Friday, 26 October 2012

The IMF proposes the death of banking

The IMF has produced a paper which purports to demonstrate the virtues of full reserve banking. More correctly, it dusts down an old idea from the 1930s (which was not implemented) known as the Chicago plan, applies some fancy maths to it because these days everything has to be proven to work through DSGE modelling, then presents it as the panacea to all our financial ills.

This paper conflates two quite different things, namely full reserve banking and debt jubilee, which causes a fair degree of confusion and I feel it would have been sensible to have separated them.  It was also very evident that the authors were far more comfortable with economic modelling than they were with accounting and financial flows, despite their claim that one of them had actually done loan accounting for a bank. The accounting models in particular are in my view seriously flawed, and insufficient consideration has been given to the impact of the suggested changes on financial flows and the role of banks. I don't propose to evaluate the authors' macroeconomic assessments in this post: I shall confine myself to an analysis of the accounting models and the effect on the financial system.

Pages 4-8 of the Introduction are concerned with the balance sheet impact of the move to full reserve banking and the debt jubilee, and they are supported by three accounting models (Figures 1, 2, and 3) at the end of the report. I'm reproducing the first two models here for convenience, and I have extracted the relevant bits of the paper here.

Model 1: changes to aggregate private bank balance sheets (click here for larger version)

















Model 2: changes to government/central bank consolidated balance sheet (click here for larger version)















Even with the models it took me quite some time to understand how the accounting worked, basically because it doesn't. However, before I take a hatchet to the models, I need to note and briefly discuss some assumptions that the IMF writers have made but failed to document.

Firstly, they do not distinguish between central bank and government. This conflicts with the IMF's long-standing preference for central banks to be independent of government. Is the IMF about to change its views on this? The writers treat central bank accounts as consolidated with government accounts. This is reasonable accounting practice where the central bank is fully state-owned, as in the UK: indeed the UK Government produces "whole government accounts" (WGA) that include the central bank. But this paper is written from a US perspective. The Feds are currently privately-owned. They cannot be consolidated with government. So, undocumented assumption #1 is - all central banks that are not currently nationalised will be.

The effect of consolidating central bank and government accounts is to show government debt and money in circulation on the liabilities side of the same balance sheet. The IMF doesn't show this, but we know from the UK's WGA that government debt bought by the central bank is eliminated from the consolidated accounts, replacing it with the central bank money issued to purchase it. In effect that debt becomes money. As I've noted before, the problem is that although the accounting consolidation "eliminates" the debt, the debt instruments themselves still exist in reality. As government debt cancellation forms part of this proposal, this problem arises in the IMF's model. More seriously, it also arises with respect to money in relation to the cancellation of private debt (debt jubilee), as I shall discuss later.

The IMF writers regard fiat money as equity rather than debt. This is reasonable, since it is not redeemable and is backed by the productive assets of the country. Therefore their consolidated government accounts model shows a capital structure similar to that of a large corporation: equity and debt balancing a portfolio of assets. This in my view is realistic -but it doesn't mean that government can be treated like a corporation for accounting purposes. It is a very different animal.

Unfortunately the IMF's view of the capital structure of private banks is not so realistic. The IMF's model shows private banks' liabilities as consisting solely of deposits and equity. There is no mention of bonds or interbank borrowings: yet these days banks are financed to a considerable extent by bond issuance and interbank borrowing. Few large retail banks have a deposit base of a similar size to their total loans, but this is what the IMF's model shows. It is over-simplified and unrealistic.

This is serious, because the accounting for the proposed "debt jubilee" depends on loans being balanced by deposits. The writers seem to assume that "deposits" includes bonds. But what about interbank and repo balances? Are they "deposits" too? Whatever, it is clear that undocumented assumption #2 is - private banks' debt consists entirely of customer deposits. 

There is a similar problem on the other side of the balance sheet. The IMF writers assume that bank assets consist only of various forms of lending to domestic corporates and households, plus a small quantity of government bonds. Oh, if only that were true! The fact is that banks are major investors in non-government bonds, equities and derivative instruments, and they lend to each other and to non-bank financial institutions. And many of their assets are cross-border and denominated in foreign currency. Undocumented (and totally wrong) assumption #3 is - private banks lend only to domestic households and corporates. 

So, having made three assumptions that are both wrong and undocumented, the writers then go on to explain  the accounting for full reserve banking and the associated debt jubilee. The key components are as follows.

1. Banks must hold reserves in the form of government-issued money to an amount equal to the amount of customer deposits they hold.

As customer deposits are a moving target, I assume this means that the central bank will have to provide reserves on a daily basis as at present, though the paper doesn't say so. However, the central banking accounting for reserve creation is different in the IMF's model. There are no open market operations or collateralised lending. Instead the writers create a "financial asset" called "Treasury Credit" to balance the reserves created to back customer deposits. Effectively the CB will lend money to banks (unsecured) every time a customer deposits money, and the balancing asset will simply be a debt liability of the receiving bank. This is fractional reserve banking as we know and love it - a bank creating a deposit ex nihilo balanced by a loan account - but done by the central bank in relation to private banks on a simply massive scale. The result would be that banks would suddenly have enormous debt liabilities with regard to the Government/CB, and Government would have a balance sheet vastly expanded by the inclusion of the total of all domestic customer deposits (and possibly wholesale ones as well) in the form of equity. Figure 2 in the IMF paper shows this.

This is not so far removed from the "narrow banking" preferred by the Bank of England's Mervyn King. The difference is that reserve backing for deposits is provided by money, not by government debt. There are unresolved issues with the IMF writers' proposal because they have over-simplified private bank balance sheets. But otherwise, the accounting makes sense provided that assumption #1 holds.

If bank bonds were included in "deposits", then they would become risk-free assets equivalent to Government debt, or alternatively they might be redeemed. The paper doesn't say, but I assume that repo and interbank borrowings would be redeemed rather than backed, since banks would no longer be allowed to obtain funds from each other. This brings me to component two - the changes to bank funding.

2. Banks will not be able to use customer deposits (or any other sort of private borrowing) to fund lending.

All lending must be funded either from own equity or borrowing from government/CB. This last is particularly bizarre as it means the bank would have large amounts of money sitting around doing nothing, yet it must borrow EVEN MORE money in order to lend.

At this point I get irritated with the writers' unrelenting balance sheet focus. They seem to have completely forgotten about the profit & loss account and, indeed, the purpose of private banks. The sole aim of private banks is to make money, principally through lending. And the sole point of taking deposits is to fund lending. If deposits couldn't be used to fund lending, why on earth would banks want them? Deposits that couldn't be productively used, and that would moreover COST the bank money because of the 0.49% proposed interest charge on reserves required to back them, would not be commercially viable. Banks would inevitably look for some way of making money from depositors, probably in the form of safe deposit fees and management charges. The paper suggests that the real interest rate on deposits would be zero. I beg to differ. I think the real interest rate would be negative. Banks would have to be able to make money from them somehow, especially given the severe curtailment of lending and its low margin under this proposal.

