suggestions discussed would lead to a true fiat money system and thus true MMT friendly chartalism, not the hybrid system now. But that is another post.