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Martin Wolf's recent public adoption of the Positive Money group's full reserve banking policy has led to quite a bit of discussion in the econoblogosphere:

"Strip private banks of their power to create money"

I do not necessarily agree with the full reserve banking position, as I've never read any literature that satisfactorily explains how it would work. So here are some questions that maybe a FRBing advocate would be able to address....follow below the fold for more.

First of all, in order to examine the potential impacts of a full reserve banking system (subsequently referred to as FRB), we must understand the operations of the current institutional system. So let's start there. Here are some fundamental operational facts about the way the system currently works:

1) Banks do not lend out reserves to non-financial institutions. There is never a corresponding debit to any commercial deposit account when a bank expands it's balance sheet through making a loan. This is the mechanism by which banks create their form of money aka bank deposits.

2) The Fed is the monopoly supplier of reserves

3) Fractional Reserve Banking is largely a myth. Especially the 10% reserve requirement meme, there is no evidence for that position. Yes, reserves (more accurately described as settlement balances) increase slowly over time as more and more transactions occur and their value increases. But Reserves are in no way a constraint to bank lending.
4) Before QE, the level of reserves was always the level of required reserves necessary to maintain the Fed's interest rate target and satisfy settlement balance requirements through the payments system.

5) All Govt spending, taxing, and bond issuance is done only through the reserve system.

So how do these facts play out in the operations?

We wont concern ourselves with equity because that's largely irrelevant to the functioning of reserves in this discussion and are beyond the scope of this post. Lets assume that the Fed's target interest rate is 5% (Obviously its not 5% right now because there really is no 10% reserve requirement, but this is the argument that FRBers are making)

Private banks:
$42T in liabilities (bank deposits = private debt)
$42T in assets ($4T reserves, $38T in other assets)

Citizens:
$42T in liabilities (Bank Loans)
$42T in assets (Bank deposits)

Govt:
$18T in liabilities ($4T in reserves and $14T in securities held by the Non-Fed)
Govt dollar assets are by definition infinite.

Here's our baseline. What happens when bank loans increase $1T in a given period (say 1 year)?

Bank loans and deposits will both increase by $1T, and the amount of required reserves would go up by $100B. But where do the extra reserves come from? If the Fed does not supply them through repos and open market operations, then the supply would be less then the demand and interest rates (the price of reserves) would go up from 5%. If the Fed supplied too many reserves, then the supply would be greater then the demand and the interest rate (price of reserves) would go down from the target of 5%.

So these are the operations and accounting of the way the current system operates (minus the fact that the reserve requirement is not really 10%).

Now lets look at the FRB proposal of 100% reserves:

In the Positive Money proposal, instead of bank lending increasing first and the level of reserves second. The reserves would have to come first through deficit spending, and then banks could make loans up to that amount of reserves. This part is not hard to understand. In this framework, bank lending really would be constrained to the level of sovereign deficits (net reserve addition).

My first question is: how would we create the $38T in reserves necessary to match private debt on a 1 to 1 or 100% basis?

QE could only account for a possible $14T in additional reserves. The Fed would buy every TSY security in existence. Which means they would debit $14T worth of securities accounts and credit $14T worth of reserve accounts. After this first step, the accounting would be:

$42T in bank loans and deposits
$18T in Govt liabilities ($18T reserves and $0 in securities)

So that gets us part way to our goal of $42T in reserves, only $24 T to go.

There is no current legal mechanism for the Fed to add this many reserves once the securities are all gone as the Fed can only exchange financial assets, they are not allowed to create new NET financial assets as this is the domain of fiscal policy by Congress and the TSY.

But our current securities model of Govt deficit spending means that deficit spending has a net zero impact on reserve levels. So FRBers advocate for a reserve injection only model of deficit spending. Thats all well and good, but how long will it take to reach the requisite level of reserves? If we do $2T (almost 13% deficit to GDP) in deficit spending every year, then we could get the additional $24T in reserves within 12 years, but this assumes that bank debt doesn't increase over this 12 year period. How would that be accomplished?

I'm not so much worried about the Fed's ability to set the interest rate since they can always pay Interest on Reserves in a non-securities model of deficit spending.

