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Tuesday, December 4, 2012
JKH — Banking in the Abstract – The ‘Chicago Plan'
JKH analyzes Jaromir Benes and Michael Kumhof's "The Chicago Plan Revisited." JKH also compares and contrasts Benes-Kumhof (BK) with Warren Mosler's MMT-based plan.
Here's an issue I don't understand. Yes, if a banking system like the US moves from a 10% reserve system to a 100% reserve system, that does not alter the fundamental institutional facts that permit endogeneity, and permit loans to precede any required additions to reserves.
But wouldn't the change influence the price of additions to reserves? If a bank has deposits of $100 million and reserves also at $100 million (so exactly the new required ratio), and it wants to make loans that will increase its deposits by $10 million, it will subsequently have to increase its reserves by $10 million also during the calculation and compliance periods, in order to maintain its reserve requirement. Suppose the interbank rate stands at 2%. Then the additional reserves will cost $200 thousand - a bit more if they are eventually borrowed from the Fed.
This is ten times more than the additional required reserves would cost if the reserve requirement were only 10%. In that case, we again imagine that the bank starts with $100 million in deposits. But in this case they have reserves of only $10 thousand in deposits - the required amount. Now to expand their deposits by $10 million, they will need to acquire only $1 million in additional reserves. Assuming the 2% rate again, the cost $20,000.
So in the 100% reserve situation, the cost of adding $10 million in deposits is $200,000; while in the 10% reserve situation, the cost of adding $10 million in deposits is $20,000. Since the attractiveness of making additional loans depends on the spread between the expected return on the loans and the cost of making them, the higher cost under the 100% system should have an inhibitory effect on lending.
As I understand it, your observation is spot on. An increase in reserve requirements under those conditions is just an increase in bank lending costs. It's functionally little different than an increase in the FFR. It doesn't change lending capacity, only adds costs that may be passed through to the bank's customers.
The overall effect is extremely configuration-sensitive. Different arrangements have different net interest margin effects.
In the Chicago Plan (my interpretation of it), that $ 10 million loan is funded by a non-reservable injection of government funding. That injection brings $ 10 million of reserves into the lending bank. At the same time, the lending bank has created an endogenous deposit of $ 10 million. The deposit is therefore matched by reserves. The Plan (my understanding of it) specifies a zero rate of interest on reserves and a zero rate of interest on deposits. So that reserve/deposit gross interest margin is zero. The loan/government funding interest margin is left.
The reserve rate and the deposit rate are the same. So there’s no gross margin pressure due to 100 per cent reserves.
Pricing of reservable deposits is basically government mandated in the Chicago Plan. The government has really taken over that part of the banking system balance sheet.
That’s their operational theory, anyway.
The usual conventional required reserve set up is reasonably low ratio, with the option of zero interest earned on reserves, but where there is pricing competition for reservable deposits, like everything else. With a low ratio, any net interest margin hit from the reserve itself can be absorbed more easily, given that much of the deposit will be matched off against an interest earning asset. It is important that there be a mathematical balance between the level of the ratio and the potential for negative interest margins on reserves, as you point out. The Chicago Plan gets around that by essentially government mandating the gross interest margin at zero, so there's no pricing distortion due to that particular piece. (But there's potential distortion from other areas of the plan).
The low ratio reserve where there is a negative interest margin is basically a tax. The Chicago Plan is not looking for a direct tax per se – it’s looking for a method of 100 per cent risk protection on deposits.
The whole point of 100% reserves is that your “endogeneity” is not allowed. I.e. banks just cannot make loans before the corresponding reserves are created. For example under Laurence Kotlikoff’s version of full reserve, depositors can do two things with their money.
1. Go for a safe / instant access account. In that case the money is put in into the equivalent of money market funds, where the money is used ONLY to buy ultra safe stuff like government bonds. (Personally I don’t think that money should ever be invested in anything).
2. Depositors can put their money into mutual funds, and the latter invest in existing stock market securities. And those mutual funds (as is the case with existing mutual funds) cannot “lend money into existence” as banks currently do.
In neither case are loans created before reserves.
Doubtless it would not be possible to police that system with perfection. But then just look at the utterly shambolic way the EXISTING SYSTEM is policed. That’s given us a complete disaster in the form of the credit crunch. Plus the latest attempt at something better (Dodd-Frank) stands at 30,000 pages! That’s just another shambles.
My understanding is that the BK Chicago plan also requires that banks fund the loans by issuing equities in addition to state funding which is probably seen as temporary.
So the pricing will depend on additional things as well, isn't it?
"Money is therefore properly treated as government equity rather than government debt, which is exactly how treasury coin is currently treated under U.S. accounting conventions (Federal Accounting Standards Advisory Board (2012)).”
Is that correct, regarding coin being treated as "equity"?
Yes, bank loan pricing is and would be a function of the cost of the entire funding/capital structure, plus any other expenses. The funding/capital structure in this case consists of government funding plus an equity capital piece. Other expenses would include any negative interest margin associated with required reserves (if there is one, but I think the C plan specifies not), as well as normal stuff such as salaries and taxes, etc. Also, each loan has an expected loss associated with it, which is treated similarly to an expense. (The risk to equity capital is the risk around that expected loss).
Those things are all assumed/estimated, and plugged into an equation which includes the desired expected return on equity capital, and loan pricing pops out of that equation.
I didn't see where equity capital funding is assumed to be temporary. Can you point me to that, if its in the paper? thx
I saw that, but didn’t explore it. The intended meaning of it, whatever it is, makes no difference to how I suggest the subject of “government equity” be treated from an economic and financial standpoint, which is described in some detail in that section of my post.
JKH, I might be misunderstanding the Chicago Plan proposal, but are you talking about the policy borrowing rate or the rate of interest on reserves - the "holding" rate? Up until a couple of years ago, there was no interest paid on reserve balances, and so the rate of interest on reserves was 0%. But of course all through that era there was always a positive Fed Funds rate, which ultimately became the policy rate explicitly targeted by the Fed, and that rate was typically much larger that the current ZIRP rates. So are you saying that your understanding of the Chicago Plan is that the Fed would hold the Fed Fends rate at zero? If that's the plan, then it seems the hundred percent reserves regime would not accomplish anything of what its defenders are aiming for.
I think when I ask about this before, maybe it was here or maybe at Warren's site, Warren or Scott was of the opinion that the Fed "necessarily" will provide whatever volume of reserves are demanded, so that if there is a higher volume of required reserves, the FF rate will of necessity be lower. But is that true. The volume of reserves demanded will always be a function of price, and if the government is the price setter the volume of demand for lending and reserve-building is to some degree a government policy choice. There is no necessity here other than the fact that once the government sets it rate target, it will have to supply whatever volume of reserves it wants to hit that target.
Maybe the point is just that we are talking about a six of one, half-dozen of the other situation. If people want the government to supervise a tighter lending regime with a slower and more deliberate pace of capital formation, why not just propose a higher policy rate with no change in reserve requirements?
