Yves Smith of Naked Capitalism has pointed out that Irwing Fisher had proposed something similar in his book, 100% Money (Published in 1935).
Here is how my proposal is different:
Irving Fisher in his book 100% Money (1935) proposed that all banks be required to hold 100% reserves for money deposits payable on demand. In other words the government should outlaw fractional reserve banking. Fisher believed that booms and busts are a result of credit created by fractional reserve banking.
I propose that the government require commercial banks to provide 100% reserve account as one of the options. I do NOT propose that the government should outlaw fractional reserve banking.
Summary:
a) The 100% reserve accounts would just be another option that a public would have. I am in no way saying that banks should be forced to offer 100% reserve deposit accounts only just that they must provide it as one of the choices.
b) I also propose that many institutions absolutely necessary to maintain law and order must not take any credit risk with their liquid capital (utility companies, municipalities, states, hospitals, etc). The idea here is that civil law and order should not be disrupted even if several very large financial institutions fail at the same time.
c) I would also remove the protection of FDIC insurance for moral hazard reasons. But I would still have an FDIC like institution to facilitate a quick and smooth transfer of 100% reserve accounts to another bank from the failing bank. The idea here is to keep the payment system running smoothly so day-to-day commerce can continue to function even if a very large deposit taking institution fails.
d) The main objective is to preserve Adam Smith’s invisible hand in disciplining and destroying poorly managed very large financial institutions. I am not proposing that we write a more stringent Glass-Steagall Act or keep anyone from creating complex financials products (securitization, derivatives, etc.) or keep any bank from investing non-100% reserve bank deposits in risky and/or complex financial products. In fact, I would want most banking regulations repealed, as they are unable to protect us from systemic meltdown. Doing this will greatly lower regulatory compliance costs for banks.
e) I strongly believe that if we don’t let very large financial institutions die then they will eventually economically destroy us by mis-allocating huge amounts of capital. There should be no such bank that is too big to fail. But we also don’t want to descend into total chaos after a meltdown and not be able to maintain a basic payment system to conduct day-to-day commerce.
f) In short, our basic electronic ledger based payment system should function even if several very large deposit taking financial institutions fail at the same time without resorting to physical paper cash to conduct day-to-day transactions. Deposits in 100% reserve accounts will provide a basis to build new viable financial institutions if a meltdown occurs.
g) My proposal is a variation on what is sometimes called “Free Banking” with the 100% reserve deposit account as a required option for the public.
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6 comments:
Hi, Aquinum. Got your thinkin' hat on?
I observe that your proposal is not a "fix" for the current crisis, but a policy for the long term, so that financial crises can be avoided. No, not avoided.... So that crises can be "survivable" for people who make the right choices, perhaps.
Okay. Say your proposal had been set up 20 or 30 years ago. Say it was in place and working. And (for the sake of argument) say that nothing else in our economy was different, up until the financial crisis hit in September, 2008.
(Ok, things would have gradually changed because of your policy. Explain?)
I should say it is difficult to imagine a proposal like yours, except in the context of the actual circumstances of our present economy. And the recent experience of our economy dropping to its knees may blind me to some of the changes your proposal would bring. Nevertheless:
It seems to me that when everything fell apart (September & October, 2008) everybody would have been trying to switch their zero-reserve accounts over to 100% reserve accounts, all in a panic. And this would have resulted in a fiscal crisis much like the one we actually had. If so, then where is the benefit of the 100%-reserve option?
I see an answer in your Item F: "In short, our basic electronic ledger based payment system should function even if several very large deposit taking financial institutions fail at the same time...."
Idunno. I think after the Great Depression people were very cautious for a very long time. Plus, the economy was in great shape in the 1950s and '60s. But in the '70s there were problems. In the '80s & '90s we de-regulated to "get government off our back." De-regulation lifted profit and boosted economic growth. Since the '80s people grew less and less cautious.
As the stock market went up, and as the chance to quickly make a significant profit became more common, people more and more threw caution to the wind. Under your plan, since the 1980s people would have been moving more and more of their money from 100%-reserve accounts to zero-reserve accounts, like sharks smelling blood in the water. I think it is human nature that, when some people profit by abandoning caution, more and more will follow.
