Bancos de reserva de 100 por cento e bancos estaduais Hoje examinamos duas proposições: (a) banco bancário de reserva de 100% e (b) gastos do governo nacional sem tributação e emissão de dívida. Acredite ou não, as duas proposições foram relacionadas nos debates ao longo de muitos anos. A teoria monetária moderna (MMT) é agnóstica para a primeira proposição, embora indivíduos dentro do paradigma tenham visões divergentes. No entanto, no caso da segunda proposição, é fundamental para o MMT que um governo emissor de moeda não tenha restrição de receita e não deve emitir dívida para corresponder às despesas líquidas. Além disso, a tributação é uma ferramenta eficaz para atenuar a demanda agregada global em vez de aumentar a receita para um governo que pode gastar independentemente. A discussão no meu blog nos últimos dias centrou-se, em parte, no que fazer com os bancos e, especificamente, se devemos ter um sistema bancário de reserva total que é descrito como um sistema bancário: 8230 em que o montante total de cada depositante8217s financia Estão disponíveis na reserva (como dinheiro ou outros ativos altamente líquidos) 8230. e 8230 quando cada depositante tinha o direito legal de retirá-los. O banco bancário de reservas completas é um sistema bancário de reserva de 100 por cento ou um sistema Giro (o último dos antigos dias do Banco de Amsterdã). O Postbank na Holanda ainda administra um banco Giro. Uma proposta relacionada foi adotada por James Tobin em 1985 (20-21), onde propôs uma nova moeda.8221depositada.8201 que seria paga a qualquer pessoa por demanda pelo banco central ou pelos bancos comerciais. No último caso, os bancos de depósito teriam que comprar títulos do governo com os depósitos antes que pudessem emitir 8220postos de moeda8221. Isso eliminaria a necessidade de reservas e seguros de depósito. É justaposto com o chamado sistema de reserva fracionada, onde os empréstimos bancários criam depósitos que não são suportados em 100 por cento pelas reservas. Este debate se sobrepõe a um debate arcano e de longa data dentro da escola de economia austríaca ainda mais arcana sobre quem está certo 8220100 percenters8221 ou 8220 Reservadores Fragmentais8221. Os austríacos pensam que apoiam a liberdade, mas definem isso como uma ausência de coerção (principalmente pelo governo). Neste contexto, o 8220100 percenters8221 considera 8211 em sua representação 8211 que um sistema de reserva fracionada é fraudulento porque promete pagar montantes em excesso ao que realmente existe e que a fraude é coerção. Portanto, o sistema de reserva fracionada é o anátema da liberdade. Traga os 8220 Reservadores Fragmentais8221 que dizem que a liberdade significa fazer o que você gosta e por que parar bancos e mutuários fazendo o que eles gostam. É tudo uma troca gratuita depois de tudo. Eles afirmam que as pessoas vão entender que alguns bancos são menos propensos a permanecer solventes do que outros e o mercado vai cuidar disso. De qualquer forma, estou feliz por esses personagens passarem seu tempo debatendo entre eles 8211, correndo em círculos perseguindo suas caudas à medida que ficam cada vez mais agitados sobre qual esquema promove melhor a liberdade. Desta forma, eles reduzem o tempo que deixaram para incomodar o resto de nós. Você sente o sentimento pelas emoções que os austríacos detém a esse respeito, quando você lê o trabalho do libertador norte-americano notório (mal orientado), o falecido Murray Rothbard. Na edição de outubro de 1995 do trapo austríaco, o Freeman 8211, ele chamou de banco de reserva fracionada 8220a gigantesca scam8221 (ver Reimpressão): 8230 a idéia, que a maioria dos depositantes acreditam, que seu dinheiro está no banco, pronto para ser resgatado em dinheiro a qualquer momento. Se Jim tiver uma conta de cheques de 1.000 em um banco local, Jim sabe que este é um depósito de 8220demand, 8221, ou seja, que o banco promete pagar-lhe 1.000 em dinheiro, sob demanda, quando quiser desejar gastar dinheiro.8221 Naturalmente, os Jims deste mundo estão convencidos de que seu dinheiro está seguro lá, no banco, para que eles tirem a qualquer momento. Por isso, eles pensam em sua conta corrente equivalente a um recibo de depósito. Se eles colocam uma cadeira em um armazém antes de fazer uma viagem, eles esperam receber a cadeira sempre que apresentarem o recibo. Infelizmente, enquanto os bancos dependem da analogia do armazém, os depositantes são sistematicamente iludidos. Seu dinheiro está lá. O antigo sistema bancário reservado 8220Giro8221 ou 8220100 por cento, operado por pessoas que depositaram 8220specie8221 (ouro ou prata), que então lhes deu acesso a notas bancárias emitidas até o valor dos ativos depositados. As notas do banco foram então emitidas em uma taxa fixa contra a espécie e, portanto, a oferta monetária não poderia aumentar sem que novas espécies fossem descobertas. Rothbard justapõe isso contra o sistema 8220s que afligia ou contrafeita8221, que é digno do termo 8220 banco bancário-reserva bancária82218221 8211, pelo qual os bancos agora criam depósitos do ar 8211 8220, o que significa que os depósitos bancários são apoiados apenas por uma pequena fração do dinheiro que eles prometem ter em Mão e resgatar.8221 Os austríacos afirmam que os governos são partes da pirâmide de falsificação inflacionária.8221, porque em um mercado livre, os bancos que operam sob a reserva bancária bancária 82221 irão virar praticamente imediatamente, assim que outros bancos exigirem dinheiro de um banco que tenha estendido um Empréstimo com dinheiro que eles não tiveram. A única forma de persistir este momento é que o governo apoia o cartel acolhedor através da criação de um banco central porque: os bancos continuam a verificar os depósitos no Fed e esses depósitos constituem suas reservas, nos quais eles podem e piramide dez vezes o valor em talão de cheques dinheiro. Ele então descreve o processo de transações de mercado aberto (banco central que compra títulos do governo dos bancos em troca de um cheque do governo) como o primeiro passo do processo inflacionário de falsificação8221. O resto de seu discurso é uma exposição do processo multiplicador de dinheiro familiar, o que significa que ele está apenas perpetuando o mito dominante sobre como funciona o sistema bancário. Por favor, leia meu blog 8211 multiplicador de dinheiro e outros mitos 8211 para ver por que Rothbard não consegue entender a essência da banca moderna. De qualquer forma, Rothbard diz: Assim, a Reserva Federal e outros sistemas de bancos centrais atuam como criadores gigantes do governo e responsáveis por um cartel bancário, o Fed resgata os bancos em dificuldade e centraliza e coordena o sistema bancário para que todos os bancos 8230 possam inflar juntos. Sob a operação bancária gratuita, um banco que se expandia além de seus bolsistas estava em perigo de falência iminente. Agora, sob o Fed, todos os bancos podem expandir-se juntos e proporcionalmente. Ele então ataca o 8220lie do seguro de depósito do 8220bank82218221 como um hoax8221 do autor 8220 porque ele apenas apoiou o governo federal dos EUA em vez de qualquer fundo de seguro de endividamento 82201. Suponha que, amanhã, o público americano de repente tenha percebido a escravidão bancária e foi para Os bancos amanhã de manhã, e, em uníssono, exigiram dinheiro. O que aconteceria Os bancos ficariam instantaneamente insolventes, já que só podiam reunir 10% do dinheiro que eles deviam aos clientes desapontados. Nem o enorme aumento de impostos necessário para garantir que todos fossem todos palatáveis. Não: a única coisa que o Fed poderia fazer, e isso seria em seu poder, seria imprimir dinheiro suficiente para pagar todos os depositantes bancários. Infelizmente, no estado atual do sistema bancário, o resultado seria um mergulho imediato nos horrores da hiperinflação. Então, linguagem muito emotiva, que é uma característica comum da gangue 8220sound money8221 (libertário austríaco). Eles parecem ficar tão preocupados sempre que estão falando sobre economia que você tem a impressão de que eles pensam que o céu está prestes a entrar neles em breve. Mesmo as milícias privadas que eles apoiam, ajudem-nas se o céu já cair. Mas toda essa liberdade absurda realmente me diverte. Eu sei que não cresci nos EUA, onde o termo está marcado implacavelmente. Mas os comerciantes livres nunca consideram a coerção do mercado quando você é pobre e está morrendo de fome e o resto disso. Mais importante, também é uma pena que suas posições emocionais não sejam apoiadas por uma compreensão de como o sistema monetário realmente funciona. Eles retornaram ao padrão ouro que colocou os governos em uma camisa de força financeira e impediu que eles reagissem efetivamente a crises do tipo que quase acabaram com a economia mundial nos últimos anos. A sua representação do mundo fracionário de reserva-dinheiro multiplicador exemplifica esse mal entendido das operações bancárias. A idéia de que a base monetária (a soma das reservas bancárias e da moeda) leva a uma mudança na oferta monetária através de múltiplos não é uma representação válida da forma como o sistema monetário opera, mesmo que apareça em todos os livros didáticos de macroeconomia e é implacavelmente Derrubou as gargantas dos estudantes econômicos desavisados. Esses alunos tornam-se funcionalmente analfabetos nos caminhos da economia a partir do primeiro dia de entrar em seus estudos e, no final de um programa de graduação típico, são reduzidos a balbuciar declarações de uma linha sem sentido, sem sentido, como aqueles com os quais os austríacos regularmente rejeitam seus escritos. O mito multiplicador de dinheiro leva os alunos a pensar que, como o banco central pode controlar a base monetária, ele pode controlar a oferta monetária. Além disso, dado que a inflação é supostamente o resultado da oferta de dinheiro crescendo muito rápido, então a culpa é abandonada em casa para o governo 82201 (o banco central neste caso). A realidade é que os requisitos de reserva que podem estar em vigor a qualquer momento não proporcionam ao banco central uma capacidade de controle da oferta monetária. Nós atravessamos regularmente esse ponto. No mundo em que vivemos, os empréstimos bancários criam depósitos e são feitos sem referência às posições de reserva dos bancos. O banco garante que suas posições de reserva sejam legalmente compatíveis como um processo separado sabendo que sempre pode obter as reservas do banco central. A única maneira que o banco central pode influenciar a criação de crédito nesta configuração é através do preço das reservas que fornece sob demanda aos bancos comerciais. Mesmo a representação de Rothbard8217 de operações de mercado aberto como um veículo do banco central para aumentar a oferta monetária é errônea. O argumento é que o banco central compra títulos do governo de bancos privados para 8220cash8221, que depois se expande através do multiplicador de dinheiro (o modelo de reserva fracionada). No entanto, o que realmente acontece quando uma compra no mercado aberto é feita é que o banco central adiciona reservas ao sistema bancário. Isso reduzirá a taxa de juros se a nova posição de reserva estiver acima do mínimo desejado pelos bancos. Se o banco central quiser manter o controle da taxa de juros, ele deve eliminar todos os esforços dos bancos comerciais no mercado interbancário da noite para eliminar o excesso de reservas. Uma maneira de isso fazer é vender títulos de volta aos bancos. O mesmo funcionaria em sentido inverso se fosse tentar contratar a oferta monetária (a lógica do multiplicador de dinheiro) vendendo títulos do governo. O ponto é que o banco central não pode controlar a oferta de dinheiro desta forma (ou de qualquer outra forma), exceto para cobrar as reservas em um nível que possa provocar o empréstimo bancário. O fato é que são mudanças endógenas na oferta monetária (impulsionadas pela criação de crédito bancário) que levam a mudanças na base monetária (como o banco central adiciona ou resta as reservas para garantir que o preço 82201 das reservas seja mantido em sua política desejada ). Exatamente o oposto do descrito no modelo multiplicador de dinheiro principal. O outro fato é que a oferta monetária é gerada de forma endógena pelas atividades de crédito horizontal (alavancagem) realizadas por bancos, empresas, investidores, etc. O banco central não está envolvido nesse nível de atividade. Agora volte para propostas de banco de reservas de 100 por cento. Se você exige que todas as instituições detenham reservas líquidas de igual valor para seus depósitos, o medo de uma corrida bancária é eliminado. Na atual recessão, a corrida no Northern Rock no Reino Unido teria sido evitada. Os bancos são raros, mas são perturbadores. Os proponentes também argumentam que eliminaria a necessidade de o banco central emprestar reservas a bancos que são deficientes em qualquer momento. Então, os bancos sempre teriam reservas suficientes para satisfazer qualquer necessidade. A eliminação do banco central, evidentemente, satisfaz o ódio dos austríacos ao governo. A outra reivindicação é que um sistema bancário de reserva de 100 por cento permitiria ao governo controlar a oferta monetária e, portanto, manter a estabilidade de preços. Isso ocorre porque todo o dinheiro seria criado pelo governo nacional neste sistema. Os bancos não poderiam criar depósitos mediante a concessão de empréstimos. Então, a idéia é que os bancos teriam uma taxa de reserva-depósito de 100 por cento, o que garante que a oferta monetária seja 1 por 1 múltiplo da base monetária. Qualquer empresa que pretendesse emprestar fundos teria que emitir um ativo convincente como garantia. No entanto, um modelo híbrido do sistema bancário de reserva de 100 por cento reconhece que a intermediação financeira é necessária para um sistema de produção de bom funcionamento. Isso significa que muitos pequenos poupadores podem depositar com um banco que expande o risco8221 e presta empréstimos para empresas que precisam de fundos para capital de giro. Os defensores mais razoáveis do banco de reservas completas reconhecem que você precisa de instituições separadas que correrão riscos e fornecerão crédito. Então, os bancos ainda emprestam, mas apenas para cada dólar de moeda que possuem (pode aumentar). Os depositantes podem renunciar formalmente ao seu direito de retirar seus fundos por algum prazo fixo e, em troca, eles receberiam juros. Isso deixaria as corridas bancárias e supostamente garantiria que, no final do período, os fundos estariam disponíveis para o depositante. Eles afirmam também que, com uma oferta monetária controlada, o crescimento da produtividade verificaria que os preços caíram e o aumento da riqueza. Eles alegam que não haveria escassez de dinheiro para alimentar o crescimento porque menos dinheiro teria que ser usado (com preços mais baixos). É um argumento louco. Pode até haver um setor bancário de dois níveis (isso é semelhante à idéia de Tobin8217s). Alguns bancos se tornariam instituições de depósito que detêm dívidas governamentais e gerenciam o sistema da câmara de compensação (para a reconciliação diária de cheques entre bancos comerciais). Mas a criação de crédito torna-se o domínio de outras instituições para assegurar que a economia real tenha acesso ao capital de trabalho para facilitar a produção. Para garantir a estabilidade financeira, essas instituições ainda precisarão de acesso às facilidades de desconto do banco central (descobertos) para garantir que o sistema da câmara de compensação não falhe ou que eles sejam obrigados a emitir suas próprias responsabilidades atraentes para potenciais credores. A este respeito, o comentador regular JKH observou que: I8217d sempre assumiu que a resposta (8220 teórica8221) era que os descobertos não seriam permitidos, uma vez que, como você disse, permitir que eles não conseguissem nada 8211, ele contradiz efetivamente a finalidade de reservas de 100 por cento no dinheiro da demanda . Por conseguinte, as instituições de concessão de crédito consideraram que as instituições deveriam emitir os passivos primeiro para depósitos à vista de armazém (que são 100 por cento reservados pelo banco emissor do depósito) antes de ampliar o novo crédito. Sim, esta é a posição tomada, por exemplo, por Henry C. Simons (economista da Escola de Chicago) que formulou o chamado Plano de Chicago, que você pode ler mais detalhadamente AQUI. A maioria da escola austríaca também o apoiou (particularmente Ludwig von Mises). Ele foi expressado claramente por Milton Friedman em uma apresentação famosa ao subcomité da Casa dos EUA (US House, 1975, 2156-57). Friedman disse: acredito há muito tempo que a maneira mais eficaz de reduzir a regulamentação é separar as funções monetárias dos bancos comerciais da consciência de crédito. A maneira de fazer isso seria exigir que todas as instituições que oferecem depósitos à vista para manter reservas de 100 por cento torná-los instituições de depósito de fato e não, como agora, simplesmente em nome. A entrada livre nesta indústria pode ser permitida. As instituições podem competir por clientes financiados pelos juros recebidos do governo e por taxas de serviço aos clientes. As atividades de empréstimos e investimentos dos bancos comerciais de hoje8217 serão realizadas por novas instituições criadas por eles, que elevariam seus recursos através de depósitos a prazo ou debêntures ou ações. Essas instituições seriam liberadas quase inteiramente da regulamentação. Esta não é uma nova proposta. Ele remonta há mais de 40 anos. Foi apoiado em 19308217s por Henry Simons na Universidade de Chicago. Foi proposto em um livro do grande economista de Yale, Irving Fisher. Friedman mais tarde mudou sua posição um pouco, mas essa é outra história. Como um lado, algumas pessoas amarraram Minksy com o acampamento de reservas de 100 por cento. Ele definitivamente não estava nesse campo. Havia um artigo em 1991 de Charles Whalen (Estabilizando a economia instável: mais sobre a conexão de Minsky-Simons, Journal of Economic Issues. 25 (3), 739-763) onde este assunto foi considerado em relação às semelhanças e contrastes entre Minsky e Henry Simon8217s (um economista da Escola de Chicago que ensinou Minksy). Whalen disse que: as reformas bancárias de Simons8217s são mais drásticas do que as propostas por Minsky. Por exemplo, Simons recomendou as seguintes alterações: (a) 8220 separação completa, entre diferentes classes de empresas, das funções de depósito e empréstimo dos bancos de depósito existentes8221 (b) 8220 legislação que exige que todas as instituições que mantêm passivos de depósito ou fornecem instalações de verificação (ou qualquer Substituir, portanto) deve manter reservas de 100 por cento em dinheiro e depósitos junto aos bancos da Reserva Federal8221 e (c) deslocamento de 8220 por notas e depósitos dos bancos de reserva do crédito do banco privado e todas as outras formas de moeda em circulação, dando-nos uma Meio de circulação nacional completamente homogêneo8221 8230 No entanto, as recomendações bancárias desses homens estão ligadas por uma similaridade importante. 