An important historical consideration, I think, is that the original Chicago Plan was proposed in March, 1933, and the Banking Act establishing the FDIC was enacted later that year. The major point of 100% reserves proposal, I thought, was to prevent bank runs. And the FDIC approach accomplished that in a different way at the commercial bank level. In the recent crisis we did not have a commercial bank run on ordinary deposits. We did, however, have a run of sorts in the markets for derivative financial products in insurance, investment banking, and non-traditional commercial banking. Isn't that where the focus should be? If the concern is that commercial banks were too free in making ordinary loans, it seems to me that the answer is to prevent people from securitizing bad loans with products created by people at many removes of control and agency responsibility from the loans, and to prevent people from making bets on failure.
- Bank makes $ 10 million loan - Bank obtains non-reservable funding for $ 10 million from government (Set aside equity funding; it’s a smaller amount and an operational detail) -Bank credits $ 10 million to borrower’s account as a reservable deposit - Government funding at the same time has produced $ 10 million in reserves
Now:
Match the loan to the government funding – that’s a risk hedge (credit and liquidity)
Match the reserves to the reservable demand deposit – that’s a risk hedge (credit and liquidity)
Now:
Consider the reserve/deposit piece almost as a separate bank
It could be viewed as a government bank
Government mandates pricing, in effect
Reserves pay zero interest; deposits pay zero interest
Then:
I think you have to almost forget about the fed funds market as a concept, because the BK Chicago proposal is so different
It’s not even clear what monetary policy means – although it involves control over the reserve/deposit rate relationship, as well as control over the funding rate – to the point where they even suggest the funding rate can be nominally negative
I don’t think you can compare this particular proposal to existing competitive market mechanisms very easily
Damn! The paradoxical approach of the paper can mean one can interpret it anyway. Page 34's discussion was interpreted by me as something in which the government requires banks to match loans with own equity (since government funding was considered exogenous).
i.e., what I am saying is that the while government will be forced to provide banks with reserves when lending increases, it may require it to issue equities so that the plan doesn't have the government itself funding the banks but it happens through the private market.
Re your first comment above, you are quite right to say that full reserve makes it more difficult for banks to lend. And my reaction is “quite right too”. Reason is that under the existing fractional reserve system, banks are heavily subsidised. Plus the whole borrow / lend / investment market is skewed in favour of banks and against other borrow / lend / invest institutions like the stock exchange. Those privileges enjoyed by banks should be removed which means the bank industry shrinks.
Moreover, the banking industry in the UK has expanded a whapping TEN FOLD relative to GDP over the last thirty years. Much the same in the US. And what have we got for it? Absolutely nothing, except disastrous credit crunches, and banks more or less controlling the White House and Congress. So shrinking the industry won’t do any harm.
The above subsidy is as follows. Currently banks can accept deposits of $X, promise to repay that sum, while investing the money in less than 100% investments, loans, etc. That’s a risk. And when the risk goes seriously wrong, the taxpayer foots the bill.
As to the deflatonary effect of the above reduced bank lending, that’s no problem. The government / central bank machine can just spend base money into the economy. That way everyone has more money and thus won’t NEED TO borrow so much. Plus there’d be less bank loan funded activity and more zero loan funded activity plus activity funded by loans from sources other than banks.
Next, banks create money when they lend. In contrast, under full reserve (at least Kotlikoff’s version) commercial banks do not create money, because when a commercial bank lends on depositors’ money, the latter money vanishes, and depositors get mutual fund units instead (the value of which falls when the underlying loans or investments fall).
Ramanan,
Neither the Laurence Kotlikoff version of full reserve, nor that proposed by Richard Werner (economics prof in the UK) propose “banks fund the loans by issuing equities”. Loans are funded (as now) primarily by depositors. For Werner, see:
As to the IMF paper, it’s ludicrously long, and from what I’ve gleaned from skimming thru it, it’s rubbish. For example, far as I can see from the balance sheets on their p.64, mortgages are all written off! Absolutely crazy. They mix up a large scale debt jubilee and full reserve banking: two separate issues.
JKH:
Re your claim that “Money is therefore properly treated as government equity”, neither Kotlikoff nor Werner propose that government or central bank take any sort of equity stake in anything.
Dan,
Re your 8.07 comment above and the question of the price at which the central bank issues reserves, the answer is a “zero price”, i.e. zero rate of interest. That is, under full reserve (as advocated by Milton Friedman and Werner) the central bank / government machine just spends base money into the economy when and to the extent that stimulus is needed. Under Werner’s system, interest rates are left to look after themselves, a policy I fully agree with. Interest rate adjustments by central banks are a complete farce for reasons I set out here:
For Milton Friedman, see the URL below, but in particular the para starting “under the proposal..” (p.250) and item No.1 under the heading “The Proposal”, p.247 here:
http://nb.vse.cz/~BARTONP/mae911/friedman.pdf
Warren Mosler also advocates a zero rate. See 2nd last para here:
“Their loan portfolio now has to be backed by a combination of their own equity and non-monetary liabilities. For the reasons discussed in section II.B, we assume that this funding is supplied exclusively by the government treasury, with private agents limited to holding either bank equity or monetary instruments that do not fund any lending.”
That seems relatively straightforward and is my understanding of it (although I disagree with the sentence just preceding this quote.
I.e. the government funds bank lending except for bank equity funding, which must therefore be held by private agents
Interesting – this description also gives an opening for private agents to hold government bonds, which I suggested must still be the case in order to control money supply (in addition to however they are used to finance any budget deficit)
I have to go into a meeting at 10am, so I'll come back to this later. But for now, this is my question. When you say:
"Bank obtains non-reservable funding for $ 10 million from government."
I ask, how? By what means? At what cost? It seems impossible to assess the impact of the plan without knowing something about the proposed funding costs.
Banks are forced to source funding from government.
Government sets the price.
That's an input to all the factors that determine loan pricing, as I said above.
My goodness - I hope you don't think I'm endorsing this thing! I made that evident in my intro to the post. So when I say its a "detail", my primary interest here has been to try and understand what BK is proposing in terms of change to the general framework of the monetary system - not how the details of loan pricing or funding for loans will work. But you're quite right - its not clear from their paper how that would work, along with a few other things.
Suppose the interbank rate stands at 2%. Then the additional reserves will cost $200 thousand - a bit more if they are eventually borrowed from the Fed. Dan K
You assume two major government subsidies for the banks - a legal tender lender of last resort, the Fed, and government deposit insurance. Remove those subsidies and let the monetary sovereign itself provide a risk-free fiat storage and transaction service and the cost of borrowing reserves might be much higher.
Also, the ethical way to 100% reserves is a universal and equal bailout of the population till all deposits are 100% backed - not borrowing them from the CB.