But where would the reserves come from to get to a 100% reserve system?

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Comment Preferences

  •  Tip Jar (7+ / 0-)

    "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

    by Auburn Parks on Sun Apr 27, 2014 at 07:49:24 AM PDT

  •  Two parts (1+ / 0-)
    Recommended by:
    Odysseus

    First, a lot of those reserves are time deposits, which are not restricted in Wolf's proposal.

    Second, insofar as reserves are affected, then the government would have to make additional loans or expenditures sufficient to cover the loans the banks no longer make. That's at the crux of the change; at present the banks get most of the benefits from currency creation even though it's the government that makes currency possible and has to bear the costs in case of a panic. It's the old game of privatized profits and socialized costs. Positive money ends that game and returns the benefits to the public that's bearing the cost.

    Yes, there would have to be statutory changes to the banking system to make it work - not exactly a shock, given there would have to be statutory changes to make it happen. The most straightforward change would be to create a national bank analogous to the North Dakota state bank. In practical terms, the Federal Reserve could provide the money and the Post Office could do the banking.

    I don't think it's a coincidence that all of the developed Western countries with strong manufacturing - Japan, Germany, and South Korea - all have major postal banks. A fairer money system produces a stronger economy.

    •  Its not that I disagree necessarily with the (0+ / 0-)

      concept of public banking, I just think there are some important things being overlooked.

      "First, a lot of those reserves are time deposits, which are not restricted in Wolf's proposal."

      ???

      In today's system, no reserves are time deposits. Reserves are demand deposits and securities entries are timed.

      Where would the $42 T in necessary reserves come from to take the USA to a 100% reserve backed system?

      I've already accounted for $18T through an expanded QE, what about the other $24T?

      "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

      by Auburn Parks on Sun Apr 27, 2014 at 08:39:13 AM PDT

      [ Parent ]

      •  That $42 trillion is all financial instruments (0+ / 0-)

        Not just monetary reserves. It's mostly bonds.

        •  The $42 T figure is the amount of (0+ / 0-)

          non-financial sector debt. That is bank loans. The Positive Money folks talk about how to limit Bank Loans. So, if we are going to convert to a 100% reserve to bank loan model, then either

          A) bank loans will have to come down to the level of reserves

          or

          B) Reserves will have to increase to the current level of bank loans

          Which is $42 T.

          So where, will the extra $24 T in reserves come from to match the amount of bank loans that have been made?

          https://research.stlouisfed.org/...=

          "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

          by Auburn Parks on Sun Apr 27, 2014 at 09:23:32 AM PDT

          [ Parent ]

          •  The positive money proposal only addresses M1/M2 (0+ / 0-)

            It doesn't bar bank loans in general, only loans based on demand deposits.

            Banks could loan as much money as they wished by issuing bonds.

            •  again, corporate bonds are not money. (0+ / 0-)

              Bank loans create bank deposits. This is where the PM claim that banks create money out of thin air comes from.

              PM wants to limit bank loans to the amount of reserves. Reserves only come from one place, The Fed. How will we create $24T in additional reserves to match the already existing supply of bank loans = deposits?

              "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

              by Auburn Parks on Sun Apr 27, 2014 at 09:54:30 AM PDT

              [ Parent ]

              •  you might want to include a longer series (0+ / 0-)

                Be the change that you want to see in the world

                by New Minas on Sun Apr 27, 2014 at 10:26:01 AM PDT

                [ Parent ]

                •  The entire framework of the monetary system (0+ / 0-)

                  changed after 1971 and 100% fiat, floating FX was implemented.

                  Its like talking about traveling great distances before the airplane and after. Its not really apples to apples.

                  "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

                  by Auburn Parks on Sun Apr 27, 2014 at 10:39:39 AM PDT

                  [ Parent ]

              •  But bonds *are* credit market instruments (0+ / 0-)

                Credit Market Instrument Examples  They're the archetypical credit market instrument, actually. And so they are part of (most of, actually) that $42 trillion.

                •  Right, we know where the bonds come from, (0+ / 0-)

                  there issuing entity. But what you are not acknowledging is that all those corporate bonds were BOUGHT with bank deposits at some point. Where do those bank deposits come from? Who is there issuing authority?