8211 ambos desejam uma descentralização radical8221 que facilitaria 8220 novas empresas bancárias e não bancárias8221 e a multiplicação de 8220 pequenas e médias empresas.8221 No entanto, Minksy fez Argumentar, como citações de Whalen (página 750), que o economi C sistema: 8230 seria mais estável se o sistema bancário fosse descentralizado, com muitos bancos pequenos e independentes atendendo a uma estrutura industrial e comercial de pequenas e médias empresas 8230 e mais tarde 8230, uma grande reforma necessária é que o Federal Reserve mude de A técnica do mercado aberto para desconto. Mas Minsky ainda vê um papel crucial para o banco central na manutenção da estabilidade financeira. O lobby do banco Giro não vê nenhum papel para o banco central. Como isso se encaixa na teoria monetária moderna (MMT) Observe que a prática atual é que os empréstimos criem depósitos. Claramente, sob um sistema de reserva de 100 por cento, todas as instituições de concessão de crédito teriam que adquirir os fundos antes de seus empréstimos. Haveria o equivalente a um padrão ouro imposto à banca privada que poderia invocar forças deflacionárias severas. Além disso, o sistema bancário de reserva de 100 por cento não elimina o risco de crédito para que as crises ainda possam ocorrer se houvesse padrões significativos sob a variação de 8220 fixo-prazo8221. E sobre a banca estadual Isso se sobrepõe ao debate sobre o banco de reserva de 100 por cento. Houve uma discussão nos últimos dias neste blog sobre as propostas de Ellen Brown em seu recente livro, a Web of Debt. Para aqueles que não desejam ler este livro, você pode ver um bom resumo das principais proposições em seu artigo 8211 de dezembro de 2008, um Plano Radical para Financiamento de um Novo Negócio. O artigo coloca a questão (lembre-se que foi escrito como a crise estava se intensificando em 2008): como o novo presidente pode resolver esses enormes desafios de financiamento que Thomas Jefferson percebeu há dois séculos que existe uma maneira de financiar o governo sem impostos ou dívidas. Infelizmente, ele chegou a essa realização somente depois que ele deixou a Casa Branca, e ele não conseguiu pôr em ação. Com alguma sorte, Obama descobrirá esta solução de financiamento no início do seu próximo mandato, antes que o país seja declarado falido e abandonado por seus credores. MMT diz-lhe como uma questão de primeiros princípios que os impostos ou a dívida não financiam os gastos do governo em um sistema monetário fiat. A realidade é que os governos nacionais atuam como se ainda operassem sob uma moeda convertível (padrão-ouro) onde os impostos e a emissão de dívidas fossem usados para defender as reservas de ouro da nação (isto é, despesas financeiras). Brown observa em relação aos EUA que: há muito se considerava o direito soberano dos governos de criar a oferta monetária nacional, algo que as colônias haviam feito com sucesso por cem anos antes da Revolução. Então, por que o novo governo entregou o poder gerador de dinheiro para banquistas privados, apenas se ocupando de ter dinheiro8221 Por que ainda estamos, 200 anos depois, rastejando diante de bancos privados que são verdadeiramente falidos. A resposta pode ser simplesmente isso, então, como agora, Os legisladores, juntamente com a maioria das outras pessoas, não entenderam como funciona a criação de dinheiro. Eu concordo com algum desse sentimento. O sistema de moeda fiduciária liberta o governo de sua restrição de receita padrão-ouro. Mas Brown está apresentando um cenário de tudo ou nada e sugere a abordagem de banco de reservas de 100 por cento. Não penso que o reconhecimento de que o governo nacional não está sujeito a receita leva logicamente à segunda proposição de que a criação de crédito do banco privado não é desejável. Veja mais sobre isso mais tarde. Concordo, no entanto, com a opinião de que 8220 (n) ot são apenas os bancos apenas fingindo ter o dinheiro que eles nos emprestam, mas hoje exigem descaradamente que os resgamos por suas próprias dívidas de jogo imprudentes para que possam continuar a nos emprestar Dinheiro que eles não têm.8221 É profundamente perturbador que o setor bancário tenha se tornado tão poderoso em nossas economias modernas. Um sistema bancário devidamente regulado teria impedido isso. Mas isso não é o mesmo que abandonar a criação de crédito privado. Brown, em seguida, considera 82203 formas de financiar o 8220New8221 New Deal8221 nos EUA, que claramente tem relevância para todos os governos soberanos. Ela observa que uma estratégia sólida começaria com a nacionalização de bancos privados falidos em vez de resgatá-los: a acumulação de uma rede de bancos públicos seria uma questão simples hoje. À medida que os bancos se tornaram insolventes, em vez de tentar resgatá-los, o governo poderia apenas colocá-los em bancarrota e levá-los acima de 8230. Como em qualquer aquisição corporativa, os negócios nos bancos nacionalizados pelo governo poderiam continuar como antes. Nem muito precisaria mudar além dos nomes nos certificados de ações. Os bancos estarão sob nova administração. Eles poderiam adiantar empréstimos como entradas contábeis, assim como fazem agora. A diferença seria que os juros sobre os adiantamentos de crédito, em vez de entrar em cofres privados para lucro privado, iriam aos cofres do governo. Eu definitivamente vejo a criação de bancos públicos (ou na Austrália 8211 o retorno aos bancos públicos 8211, que foram todos privatizados nos dias difíceis do neoliberal) como um caminho a seguir em um novo sistema bancário. Um banco público pode disciplinar a estrutura de custos dos bancos privados. Por exemplo, na Austrália, o banco comercial é executado como um cartel e prejudicam os clientes com todos os tipos de cobranças que não têm nada a ver com seus próprios custos. Um banco público com acesso a fundos soberanos poderia oferecer taxas muito baixas. O lobby do mercado livre argumentará que esta é uma concorrência injusta 8211 porque o governo tem o apoio de sua capacidade de emissão de moeda. É verdade, mas o mesmo lobby está sempre nos lembrando que o governo está prestes a entrar em falência. Além disso, se todo o banco público estava fazendo restabelecer um certo equilíbrio entre os custos dos bancos e os honorários dos consumidores, então, isso aborda uma externalidade decorrente de um mercado não competitivo do setor privado. Eu também não teria resgatado uma instituição financeira. Em vez disso, como Brown observa, o governo poderia ter acabado de assumir as preocupações operacionais, reparou as bases de capital e continuou oferecendo serviços que avançavam de propósito público. Neste contexto, Brown considera as outras maneiras pelas quais o governo poderia financiar-se sem endividar os credores privados ou tributar o povo8221: (1) o governo federal poderia criar sua própria facilidade de crédito federal (2) que os estados poderiam estabelecer Instalações estatais de empréstimo ou (3) o governo federal poderia emitir moeda diretamente, para ser gasto na economia em projetos públicos. Existe um precedente viável para cada uma dessas alternativas: a primeira opção seria ver um banco federal estabelecido para disponibilizar crédito para desenvolvimentos de infraestrutura e similares. Posso ver vantagens em um banco público que ajuda investimentos estratégicos do setor privado (que promovem o interesse público). Mas se a proposta é uma maneira de superar alguma percepção de que há restrições financeiras sobre os gastos do governo, a idéia é inaplicável a uma economia monetária moderna. Se é para fornecer crédito barato para o setor não-governamental para avançar o propósito público, então a idéia está bem. Também daria controle de volta ao governo na determinação do tipo e padrão de desenvolvimento de infra-estrutura pública. Durante o período neoliberal, vimos o surgimento das ridículas parcerias público-privadas como o principal método de desenvolvimento da infra-estrutura pública. A realidade era que os governos tornaram-se tão rígidos que eles permitiram que os grupos de private equity determinassem a forma como a infra-estrutura pública era fornecida e existem inúmeros exemplos que emergiram com demonstrar que o padrão de desenvolvimento não serve de propósito público. Sydney8217s pedágio estradas são um bom exemplo. A segunda opção é uma criatura de um sistema federal e permite que os Estados nos Estados Unidos emitam crédito de juros baixos 8220 no modelo de reserva fracionada8221. Na Austrália, os bancos do governo estadual eram comuns até serem privatizados. Eles prestaram serviço ao segmento de varejo do setor e até que os neoliberais começaram a desregulamentar o mercado financeiro (que empurrou esses bancos para o segmento de atacado 8211 que os enviou quebraram) esses bancos desempenharam um grande objetivo. No entanto, se este serviço fosse fornecer financiamento para os caçadores de casas de baixa renda, acho que seria muito melhor para o setor público fornecer a habitação e eliminar o risco de crédito 8211 que atingiu proporções maciças no mercado sub-prime. Não há nada de errado com a ambição pública de abrigar todos os seus cidadãos. Mas há boas e más maneiras de fazer isso. Fannie e Freddie nos últimos dias exemplificaram o mau jeito de fazê-lo. A opção final de uma moeda emitida pelo governo é totalmente consistente com o MMT. Uma terceira opção para a criação de um governo auto-sustentável seria que o Congresso simplesmente crie o dinheiro que precisa em uma imprensa ou com entradas contábeis, e gaste esse dinheiro diretamente para a economia. O governo dos EUA já faz mais ou menos isso. Isso apenas obscurece que está fazendo isso, colocando uma série de restrições voluntárias sobre si mesmo, sobretudo o seu programa de emissão de dívidas. Seria muito mais eficiente se os governos nacionais em todo o mundo eliminassem essas operações e enviassem os oficiais que gerenciam a emissão de dívidas para fazer algo produtivo, como cuidar do meio ambiente ou pessoas doentes e idosas. Brown observa que a objeção geral a essa alternativa é que seria altamente inflacionária8221, mas também diz que, se o dinheiro fosse gasto em empreendimentos produtivos que aumentassem a oferta de bens e serviços 8211 transporte público, habitação de baixo custo, desenvolvimento de energia alternativa e Como a oferta e a demanda 8211 aumentariam e a inflação de preços não resultaria em 8221. Portanto, isso é claro 8211 se a demanda nominal crescer ao mesmo ritmo que a capacidade produtiva, então a inflação não ocorrerá. Os ravados loucos de Rothbard de que toda a base de dinheiro e a criação de crédito privado é inflacionária é uma afirmação dogmática. Pode ser em circunstâncias em que o crescimento da demanda nominal supera a capacidade real para entregar novos bens e serviços. Comentador regular, Tom Hickey observa a este respeito que: Todos os gastos com bens públicos resultam no aumento da produção de bens e serviços, alguns que são fornecidos pelo setor privado, uma vez que o governo funcionaria principalmente como contratado contratando subcontratados. Isso aumentaria a capacidade de produção real, o PIB e a prosperidade nacional (reduzindo o coeficiente de Gini). Estabilizadores automáticos podem ser usados para estabilizar 8230 demanda agregada nominal 8230 em relação à capacidade de saída real para manter a estabilidade de preços, alterando adequadamente as despesas e tributação. Além de escrever coisas com 8220z8221, concordo com este resumo da questão da inflação :-). Eu observo que algumas pessoas afirmam que a inflação pode ocorrer quando há alto desemprego 8211, a chamada estanflação. Pode, porém, resultar de pressões de custos ao invés de pressionar a demanda. Nesses casos, as estratégias de metas de inflação são inúteis de qualquer maneira. Além disso, também é verdade que as classes de ativos específicas podem se inflar antes que o pleno emprego seja alcançado como a bolha do preço dos ativos. Mas uma bolha de ativos não é inflação, que é definida como um aumento contínuo no nível geral de preços. Não é sensível abordar uma bolha em uma classe de ativos específica (digamos, habitação), desinflando toda a economia. São necessárias medidas mais direcionadas e a política fiscal é melhor atendida para oferecer soluções efetivas neste contexto. Leia este blog 8211 Bolhas de ativos e a condução dos bancos 8211 para obter mais informações sobre esse assunto. Não apoio um sistema bancário de reservas de 100 por cento. É o trabalho de um lobby que odeia e desconfia do governo. Não tenho objeção a grandes reformas do sistema financeiro, conforme especificado abaixo, mas também considero que não há nada intrinsecamente errado com o crédito privado. O setor privado deve poder emprestar e os bancos criam crédito nas condições estritas abaixo. A explosão da dívida que trouxe a economia mundial de joelhos não foi culpa da criação de dinheiro endógeno. Foi o resultado de uma atividade criminosa de regulação laxista e uma obsessão neoliberal de que os governos nacionais tiveram que gerar excedentes (e, portanto, espremer a liquidez e a riqueza do setor privado). Com essa obsessão dominando a política pública nas últimas décadas, as economias só poderiam crescer (principalmente) se o setor privado assumisse níveis crescentes de endividamento. The rise of the financial engineering sector 8211 with the elimination of regulations that might have reasonably controlled its errant tendencies 8211 guaranteed that the households would take on this debt 8230 on increasingly dubious grounds. I start from the proposition that the only useful thing a bank should do is to facilitate a payments system and provide loans to credit-worthy customers. Attention should always be focused on what is a reasonable credit risk. In that regard, the banks: should only be permitted to lend directly to borrowers. All loans would have to be shown and kept on their balance sheets. This would stop all third-party commission deals which might involve banks acting as brokers and on-selling loans or other financial assets for profit. should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced. This will force banks to appraise the credit risk more fully. should be prevented from having 8220off-balance sheet8221 assets, such as finance company arms which can evade regulation. should never be allowed to trade in credit default insurance. This is related to whom should price risk. should be restricted to the facilitation of loans and not engage in any other commercial activity. So this is not a full-reserve system. The government can always dampen demand for credit by increasing the price of reserves andor raising taxescutting spending. The issue then is to examine what risk-taking behaviour is worth keeping as legal activity. I would ban all financial risk-taking behaviour that does not advance public purpose (which is most of it). I would legislate against derivatives trading other than that which can be shown to be beneficial to the stability of the real economy. So I support bank nationalisation Probably, but that is for another day. Having a strong public banking system to compete against the private banks will achieve mostly the same ends and is more likely to be politically acceptable in the current climate. That is enough for today I forgot to mention in the main body of the post the following point. While I think MMT is agnostic to the concept of 100-percent reserve banking there are strong reasons why, for consistency, an MMT proponent would not want to support it. A major proposition is that the banks will store the deposits they attract as risk-free government bonds. This allows them to earn a modest interest which helps them to attract depositors to their business and ensures they have liquidity on demand as per the logic of the proposal. This, of-course presupposes that there are risk-free government bonds being available in quantities sufficient to support such a scheme. MMT shows the futility of issuing government debt. Further MMT leans towards a zero interest rate policy with fiscal policy then performing the counter-stabilisation (which it is a more effective tool than interest rate adjustments anyway). So there is no need to issue to debt to manage bank reserves and thereby allow the central bank to maintain a non-zero interest rate in the fact of budget deficits. In that sense, how will a 100-percent reserve banking scheme store the deposits safely Spread the word. Bill, good post. I handy link to have to deflect the inevitable attacks by rabid libertarians that must be endured from time to time I find it odd you do not much mention the issue of maturity transformation. I consider this rather vital to the functioning of a modern economy and although you do allude to it the skimpy treatment it gets here leads me to think you don8217t consider it as one of the top problems with the full reserve camp. Excellent Have you considered backing up your blog in atleast 10 places. Offline, solid state drives, I guess are the more safer ones, though flash drives may do the job for you. I was wondering what your thoughts were on proposals for full-reserve banking for ecological reasons The argument goes that fractional-reserve banking necessitates growth and thus has negative environmental (and social) consequences. Herman Daly, for instance, argues this. Other arguments can be found at Feasta8217s website and as presented in the Money as Debt video. A lot of the concern has to do with the charging of interest as well. Is this too a misunderstanding of fractional-reserve banking Also, I would love to see a post about your thoughts on alternative currencies. POSTSCRIPT Wednesday, January 13, 2009 I have added an additional point to this post this morning about the stance MMT should take to 100-percent reserve banking. It is at the end of the main body of text. best wishes bill Bill, thanks for addressing full-reserve banking(FRB here). I stumbled on your blog some months ago through the UMKC connection, mainly through Dr. Hudson, and was immediately impressed with your grasp of how money works, and I have spent a great deal of time poring over the historical MMT writings. Being an all-my-adult-life monetary reformist, I have to admit there are several areas of non-understanding yet with MMT, and the question of full-reserve banking was a gnawing uncertainty. Thanks again for the lengthy presentation, but I remain unconvinced of the substance of your stance. Rather than deleting the BillyBlog link, I thought Id give my opinion here. I dont think you gave Murray Rothbard his due on the subject of FRB, and I am a progressive, people-first activist. But I leave the libertarians to defend Murray. While I can see the difficulty in matching up full-reserve banking with other aspects of MMT, I never saw it as a conflict, more of a rough fit that would require some re-thinking. Having read Minskys Foreword to Dr. Ronnie Phillips book on the Chicago Plan and New Deal Banking Reform, I also feel that your separation of Minsky from FRB leaves a lot unsaid. But what struck me as inadequate were your reasons for not supporting it, even conditionally and I know that my disagreement with your position stems from my agreement with the position of Simons, Douglas, Fisher and Soddy that the government of any sovereign nation should create ALL THE MONEY. So, to me, I was looking for the WHY NOT And I didnt see anything convincing in your concerns. Something about there being a need for liquidity or financial flexibility that the government cant provide. But, never looking for a solution to whatever that problem is. Like I could only support FRB and government-issue of all the monies IF I say there needs to be a fully-founded public money supply capable of meeting all the needs of the economy and for whatever shortfall comes up, we can solve it. You decry the so-called progressive economists who line up behind the deficit hawks as both ignorant and immoral, and I agree. But to me it is as simple as an American to say that Only the Congress shall create ALL THE MONEY, and then lets have it as to whether bank credits are money. Im sorry but the tradition of private credit creation is not a family value in my family. If it is to be defended, it cannot be because we have always done it thus(in our lifetimes). And I don8217t see it as a progressive value. But there we go again8230 Those who historically have supported the FRB option ALWAYS gave the rationale as monetary and economic stability it naturally being counter-cyclical as to inflation and deflation. You can attempt to replace that stability through draconian regulation with some success, of course, only bringing about another deregulation cycle for the grandkids to deal with as we are here. So, again, to me looking at FRB from a historic perspective not having anything to do with free-banking, I say that you have not really provided any substantive discussion as to why you are opposed to it. Fisher8217s Chapter 10 proposal in Ritter8217s Money and Economic Activity 8211 Readings in Money and Banking makes a damned good case for FRB. I remain a supporter of this concept. But you still have the best economic blog going. Respectfully. A third option for creating a self-sustaining government would be for Congress to simply create the money it needs on a printing press or with accounting entries, then spend this money directly into the economy. The US government already more or less does this. It just obfuscates that it is doing this by placing a series of voluntary constraints on itself most notably its debt issuance program. It would be much more efficient if the national governments around the world eliminated those operations and sent the officers who manage the debt-issuance off to do something productive like caring for environment or sick and old people. Brown notes that the usual objection to that alternative is that it would be highly inflationary but also says that if the money were spent on productive endeavors that increased the supply of goods and services public transportation, low-cost housing, alternative energy development and the like supply and demand would rise together and price inflation would not result. So this is clear if nominal demand grows at the same pace as productive capacity then inflation will not occur. The mad ravings of Rothbard that all money base andor private credit creation is inflationary is a dogmatic assertion. It might be under circumstances where nominal demand growth outstrips real capacity to deliver new goods and services.8221 Wow, this is true utopian dreamland stuff. What possible basis do you have for believing that all money would be spent productively, and output would increase perfectly in line with spending For example, if the Australian govt funded it8217s AUD 300bn budget in this manner, instead of through taxation and borrowing, do you truly imagine output would increase 30 The reality is that debt-funding of deficits is a mechanism that imposes a restraint which helps to ensure that government spending is kept productive. In your world, people would pay for government services indirectly through persistant, high levels of inflation, rather than directly through taxation. Taxation is open and explicit inflation is a hidden and insidious. Wow, this is true utopian dreamland stuff. What possible basis do you have for believing that all money would be spent productively, and output would increase perfectly in line with spending There is a difference between 8220spending productively8221 and spending to increase production. You seem to be