Not only would banks not want to accept deposits, savers wouldn't want to make them. The model assumes a real interest rate of 1.07% on government bonds. Why on earth would savers (except very short-term ones) put money in a deposit account at 0% or less when they could buy government bonds at 1.07%? It seems likely that the effect of the rate inversion (deposit rate < reserve rate < government bond rate) would be to restrict bank deposits to safe deposits and checking accounts only. Time deposits and "at risk" sight deposits would become a thing of the past - banks would have no need to offer them since they would not need them for funding, and savers would have no reason to want them since there would be a plentiful supply of government bonds at a much better interest rate.

So this rule would be likely to end much bank deposit-taking. It would also end shadow banking, which is essentially a chain of deposits repeatedly on-lent against safe collateral.  But from a lending perspective, the picture is much less clear. This rule alone would not restrict commercial lending, but there is no explanation of how reserve interest would be paid, or how money supply inflation would be managed

Consider a bank making its first loan. The bank must obtain funds from the central bank in advance of the loan being agreed (since the money supply inflates when the book entries for the loan are made, and it is that inflation the writers are trying to eliminate). Those funds are loaned to the bank at the reserve rate. Because this is its first loan, the bank has no interest income, so it must either pay the interest from its own capital or it must also borrow from the central bank the money required to pay the interest. If the latter, then this funding model is a Ponzi scheme.

As at present, the book entries for the loan create a deposit, but this time it is 100% backed by new reserves already provided by the central bank. So the loan STILL inflates the money supply - it's just that the central bank creates the new money rather than the lending bank creating it. Is the decision whether or not to grant the loan going to rest with the central bank - or is the central bank just going to do what the lender wants without question? If the latter, in what way is this form of money creation an improvement on the present situation? If the former, in what way is the central bank better placed to decide on the merits of a loan application than the lender?

When a deposit is drawn, the person or business receiving the money deposits it in another bank. Will reserves automatically transfer from lending to receiving bank, even for smaller banks and shadow banks that don't currently use central bank settlement accounts? If so, then the deposit would remain 100% backed by reserves when it moves from one bank to another. If not, then reserve imbalances could quickly build up, leading to deposits becoming "at risk" in net lenders. I foresee quite a lot of systems enhancements to extend central bank settlement facilities to those players that don't currently have access to central bank settlement facilities.

3. Existing household and short-term corporate loans will be bought out by government/CB (debt jubilee). 

This is where it all goes very, very wrong. The IMF writers, gleefully looking at a Government/CB balance sheet vastly inflated with huge amounts of equity, wish to take the opportunity to get rid of most corporate and household debt. So they buy an asset - customer loans from private banks - and write it off against equity. But in so doing they have forgotten that the equity is not simply shareholders' funds and retained earnings, as it is in a corporation. It is real money that is used in the real economy to buy real goods and pay real wages. If the equity on the Government's balance sheet were reduced the real money in circulation wouldn't reduce, and the result would be an enormous imbalance between the book records of money issued and the money actually in circulation (nearly all of which would be recorded in the books of private banks, and on which they would be paying interest). Figures 1 and 2 (third column) show this clearly. In effect, the Government would have issued a very large amount of interest-bearing money that it had not accounted for. I think they call this accounting fraud.

If they actually tried to balance the public records with private bank reserves, the result could be even worse. They would have to instruct all private banks to write down reserves by the value of the loans written off. As reserves would be the backing for deposits, the value of deposits would also have to reduce by the same amount. That would be a MASSIVE hit to depositor value. Effectively they would have trashed the currency (since it is the value of money in circulation that is written down) and people would have lost virtually all their savings.

The alternative would be for the private debt to remain on the central bank's balance sheet, where it could be segregated and treated as non-performing. This would have no impact on reserves, but would reduce the Treasury Credit. In effect, the central bank would be accepting private debt assets as settlement of the Treasury Credit (loan) imposed on banks in the move to full reserve banking. However, it can't be assumed that the Treasury Credit would match the total value of household debt and short-term corporate debt. If there was a shortfall for a particular bank (this is quite likely in large retail banks reliant on wholesale funding), would the central bank force the private bank to accept more reserves than it needs? As the writers envisage the repayment of debt being done by the borrowers themselves using money paid by the central bank into segregated customer accounts that could only be used to repay debt, it seems the answer is yes, it would. But the bank would have to pay interest on those reserves. The only way it could make money to pay the interest on those excess reserves is to lend more. Which brings us to component number four - the future purpose of bank lending.

4. In future, banks will be allowed to lend only for investment projects. 

Presumably this means that there would be legislation to specify the types of borrower and lending purposes that would be allowed, and Government would review each lending decision for compliance with this legislation prior to providing funds. The administrative overhead is frankly mind-boggling, but perhaps more importantly, it means that lenders would no longer be in control of lending decisions. They would simply be passive money-shufflers.

This does of course raise the question of how future lending needs other than investment projects would be met. Mortgage lending, for example. No provision exists in the model for banks to lend to FUTURE households to enable them to buy homes. Are the authors assuming that ending domestic mortgage lending will force a house price crash of a sufficient size to enable the majority of future households to buy houses without borrowing? Or are they assuming that people in future will rent rather than buying - and if so, how will landlords finance the purchase of property for letting? Or are they assuming that Government agencies (Fannie & Freddie) will lend directly to households, rather than indirectly via mortgage originators as at present? They don't seem to have thought about this at all.

If banks were restricted to lending for investment projects only, lending volumes would of course be seriously reduced. And furthermore, banks would make far less money from their remaining lending, since spreads would be tiny because the corporate debt write-off is assumed to reduce risk. The model assumes that corporate borrowers could alternatively obtain finance for investment from the capital markets at close to the risk-free rate, and that therefore bank lending rates could not exceed that. If that is the case, then bank lending is likely to be unprofitable given the cost of reserves required to fund it.


So, to sum up this rather long and detailed analysis: as far as I can see, in this model it is virtually impossible for private banks to be profitable. In which case they would soon cease to exist, and government would be forced to create state banking facilities to replace them. The question is, why did the authors stop short of recommending full nationalisation of the banking system, since that is the only way the model could work in the longer term? The authors think that private banks funding long-term investment projects is a Good Thing, but they offer no explanation for this belief. Could it be that they have retained private banks in their model because recommending a move to a wholly state-owned system would not be taken seriously by most economists and politicians? After all, state ownership of banking has been a far-left wet dream for a very long time. I'm not a fan of a wholly state-owned banking system, but it would surely be better than a system in which supposedly private banks are prevented from making commercial lending decisions, forced to borrow (and pay interest on) money they don't need and unable to make profits.