                  The answer to those two questions is mostly private banks through making loans. Loans create deposits.

                  So in order to know how many bank deposits have been created, we must look to the level of bank loans. Which is $42T.

                  Before QE, the amount of reserves was about $1T. So if we want to have 100% reserve requirements, we must match loans to reserves.

                  Where are the $24T in additional reserves going to come from? I've already gotten you to $18T through an expanded QE program. You can't answer this question, and this is the crux of the Positive Money's proposal's problem.

                  Would the Fed just give $24T in reserves away to the banks?

                  Congress could deficit spend $24 T and not issue securities but even I think that would be inflationary, given that the entire GDP is only $17T

                  "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

                  by Auburn Parks on Sun Apr 27, 2014 at 01:16:46 PM PDT

                  [ Parent ]

                •  Ahh, I see your point now. We'd need to subtract (0+ / 0-)

                  the level of bonds from the $42T number. According to Wiki, that approximate # of bonds included in this count is $20T.

                  So we'd have to get to $22T from $18T. $4T is not that bad, we could do deficits like that for 2 to 3 years and get back to full employment.

                  Thanks, for working through all this. Its been good. Will update the post to reflect the new numbers.

                  "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

                  by Auburn Parks on Sun Apr 27, 2014 at 01:56:46 PM PDT

                  [ Parent ]

                •  oops here's the link: (0+ / 0-)

                  http://en.wikipedia.org/...

                  In reality wee should probably get a few different sources and average them but this isn't an academic paper. Let me know if this satisfies your position.

                  "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

                  by Auburn Parks on Sun Apr 27, 2014 at 01:57:54 PM PDT

                  [ Parent ]

                •  Nope, I take that back. I thought through it too (0+ / 0-)

                  quickly. $42 T still stands. Because like I said, at some point, those bonds worth $20T had to be bought with bank deposits and those bank deposits had to come from somewhere. And the only place those come from is Bank Loans.

                  "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

                  by Auburn Parks on Sun Apr 27, 2014 at 02:09:28 PM PDT

                  [ Parent ]

        •  Somehow, you are misunderstanding what I am (0+ / 0-)

          talking about and therefore what the Positive Money people are talking about.

          Reserves are BASE money:

          $4T

          https://research.stlouisfed.org/...=

          Govt Bonds are $17T

          All Private sector bonds are purchased using bank deposits, so they do not count in our monetary aggregates. All the Bank deposits used to purchased private sector bonds have come into existence through banks making loans and thereby creating those deposits or money.

          "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

          by Auburn Parks on Sun Apr 27, 2014 at 09:26:18 AM PDT

          [ Parent ]

          •  Private sector bonds don't count as money (0+ / 0-)

            but they most definitely are financial instruments, and are included in the $42 trillion figure.

            •  No, I don't think that is true. (0+ / 0-)

              That Fed data does not include private bonds.

              If Microsoft issues a corporate bond. They are creating a financial asset out of thin air (Just as Google did while splitting their stock), but in order for that corporate bond to be of value to microsoft, they must exchange it for someone else's bank deposits.

              Those bank deposits only come into existence through bank loans. Which is what PM want to limit.  And where our miscommunication is taking place.

              "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

              by Auburn Parks on Sun Apr 27, 2014 at 09:52:22 AM PDT

              [ Parent ]

              •  It absolutely includes bonds (0+ / 0-)

                See the comment above.

                Bonds don't create money. The buyers give up money to get them, but they then no longer have it. They then have bonds, which are not money. Demand deposits create money because the depositors give the bank their money, but still have money in the form of a bank deposit.

                If a bank issues a bond to get money to loan, they create bonds counterbalancing loans (and thus credit market instruments) but no money, because neither the bond nor the loan is money.

                •  Lets break this down: (0+ / 0-)

                  "Bonds don't create money."

                  Correct

                  "The buyers give up money to get them, but they then no longer have it."

                  Again correct. They give up bank deposits.

                  "They then have bonds, which are not money."