confused about that. I also assume you mean 8220real8221 output here. Nominal output will increase - for - in line with government net spending by definition. But the issue is what will happen to real spending. I would gather from your hostility that our definitions of what is 8220productive8221 will differ. For example, it is highly productive, when considered on an intertemporal (intergenerational) basis just to have adults working each day. The gains come from the learning that their children do watching their parents go to work. The empirical evidence is overwhelming that children who grow up in jobless households have inferior outcomes in their own adult lives 8211 lower investment in education, lower incomes and the rest of the pathologies of disadvantage. You won8217t find that concept of productivity and dynamic efficiency in one of the mainstream textbooks that your rhetoric seems to mimic. Further, I have never assumed (or said) that 8220output would increase perfectly in line with spending8221. I actually think that real output will rise by a greater factor than the dollar injection of net public spending. The robust studies of the value of the expenditure multiplier, especially when there is so much excess capacity, points one to that conclusion. Have you studied that literature in detail I doubt it from the tenor of your remarks. I also have never advocated zero taxation and you will not see that in the blog 8211 so the statement that 8220if the Australian govt funded its AUD 300bn budget in this manner8221 is erroneous and a misrepresentation. In MMT, taxation has a very important function although that function has nothing to do with 8220funding8221 national government spending. The reality is that debt-funding of deficits is a mechanism that imposes a restraint which helps to ensure that government spending is kept productive. That is your un-researched opinion. It doesn8217t bear scrutiny. Can you outline the mechanisms whereby bond markets (and the auctions conducted by the AOFM) determine projects that are allegedly 8220productive8221 against those that are not Can you show me once when the bond auctions have failed because the investors thought the government was 8220wasting money8221 Given that the auctions never fail, perhaps by your own logic, you are thinking that all net public spending to date has been productive. The proposition that bond markets bear witness to the 8220productivity8221 of net government spending is completely far fetched. They do nothing of the sort. The proposition also raises the issue 8211 again 8211 of what we are going to call 8220productive8221. However, that debate is never conducted within the realm of a government bond auction. So your 8220reality8221 is just your ideological prejudice 8211 nothing more. Further, you said: For example, if the Australian govt funded its AUD 300bn budget in this manner, instead of through taxation and borrowing, do you truly imagine output would increase 30 Finally, you once again misrepresent my position as advocating no taxation. The only statement I made was that net positions would not be matched by debt-issuance if I was running the show. Further, you do not understand the way in which the fiat currency system operates 8211 taxes do not 8220fund anything8221. Taxation merely takes purchasing power out of the hands of the non-government sector so they don8217t spend as much. And 8230 there is a logical gap here that you haven8217t quite worked out 8211 if there was no taxation then the federal budget would be very much closer to zero than the figure you state. best wishes bill gtId always assumed that the (theoretical) answer was that overdrafts wouldnt be permissible, since as you say allowing them would not accomplish anything it effectively contradicts the purpose of 100 per cent reserves on demand money. Therefore Ive assumed credit granting institutions would have to issue liabilities first in order to warehouse demand deposits (that are 100 per cent reserved by the deposit issuing bank), before extending new credit. lt Hi Bill JKH and all others, If I understand correctly, a 100 Reserve Banking system would effectively, if thought through, outlaw credit as we know it (as has been the case in previous centuries and as is still demanded by the Sharia e. g.) As JKH says above, that would be the end of demand money because all credit money would 8211 per definition 8211 have to be in circulation prior to the lending act. While I assume that this could have a sobering effect on bankers039 bonuses, I also presume the (remaining) credit system would either grind to a halt andor just shift to illegal loan-sharking or what not (is that one of your objections). My other question is, where would new money enter the system to offset deflation in a growing economy The only mechanism I see would be through active government spending because the direct 8211 and obviously sometimes corrupting 8211 link between banks and the currency issuing agency would effectively have been capped. So is it true that the Austrians, and the other 100 RB proponents, are actually 8211 if unwittingly 8211 proposing massive, ongoing, fiscal interventions And is this in any way coherent with their demands for a balanced budget Or are they just too ideologically blinded to see the problem The productivity argument you mention can039t possibly account for things like population growth, can it Or am I getting this all wrong Excellent post. Ive never been clear on 100 per cent reserves. Its always been a confusing, amorphous Rubiks cube of risk considerations and institutional possibilities. Discussions are typically clouded on issues of liquidity risk, credit risk, maturity transformation, and macroeconomic money supplyinflation considerations. Theyre often vague on the specification of the substance of the reserve and the domain of reservable deposits. Assuming a 100 per cent scenario, is the reserve substance gold Is it government bonds Is it current central bank reserves Are checkable deposits reservable Are all deposits reservable What is the proposed institutional configuration Is it a government system or part of the private banking system Is it a two tier banking system, or a banking system with two tier banks (100 per cent reservable deposits and other liabilities) Is there still credit created money Is the motivation for 100 per cent reserves an erroneous interpretation of the multiplier Does the solution to the problem pertain to the liquidity risk of depositor funds, or control of money supplyinflation, or both The potential permutations and combinations seem endless. I think 100 per cent reserves is a very complicated subject, because its at the intersection of so many different issues. In that sense, its somewhat understandable that the official MMT position on it is agnostic. It seems to me that the top down issue is the question of the substance of the reserves, which in turn reflects institutional design for the location of deposits and reserves. If deposits are fully reservable in government bonds for example, then whatever the balance sheet configuration, the result is effectively a risk free segregation of credit and liquidity risk with respect to bank deposits. That compares to todays mechanism, where risk management issues are dealt with by the combination of bank capital, FDIC deposit insurance, regulation, and self-imposed risk policy for a heterogeneously composed balance sheet. Thats supposed to be enough to result in prudent levels of deposit liquidity and safety without requiring 100 per cent reserves. There is a difference between the two systems, though. If 100 per cent reserves were held in government bonds or in existing central bank reserves as in todays system, they would become an ongoing source of deficit financing, as per MMT interpretation with limited reserves (normally) as they exist today. But if the FDIC requires money to cover losses on deposits in excess of its own existing fund for this purpose, it can mean an increase in the deficit. From this standpoint, 100 per cent reserves are closer to an imposed form of self-insurance in terms of the immediacy of the reserves that are set aside. The question is whether the deficit tail risk is manageable by comparison, and whether or not there are other advantages to the existing system that are foregone in a 100 per cent reserve system. A reasonable answer is that the deficit tail risk is manageable provided that first loss private capital is set at a prudent level. The idea that one would specify government bonds as reserves rather than the present form of central bank reserves seems silly. Theyre both fiat creations. If the reserve is government bonds, why shouldnt it be any instrument of fiat creation, including central bank reserves in their existing form An ideological hatred of central banks isnt a particularly good reason per se to insist on government bonds rather than central bank reserves as they exist now. Conversely, if the argument from Rothbard et al is that 100 per cent reserves are the panacea for a banking system run wild on the deposit multiplier, then they dont know what theyre asking for, because they dont know what theyve got. That the multiplier model is a fallacy is clear from MMT, which is a description of accounting reality, among other things. Moreover, there is a rich irony in the misunderstood belief in the deposit multiplier mechanism. Because the central bank supplies reserves in response to deposit growth, the specified reserve ratio has no direct effect on the pace of credit created money. Isto é, the direct effect is the same, whether the reserve requirement is 10 per cent (US) or 0 per cent (Canada). This fact has allowed a number of countries to move to a zero reserve requirement. What this means is that a more accurate description of any supposed multiplier mechanism is that it is closer to infinite, at least in theory, because no reserves are required to expand deposits. The multiplier believers have missed out on being wrong in an even more spectacular way than with allegations of mere finite multiplier power. This irony compounds further as the multiplier believers attempt to solve the multiplier problem by recommending 100 per cent reserves. Thats because it is still possible to have 100 per cent reserves in a system of credit created money, provided that the institutional configuration allows it, and provided that institutional forces are allowed to control the pace of reservable deposit growth by issuing non reservable liability alternatives (NRLs) e. g. qualifying term liabilities, perhaps including time deposits if they are deemed not reservable. Thus, it is possible to have a 100 per cent reserve requirement in a system of credit created money. However, the higher the specified reserve ratio, the more the overall balance sheet result depends on bounds attributable to macro level trends in customer selection of banking system liability mix. Isto é, the bounds on reservable deposit expansion and reserve expansion in a 100 per cent reserve system will depend on the success with which banks can issue non reservable liabilities in order to arrest the pace of growth in credit created reservable money. This view may differ from your interpretation, Bill, because I think you impose some assumed institutional constraints on a 100 per cent reserve system i. e. that banks presumably are not allowed to create money from the process of lending. I agree with your explanation, but I believe that institutional specification is a choice between two alternatives for money creation, as I shall explain further below. One of your points: Note that the current practice is that loans create deposits. Clearly, under a 100-percent reserve system, all credit granting institutions would have to acquire the funds in advance of their lending. Thats what I originally assumed, as per your quote of my comment. Thinking about it further, that may or may not be the case. Let me play devils advocate. As an extreme example of a credit created money system with 100 per cent reserves, consider the hypothetical transformation of the current US banking system to a 100 per cent reserve system: Here are some recent deposit numbers for the US banking system: Domestic checkable deposits .7 Small time and savings deposits 4.9 Large time deposits 1.8 Total 7.4 trillion Now suppose the reserve regime is changed in a very aggressive fashion to stipulate that this entire 7.4 trillion deposit base requires 100 per cent reserves. Then assume the Fed supplies the newly required reserves by purchasing virtually all of the open market treasury debt. The immediate effect is that the pre-existing 7.4 trillion deposit base becomes 100 per cent reserved, but that the banking system also suddenly has an ADDITIONAL 7.4 trillion in what are INITIALLY the demand deposits created as the result of the Feds debt repurchase. Now assume the banking system issues new non reservable liabilities (NRLs) in exchange for those new demand deposit liabilities. The outcome of course depends on the willingness of the public to redeem its demand money for such NRLs. But there would be a considerable propensity for them to do so at the right price, since the public has just sold its term treasury debt at what is presumably an acceptable price, and it would simply be a matter of pricing the terms on which it would replace the term structure it just lost with somewhat higher risk bank term NRLs instead. The effect of such an aggressive expansion of both the scope of deposits subject to reserves and the required reserve percentage results in a massive increase in aggregate required reserves in this example. This requires a matching injection of actual reserves by the central bank. The central bank manufactures that injection by purchasing an equal amount of the governments outstanding market debt. The net result is that the banking system becomes the new primary conduit for cumulative deficit financing, up to the level of required reserves. In this example, the initial required injection of reserves approaches if not exceeds the total level of outstanding market debt. Interestingly, the overall result of this banking system transformation is not dissimilar to would follow from the sudden implementation of the MMT idea of zero interest rates with elimination of debt issuance, which would also leave the money and reserve impact of cumulative deficit spending residing in the banking system. Although the 7.4 trillion example is extreme, it illustrates that the MMT observed function of credit created money can continue in this institutional structure, notwithstanding the fact that the banking system is 100 per cent reserved against the most broadly defined deposit base. Here is a micro explanation of the same dynamic: Consider a new loan of 100. It creates a new deposit of 100. The central bank then supplies new required reserves. In doing so, it also creates a second reservable deposit of 100. The temporary position is loans 100, reserves 100, deposits 200, and a newly created shortfall of 100 in reserves. This iterative process apparently has the potential to be endless, since reserve injections create new deposit liabilities that create more reserve requirements, with a 1:1 repetition. The commercial banks break this chain by issuing 100 in NRLs (non reservable liabilities). That extinguishes 100 in reservable deposits, and the system is in balance. The stability of the system would then depend on the ability of the banking system to issue NRLs at the margin, displacing new reservable deposits at the margin. At a macro level, the stability of the system would depend on the trend liability composition of the banking system, as between reservable deposits and non reservable liabilities. The mix in my example is 7.4 trillion each. The Ponzi type risk to which I referred would include the case where the public simply refused to pare back its initially transformed position of 7.4 trillion in new reservable deposits i. e. it refused to redeem them for new bank NRLs. The constraint is that banks will seek to issue NRLs (provided that they are allowed institutionally) in order to drain reservable deposits and thereby arrest the dynamic process by which their money creation would otherwise cause a cascade of additional reserve requirements and additional injections of reserves and reservable deposit creation into the banking system. It is in theory a potentially infinite iteration of reserve requirements until arrested as a process by proactive bank liability management that also serves the interest of maintaining suitable liquidity and maturity transformation standards with respect to its credit portfolio and supporting liabilities. The example of 7.4 trillion in reservable deposits seems wild. It also approaches being problematic in terms of the natural supply of fiat backing. What would happen in theory if the specified reservable deposit base with 100 per cent reserves exceeded the cumulative budget deficit Then the government would have to purchase non government assets in order to manufacture the required fiat backing. As it happens, the 7.4 trillion number wouldnt necessarily be a problem, given the cumulative budget deficit and its prospects. The constraint is that the composition of liabilities must stabilize to some reasonable degree as between reservable deposits and non reservable instruments. Otherwise, there is a potential Ponzi like growth in deposits and reserves. However, this aggressive example would result in an important change in the risk profile of the financial system. The existing profile is one of 7.4 trillion in deposits, which are mostly insured by FDIC (or could be insured), plus an additional amount of outstanding treasury debt which currently just happens to be near the same order of magnitude as the 7.4 trillion in deposits. So the existing system is fairly close to 14.8 trillion in (gross) risk free assets available to the non-government sector. But once the government debt is eliminated, and the deposits that replace it converted to NRLs, the government supply of gross risk free assets is cut in half. The banking system would roughly double in size, but half of the new liability profile ( 7.4 trillion in NRLs) would be risky, as compared to the risk free treasury debt it replaced. Given the risk on NRLs, the willingness of the public to replace its risk free term treasury debt holdings with risky bank term liabilities depends on pricing that risk. The example is extremely aggressive in the defined scope of the reservable deposit base, including all checkable, saving, and time deposits at 7.4 trillion. A more benign example could restrict the reservable scope to 700 billion in checkable deposits. The dynamic of credit created money feeding back into 100 per cent reserve requirements would be more moderate as a proportion of the banking system balance sheet. An intermediate example might exclude time deposits. This is a logical possibility, given the deferred nature of any liquidity risk on such deposits. FDIC insurance now in place is effectively a put option on deposit risk. A hypothetical shift to 100 per cent reserves would convert this put option to a balance sheet equivalent i. e. deposits backed by risk free fiat reserves. This converts an option derivative arrangement into a risk free balance sheet arrangement. It seems intuitive that because loans create deposits works under the existing FDIC put option arrangement, it might also work under the derivative to cash transformation Ive described. 