Tuesday, 28 February 2017
Adair Turner’s flawed objections to full reserve banking.
Turner is former head of the UK’s Financial Services Authority and he recently published a book, “Between Debt and the Devil”. Geoff Tily (economist for the trade union movement in the UK) described Turner’s book as “conservative” which is a fair description, except that Turner is quite daring in the final (5th section) of the book where he tentatively advocates deficits funded by new base money.
That idea is not new (Keynes advocated it in the early 1930s), but by the standards of today’s ultra conservative central bankers, it’s daring / original.
In chapter 12 Turner sets out his reservations about full reserve banking. His three reservations are not too clever, to put it politely. I’ll run thru them sentence by sentence and paragraph by paragraph. I’ve put his words in green italics. The first paragraph of his first reservation reads:
“However there are three reasons for caution. The first and most fundamental is that there may be some positive benefits to private rather than public creation of purchasing power. Wicksell's confidence that private credit creation would be optimal provided central banks set interest rates appropriately turned out to be se¬riously misplaced. But it could still be true that not only debt contracts but also banks can play a useful role in mobilizing capital investment that would not otherwise occur. Maturity transforming banks enable long ¬term investments to be funded with short-term savings: that might seem like an illusion, a sort of confidence trick, but it may be a useful one. Inevitably it creates instability risks, but some instability may be the inevitable and reasonable price to pay to gain the benefits of investment mobilization and thus economic growth.”
First, let’s take his claim that “Maturity transforming banks enable long ¬term investments to be funded with short-term savings..”.
The reality is that we do not need “maturity transforming banks” in order to “enable long ¬term investments to be funded with short-term savings..”.
When savers buy into stock exchange shares or a unit trust (“mutual fund” in the US), they are free to sell their holding a week after buying it. I.e. that system enables “long term investments to be funded with short-term savings”.
Of course the stock exchange and unit trusts are not for everyone, plus in the latter scenario, savers are not GUARANTEED to get all their money back: they may make a loss (or they may make a profit). So maturity transforming (MT) banks seem to solve that problem: they seem offer something almost too good to be true for those who want to play safe. Indeed, as Turner puts it: “that might seem like an illusion, a sort of confidence trick, but it may be a useful one”.
Now when something seems too good to be true, it normally is, and indeed there is a catch in the above magic “something for nothing” MT. I’ve put more than one article on this blog in the past demolishing the basic idea behind MT, but I’ll run thru the arguments again.
The big attraction of MT is that it seems to enable us to fund investments with less saving. That is, where MT is banned, savers can fund investments only with term accounts or similar rather than with instant access accounts. So assuming a switch from a “MT allowed” to a “MT banned” scenario, and assuming people need some minimum stock of instant access money for day to day transactions, saving to fund loans or investments can only be achieved, on the face of it, by their going out to work, sweating their guts out and saving up more money which goes into term accounts.
Well the first flaw in the latter idea is that it’s just not compatible with the laws of physics, never mind the laws of economics. To illustrate, with a simple example from a Medieval village, if a farmer wants save in the form of building up a stock of potatoes to see him thru the Winter, he’ll have to go thru the painful process of producing more potatoes than he consumes during the Summer. Same goes for the entire village.
Now there is just no way that fiddling around with money or book-keeping entries gets round that brute physical fact, that is, extra potatoes cannot be produced by fiddling with book-keeping entries. In particular, changing the law relating to what type of bank account can fund investments can’t make any difference to the latter brute physical fact of life.
Returning to 2017 banking practice, if MT were banned, it would mean that (shock horror) loans and investments could no longer be funded via instant access accounts. So as suggested above, it might seem that people would have to save more so as to enable them to fund the amount of loans and investments that they wanted to. But saving is deflationary: that is, as Keynes pointed out in his famous “paradox of thrift” point, saved money is money not spent. And less spending raises unemployment.
But the reaction of any rational government to the latter unemployment would be to combat it with stimulus: e.g. by simply creating new money and running a deficit. The exact form the deficit took wouldn’t matter: let’s say it takes the form of tax cuts. So lo and behold everyone finds, as if by magic, that their take home pay has risen: there’s no need for them to work extra hours to come by the money they want to invest with a view to earning interest. That is, government in effect simply prints money and dishes it out to everyone. Of course the latter helicopter drop type of stimulus is not the only possible way of implementing stimulus: for example there is standard fiscal stimulus combined with QE, a combination that has been popular over the last few years. But that comes to the same thing as a helicopter drop.
In short, banning MT has no effect on the ease with which savers can fund loans and investments and earn interest.