I neglected to add that the fiat storage and transaction service provided by the monetary sovereign would make no loans so there would be no hope of banks borrowing reserves from it apart from individual depositors making private loans.
Endogenous private money creation is great but let's make sure it is truly private, eh? And if it is truly private then we can be sure that the issuers will have to provide genuine value to the population rather than loot them.
My understanding of Benes&Kumhof regarding money as debt/equity is simply:
1) It makes little sense to call money a government debt as the government doesn't actually owe anything (that would normally be called a "debt") as a consequence of issuing money. It only agrees to accept it in payment. Is that a "debt"?
2) Therefore, keep money on the right-hand side of the government's balance sheet, but move it from 'liabilities' to 'equity'.
No, I know that you are skeptical of the proposal. I am too, but I think a little bit less than you are. I'm just trying to figure out what the defenders of the proposal are trying to accomplish, and the answer depends on both institutional and operational detail.
"Endogeneity" is a term that is used somewhat vaguely in the economics literature to cover a lot of different institutional frameworks. The basic mental model of an endogenous money system is one in which the private sector economy somehow internally generates the additional money it needs to transact business in a growing economy with more-or-less stable price. A so called "free banking" regime would be the starkest form of endogeneity.
An exogenous money system is one in which the government or some other agent external to the private sector economy is directly responsible for the supply of each additional unit of the currency in which the private sector conducts its monetary exchanges.
We live under neither a purely endogenous monetary regime nor a purely exogenous one. In our system, banks are required to transact most payments among themselves in a form of money that is provided by the government. Banks in the aggregate can't endogenously create their own clearing balances. Increases in aggregate reserve balances come from the government and the government only.
On the other hand, banks can create liabilities in the form of deposit balances for loan customers without first obtaining required balances of matching reserve assets, and the central bank generally follows an accommodative policy for supplying these balances governed by an interest rate target. But the liabilities the bank issues, when mature, are effectively liabilities for the money issued by the government. Demand deposit balances have a redeemability guarantee. The redemption might take the form of exchanging a portion of one's electronic balance for physical cash - a direct government liability. Or it might take the form of a payment made to a depositor at another bank, which necessary triggers a transfer of government-issued reserve balances from one bank to the other.
You proposal has no appeal to me personally. I do not understand why we should want to live under such a system. It turns government-issued currency into just another currency issued by just another currency-issuer, competing with private currencies. I don't see why the public should want to surrender its control over the national monetary system.
Therefore, keep money on the right-hand side of the government's balance sheet, but move it from 'liabilities' to 'equity'.
It seems to me that if someone thinks it makes no sense to classify money in circulation as a liability of the government, then it makes even less sense to classify it as a government asset among the government's equity. Surely the person with the asset is the person who has the money.
There is an alternative approach for those who want to go down this route. Remember it is only in financial accounting that all of the assets in a closed system have to be matched by corresponding liabilities. Financial assets are promises - so there is always a promisor and a promisee, someone who owes and someone who is owed. But other kinds of assets are non-financial. If I own an apple tree worth +X to me, that doesn't mean there is someone out there with a liability worth -X to them. If I trade some apples to somebody for any other kind of thing, or if I give the apples away, the apples no longer go on my balance sheet - although they might go on the accounting record of my previous transactions.
So I suppose you could treat a HPM dollar as a non-financial asset manufactured by the government. Treasuries are genuine government liabilities representing that the government owes you some quantity of dollars, in the same way as an IOU for apples is a liability representing that issuer of the IOU owes the bearer some quantity of dollars. But the dollars are not themselves liabilities any more than the apples are. They are what is owed, but not themselves IOUs representing the owing of something.
But if people don't find this approach appealing, and insist in thinking that after a dollar is issued it still belongs on the government's balance sheet somehwere, then it only makes sense to put it on the liability side, since it can used by the bearer to offset a tax obligation - which must go on the other side of the balance sheet since taxes are owed by taxpayers to the government.
It's a bit too technical in parts for me, though I'd be interested to see what BK think. Maybe you should email them your text, if you haven't already?
If they're correct that treasury coin is treated as equity this does raise the question of why that would be. Might it be some sort of error?
BK are coming from the Monetary Reform (Zarlenga/AMI) angle, which sees (state) "money" as an abstract legal/ social concept totally distinct in character from private credit/debt. They assert that (state) "money" and "debt" are necessarily distinct categories, with (state) "money" being: "a definitive (or unconditional) means of payment" established by law.
(From that point of view, it seems to follow that there isn't necessarily an existing accounting category which fully or correctly describes state money, though "equity" is probably better than liability or debt).
Interestingly, Knapp seems to be the originator of this view, (possibly putting him at odds with MMT):
"Money always signifies a Chartal means of payment. Every Chartal means of payment we call money. The definition of money is therefore "a Chartal means of payment."
"There is also another objection which is often raised against non-material Chartal money. Such tickets as paper money pure and simple are, it is said, acknowledgments of the State's indebtedness. Payment in such tickets is therefore only a claim on the State, a provisional satisfaction still leaving something to be done on the part of the State. It is not a definitive payment, consequently not a payment at all in the strict sense.
“The question is, how these pieces stand in the eye of the law... In the case of paper money proper the State offers no other means of payment; therefore it is not an acknowledgment of the State's indebtedness...
"A note would only be a debt in the legal sense if it were convertible without any radical general change in the means of payment, and this the note according to our premises certainly is not.
Instead of perpetually insisting on the defects of autogenic money, just think a little of its services. It frees us from our debts, and a man who gets rid of his debts does not need to spend time considering whether his means of payment were material or not. First and foremost it frees us from our debts towards the State, for the State, when emitting it, acknowledges that, in receiving, it will accept this means of payment."
All I have been able to find is that coin is listed on the Fed's balance sheet as an asset. But I would assume that is because coin is issued by the Treasury. So as in the case of Federal Reserve Notes and reserve balances, issued money is accounted for as a liability of the issuer and an asset of the holder. Similarly, if the Treasury has some Federal Reserve notes, then those notes would appear as assets of the Treasury and liabilities of the Fed.
This just means the government has two operational arms, and each can hold the liabilities of the other. But once these forms of money are circulating outside the government, then they remain on the liability side of the appropriate government balance sheet, but not on the asset side of either sheet. The non-governmental entity holding the money is the one with the asset in that case.
"it makes even less sense to classify it as a government asset among the government's equity. Surely the person with the asset is the person who has the money"
If you think of government as a business, then state money (treated as equity) would be like a type of "shareholders' equity" (with whoever holds the money being a sort of "shareholder").
It's on the liabilities side of the business' balance sheet, but isn't a debt.
Geoff, it seems to me that the reserve balances required to back expanded loans by individual banks can be supplied primarily by attracting depositors; but the loans of the banking system in the aggregate cannot. If 100 people come into Ban A, and each deposits $10,000 dollars by writing Bank A a check drawn on their account at another bank, then the checks will be cleared when $1 million in reserve assets have been transferred from the reserve accounts of those other banks to the reserve account of Bank A. And in this way, Bank A can grow their reserves without directly paying either the government or the other banks for those reserves.
