Frances Coppola makes the same mistake as Positive Money.

Frances Coppola claims that if say 10% of the money supply is physical cash, then the remaining 90% must be money created by private banks. See item No.1 in her first comment after the article here. Positive Money put the same argument, though they claim the relevant percentages are 3% and 97%.

 

That idea relies on the idea that bank reserves do not circulate in the economy (a point explicitly made by Coppola) therefor they are to be ignored. I suggest that argument is flawed for the following reasons.

Reserves come into existence when a private sector entity is paid money by the central bank or government (and that’s central bank created money). E.g. it might be me selling $X of government debt or some other asset as part of the QE operation.

I then get a cheque from the government / central bank for $X and lodge it at my commercial bank, which in turn gets the central bank to credit its account in the books of the central bank to the tune of $X. But that money is very much available to me to spend as I wish. I.e. that money “circulates” in the economy.

Or as Richard Lipsey puts it in his text-book in bold print: “The central bank gets high-powered money into the economic system simply by buying securities (usually government debt instruments). It pays for these purchases with newly issued high powered money.”

Coppola then goes on to claim that private banks can purchase government debt with private bank created money. Er…no. Central banks just don’t accept private bank created money – ever. Indeed, even a private bank won’t accept money created by another private bank: it invariably wants central bank money in settlement (or an admission by the first bank that it owes the second $Y of CB money).

However, Frances Coppola works hard and produces plenty of interesting articles. No one can be 100% right 100% of the time (apart from me of course?!?!).

 

 

Adair Turner.

Adair Turner advocates a range of bureaucratic measures to be imposed on banks so as to deal with what he claims to be excessive debt. I’m getting very tired of respectable members of the establishment (Dodd-Frank, Vickers, etc) advocating measures of Byzantine complexity to deal with banks, which by general agreement are near useless.

Also, Adair Turner doesn’t actually produce any good evidence that debts really are excessive. But never mind. I’ll come to his rescue.

There is a very simple reason for thinking debts are excessive: the simple fact that debt creating entities (i.e. commercial banks) are subsidised. There’s the TBTF subsidy, taxpayer backing for retail deposit accounts, lender of last resort facilities and so on.

So why not have a free market? The free market is by definition subsidy free.

And a free market can be brought about by implementing the banking system proposed by Milton Friedman, Positive Money and others. That’s a system where when depositors want 100% safety for their money, their money is simply warehoused (e.g. deposited at the central bank). So it’s 100% safe. So no need for taxpayer backing there.

In contrast, if depositors want interest, then they must in effect buy a stake in a unit trust that lends on their money or invests it in whatever they want. They might choose safe mortgages or NINJA mortgages: that’s up to the investor.

Notice that that would probably deal with the 100% mortgages which Turner complains about. I mean if you want 99.9% safety for your money are you going to have your money fund mortgages where house owners have a decent equity stake, or are you going to fund NINJA mortgages?

The above system does not require any sort of taxpayer backing, lender of last resort facility, etc.

A possible criticism of the above system is that it might seem to be “non free market” in the sense that it forbids fractional reserve banking. Well the simple answer to that is that fractional reserve banking is fraudulent. Or as Martin Wolf, chief economics commentator at the Financial Times put it, “If we were not so familiar with banking, we would surely regard it as fraudulent”. And the free market is a system where you can do what you want, as long as it  doesn’t involve fraud. So why is fractional reserve fraudulent? Well the reasons are simple and as follows.

Under fractional reserve, banks first accept deposits, second lend on the money in ways that are less than 100% safe, and third, promise to return to depositors the sums deposited. Well it should be plain as a pikestaff that that is a promise that is certain to go wrong at some stage. That is, it is a mathematical certainty that at some point, any bank will make a series of unsuccessful or silly loans, at which point it is insolvent.

The above promise is therefore fraudulent and should be banned.

And indeed, under the Milton Friedman / Positive Money system, banks do not make the above promise. And as to the idea always pushed by banks that less lending and debt means less economic growth, that’s nonsense: any deflationary effect stemming from that reduced lending can be countered by standard stimulatory measures, monetary and/or fiscal. And that costs nothing in real terms. (Both Milton Friedman and Positive Money actually advocate/d a 50:50 mix of fiscal and monetary policy, which in effect means simply printing new money and spending it and/or cutting taxes.)

If after implementing the above free market style banking system, debts still appeared to be too high, then by all means go for the sort of bureaucratic controls on mortgages suggested by Adair Turner. But it’s ridiculous to subsidise private banks (i.e. subsidise the debt creation process) and then complain about excessive debt.

And finally it should be said that there is a distinction to be made between small and large banks in the US. That is, small banks are covered by FDIC insurance. So if the Friedman / Positive Money system were to be implemented there, small banks could be allowed to make the “fractional reserve promise”. But FDIC cannot cope with systemic failures of the entire bank system, including large banks, of the sort we saw in 2008-9. Thus if the Friedman / Positive Money system were to be implemented in the US, large banks would have to be barred from making the above promise, as would shadow banks not covered by FDIC.