100 per cent as a reserve requirement is one number from a continuum of such choices 0, 10 8230 100. The question becomes, where on this continuum does a floating rate fiat system suddenly become a fixed rate system It depends more on the institutional configuration than the number. A fixed rate system really requires that banks be prohibited explicitly from creating money from credit. Otherwise, as the example shows, the continuation of a floating rate system is at least theoretically feasible. The freedom to create money is separate from the level of reserves required against that money. There is no natural dividing line between a 99 per cent reserve requirement and a 100 per cent reserve requirement. Bill, the points listed in your conclusion summarize potential institutional structure in terms of permissible risk scope. The way I interpret it, the banking system remains dedicated to direct GDP credit support, following prudent risk management guidelines and financial activity involvement in doing so. The casino asset trading system is banished from the banking system. This general directional emphasis seems fairly broadly favoured among the PKChartalistMMT group. While Ive attempted to demonstrate that credit created money can continue in a 100 per cent reserve system, I agree that 100 per cent reserves arent necessary. Moreover, it seems to me that favouring zero per cent reserves is a natural position for those who understand the true role of reserves (i. e. settlement balances) in todays system, in the sense that anything more than that is redundant in a system that could be structured efficiently otherwise with respect to risk bearing. bill, thanks for your reply. There is no confusion for me between real and nominal output. You clearly stated that prices would not increase, so these are one and the same. Your theory pays scant regard and shows little understanding of the problems of price and currency inflation and how they are related. This is the main objection that I have, and general hand-waving assertions such as: 8220So this is clear if nominal demand grows at the same pace as productive capacity then inflation will not occur8221 amount to nothing. Perhaps you might consider a simple investigation between the rate of inflation of consumer price inflation and currency inflation (adjusted for real growth). Use the currency measure provided by the RBA in their statistical tables 8211 I think you would be surprised to see the stability of the relationship. There have been numerous examples governments where unable to continue to fund themselves through the bond markets. This has generally occurred following a period of persistant budget deficits combined with some monetization of this deficit. At some point, these governments were faced with a choice between default or monetization. At this point, monetization has in some cases led to hyperinflation. To be fair there are two examples which run counter to this argument 8211 namely Japan and the US, both of which are now running large deficits, partly funded by printing money. The Japanese situation has persisted for a long period of time without fostering inflation or a bond market revolt. The US situation is playing out before our eyes. If the US treasury begins funding their deficits directly through issuing bonds to the Fed, and inflation remains contained, then your theory will receive some validation. Tom Hickey says: Great post, Bill. Thanks for elucidating a subject that I had sensed that sound money advocates had not sufficiently thought through, but could not put my finger on in detail. However, I had never put much attention on either 100 reserve banking, or the gold standard, etc. that the sound money folks harp on because it is not feasible politically. Moreover, a proper understanding of MMT makes sound money arguments rather irrelevant today in achieving a stable system capable of meeting public purpose and 8220providing for the general welfare.8221 Politically speaking, a 100 reserve requirement has about as much chance as a return to the gold standard in the US, in fact, probably even less. This would involve changing the commercial banking as it presently exists in radical ways, when the problem that the US faces is putting a leash on financial oligarchs, which seems to be beyond its reach. I think that the pressing issue is dealing with credit money in relation to Minsky8217s financial instability hypothesis and debt deflation. The US and world are where they are now because we are now experiencing the end of a financial cycle and the consequences of the Ponzi finance that characterizes it. The sound money solutions in this regard are basically to eliminate commercial banking. However, according to MMT a principal reason that debt rises in relation to income is insufficient net financial assets of non-government, caused by too little deficit spending (which creates NFA) or too much taxation (which reduces NFA). If government fiscal policy matches nominal aggregate demand with real output capacity, then this imbalance need not arise in the first place. Moreover, there is little evidence I see for the claim that either the FRB or fractional reserve lending resulted in the present crisis, or in the onset of the Great Depression. It seems to be grounded in fitting 8220evidence8221 selectively to ideology to arrive at a conclusion. Rather, in a late-stage financial cycle, Ponzi finance dominated, and risk was not only underpriced but also misrepresented. 8220What is underpriced is over-used.8221 The crisis arose not because of any inherent failure of the financial system itself, but because the system was subverted by special interests. It is ridiculous to blame home buyers for lying on their applications, when this could easily have been checked, or borrowers who were lured into deals they couldn8217t carry. This is predatory lending and fraud, regardless of rates, and both are illegal. Similarly, it wasn8217t fractional reserve banking, low rates, or CRA, Gramm-Leach-Billey, or repeal of Glass-Steagall. It was playing loose. Laws and regulations were in place to prevent it. They were placed in abeyance due to neoliberal ideology and special-interest influence. Not that other regulation would not have helped. Elizabeth Warren recently said that if there were adequate consumer protection legislation, regulation, and oversight in place, the crisis could have been averted (not 8220might have been averted,8221 as she is sometimes erroneously quoted). The system itself does not need to be replaced with a step backward in time into an age that had its share of bubbles and panics, too. The system needs to be reformed so to insure that best practices are adhered to, preventing Ponzi finance, and there are adequate rules and a sufficiently independent watchdog in place to make sure of that. Credit money is like dynamite a powerful tool in the hands of experts that know how to use it constructively and do, and extremely dangerous otherwise. My sense is that the private banking system is now entrenched, and the challenge is to insure that that is it operating in accordance with fiduciary responsibility and best practices, and serving public purpose instead of being subverted by special interests. My own political position is radical, so I would rather see things otherwise, but I realize that my best-case scenario is not going to happen barring a political revolution that I don8217t foresee anytime soon. And if there were to be a political revolution, the outcome is far from clear. Realistically speaking, the US is a capitalistic democracy at present, not a social democracy, so trying to essentially change the private financial sector that is at the heart of US capitalism is a waste of energy. Better to work toward an understanding of how the monetary system works and craft a solution that is politically viable. A lot can be done if the ignorance is removed. But that is a huge task, given the inertia of the public mindset and the influence of self-serving opposition. The principal issue is serving public purpose. If we can insure that a private financial sector can do that without threat of being subverted, I can live with that. But it remains to be seen if even that can be achieved at present with all the money flying around Washington. What is the difference between a 100 capital requirement and 100 reserve requirement 8220The voluntary constraints, in turn, create political constraints on the government such that it has been pressured to maintain high rates of labour underutilisation for the last 35 years in most countries because they are unable to run deficits that are required to match the saving desires of the non-government sector. As a consequence, aggregate demand has been restricted and even undermined in recent decades by the pursuit of budget surpluses and the non-government sector has been pushed into dis-saving (and increased indebtedness).8221 Do you ever look at wealthincome inequality I like to look at it like this. (savings of the rich)(dissavings of the gov8217t) plus (dissavings of the lowermiddle class) It also seems to me that the richcentral banks use the interest rate to suppress aggregate demand to keep the labor market from tightening up so that the richcentral banks can exploit an oversupplied labor market to produce excess corporate profits (including banking profits) for themselves. JKH said: 8220Here are some recent deposit numbers for the US banking system: Domestic checkable deposits .7 Small time and savings deposits 4.9 Large time deposits 1.8 Total 7.4 trillion8221 I think there is about 1 trillion of U. S. currency and at least half of it is held overseas. If so, what makes up the other 8220at least8221 6.4 trillion Oliver Wednesday, January 13, 2010 at 22:37 One possibility is that the government creates new money by spending, resulting in cheques cashed at banks qualified to accept deposits, creating new deposit liabilities and accompanying bank reserves. The government decides on the level of money desired, and issues bonds to the public to drain any unwanted excess from the system. The credit or lending function then takes place in another set of institutions that must source such deposit money before lending it and who are prohibited from creating money by lending. This is comparable to a fixed rate monetary system. I believe this is close to what Bill described in his blog. An alternative which I attempted to describe in my comment above is that a single banking system continues conduct both lending and deposit functions, even with 100 per cent reserves. It continues to create money by lending, while issuing non-reservable liabilities to temper the growth in reservable deposits. Those numbers are deposits in the banking system. Currency is not a deposit. Reserves are an asset. 100 per cent reserve requirement means the level of required reserves is equal to the size of the deposit requiring reserves. The deposit is a liability. Asset size liability size. Capital is on the right hand side of the balance sheet (e. g. equity). 100 per cent capital requirement means the level of required capital is equal to the size of the asset requiring capital underpinning. The asset is on the left hand side of the balance sheet. Asset size capital size. Tom Hickey says: 8220It also seems to me that the richcentral banks use the interest rate to suppress aggregate demand to keep the labor market from tightening up so that the richcentral banks can exploit an oversupplied labor market to produce excess corporate profits (including banking profits) for themselves.8221 Bill and other MMT8217ers have addressed this issue in depth in books and articles. MMT shows that it doesn8217t have to be this way since the government can use fiscal policy to create full employment (only frictional unemployment with no cyclical or structural unemployment) along with price stability, which neoliberals theorize is impossible. The neoliberal concept of NAIRU and monetary policy that supports it are chiefly ideological rather than empirical. This theory assumes a 8220natural rate of unemployment8221 of 5, even though frictional unemployment is only 2. It also posits that 8220inflationary expectations8221 increase below that rate. The reality is that these assumptions result in policy decisions that create a permanent stock of unemployment, which undermines the bargaining power of labor. Coincidence You take 100 in currency to the bank: Bank asset 100 currency Bank liability 100 deposit Fed Up asset 100 deposit You withdraw 100 currency a week later Bank asset 0 Bank liability 0 Fed Up asset 100 currency US banks hold 53 billion in currency, compared to 7.4 trillion in deposits. Tom Hickey says: 8220Tom Hickey and others, does it matter if the govt deficit spends with currency or govt debt8221 The government spends by the Fed adding reserves on a spreadsheet to the Treasury account so that it8217s checks clear in the reserve system when they are cashed at commercial banks. The government never pays with taxes or debt. It only looks this way because the US government is required politically, not financially, to offset spending 4. This is a voluntary decision that is not a requirement of the modern monetary system, where the sovereign government is the monopoly provider of a non-convertible floating fx currency of issue. To think otherwise is to confuse the currency issuer with currency users (household, firms and in the US, states), or use principles that apply to a (now obsolete) convertible fixed rate currency system. The US government is not financially constrained and does not need to tax or borrow to spend, other than an arbitrary requirement in the name of 8220fiscal responsibility8221 as a political decision. This difference between issuer and user lies at the core of MMT. See A simple business card economy for an easily accessible explanation. Tom Hickey said: 8220The government spends by the Fed adding reserves on a spreadsheet to the Treasury account so that its checks clear in the reserve system when they are cashed at commercial banks.8221 Could currency be used to clear the checks And if so, why isn8217t currency used A little off topic but8230 It seems to me that positive productivty growth and cheap labor produce price deflation. If the fed wants to maintain a small positive price inflation amount, they need to price inflate with currency, price inflate with debt, or price inflate some other way. They almost always choose to price inflate with debt which means they will probably need low interest rates, low reserve requirements, and low capital requirements. I8217m trying to understand the debt creation process and if, in my scenario, that leads to excess savers and excess debtors. Thoughts Tom Hickey says: 8220Could currency be used to clear the checks And if so, why isnt currency used8221 I assume you mean 8220cash,8221 money in circulation, or physical currency. Imagine the inconvenience of settling up that way on a daily basis among banks. As an aside, I was in the international gold reserve vault cellar of the Federal Reserve Bank of NY in the 608217s when the world was still on a gold reserve standard for international trade. Each country had a vault with its name over the door stacked with gold bars. There were a couple of guys (gnomes) wearing steel shoes (gold bars are heavy) with a cart, transferring gold bars from one country8217s vault to another based on the day8217s settlement. Really, that8217s how it was done in those days. Quite an amazing sight. But it8217s a whole more convenient just to enter numbers in a spreadsheet by computer under the present non-convertible floating fx monetary system, instituted when President Nixon unilaterally shut the gold window on August 15, 1971, at Treasury Secretary Connally8217s suggestion when there was a run on the dollar. What happened Nothing, just a Connally predicted. BTW, when we speak of the government as 8220currency issuer,8221 and 8220currency of issue,8221 we mean coin minted by the Treasury, Federal Reserve notes, and bank reserves. Most of the 8220currency8221 issued by the government is in the form of bank reserves, which are just entries on a spreadsheet. Physical currency is sometimes even included in the notion of bank reserves because banks get physical currency by exchanging reserves for it when there is a public demand. With the advent of credit cards, a lot less physical currency is used in transactions. The government doesn8217t spend with physical currency. The Treasury pays by check and the Fed make sure that the Treasury has the reserves to cover them. While the checks may be physical paper or electronic transfers, the Fed8217s creation of reserves is digital not physical. Tom Hickey says: 8220If the fed wants to maintain a small positive price inflation amount, they need to price inflate with currency, price inflate with debt, or price inflate some other way. They almost always choose to price inflate with debt which means they will probably need low interest rates, low reserve requirements, and low capital requirements.8221 Under normal conditions, the Fed attempts to manage 8220inflationary expectations8221 with interest rates in relation to actual and potential GDP, using some variation of the Taylor rule . Tom Hickey said: 8220BTW, when we speak of the government as currency issuer, and currency of issue, we mean coin minted by the Treasury, Federal Reserve notes, and bank reserves. Most of the currency issued by the government is in the form of bank reserves, which are just entries on a spreadsheet.8221 Sounds to me like a bank reserve could be defaulted on then. IMO, that makes it a debt instrument. Tom Hickey said: 8220Under normal conditions, the Fed attempts to manage inflationary expectations with interest rates in relation to actual and potential GDP, using some variation of the Taylor rule.8221 What if 8216expectations8217 and reality are different Is it possible to have too much debt and not enough currency Bill does a good job in the above main post of listing and mocking some of the dafter claims made by the full reserve camp. But I still like the basic idea of FR (or perhaps 90 reserve banking). Bill claims that FR would be the equivalent of a gold standard imposed on private banking which could invoke harsh deflationary forces My answer: not if the state creates sufficient money. Indeed, if the state created too much, far from deflation, one would get INFLATION. Mugabwe has just proved that. I agree that FR, as Bill says, does not eliminate credit risk. Bill says I do not support a 100-percent reserve banking system. It is the work of a lobby that hates and distrusts government. My answer: the fact that a movement includes hate filled nutters, as the FR movement unfortunately does, is a weak argument. Its the BEST arguments for any philosophy that one should always address. In this connection, the only claim for FR made by Friedman in his 1948 American Economic Review paper was that FR helps bring more stability. Concordo. Bills answer is that better bank regulation andor government intervention to dampen demand when required would be better than FR. That is correct in theory. He also says . The government can always dampen demand for credit. True in theory, but governments failed to do this in 2005-6. The reality is that the bubble leading up the recent credit crunch just wasnt spotted. And another piece of brute reality is that the world economy has taken a trillion, trillion dollar hit (or whatever the figure is) which should have been enough of a jolt to induce a bit of better bank regulation But what has actually happened Absolutely nothing, far as I can see. Wall Street banks are up to all their old tricks again. The problem with better bank regulation is that it is complicated: banks will always outmanoeuvre politicians here. The reality is that Capitol Hill is swarming with bank funded lobbyists, cowboys, and other forms of bank funded low life. FR is a nice simple rule. Tom Hickey says: 8220Is it possible to have too much debt and not enough currency8221 No, the government as currency issuer is not financially constrained and can always issue the necessary to cover its obligations and commitments. Claims that the US is 8220running out of money,8221 is 8220going bankrupt,8221 becoming 8220insolvent,8221 or is 8220at risk of default,8221 are based on a misunderstanding (or misrepresentation) of how the modern monetary system operates. Such claims either take the government to be revenue constrained as a currency user when it the monopoly issuer, or else are couched in terms of a convertible fixed rate system when the US is now on a non-convertible floating fx system. Tom Hickey says: Ralph: 8220FR is a nice simple rule.8221 Good analysis. But I have a practical question. Bill began by observing that MMT is agnostic about this. It is therefore not so much an economic decision as far as MMT is concerned as a political one, largely based on one8217s attitude toward the financial sector. I am sympathetic to your argument, but to say that the banks cannot be controlled through reform and propose the political practicality of FR seems to me to be contradictory. I don8217t see any chance of something like this actually happening in the US when even the most basic reform is being stymied, and there has been almost zero accountability or transparency. Maybe the new Pecora commission (not) will be able to reverse this, but it apparently doesn8217t have any real clout. At bottom, I think that the problem probably lies almost as much with the American people as the banks. On one hand, people are clamoring for financial reform, but that would mean, on the other, the end of the loose credit that they have been enjoying and have become increasingly dependent upon. People hate debt but love credit. I suspect that the banks are 8220banking8221 on taking advantage of this internal conflict, just like they did at the onset of the crisis when the public was against a bailout, but was more against a 8220government take-over8221 of the financial system through resolution, which was demonized as 8220nationalization.8221 This politics of this is more complicated than the economics in that it involves the interaction of fear and anger, and greed. Other than Ron Paul, I don8217t hear anyone in Congress loudly calling for FR. And Ron Paul on the right has about as much influence as Dennis Kucinich on the left. In, fact they sometimes team up where the libertarian position intersects with the radical position. What Mugabwe proved was that creating money to maintain aggregate demand when aggregate supply has crashed (because 45 of the farm land is no longer being used) than you get lots of inflation. The same thing happened in Germany in the 19208217s when France and Belguim used the Treaty of Versille to seize the coal mines of the Rhineland 8211 Germany created money to provide an income for those displaced from the Rhineland and