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Economics, Governance, Media, Relations

Economists Calling for Full Reserve Banking Fri, 21st Oct 2011 by Mira Tekelova (Positive Money)

It may appear that Positive Money’s proposal for banking reform is somehow too radical or too marginal, since mainstream media are rather silent about it and even the Independent Commission on Banking in the UK is so immersed in conventional thinking that it doesn’t see a need to ask a fundamental question: “Who should create the national money supply, and in what form?”

But despite the fact that this information rarely makes it into current news, the fact is that many very well-known, important, respected and famous economists were or are calling for a full reserve banking system. Their proposals differ from each other, however the 100% reserve requirements is common to all of them.

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Let’s start from the old tradition established by some members of the Chicago School.

They suggested monetary reforms, including a call to end the fractional reserve banking and impose 100% reserves on demand deposits in a memorandum that came to be known as the “Chicago plan”. The Chicago plan was a proposal to radically change the structure of the financial system.

Supporters of the plan were: F H Knight, L W Mints, Henry Schultz, H C Simons, G V Cox, Aaron Director, Paul Douglas, and A G Hart.

The memorandum generated much interest and discussion among lawmakers but the suggested reforms were set aside and replaced by watered down alternative measures.

After the Great Depression that began in 1929, there was an apparent recovery in the mid-1930s, but by 1939 the US was again in recession and economists circulated a draft proposal titled  A Program for Monetary Reform” calling once more for an end to fractional-reserve banking. It resurrected proposals for banking and monetary reform from the Chicago plan.

The program was sent to the most complete list of academic economists available at the time. General approval of the program was expressed by 235 economists from 157 universities and colleges; another 40 economists approved of it with some reservations; only 43 economists expressed disapproval.

A Program for Monetary Reform was coauthored by six notable economists:Paul H. Douglas, Frank D. Graham, Earl J. Hamilton, Willford I. King, Charles R. Whittlesey and  Irving Fisher, who was a celebrated American economist and professor of economics who is best known for his work on the quantity theory of money. Fisher was a true celebrity and one of the major influences on Milton Friedman’s monetarism. Friedman called Fisher “the greatest economist the United States has ever produced”.

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On the other side of political spectrum there is the Austrian school of economics, which is associated with libertarian political perspectives. While with different theoretical roots and with totally different objectives, they came to the same conclusion – and called for the abolition of fractional reserve banking.

The Austrian theorists argue for an extremely limited role for government and the smallest possible amount of government intervention in the economy. They see the 100-percent reserve requirement as an imperative which is vital for the correct functioning of a market economy. (Economists of the Chicago school proposed a 100-percent reserve requirement to make government monetary policy more effective and predictable – to assist governments in administering a stable monetary policy by preventing the elastic, distorting credit expansion which all fractional reserve banking systems generate from nothing.)

Ludwig von Mises was the first twentieth-century economist to propose the establishment of a banking system with a 100-percent reserve requirement on demand deposits.

Nobel Laureate Friedrich.A. Hayek also speaks of establishing a banking system based on a 100-percent reserve requirement.

Professor Murray N. Rothbard (in 1962) developed his proposal for a pure gold standard based on a free-banking system with a 100-percent reserve requirement. Rothbard compared the banker who operates with a fractional reserve with the criminal who commits the crime of misappropriation.

In Europe, the French economist Maurice Allais, who received the Nobel Prize for Economics in 1988, has championed the proposal of a banking system subject to a 100-percent reserve requirement.

Jesus Huerta de Soto is today’s leading Austrian school economist, and in his book “Money, Bank Credit and Economic Cycles” published a proposal for a reform of the banking system. He suggests: “a 100-percent reserve requirement would be established for private banks. This step would necessitate certain legislative modifications to the commercial and penal codes. These changes would allow us to eradicate most of the current administrative legislation …”

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Strong criticism of fractional reserve banking comes also from Frederick Soddy (a winner of the Nobel Prize for Chemistry). He could not accept the comfortable view that scientists have no responsibility for the uses to which their work is put. The world’s real problem was faulty economics, not faulty chemistry, and for the second half of his nearly eighty years economics replaced chemistry as the centre of his intellectual life.

There is one more outstanding economist who has backed monetary reform. Milton Friedman, a Nobel Prize winner – known now as one of the most influential economists of the 20th century, wrote a book in 1960 called, A Program For Monetary Stability. On page 65 he stated that he was in favour of what Henry Simons and Lloyd Mints were advocating, that is, 100% reserve. In other words, he advocated that governments, rather than private banks, should issue the money supply. Dr. Friedman also praised the American Monetary Reform Act  (See his comments here).

 

In more recent years more and more economists have been advocating a sound and stable monetary system based on 100% reserves. They include Laurence Kotlikoff, Josef Huber, James Robertson, James Tobin(who received the Nobel Prize for Economics in 1981 and has proposed a “deposit currency” system which incorporates many aspects of the Chicago Plan for a 100-percent reserve requirement), and Herman Daly, former Senior Economist at the World Bank, who strongly endorses full reserve banking, saying “I think we can really do a whole lot for our economy if we would just move away from fractional reserve banking and go back in the direction of 100% reserve requirement.” (See the video here)

Finally, let’s conclude with the quote of the governor of the Bank of England Sir Mervyn Kinghimself  which hints that full reserve banking is not such a bad idea after all:

“Another avenue of reform is some form of functional separation. The Volcker Rule is one example.Another, more fundamental, example would be to divorce the payment system from risky lending activity – that is to prevent fractional reserve banking”. 

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