This proposal is poorly thought through. Or maybe it isn't. Maybe the real purpose of this proposal is to force the death of commercial banking, and in particular, shadow banking. For that is what it would achieve if it were implemented.


41 comments:

  1. Frances

    I'm still trying to work my way through the paper, but a couple of intial thoughts on your post :

    1) Consolidation of CB + govt balance sheets is common practice. The fact that CB holds govt bonds simply means that it earns a coupon, any profits or losses from which (and other) activity is turned over to the treasury. This is the case even in the US. SO this is not an assumption I' disagree with.

    2) The authors maybe misplaced in having only equity back the non-reserve assets of private banks, but one could easily change 'equity' with 'capital' which could be debt or equity. 100% reserve banking could still work. All deposits are backed by reserves (which pay interest and themselves are backed by t-bills held by the CB).

    Now from a state of equilibrium, a bank makes a loan, adding to its deposit. It is now short reserves. So it borrows, in the short term money markets perhaps at first, and in the capital markets later. But it borrows and keeps the proceeds as reserves.

    3) How does a bank make a profit in such a system? Two sources :

    A ) Bank compete for deposits : Every bank gets the same interest on its reserves, but the rate it pays on deposits and the efficiency with which it manages its deposits may be different. A well run bank could attract deposits at a cheaper rate, or could run itself cheaper than others and hence make money.

    Additionally, deposits created on account of loans extended pay nothing, so the interest on reserves backing those deposits is pure revenue.

    B ) Banks are superior assessors of idiosyncratic credit risk: There's a small business loan with a 'true' PV of 2% above the rate on reserves, but the market is only pricing it at 5% currently. The bank steps in to price it at 4%, funds the expansion of the balance sheet at the true PV of 2% and collects its 2% NII.

    This is the 'knowledge' based model of banking, one that depends on knowing your loans and making profits through that knowledge.

    Essentially, the Chicago plan restores the pure seigniorage revenues back from the private banks to the government. Hvaing only a deposits + equity based model is not necessary for it - there could still be wholesale debt markets. But the debt now is a question of solvency, not liquidity. If a bank has to borrow from the CB itself to meet its reserve obligations, it borrows at the discount window rate, the top end of the interest rate corridor of reserves set by CB.

    In lieu of this, other banking regulations could be made much more simplified.

    Again, I'm still working through the paper itself. But the basics of the Chicago plan are quite solid.

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    1. Sorry, Ritwik, I disagree with nearly everything you've said.

      1) You cannot consolidate privately-owned institutions into government accounts. No accounting standard on earth would allow that. The Fed's accounts are not consolidated with the US government's.

      I think you are confusing the Fed's refund of interest on USTs with accounting consolidation. It is not remotely the same thing.

      2)I don't have a problem with equity backing for deposits. I've noted before that there is little difference between money and government debt. I actually said that the accounting for this makes sense, if 100% reserve backing is what you want - and I'm not in principle opposed to it. Reserve backing for deposits is not the real problem with this model, though they haven't thought about how they avoid money supply inflation when deposits move from bank to bank, or why the CB should accept credit risk which it doesn't accept at the moment (since reserve lending is collateralised). The real problem is the restriction of lending and funding.

      3)A)Deposits are a COST for the bank under this model, because reserve interest rates are higher than deposit interest rates, and they are not needed by the bank because all funding comes from the CB. So banks simply would not want deposits. They would be competing to get rid of them, not to attract them. The only way deposits could be profitable for them would be if they could charge fees.

      There are no "free" deposits created as part of lending in this model. All loans are pre-funded by the CB, and all loans and deposits carry a reserve funding cost of 0.49%.

      3)B)Yes, I agree that loans of this type would generate interest income. But since deposits would be a cost, and banks have overheads and running costs too, the likely volumes of this sort of lending would be insufficient to generate profits unless the margins were much higher than the model proposes.

      You don't seem to understand that this model effectively ends private banking. As indeed the original Chicago plan would have done - which is probably why it was never implemented.


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    2. Frances

      I'm not sure I was able to explain my point properly earlier. I get that deposits are a cost, etc.

      Perhaps I'll do a post myself!

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  2. I support full reserve, but like Francis, I think those IMF authors made a few mistakes with their balance sheets. I set out my reasons, for what they are worth, here:

    http://ralphanomics.blogspot.co.uk/2012/08/imf-authors-get-full-reserve-wrong.html

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  3. Good post Frances - and I'm glad you read it all so I don't have to. The main upshot seems to be, as ever, that if you're offered a free lunch, the bill will probably come along in the end. Like you, I can't see why commercial banks would continue to offer deposits, and the insistence on lending only for "investment" only invites bureaucracy.

    Like most half-way house proposals, it takes the bad features of nationalisation and throws in some worse elements. You'd create a mechanism for central planning of investment (which normally works so well..) while denying normal people the assurance of deposit saving and the ability to smooth consumption through borrowing. So, you add massive bureaucracy to the supply-side while shoving the demand-side in a positively feudal direction. (The good news is that if any country tried to do this on its own, the internet would make it unworkable.)

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  4. Conjecture:

    If the Chicago plan was implemented it would just send private banking and shadow intermediation into the criminal underworld, where it cannot be regulated at all. And it would be very profitable and lucrative, enriching a new criminal class, like those drug lords who are ruining life for Northern Mexicans today. Ponzi schemes galore.

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    1. Absolutely agree. You probably know that the existing shadow bank network grew as a way of avoiding regulations such as Glass-Steagall and deposit rate caps. This proposal is even more highly regulated. Real banking would be driven underground.

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    2. This is an interesting point. I would be interested to know whether the supposed current failure to lend by British banks has resulted in black market loans to business. Jim

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    3. The shadow banking industry for the most part connects large borrowers to large lenders: that is, the shadow banking industry is into casino banking rather than high street or retail banking. And if a casino bank goes bust, who cares? Barings went bust in 1995 and no one turned a hair. Plus Barings was not a backstreet “in the shadows” bank. It was biggish.

      Next, shadow banks are not a threat to full reserve banking for the following reasons. Fractional reserve involves money creation by private institutions, while full reserve aims to stop this. Now any old fool can create money in theory: I can do it by writing an uncrossed cheque and trying to persuade the person I give the cheque to they’ll be able to endorse it and pass it on to a third party in payment for goods and services. But that’s just a joke. It doesn’t work 99.99% of the time. In general terms, money creation by small unheard of organisations is difficult. And far as I know, shadow banks don’t create money: as pointed out above, they are primarily intermediaries between large borrowers and lenders.