maintain aggregate demand but aggregate supply crashed because of the seizure of the Rhineland 8211 France and Belguim appropriated any coal that was mined (using their own nationals) for their own domestic purposes. Similarily, governments creates inflation if they create money to increase aggregate demand and there is no increase in aggregate supply. Aggregate demand v aggregate supply, and the competition for profits between workers and firms determines inflationdeflation outcomes not the amount of money in the economy. However, the amount of money may influence the above factors, but the amount of money is not the sole driver. More importantly, it is also a pity that their emotional positions are not backed by an understanding of how the monetary system actually works. They hark back to the gold standard which placed governments in a financial straitjacket and prevented them from reacting effectively to crises of the sort that has nearly crippled the world economy over the last few years. I think the way to understand Austrian theory is as 8220the road not taken8221. From 1870 through the early 19308217s the world was struck by numerous financial crises that turned into wide scale recessions or depressions. The keynesianmonetariststatist response was, 8220Look, the private sector is inherently unstable, the gold standard is inherently bad, thus we need a fiat standard with government regulatedcontrolled banking8221. The libertarianAustrian response was, 8220The market is not inherently unstable, government policies broke the market. The government instituted a national policy of fractional reserve banking, which is inherently unstable. Second, it tried to maintain a gold to dollar conversion rate of 22ounce, while printing far more greenbacks than could be backed by gold. If you do those two things, of course you are going to get a crash. If the government simply stops breaking things, we can get a fully privatized financial sector that will be perfectly stable without any systematic crises8221 The proper Austrian response to the Great Depression would be to do a monster devaluation and then go back to the gold standard at a sustainable ratio. I think this could have worked. Instead, the government decided to go off the standard altogether. I think a fiat system can be made to work well, or a 100 reserve gold standard could be made to work well. Like programming languages, often it8217s much more important to know how to use your tool well, than to waste time discussing which tool is best. The U. S. government in the 19208217s and 308217s did not know how to run a gold standard well. Now it does not know how to run a fiat standard very well. This tells me that maybe we should spend more time worrying about how we get better engineers, than worrying about what tools those engineers should use. I do not know if the Austrian claim that a fully free market, maturity matched banking system would work and be crisis free. The logic seems fairly plausible. But I do know that a) there has never been a free market banking system in the industrialized world and b) every major recession and depression has been grounded in the problems in the bankingcredit system. Finally, I agree that the vast majority of Austrians have no clue how the modern financial system would work. Should they actually seize the reins of power, they almost certainly would leave the entire economy in a heap of rubble. There may be some theoretical path that could transition the economy from its current state to an Austrian utopia. But no one close to power has any clue how to find that path. That said, it8217s not useless to study Austrian economics. It8217s interesting to understand 8220the road not taken8221. It8217s also interesting because even though Federal Reserve banks do not maturity mismatch anymore, other parts of the banking sector do. If you want to understand what happened to the money market funds and the shadow banking sector, the Austrian insights can be quite helpful. The mad ravings of Rothbard that all money base andor private credit creation is inflationary is a dogmatic assertion. When Rothbard talks of 8220inflation8221 he means 8220dilution8221, which was the original meaning of the word inflation. That printing money creates dilution is a truism. If the government increases the supply of what I call 8220broad money8221 ( by broad money I mean all government backed paper 8211 currency, bank deposits, CD8217s, t-bills, etc), it dilutes the existing holders of broad money. Just as issuing new shares of stock dilutes the existing shareholders. Imagine counterfeiters printed enough money to dilute the broad money supply at 3 a year. Imagine productivity also grew at 3 a year due to advances in green energy. You get no CPI inflation. Yet the counterfeiters are still stealing from existing holders of broad money. Instead of enjoying increased purchasing power as productivity rises, they are stuck stationary while the counterfeiters gain purchasing power with their newly printed money. Similarly, if the government prints broad money and siphons it to political favored constituencies, then that is a seignorage tax. Holders of broad money are being taxed to support the government8217s favored spending plans. Maybe Rothbard is wrong to get so upset about just another tax. But there is no denying that it is a seignorage tax. Just because the economy grows at 3 does not mean the tax does not exist. It just means it is camouflaged. Excelente postagem. Ive never been clear on 100 per cent reserves. Its always been a confusing, amorphous Rubiks cube of risk considerations and institutional possibilities. Discussions are typically clouded on issues of liquidity risk, credit risk, maturity transformation, and macroeconomic money supplyinflation considerations. Theyre often vague on the specification of the substance of the reserve and the domain of reservable deposits. Assuming a 100 per cent scenario, is the reserve substance gold Is it government bonds Is it current central bank reserves Are checkable deposits reservable Are all deposits reservable What is the proposed institutional configuration The first thing to understand about 100 percent reserves, is that it8217s a policy for a radically different banking system. Trying to map our current rube goldberg banking system, to a theoretical Austrian, 100 reserve system, is a non-trivial task. Instead, I8217ll try and answer your question from the perspective of a theoretical, blank slate system. The two key principles to a 100 reserve system are a) maturities must be matched and b) the backing asset should be what the depositorlender believes it to be. If the customer puts US dollars in a demand deposit account, then the bank should just keep that money in a safe, to be available on demand. The bank should not lend out the dollars for any amount of time. If the customer places U. S. dollars in a time deposit account, where he must give 60-days notice for redemption, the bank should not lend out the dollars for more than 60-days. If the customer purchases a 3-year CD, then the bank should not lend out the dollars for more than 3 years. The bank in turn buy a 3-year corporate bond, a 3-year treasury bill, or something else. The bank should be up front to the customer about the risk profile of the loans it makes. If the legal tender of the land is gold coins, and the customer places gold coins in a demand deposit account, then the bank should actually store the gold coins. Under this type of banking system, there is never any 8220liquidity8221 risk. A bank is never in a position where it has to sell off a security before it has matured, in order to meet the demands of depositor. There still is credit risk. There is no private credit extension. If the government wishes to increase the money supply, it must actually print more currency (or mine more gold if it8217s running a gold standard). There also could be bond mutual funds in a maturity matched system. The buyer of a share in a bond fund should be very careful about the average maturity of a bond fund. If he only intends to hold shares in the fund for a year, he should not buy a fund that has an average bond maturity of 10 years, because there is substantial risk of short term price drops. If you want to read more about a theoretical, Austrian banking system, I recommend this comment thread by Mencius Moldbug. He does a good job explaining to a modern financial professional how a maturity matched system would work. Obrigado. Thats actually pretty clear the way youve written it. Im interested mostly in trying to visualize the institutional configuration. Is the system integrated (credit and deposits in the same institutions) or is it bifurcated (credit and deposits in separate institutions) Viewed this way, the issue of reserves is quite separable from the question of who creates new money. Thats notwithstanding the preference of some to conflate requirements for both characteristics (as well as that for maturity transformation) in the definition of a 100 per cent reserve system. That may be a definition of choice, but it doesnt follow analytically. That is what I meant in the opening paragraph you quoted. Por exemplo. its quite possible to visualize an integrated institutional system with 100 per cent reserves that is the same as the prevailing institutional system we have in every way with the exception of the magnitude of the required reserve ratio. That is exactly what I did with the extreme example in my comment whereby 7.4 trillion in deposits is 100 per cent reserved. You may object to such an example because it doesnt refer to such characteristics as maturity transformation. But thats exactly my point regarding the arbitrary configuration of multiple characteristics that is given the label of a single characteristic. My first order of business is examining the variable of 100 per cent reserves. Im quite interested in the parameter of maturity transformation beyond that, but there is nothing analytical or logical that demands a particular association between the reserve ratio variable and the maturity transformation parameter in all cases. As another example, it is quite possible to visualize a bifurcated institutional system with 100 per cent reserves held against deposits in one set of institutions and credit extended against non-deposit liabilities in another set of institutions. However, there are important issues regarding payment system surrounding such a set of credit institutions. What is the institutional mechanism whereby this set of institutions effects payments across its members In what account does it temporarily store the payment medium in order to settle such transactions How does it clear and settle these payments And most importantly, how does it handle a potential shortfall in payments in any one institution Because it is extremely doubtful that such a set of institutions could exist indefinitely without experiencing any payment shortfall at some point. If perfectly matched, I suppose this is theoretically possible. But the idea that all credit is renewable at maturity only on the basis of a pre-existing renewed liability seems to be quite a tightrope to walk. It suggests massive uncertainty as a permanent structural feature in the supply of credit. Any breach in this assumption requires some lender of last resort. And whether that lender of last resort is a central bank or merely one of the depository banks acting as clearing agent for a customer credit bank, the jig is up in terms of maintaining a pristine maturity matched credit system. And the jig is up the first time it happens. Im familiar with various Moldbug discussions going back several years on this issue, and others like Kling. Moldbug in particular is impressive. But Im not convinced that the subject has received the full analytical vetting it warrants yet. Again, JKH, you8217ve said exactly as I would in your second-to-last paragraph at 7:09. Perfect maturity matching doesn8217t get rid of the liquidity risk issue not even close. Thanks for the thoughtful comment. I agree that existing systems (whatever they are) can be made to work better if the policy makers really understand the possibilities. But that is the point 8211 the possibilities presented a national government under a gold standard are limiting and may not allow it to achieve true full employment. It forces monetary policy to be working against fiscal policy if full employment is your objective. The conjunction of fiscal and monetary policy is achievable under a fiat monetary system. At present, the policy makers pretend they have a gold standard 8211 or some hybrid and act as though they are as constrained as they would be under a gold standard. That is why we are getting such unsatisfactory responses to the current crisis and also why most nations have endured very high levels of unemployment (relatively) over the last 30-35 years. On dilution: I don8217t use the terminology 8220printing money8221 to describe government spending. But that said, I disagree with the proposition that 8220printing money 8230 by which I will call government deficit spending not matched by debt-issuance 8230. creates dilution is a truism8221. Dilution can only occur if what you can buy in real terms per is reduced. That is not a function of the stock of 8220liquidity8221 8211 but what the liquidity can purchase in real terms. In economies with high degrees of capacity underutilisation and unemployment, increase public deficits can actually increase the amount of real goods and services at the disposal of the individual (for example, giving the unemployed a job) without reducing the real capacity per held by others. Your last paragraph also confuses the role of taxation. No-one is taxed to pay for anything 8211 whether it be broadly-spread spending or narrow pork-barrelling. That is the misconception of the Austrian paradigm (and mainstream economics as well). Taxes are levied to regulate overall purchasing power (and in some cases to reallocate resources away from 8220bads8221 such as tobacco taxes). So no-one is being taxed to support government spending 8211 which occurs independent of the so-called revenue raising initiatives. best wishes bill Dear Devin (and JKH and Scott) If the point of the 100-percent reserve banking system is to reduce bank losses then I fail to see how it does that unless it prohibits credit creation at all. As soon as the bank starts making loans (even if the funds lent are fixed-term deposits already acquired) then credit risk is possible. Widespread failures (defaults) are still possible which just means that at some point in the future (when the fixed-term deposits expire) the 8220bank run8221 occurs. In that sense, I don8217t see the point of it and so I start thinking about the other motives that are behind the suggestion 8211 the Austrian 8220sound money8221 motives 8211 which in my view disable the capacity of the national government to pursue and achieve public purpose 8211 full employment, equity in opportunity, environmentally sustainable growth, and price stability. best wishes bill Trying to imagine what the banking sector would look like if you just change one variable ( ex. requiring 100 reserves) is a near impossible task. There are any number of directions it could take, some resulting in complete disaster, some being quite good, depending on the hoary details of the implementation. My own take is that switching to a 100 reserves should only be part of a complete switch to 8220temporal8221 based accounting, with maturity matching at every level. Just instituting 100 reserves now would do pretty much nothing, especially since deposit accounts are FDIC insured anyway. Exchanging a government backed 8220put8221 for a government greenback isn8217t really changing anything. To respond to your second paragraph, I can conjure up at least one vision of how a port of our current banking system to an Austrian-like system could occur. This is of course pure fantasy, interesting as a fun intellectual exercise only. First, create an accounting of all government backed paper (FDIC insured accounts, treasury bills, AMLF backed money market funds, etc). Create enough dollars to back all government paper (on the order of 20 trillion). Account for those dollars in a new software system run by the Fed. The Fed8217s digital ledgers would have a database with a row for every dollar. The row contains the serial number, it8217s current status, and the current owner (where the owner is basically a tax payer id). All deposit accounts, money market funds, etc, would be converted to direct accounts held at the Federal reserve. Instead of having 15K in a deposit at Bank of America, there would be 15K digital dollars held in my account at the Fed, with my social security number attached to them. Instead of having a treasury bond payable for 10K in 5 years, I would have a 10K in digital dollars held at Fed, with a 8220non-transferable8221 restriction on it for 5 years. The job of the banks would then to be as intermediaries for borrowing and lending. I would go to a bank and purchase a 15-year CD for 10K, that promised a repayment of 30K in 15 years. The bank would cash my check at the Fed, and the Fed would transfer money from my account to the bank8217s account. My account at the Fed would be 10K less, and I would have an IOU from the bank. The bank would then lend out that money to a home buyer, who takes out a 15 mortgage. The home buyer deposits the bank8217s check, and the Fed decrements the bank8217s account and increments the home buyers account. The actual clearing of the checks is a trivial matter of software. So what happens if there is a shortfall you ask The most likely reason for a shortfall is that the home owner defaults on their mortgage. Keep in mind that in the example above, the bank is not going to be matching up one CD to one mortgage, but rather a pool of CD8217s to a pool of mortgages. The bank might have 100 mortgages due on Jan 1st 2015, and 500 CD8217s it needed to pay off on Feb 1st 2015 (this is simplified as mortgages have a different re-payment structure than CD8217s, but for now imagine their repayment structure is the same). The bank would expect a certain default rate on the mortgages. So the bank might offer a 5 interest rate on the CD8217s, and make the mortgages at 7. Part of the difference would be eaten up by expected defaults. The rest of the difference would be profits for the bank. If the bank makes exceptionally good lending decisions, it profits more. If it makes poor lending decisions, the defaults will eat up its profits. If the defaults eat up all the profits, the bank will have to either borrow against future profits, or sell stock to raise capital. If that doesn8217t work, then the bank must default on it8217s CD8217s, and the owners of the CD8217s would get slightly less than face value. If a set of mortgages are simply delinquent then the bank may issue short term bonds to third party, in order to get funds to payback the CD8217s. The bank would want to avoid this situation, so it probably would always maintain a small buffer of cash to make any such desperate measure very rare. So in summary, defaults andor delinquencies hit the bank stock holders first, and the CD holders second. I would consider both defaults and delinquencies cases of 8220credit risk8221 not 8220liquidity risk8221. The described system certainly has credit risk, but I do not see how it has liquidity risk. I8217m not sure what the 8220tightrope8221 walk you refer to is. Obviously the bank has to understand it8217s risks very well, and keep a healthy margin for error, or else it will get wiped out. Shareholders do not want to get wiped out, so they would demand that the bank keep the spread between the interest on the CD8217s and on the mortgages large enough to cover even unexpected defaults. Shareholders do not the bank walking a tightrope, because they are first in line to get wiped out. This is all a feature not a bug, as it keeps the incentives of the bank8217s lending officers pointing the right way. The above plan is essentially the Austrian solution for 8220liquidity8221 crises. The PK8217s solution is obviously very, very different. The advantage of the Austrian plan is that it does not require any sort of FDIC insurance or lender of last resort. Thus it does not have a moral hazard problem and thus does not require a central government regulator basically monitoring and approving all lending activities. The disadvantage is that it looks nothing like our current banking system, and nothing like the banking systems that have been running the world for the last three hundred years. So who know8217s what it would it look like in practice, and certainly no current political authority is capable of implementing it. Credit is the backbone of a modern monetary system. Banks were created by the constitution as a great vehicle to have both capitalism and full employment. The private sector by itself cannot create full employment because of financial constraints and needs buffer for uncertainty and the government has to step in. Banks hold a unique position, else credit will be difficult and pricey. Banks have this unique ability to lend by expanding out its balance sheet. Preventing an easy expansion of the balance sheet will just increase the loan rates. The settlement balances at the Federal Reserve have just two roles 8211 settlement and help satisfy the household need for currency notes. The central bank is also the lender of the last resort and can lend as much as possible. The whole system is designed wonderfully so that entrepreneurs, academicians, scientists, engineers, artists, advertisers, sales persons, managers, HR, unskilled laborers can make use of this and increase the quality of life for themselves and others. If the households permanently decide to use more cash, the central bank can help banks slowly reach that state where they keep more settlement balances, lending in unlimited quantities in the meantime. Its a misunderstanding of the system and poor economics which led to the crisis. Economic advisors to governments have no concept of 8220domestic private sector deficit8221 in their analysis. If they had noticed that the private sector was getting weak, they would not have allowed a credit boom to have happened. Instead they supported the boom and ignored reports showing scams and forgeries. It is neither low interest rates or low reserve requirerments which caused this crisis. Blaming the crisis for these two things is like blaming the invention of fire instead of blaming the fire prevention system. Too much worry about monetary aggregates will never be on Bill8217s mind. The design you have mentioned is unachievable. Imagine the start of the world 8211 government spends 100 and taxes 20. The private sector has 80 in their account at the central bank. The government cannot issue debt 8211 it will take away those 80 from the central bank8217s account and it will get replaced with government debt. So the government cannot issue debt - for - for its deficit spending. Nothing wrong about it but Austrians will object. However, the most important flaw in the design I can see is that the amount of debt is totally upto household8217s liquidity preferences. Households refuse to buy CDs and the interest rates shoot The advantage of having a bank is that the banking system sets the price 8211 the interest rates because of its ability to expand its balance sheet. 