But clearly the banking system as a whole cannot grow their reserves in this way.
Also note that I said that Bank A doesn't pay the government or other banks directly for the reserves. But note that to attract those walk-in deposits, the bank has to offer the depositors interest on their accounts and other services and benefits, which have a cost.
y, OK I see. Yes, you can treat money as in some sense an asset of "the public", but a liability of the government.
However, I think in that case, you wouldn't want to treat the value of this asset as equal to the nominal value of the currency. Just as when the Fed holds a Treasury liability as a Fed asset, the asset and liability cancel out to zero from the consolidated point of view, so I think that if a member of the public holds the government's liability, we should think of the combined effect on the total consolidated "public balance sheet" or "United States balance sheet" as zero.
Or maybe we can think of the value of the dollar in circulation as something like the marginal addition to public utility that is made by having one more dollar in circulation. I would say the value of this is not equivalent to one dollar of goods as measured in current prices, but is somewhat less than that.
"deposits don't fund loans, rather loans create deposits?"
A loan creates a deposit, but then the borrower spends the deposit. Say the person receiving the borrower's spending has their account at another bank, the first bank then owes that money to the second bank. So it has to attract depositors or borrow money if it want to keep things in balance until the loan is repaid, whilst still making a profit from the loan. So in that sense, loans create deposits, then deposits serve as a source of funding for the loan in retrospect.
It turns government-issued currency into just another currency issued by just another currency-issuer, competing with private currencies. Dan K
Not at all. Government money (which should only be inexpensive fiat) will always have the advantage of being the only means of extinguishing tax liabilities. That is an enormous advantage and means that most people would choose to use fiat for private debts too UNLESS the government wasted the purchasing power of its money by say, funding useless wars or bailing out banks.
And it is our current system of government backed banks that destroys the ability of the monetary sovereign to create money without price inflation except during busts (caused by the banks) when it becomes a necessity. Yet you defend that system?
Dan, shareholders own claims on a business, but those claims aren't debts of the business to shareholders. If you treat money as equity it's still a claim on the govt, but not a debt in the way that a bond is a debt, for example.
It's a claim in two senses perhaps: 1) it can be used to cancel debts owed to the govt, 2) it's a stake in the money system as a whole, a legally-established means of final payment acceptable throughout the economy.
I guess it doesn't make sense (not your points of course but BK). The construction is such that it violates its own spirit. I guess one can say the same about the old plans as well.
The 100% reserve requirement is a pure illusion because it is borrowed reserves. Except maybe for some minor technicalities, it looks identical to zero reserve requirement.
The only sense one can get out of the plan is lending for capital formation by firms and working capital financing is excluded.
So in that sense, loans create deposits, then deposits serve as a source of funding for the loan in retrospect. y
Without government deposit insurance and a legal tender lender of last resort and if the monetary sovereign itself (as it should) provided a risk-free fiat storage and transaction service that made no loans then imagine what would happen if a bank lent deposits into existence? Would those deposits not lead to a rapid reserve drain from that bank to the risk-free fiat storage service?
Thus the banks' ability to create money (so-called "credit") is based on both government privilege and government negligence wrt its responsibilities as a monetary sovereign.
In your 11.33 and 11.36am comments you say you don’t see the advantages of full reserve. As I pointed out earlier, the main advantage is that it does not require a subsidy. Fractional reserve does: a fact that has been laid bare in dramatic fashion over the last 5 years. But quite apart from the credit crunch, there is the ongoing TBTF subsidy. Andrew Haldane of the Bank of England has estimated the total subsidy going to banks over the last decade as being several times their profits.
I.e. fractional reserve is a clapped out, loss making, uneconomic, commercially non-viable, shambles. It’s part of the social security for the rich system. It’s an iron rule of free markets and capitalism that loss makers are closed down, or shrunk, or remodel themselves.
A second problem with fractional reserve is that it is not stable: witness the rapid rise in M4 relative to base money in the UK prior to the crunch. There’s a nice chart (scroll half way down) here:
I’m not suggesting full reserve would be 100% stable. But at least it ameliorates the feed back loop: banks lend money for property, which boosts property prices, which makes property better collateral, when facilitates more lending for property.
I’m not suggesting full reserve would be 100% stable. Ralph Musgrave
Usury alone is unstable according to Dr. Michael Hudson and Karl Denninger since the debt eventually compounds faster than real economic growth.
However, common stock as private money does not even require borrowing, much less borrowing at interest. So why isn't common stock widely used as private money? ans: It can't compete with stealing purchasing power via loans from the government subsidized credit cartel, our banking system.
I got the dinner notice from another time zone. Everyone has left the building.
Surfaces have been well scratched here. Ralph, JKH and y have, in particular, brought the proposed understanding of public money administration well forward.
Yet there remains an obvious gap in understanding and only minimal acceptance of the results of the modeling and the conclusions of the research work done.
I hope that everyone approaches this study with the same open mind that they bring to their existing understandings of modern money.
In his public presentations of the B-K work, Dr. Kumhof is fond of reminding people that it is not a policy recommendation, it is a research study.
As it goes miles beyond either the original Chicago Plan or Fisher's 100 Percent Money proposals, it is more than a struggle just to understand what it proposes to accomplish, and thus to draw a contrast with any other system that is out there. And that includes the accounting.
Here's an issue I don't understand. Yes, if a banking system like the US moves from a 10% reserve system to a 100% reserve system, that does not alter the fundamental institutional facts that permit endogeneity, and permit loans to precede any required additions to reserves.
ReplyDeleteBut wouldn't the change influence the price of additions to reserves? If a bank has deposits of $100 million and reserves also at $100 million (so exactly the new required ratio), and it wants to make loans that will increase its deposits by $10 million, it will subsequently have to increase its reserves by $10 million also during the calculation and compliance periods, in order to maintain its reserve requirement. Suppose the interbank rate stands at 2%. Then the additional reserves will cost $200 thousand - a bit more if they are eventually borrowed from the Fed.
This is ten times more than the additional required reserves would cost if the reserve requirement were only 10%. In that case, we again imagine that the bank starts with $100 million in deposits. But in this case they have reserves of only $10 thousand in deposits - the required amount. Now to expand their deposits by $10 million, they will need to acquire only $1 million in additional reserves. Assuming the 2% rate again, the cost $20,000.
So in the 100% reserve situation, the cost of adding $10 million in deposits is $200,000; while in the 10% reserve situation, the cost of adding $10 million in deposits is $20,000. Since the attractiveness of making additional loans depends on the spread between the expected return on the loans and the cost of making them, the higher cost under the 100% system should have an inhibitory effect on lending.