In contrast to the conventional story about MT set out in economics text books which is plain incompatible with the above mentioned brute physical reality, the latter “free extra money” story is entirely compatible with the above brute physical reality.
In short, Turner is talking nonsense when he says “but some instability may be the inevitable and reasonable price to pay to gain the benefits of investment mobilization..”. The reality is that “investment mobilization” can be achieved with none of the instability that comes from engaging in “too good to be true” tricks, so popular with banksters and the naïve authors of economics text books.
“Moreover, any risks of private credit creation need to be balanced against the risks that would arise if we instead relied entirely, as the Chi¬cago Plan proposed, on fiat money creation to increase nominal demand. For if we allow governments to run money financed fiscal deficits, there is a danger that they will do so in excess or will allocate the spending power inefficiently for short-term political advantage.”
A danger governments will do so in excess? I.e. a danger they will implement too much stimulus? Well is that danger entirely absent from the existing system, or something? The very idea is a joke.
Certainly in the case of a non-independent central bank (e.g. the Bank of England prior to Gordon Brown giving it independence), politicians were free to give the economy an irresponsibly large amount of stimulus “for short term political advantage”. The evidence is that politicians do actually fall for that temptation TO SOME EXTENT, but that normally they don’t abuse that power too much. (The obvious exceptions being the Weimar period in Germany and Robert Mugabe.)
In fact Turner is insulting the intelligence of full reserve advocates if he thinks they have not thought of the possible need to keep politicians away from the printing press. If Turner had really got to grips with Positive Money’s literature he would have found that PM (and indeed other advocates of full reserve) advocate that decisions on the size of stimulus packages should be taken by some sort of committee of economists, which could perfectly well the be existing Monetary Policy Committee at the BoE. In short, systems for keeping politicians away from printing presses under full reserve can be almost identical to the equivalent systems under existing arrangements.
Turner’s point there is well and truly in check mate. Next Turner says:
“One of this book's messages is that we must not assume private credit creation is perfect nor treat fiat money creation as taboo, but neither should we iconize fiat money and demonize private credit. We face a choice of dangers, and the best policy is unlikely to lie at either extreme.”
Well that’s so vague it was hardly worth printing. As for the later “dangers”, I’ve hopefully dealt with those in the paragraphs above and below.
Turner's second basic objection to full reserve.
That starts as follows.
“Second, we must certainly be clear that 100% reserve banking will not be sufficient to solve the problem of excessive private credit creation.”
True: it’s not a 100% perfect solution, but nor is the existing bank system, even after the alleged improvements brought about by Vickers, Dodd-Frank and so on. But interest rates are higher under full reserve, as the Vickers commission suggested, so that at least does something for curbing “excess credit creation”.
Next, Turner says:
“A modern economy needs some private debt contracts both to support the mobilization of capital investment and to lubricate the exchange of existing real estate between and within generations. Proponents of 100% reserve banking argue that they can be provided outside the banking system, in ways that do not involve new money and purchasing power creation. But near-money equivalents and new credit and purchasing power can be created outside banks. If promissory notes are believed to be low risk, they can be used as a money equivalent; and as Chapter 6 describes, the development of shadow banking illustrates the remark¬able ability of innovative financial systems to replicate banklike maturity transformation and thus the creation of near-money equivalents outside the formal banking system. The challenge of constraining credit and money creation would not be wholly resolved by requiring the formal banking sector to hold 100% reserves.”
Well Turner has some sort of point there, but for the large majority of day to day transactions, buying houses or cars, or small and medium size firms setting trade debts, there is only one form of money: what might be called bog standard high street bank money. I.e. when paying for a house or car or doing the weekly shopping at the supermarket, or when a restaurant settles up with the firms that supply it with food, £10 notes are accepted as money, as are cheques drawn on Barclays or Lloyds bank. “Promisory notes” just don’t get a look in.
Turners third objection.
This is essentially that two individuals, Jaromir Benes and Michael Kumhof, advocate a massive debt jubilee as part of the process of introducing full reserve, and that such a debt jubilee is highly questionable. Well Turner is right there, only I’d put it more strongly: something like Benes and Kumhof are clueless. That is B&K seem to be under the illusion that implementing full reserve cannot be done without a massive debt jubilee. I pointed to that mistake by B&K long ago on this blog.
No other advocates of full reserve want to do that, as Turner presumably knows, since he is clearly acquainted with those “other advocates”: i.e. Milton Friedman, Lawrence Kotlikoff, Positive Money and so on.
Put another way, debt jubilees may well have merits, but the pros and cons of debt jubilees are entirely separate from arguments for and against full reserve. In short, Turner’s third objection to full reserve falls flat on its face, as do his first two objections.