      On the other hand, as soon as a shadow bank becomes “big”, it cannot escape the notice of the authorities. If the tax authorities can catch out self-employed plumbers or electricians with a turnover of say £50,000 a year who are trying to avoid being noticed by the authorities, the authorities shouldn’t have much difficulty in spotting a shadow bank with a turnover of a million a year. And a million a year turnover bank is minute half-baked sort of bank.

      And if an organisation comes to the notice of the authorities, it can be made to obey the rules of the game, just as Lloyds or Barclays would have to obey to rules of the game under full reserve. I.e. while the flight of depositors from the shadow bank industry explained much of the crunch, this wouldn’t happen if shadow banks were made to obey the rules of the game.

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    4. Ralph, I refer you to my post "I am a bank" on small non-banks creating money.

      Shadow banks do create money. Much of the expansion in M4 (M3 in the US) prior to the financial crisis came from the shadow banking network. Shadow banking is exactly the same as licensed banking, just unlicensed - and these days, arguably safer than licensed banking since it is fully collateralised, mostly with government debt or cash, unlike licensed banking. It has, in a way, already created its own version of full reserve banking.

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    5. Francis,

      The scenario you set out in the “I am a bank” post does not involve money creation. Money is anything widely accepted in payment for goods and services (a definition you yourself agree with in your post entitled “The nature of money”.)

      The debt owed to you by your customers cannot be readily passed from hand to hand in payment for goods and services. So it’s not money. In contrast, (as was common practice in the 1800s) where a trade debtor gives the creditor a bill of exchange (i.e. a promise to pay), and that bill is widely respected and passed from hand to hand, then THAT IS money creation.

      Same goes for debts owed by shadow banks: those debts are not widely accepted in payment for goods and services, so that’s not money, or at least it’s a very poor form of money. In contrast, the debts owed by Lloyds, Barclays, etc to customers to whom they have granted overdraft facilities are VERY WIDELY accepted and easily transferred. My credit card has never been turned down by a retailer.

      However, I accept that allowing trade credit makes more efficient use of the existing stock of money, which has a stimulatory effect. Indeed, it’s widely accepted that the BUILD UP of debt is stimulatory (e.g. in the years leading up to the crunch).

      Also shadow banks have had no net stimulatory effect over the last decade in that all they’ve done is to pinch business from regular banks.

      Re your claim that much of the expansion of M4 came from shadow banks, do you have any sources to confirm that? I’ve done a quick Google and can’t find anything.

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    6. Ralph,

      Read the discussion in the comments on "I am a bank". The explanation of how money is created is in there. It concerns the use that my debtors make of the money that they fail to pay to me.

      "Poor form of money"? Money is money. Qualitative judgements are irrelevant. If it can be used to make the exchanges for which it is intended - even if those exchanges are limited by location, market or product - it is fit for purpose.

      You don't know much about shadow banking, do you? Much of the money that goes through shadow banks wouldn't go through "regular" banks. The main source of shadow bank money is mutual funds, and the money is lent out against safe collateral for a return. The problem was that rather a lot of the supposedly "safe" collateral turned out to be anything but. These days they use government debt as safe collateral. This is effectively full reserve banking, is it not - especially as the collateral is subject to haircuts?

      If you want to know how money is created in the shadow banking system, look at the accounting for repo. I did a very basic example in this post:

      http://coppolacomment.blogspot.co.uk/2012/06/money-machine.html

      You really should read more of what I write!

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  5. Under our current fractional banking system, economies get into trouble when people have too much confidence and there is too much credit creation. Or people don't have enough confidence and not enough credit creation is taking place. Since World WarII a recession cycle has been preceeded by an inflation cycle. The Great Recession was preceeded by the poping of a housing price bubble created by the excessive use of credit. Currently the Federal Reserve uses monetary policies to change interest rates up or down to try to rebalance the economy. Using higher interest rates to control inflation psychology and bubble creation is a flaw in our economic polices, because this is similar to using a sledge hammer to drive in a tack. Too much unnecessary damage is done to the economy when interest rates rise. When interest rates are decreased we go back to the same credit leveraging use, we were using that created the inflation and the excessive money creation, that creates inflation. Cost of production and consumption increases. Small businesses close their doors, people lose their homes, jobs, and go bankrupt. The government's social programs increase in size. Taxes or deficits increase.
    A better way to control the excessive use of credit, during the inflation cycle or when bubbles are being created, is to use the income tax. The income tax would reduce demand from the top of the economic ladder, where the excessive demand starts and is coming from. The normal consumption and production economy would continue to operate, maintaing jobs and small businesses, which would increase competition. How do we use the income tax to obtain and maintain a better balance in our economy, and make it more productive? wp.me/p1gMnS-8i

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    1. Interesting idea, Leonard. You are suggesting using fiscal policy rather than monetary policy to dampen boom-bust cycles. How would this work, given that fiscal policy is under the control of politicians who have vested interest in creating booms?

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    2. Hólmsteinn Jónasson27 October 2012 20:18

      Visit Leigh Harkness site :)http://www.buoyanteconomies.com/TechnicalitiesOfMonetarySystem.htm

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  6. Hi Ms CoCoppola, Thank you for replying. You are correct to say that fiscal and monetary policy makers have a vested interest in creating booms. This is why the Zero Inflation Taxation Policy is tied to how the economy is preforming, not on the whims of the Federal Resrve or Congress. We have a dynamic economy, but we have static guiding polices(tax code). In real estate it is loction, location location. In macro economics its timing, timing, timing. The Fed's policies are out dated for our large and complex economy. Our economy is continually changing between economic cycles. We can't rely on a 535 policticaly divided committee to act quickly enough to prevent inflation pychology from growing cancerous. The people would be correctly guided, during the correct economic cycle, to increase the money supply when the economy was slowing down. The tax code would still have the lower capital gains tax rate. The higher tax rate on savings and money investment would also remain. It is only when the economy starts to become unbalanced and collatoral prices begin to rise to fast, that the percentage of tax on savings and, money investments would begin to change, base on the true inflation rate. When interest income is taxed at the same rate as capital gains, the stimuli to capture capital gains from inflation would be neutralized. The interest deduction would also be reduced by the same percentage amount. This taxation policy would maintain a closer balance of values between the money that is lent and the paper profits on capital assets during the inflation cycle. The lower capital gains tax rate would still be available for productive investment and production. By slowing down the veloity of money in this manner, it would give production the time it needs to balance supply with normal demand, maintaining employment. We also would not be doing the same thing at the same time which creats the herd effect. Appreiation of capital assets, without improvement, would not be taken for granted.
    I am sure you realize that there is a transfer of value from the money holders to the holders of capital assets as inflation occurrs. At the end of the year the values would be somewhat balanced. One person would pay a little more tax and the other would pay a little less tax if inflation was occuring. In this way we don't allow the balance of values to to get so far out of balance that the economy has to be put through a recession to increase the value of money (debt), as the economy is presently doing. You can now buy more realestate with less debt (money). The value or purchasing power of money has increased in the last 5 years. During inflation cycles and bubbles money loses purchasing power, it takes more debt to buy real estate to focus on one commodity.

