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{{Public finance}} '''Full-reserve banking''' is a [[bank]]ing practice in which the full amount of each [[Deposit account|depositor's]] funds are kept in [[bank reserves|reserve]], as [[cash]] or other highly liquid assets. In other words, funds deposited are not [[Loan|lent out]] by the bank as long as the depositor retains the legal right to withdraw the funds on demand. Alternatively, a saver could entrust their money with a bank for investment, whereupon the money may not available to withdraw on demand leaving the bank an ability to lend out that money<ref>{{cite web|url=http://en.wikipedia.org/wiki/A_Program_for_Monetary_Reform |title=A Program for Monetary Reform, Douglas, Paul H.; Hamilton, Earl J.; Fisher, Irving; King, Willford I.; Graham, Frank D.; Whittlesey, Charles R. (July 1939)}}</ref> and act as an intermediary between investors and borrowers. Full-reserve banking was practiced historically by the [[Bank of Amsterdam]] and some other early banks but was displaced by [[fractional reserve banking]] after 1800.<ref>[http://www.mises.org/books/desoto.pdf ''Money, Bank Credit, and Economic Cycles''], Jesus Huerta de Soto, First English edition (2006), pp. 98-114</ref> Proposals for the restoration of full-reserve banking have been made, but are generally ignored or dismissed by [[mainstream economics|mainstream economists]], who believe that the costs of such a change would outweigh any benefits.{{Citation needed|date=January 2011}}
{{Public finance}} '''Full-reserve banking''' is a [[bank]]ing practice in which the full amount of each [[Deposit account|depositor's]] funds are kept in [[bank reserves|reserve]], as [[cash]] or other highly liquid assets. In other words, funds deposited are not [[Loan|lent out]] by the bank as long as the depositor retains the legal right to withdraw the funds on demand. Alternatively, a saver could entrust their money with a bank for investment via a [[time deposit]], whereupon the money may not available to withdraw on demand leaving the bank the ability to lend out that money<ref>{{cite web|url=http://en.wikipedia.org/wiki/A_Program_for_Monetary_Reform |title=A Program for Monetary Reform, Douglas, Paul H.; Hamilton, Earl J.; Fisher, Irving; King, Willford I.; Graham, Frank D.; Whittlesey, Charles R. (July 1939)}}</ref> and act as an intermediary between investors and borrowers. Full-reserve banking was practiced historically by the [[Bank of Amsterdam]] and some other early banks but was displaced by [[fractional reserve banking]] after 1800.<ref>[http://www.mises.org/books/desoto.pdf ''Money, Bank Credit, and Economic Cycles''], Jesus Huerta de Soto, First English edition (2006), pp. 98-114</ref> Proposals for the restoration of full-reserve banking have been made, but are generally ignored or dismissed by [[mainstream economics|mainstream economists]], who believe that the costs of such a change would outweigh any benefits.{{Citation needed|date=January 2011}}


==History==
==History==

Revision as of 09:16, 25 January 2011

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Full-reserve banking is a banking practice in which the full amount of each depositor's funds are kept in reserve, as cash or other highly liquid assets. In other words, funds deposited are not lent out by the bank as long as the depositor retains the legal right to withdraw the funds on demand. Alternatively, a saver could entrust their money with a bank for investment via a time deposit, whereupon the money may not available to withdraw on demand leaving the bank the ability to lend out that money[1] and act as an intermediary between investors and borrowers. Full-reserve banking was practiced historically by the Bank of Amsterdam and some other early banks but was displaced by fractional reserve banking after 1800.[2] Proposals for the restoration of full-reserve banking have been made, but are generally ignored or dismissed by mainstream economists, who believe that the costs of such a change would outweigh any benefits.[citation needed]

History

Further information: Fractional reserve banking § History

Debate over full-reserve banking

During the Great Depression, Chicago economists suggested monetary reforms, including a call to end the fractional-reserve banking in two 1933 memorandum that came to be known as the "Chicago plan". After an apparent recovery in the mid-1930s, America was again in recession and in 1939 economists circulated a draft proposal titled A Program for Monetary Reform calling once more for an end to fractional-reserve banking.