Dan,
ReplyDeleteAs I understand it, your observation is spot on. An increase in reserve requirements under those conditions is just an increase in bank lending costs. It's functionally little different than an increase in the FFR. It doesn't change lending capacity, only adds costs that may be passed through to the bank's customers.
Dan,
ReplyDeleteThe overall effect is extremely configuration-sensitive. Different arrangements have different net interest margin effects.
In the Chicago Plan (my interpretation of it), that $ 10 million loan is funded by a non-reservable injection of government funding. That injection brings $ 10 million of reserves into the lending bank. At the same time, the lending bank has created an endogenous deposit of $ 10 million. The deposit is therefore matched by reserves. The Plan (my understanding of it) specifies a zero rate of interest on reserves and a zero rate of interest on deposits. So that reserve/deposit gross interest margin is zero. The loan/government funding interest margin is left.
The reserve rate and the deposit rate are the same. So there’s no gross margin pressure due to 100 per cent reserves.
Pricing of reservable deposits is basically government mandated in the Chicago Plan. The government has really taken over that part of the banking system balance sheet.
That’s their operational theory, anyway.
The usual conventional required reserve set up is reasonably low ratio, with the option of zero interest earned on reserves, but where there is pricing competition for reservable deposits, like everything else. With a low ratio, any net interest margin hit from the reserve itself can be absorbed more easily, given that much of the deposit will be matched off against an interest earning asset. It is important that there be a mathematical balance between the level of the ratio and the potential for negative interest margins on reserves, as you point out. The Chicago Plan gets around that by essentially government mandating the gross interest margin at zero, so there's no pricing distortion due to that particular piece. (But there's potential distortion from other areas of the plan).
The low ratio reserve where there is a negative interest margin is basically a tax. The Chicago Plan is not looking for a direct tax per se – it’s looking for a method of 100 per cent risk protection on deposits.
Dan,
ReplyDeleteThe whole point of 100% reserves is that your “endogeneity” is not allowed. I.e. banks just cannot make loans before the corresponding reserves are created. For example under Laurence Kotlikoff’s version of full reserve, depositors can do two things with their money.
1. Go for a safe / instant access account. In that case the money is put in into the equivalent of money market funds, where the money is used ONLY to buy ultra safe stuff like government bonds. (Personally I don’t think that money should ever be invested in anything).
2. Depositors can put their money into mutual funds, and the latter invest in existing stock market securities. And those mutual funds (as is the case with existing mutual funds) cannot “lend money into existence” as banks currently do.
In neither case are loans created before reserves.
Doubtless it would not be possible to police that system with perfection. But then just look at the utterly shambolic way the EXISTING SYSTEM is policed. That’s given us a complete disaster in the form of the credit crunch. Plus the latest attempt at something better (Dodd-Frank) stands at 30,000 pages! That’s just another shambles.
JKH,
ReplyDeleteMy understanding is that the BK Chicago plan also requires that banks fund the loans by issuing equities in addition to state funding which is probably seen as temporary.
So the pricing will depend on additional things as well, isn't it?
JKH,
ReplyDeleteBenes & Kumhof:
"Money is therefore properly treated as government equity rather than government debt, which is exactly how treasury coin is currently treated under U.S. accounting conventions (Federal Accounting Standards Advisory Board (2012)).”
Is that correct, regarding coin being treated as "equity"?
Ramanan,
ReplyDeleteYes, bank loan pricing is and would be a function of the cost of the entire funding/capital structure, plus any other expenses. The funding/capital structure in this case consists of government funding plus an equity capital piece. Other expenses would include any negative interest margin associated with required reserves (if there is one, but I think the C plan specifies not), as well as normal stuff such as salaries and taxes, etc. Also, each loan has an expected loss associated with it, which is treated similarly to an expense. (The risk to equity capital is the risk around that expected loss).
Those things are all assumed/estimated, and plugged into an equation which includes the desired expected return on equity capital, and loan pricing pops out of that equation.
I didn't see where equity capital funding is assumed to be temporary. Can you point me to that, if its in the paper? thx
y,
ReplyDeleteI saw that, but didn’t explore it. The intended meaning of it, whatever it is, makes no difference to how I suggest the subject of “government equity” be treated from an economic and financial standpoint, which is described in some detail in that section of my post.
JKH,
ReplyDeleteI meant government funding as temporary, not equity capital funding (in the paper).
R,
ReplyDeleteRight - sorry, that's what I really meant to ask. Can you point to that in the paper?
JKH, I might be misunderstanding the Chicago Plan proposal, but are you talking about the policy borrowing rate or the rate of interest on reserves - the "holding" rate? Up until a couple of years ago, there was no interest paid on reserve balances, and so the rate of interest on reserves was 0%. But of course all through that era there was always a positive Fed Funds rate, which ultimately became the policy rate explicitly targeted by the Fed, and that rate was typically much larger that the current ZIRP rates. So are you saying that your understanding of the Chicago Plan is that the Fed would hold the Fed Fends rate at zero? If that's the plan, then it seems the hundred percent reserves regime would not accomplish anything of what its defenders are aiming for.
ReplyDeleteI think when I ask about this before, maybe it was here or maybe at Warren's site, Warren or Scott was of the opinion that the Fed "necessarily" will provide whatever volume of reserves are demanded, so that if there is a higher volume of required reserves, the FF rate will of necessity be lower. But is that true. The volume of reserves demanded will always be a function of price, and if the government is the price setter the volume of demand for lending and reserve-building is to some degree a government policy choice. There is no necessity here other than the fact that once the government sets it rate target, it will have to supply whatever volume of reserves it wants to hit that target.
Maybe the point is just that we are talking about a six of one, half-dozen of the other situation. If people want the government to supervise a tighter lending regime with a slower and more deliberate pace of capital formation, why not just propose a higher policy rate with no change in reserve requirements?
An important historical consideration, I think, is that the original Chicago Plan was proposed in March, 1933, and the Banking Act establishing the FDIC was enacted later that year. The major point of 100% reserves proposal, I thought, was to prevent bank runs. And the FDIC approach accomplished that in a different way at the commercial bank level. In the recent crisis we did not have a commercial bank run on ordinary deposits. We did, however, have a run of sorts in the markets for derivative financial products in insurance, investment banking, and non-traditional commercial banking. Isn't that where the focus should be? If the concern is that commercial banks were too free in making ordinary loans, it seems to me that the answer is to prevent people from securitizing bad loans with products created by people at many removes of control and agency responsibility from the loans, and to prevent people from making bets on failure.
