Martin Wolf proposes the death of banking

Martin Wolf is the latest in a long line of people to propose full reserve banking and removal of banks "money creation" powers. But as I noted when I reviewed the IMF researchers Benes & Kumhof's proposal for full reserve banking, this would mean the death of commercial banking. Maybe that's not such a bad thing.....but wouldn't it be better to say so directly?

Oh, and money creation by committee IS a bad thing. Definitely.

More here. (Pieria)


  1. “But there is a problem. The functions that distinguish “banks” from other financial institutions are credit intermediation (deposit-taking and lending) and maturity transformation (borrowing short, lending long). Once banks no longer do either of these, they cannot be regarded as banks. They are simply shops. Once again, we are faced with the death of commercial banking.”

    Under a system where the central bank can directly expand the amount of money to the public through issuance of accounts while maintaining the existing banking system this problem won’t arise.

    “But once again, there is a problem. Banks are not fund managers. People who want to put money at risk for a return don’t generally put it in banks: they invest it in funds or manage their own portfolio. People put money in banks for two reasons:

    • because they want safety AND a return
    • because they need liquidity (including access to payments systems)”

    If the commercial banking system is maintained as it is while the CB also develops the mechanism to expand money to broad public then this is no problem right?

  2. Removing banks (as we knew them) from the system doesn't change much really. It's all about taking out a single misunderstood and perennially mispriced product: the synthetic gilt (aka bank savings). Broad money (equity, corporate bonds, commercial payment terms, etc) keeps on being created privately subject to market forces. Narrow money (gilts and reserves) keeps on being created by committee as usual because it's the only way it can be done (the central bank cannot not set the interest rate and reserve rules, the treasury cannot not decide how much paper they issue).

    The only objection could be that banks have been used as a channel for arbitrage between broad and narrow money. It's not been a reliable or efficient one. Governments (aka central banks) can use direct intervention in broad money (trade broad indices of private paper) and/or use the tax system (just give the monetary policy committee the power to set the VAT rate for instance).

  3. "Oh, and money creation by committee IS a bad thing. Definitely."

    Evidence? Very good thing, surely. Probably depends on the amount and the distribution. Every citizen gets the same amount when people are short of money, (ultimate aim: keeping inflation - including property inflation - in check and unemployment down), it is a very good thing.

    I do not see why full reserve banks cannot work as banks? There is no shred of evidence that this would not work. Try and see. It's the author's opinion that this is the death of banking, fair enough, but not based on any evidence either.

    1. I don't think you've bothered to read the linked Pieria piece, have you?

      I have explained why money creation by committee is a bad idea. Please read the Pieria piece and the pieces linked in it.

      Actually there is considerable evidence that full reserve banks do not work. The UK used to have full reserve banks - they were called "savings banks". They disappeared in the high inflation of the 1970s because returns on the gilts with which deposits were backed were too low to prevent erosion of savers' capital through inflation.

      There have also in the past been lenders that lent exclusively from own capital, but they operated in specialist niches such as merchant banking. To my knowledge there has never been a successful full-reserve lending bank offering mainstream lending services.

      Your suggestion "try and see" is therefore suggesting that we should take a massive gamble with our financial system.

      My view that Wolf's proposal would mean the death of commercial banking is opinion, yes, but that does not invalidate it. I have considerable knowledge of banking and my opinion is carefully considered - as you would know if you had read the Pieria post and, more important, the other linked pieces in the Pieria post.

    2. Massive gamble with our financial system?

      I suggest we are taking a massive gamble with our financial system at the moment, which is only slightly less precarious as it was before the 2008 recession. It serves to enrich bankers and hedge funds whilst being underwritten by the general public. The government does not do anything about it, as the Conservatives are financed through donations by hedge funds who benefit from the status quo. That is the real danger to our democracy. To completely ignore that is misses the underlying point what is going on in our society..

      So the absolute right action should be to take a massive gamble, which would at a stroke cut of the parasitic elements of banking, which only work through the subsidies given through the existing banking system. (If all these derivatives and trading activities work outside the banking system, fine, they could still continue, but I doubt that.)

      More and more people recognise that, including Wolf. The changes would be revolutionary, as far as banking is concerned.

      Clearly we disagree that commercial banking would work, but if unit trusts work, there is no reason to doubt that commercial banking based on the unit trust principle would work, too. And that full reserve banks to be used only for a for a payment system work, goes without saying.

  4. Positive Money's response is here:

  5. TravisV from TheMoneyIllusion comments section here.

    Mark Sadowski commented on your Martin Wolf article here:

    Here's my (shorter) response:

    (1) A futures markets where participants estimate future NGDP is a perfect solution to "problem of accuracy and timeliness of information" you mentioned. Sumner has proposed that the Fed create and subsidize such a market numerous times.