8220Loans create deposits8221 is a good thing Thanks. Thats one of the clearer expositions Ive seen for Austrian type architecture. It helps when probing the underlying ideas. In your constructed version of a 100 per cent reserve system, you blend all government backed paper, including what would have been FDIC insured deposits, into a big liability bucket of the Fed. There might be other ways of doing it, but using the Fed simplifies such an example. A separate non government credit banking system includes the usual loan assets etc. match funded by term liabilities of some sort. The credit banking system is not allowed to make loans without having the money in place first i. e. without having issued liabilities to fund new loans, and then only on a matched maturity basis. Thats the pure interpretation as I understand it. I realize that there are deviations from perfection in the implementation, but Ill focus on the pure model first. Ill refer to the Fed deposit system, a separate credit banking system, and the combination of the two as the bifurcated system. The Fed deposit system effectively eliminates liquidity risk on 100 per cent reserved deposits by virtue of its fiat powers of money creation. This eliminates credit risk at the strategic level, because the liquidity creating power of fiat currency issuers dominates potential concern about government solvency. It eliminates liquidity risk at the operational level, because fiat currency issuers can exercise this power at any time. The design of the credit banking system as I understand it is intended to eliminate liquidity risk through the combination of two characteristics. First, banks must have money before they can lend. Second, banks must match maturities of loans and deposits. The credit banking system still has credit risk, and non government capital is required against that risk. While the Fed system features 100 per cent reserves, the combined system requires dual reserves, in effect. Youve noted that the credit banks would maintain bank accounts at the Fed. A credit bank by requirement must attract term liabilities before it can make a corresponding loan. Therefore, it must have funds in its Fed account, before allowing the drawdown of such a loan. It must show a long position in this account before advancing funds. Given this requirement, this is a reserve account in spirit. The credit banks hold these lending reserves with the Fed, which in turn holds 100 per cent reserves against all of its liabilities, including the reserves of the credit banks. Liquidity risk in its extreme form is a run on the bank. Essentially, depositors fear for the safety of their money due to concerns about a banks solvency. Whether those concerns reflect actual or perceived insolvency, the effect on liquidity risk is the same. Depositors want out particularly those who arent insured. We know how that works for the conventional structure. How does it work in a bifurcated system First, as noted above, the Fed deposit system is fully protected from liquidity risk, and fully protects the liquidity properties of its deposits. A government issuing a fiat currency doesnt have to worry about liquidity risk on its own liabilities. The reason is that the government manufactures its own liquidity. Any concern regarding government solvency is superseded by its liquidity powers when the government is a currency issuer. This is a variation on the interpretation of the central PK MMT theme that governments are not revenue constrained. As you note, capital protection is featured in the credit system. Such capital protection combined with maturity matching should then mitigate liquidity risk in the bifurcated arrangement. But does it I would say not. Liquidity risk and solvency are intertwined in market perceptions. But liquidity and solvency are very distinct characteristics at an operating level. (The term solvency is used in the sense of balance sheet solvency or net equity.) Indeed, because of this distinction, the purest version of the matched maturity system you have sampled is subject to an extreme form of liquidity risk. Consider the following example: Suppose a pure credit bank is set up just about as perfectly as you can make it on a matched maturity basis. Again, youve noted that there are practical limitations to perfect matching, but lets just assume such a perfect matching situation is possible in concept. And suppose this bank has a capital position that is in fact quite adequate. Now suppose there is a credit scare. And, one of this banks loans goes bad all of a sudden. The loan comes up for maturity. At maturity, the bank declares it lost. It gets no cash back from the borrower. The bank writes the loan off. It deducts the loan loss from its capital. It still has plenty of capital though. This bank is perfectly matched. So it has a liability maturing at the same time as the loan. Assume that on the day prior to the simultaneous maturities of the loan and the liability, the market suddenly becomes fearful about the existence of more bad loans approaching their contractual maturity. The result of such fear is that the bank is unable to attract additional liabilities. There isnt a run on the bank though, because liability holders cant withdraw their money prior to their respective maturities. Theyre locked in. Hence no run. What happens on the day both the loan and the liability mature The bank adjusts its capital position to record the actual loan loss. Isso é bom. But here is the essential point of distinction: the capital write-off has absolutely no bearing on the banks ability to repay that maturing liability. The capital write-off is a pure internal accounting wash: credit loans (down) debit capital (down). Effect on liquidity position: none. The banks capital position, assumed to be quite adequate in this example, is in a first loss position by virtue of its ranking in the liability structure. Credit bank liability holders are senior to capital. They do not absorb the loss while capital is in place to perform that function. They expect losses to be absorbed by capital. Anything to the contrary would make a mockery of the capital structure, and would essentially put creditors in a ramped up loss exposure simply due to the luck of the draw on maturity matching. Why would creditors expect to take a loss while plenty of capital was still extant If they cant get their money, its off to bankruptcy court or whatever wind-down resolution facility is in place. They wont let the banks maturity matching scheme impede their access to their money, and the banks capital, as necessary. Notwithstanding the likely viability of its capital position, the bank has no money with which to repay the maturing liability. Moreover, the community of potential liability buyers has decided all of a sudden that in its view, rightly or wrongly, the viability of the banks capital position is at great risk. While there is no run on the bank, there is also no run into the bank. So if it cant attract any more money to replace the liability, what happens next Before answering that, consider the banks deposit account operation at the Fed (which Ive called a reserve account). On the day of the deposit maturity, the bank has no money in its reserve account. It has none coming in from the maturing loan, and it has none coming in from new liability buyers due to the spreading credit scare. Apparently, it has two choices. It can fail on the payment and declare bankruptcy. Or it can make the payment and go overdraft on its reserve account. In either case, the choice for the maturity matched credit bank is not pleasant. How did it get into this difficulty, given such good intentions Lets assume this bank wants to go on living. So it goes overdraft on its reserve account. It appears to me thats the end of the Austrian architecture right there. The crumbling logic is due to the requirement for an overdraft privilege with the central bank, which must exist in order to avoid failure in the purest of matched maturity models. And that is an earthquake of a contradiction in the overall Austrian architecture, as I see it. If the overdraft privilege exists, the discipline of loanable funds essentially vanishes as the underlying principle motivation for institutional bifurcation in the first place. If overdrafts are permissible, the constraint is no longer binding that funds must be available prior to lending, and there is no longer any reason for institutional bifurcation. We are back to the idea of an integrated system, even with 100 per cent reserves, as I described in the 7.4 trillion extreme case in my earlier comment in this thread. That system is a full fiat and loans create deposits operation, where banks continue to create money from credit, notwithstanding the balance sheet implications of 100 per cent reserves. 100 is just another number in that case like 99, 10, or 0. It seems bizarre, but this most pristine of matched maturity examples leads to a catastrophic liquidity interruption, that is only solvable by government intervention. The bifurcated model exacerbates potential liquidity risk well beyond the normal dimensions that exist in the more conventional integrated system. Banks dont normally fail when the first loan goes bad. But such failure is implied by the bifurcation architecture in its purest form. BTW, Scott Fullwiler has emphasized the critical nature of the overdraft question in several comments here and elsewhere in recent days. Bill makes a similar point above. The importance of the overdraft event per se is central to PK MMT analysis of the monetary system. It is one thing to say that new rules are intended to preclude overdrafts. It is another to say they cannot or will not occur. Real world modifications to this pristine example might include an element of delay in the process of crying uncle with respect to the premise of matched maturity protection. The logic crumbles quickly in the purist model more slowly in a compromised model (more like real world banks in the current system). The credit bank reserve concept means that well run banks might tend to stockpile reserves of incoming term liabilities in order to offer some decent selection of maturities to customers coming in for loans. Such an approach would lead to some level of self-imposed reserves, created by an inventory of excess liabilities. This would position credit banks favourably in the short term for the type of creditliquidity shock described in the pristine example, but the protection thus created would only be temporary, and the result only delayed, depending on the size of the liability stockpile and corresponding reserves. Given the system constraint that liabilities must be in place before loans are made, the maturity structure of credit in aggregate depends on the maturity structure of liabilities in aggregate. In addition to the bank being under this constraint, the banks borrowing customers are under it. Under todays system, banks cover their liquidity requirements as a function of credit demand. Under the Austrian type reserve constrained maturity matched system, banks offer a credit menu on the basis of liquidity provided by liability holders. As a result, this is a highly constrained system for borrowers. Borrowers no longer have unconstrained options on term structure. They can only choose whats available at the time. I guess thats what loanable funds means under such a system. But its loanable funds not only on the basis of available quantity, but available quantity per maturity. In summary, the intention of 100 per cent reserve requirements is to ensure credit and liquidity protection for bank deposits and government liabilities. The maturity matching motivation is a discipline imposed on the credit banking side of the framework. Banks are not permitted to create money from credit. They must have money before they lend it, and they do this by issuing liabilities prior to lending. This requirement combined with maturity matching and capital discipline should make liquidity risk a non-issue. But a fundamental problem gets in the way of this objective. Credit banks in a bifurcated framework cannot avoid liquidity risk. Credit banks require accounts with the depository institutional framework in order to make and receive payments. In particular, they require such an account to make payment to holders of maturing liabilities. If a maturity matched liability coincides with a bad loan maturity, there will be no matching funds to make payment. The fact that capital is available to absorb the loan loss has no effect on operational liquidity. Liquidity and capital are distinct. The bank in that situation has two choices. It can fail on the payment and go bankrupt (or some other form of wind-up). Or it can go overdraft on its deposit account at the Fed. In order to make the second choice, it must have a pre-existing privilege to do so. If such a credit facility is in place, it means that the principle of pre-existing funding has been broken. In either case, the bank has definitely experienced liquidity risk, notwithstanding matched funding. The bottom line is that the combination of 100 per cent reserves and maturity matching provides no ultimate protection against liquidity risk. Liquidity risk is a function of perceived solvency risk. At the same time, the ex post balance sheet impacts of liquidity risk and solvency risk are operationally separate because those impacts are recorded through entirely different accounts. It is that account separation that precludes capital from protecting realized liquidity exposure at the operational level. Finally, real world extrapolations of the pristine Austrian type model may add an element of buffer protection afforded by a self-imposed reserve of excess liabilities and corresponding deposits at the Fed. But the solvencyliquidity dynamic still operates, and will prevail according to the duration of the liquidity crisis and the time protection offered by such a liquidity buffer. THank you for the response. Some people design fantasy football teams, I design fantasy banking systems. Glad you find the exercise interesting. I would argue that the crisis that you call a 8220liquidity8221 crisis is really a 8220credit8221 crisis. The bank made a really bad loan, and thus cannot pay back it8217s CD holders. That8217s a credit problem, not a liquidity problem. I did make a big mistake in my description when I talked about 8220capital8221. You are correct that 8220capital8221 in the balance sheet sense does not represent liquidity. I should have said that the bank would make up losses first with 8220cash on hand8221. Every bank with sound management will have a cash 8220buffer8221. This buffer is a cash desposit account, held in the bank8217s own name at Fed. The buffer was originally funded and filled through either selling shares or retained earnings ( this makes it quite different than a reserve). If a home owner fails to pay their loan back to the bank, the bank will need to repay the CD holder out of the banks own buffer account. This will show up as a loss on the quartly earning statement. The bank will need to replenish the buffer by selling stock or retainined cash flow. How do we know this buffer will be big enough to cover losses in practice Well, simple. As you point out, if the buffer is too small ( ie zero), the bank defaults at the slightest problem. Shareholders get wiped out. This is not good. The buffer therefore must be large enough to cover any reasonable variation in loan repayment. But if the buffer is too large, the bank is leaving idle money in an account that8217s earning no returns for the shareholder. It is up to the shareholders andor the management to figure out the appropriate size of the buffer. Maybe it8217s 1 of desposits due in given year, maybe 5. I8217m not sure. But shareholders and management have a very strong incentive to get the buffer size right. So in your actual example of a failing loan, the process will go: a) Repay the maturing CD out of the buffer. Then, overtime the bank will need to replenish the buffer by either issuing more stock or retaining earnings. b) If the defaults are so great, they eat up the entire buffer, then the bank will need to take out an emergency loan. It will need to find a third party (not the Fed, but an ordinary private bank that has a better credit position) to make the loan. The loan would likely be made against the bank8217s future profits or equity. The third party will make this loan if it thinks the bank is fundamentally healthy, and has just hit a temporary rough patch. c) If no third party is willing to make a bridge loan, then the bank is insolvent. It goes into default on the CD8217s. Shareholders get wiped out. The owners of the CD8217s are first in line to be paid off, but they will probably not get all of their money back. Under no circumstance can a 8220credit bank8221 run an overdraft at the Fed. As you correctly point out, this would defeat the entire point of the system. So I made a mistake in my original proposal in leaving out the part of the buffer. With the buffer, and with the ability to take out loans from third parties, a bank will only fail if it makes so many bad loans that it overwhelms all its existing cash, plus all its expected future profits. There is no failure due to a liquidity crunch, only due to major mistakes in making bad loans. What you did in your example is design a system pristine from the maturity matching perspective. But it was very impure from the credit risk perspective, and the bank in your example was making the unsound decision to have no buffer. Thus it failed instantly upon the first default. If the economy was 8220pristine8221 from a credit risk perspective, ie no defaults or deliquencies, then there would be no need for a cash buffer account. In the real world, there will be substantial credit risk, and thus all sound banks will keep a cash buffer account. The Austrian system I described does not eliminate credit risk. Banks will make mistakes, banks will fail, CD holders will occaisionally lose money. But incentives are aligned. Shareholders take losses first, so they have an incentive to makek good lending decisions and keep a sufficient buffer. This would position credit banks favourably in the short term for the type of creditliquidity shock described in the pristine example, but the protection thus created would only be temporary, and the result only delayed, depending on the size of the liability stockpile and corresponding reserves. This is correct. In fact, a bank should never do this even as a temporary measure. If a loan goes bad, and it needs to repay a CD, it should never repay the CD with a 8220reserve8221 or from someone elses loan repayment. Those loan repayments are already marked for someone else. It should only repay out of the buffer. As a result, this is a highly constrained system for borrowers. Borrowers no longer have unconstrained options on term structure. They can only choose whats available at the time. This is true. But in the