Dan,
ReplyDeleteTake my modification of your example:
- Bank makes $ 10 million loan
- Bank obtains non-reservable funding for $ 10 million from government
(Set aside equity funding; it’s a smaller amount and an operational detail)
-Bank credits $ 10 million to borrower’s account as a reservable deposit
- Government funding at the same time has produced $ 10 million in reserves
Now:
Match the loan to the government funding – that’s a risk hedge (credit and liquidity)
Match the reserves to the reservable demand deposit – that’s a risk hedge (credit and liquidity)
Now:
Consider the reserve/deposit piece almost as a separate bank
It could be viewed as a government bank
Government mandates pricing, in effect
Reserves pay zero interest; deposits pay zero interest
Then:
I think you have to almost forget about the fed funds market as a concept, because the BK Chicago proposal is so different
It’s not even clear what monetary policy means – although it involves control over the reserve/deposit rate relationship, as well as control over the funding rate – to the point where they even suggest the funding rate can be nominally negative
I don’t think you can compare this particular proposal to existing competitive market mechanisms very easily
JKH,
ReplyDeleteDamn! The paradoxical approach of the paper can mean one can interpret it anyway. Page 34's discussion was interpreted by me as something in which the government requires banks to match loans with own equity (since government funding was considered exogenous).
i.e., what I am saying is that the while government will be forced to provide banks with reserves when lending increases, it may require it to issue equities so that the plan doesn't have the government itself funding the banks but it happens through the private market.
So it thinks of m_t as exogenous.
Dan,
ReplyDeleteRe your first comment above, you are quite right to say that full reserve makes it more difficult for banks to lend. And my reaction is “quite right too”. Reason is that under the existing fractional reserve system, banks are heavily subsidised. Plus the whole borrow / lend / investment market is skewed in favour of banks and against other borrow / lend / invest institutions like the stock exchange. Those privileges enjoyed by banks should be removed which means the bank industry shrinks.
Moreover, the banking industry in the UK has expanded a whapping TEN FOLD relative to GDP over the last thirty years. Much the same in the US. And what have we got for it? Absolutely nothing, except disastrous credit crunches, and banks more or less controlling the White House and Congress. So shrinking the industry won’t do any harm.
The above subsidy is as follows. Currently banks can accept deposits of $X, promise to repay that sum, while investing the money in less than 100% investments, loans, etc. That’s a risk. And when the risk goes seriously wrong, the taxpayer foots the bill.
As to the deflatonary effect of the above reduced bank lending, that’s no problem. The government / central bank machine can just spend base money into the economy. That way everyone has more money and thus won’t NEED TO borrow so much. Plus there’d be less bank loan funded activity and more zero loan funded activity plus activity funded by loans from sources other than banks.
Next, banks create money when they lend. In contrast, under full reserve (at least Kotlikoff’s version) commercial banks do not create money, because when a commercial bank lends on depositors’ money, the latter money vanishes, and depositors get mutual fund units instead (the value of which falls when the underlying loans or investments fall).
Ramanan,
Neither the Laurence Kotlikoff version of full reserve, nor that proposed by Richard Werner (economics prof in the UK) propose “banks fund the loans by issuing equities”. Loans are funded (as now) primarily by depositors. For Werner, see:
http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf
As to the IMF paper, it’s ludicrously long, and from what I’ve gleaned from skimming thru it, it’s rubbish. For example, far as I can see from the balance sheets on their p.64, mortgages are all written off! Absolutely crazy. They mix up a large scale debt jubilee and full reserve banking: two separate issues.
JKH:
Re your claim that “Money is therefore properly treated as government equity”, neither Kotlikoff nor Werner propose that government or central bank take any sort of equity stake in anything.
Dan,
Re your 8.07 comment above and the question of the price at which the central bank issues reserves, the answer is a “zero price”, i.e. zero rate of interest. That is, under full reserve (as advocated by Milton Friedman and Werner) the central bank / government machine just spends base money into the economy when and to the extent that stimulus is needed. Under Werner’s system, interest rates are left to look after themselves, a policy I fully agree with. Interest rate adjustments by central banks are a complete farce for reasons I set out here:
http://ralphanomics.blogspot.co.uk/2012/03/sixteen-reasons-why-mmt-is-right-on.html
For Milton Friedman, see the URL below, but in particular the para starting “under the proposal..” (p.250) and item No.1 under the heading “The Proposal”, p.247 here:
http://nb.vse.cz/~BARTONP/mae911/friedman.pdf
Warren Mosler also advocates a zero rate. See 2nd last para here:
http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html
Ralph,
ReplyDelete"neither Kotlikoff nor Werner propose that government or central bank take any sort of equity stake in anything"
neither have BK, nor I
Dan,
ReplyDeleteI said:
"Match the loan to the government funding – that’s a risk hedge (credit and liquidity)"
that's wrong; too quick this a.m.
it's mostly a funding liquidity hedge (e.g. matched term to maturity, etc.)
the other risks are supported by equity funding
but the reserve/deposit match is a full risk credit and liquidity hedge
Ramanan,
ReplyDeletePage 34:
“Their loan portfolio now has to be backed by a combination of their own equity and non-monetary liabilities. For the reasons discussed in section II.B, we assume that this funding is supplied exclusively by the government treasury, with private agents limited to holding either bank equity or monetary instruments that do not fund any lending.”
That seems relatively straightforward and is my understanding of it (although I disagree with the sentence just preceding this quote.
I.e. the government funds bank lending except for bank equity funding, which must therefore be held by private agents
Interesting – this description also gives an opening for private agents to hold government bonds, which I suggested must still be the case in order to control money supply (in addition to however they are used to finance any budget deficit)
JKH,
ReplyDeleteI have to go into a meeting at 10am, so I'll come back to this later. But for now, this is my question. When you say:
"Bank obtains non-reservable funding for $ 10 million from government."
I ask, how? By what means? At what cost? It seems impossible to assess the impact of the plan without knowing something about the proposed funding costs.
Dan,
ReplyDeleteThat's a detail.
Banks are forced to source funding from government.
Government sets the price.
That's an input to all the factors that determine loan pricing, as I said above.
My goodness - I hope you don't think I'm endorsing this thing! I made that evident in my intro to the post. So when I say its a "detail", my primary interest here has been to try and understand what BK is proposing in terms of change to the general framework of the monetary system - not how the details of loan pricing or funding for loans will work. But you're quite right - its not clear from their paper how that would work, along with a few other things.
Suppose the interbank rate stands at 2%. Then the additional reserves will cost $200 thousand - a bit more if they are eventually borrowed from the Fed. Dan K
ReplyDeleteYou assume two major government subsidies for the banks - a legal tender lender of last resort, the Fed, and government deposit insurance. Remove those subsidies and let the monetary sovereign itself provide a risk-free fiat storage and transaction service and the cost of borrowing reserves might be much higher.
Also, the ethical way to 100% reserves is a universal and equal bailout of the population till all deposits are 100% backed - not borrowing them from the CB.
I neglected to add that the fiat storage and transaction service provided by the monetary sovereign would make no loans so there would be no hope of banks borrowing reserves from it apart from individual depositors making private loans.
