Sunday, October 31, 2010
Bank of England Chief Mervyn King Proposes Eliminating Fractional Reserve Banking
Mervyn King - the governor of the Bank of England - has proposed abolishing fractional reserve banking.
As the BBC noted last week:
Mervyn King, the governor of the Bank of England, has tonight made a big intervention into the debate on banking reform. In a speech at Buttonwood, New York, he [listed] much more radical proposals.
1. Forcing the riskiest banks to hold capital "several times the magnitude" of requirements at present.
2. The Volcker rule-style enforced breakup of banks into speculative and non-speculative arms.
3. The "Kotlikoff proposal", which forces banks to match each pool of risks with a requisite amount of capital, preventing losses in one spilling over into another.
4. Stunningly, Mervyn King imagines the "abolition of fractional reserve banking":"Eliminating fractional reserve banking explicitly recognises that the pretence that risk-free deposits can be supported by risky assets is alchemy. If there is a need for genuinely safe deposits the only way they can be provided, while ensuring costs and benefits are fully aligned, is to insist such deposits do not co-exist with risky assets."
King does not advocate any of these radical plans - but the fact that he goes out of his way to list them, and to place them on the agenda of the UK's Independent Commission on Banking, means that we are not yet at the end of the debate about long-term reform of the banks.
***
Beyond the technicalities, the fact that a central banker in a G7 country is prepared to imagine such outcomes is itself significant.
Moreover, King wrote to Ben Dyson and stated:
You suggest that banks should be forced to conform to the underlying purpose of the 1844 Bank Reform Act. You might be aware that I have said publicly that I think ideas in this spirit - such as those advocated by John Kay - certainly merit serious consideration in the debate as to how we reform our financial system. I remain sympathetic to these views. But as I said in my previous letter, I do not want to prejudice the outcome of the Banking commission's deliberations. Now the Commission has been set up, I think we all should wait to see its conclusions."
As Dyson explains:
The 1844 Bank Charter Act ('Reform' is a typo) was a piece of legislation that prohibited commercial banks from printing paper notes (£1, £5, £10 and so on). Before this law was passed, banks were permitted to print as many paper notes as they wanted, up to the point where they printed too many and went bankrupt (as everyone cashed in their paper notes at once).
That situation should sound very similar to the situation that we have today - we currently allow commercial banks to 'print' money in the form of digital bank deposits (the numbers in your bank account). In the years up to 2007, the banks 'printed' far too much of this digital money, to the extent that they - and the economy - started to collapse.
The 'underlying purpose' of the 1844 Bank Charter Act was to prevent the commercial banks creating money and to restore that privilege to the state. It had become obvious to the government of the day that if banks were allowed to create money, they would keep creating money up until the point where it destabilized the economy, so they could not be trusted with this responsibility.
So, in plain English, Mervyn King appears to be saying:
"I agree that banks should probably be stopped from creating money, and recommend John Kay (or Laurence Kotlikoff's) proposals. But it's not for me to say - let's leave it to the Banking Commission."
It's very reassuring to know that the top guy at the Bank of England understands the root of the issue and is promoting solutions that would go a long way to addressing it. Both John Kay and Laurence Kotlikoff's proposals would prevent commercial banks from creating money (or 'issuing credit') for their own benefit at the expense of the wider economy and the public.
Ironically, while King is proposing the potential elimination of fractional reserve banking (i.e. a return to 100% reserves), Ben Bernanke has proposed the elimination of all reserve requirements (i.e. requiring no reserves):
The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.Hat tip: Luis.
13 comments:
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King discusses eliminating fractional reserve lending? Hasn't this been irrelevant since countries went off the gold std, since loans create reserves in a fiat currency regime?
ReplyDeleteDoes King not know he's no longer dealing with a gold std monetary system?
roger erickson
hello again,
ReplyDeleteHaven't had the chance to read it, it's 23 pages long, but here's Mervyn King's speect to the The Economist’s Buttonwood Gathering last Monday:
http://www.bankofengland.co.uk/publications/speeches/2010/speech455.pdf
It's probably the kind of stuff you like to read.
Sorry I can't contribute to your funding drive, the bank's ate my homework.