    (2) Even in the absence of NGDP futures markets, if the Fed targeted the five-year TIPS spread, that would be a HUGE improvement over current practice.

    1. Travis,

      Unfortunately all of you - Mark, Scott and your good self - missed the point entirely, because you ignored the implications of Full Reserve Banking. So let me explain.

      The present situation is that the principal medium of exchange (MoE, not MoA) in the economy is produced primarily by commercial banks in response to demand for loans. That is what I meant by the money supply responding to demand. I do not accept Scott's restriction of the term "money supply" to mean the monetary base: in a fractional reserve system, the money supply (in the MoE sense) is made up of bank credit plus physical currency, i.e. M1/M2 not M0. The central bank therefore does not directly control the money supply, but it does influence it by controlling the price of what we might call "bank money", namely reserves. In deference to Scott's strict monetarist position, though, I would add that the fact that in normal times the monetary base tends to lag M1 suggests that it also responds to loan demand in the absence of excess reserves. In other words, in normal times M0 is primarily endogenous, not exogenous. Obviously that's not the case at the moment.

      However, monetary policy is not the only influence on credit supply: regulatory requirements, the state of bank balance sheets and the level of indebtedness of households and businesses are also important influences, as is the behaviour of bond yields (as you mention).

      What Wolf endorses is fundamentally different. In all of the forms of Full Reserve Banking discussed by Wolf, M1 & M2 would no longer exist. All money in the economy would be M0, and would be created only by the central bank in response to economic indicators. If the central bank got it wrong - which given their record seems rather likely - there might be serious consequences for aggregate demand. Hence my concern about timeliness and accuracy of information.

      It would have been good if Mark had read and understood the whole post - and if he didn't understand it, asked me to explain, as (to be fair) Scott did - rather than cherry-picking the bits that happened to suit his particular agenda.

    2. TravisV from TheMoneyIllusion comments section here.

      Prof. Sumner and Mark Sadowski each responded to your reply below:

  6. Frances, A couple points:

    1. The fact that the base lags behind M1 does not tell us anything about which is causing which to change. And by the way, that is not always true---in 1929-30 changes in the base led M1.

    2. More importantly, I still don't know what you mean by monetary policy responding to changes in the demand for loans. How should it respond? What is the indicator that the demand for loans has changed? (Surely not the quantity of loans, which is also equal to quantity supplied.) When they do see the demand for loans change, precisely how do they respond? I still don't understand the policy that is being proposed here.

    1. Hi Scott,

      1. During gold standard periods - as was the case in 1929-30 - I would expect the base generally to lead, rather than lag, M1. Gold takes time to obtain.

      2. Your point about supply versus demand for loans is interesting. I think we all have this the wrong way round. Banks don't supply loans. They supply money. It is households, businesses and governments that supply loan assets, in return for which banks provide money. The interest rate on the loan is the price of the money supplied, and that price is the risk-free rate plus a risk premium that is determined by the quality of the loan asset supplied. Monetary policy is therefore actually responding to the demand for money, not the supply or demand for loan assets. We may disagree over what we mean by "money", in this context, but I think this may be a more helpful way of thinking about the supply versus demand question.

      I shall develop this more in another post.

  7. I'm OK with the death of commercial banking.

    Your defense of commercial banking is primarily that it can creates money on demand, rather quickly. Sort of true. It tends to *overproduce* money and get us into booms. It can't destroy the money it's created in an efficient fashion; it requires a central bank to "take away the punchbowl", which usually doesn't happen. Intermittently, there are bank failures and as a result sudden instantaneous drops in the money supply -- which we have to patch over with deposit insurance. If a shadow bank like a money market fund collapses, then the instant money supply collapse is even worse.

    Then, in busts, the commercial banks get too conservative about lending; they proceed to misallocate the money: they push loans on people who don't need them and deny loans to people who do need them. This means they aren't creating the money on demand as needed.

    I'd rather have a committee, all things considered. It can't possibly do worse. Bluntly speaking, bank lending policy (== money creation policy) is *already* done by committees that operate in the commercial banks; a government committee would at least theoretically be under some sort of democratic control.

    The commercial banks don't seem to have the right incentives or structure to supply money when needed.

    Some sort of standardized payment system is needed, of course -- a post office bank, perhaps.

    Your second defense is that people want a safe place to store their money and collect interest. That's what government savings bonds are for. Problem solved.

    Martin Wolf is a smart man. I'm not sure it's possible to eliminate commercial banking (people may just reinvent it under other names, like "money market funds"), but I don't see any *downside* to eliminating it if it is possible.

    1. I'm not opposed to ending commercial banking. Indeed I think the commercial banking model is dying anyway: All I wanted to do in this post was point out the implications of full reserve banking.


Post a Comment

Popular posts from this blog

Lessons from the Long Depression

The Case for People's Quantitative Easing

A lack of compassion