{"id":7299,"date":"2010-01-12T18:29:55","date_gmt":"2010-01-12T07:29:55","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=7299"},"modified":"2010-01-12T18:29:55","modified_gmt":"2010-01-12T07:29:55","slug":"100-percent-reserve-banking-and-state-banks","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=7299","title":{"rendered":"100-percent reserve banking and state banks"},"content":{"rendered":"

\t\t\t\tToday we examine two propositions: (a) 100-percent reserve banking; and (b) national government spending without taxation and debt issuance. Believe it or not the two propositions have been related in the debates over many years. Modern monetary theory (MMT) is agnostic to the first proposition although individuals within the paradigm have diverging views. However in the case of the second proposition it is central to MMT that a currency-issuing government has no revenue-constraint and should not issue debt to match net spending. Further, taxation is an effective tool for attenuating overall agggregate demand rather than raising revenue for a government that can spend regardless.
\n
\nBefore reading this blog I suggest you consult some earlier blogs – Operational design arising from modern monetary theory <\/a> – Asset bubbles and the conduct of banks<\/a> – Functional finance and modern monetary theory<\/a> – Breaking up the banks<\/a> – as background material.<\/p>\n

The discussion on my blog in recent days has, in part, focused on what to do with banks and specifically whether we should have a Full-reserve banking system<\/a> which is described as a banking system:<\/p>\n

\n… in which the full amount of each depositor’s funds are available in reserve (as cash or other highly liquid assets) …. [and] … when each depositor had the legal right to withdraw them.\n<\/p><\/blockquote>\n

Full-reserve banking is a.k.a a 100-percent reserve banking system or a Giro system (the latter being from the old days of the Bank of Amsterdam). The Postbank in the Netherlands still runs a Giro bank!<\/p>\n

A related proposal was advanced by James Tobin<\/a> in 1985 (20-21) where he proposed a new “deposited currency” which would be payable to anyone on demand by either the central bank or the commercial banks. In the latter case, the deposit-taking banks would have to buy government bonds with the deposits before they could issue “deposited currency”. This would eliminate the need for reserves and deposit insurance.<\/p>\n

It is juxtaposed with the so-called fractional reserve system where bank loans create deposits which are not backed 100 per cent by reserves.<\/p>\n

This debate overlaps with an arcane and long-standing debate within the even more arcane Austrian school of economics about who is right – the “100 percenters” or the “Fractional Reservers”. Austrians all think they support freedom but define this to mean absence of coercion (principally by government).<\/p>\n

In this context, the “100 percenters” consider – in their representation – that a fractional reserve system is fraudulent because it promises to pay amounts in excess to what actually exist and that fraud is coercion. So the fractional reserve system is the anathema of freedom.<\/p>\n

Bring on the “Fractional Reservers” who say that freedom means doing what you like and so why stop banks and borrowers doing what they like. Its all a free exchange after all! They claim that people will understand that some banks are less likely to remain solvent than others and the market will take care of that.<\/p>\n

Anyway, I am happy for these characters to spend their time debating among themselves – sort of running around in circles chasing their tails as they get increasingly agitated about which scheme best promotes freedom. This way they reduce the time they have left to bother the rest of us.<\/p>\n

You get a feeling for the emotions that the Austrians hold in this regard, when you read the work of noted (misguided) US libertarian, the late Murray Rothbard. In the October 1995 edition<\/a> of the Austrian rag, The Freeman<\/a> – he called fractional reserve banking “a gigantic scam” (see Reprint<\/a>):<\/p>\n

\n… the idea, which most depositors believe, that their money is down at the bank, ready to be redeemed in cash at any time. If Jim has a checking account of $1,000 at a local bank, Jim knows that this is a “demand deposit,” that is, that the bank pledges to pay him $1,000 in cash, on demand, anytime he wishes to “get his money out.” Naturally, the Jims of this world are convinced that their money is safely there, in the bank, for them to take out at any time. Hence, they think of their checking account as equivalent to a warehouse receipt. If they put a chair in a warehouse before going on a trip, they expect to get the chair back whenever they present the receipt. Unfortunately, while banks depend on the warehouse analogy, the depositors are systematically deluded. Their money ain’t there.\n<\/p><\/blockquote>\n

The old “Giro” or “100 percent reserve” banking system operated by people depositing “specie” (gold or silver) which then gave them access to bank notes issued up to the value of the assets deposited. Bank notes were then issued in a fixed rate against the specie and so the money supply could not increase without new specie being discovered.<\/p>\n