In the end, again, financial crisis would ensue. Because of human nature. We don't "make the right choices." We are sharks.
Me? I'm not big on making proposals. My interest is to understand the past or, rather, to understand the process. If we understand *how* the economy works, solutions will present themselves. However...
#1. The use of credit adds to the quantity of money in circulation. Therefore, the repayment of debt is a way to fight inflation. I would set up tax incentives to encourage people (and businesses) to pay off their debt a little faster than we have done since the 1970s say. Accelerated repayment of debt would fight inflation and reduce debt at the same time. Sweet.
#2. Taking that a step further, I would change the income tax. (I'm not talking about the LEVEL of taxation, but the EFFECT of it.) When a person (or business) borrows, his/her debt-to-income ratio increases. I would make the TAX RATE vary with the debt-to-income ratio. Your tax rate would become variable, like the rate of interest. And at a comparable percentage as well, I imagine. You could reduce your taxes by reducing your debt!
#3. The variable rate of taxation would *replace* the variable rate of interest in our economy. And the Federal Reserve would therefore be able to keep interest rates permanently low. This would be beneficial for economic growth.
#4. In the long view, I foresee that the "credit cycle" would become a thing of the past. Indeed, everyone would have his own credit cycle. But the economy as a whole would see no cyclic pattern. Thus, the major force that drives the business cycle would be eliminated. Economic growth would be driven by low interest rates and other factors, but there would never be an accumulation of debt that leads to recession or depression. Long view, of course.
Thanks for asking!
To Arthurian,
You are correct. My resolution to this issue will not help much if significant part of the money supply is not in 100% reserve accounts at the time of a financial system meltdown. A much better long term resolution to this issue is to have a mostly equity based economy rather than a mostly debt based economy. In a mostly equity based economy there would not be much credit money waiting to be destroyed in a financial meltdown. Equity adjusts more easily and quickly to changes in values of underlying assets. Debt has a much more difficult time (specially bank deposit debt) adjusting to changes in the value of underlying assets.
We will have these exaggerated credit induced boom and bust cycles as long as there is significant fractional reserve lending in the economy. And sometimes busts will lead to depressions. It may take a hundred years but it will happen eventually. Even if we outlawed fractional reserve lending people will find ways around it by constantly switching funds between 100% reserve accounts and regular savings accounts and CDs.
However, there some simple things we can do to make the markets more efficient. For example, when a bank becomes insolvent we should quickly "break the buck". That is, reset the value of each non-100% reserve dollar in the deposit accounts in that bank to "take" the loss immediately to the point of bringing the bank to solvency. The will at least not "remove" all of the money supply from the failing bank (non-FDIC money market funds work this way) from the economy.
You see amount of money in an economy is a yardstick for measuring economic value and store of economic value. Fractional Reserve Lending process causes the yardstick to change (by changing the amount of total money in an economy). Depressions cause money supply to contract suddenly. This contraction throws our economic relationships off balance as it impacts asset values and real value of debt burdens. Note that in current crises no “nuclear bombs” hit our civilization but impact of a depression/financial meltdown would be almost as bad. This is because we are in a midst of a crises in measurement of economic values. That is, we are confused about what things are worth and who owes what to whom. A sudden change in money supply throws of our economic relationships because it throws off the “accounting”. It is as if in science the length of the meter stick suddenly changed. Impact of contracting money supply is so enormous that it impacts each and every one of us and every economic transaction in our society directly or indirectly.
Aquinum, we have much in common.
You say, the "long term resolution to this issue is to have a mostly equity based economy rather than a mostly debt based economy."
Yes. (With reference to our definition of money as equity.) My every reference to "credit in use" is of course a reference to debt. For debt is the measure of credit in use. It is the balance -- or rather the imbalance -- between equity and debt, between money and credit in use, that is the recurring problem.
