Friday, January 2, 2009

Full-reserve banking (100% money)

Full-reserve banking is the banking practice in which the full amount of each depositor'sfunds are available in reserve (as cash or other highly liquid assets) when each depositor had the legal right to withdraw them. Full-reserve banking was practiced historically by theBank of Amsterdam and some other early banks but was displaced by fractional reserve banking after 1800.[citation needed] Proposals for the restoration of full-reserve banking have been made, but are generally ignored or dismissed by mainstream economists.


The case for full reserve

This would eliminate (or at least greatly reduce) the financial risks associated with bank runs, as the bank would have all the money in reserve needed to pay depositors - regardless whether depositors actually claimed their money.[6][7][5]

This form of banking would also eliminate the need for a lender of last resort (such as acentral bank), which is normally needed to support the banking system in times ofsystemic risk or financial contagion, as these financial risks would not exist in a full-reserve banking environment.[8]

This simply requires that the resources available to the banks issuing credit money and demand deposits would be sufficient to convert all currency at once if so required. It was a central component in Social Credit proposals.[9]

Because fractional-reserve banking necessarily increases in the money supply and causesmonetary inflation, some economists (most notably the Austrian School) consider this aspect of fractional-reserve banking to have deliterious and destabilizing effects on the economy over time.[10][11][5][12]

It is argued by these economists that, in contrast to fractional-reserve banking, full-reserve banking guarantees a stable money supply, which ensures that the means of exchange is not debased over time. This improves the efficiency of the price mechanism, promotes saving and the deferral of consumption, provides much greater confidence in the financial system and in the integrity of all commercial transactions and therefore encourages sustainable, non-speculative productive investment...


The great depression in Irving Fisher's thought download pdf

...In essence, if not adequately countered by the monetary authorities, the deflationary process will set in motion a perverse, self-fueling spiral bound to cause “almost universal bankruptcy” (Fisher, 1932a, 1933a).

...Fisher realised that the open market operations promoted by the Federal Reserve had been only partially successful. His response was to promote a radical revision of the credit system, based on the abolition of fractional reserves (Allen, 1993). With this method, wrote Fisher, the “circulating medium” was in fact simply a by-product of the private debt, and monetary policy was unpredictable: an increase of the monetary base could bring about a sustained inflation or be almost ineffective (Fisher, 1936a, p. 105). This latter was exactly what had happened during the Depression: for fear of

bankruptcy, banks had used most of the liquidity obtained from the Fed to inflate their own reserves. If the situation improved, these excess reserves could fuel a surge in

inflation.22 These dangers could have been avoided by requiring the banks to hold reserves equal to their demand liabilities (so-called “100% money”)23. In this way, financial

institutions’ lending function would be clearly separated from that of money creation. The central bank would thus gain full control over the money supply. Even in this case, however, monetary policy could only be effective if the velocity of money and of the demand deposits (V and V’) were stable...

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