Rothbard juxtaposes this against the “swindling or counterfeiting” system which “is dignified by the term “fractional-reserve banking”” – whereby banks now create deposits out of thin air – “which means that bank deposits are backed by only a small fraction of the cash they promise to have at hand and redeem.”<\/p>\n

The Austrians then claim that governments are parties to the “inflationary counterfeit-pyramiding” because in a free market the banks operating under “fractional reserve banking” would go broke virtually immediately as soon as other banks demanded cash from a bank that had extended a loan with money they didn’t have.<\/p>\n

The only way this “embezzlement” can persist is because government supports the cosy cartel via the creation of a central bank because:<\/p>\n

\nBanks keep checking deposits at the Fed and these deposits constitute their reserves, on which they can and do pyramid ten times the amount in checkbook money.\n<\/p><\/blockquote>\n

He then describes the process of an open market transactions (central bank buying government bonds from banks in return for a government cheque) as the “beginning of the inflationary, counterfeiting process”. The rest of his rant is an exposition of the familiar money multiplier process which means he is just perpetuating the mainstream myth about how the banking system works.<\/p>\n

Please read my blog – Money multiplier and other myths<\/a> – to see why Rothbard fails to grasp the essence of modern banking.<\/p>\n

Anyway, Rothbard says:<\/p>\n

\nThus, the Federal Reserve and other central banking systems act as giant government creators and enforcers of a banking cartel; the Fed bails out banks in trouble, and it centralizes and coordinates the banking system so that all the banks … can inflate together. Under free banking, one bank expanding beyond its fellows was in danger of imminent bankruptcy. Now, under the Fed, all banks can expand together and proportionately.\n<\/p><\/blockquote>\n

He then attacks the “lie of “bank deposit insurance”” as an “arrant hoax” because it just backed by the US federal government rather than any pre-existing “insurance fund”:<\/p>\n

\nSuppose that, tomorrow, the American public suddenly became aware of the banking swindle, and went to the banks tomorrow morning, and, in unison, demanded cash. What would happen? The banks would be instantly insolvent, since they could only muster 10 percent of the cash they owe their befuddled customers. Neither would the enormous tax increase needed to bail everyone out be at all palatable. No: the only thing the Fed could do, and this would be in their power, would be to print enough money to pay off all the bank depositors. Unfortunately, in the present state of the banking system, the result would be an immediate plunge into the horrors of hyperinflation.\n<\/p><\/blockquote>\n

So very emotional language, which is a common characteristic of the “sound money” (Austrian libertarian) gang. They seem to get so het-up<\/a> whenever they are talking about economics that you get the impression they think the sky is about to fall in on them any time soon. Even the private militias they support won’t help them if the sky ever does fall in.<\/p>\n

But all this freedom nonsense really amuses me. I know I have not grown up in the US where the term is bandied around relentlessly. But the free marketeers never consider the coercion of the market when you are poor and starving and the rest of it.<\/p>\n

More importantly, it is also a pity that their emotional positions are not backed by an understanding of how the monetary system actually works. They hark back to the gold standard which placed governments in a financial straitjacket and prevented them from reacting effectively to crises of the sort that has nearly crippled the world economy over the last few years.<\/p>\n

Their depiction of the fractional reserve-money multiplier world exemplifies this misunderstanding of banking operations.<\/p>\n

The idea that the monetary base (the sum of bank reserves and currency) leads to a change in the money supply via some multiple is not a valid representation of the way the monetary system operates even though it appears in all mainstream macroeconomics textbooks and is relentlessly rammed down the throats of unsuspecting economic students.<\/p>\n

These students become functionally illiterate in the ways of the economy from day one of entering their studies and by the end of a typical undergraduate program are reduced to babbling meaningless trite one line statements like those that the Austrians regularly litter their writings with.<\/p>\n

The money multiplier myth leads students to think that as the central bank can control the monetary base then it can control the money supply. Further, given that inflation is allegedly the result of the money supply growing too fast then the blame is sheeted home to the “government” (the central bank in this case). <\/p>\n

The reality is that the reserve requirements that might be in place at any point in time do not provide the central bank with a capacity to control the money supply.<\/p>\n

We have regularly traversed this point. In the world we live in, bank loans create deposits and are made without reference to the reserve positions of the banks. The bank then ensures its reserve positions are legally compliant as a separate process knowing that it can always get the reserves from the central bank.<\/p>\n