ReplyDeleteEndogenous private money creation is great but let's make sure it is truly private, eh? And if it is truly private then we can be sure that the issuers will have to provide genuine value to the population rather than loot them.
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ReplyDeleteJKH,
ReplyDeleteMy understanding of Benes&Kumhof regarding money as debt/equity is simply:
1) It makes little sense to call money a government debt as the government doesn't actually owe anything (that would normally be called a "debt") as a consequence of issuing money. It only agrees to accept it in payment. Is that a "debt"?
2) Therefore, keep money on the right-hand side of the government's balance sheet, but move it from 'liabilities' to 'equity'.
y,
ReplyDeleteyes, I agree that's what they do
but I disagree with it
you'd really have to spend some time on my post if you're interested in the argument as to why; if not, no sweat
JKH,
ReplyDeleteNo, I know that you are skeptical of the proposal. I am too, but I think a little bit less than you are. I'm just trying to figure out what the defenders of the proposal are trying to accomplish, and the answer depends on both institutional and operational detail.
"Endogeneity" is a term that is used somewhat vaguely in the economics literature to cover a lot of different institutional frameworks. The basic mental model of an endogenous money system is one in which the private sector economy somehow internally generates the additional money it needs to transact business in a growing economy with more-or-less stable price. A so called "free banking" regime would be the starkest form of endogeneity.
An exogenous money system is one in which the government or some other agent external to the private sector economy is directly responsible for the supply of each additional unit of the currency in which the private sector conducts its monetary exchanges.
We live under neither a purely endogenous monetary regime nor a purely exogenous one. In our system, banks are required to transact most payments among themselves in a form of money that is provided by the government. Banks in the aggregate can't endogenously create their own clearing balances. Increases in aggregate reserve balances come from the government and the government only.
On the other hand, banks can create liabilities in the form of deposit balances for loan customers without first obtaining required balances of matching reserve assets, and the central bank generally follows an accommodative policy for supplying these balances governed by an interest rate target. But the liabilities the bank issues, when mature, are effectively liabilities for the money issued by the government. Demand deposit balances have a redeemability guarantee. The redemption might take the form of exchanging a portion of one's electronic balance for physical cash - a direct government liability. Or it might take the form of a payment made to a depositor at another bank, which necessary triggers a transfer of government-issued reserve balances from one bank to the other.
frlbane,
ReplyDeleteYou proposal has no appeal to me personally. I do not understand why we should want to live under such a system. It turns government-issued currency into just another currency issued by just another currency-issuer, competing with private currencies. I don't see why the public should want to surrender its control over the national monetary system.
Therefore, keep money on the right-hand side of the government's balance sheet, but move it from 'liabilities' to 'equity'.
ReplyDeleteIt seems to me that if someone thinks it makes no sense to classify money in circulation as a liability of the government, then it makes even less sense to classify it as a government asset among the government's equity. Surely the person with the asset is the person who has the money.
There is an alternative approach for those who want to go down this route. Remember it is only in financial accounting that all of the assets in a closed system have to be matched by corresponding liabilities. Financial assets are promises - so there is always a promisor and a promisee, someone who owes and someone who is owed. But other kinds of assets are non-financial. If I own an apple tree worth +X to me, that doesn't mean there is someone out there with a liability worth -X to them. If I trade some apples to somebody for any other kind of thing, or if I give the apples away, the apples no longer go on my balance sheet - although they might go on the accounting record of my previous transactions.
So I suppose you could treat a HPM dollar as a non-financial asset manufactured by the government. Treasuries are genuine government liabilities representing that the government owes you some quantity of dollars, in the same way as an IOU for apples is a liability representing that issuer of the IOU owes the bearer some quantity of dollars. But the dollars are not themselves liabilities any more than the apples are. They are what is owed, but not themselves IOUs representing the owing of something.
But if people don't find this approach appealing, and insist in thinking that after a dollar is issued it still belongs on the government's balance sheet somehwere, then it only makes sense to put it on the liability side, since it can used by the bearer to offset a tax obligation - which must go on the other side of the balance sheet since taxes are owed by taxpayers to the government.
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ReplyDeleteJKH,
ReplyDeleteIt's a bit too technical in parts for me, though I'd be interested to see what BK think. Maybe you should email them your text, if you haven't already?
If they're correct that treasury coin is treated as equity this does raise the question of why that would be. Might it be some sort of error?
BK are coming from the Monetary Reform (Zarlenga/AMI) angle, which sees (state) "money" as an abstract legal/ social concept totally distinct in character from private credit/debt. They assert that (state) "money" and "debt" are necessarily distinct categories, with (state) "money" being: "a definitive (or unconditional) means of payment" established by law.
(From that point of view, it seems to follow that there isn't necessarily an existing accounting category which fully or correctly describes state money, though "equity" is probably better than liability or debt).
Interestingly, Knapp seems to be the originator of this view, (possibly putting him at odds with MMT):
"Money always signifies a Chartal means of payment. Every Chartal means of payment we call money. The definition of money is therefore "a Chartal means of payment."
"There is also another objection which is often raised against non-material Chartal money. Such tickets as paper money pure and simple are, it is said, acknowledgments of the State's indebtedness. Payment in such tickets is therefore only a claim on the State, a provisional satisfaction still leaving something to be done on the part of the State. It is not a definitive payment, consequently not a payment at all in the strict sense.
“The question is, how these pieces stand in the eye of the law... In the case of paper money proper the State offers no other means of payment; therefore it is not an acknowledgment of the State's indebtedness...
"A note would only be a debt in the legal sense if it were convertible without any radical general change in the means of payment, and this the note according to our premises certainly is not.
Instead of perpetually insisting on the defects of autogenic money, just think a little of its services. It frees us from our debts, and a man who gets rid of his debts does not need to spend time considering whether his means of payment were material or not. First and foremost it frees us from our debts towards the State, for the State, when emitting it, acknowledges that, in receiving, it will accept this means of payment."
p.38 - 52
http://socserv.mcmaster.ca/econ/ugcm/3ll3/knapp/StateTheoryMoney.pdf
Ralph said: "Loans are funded (as now) primarily by depositors"
ReplyDeleteRalph, I believe that is blasphemy around these parts :)
Wouldn't Mr. Mosler say the reverse, i.e. deposits don't fund loans, rather loans create deposits?
All I have been able to find is that coin is listed on the Fed's balance sheet as an asset. But I would assume that is because coin is issued by the Treasury. So as in the case of Federal Reserve Notes and reserve balances, issued money is accounted for as a liability of the issuer and an asset of the holder. Similarly, if the Treasury has some Federal Reserve notes, then those notes would appear as assets of the Treasury and liabilities of the Fed.
ReplyDeleteThis just means the government has two operational arms, and each can hold the liabilities of the other. But once these forms of money are circulating outside the government, then they remain on the liability side of the appropriate government balance sheet, but not on the asset side of either sheet. The non-governmental entity holding the money is the one with the asset in that case.