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    1. Where does the democratic right to decide how you will be taxed fit into this?

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  7. Any form of currency involving discussion this wonkish is wrong. Money needs to belong to and be understood by plain ordinary people, not be the exclusive preserve of academics. It's all got lost, hasn't it?

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    1. If you think this is wonkish, you should try reading the IMF's paper. Mega-mathematical. I didn't attempt to dissect their DSGE model - restricted myself to accounting and pricing!

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  8. In a free representative country the people have the right to confer and advise their representatives in government. The government serves the people. Our forefathers went to war with England to gain the right to make our own determination on how we the people would be taxed.
    The people have the right of free speech, petition and assembly. I believe people are ready for a change. They are tired of the cycles of boom and bust in our economy. Our reprentatives and the people will need to be educated on the benefits of the Zero Policy. Accademia needs to be envolved. If necessary the people need to use their rights to encourage our representatives to make the needed changes to the tax code. The timing could not be better. Tax reform discussions are scheduled to start in 2013 in the USA. The financial sector and special interest has had their way for the last 30 years. The people need to stand up and speak out so they will be seen and heard. Our revolution history is proof that we can do it again.

    What are your thoughts on the Zero Policy? Will it make our economy more productive and efficent? Will less paper profits be created and more real wealth be ceated. The real wealth that is needed to increase the standard of living in countries. Will it help dampen the cycles of high inflation and deep recessions. Would you support the change to the tax code. I believe the Policy should be adopted in all modern economies around the world. Many countries have a income tax with the same guiding polices of the USA, even Australia, where I was born.

    Have you read any of my articles? I have tied @ProfSteveKeen's relvelations to the Zero Policy in this article. wp.me/p1gMnS-8i

    What do you think about using the Ascending Interest Rate Mortgage, and monthly principal reduction for underwater mortgages, to increase people's confidence and disposable income, which will increase aggregate demand. An increase in aggregate demand is needed to decrease unemployment. The AIR Mortgage would help countries like Spain, to stabilize their housing market and their financial sector.

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    1. Leonard, I am very uncomfortable with the notion that taxation should be decided by "technocrats". To me this is an unacceptable dilution of democracy. The "whims" of Congress, or Parliament in the UK, represent the democratic will of the people and therefore should be acted upon, not sidelined in the interests of "maintaining economic stability".

      As far as mortgage policy is concerned...I don't know what the Ascending Interest Rate mortgage is. I'm in the UK. Most people have variable rate mortgages here, and at the moment we don't have that many underwater borrowers. Where there are a lot of underwater borrowers in a stagnant economy, it makes some sense for the government to provide some relief in order to support aggregate demand. Beyond that I can't comment, I'm afraid.

      I don't plan to comment further on your ideas here. If you wish to discuss the points made in this post, I am happy to do so. But this blog is not the place to promote your ideas.

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  9. The only business that remains for private banking is a certain fee for handling transactions. I think in such a model a bank is simply part of the central banks money distribution infrastructure. Maybe different brands of the same distribution network controlled by a central bank/Monetative.

    Who does control the central bank or the Monetative. The Monetative is a 4th force in the democracy. Who is going to make the decisions? How can a society control it's money.

    Another question is, 'What kind of political system does fit to such a model described in the paper'.

    I don't comment on the paper, it's interesting what these guys wrote about, agreed it's another paper - I think it's a fake. Authors are still thinking in terms of materialism and competition. Honestly, it's not the capitalism that runs out of arguments it's the materialism. It's somehow in the paper, the authors don't say a word about the 'other' economy... I have heard that the U.S. want to switch back to save first and invest the money saved - doing hard to believe in.

    In the last month I have studied some of the alternatives but none of them was assuming a democracy we have today and a change in the finance system alone, does not lead to a solution.

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    1. Bunny,

      Good point about banks becoming simply part of the money distribution machine. There doesn't seem to be a role for "banking" as such.

      I share your concerns about the future of democracy. We seem to be swinging towards technocratic control of economies. That may make for stability, but at the price of loss of democracy. I think that's too high a price to pay.

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  10. Central banks should not be privately owned entities. The U.S. system is out of kilter compared with practises elsewhere in the world.

    JH

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  11. The Federal Reserve System is basically divided into the Board of Governors of the Federal Reserve, and twelve regional Federal Reserve Banks. The Board of Governors, located in Washington, is an 'independent agency of the federal government' (part of the executive branch), and is appointed by the president of the US. The Board determines monetary policy, oversees the Federal Reserve System, and issues currency in accordance with its mandate, as established by Congress.

    The regional Federal Reserve Banks are public-private institutions that carry out monetary policy in their region, as determined by the Board. The stock in the regional FR Banks is owned by their private member banks on a specific legal basis, however the FR Banks are also defined as instrumentalities of the federal government, whose profits belong to the government.

    "The amount of stock a member bank must own is equal to 3% of its combined capital and surplus. However, holding stock in a Federal Reserve bank is not like owning stock in a publicly traded company. These stocks cannot be sold or traded, and member banks do not control the Federal Reserve Bank as a result of owning this stock. The charter and organization of each Federal Reserve Bank is established by law and cannot be altered by the member banks. Member banks, do however, elect six of the nine members of the Federal Reserve Banks' boards of directors. From the profits of the Regional Bank of which it is a member, a member bank receives a dividend equal to 6% of their purchased stock. The remainder of the regional Federal Reserve Banks' profits is given over to the United States Treasury Department."

    http://en.wikipedia.org/wiki/Federal_Reserve_System#Legal_status_of_regional_Federal_Reserve_Banks


    Federal Reserve liabilities are liabilities of the US government. As such, US government debt and Federal Reserve liabilities can be placed on the same side of a consolidated balance sheet if needs be.

    "Federal reserve notes, to be issued at the discretion of the Board of Governors of the Federal Reserve System for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are authorized. The said notes shall be obligations of the United States"

    http://www.law.cornell.edu/uscode/text/12/411

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    1. Thank you. I stand corrected!