age of the internet and global finance, I8217d expect that borrowers would have a wide variety of choices available. The bank made a really bad loan, and thus cannot pay back its CD holders. Thats a credit problem, not a liquidity problem. We differ there. Its a credit problem at origin, but the credit problem is absorbed by capital. The purpose of capital is to absorb losses. Its also a liquidity problem. But the liquidity problem isnt resolved in either situation I outlined without an overdraft from the Fed. If you allow overdrafts from the Fed, then you can define it as resolved, but that contradicts the point of setting up a separate credit bank system. You are correct that capital in the balance sheet sense does not represent liquidity. I should have said that the bank would make up losses first with cash on hand. Capital and liquidity are distinct but related. The purpose of capital is to absorb unexpected losses. The purpose of liquidity is to meet cash flow obligations. It happens that capital as a balance sheet item is also a source of liquidity (as funding), but its not the only source of liquidity in a leveraged institution. Every bank with sound management will have a cash buffer Agreed 8211 but it wont protect a bank in the worst form of liquidity crisis due to insolvency. The bank will need to replenish the buffer by selling stock or retained cash flow. Banks issue stock and generate earnings to replenish their capital positions first. That also improves liquidity as per my previous comment, but improvement of liquidity is not the primary purpose of capital replenishment. There is a difference between a buffer against liability obligations (liquidity) and a buffer against losses (capital). How do we know this buffer will be big enough to cover losses in practice The liquidity cushion doesnt cover losses. Thats what capital does. So in your actual example of a failing loan, the process will go8230 It doesnt go that way because I specified a liquidity crisis that caused depositors to stay away. The bank may actually be insolvent, which is a condition of negative equity. But it only needs to be perceived as insolvent for there to be a liquidity crisis. Under no circumstance can a credit bank run an overdraft at the Fed. As you correctly point out, this would defeat the entire point of the system. So I made a mistake in my original proposal in leaving out the part of the buffer. I anticipated that by briefly noting the buffer scenario at the end (I should have spent more time on it.) The point is that in the worst case, a finite buffer cannot protect against a liquidity crisis that is driven by actual or feared insolvency. It can only buy time, but time will run out in the worst case. Thats the point about the distinction between liquidity and capital. So the credit bank must either go out of business or get an overdraft from the Fed. The latter is a contradiction because overdraft privileges arent provided. There is no failure due to a liquidity crunch, only due to major mistakes in making bad loans. The root cause of the liquidity crunch is real or perceived insolvency from a capital perspective (expected losses due to bad loans), but the failure mechanism the death spiral 8211 is the actual liquidity crunch and failure to repay liability holders. If the economy was pristine from a credit risk perspective, i. e. no defaults or delinquencies, then there would be no need for a cash buffer account. In the real world, there will be substantial credit risk, and thus all sound banks will keep a cash buffer account. My point was to demonstrate first a contradiction in the pristine case that the credit bank required an overdraft. I then generalized it to a contradiction in the buffer case, where a sufficiently severe liquidity crisis always overpowers a finite buffer. I recognize that sound banks from a liquidity perspective carry a buffer, but that doesnt prevent them from going down if real or perceived solvency (capital adequacy) is the underlying problem and that problem outlasts the finite liquidity buffer. Thats why a system with credit banks cant exist without overdraft privileges or it simply goes down at the first instance of a liquidity crunch without the option of a temporary overdraft. This is correct. In fact, a bank should never do this even as a temporary measure. Its finite by definition and therefore temporary by definition. No matter how large the buffer, it will not prevent a bank from going down due to the most severe solvencycapital real or perception problems. Thats generally how banks go down. The whole point of my piece was to present an example that juxtaposes a realperceived credit problem against liquidity resources that are finite by definition pristine or otherwise. The two finite cases are zero buffer (pristine maturity matching) or non-zero buffer (technically a form of favourable maturity mismatching). Both cases produce a contradiction in that the credit bank needs a Fed overdraft in order to avoid going down due to its liquidity crisis it cant repay its liability holders. Perception of credit problems is the cause of the liquidity crisis in the examples exhaustion of finite liquidity is the mechanism. It always works that way in the real world, and its no different for credit banks as defined. Thats why the Austrian architecture fails. It cant protect against the most severe liquidity crises, as in the real world. But in the age of the internet and global finance, Id expect that borrowers would have a wide variety of choices available. Interesting point on information but the internet information itself doesnt produce the stockpile of liabilities that is required before lending. Its a difficult subject. We may be talking past each other a bit. My general observation is that its important to understand that the purpose of capital is to absorb losses. Liquidity management is not about absorbing losses. Its about meeting required cash flows. These are separate but related issues. Liquidity crises are generally about the perception andor reality of balance sheet insolvency or expected balance sheet insolvency (i. e. negative capital), or at least enough of a capital risk problem that people want to get their money out and not take the risk of hanging around. Capital is also a source of liquidity in the sense of funding, but it is not the only source in a leveraged institution with liabilities. Those liabilities are not capital per se. They magnify the nature of a liquidity crisis, just as they magnify or leverage risk taking in the first place. Only when an institution is 100 per cent capital funded (i. e. equity) does a liquidity crisis blend perfectly into a capital crisis, because equity holders only expect to get the residual value of the firm out in the form of cash (i. e. liquidity). Thank you for the thoughtful response. But that is the point the possibilities presented a national government under a gold standard are limiting and may not allow it to achieve true full employment. As I explained before, if you are running 100 reserve, gold standard, full employment is achievable if follow two rules 1) do not print more money that you have backed by gold at the fixed conversion rate and 2) if you break rule 1) devalue, devalue, devalue. If you run a fractional reserve system with a gold standard, then the central bank must follow Bagehot8217s rules. The Bank of England followed Bagehot8217s rules from 1870 to 1914 and had full employment and a tamer business cycle than we have now. When the Bank of England stopped following those rules, it ended in predictable disaster. When the government printed more money that it had gold, and then refused to devalue, it created ruin. It should have devalued in the 19208217s. Again, the gold standard is fine tool, that can be used to achieve full employment if used properly. At present, the policy makers pretend they have a gold standard or some hybrid and act as though they are as constrained as they would be under a gold standard. Our problems today are analagous to those of the 208217s and 308217s. But the problem is not 8220gold standard8221 mindset. The problem is a refusal to devalue. Why is there a refusal to devalue Popular outrage for one, and an ability to admit mistakes for second. That is why we are getting such unsatisfactory responses to the current crisis and also why most nations have endured very high levels of unemployment (relatively) over the last 30-35 years. Unemployment has certainly been a problem during recessions. And recessions certainly call for stimulus to maintainrestore employment. But I don8217t see unemployment due to deficient aggregate demand as a chronic, ongoing problem. From 2003 to 2007, loose money led due to credit expansion led to pulling millions of workers from Mexico north into America to build houses. Dilution can only occur if what you can buy in real terms per is reduced. That is not a function of the stock of 8220liquidity8221 but what the liquidity can purchase in real terms. This is simply incorrect. Dilution may be offset by an increased demand for money, or by productivity increases, but it8217s still dilution. Dilution may be a good idea in some circumstances (such as an aggregate demand shock), but it8217s still dilution. If you own stock in a company, and issues 3 more shares every year to payoff executives, do you consider this dilution 8220not to exist8221 if the economy also grows by 3 a year If so, I have some stock to sell you 8230 Like dilution of the money supply, dilution of a stock can be a good idea in some circumstances (such as to raise money from venture capitalists), but it8217s still dilution. In economies with high degrees of capacity underutilisation and unemployment, increase public deficits can actually increase the amount of real goods and services at the disposal of the individual (for example, giving the unemployed a job) without reducing the real capacity per held by others. This is true. But keep in mind the government doesn8217t just dilute the currency during recessions. By any measure you choose, there was a very high rate of dilution during the 2003-2008 period. This dilution is an ongoing transfer of resources from the holders of government paper to the government8217s favored constiuencies. A five year treasury bill bought in 2003 actually lost money in real terms, because the dilution rate was so high. Your last paragraph also confuses the role of taxation. It is correct to describe the system as one where government creates money to spend, and taxes to sterilize. You can also model the system as one where the Fed creates money, and the Treasury taxes to fund government operations. Technically, this is what happens, and this is how the government iteslf describes its operations. Either way, it8217s a fiat currency, and in no theoretical sense is spending in dollars constrained by taxes. But the overall point, is that when the government extends credits ( or rather, gives banks a license to extend credit) real resources are transferred from the existing holders of money and government paper, to the people receiving the loans. If the point of the 100-percent reserve banking system is to reduce bank losses then I fail to see how it does that unless it prohibits credit creation at all. The point is to eliminate liquidity crises and bank runs. Not to eliminate credit risk. Credit risk will still be present. Almost all the major crises, from the panic of 1819 to the Great Depression to the run on the money markets last september have had maturity transformation at their heart. Widespread failures (defaults) are still possible which just means that at some point in the future (when the fixed-term deposits expire) the 8220bank run8221 occurs. A bank run is a totally different phenomena than a default. If there are widespread defaults in the maturity matched scenario, there is no bank run. When the desposits expire, the holder simply gets .95 on the dollar (or whatever the losses were). A bank run is when a bank has made a lot of promises to redeem notes on demand, but does not have the liquid reserves to meet those obligations. As a result there is a race to the bank to get their hands on the last bit of cash. When it8217s gone, the holders of desposits often end up with pennies on the dollar, which is why bank runsmaturity mismatching crises have been historically much more of a problem than default crises. This point gets obscured though, because a bank run that wipes out desposits will often result in defaults (the bank run causes banks to fail and the money supply to contract, the contracting money supply causes aggregate expenditures to fall, thus income falls, thus businesses cannot pay back loans). A bank run can occur even in the complete absence of any defaults. In most practical cases, defaults trigger the run, but the losses from the run far, far exceed the losses from the default. To understand this, there are number of articles, try here or here or read up on the here or read up on the Diamond-Dybvig model. In that sense, I dont see the point of it and so I start thinking about the other motives that are behind the suggestion the Austrian 8220sound money8221 motives which in my view disable the capacity of the national government to pursue and achieve public purpose full employment, equity in opportunity, environmentally sustainable growth, and price stability. Rothbard has a whole framework of his definition economic liberty, and its from this framework that he defines his idea of what banking should be. He often ignores evidence that does not fit his pre-existing framework. For instance, he does not recognize that once a deflation happens the government should step in and stop it. Other libertarians have a public choice perspective. They do not believe the government ever acts in the public interest, so they want it do as little as possible. When you look at the current response to the financial crisis, can you really fault them for this view As for me, I note that markets are themselves creation of the government courts, so the whole free market versus government dichotomy never made sense to me. The government will do what the government does, I have no control over it. I prefer to analyze proposals from an intellectual stand point and figure out what they get right and what they get wrong. I think we are using different definitions of the word 8220liquidity8221. When you say, 8220but it wont protect a bank in the worst form of liquidity crisis due to insolvency.8221 you are using a different definition of the word 8220liquidity8221 than I was. Frankly, economists have abused the word 8220liquidity8221 to within an inch of its life. Keynes basically completely redefined the word in his general theory. It may be more fruitful to continue discussion without using the word, so that we don8217t cross signals. It doesnt go that way because I specified a liquidity crisis that caused depositors to stay away. The bank may actually be insolvent, which is a condition of negative equity. But it only needs to be perceived as insolvent for there to be a liquidity crisis. This sentence I do not understand. How does a perceived insolvency prevent the bank from meeting its cash flow obligations to people redeeming CD8217s and deposits Terms are matched, so as long as the loans are repayed, the bank has funds to redeem CDs. If loans do not get repaid, that8217s not a perceived crisis, that8217s an actual one crisis. Perhaps an example would help (It may also be that we are using different definitions of the word insolvent. My definition of the insolvent is that a bank is insolvent if it does not have the cash to pay off people dedeeming desposits. My banking system does not use any sort of mark-to-market accounting, and so the entire concept of 8220negative equity8221 has no meaning. It might be more fruitful to imagine these banks using a temporal based, cash based accounting system, no such accounting system currently exists, but it would have to be invented for the above banking system to work). The root cause of the liquidity crunch is real or perceived insolvency from a capital perspective (expected losses due to bad loans), but the failure mechanism the death spiral is the actual liquidity crunch and failure to repay liability holders. I can certainly see how actual losses due to bad loans can cause a failure to repay depositors redeeming. I cannot see how simply 8220perceived8221 losses can cause a failure to repay despositors. Both cases produce a contradiction in that the credit bank needs a Fed overdraft in order to avoid going down due to its liquidity crisis it cant repay its liability holders. In my system, banks will fail if the losses on their loans exceed it8217s cash on hand and ability to brorrow against future profits. Failure will hopefully be rare, but it will happen. Having some failure keeps any system healthy, it purges the banks with bad lending practices. Thats why the Austrian architecture fails. It cant protect against the most severe liquidity crises, as in the real world. I think deserves longer comment, but I8217ll wait for your responses above. The point of the Austrian scheme is to elminate crises due to bank runsmaturity transformation in way that does not introduce moral hazard and regulated lending. The Austrian scheme does not protect against all losses everywhere. It does not protect against banks failing and despositors losing money. It the Austrian view that losses due to bank runsmaturity transformation have been responsible for all major financial crises (not losses due to bad loans), and thus that is the problem to solve. Solve that problem without creating moral hazard, and the banking system will be stable and productive. Im defining solvency as balance sheet solvency positive capital or positive equity which in my view is the correct definition. Cash flow matching does not define solvency. Solvency is defined as to whether there is any capital left to absorb more losses. Liquidity and solvency are different characteristics. How does a perceived insolvency prevent the bank from meeting its cash flow obligations to people redeeming CDs and deposits 8230 I cannot see how simply perceived losses can cause a failure to repay depositors. This is fundamental to any liquidity crisis. Ive described it several times in examples. In the case of a credit bank, a matched maturity loan goes bad. The bank cant repay the depositor. Other depositors fear balance sheet insolvency. The bank cant repay the first depositor by attracting a second one. Therefore the bank needs an overdraft or goes down. Negative equity doesnt depend on marked to market accounting. It happens when the book value of liabilities exceeds the book value of assets. That can happen in the future and can be reflected as an expectation today. The point of the Austrian scheme is to 8230 What Ive depicted several times is that maturity matching alone cant prevent a liquidity crisis. In fact, you need inverse maturity mismatch (liability duration longer than asset duration) in order to build a cash buffer. Lost in my comments perhaps is that I agree that maturity matching reduces liquidity risk. But it doesnt prevent a bank going down if the market is determined to bring it down because of fears of insolvency. The only alternative is a Fed overdraft facility, which again is a contradiction. This is what the Austrian school is worried about 8230 Taken from Rothbard8217s The Mystery of Banking On the contrary, its liabilitiesits warehouse receiptsare due instantly, on demand, while its outstanding loans to debtors are inevitably available only after some time period, short or long as the case may be. A banks assets are always longer than its liabilities, which are instantaneous. Put another way, a bank is always inherently bankrupt, and would actually become so if its depositors all woke up to the fact that the money they believe to be available on demand is actually not there. Very interesting commentary, taking on the structural question of FR, focused on the Austrian model proposed by Devin. While I appreciate all of these comments and a hard look at FR8217s inner workings, I think there are larger cohort issues that just aren8217t being addressed. Full-reserve banking doesn8217t stand on its own. It can be either related to the Austrian approach or the Chicago Plan approach, IMHO. Bill said originally that he didn8217t see FR working without government creating all the money, a la Henry Simons and the Chicago Plan. I never saw an Austrian model that embraced the Chicago Plan approach of government money-creation, so the tale being told here avoids that larger question. Scott has weighed in that FR doesn8217t come close to solving the liquidity crisis, in and of itself. I think that is mainly because there is no provision for liquidity in FR banking. Given the Austrian or Chicago Plan approach, somebody has to FIRST create the new money. I agree with Ralphonomics on where the money-creation powers do and ought to lie. MMTers know that the Chicago Plan was a progressive idea that adopted the oft-debated FR concept as a part of the structure for monetary stability, that was in turn necessary to promote economic stability. My own position is that FR is superior