As we saw last week, the real problem with fractional reserve
banking is not that it allows commercial banks to create money. That’s what commercial banks were invented to
do. The problem is that fractional
reserve banking forces a bank to make a pre-determined amount of loans,
regardless of the actual needs of the market and the economy as a whole. After the repeal of Glass-Steagall, banks
could use “excess reserves” to speculate in the stock market — which, as we’ve
been hinting all along in this series, is not a proper function of a bank.
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| Henry Thornton, Banking Principle Guru |
Surprisingly, all these abuses can easily be stopped by the
implementation of a 100% reserve requirement under Banking Principle
assumptions. If all loans made by
commercial banks qualified for rediscount at the central bank (the Federal
Reserve in the case of the United States), then all loans would ipso facto be good loans — at least as
far as human judgment could determine that (or the loans would not be made,
obviously).
It would not even be necessary actually to rediscount all
the loans, or even a majority as long as they qualified. With electronic communications, rediscounting
could be virtually instantaneous, and it would be pretty much irrelevant
whether a loan was rediscounted — as long as it qualified for rediscounting.
In the beginning of such a program, of course, it would be
best to enforce 100% immediate rediscounting of all loans. This would ensure proper implementation of
the program across the board, especially if the commercial banks were
prohibited from issuing promissory notes to back new demand deposits until the
central bank approved the loan and issued its own promissory note to back the
commercial bank’s promissory note. Every
bank would periodically be required to rediscount all of its outstanding loans
without advance warning.
When the system was in place and any bugs eliminated, and
banks used to the new requirements, the need for rediscounting could be
eased. As an automatic audit, however,
there should be random checks on commercial banks for immediate rediscounting
of all loans held. Since a bank would
never know when such a demand would come, it would have to ensure that all
loans met the requirements for rediscounting at all times, i.e., be qualified loans.
The obvious benefit to this form of the 100% reserve
requirement is that a bank would be “forced” to make only financially feasible,
qualified loans — and the market would determine the actual needs of the
economy, not some government bureaucrat or academic economist. This would also facilitate the shift from a
debt-backed to an asset-backed reserve currency, and be completely elastic,
matched directly to the market-determined needs of the economy.
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| Henry Simons |
Note that while there is a similarity with the “Chicago
Plan” developed by Henry Simons in the 1930s, there is a significant
difference. Simons’s proposal for a 100%
reserve requirement assumed as a given that all banks are banks of deposit,
functioning solely within the past savings paradigm. Commercial banks and central banks, not being
within the Currency Principle, based on past savings, had no place in Simons’s
plan. They would all be converted to
purely “depository institutions.”
This created a problem.
By abolishing commercial banks and central banks, Simons’s proposal
removed the possibility for most people of being able to finance economic
growth with the present value of future increases in production — that is, with
bills of exchange. Instead, any increase
in the money supply would come from new issuances of government debt — bills of
credit, backed only by the faith and credit of the government, meaning the
ability of the government to collect taxes in the future out of existing or
future wealth. The currency would be
debt-backed rather than asset-backed.
Fortunately, however, Simons realized there was a fatal flaw
in his plan, one that he as an opponent of monopoly power refused to
countenance. Part of his proposal was to
have a special commission appointed to determine the amount of new money each
year to be created by government.
Knowing that politicians inevitably managed to circumvent
such regulatory requirements whenever they wanted more money (and when did a
politician not “need” more money?), Simons refused to endorse his own proposal
until and unless a means could be found to prevent politicians or private
special interests from seizing control of the commission. Simons’s plan, however, required human beings
to become perfect and incorruptible as a matter of course, and no means of
“guarding the guards” and preventing a government or capitalist takeover of the
economy was ever devised.
Full, private sector asset-backed reserves are one essential
feature to restoring a market economy. A
100% reserve requirement, however, will only work if based on future savings,
not past savings. Anything else simply
concentrates more and more power in the hands of the people who control past
savings, whether it’s a capitalist private sector, or socialist State sector.
Tomorrow we’ll look at how misuse of the banking system by
both the private sector and the public sector has set the stage for a stock
market meltdown.
#30#