      Nonetheless, the IMF writers do conflate government and central bank, which is contrary to the IMF's usual insistence that the central bank must be independent of government.

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  12. I fear that you read rather more into this paper than is actually there.

    FC: "undocumented assumption #1 is - all central banks that are not currently nationalised will be."

    The status of the central bank is irrelevant to the argument of the paper. It is the means of final settlement of payments that is to be nationalised, not the central banks. The authors state: "Our model completely omits two other monetary magnitudes, cash outside banks and bank reserves held at the central bank. ... Bank reserves held at the central bank ... do not play any meaningful role in the determination of wider monetary aggregates. ... Banks are therefore modeled as having no incentive, either regulatory or precautionary, to maintain cash reserves at the central bank." Under the Chicago Plan, central banks, whether publicly or privately owned, lose their monetary relevance.

    FC: "The writers seem to assume that "deposits" includes bonds. But what about interbank and repo balances? Are they "deposits" too? Whatever, it is clear that undocumented assumption #2 is - private banks' debt consists entirely of customer deposits. "

    That is certainly how the Bank of England views them. They are all officially classed as deposit liabilities. Only derivatives, accruals and items in suspense and transmission count as non-deposit liabilities.

    FC: "Undocumented (and totally wrong) assumption #3 is - private banks lend only to domestic households and corporates. "

    This is a valid criticism. The Chicago Plan is concerned only with deposits and loans denominated in the domestic currency of a monetarily sovereign state, but failure to recognise the potential impact of foreign currency assets and liabilities on banks' domestic currency balances undermines the generality of the model. The authors do go to considerable lengths, however, to explain how and to what extent they have incorporated interbank lending and shadow banking into the calibration of their model.

    FC: "As customer deposits are a moving target, I assume this means that the central bank will have to provide reserves on a daily basis as at present, though the paper doesn't say so."

    This is so only under the current situation where banks create and destroy deposits by extending and redeeming loans. The Chicago Plan puts a stop to all that. Customer deposits will constitute a closed pool and merely transfer between banks, accompanied by the pre-existing underlying reserves. Reserves will be created only when the government spends new money into existence, into the recipients' deposits. The central bank will be out of the picture except to the extent that it operates the payents settlement system.

    FC: "The result would be that banks would suddenly have enormous debt liabilities with regard to the Government/CB, and Government would have a balance sheet vastly expanded by the inclusion of the total of all domestic customer deposits (and possibly wholesale ones as well) in the form of equity. Figure 2 in the IMF paper shows this."

    Which is the inevitable consequence of repatriating all of the money that the banks have created to their own advantage over the previous two to three hundred years.

    FC: "2. Banks will not be able to use customer deposits (or any other sort of private borrowing) to fund lending."

    It is important to distinguish between the model specified by the IMF authors and the Chicago Plan of which the model is a representation. In 1939, the principal authors of the Chicago Plan published "A Program for Monetary Reform," the full text of which is available on Wikipedia under this title, and it makes it clear that bank lending was to be funded from the repayment of existing bank loans, from the banks' own retained earnings and from money borrowed for the purpose from customers and other sources (which would not exclude other banks). The IMF model doesn't consider this, which is another shortcoming.

    ... continued

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  13. ... continued


    FC: " ... the bank would have large amounts of money sitting around doing nothing, yet it must borrow EVEN MORE money in order to lend."

    This is the true criticism of the Chicago Plan. It leaves checking deposits (current accounts) as liabilities of the banks, balanced 100% with assets which are owned by the banks but which the banks aren't allowed to touch. In contrast, the apparently similar reforms proposed by Positive Money (www.positivemoney.org.uk) remove current accounts from banks' balance sheets and leave the banks free to use their own assets in whichever way they please.

    FC: "When the loan is drawn, the borrower spends the money and the person or business receiving the money deposits it in another bank. The lending bank then has an excess of reserves equal to the amount of the loan, and the receiving bank has an equivalent shortage of reserves. Under the present system this imbalance would be mopped up at the end of the day through interbank lending."

    Under the present system the receiving bank only consents to accept the increased deposit liability to the payee if the lending bank provides a balancing transfer of assets - reserves. Clearing payments through the interbank settlement system is not interbank lending. Covering excess reserves through interbank lending is an entirely different activity. Payments settlement under the Chicago Plan would be just the same as under the current system.

    FC: "4. In future, banks will be allowed to lend only for investment projects. "

    The authors state " ... it is plausible to assume that a real-world implementation of the Chicago Plan would involve at least some, and potentially a very large, [Government] buy-back of private debt. In the simulation of the Chicago Plan presented in this paper we will assume that the buy-back covers all private bank debt except loans that finance investment in physical capital." It is not the case, therefore, that banks would necessarily be restricted in their future lending, other than by the availability of finance. Other models could be devised which would simulate the effects of further bank lending to consumers, housebuyers and businesses.

    A consequence of this assumption is, however, that the changes reported in the levels of consumer and mortgage loans on the banks' balance sheets during the transition cannot be taken to reflect the changes in levels of household indebtedness, since the model does not consider recourse to non-bank lenders.

    FC: "The question is, why did the authors stop short of recommending full nationalisation of the banking system, since that is the only way the model could work in the longer term? The authors think that private banks funding long-term investment projects is a Good Thing, but they offer no explanation for this belief."

    The authors aren't proposing anything or recommending anything. The sole purpose of the paper is to assess the extent to which claims made by Fisher to four major advantages of the Chicago Plan were justified.

    FC: "Maybe the real purpose of this proposal is to force the death of commercial banking, and in particular, shadow banking."

    What's so great about shadow banking? Borrowing from A to lend to B so B can lent to C who lends it back to A is not just a monumental waste of human endeavour it is also guaranteed to destroy economies. £600 billion of fictitious bank deposits were created in this way between 2001 and September 2007, and it had all disappeared by December 2007, following the collapse of Northern Rock.

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    1. Graham,

      I fear you don't entirely understand some of my remarks.

      - Re central banks. The central bank, not government, creates reserves. Full reserve banking is not possible unless there is a central bank. The IMF paper continually refers to "government" not to central bank when it talks about reserves. Therefore it is treating the central bank as an adjunct of government. This is contrary to the IMF's historic insistence that central bank must be independent of government.

      Although I was corrected over whether the Fed could be consolidated into US federal government accounts (see comment above), there would be a considerable problem with treating the ECB in this way. The ECB was set up to be independent of government, and there is currently no government with which it could be meaningfully consolidated. Nor is there a government which could agree to the ECB issuing reserves to back deposits in national banks. Full reserve banking as proposed here would not be possible in Europe at the moment, though they are making progress towards banking union.