With the advent of what is being called the Great Recession beginning in 2007, some economic reform advocates are again calling for an end of to fractional-reserve banking. One proposal is being put forward by Stephen Zarlenga and the American Monetary Institute; it is being called The American Monetary and Financial Security Act.[3]

Mainstream economists seldom discuss the merits of full-reserve banking. However, monetarist and Nobel Prize winning economist, Milton Friedman once supported a 100% reserve requirement for checking accounts.[4] And, well known for his advocacy of simple reforms, economist Laurence Kotlikoff has also called for an end to fractional-reserve banking .[5] Austrian economists, such as Murray N. Rothbard and Jörg Guido Hülsmann generally support full-reserve banking and hold the view that fractional-reserve banking is "fraudulent and inflationary".[6][7][8][9][10]

The case for full reserve

This would eliminate (or at least greatly reduce) the financial risks associated with bank runs, as the bank would have all the money in reserve needed to pay depositors - regardless whether depositors actually claimed their money.[11][12][13]

This form of banking would also eliminate the need for a lender of last resort (such as a central bank), which is normally needed to support the banking system in times of systemic risk or financial contagion, as these financial risks would not exist in a full-reserve banking environment.[14] This simply requires that the resources available to the banks issuing credit money and demand deposits would be sufficient to convert all currency at once if so required. It was a central component in Social Credit proposals.[15]

Were the United States to adopt full-reserve, all currency would be created by the federal government, and as a result all seigniorage revenue would also accrue to the federal government.[16] This is in contrast to the current US system, where a large proportion of the currency supply is in the form of demand deposits created by private banks.[17] When the Federal Reserve creates currency and uses it to buy treasury bills, it collects seigniorage revenue in the form of interest payments which it then returns to the United States[18] (for example, in 2002 the United States earned $24.495 billion in this manner).[19] When a private bank creates currency, the government cannot collect any seigniorage from it. Since the Federal Reserve has a target for the size of the currency stock, any currency created by private banks is currency that is not created by the Fed and thus constitutes lost seigniorage.[20] Some consider this an illegitimate "privatization" of what should be a public good, with these profits being retained by the government to finance essential social services and capital works.[21][22][23]

Because fractional-reserve banking necessarily increases the money supply and causes monetary inflation, some economists (most notably the Austrian School) consider this aspect of fractional-reserve banking to have deleterious and destabilizing effects on the economy over time.[11][12][13][24]

It is argued by these economists that, in contrast to fractional-reserve banking, full-reserve banking guarantees a stable money supply, which ensures that the means of exchange is not debased over time. This improves the efficiency of the price mechanism, promotes saving and the deferral of consumption, provides much greater confidence in the financial system and in the integrity of all commercial transactions and therefore encourages sustainable, non-speculative, productive investment.[11][12][13][24]

Reserve ratio

The reserve ratio of all banks operating in such a system would be 100%, making the deposit multiplier equal to one (1xM=M). This contrasts with fractional-reserve banking, in which the bank would hold only a fraction of all client deposits as reserves with the remainder used to supply loans and create credit.

Some advocates believe that full-reserve banking should only apply to demand not fixed loan deposits.[25] The distinction that full reservists make is that demand deposits such as checking and some modern savings accounts are available for immediate use by the owner of the account, whereas a traditional savings account is restricted.

Criticism

The most common criticism of full-reserve banking, and by contrast, argument for fractional reserve banking, is the need for financial intermediation. Small savers often cannot lend or invest their meager savings, for want of knowledge and sufficient capital to make a loan. Likewise, without financial intermediaries, borrowers must seek out someone who can loan them the exact amount they need, instead of being able to draw on several loans from different small savers. Savers also face significant risk as individual investors, since if they lend to a single firm or individual, that entity can collapse, leaving the saver penniless. Furthermore, if they act as individual lenders, savers must wait for their loans to mature before recouping their money; a bank can make their deposits available at any time. There are also significant economies of scale in banks making investment and lending decisions, as they have access to knowledge and expertise which individual investors or lenders generally do not. Under full-reserve banking, a great deal of money would sit idle, as savers stored up their money, while entrepreneurs went without much-needed capital.[26][27][28]

This criticism is contradicted by A Program for Monetary Reform.

Criticisms of full-reserve banking combined with a gold standard

Central banks have several methods of controlling the money supply. For one method, they set the reserve fraction (either explicitly or through the use of monetary policy tools like the paying of interest on excess reserves). In another method, they buy and sell assets on the open market. Full-reserve banking removes the need for setting a reserve fraction, as the effective reserve fraction is one. Some supporters of full-reserve banking also support a gold standard. The combination of the two would eliminate the need for open market purchases and related policy tools, as the money supply size would then be fixed by the amount of the commodity; the value of money would also be tied to the value of one commodity. This creates additional criticisms that do not apply to full-reserve banking with fiat money.