The only way that the central bank can influence credit creation in this setting is via the price<\/strong> of the reserves it provides on demand to the commercial banks.<\/p>\n

Even Rothbard’s depiction of open market operations as a central bank vehicle for increasing the money supply is erroneous. The argument is that the central bank purchases government bonds from private banks for “cash” which then expands via the money multiplier (the fractional reserve model).<\/p>\n

However, what really happens when an open market purchase is made is that the central bank adds reserves to the banking system. This will drive the interest rate down if the new reserve position is above the minimum desired by the banks. If the central bank wants to maintain control of the interest rate then it has to eliminate any efforts by the commercial banks in the overnight interbank market to eliminate excess reserves.<\/p>\n

One way it can do this is by selling bonds back to the banks. The same would work in reverse if it was to try to contract the money supply (a la money multiplier logic) by selling government bonds.<\/p>\n

The point is that the central bank cannot control the money supply in this way (or any other way) except to price the reserves at a level that might temper bank lending.<\/p>\n

The fact is that it is endogenous changes in the money supply (driven by bank credit creation) that lead to changes in the monetary base (as the central bank adds or subtracts reserves to ensure the “price” of reserves is maintained at its policy-desired lavel). Exactly the opposite to that depicted in the mainstream money multiplier model.<\/p>\n

The other fact is that the money supply is endogenously generated by the horizontal credit (leveraging) activities conducted by banks, firms, investors etc – the central bank is not involved at this level of activity.<\/p>\n

Please see the following blogs – Deficit spending 101 – Part 1<\/a> – Deficit spending 101 – Part 2<\/a> – Deficit spending 101 – Part 3<\/a> – for further information about all this.<\/p>\n

Now back to 100-percent reserve banking proposals.<\/p>\n

If you require all institutions to hold liquid reserves of equal value to their deposits then the fear of a bank run is eliminated. In the current recession, the run on Northern Rock in the UK would have been avoided. Banks runs are rare but disruptive.<\/p>\n

The proponents also argue it would eliminate the need for the central bank to lend reserves to banks who are deficient at any point in time. So banks would always have enough “liquid” reserves to meet any need. The elimination of the central bank, of-course, satisfies the Austrians hatred of government.<\/p>\n

The other claim is that a 100-percent reserve banking system would allow the government to control the money supply and hence maintain price stability. This is because all money would be created by the national government in this system. Banks would not be able to create deposits by extending loans.<\/p>\n

So the idea is that the banks would have a 100 per cent reserve-deposit ratio which ensures that the money supply is 1-for-1 multiple of the monetary base.<\/p>\n

Any firm that wanted to borrow funds would have to issue a convincing asset as collateral.<\/p>\n

However, a hybrid model of the 100-percent reserve banking system recognises that financial intermediation is necessary for a smooth functioning production system. This means that many small savers can deposit with a bank who “spreads the risk” and on-lends to firms who need the funds for working capital.<\/p>\n

The more reasonable advocates of full-reserve banking recognise that you need separate institutions that will take risk and provide credit.<\/p>\n

So banks would still lend but only for each dollar of currency they hold (can raise). Depositers could formally forego their right to withdraw their funds for some fixed-term and in return they would receive interest. This would stop bank runs and allegedly ensure that at the end of the period the funds would be available to the depositer.<\/p>\n

They claim also that with a controlled money supply, productivity growth would see prices fall and wealth increase. They allege that there would be no shortage of money to feed growth because less money would have to be used (given lower prices). It is a crazy argument.<\/p>\n

There might even be a two-tier banking sector (this is similar to Tobin’s idea). Some banks would become deposit-taking institutions who hold government debt and manage the clearing house system (for the daily reconciliation of cheques between commercial banks).<\/p>\n

But then the credit creation becomes the domain of other institutions to ensure that the real economy has access to working capital to facilitate production. To ensure financial stability, these institutions will either still need access to central bank discount facilities (overdrafts) to ensure the clearing house system doesn’t fail or they would be required to issue their own liabilities that were attractive to prospective lenders.<\/p>\n

In this regard, regular commentator JKH noted that:<\/p>\n

\nI’d always assumed that the (“theoretical”) answer was that overdrafts wouldn’t be permissible, since as you say allowing them would not accomplish anything – it effectively contradicts the purpose of 100 per cent reserves on demand money. Therefore I’ve assumed credit granting institutions would have to issue liabilities first in order to warehouse demand deposits (that are 100 per cent reserved by the deposit issuing bank), before extending new credit.\n<\/p><\/blockquote>\n