      - Re deposits. The definition of "deposits" does matter if 100% of all deposits are to be backed by reserves. This is the IMF's paper, not the Bank of England's. The IMF writers have not defined their terms.

      - Re Chicago plan. I was reviewing the IMF's proposal, not the original Chicago plan. I think I made that clear.

      - Re reserve movements. You have inadequately described the present system. The intraday transfer of reserves from the lending bank in the RTGS system creates a reserve imbalance which is managed during the day by intraday repo from the central bank, and at the end of the day by interbank lending.

      Interbank lending is NOT separate from the RTGS system - it is consequent upon its operation. The IMF's plan would end interbank lending, so in future the central bank would have to perform a rebalancing function - actively recycling excess reserves to fill gaps elsewhere. It doesn't currently do this.

      - Re investment lending. See p.52 of the report:

      "Of course this presupposes that banks can be prevented from borrowing from the treasury for the purpose of investing in reserves, or in other words that treasury credit can be guaranteed to strictly only be disbursed to finance investment projects. That however does not need to be difficult to do."

      Sounds like restriction of lending to investment projects to me.

      They are inconsistent, though - in the calibration of their DSGE model they gave steady-state interest rates for mortgages and unsecured loans. It really isn't at all clear exactly what they are proposing regarding the scope of lending post-transition.

      But actually continuing to allow lending other than for investment projects is not a great idea. Current mortgagees get their debts written off, but future ones don't? Political dynamite.

      I think you are wrong that this model doesn't consider non-bank lenders. It's written with a US focus, remember, so the authors will be mindful of the existence of GSEs - which are effectively already guaranteed by government. But the authors clearly intend the model to encompass all forms of "banking", not just traditional banks.

      - Re shadow banking: that is a very typical UK comment. The UK has universal banks and an originate-to-hold banking model (Northern Rock and HBOS were exceptions). The US has a far more fragmented banking system and an originate-to-distribute model. It relies very heavily on shadow banking. As do pension funds, money market funds and so on. The effect of killing all this off needs to be carefully thought through. I'm not necessarily saying it's a bad thing, but it's a much bigger change than UK people tend to realise.





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    2. Graham,

      However, I have changed the section about reserve movements. If all banks used central bank settlement facilities then 100% reserve coverage for deposits would be maintained when they move. However, not all banks use central bank settlement facilities. There is also a considerable issue with money supply management: this proposal does not end money supply inflation through lending, it just moves it from lending bank to central bank, which creates uncertainty regarding the responsibility for authorising loans.

      Delete
  14. Excellent post

    I’m currently working my way through this monster (the paper, not your post), having just seen it yesterday.

    I think I see roughly what they’re doing in terms of the transition, but having difficulty visualizing some aspects of the thing when it’s up and running.

    Just wondering - do you understand how new deposits are actually created in this? Even a highly restricted system such as this would require some assumption of trend deposit growth over time, in line with economic growth. What would be an accounting example of how those deposits are created, if banks are no longer allowed to create them in the process of lending? Implicitly, my question would be – how does the government (I guess) cause the creation of the the first new bank deposit liability following the transition stage? What is the transaction and the accounting for it?

    Although, maybe I’m seeing this differently than you, because I don’t see this:

    “The result would be that banks would suddenly have enormous debt liabilities with regard to the Government/CB, and Government would have a balance sheet vastly expanded by the inclusion of the total of all domestic customer deposits (and possibly wholesale ones as well) in the form of equity. Figure 2 in the IMF paper shows this.”

    My reading of it is that the government balance sheet does not include “deposits” (meaning bank deposit liabilities that now require 100 per cent reserves). It includes the reserve liabilities that banks must hold against deposits and it includes credit advanced to banks. But it does not include bank deposits liabilities (as government assets presumably is what you inferred there).

    “If deposits couldn't be used to fund lending, why on earth would banks want them?”

    I would guess/view the reserve/deposit section of the bank balance sheets as essentially a government function farmed out to the banking system, in exchange for continuing their remaining banking business. There would be no capital requirement against this section of the balance sheet. It would make sense for the government to regulate it in such a way as to compensate the banks for their non-capital costs – i.e. break even. Not saying I agree with it though. There are lots of problems with this alone the lines of what you’ve suggested, but they pale in comparison to the larger macro problems of this proposal for the efficient functioning of the financial system, I suspect.

    “Because this is its first loan, the bank has no interest income, so it must either pay the interest from its own capital or..”

    I don’t see a real problem there. It’s still a spread business. Marx notwithstanding, the accounting still works for that.

    “As at present, the book entries for the loan create a deposit, but this time it is 100% backed by new reserves already provided by the central bank. So the loan STILL inflates the money supply - it's just that the central bank creates the new money rather than the lending bank creating it.”

    That goes back to my first question – but why do you think the loan creates a deposit? My understanding is they’re not allowing this.

    “Will reserves automatically transfer from lending to receiving bank, even for smaller banks and shadow banks that don't currently use central bank settlement accounts?”

    Agreed - that type of question in general is a huge area/problem not addressed by the paper.

    “This does of course raise the question of how future lending needs other than investment projects would be met. Mortgage lending, for example ....”

    Agreed – another huge problem with the paper. It sort of makes the whole thing a joke, IMO.

    “This proposal is poorly thought through”

    It certainly looks that way.

    On the other hand - it’s amazing what bad writing alone can achieve.

    :)

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    1. P.S.

      I have no problem with the Treasury/CB consolidation treatment at this level of architectural change. That stuff can always be sorted out in an accounting sense and a policy sense. What's at stake here is higher level than that.

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    2. JKH,

      Re government deposits - sorry, I haven't been entirely clear. The IMF writers are not suggesting that deposits themselves would be on the government balance sheet (in this they differ from Positive Money, who do suggest this). I meant that the government balance sheet would be expanded by the amount of reserves created by the central bank to back the deposits held by private banks. This has the effect of expanding the government's balance sheet by the value of the deposits held by private banks, but not by the deposits themselves. Does this make sense?

      Your question regarding deposit growth I think needs a loan accounting example. Loan accounting under full reserve banking would still be double entry and would still have to involve putting money into a deposit account (because the borrower can only draw money or make a payment from a deposit account). So loans under full reserve banking can still be said to "create" deposits. The difference is that the bank can't simply create the deposit entry ex nihilo as at present - it must already have obtained funding and (since this is full reserve banking) reserves for the deposit from the central bank. The central bank creates that funding ex nihilo when the bank requests it. What bothers me is that as far as I can see the central bank actually has to create twice as much money as the amount of the loan, because of the need to back deposits 1-to-1 with reserves. Lending is starting to look exceedingly expensive.