                  Correct

                  "Demand deposits create money because the depositors give the bank their money,"

                  This is wrong. "The depositors give the bank their money" Are you talking cash here?
                  Because if I give Chase my "money" and that money is in the form of bank deposits at Bank of America. Then NO new money is created.

                  Where did your bank deposits come from?
                  You either earned them through trading your labor or goods and services. In any of these examples no money is created, only transferred.

                  or

                  You take a loan out from a bank. In which case the bank is creating brand new bank deposits aka money for you. This is what we are talking about and what you are not realizing. All the bank deposits ever created were done so through banks making loans (or technically through buying T-bonds).

                  "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

                  by Auburn Parks on Sun Apr 27, 2014 at 01:24:40 PM PDT

                  [ Parent ]

  •  Private banking should be eliminated. (0+ / 0-)

    There should be only one bank, and it should be owned and operated by the People.

    Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

    by hestal on Sun Apr 27, 2014 at 09:56:58 AM PDT

    •  Then how are people going to get loans? (0+ / 0-)

      Is the Govt supposed to loan money to businesses?
      Which ones?
      How much?
      At what interest rate?

      "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

      by Auburn Parks on Sun Apr 27, 2014 at 10:07:33 AM PDT

      [ Parent ]

      •  The government will provide all (0+ / 0-)

        the financial services that banks provide now with a few exceptions.

        Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

        by hestal on Sun Apr 27, 2014 at 01:20:44 PM PDT

        [ Parent ]

        •  This is not possible. It may be desirable but not (0+ / 0-)

          possible.

          Banks have teams of MIT and Wharton math geniuses cranking away at making financial instruments and making $Millions per year. There is no way it would be practically possible for the Govt to recreate the entire breadth of financial services that banks provide.

          But I assume you are referring to something more basic, realistic, and desirable. And in that I agree.

          However, you did not attempt to answer even one question I proposed.

          "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

          by Auburn Parks on Sun Apr 27, 2014 at 01:28:20 PM PDT

          [ Parent ]

          •  Well, actually, I answered every one of them. (0+ / 0-)

            Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

            by hestal on Sun Apr 27, 2014 at 02:05:59 PM PDT

            [ Parent ]

            •  I should have added that without the work (0+ / 0-)

              of me and my generation build on, you would not be able to tell me that I wrong like you just did, and I would not be able to reply as I am.

              Again, you're welcome.

              Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

              by hestal on Sun Apr 27, 2014 at 02:12:41 PM PDT

              [ Parent ]

            •  How do you figure? (0+ / 0-)

              You said that we should eliminate all private banks:

              H: "Private banking should be eliminated"

              ME: "Then how are people going to get loans? (0+ / 0-)
              Is the Govt supposed to loan money to businesses?
              Which ones?
              How much?
              At what interest rate?"

              H:The government will provide all (0+ / 0-)
              the financial services that banks provide now with a few exceptions.

              How does that answer what the interest rates will be?

              Or what qualifies as a credit worthiness

              Any limits to how much we can lend to any one entity?

              "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

              by Auburn Parks on Sun Apr 27, 2014 at 02:12:58 PM PDT

              [ Parent ]

              •  As my father said in the late 1940's (0+ / 0-)

                "A person who does not read might as well be a person who cannot read."

                I said that the government would provide all services that banks now provide, and banks make a variety of loans at a variety of rates.

                In addition, I have tried to be polite to you, but that stops now. Have a nice life.

                Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

                by hestal on Sun Apr 27, 2014 at 02:16:04 PM PDT

                [ Parent ]

                •  Whats with your bad attitude? (0+ / 0-)

                  My three questions are not unreasonable. They are literally the most basic things to answer to make a proposal such as eliminating all private banking.

                  "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

                  by Auburn Parks on Sun Apr 27, 2014 at 02:17:34 PM PDT

                  [ Parent ]

          •  Yes it is possible. In fact it won't even be hard. (0+ / 0-)

            That is the technical aspects will be straightforward. But there is always the problem of attitude and unjustified certainty both of which you have just exhibited.

            My generation heard complaints like yours over and over. But we just kept on designing programs and coding and testing, and all of a sudden the nation was computerized. You need to think about that for a second. Where do you think all of these automated systems came from? There was a time, just before my generation started to work, that such systems did not exist. Now, thanks to us, they do.