Dan,
ReplyDelete"it makes even less sense to classify it as a government asset among the government's equity. Surely the person with the asset is the person who has the money"
If you think of government as a business, then state money (treated as equity) would be like a type of "shareholders' equity" (with whoever holds the money being a sort of "shareholder").
It's on the liabilities side of the business' balance sheet, but isn't a debt.
Geoff, it seems to me that the reserve balances required to back expanded loans by individual banks can be supplied primarily by attracting depositors; but the loans of the banking system in the aggregate cannot. If 100 people come into Ban A, and each deposits $10,000 dollars by writing Bank A a check drawn on their account at another bank, then the checks will be cleared when $1 million in reserve assets have been transferred from the reserve accounts of those other banks to the reserve account of Bank A. And in this way, Bank A can grow their reserves without directly paying either the government or the other banks for those reserves.
ReplyDeleteBut clearly the banking system as a whole cannot grow their reserves in this way.
Also note that I said that Bank A doesn't pay the government or other banks directly for the reserves. But note that to attract those walk-in deposits, the bank has to offer the depositors interest on their accounts and other services and benefits, which have a cost.
y, OK I see. Yes, you can treat money as in some sense an asset of "the public", but a liability of the government.
ReplyDeleteHowever, I think in that case, you wouldn't want to treat the value of this asset as equal to the nominal value of the currency. Just as when the Fed holds a Treasury liability as a Fed asset, the asset and liability cancel out to zero from the consolidated point of view, so I think that if a member of the public holds the government's liability, we should think of the combined effect on the total consolidated "public balance sheet" or "United States balance sheet" as zero.
Or maybe we can think of the value of the dollar in circulation as something like the marginal addition to public utility that is made by having one more dollar in circulation. I would say the value of this is not equivalent to one dollar of goods as measured in current prices, but is somewhat less than that.
"deposits don't fund loans, rather loans create deposits?"
ReplyDeleteA loan creates a deposit, but
then the borrower spends the deposit. Say the person receiving the borrower's spending has their account at another bank, the first bank then owes that money to the second bank. So it has to attract depositors or borrow money if it want to keep things in balance until the loan is repaid, whilst still making a profit from the loan. So in that sense, loans create deposits, then deposits serve as a source of funding for the loan in retrospect.
It turns government-issued currency into just another currency issued by just another currency-issuer, competing with private currencies. Dan K
ReplyDeleteNot at all. Government money (which should only be inexpensive fiat) will always have the advantage of being the only means of extinguishing tax liabilities. That is an enormous advantage and means that most people would choose to use fiat for private debts too UNLESS the government wasted the purchasing power of its money by say, funding useless wars or bailing out banks.
And it is our current system of government backed banks that destroys the ability of the monetary sovereign to create money without price inflation except during busts (caused by the banks) when it becomes a necessity. Yet you defend that system?
Dan, shareholders own claims on a business, but those claims aren't debts of the business to shareholders. If you treat money as equity it's still a claim on the govt, but not a debt in the way that a bond is a debt, for example.
ReplyDeleteIt's a claim in two senses perhaps: 1) it can be used to cancel debts owed to the govt, 2) it's a stake in the money system as a whole, a legally-established means of final payment acceptable throughout the economy.
JKH,
ReplyDeleteI guess it doesn't make sense (not your points of course but BK). The construction is such that it violates its own spirit. I guess one can say the same about the old plans as well.
The 100% reserve requirement is a pure illusion because it is borrowed reserves. Except maybe for some minor technicalities, it looks identical to zero reserve requirement.
The only sense one can get out of the plan is lending for capital formation by firms and working capital financing is excluded.
JKH,
ReplyDeleteCheck this Tweet:
https://twitter.com/WhelanKarl/status/276398339988271104
So in that sense, loans create deposits, then deposits serve as a source of funding for the loan in retrospect. y
ReplyDeleteWithout government deposit insurance and a legal tender lender of last resort and if the monetary sovereign itself (as it should) provided a risk-free fiat storage and transaction service that made no loans then imagine what would happen if a bank lent deposits into existence? Would those deposits not lead to a rapid reserve drain from that bank to the risk-free fiat storage service?
Thus the banks' ability to create money (so-called "credit") is based on both government privilege and government negligence wrt its responsibilities as a monetary sovereign.
ReplyDeleteDan,
ReplyDeleteIn your 11.33 and 11.36am comments you say you don’t see the advantages of full reserve. As I pointed out earlier, the main advantage is that it does not require a subsidy. Fractional reserve does: a fact that has been laid bare in dramatic fashion over the last 5 years. But quite apart from the credit crunch, there is the ongoing TBTF subsidy. Andrew Haldane of the Bank of England has estimated the total subsidy going to banks over the last decade as being several times their profits.
I.e. fractional reserve is a clapped out, loss making, uneconomic, commercially non-viable, shambles. It’s part of the social security for the rich system. It’s an iron rule of free markets and capitalism that loss makers are closed down, or shrunk, or remodel themselves.
A second problem with fractional reserve is that it is not stable: witness the rapid rise in M4 relative to base money in the UK prior to the crunch. There’s a nice chart (scroll half way down) here:
http://tutor2u.net/economics/revision-notes/a2-macro-monetarism.html
I’m not suggesting full reserve would be 100% stable. But at least it ameliorates the feed back loop: banks lend money for property, which boosts property prices, which makes property better collateral, when facilitates more lending for property.
I’m not suggesting full reserve would be 100% stable. Ralph Musgrave
ReplyDeleteUsury alone is unstable according to Dr. Michael Hudson and Karl Denninger since the debt eventually compounds faster than real economic growth.
However, common stock as private money does not even require borrowing, much less borrowing at interest. So why isn't common stock widely used as private money? ans: It can't compete with stealing purchasing power via loans from the government subsidized credit cartel, our banking system.
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ReplyDeleteThis comment has been removed by the author.
ReplyDelete"2. its monetary value is unstable and unpredictable vis a vis other assets, including money" y
ReplyDeleteIts monetary value is unstable because the money it is measured in expands and contracts as credit is created and repaid?
I got the dinner notice from another time zone. Everyone has left the building.
ReplyDeleteSurfaces have been well scratched here.
Ralph, JKH and y have, in particular, brought the proposed understanding of public money administration well forward.
Yet there remains an obvious gap in understanding and only minimal acceptance of the results of the modeling and the conclusions of the research work done.
I hope that everyone approaches this study with the same open mind that they bring to their existing understandings of modern money.
In his public presentations of the B-K work, Dr. Kumhof is fond of reminding people that it is not a policy recommendation, it is a research study.
As it goes miles beyond either the original Chicago Plan or Fisher's 100 Percent Money proposals, it is more than a struggle just to understand what it proposes to accomplish, and thus to draw a contrast with any other system that is out there. And that includes the accounting.
Ever upward.