Yes this is the position taken, for example, by Henry C. Simons (Chicago School economist) who formulated the so-called Chicago Plan which you can read about in more detail HERE<\/a>. Most of the Austrian School also supported it (particularly Ludwig von Mises).<\/p>\n

It was expressed clearly by Milton Friedman in a famous presentation to the US House sub-committee (US House, 1975, 2156-57). Friedman said:<\/p>\n

\nI have long believed that the most effective way to reduce regulation is to separate the monetary functions of the commercial banks from their credit conscience. The way to do this would be to require all institutions offering demand deposits to keep 100-percent reserves; make them depositary institutions in fact and not, as now, simply in name. Free entry into this industry could be permitted. The institutions could compete for customers financed by the interest received from the Government and by service charges to customers. The lending and investing activities of today’s commercial banks would be carried out by new institutions created by them which would raise their funds through time deposits or debentures or stock. These institutions would then be freed almost entirely from regulation. This is not a new proposal. It dates back over 40 years. It was supported in the 1930’s by Henry Simons at the University of Chicago. It was proposed in a book by the great Yale economist, Irving Fisher.\n<\/p><\/blockquote>\n

Friedman later changed his position somewhat but that is another story.<\/p>\n

As an aside, some people have tied Minksy in with the 100-percent reserves camp. He was definitely not in that camp. There was an article in 1991 by Charles Whalen (Stabilizing the Unstable Economy: More on the Minsky-Simons Connection, Journal of Economic Issues<\/em>, 25(3), 739-763) where this matter was considered in relation to the similarities and contrasts between Minsky and Henry Simon’s (a Chicago School economist who taught Minksy).<\/p>\n

Whalen said that:<\/p>\n

\nSimons’s banking reforms are more drastic than those proposed by Minsky. For example, Simons recommended the following changes: (a) “complete separation, between different classes of corporations, of the deposit and lending functions of existing deposit banks;” (b) “legislation requiring that all institutions which maintain deposit liabilities and\/or provide checking facilities (or any substitute therefore) shall maintain reserves of 100 per cent in cash and deposits with the Federal Reserve banks;” and (c) “displacement by notes and deposits of the Reserve banks of [private-bank credit and] all other forms of currency in circulation, thus giving us a completely homogeneous national circulating medium” … Nonetheless, the banking recommendations of these men are linked by an important similarity – both desire a “radical decentralization” that would facilitate “new [bank and non-bank] enterprise” and the multiplication of “small and moderate-size firms”\n<\/p><\/blockquote>\n

However, Minksy did argue, as Whalen quotes (page 750), that the economic system:<\/p>\n

\n… would be more stable if the banking system were decentralized, with many small and independent banks serving an industrial and commercial structure of small and medium-size firms … [and later] … a major necessary reform is for the Federal Reserve to shift from the open-market technique to discounting.\n<\/p><\/blockquote>\n

But Minsky stills see a crucial role for the central bank in maintaining financial stability. The Giro bank lobby sees no role for the central bank.<\/p>\n

How does this fit into modern monetary theory (MMT)?<\/p>\n

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.<\/p>\n

There would be the equivalent of a gold standard imposed on private banking which could invoke harsh deflationary forces. Further, the 100-percent reserve banking system does not eliminate credit risk so that crises could still occur if there were significant defaults under the “fixed-term” variation.<\/p>\n

State banking<\/strong><\/p>\n

What about state banking? This has overlaps with the debate about 100-percent reserve banking.<\/p>\n

There has been some discussion in recent days in this blog about the proposals by Ellen Brown in her recent book the Web of Debt. For those who don’t wish to read this book you can see a good summary of the principle propositions in her December 5, 2008 article – A Radical Plan for Funding a New Deal<\/a>.<\/p>\n

The article poses the question (remember it was written as the crisis was intensifying in 2008):<\/p>\n

\nHow can the new President resolve these enormous funding challenges? Thomas Jefferson realized two centuries ago that there is a way to finance government without taxes or debt. Unfortunately, he came to that realization only after he had left the White House, and he was unable to put it into action. With any luck, Obama will discover this funding solution early in his upcoming term, before the country is declared bankrupt and abandoned by its creditors.\n<\/p><\/blockquote>\n