            You're welcome.

            Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

            by hestal on Sun Apr 27, 2014 at 02:10:26 PM PDT

            [ Parent ]

            •  Umm how old are you, cause you dont know (0+ / 0-)

              how old I am.

              And you digressing. What are your opinions about my three questions?

              "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

              by Auburn Parks on Sun Apr 27, 2014 at 02:14:34 PM PDT

              [ Parent ]

    •  Dont get me wrong, I'm not flat out rejecting (0+ / 0-)

      your premise, there are just many questions that need to be answered, of which my comment only listed a few

      "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

      by Auburn Parks on Sun Apr 27, 2014 at 10:08:26 AM PDT

      [ Parent ]

      •  I understand. (0+ / 0-)

        But you and I don't have to ask and answer all those questions right this minute. What we have to do is agree that we want to end all private banking and compile a list of all the benefits that would flow from such a change. Then we enlist others, and finally as more and more questions and objections come in we who are willing to do the work will have to get together and develop a system description that will deal with them. Out of this process we will have a document that will enable us to gain the support of many more people.

        Such a process can be simultaneously followed for all kinds of government systems.

        And such a process has been widely used since 1960, and I spent thirty years of my working life doing it every day. How do you suppose that modern banks got the systems they use today? And insurance companies, Medicare, Medicaid, the VA, the airlines. hospitals, department stores, railroads, and all kinds of enterprises got the systems they use today? They used this same development process. It takes a little effort and determination, but there is nothing hard about it.

        A good rule of thumb that applies to the development of enterprise systems is that if it looks easy it is hard, and if it looks hard it is easy.

        Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

        by hestal on Sun Apr 27, 2014 at 01:28:37 PM PDT

        [ Parent ]

        •  I don't disagree with anything you said (0+ / 0-)

          about systems development.

          And the only thing I've said was impossible was in response to your comment about providing all the services private banks do now, which is certainly not just extending loans.

          We just happen to disagree about the need to eliminate all private banks. I don't see this as practical. Nothing for you to insult me about.

          "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

          by Auburn Parks on Sun Apr 27, 2014 at 02:20:27 PM PDT

          [ Parent ]

  •  This subject is largely beyond my understanding, (0+ / 0-)

    but Mosler addresses it here.

    It seems to me that a FRB system would unnecessarily restrict policy space, requiring Tsy and Congress to target the deficit to meet private sector borrowing desires. By removing "horizontal" money creation, "vertical" money would need to be much more responsive to changes in these desires.

    I do like the idea of a Postal Bank, whose interest rates on savings and basic loans would define de-facto boundaries within which private banking would operate. But full reserve requirements on private banks would reduce their ability to meet the borrowing needs of their customers by requiring them to acquire reserves before lending. This seems sub-optimal to me.

    ...if you plant ice you're gonna harvest wind. (RH/JG)

    by telebob1 on Sun Apr 27, 2014 at 10:48:15 AM PDT

    •  Hey Bob, I've definitely read Mosler's critique (0+ / 0-)

      and I agree with most of it.

      He never addresses what I'm talking about explicitly, neither have any of the PM people for that matter, which is why I've brought it up.

      See, this subject is not "largely beyond my understanding", you've beautifully articulated one of the main problems with a FRB system.

      "It seems to me that a FRB system would unnecessarily restrict policy space, requiring Tsy and Congress to target the deficit to meet private sector borrowing desires. By removing "horizontal" money creation, "vertical" money would need to be much more responsive to changes in these desires."

      And I too, think the idea of a postal bank is great. Why don't we do something as pragmatic and sensible is this?

      It just might have something to do with the billions of dollars on lobbying, marketing, and bribing the financial industry does to prevent the postal bank from hurting its profits. But then again, maybe spending all that money didn't buy them anything :)

      "The Earth is my country and Science my religion" Christiaan Huygens. The gold standard ended on August 15, 1971, its time we start acting like it. If we can afford full employment killing Germans, we can afford full employment during peace-time.

      by Auburn Parks on Sun Apr 27, 2014 at 11:03:37 AM PDT

      [ Parent ]

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