      I would give a loan accounting example here but I don't think the formatting will work. I'll do one on Excel and post it here as a pdf some time this week. it will help my own thinking too - this is really quite complex stuff and the IMF's dodgy accounting doesn't help matters.

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    3. Thanks for that response.

      “I meant that the government balance sheet would be expanded by the amount of reserves created by the central bank to back the deposits held by private banks.”

      Yes, that makes perfect sense, thanks. (I thought you might have meant that, but wanted to confirm.)

      “Loan accounting under full reserve banking would still be double entry and would still have to involve putting money into a deposit account (because the borrower can only draw money or make a payment from a deposit account). So loans under full reserve banking can still be said to "create" deposits. The difference is that the bank can't simply create the deposit entry ex nihilo as at present - it must already have obtained funding and (since this is full reserve banking) reserves for the deposit from the central bank. The central bank creates that funding ex nihilo when the bank requests it.”

      Again, I assumed/expected something along those lines, but wanted to confirm, thanks.

      However, one operational wrinkle plus one wrinkle of substantive interpretation:

      a) It would be possible operationally I suppose for a lending bank to pre-position reserve sourcing from the government, to deny deposit creation to the borrower, and to cut the borrower a cheque which the latter then deposits elsewhere. The reserves would clear from the lender to the new depository bank to make way for the new loan asset on the lender’s balance sheet. That’s just an operational permutation that would sever the deposit creation connection from the lender. However, this mode of example is silly and pointless really, except that it demonstrates an apparent but trivial operational adherence to one version of the notion that "loans create deposits" is somehow threatened by this type of reserve system. On that idea however, my more substantial point is (b) as follows:

      b) “It must already have obtained funding and (since this is full reserve banking) reserves for the deposit from the central bank. The central bank creates that funding ex nihilo when the bank requests it."

      This actually doesn’t eliminate the substance of the phenomenon that “loans create deposits” at all, in my view, including a comparison with today's system. And this is one significant logical flaw in the overall argument of the paper, IMO, and in the larger generic argument for 100 per cent reserves, which itself is bigger than the paper. All it says is that in order to lend, the lending bank may well have to “back into” the central bank to source the required reserves associated with that lending – whether for immediate deposit creation purposes, or for immediate clearing purposes, as noted in the a) example above. I don’t regard this as a true operational constraint at all. There are several tributary issues which are more operational details than substantive additional constraints:

      First, the size of the required reserve ratio - 100 per cent versus today’s less than 100 per cent, including the case of a system like Canada’s with 0 per cent. But the idea remains that the central bank is still there to produce those reserves on demand operationally. Second, the only effective constraint on supply of reserves and/or credit is effectively a continuation of what already exists today, which is pricing discipline in the form of the administered policy interest rate (today, the discount rate), and quantity discipline in the form of Basle type constraints on capital ratios etc. as noted in the paper. So this looks to me to be a big logical flaw in the positioning of 100 per cent reserves in the paper.

      And BTW, the paper’s particular implementation of 100 per cent reserves cum jubilee cum major system balance sheet changes is only one permutation on the more general issue of 100 per cent reserves. So that type of error in thinking also runs deep in the subject matter.

      cont'd ...

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    4. ... cont’d:

      “What bothers me is that as far as I can see the central bank actually has to create twice as much money as the amount of the loan, because of the need to back deposits 1-to-1 with reserves.”

      I think I understand the overall rationale in that area of the paper. The full implementation envisages the swapping of those reserve creating bank credits for legacy bank assets already in existence – in that regard, it seems to be a combination of government debt funding, jubilee bank funding, and perhaps core bank funding for what are now the residual bank lending businesses (although I still have to nail down the full balance sheet implications on the latter).

      Almost all this sort of stuff in the paper amounts to asset swaps through balance sheet reconfiguration – that’s really what’s involved in the end result of a lot of circuitous and difficult to read transactional accounting. It’s quite obscured in the logical flow of the paper – at least my reading so far - and makes it difficult to read and/or understand.

      “I would give a loan accounting example here but I don't think the formatting will work. I'll do one on Excel and post it here as a pdf some time this week. it will help my own thinking too..”

      That would be good for everybody. I think I’m OK with it myself, but it would be helpful generally. BTW, I’m not sure the IMF accounting explanation is nearly as much the culprit here as the more general logical flow of the paper (which the accounting should be reflecting – not vice versa).

      I may try to write up something over the next week or so for Cullen Roche’s sites. Again, I’m just back from being away and seeing the paper for the first time today. If it’s OK, I may have a few questions about your interpretation over the next few days – that would be very helpful for me, I’m sure.

      Thanks again.

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    5. From above,

      "There are several tributary issues which are more operational details than substantive additional constraints..."

      Sorry, I meant to add that I don't regard the simultaneous or advance securing of reserves to be a substantive issue either - it's just timing in relation to the connection between reserves and lending and deposit creation (compared to today's lagged system where reserve requirements do exist). There is no additional supply constraint due to such timing niceties - this is an illusion held by those who believe in this 100 per cent stuff. The CB still runs the overall system book according to interest rate pricing and capital ratio supervision, just as it does now. And the fact that it takes a bunch of stuff off bank books is a separate issue - having to do with the design for the institutional distribution of risk in the system.

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    6. JKH,

      Yes, by all means, if you have more questions do ask. This is a complex subject and I think there are a lot of problems with this paper generally - not just in the accounting - so it would be good to share views.

      I agree with you that the proposal does not eliminate deposit creation as a consequence of lending. All it does is give funding precedence. But it would be a brave central bank that refused loan funding requests in the interests of keeping the money supply under control. So this proposal must rely on other means to restrict lending growth. As far as I can see, like the other two "full reserve" proposals I've looked at (Positive Money UK and Lawrence Kotlikoff) it actually relies on legislation and regulation to restrict lending growth.

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    7. Thank you for all the interesting comments on the IMF paper!

      I disagree that the proposals do not eliminate money creation by banks however. Indeed they do not eliminate deposit creation because to utilize a loan the borrower requires a deposit. However, if the loan can only be extended if someone else has deposited money in the form of savings, then the net effect is no money creation since savings take money out of circulation. Correct?

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    8. Incorrect, I'm afraid. The IMF's proposal does not place deposits at risk. All funding for lending has to come from the central bank, not from deposits. Therefore money creation is involved in lending. I discussed this extensively in the post.

      Delete
  15. Didn't like Chicago.

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  16. Frances,

    fyi:

    http://monetaryrealism.com/banking-in-the-abstract-the-chicago-plan/

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