Among criticisms of a full-reserve banking system is the argument that full-reserve banking combined with commodity money (e.g. a gold standard) implicitly means that there is no government-controlled "monetary policy" at all. Critics also argue that a full-reserve, commodity money system leaves us with an inelastic currency. Proponents argue that the lack of a government-manipulated currency (the lack of a "monetary policy") and the presence of a sound currency (as opposed to an "elastic" one) are advantages to a full-reserve, commodity money system. More subtly, since full-reserve banking combined with commodity money means that during periods of high demand for money, the prices of other goods must fall, the broader real economy may bear adjustment costs that are (in principle) no different from those it would bear during periods of moderate inflation (that is, if the cost of adjusting to absolute prices is low or negligible, moderate inflation should be no more problematic than moderate deflation).[29] However, this subsequent deflationary effect is likely to have deleterious consequences if some prices are stickier than others; in particular, wages are often significantly stickier than other prices. Most economists believe that given wage stickiness, the adjustment costs of deflation are significantly higher than an equivalent inflation.[30]

Pascal Salin, former professor at the Université Paris-Dauphine and former Mont Pelerin Society president, opposes such regulation of banking and disputes Murray Rothbard's characterization of fractional-reserve banking as a simple form of recursive embezzlement. He argues that a situation of perfect certainty doesn't exist even in a full-reserve banking system. He also argues that in a perfectly free banking system any customer must be free to choose the kind of notes and the system of payments for services he prefers since optimality cannot be defined independent of the wants of the individual.[31]

Advocates of full-reserve banking do not necessarily advocate that the government lay down regulations stipulating a full-reserve system. In fact, some economists, such as Murray Rothbard (of the Austrian School) believe that government intervention sustains fractional-reserve banking, as governments have formalized the practice by making it legal and supporting it through the creation of central banks. Murray Rothbard argues that in doing this they have prevented periodic bank runs and other natural checks that would otherwise be placed on banks by astute customers, anti-fractional-reserve consumer groups, and other such organizations. Rothbard expresses this concern, and argues the case for 100% gold or silver-backed money, in his book What Has Government Done to Our Money? and other prominent published works.[11] Austrian monetary theorist George Selgin disputes the Rothbardian account, arguing: "Those self-styled Austrian economists, mostly followers of Murray Rothbard, who insist on its fraudulent nature or inherent instability are, frankly, making poor arguments. I don't think the evidence supports their view, and that they overlook overwhelming proof of the benefits that fractional reserve banking has brought in the way of economic development by fostering investment."[32]

Current examples

There are currently no examples of full reserve banking with an established history of operation. However, a variety of organisations aspire to provide full-reserve banking or claim to do so.

Islamic banking

In theory, Islamic banking is often synonymous with full-reserve banking, with banks achieving a 100% reserve ratio.[33][34] In practice, however, this is not the case, and no examples of 100 per cent reserve banking are observed. According to Islami Bank Bangladesh:[35]

The fractional reserve system versus 100% reserves would have different policy implications. Under the former system, banks would have the ability to draw profits on funds that they have exerted no productive effort. Such earning is against the original spirit of Islamic banking. One solution may lie in the nationalization of commercial banks, which has already occurred in most of these countries. As regards the latter, we have a fair amount of theoretical insight from the western literature but do not have any valuable empirical observations on the operations of 100% reserves even in countries that have adopted Islamic banking. These Islamic banks are still operating under fractional reserve system. Hence, the operation of monetary policy under 100% reserves system needs further research.

Digital gold or silver

Since 1996, a form of private currency called digital gold currency has been in circulation. Many of these currency providers claim to act like full-reserve "private banks" with a one-to-one ratio of the currency they issue and the hard asset, usually gold or silver, that they store as reserves. The most prominent examples are GoldMoney and e-gold, with the latter encountering various issues.[36] Also available are physical gold exchangers and storage providers, such as BullionVault.

Some monetary reformers believe a new free market will emerge in money production and distribution, as the Internet allows renewed decentralisation and competition in this area, eroding the central government's and bankers' old monopoly control of the means of exchange.[37][38] Some monetary reformers believe that in a genuine free market, where government did not impose a monopoly currency on the populace, a predominantly full-reserve banking system, backed by a gold standard or silver standard monetary system, would arise spontaneously out of the free market.[39]