Luis
My guess is Mr. King has felt the pressure building from the proposed Bank of England Act.
ReplyDeletehttp://www.bankofenglandact.co.uk/
Don't be too surprised when Mr. King has a fatal accident or commits suicide.
ReplyDeleteThe central bankers are getting scared and they should too. Folks are wising up to the government backed counterfeiting cartel.
ReplyDeleteJct: Fractional reserve banking that bases how many new chips can be issue in exchange for collateral on how many old chips are saved is stupid. Casinos don't have reserve requirements and issue as many chips as are called for by the collateral pledged. And chips backed up by collateral do not inflate. Interest on the loan makes them inflate. See Shift B Inflation from Turmel's Miracle Equation exposes Big Lie of Economics http://www.youtube.com/watch?v=GqlthpY94cQ
ReplyDeleteAnd chips backed up by collateral do not inflate. Interest on the loan makes them inflate. King of the Paupers
ReplyDeleteWrong. See George Soros's Theory of Reflexivity. Or are bubbles blown by interest payments alone? No, they are not.
How excellent to have this appearing in the public dialogue at a time when the people are at a loss. Please everyone who can spread the good news far and wide, and without considerations as to the risks the President Lincoln took , or any other.
ReplyDelete"And chips backed up by collateral do not inflate. Interest on the loan makes them inflate."
ReplyDeletefrlbane: Wrong. See George Soros's Theory of Reflexivity. Or are bubbles blown by interest payments alone? No, they are not.
Jct: I'm not going to see anything anywhere. If you don't have the brains to explain it, I doubt Soros did a very good job either. You didn't even watch the video, did you? Just put your mouth into operation before you put your brain into gear. I bet you $100 I can make poker chips inflate (which usually do not) simply by charging interest and foreclosing on part of the collateral pledged backing up the chips. Wanna put your money where your mouth is?
What does this say for Ron Paul's wish to have competing currencies?
ReplyDeleteI bet you $100 I can make poker chips inflate (which usually do not) simply by charging interest and foreclosing on part of the collateral pledged backing up the chips. King of the Paupers
ReplyDeleteSo what? My point is that inflation can be caused without charging interest. Suppose a bank grants me an interest free loan for a consumer item such as a house. Will that house pay for itself the way a factory might with improved productivity? No, it won't so the new money merely drives up prices, hence price inflation even with an interest free loan.
I am no fan of usury, it is unnecessary, but it is the ability of the banks to create money from thin-air that drives inflation, not just interest payments.
I do concede that interest payments are inflationary since they are an unnecessary cost.
BTW, why should anyone loan money without charging interest?
Didn't print my response to frlbane?
ReplyDeletefrlbane: "My point is that inflation can be caused without charging interest."
ReplyDeleteJct: How and when does the money enter circulation without collateral-backing resulting in inflation?
"Suppose a bank grants me an interest free loan for a consumer item such as a house. Will that house pay for itself the way a factory might with improved productivity?"
Jct: No, it will pay for itself in the same way it does now, by the consumer, who covers the depreciation and repairs, but not any interest. Exactly the same minus the interest.
"No, it won't so the new money merely drives up prices, hence price inflation even with an interest free loan."
Jct: No new chips were issued without housing bought and pledged as collateral but of course, you weren't thinking in poker chips (linked to collateral) but only in Mammon without even contemplating the collateral. "More money means inflation" is the inculcated response whether the chips are backed up by collateral or not! Think about that. The concept of the collateral backing up the new chips never even occured to you when you heard "new money" to buy that new house.
"I am no fan of usury, it is unnecessary, but it is the ability of the banks to create money from thin-air that drives inflation, not just interest payments."
Jct: It is not the ability of the bank to create chips from thin air that drives inflation since chips do not lose their receipted value. OH right, thinking in terms of Mammon made you forget about the link to collateral.
"I do concede that interest payments are inflationary since they are an unnecessary cost."
Jct: My point is that since poker chips cannot inflate, my ability make chips inflate (Shift B) by charging interest and seizing the collateral backing (you never think about) them up proves my point. Only usury on the mort-gage death-gamble causes interest of the chips since there are no hidden sources in a casino or in the economy.
BTW, why should anyone loan money without charging interest?