MMT tells you as a matter of first principles that taxes or debt do not fund government spending in a fiat currency system. The reality though is that national governments act as if they are still operating under a convertible currency (gold standard) where taxes and debt issuance were used to defend the gold reserves of the nation (that is, finance spending).<\/p>\n

Brown notes in relation to the US that:<\/p>\n

\nIt had long been held to be the sovereign right of governments to create the national money supply, something the colonies had done successfully for a hundred years before the Revolution. So why did the new government hand over the money-creating power to private bankers merely “pretending to have money”? Why are we still, 200 years later, groveling before private banks that are admittedly bankrupt themselves? The answer may simply be that, then as now, legislators along with most other people have not understood how money creation works.\n<\/p><\/blockquote>\n

I agree with some of this sentiment. The fiat currency system frees the government from its gold standard revenue-constraint. But Brown is presenting an all or nothing scenario and hints at the 100-percent reserve banking approach.<\/p>\n

I don’t think that a recognition that the national government is not revenue-constrained leads logically to the second proposition that private bank credit creation is undesirable. See more on this later.<\/p>\n

I agree however with her view that “(n)ot only are banks merely pretending to have the money they lend to us, but today they are shamelessly demanding that we bail them out of their own imprudent gambling debts so they can continue to lend us money they don’t have.”<\/p>\n

It is deeply disturbing that the banking sector has become so powerful in our modern economies. A properly regulated banking system would have prevented that. But that is not the same thing as abandoning private credit creation.<\/p>\n

Brown then considers “3 ways to fund the “New” New Deal” in the US, which clearly has relevance to all sovereign governments.<\/p>\n

She notes that a sound strategy would begin with the nationalisation of failed private banks instead of bailing them out:<\/p>\n

\nAccumulating a network of publicly-owned banks would be a simple matter today. As banks became insolvent, instead of trying to bail them out, the government could just put them into bankruptcy and take them over … As in any corporate acquisition, business in the banks nationalized by the government could carry on as before. Not much would need to change beyond the names on the stock certificates. The banks would just be under new management. They could advance loans as accounting entries, just as they do now. The difference would be that interest on advances of credit, rather than going into private vaults for private profit, would go into the coffers of the government.\n<\/p><\/blockquote>\n

I definitely see the creation of public banks (or in Australia – the return to public banks – which were all privatised in the halcyon days of neo-liberalama!) as a way forward in a new banking system.<\/p>\n

A public bank can discipline the cost structure of the private banks. For example, in Australia commercial banking is run as a cartel and they screw customers with all sorts of charges that having nothing to do with their own costs. A public bank with access to sovereign funds could offer very low charges.<\/p>\n

The free market lobby will argue this is unfair competition – because the government has the backing of its currency issuing capacity. True enough but the same lobby are always reminding us that the government is about to go bankrupt. Moreover, if all the public bank was doing was restoring some balance between banks costs and consumer fees then that is addressing an externality arising from a non-competitive private sector market.<\/p>\n

I also would not have bailed one financial institution out. Rather, as Brown notes, the government could have just taken over the operating concerns, repaired the capital bases and carried on offering services that advanced public purpose.<\/p>\n

Within this context, Brown considers the “three ways government could fund itself without either going into debt to private lenders or taxing the people”:<\/p>\n

\n(1) the federal government could set up its own federally-owned lending facility; (2) the states could set up state-owned lending facilities; or (3) the federal government could issue currency directly, to be spent into the economy on public projects. Viable precedent exists for each of these alternatives:\n<\/p><\/blockquote>\n

The first option would see a federal bank established to make credit available to infrastructure developments and the like. I can see advantages in a public bank helping strategic private sector investments (which promote public interest). But if the proposal is a way to overcome some perception that there are financial constraints on government spending then the idea is inapplicable to a modern monetary economy.<\/p>\n

If it is to provide cheap credit to the non-government sector to advance public purpose then the idea is fine. It would also give control back to the government in determining the type and pattern of public infrastructure developments.<\/p>\n

During the neo-liberal period, we saw the rise of the ludicrous public-private partnerships as the principle method of “financing” public infrastructure development. The reality was that the governments became so “debt-timid” that they allowed the private equity groups to determine how public infrastructure was provided and there are countless examples that have now emerged with demonstrate the pattern of development doesn’t serve public purpose at all. Sydney’s toll roads are a good example.<\/p>\n