You say, "We will have these exaggerated credit induced boom and bust cycles as long as there is significant fractional reserve lending in the economy. "
I would simply change your future-cast "will have" to a past-cast "have had" and offer it as evidence supporting your future-cast.
Now it gets interesting. You say: "However, there some simple things we can do to make the markets more efficient. For example, when a bank becomes insolvent we should quickly "break the buck". That is, reset the value of each non-100% reserve dollar in the deposit accounts in that bank to "take" the loss immediately to the point of bringing the bank to solvency."
Okay, so the money in non-100%-reserve accounts takes the hit when the time comes. Maybe regulation and "transparency" will be needed to catch the failing bank early enough that the non-100%-reserve account funds are adequate to cover the losses. But I don't care about that....
I'm thinkin' under your system we have two types of money: "safe" and "risky." Risky money is like common stock and safe money is like preferred stock, because common stock takes the hit before preferred, should a problem arise. So your proposal is parallel to this existing method of handling risk. That's a plus.
Also, the 'break the buck' thing... It takes me a while to catch on to catch phrases... But you're doing on the micro level the same thing FDR did on the macro level when he devalued the dollar from $20 to $32 per ounce of gold. Instead of making everyone share the loss, you're confining that loss to a failing bank's non-100% deposits. Again, your proposal parallels an existing approach.
In my previous comment I'm doing something similar, taking the macro credit-cycle and distributing it out at the micro level. There are parallels here as well.
Perhaps you would expand on your statement, "(non-FDIC money market funds work this way)." I'm not familiar with that.
Finally, you write: "we are in a midst of a crises in measurement of economic values."
Uh, I get nervous when economics starts to sound like philosophy.
Art
Vince, you have an intriguing style about you!
A transistor, I've been told, is a sandwich of N-type and P-type semiconductor materials. The N-type is "doped" so that it has extra electrons and the P-type is doped so it is missing electrons. (N is for Negative, P is for Positive. Transistors can be NPN or PNP sandwiches, etc.) Aquinum (EE), check me on this!
Money is like electrons. Debt is like holes where electrons are supposed to be.
When you put a current through a transistor, you see that the transistor has unique characteristics. It can function as an on-off switch, or as an amplifier, depending (I suppose) on how you hook it up.
When you have currency in an economy with a lot of debt, the economy develops unique characteristics. One could say when the current crisis hit, it caused our economy to turn off, much like a transistor.
I hold that the past and present problem is a monetary imbalance -- an excess of debt relative to the quantity of money in circulation. If this is correct, then the solution is to fix the imbalance by reducing debt, increasing the quantity of money in circulation, or both.
Note that the Federal Reserve is printing dollars by the trillion now. To fix the problem. I think it needs to be done. However, the Fed's plan seems to be to lend out this new money into the economy. That's just dumb dogma. They have not figured out the problem yet. If the problem is "too much debt," then lending out an extra trillion or two is not the answer.
Here is my quick-fix: Take the new trillion and use it to fund a debt-forgiveness program. To correct the monetary imbalance we must reduce debt relative to the quantity of money. So I want to use the newly printed money to pay off debt. To pay off consumer debt, if it's up to me. (And they can do me first.)
Note: If they print money and put it into circulation, that's inflationary. But if they print money and use it to pay off debt, it just fills the holes where money is supposed to be anyway. It goes into the banks, not into circulation. Thus it is not (yet) inflationary.
Note also, they are already printing money by the trillion.
So this is my quick-fix for the current crisis: Go ahead and print the money. But use it to pay off debt. (But this is a temporary plan. It must end at the first sign the crisis has ended.)
http://sites.google.com/site/arthurianeconomics/
Yikes. Talk about trying to reinvent the wheel!?!
There are already bills in congress calling for 100% reserves, changes in money creation mechanisms, repealing the Federal Reserve Act of 1913, etc.
Your ideas might benefit from a little actual research. Fisher has a lot of things right, but much has been done since his day.
Here's a few starting places:
http://www.themoneymasters.com
http://www.moneyasdebt.net/
http://webpfdebt.wordpress.com
Regards,
Jere L Hough
http://wealthmoney.wordpress.com
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