Marshall Auerback wrote a short piece criticizing the recent IMF study of the “Chicago Plan” first put forward by professors Henry Simons and Irving Fisher in 1936.
“Now there are some good things about a 100% reserve backed banking system. To the extent that we require all institutions to hold liquid reserves of equal value to their deposits then the fear of a bank run is eliminated.
But you would have massive credit constraints and, in the absence of a countervailing fiscal policy that promoted more job growth and higher incomes, there would be the equivalent of a gold standard imposed on private banking which could invoke harsh deflationary forces.”
What he seems to miss is that 100% reserves would be required against demand deposits (checking accounts) and not against savings or time deposits. All that an efficient capitalist system needs is financial intermediaries who can channel savings into credit. It is not essential for them to have the ability to create ‘new money’.
“Note that the current practice is that loans create deposits. Clearly, under a 100-percent reserve system, all credit granting institutions would have to acquire the funds in advance of their lending.”
That is true. And requiring 100% reserves against demand deposits would restrict banks ability to make loans without holding reciprocal savings/time deposits or share capital and reserves. In effect they would be prevented from creating new money by making loans where they don’t have deposits. That is the whole purpose of the proposal: to prevent rapid credit expansion by banks.
“The truth is that the debt explosion that has brought the World economy to its knees was not the fault of private sector credit creation per se.”
Really? What else but private sector credit fueled the housing bubble? The debt explosion was encouraged by lax regulation but the financial sector is far from blameless for its actions.
via ‘The Chicago Plan’ does not deserve to be revisited. – Macrobits by Marshall Auerback.
Colin
Your points are well made, however more to the point, have you actually read this latest review of the Chicago plan? The formula they use make no sense to me. Perhaps you would care to explain them in plain English.
I find this suggestion interesting. I think the banks should be required to hold 100% reserves against demand deposits. The culpability of the private sector credit system (lowering/elimination of credit standards, liar loans, ninja loans, manipulated assessments, fraudulent/manipulated titles, derivative/speculative trading of RE instruments, etc) is without a doubt a huge part of the problem, but the source of this yield chasing was the Fed. Without massive sums issued by the Greenspan Fed and the needless manipulation of treasury yields, the private sector would have allocated capital more or less accurately and the owners of capital would have determined a fair risk/reward for their funds.
So the question I have, and which others I’ve shared this concept with, is how is the “Monetary Authority” (The Fed) constrained in this arrangement? Is it still the bank of bankers? Part of the equation must be for free markets to determine capital risk/reward and for the money supply to not be a source of currency manipulation.
Craig
This is an interesting idea,however you need to read the paper.. It is 55 pages and the formula’s they use look like they make no sense. .
There are two culprits: the Fed for suppressing interest rates and allowing rapid debt expansion; and the PBOC for buying $1Tn of US Treasurys in order to suppress their exchange rate — in the process driving Treasury yields even lower. There still has to be constraints on the Monetary Authority while at the same time allowing enough leeway to defend against foreign capital flows.