See also

References

  1. ^ "A Program for Monetary Reform, Douglas, Paul H.; Hamilton, Earl J.; Fisher, Irving; King, Willford I.; Graham, Frank D.; Whittlesey, Charles R. (July 1939)".
  2. ^ Money, Bank Credit, and Economic Cycles, Jesus Huerta de Soto, First English edition (2006), pp. 98-114
  3. ^ Zarlenga, Stephen (2009), Presenting the American Monetary Act (PDF), American Monertary Institute {{citation}}: Unknown parameter |month= ignored (help)
  4. ^ Solow, Robert M. (March 28, 2002), "On the Lender of Last Resort", Financial crises, contagion, and the lender of last resort, Oxford University Press, p. 203, ISBN 978-0199247219 {{citation}}: External link in |chapterurl= (help); Unknown parameter |chapterurl= ignored (|chapter-url= suggested) (help)
  5. ^ Kotlikoff, Laurence J.; Leamer, Edward (April 23, 2009), "A Banking System We Can Trust" (PDF), Forbes.com, retrieved September 14, 2010
  6. ^ Engelhardt, Lucas M. (December 8, 2008), "100% Reserves Now", Mises Daily, retrieved September 14, 2010
  7. ^ Rothbard, Murray N. (May 23, 2005), "The Case for a 100 Percent Gold Dollar", Mises Daily, retrieved September 14, 2010
  8. ^ Rothbard, Murray N., The Mystery of Banking (PDF), Ludwig von Mises Institute, ISBN 978-1-933550-28-2, retrieved September 14, 2010
  9. ^ Hülsmann, Jörg Guido (1996), "Free Banking and the Free Bankers" (PDF), The Review of Austrian Economics, 9 (1), Ludwig von Mises Institute, retrieved September 14, 2010
  10. ^ Hülsmann, Jörg Guido (January 1, 2003), Has fractional-reserve banking really passed the market test?, Independent Review, retrieved September 14, 2010
  11. ^ a b c d The Mystery of Banking, Murray Rothbard
  12. ^ a b c The Case for a 100% Gold Dollar, Murray Rothbard
  13. ^ a b c Free Banking and the Free Bankers, Jörg Guido Hülsmann, Quarterly Journal of Austrian Economics (Vol. 9, No. 1)
  14. ^ Free Banking and Fractional Reserve Banking, Jörg Guido Hülsmann, Quarterly Journal of Austrian Economics (Vol. 1, No. 3)
  15. ^ Social credit a distributist reform of the financial system by Oliver Heydorn
  16. ^ [1], Paul Krugman, Robin Wells, Macroeconomics 2nd Ed. Worth Publishers, Page 808
  17. ^ Krugman, pg 802
  18. ^ [2] GAO Report 04-283, Page 2
  19. ^ GAO Report, pg 14
  20. ^ [3] Paul Krugman, Robin Wells, Macroeconomics 2nd Ed. Worth Publishers, Page 816
  21. ^ Brown, Ellen H. (2007), Web of Debt, Baton Rouge, Louisiana: Third Millennium Press, ISBN 0979560802, retrieved 2007-12-15
  22. ^ Rowbotham, Michael (1998), The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics, Jon Carpenter Publishing, ISBN 9781897766408
  23. ^ Stephen A. Zarlenga, The Lost Science of Money AMI (2002)
  24. ^ a b 100% Reserves Now, Lucas M. Engelhardt
  25. ^ Money Multiplier: Myth or Reality, Frank Shostak, 16 December 2002
  26. ^ Abel, Andrew; Bernanke, Ben (2005), "7", Macroeconomics (5th ed.), Pearson, pp. 266–269
  27. ^ Sullivan, Arthur (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 272. ISBN 0-13-063085-3. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)CS1 maint: location (link)
  28. ^ Mankiw, N. Gregory (2002), "Chapter 18: Money Supply and Money Demand", Macroeconomics (5th ed.), Worth, pp. 482–489
  29. ^ Microfoundations and Macroeconomics: An Austrian Perspective, Steven Horwitz, pp. 223-232.
  30. ^ Caplan, Bryan (2009-10-28). "Additive Shocks". EconLog. Library of Economics and Liberty. Retrieved 2009-10-29.
  31. ^ Free Banking and Fractional Reserves: A Comment, Pascal Salin
  32. ^ Slivinski, Stephen. "Interview: George Selgin". The Federal Reserve Bank of Richmond. Retrieved 2009-10-29.
  33. ^ A MONETARY SYSTEM WITH 100-PER CENT RESERVE REQUIREMENT AND THE GOLD STANDARD: THEORY, FACT AND POLICY
  34. ^ Siegfried, NA (2001), "Concepts of Paper Money in Islamic Legal Thought" (– Scholar search), Arab Law Quarterly, 16 (4): 319–332, doi:10.1163/A:1013840123393, ISSN 0268-0556, retrieved 2006-10-16. {{citation}}: External link in |format= (help); Unknown parameter |month= ignored (help) [dead link]
  35. ^ "Concept and ideology :: Issues and problems of Islamic banking". Archived from the original on 2007-07-16.
  36. ^ Internet currency firm pleads guilty to money laundering
  37. ^ Not Losing Your Head, Speech by Lew Rockwell
  38. ^ Free Market Money System by F.A. Hayek
  39. ^ The Theory of Money and Credit, Ludwig von Mises
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