Mason Gaffney wrote:
> Congratulations to Lloyd Mints on living to be 100; may we all do as well.
>However, it's hard to judge a scholar's work from 50 years ago by a few
>words from an aged person on a clip whom you cannot cross-examine. The idea
>of 100% cash reserves sounds conservative to the max, but also unworkable -
>how are the banks to make any loans and earn any income? So if you oppose
>all qualitative controls, and propose only an unworkable alternative, that
>leaves us with nothing.
It is not unworkable in principle. Ronnie J Phillips (with a foreword
by Hyman Minsky) wrote a book explaining the whole subject: _The
Chicago Plan and New Deal Banking Reform_ (1995) M.E. Sharpe.
Shortly after the Chicago Plan was set out in a November 1933
memorandum, Lauchlin Currie was hired (summer 1934) for the Freshman
Brain Trust at the US Treasury under Jacob Viner to prepare a
blueprint for "the most perfect monetary system for the United
States" ignoring any political considerations that might interfere
with its adoption.
Currie came up with a detailed (50-page) 100% reserve plan, submitted
to Secretary Morgenthau (later published in the 1966 reprint of his
Harvard 1934 book on _The Supply and Control of Money in the United
States_). His thinking was roughly as follows:
The money supply consists of the means of payment (cash plus
demand deposits) that themselves can settle debts without first
having to be converted into something else. These should be strictly
distinguished from financial assets such as savings or time deposits
which, even if highly liquid, first need to be converted into money
before they can finally settle debts.
Demand deposits are transactions deposits that are very much more
active than time deposits. This is why they receive zero interest, or
at least a significantly lower rate than on time deposits (and if
time deposits are treated as money they soon forfeit interest). This
is so that banks can cover their costs.
In light of his important paper, "The Failure of Monetary Policy
to Prevent the Depression of 1929-32" (JPE 1934), and the recent
collapse of the money supply, Currie insisted that monetary control
could best be achieved if money was created entirely by the FED
rather than the banks. (The state would then also capture all the
seigniorage.) This would require 100% reserves against demand deposits.
But banking qua banking could still be in private hands. Private
banks could still _administer_ the nation's money supply, by
transferring cheques and accepting and returning cash. The money
supply would be unaffected by any alteration in the ratio of cash to
demand deposits. Banks would cover their costs by charging for their
money transfer services, or could receive a state subsidy.
Financial intermediation would be a quite separate business.
Through an accident of history, banks became also financial
intermediaries, and in the process fractional reserve banking arose.
In this intermediation activity, banks were no different from
non-bank financial intermediaries -- except that, unlike NBFI, banks
created money by lending.
This is where the trouble lies. The supply of money gets tied up
with the lending of money by the private sector. Under a 100% reserve
system this link would be broken, except insofar as the central bank
could create fiat money by lending (or giving) the government some of
the money needed to finance government spending. (This is
"seigniorage", and is non-inflationaey - except on the Austrians'
definition of inflation - so long as the extra money grows in line
with real economic growth - hence with the growth of the demand for
real transactions balances.)
In Currie's ideal monetary system, reserve requirements against
time deposits ("savings" rather than "money" -- savings being a
transfer of purchasing power not a net creation thereof) would be
abolished. This would also help monetary control since transfers
between demand and time deposits would not affect the money supply proper.
Contrast the fractional reserve system with reserves required
against both DDs and TDs. Assume the RR is the same for both. An
increase in the propensity to save, hence a shift from DDs to TDs,
reduces transactions balances -- the major part of the money supply
-- without reducing RRs, because total deposits are unchanged. If DDs
decline by, say $100, reserve requirements are unchanged because no
reserves are released when savings increase. Even if RRs against TDs
are lower than against DDs, the release of required reserves would
not fully offset the decline in money and spending.
This makes the system pro-cyclical: if saving increases the
money supply declines; if savings decline, the money supply
increases. (The modern focus on "broad money" leads to the absurd
view that an increase in the propensity to save is inflationary, if
the M1 money supply is maintained.)
Lastly, monetary control under fractional reserve banking depends
on the banks always being fully loaned up. If they should suddenly
decide to hold excess reserves (by lending less), the money supply
and spending decline. The authorities then have trouble maintaining
the circular flow of income if they cannot be sure the banks will
lend the extra reserves (cf. current 2009 anxieties!). By the same
token, if the banks hold excess reserves, the central bank may have
difficulty constraining an excessive expansion of lending and
spending in the upswing. There could never be excess reserves under
the 100% money plan.
In short, 100% money places the creation of money firmly in the
hands of the government through its central bank, and breaks the
pro-cyclical link between the supply of money and the lending of
money, or between "money" and "credit" (two quite separate, though
mechanically linked, concepts).
At the US Treasury, Currie met Marriner Eccles. When Eccles left in
November 1934 to become Chairman of the Fed, he took Currie with him
and together they framed what became the 1935 Banking Act.
Roger Sandilands
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