to fractional-reserve banking, even just for its counter-cyclical qualities. Bill linked up with Ronnie Phillips paper on the Chicago Plan, certainly not a libertarian or Austrian proposal. So, to me, I can8217t grasp the minutae of the FR discussion as it is presented in this fine repartee. I ask Bill and the other MMT community to consider whether the Chicago Plan for Monetary Reform is or is not a bonafide that ought to come up to the plate, and that FR banking only be considered for its contribution to such a comprehensive reform. Make that a plea for same. I believe it was the learned JKH who scoffed at such a radical approach(FR), given that we can8217t even get Glass-Steagall to the fore. My position on all that is this. We ain8217t there yet. The debt-money system is broken and broke. There has been no official recognition of that and as a result, no substantive proposals for reform. Remember the Chicago Plan proposal came out more than 3 years after the 821729 crash. And to me, we yet await the crash. MMT is definitely a partial fix for what ails us as its foundation is monetary sovereignty. But I am left with the question of whether a reformed Fed providing reserves to private bankers is superior to the Chicago Plan or that proposed by Douglas, Fisher, Graham et al in their 1939() paper 8211 A Program for Monetary Reform. Bill, thanks so much for this whole discussion. Its fair to point out that The Austrians dont have a monopoly on the subject of maturity transformation. Maturity matching is not an Austrian mystery per se. The Austrian prescription in fact is simply a pure case of a technique that is commonly employed by banks today in varying degrees. Because its presented as a pure case in the Austrian version, or pure principle, its fair to ask the question what the institutional implications are. Moreover, when the hard questions are asked about implementation of the pure case, it turns out that the response is one of compromise, because the pure case is not viable. It then becomes clear that the pure case as presented is irrelevant, because it is not viable, and because real world banks already implement maturity matching to varying degrees. The fact is that real world banks implement both maturity matching and maturity transformation in different parts of the asset liability portfolio. As I illustrated in an earlier example, the pure case of maturity matching is conceptually dangerous from a risk management perspective. If a bank were perfectly matched to maturity, it fails when the first bad loan matures. It simply has no cash to repay the corresponding maturity liability, unless it has an overdraft privilege. Bad loans are matched to equity losses. They are no longer matched to maturing liabilities, because they can no longer produce the cash flow that is required for a perfect match. This is a matter of cash flow observation, as well as accounting for balance sheet equity. Perhaps Austrians are not as familiar with double entry book keeping as they should be. In order to protect against this contingent mismatch risk in the pure model, it is necessary to deviate from it by constructing a deliberate inverse maturity mismatch at the margin. This means that term liabilities must be mismatched against short term risk free assets. As described earlier, this means that the credit bank must build up a cash reserve with the depository for 100 per cent reserved deposits in the other part of the model. In other words, the pure Austrian matching model fails, unless it is tweaked to become a mismatched model. And there is another critical area where the pure model of maturity matching fails. All banks that take risk, including the credit bank described in this thread, require equity capital. Like liabilities, equity capital is a source of funds. But unlike liabilities, equity capital has no nominal maturity date. Therefore, it is not possible to incorporate equity capital into a coherent maturity schedule for the entire bank, without deviating from the simply maturity matching formula of the Austrian prescription. Real world commercial and universal banks know this and allow for it. All this results from the portfolio effect of liquidity (the cash deposit with the 100 per cent reserved depository, plus other liquid assets) and capital (the equity that is intended to absorb losses in the credit risk bank). Commercial and universal banks are quite aware of such an interaction in their asset liability management. The functions of liquidity management (which includes the cash reserve and other liquid assets) and capital management (the cushion against losses) are quite separate (although partially intersecting) in these real world banks. The purpose of liquidity management is to protect the cash flow profile of the bank. The purpose of capital management is to protect the loss profile. The primary intersection of the two is that equity is a source of funding that doesnt have to repaid with cash flow, unlike a liability. Therefore, in addition to providing loss protection, it improves the liquidity profile by alleviating cash flow pressures otherwise attributable to maturing liabilities. Commercial and universal banks are quite aware of these issues and typically have risk policies to deal with them. The fact is that no amount of maturity matching or other types of liquidity policies can protect against the ultimate risk of catastrophic capital loss. Catastrophic capital loss is not primarily related to liquidity it is primarily a function of other types of risks taken such as credit risk. There is no way that maturity matching can provide ultimate protection against such losses. Maturity matching cant prevent the fact that some depositors wont get their money back in the worst case for capital. It can only delay the day of reckoning in such a case. One gets the idea that the Austrians believe theyre the only ones that recognize the importance of the issue. I think its much closer to the truth that those who do recognize the issue reject the Austrian approach because their pure model is a naive treatment of a complex issue. JKH. all VERY well said, as usual. A few years ago (or more recently can8217t recall exactly) on Warren8217s blog this topic was taken up and I also noted there what I8217ve noted in the 8220when you8217ve got friends like this8221 comments (can8217t do FR wo overdrafts or liquidity crisis) and also that maturity matching doesn8217t help. Nobody took my side then. I8217m glad JKH took the time to demonstrate this in detail here. Also, as I noted in 8220when you8217ve got friends like this8221 comments and JKH and Joebhed have explained in more detail here, there are many different versions of FR. MinskyPhillips and now (at least as of Oct. 2008 when I spent 3 days discussing re-regulating the banking system with him) Kregel support FR banking. HOWEVER, they recognize, consistent with JKH, Bill, me, and others, that this does not stop credit creation in which loans simulataneously create liabilities for the financial institution. Kregel at least sees the role of FR banking as only for the purpose of establishing savingsdeposit accounts while doing away with deposit insurance. I8217m agnostic on this point in theory, but would move alongside Bill and Randy in opposing if the effect is to eliminate the community banks. The broader point is that you really can8217t compare the approach of MinskyKregel here with the proposals of Ralph and Joebhed8211since the latter want to do away with private credit creation, the proposals are like night and day. The views of MinskyKregel are far closer to Bill, Randy, JKH, and me in fact, they8217re almost identical aside from the issue of deposit insurance vs. fully backed savingsdeposits. Also, Joebhed8217s suggestion that 8220FR is superior to fractional reserve banking8221 is not persuasive (to me at least), since real-world monetary systems aren8217t fractional reserve systems anyway, as we8217ve gone over many times before. I8217ve also seen no convincing evidence that 8220the debt money system is broke and broken8221 beyond poorly designed regulation (and if not poorly designed, poorly implemented by regulators that have ideological biases against regulation) of said system. Warren, Randy, Bill, Bill Black, Eric Tymoigne and others in the MMT camp have laid out numerous proposals for re-regulating that we would argue are consistent with financial stability and continued existence of private money creation. I8217m well aware that this won8217t convince Joebhed or Ralph. I would, on the other hand, be interested in Joebhed, Ralph, or others who believe their version of FR is 8220progressive8221 could spell out in some detail how they think the system would work in combination with government money (or provide a link, perhaps, as maybe it8217s already been done). Apologies if this requestsuggestion appears naive. Until that happens, I think much of the 8220it will work8211no it won8217t8221 back and forth is about as far as we8217ll get (assuming we want to get farther. some probably don8217t, but it would be of interest to me at least). Not sure of a few things - though I think I understand Bill8217s position completely. There are two scenarios: In Bill8217s recommendation of zero interest rates and no debt issuance by the government, high amount of reserves occur naturally and not out of reserve requirements. Using 8220non-reservable liabilities8221 we can have the situation of 100 reserve requirement theoretically, though I don8217t know what purpose the latter solves. In the scenario which actually is the world we live in, and where the government issues debt for every dollar of deficit spending, 100 RR is impossible. Maybe possible to demonstrate it on a black board, but I would imagine interest rates (on bank loans) hitting the roof in this arrangement. Scott, 8220when you8217ve got friends like this8221 post was last week :-) Thanks. The Austrian idea for 100 per cent reserves is effectively more about macro credit risk than it is about the holy grail of liquidity management, as the Austrians intend it. For example, the idea of segregating deposits against 100 per cent fiat reserves as per the earlier discussion in this thread makes them risk free from a credit standpoint. That combined with the governments currency issuance powers makes them risk free from a liquidity perspective as well. Its really a cash version of FDIC insurance, which is a derivative rather than a cash structure (i. e. a put option). (The step from fiat reserves to gold reserves is an additional dial, I think.) Conversely, credit risk is contained in a separate institutional structure, where the liquidity management dial is turned up full throttle to perfect matching (before compromises to the principle begin). But that Austrian matching discipline wont necessarily prevent a catastrophic event, during which liabilities exceed assets at some point during a crisis. All liquidity crises are driven at the core by some form of non-liquidity risk (real or perceived), such as credit risk or interest rate risk. Credit risk as a core example is the origin of the crisis liquidity is the transmission mechanism whereby the perceived equity situation dooms the normal functioning for the flow of funds (liquidity). The degree of maturity matching only buys time before an eventual failure in this case. I would, on the other hand, be interested in Joebhed, Ralph, or others who believe their version of FR is progressive could spell out in some detail how they think the system would work in combination with government money I8217ll chime in. In my ideal world, here is the bank balance sheet: Have the liability side of banks to the private sector consist solely of bank capital (e. g. equity and possibly certain types of long term subordinated debt). Bank liabilities to the government are loanable funds lent from the CB at a government set rate. When a borrower wishes to borrow, the bank qualifies the borrower, sets aside risk capital according to some standard algorithm, and obtains all loanable funds form the CB. As the debtor repays the bank, the bank repays the CB with a regulated rate, earning money from the spread. There is no liquidity risk, only credit risk. Banks still can (and must) fail when loans are not repaid. No FDIC guarantees for any bank asset. Depositor services can be supplied by other institutions in exchange for fees 8212 or the government can supply a minimal set of these services in the same way as it funds book depositories :) Here are advantages as I see them: eliminate dangerous and wasteful short-term funding markets for banks, as banks have only equity liabilities to the private sector. makes it harder for banks to mislead regulators about loan performance and liabilities. makes bank funding costs much less dependent on the business cycle and market sentiment. In this case bank leverage allows a sharp increase in bank capital costs to translate into an insignificant increase in interest rates charged, effectively shielding banks from the private credit market interest rates. No need to pay interest on bank reserves, or to sell bonds to drain reserves, as there are no bank reserves. Allows the government to separate the issue of managing the size of bank loans from managing the size of the monetary base Forces banks to earn money from credit analysis rather than form yield curve arbitrage 8212 this will add much more stability to the system over time, by changing banks8217 operational focus. Private entities (banks) with their own money on the line (bank capital) still determine whether someone gets a loan or not 8212 you still have private credit creation. LBOs, forex markets and the like can be handled by investment banks that should not be able to accept FDIC insured deposits. Regulation should also shield the private credit markets from bank funding costs (e. g. only certain types of small business or consumer vanilla loans are allowed, with strict credit limits on the amount each entity can borrow). This is the main leakage (together with allowing banks to participate in the credit markets) that the bank regulation proposals that I8217ve seen fail to address, so you still exacerbate the credit cycle by having banks earn arbitrage between government set funding costs and market set return expectations. As long as there is this arbitrage opportunity, you will have exaggerated business cycles and rentier profits in the banking industry. Of course these rentier profits are exacerbated if you pay banks interest on reserves. The focus on credit-analysis, by removing yield curve arbitrage as a profit source, will advantage smaller banks and banks that lend to their own depositors, and this will in and of itself encourage banks to provide depositor services in an effort to datamine and then sell loans to depositors. Thanks, RSJ. that clears things up for me a bit. More later :) Im defining solvency as balance sheet solvency positive capital or positive equity which in my view is the correct definition. Cash flow matching does not define solvency. I was using the dictionary definition: 8220the ability to meet maturing obligations as they come due8221. I don8217t really care which definition is correct, just that we use the same definition, or else it8217s confusing. I then ask JKH: 8220How does a perceived insolvency prevent the bank from meeting its cash flow obligations to people redeeming CDs and deposits I cannot see how simply perceived losses can cause a failure to repay depositors8221 JKH responds: 8220In the case of a credit bank, a matched maturity loan goes bad. The bank cant repay the depositor.8221 But this crisis is not a result of 8220perceived8221 losses. It8217s a problem of actual losses 8211 the bank made a bad loan. If a bank makes a bad loan, it obviously only has two choices a) cover the loss itself, out of its own cash (or by borrowing against its own assets) or b) pass on the loan to the customer. And actual, the bank is not going to be matching one loan to one customer. If it was just doing that, there would be no point to the bank, the customer could just hold the loan in his own name. The point of bank is to pool risk. So it would pool 100 loans at 7 interest to 100 CD8217s at 5 interest, and expect a 1 default rate. So if a few loans go bad no problem 8211 that8217s built in, it just takes a bite out of the banks profits. No mismatch or cash buffer needed. But yeah, if you match one loan to one CD, and have no cash buffer, that bank is going to be very, very fragile. I wouldn8217t call that the 8220pure8221 version, that8217s just an unsound bank. Austrian banking, broadly speaking, is way for designing banks that are very stable without the need for any lender of last resort. Any design that fails at that is a bad design. What Ive depicted several times is that maturity matching alone cant prevent a liquidity crisis. By your definition of the word 8220liquidity crisis8221 I agree. But it will prevent the worse kinds of liquidity crisis. All the worst liquidity crises, from the panic of 1819 to the Great Depression to the run on the Shadow banking sector in 2008 were due to maturity transformation. Lost in my comments perhaps is that I agree that maturity matching reduces liquidity risk. The question then becomes does it reduce risk enough that the banking system is no longer a danger to the economy as a whole If so then you no longer need an overdraft facility, and you no longer need centralized regulations of all loans. I think that the Austrian scheme would reduce the risk great enough to make the banking system extremely stable. The reason is that in practice banks would pool loans and have a buffer. And since each bank is making it8217s own loan decisions independently, I would not expect to have huge correlated mistakes in lending. Perhaps Austrians are not as familiar with double entry book keeping as they should be. I am likely guilty as charged here. But I strongly suspect that my Austrian bank would use nothing like the book keeping banks use today. Austrian banks use temporal accounting. Unfortunately, I have not explained this, and it really could have it8217s own long discussion. Perhaps some other time. This means that term liabilities must be mismatched against short term risk free assets. I would not actual label this a 8220maturity mismatch8221 since the short term cash buffer is held in the bank8217s own name and own account, it8217s not actually matched against and CD libability. But I don8217t want to argue the semantics. If you want, we can call it 105 reserve banking :-) The point is not to argue over whether the system is 8220pure8221, but whether it is stable when all proper safeguards in place. Like liabilities, equity capital is a source of funds. But unlike liabilities, equity capital has no nominal maturity date. Pardon my ignorance, but then what is equity capital Cash Bonds Stock What does it represent If there is a link that explains it well, I can read that. Is this something I can see on a balance sheet ( finance. yahooqbssBAC038annual ) What good is capital at absorbing losses if it can8217t actual absorb the losses (ie be used to pay off depositors) When I talk about a 8220cash buffer8221, I8217m talking about the cash item on the balance sheet. If the bank makes too many bad loans, and cannot pay off depositors, it would come out of the cash. If doesn8217t have cash, it has to liquidate one of its other assets fast, or borrow from a third party, or else pass on the losses to the customer. Catastrophic capital loss is not primarily related to liquidity it is primarily a function of other types of risks taken such as credit risk. There is no way that maturity matching can provide ultimate protection against such losses. Maturity matching cant prevent the fact that some depositors wont get their money back in the worst case for capital. Credit risk as a core example is the origin of the crisis liquidity is the transmission mechanism whereby the perceived equity situation dooms the normal functioning for the flow of funds (liquidity). Here is the rub. Austrians do not believe that credit risk is the core origin of depressions. Depressions do tend to cause massive defaults, but they are not the cause. The cause of depressions is when a maturity mismatched structure collapses. So fix the maturity mismatching problem, you won8217t have depressions. The key question to answer is: why did so many deposit holders lose their money in the Great Depression There are two main candidates for answers: a) banks systematically made bad credit decisions b) a system of maturity mismatching broke down and a bubble in the price of 30 year money collapsed (a bank run is an extreme form of interest rate risk) If you believe a), then the Austrian scheme is a fix to the wrong problem. It doesn8217t fix the real problem. If you believe b), the Austrian obsession makes a lot more sense. FDIC insurance and a lender of last resort is also a fix for b). But it requires centralized regulation of all loans. But Austrians, true to their libertarian roots, desire a scheme that allows for distributed decision making, whereby every bank is responsible for its own lending decisions.
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