The second option is a creature of a federal system and allows states in the US to issue “low-interest credit on the fractional reserve model”. In Australia, state government-owned banks were common until they were privatised.<\/p>\n

They provided service to the retail segment of the sector and until the neo-liberals started to deregulate the financial market (which pushed these banks into the wholesale segment – that sent them broke) these banks served a great purpose.<\/p>\n

However, if this service was to provide finance to low-income house hunters then I think it would be far better for the public sector to provide the housing and eliminate the credit risk – which reached massive proportions in the sub-prime market. There is nothing wrong with the public ambition to house all its citizens. But there are good and bad ways of doing this. Fannie and Freddie of later days exemplified the bad way of doing it.<\/p>\n

The final option of a government-issued currency is totally consistent with MMT.<\/p>\n

Brown says:<\/p>\n

\nA third option for creating a self-sustaining government would be for Congress to simply create the money it needs on a printing press or with accounting entries, then spend this money directly into the economy.\n<\/p><\/blockquote>\n

The US government already more or less does this. It just obfuscates that it is doing this by placing a series of voluntary constraints on itself – most notably its debt issuance program.<\/p>\n

It would be much more efficient if the national governments around the world eliminated those operations and sent the officers who manage the debt-issuance off to do something productive – like caring for environment or sick and old people.<\/p>\n

Brown notes that the “usual objection to that alternative is that it would be highly inflationary” but also says that “if the money were spent on productive endeavors that increased the supply of goods and services – public transportation, low-cost housing, alternative energy development and the like – supply and demand would rise together and price inflation would not result”.<\/p>\n

So this is clear – if nominal demand grows at the same pace as productive capacity then inflation will not occur. The mad ravings of Rothbard that all money base and\/or private credit creation is inflationary is a dogmatic assertion. It might be under circumstances where nominal demand growth outstrips real capacity to deliver new goods and services.<\/p>\n

Regular commentator, Tom Hickey notes in this regard that:<\/p>\n

\nAll of the spending on public goods results in increased production of goods and services, some which are provided by the private sector, since the government would function mostly as a contractor hiring subcontractors. This would increase real output capacity, GDP, and national prosperity (by lowering the Gini coefficient). Automatic stabilizers could be used to stabilize … [nominal aggregate demand] … relative to real output capacity to maintain price stability by altering spending and taxation appropriately.\n<\/p><\/blockquote>\n

Apart from spelling things with “z” I agree with this summary of the inflation issue :-).<\/p>\n

I note that some people claim that inflation can occur when there is high unemployment – so-called stagflation. It can but that comes about from cost pressures rather than demand pressures. In these cases, inflation targetting strategies are useless anyway.<\/p>\n

Further, it is also true that specific asset classes can inflate before full employment is reached – the so-called asset price bubble. But an asset bubble is not inflation, which is defined as continuous increase in the general price level.<\/p>\n

It is not sensible to address a bubble in a specific asset class (say housing) by deflating the whole economy. More targetted measures are required and fiscal policy is better served to deliver effective solutions in this context. Please read this blog – Asset bubbles and the conduct of banks<\/a> – for more on that topic.<\/p>\n

Where I stand<\/strong><\/p>\n

I do not support a 100-percent reserve banking system. It is the work of a lobby that hates and distrusts government. I have no objection to major reforms of the financial system as specified below but I also consider there is nothing intrinsically wrong with private credit. The private sector should be able to borrow and banks create credit under the strict conditions noted below.<\/p>\n

The debt explosion that has brought the World economy to its knees was not the fault of endogenous money creation. It was the result of lax regulation; criminal activity; and a neo-liberal obsession that national governments had to run surpluses (and hence squeeze private sector liquidity and wealth).<\/p>\n

With this obsession dominating public policy over the last few decades, economies could only grow (mostly) if the private sector took on increasing debt levels. The rise of the financial engineering sector – with the elimination of regulations that might have reasonably controlled its errant tendencies – guaranteed that the households would take on this debt … on increasingly dubious grounds.<\/p>\n

My specific proposals for banking reform are dealt with in some detail in these blogs – Operational design arising from modern monetary theory <\/a> – Asset bubbles and the conduct of banks<\/a> – – Breaking up the banks<\/a>.<\/p>\n

I start from the proposition that the only useful thing a bank should do is to facilitate a payments system and provide loans to credit-worthy customers. Attention should always be focused on what is a reasonable credit risk. In that regard, the banks:<\/p>\n