A Proposed Full Reserve Banking Equivalent

[William Hummel]

A Single National Depository

Described here is a functional equivalent of a full reserve system, which is simpler and more efficient. It would consolidate the transaction deposits of the many thousands of banks into a single National Depository run by the Fed. The deposits would be actual base money rather than claims on base money, in effect the digital equivalent of cash. The term reserves would no longer be relevant and could be dropped from the financial lexicon.

The National Depository would offer accounts to all who need the payment services of a traditional bank. It would only hold transaction deposits and would pay no interest. The Depository would neither lend nor borrow. It would simply execute payment orders of its depositors and handle the accounting. The accounts at the Depository together with the circulating currency would comprise the entire supply of legal tender denominated in U.S. dollars. The Fed would have control over the total amount of deposits but would normally use it to manage the short-term interest rate rather than the total amount of money. The money supply would therefore vary as a function of demand for bank loans, just as in the fractional reserve system.

Implementation of the system would start after the full reserve system was in operation. All the reserve accounts of banks at the Fed would be transferred to the National Depository. Bound reserves would become deposits in the accounts of the respective owners. Free reserves would become deposits in accounts of the respective banks. At their option, banks could exchange their vault cash for free reserves at the Fed to be included in the transfers. The balance sheets of banks would be downsized by the transfers, but the net worth of each would remain unchanged.

 

Banks could no longer create or accept transaction deposits. However a bank could offer term accounts of various maturities and pay interest on them. The term accounts would be insured by the FDIC up to specific dollar limits, as in the current system. The funds paid by investors in those accounts would belong to the bank and credited to its account in the Depository. As long as the bank maintained a balance in its account of at least 10% of its insured liabilities, it could invest in mortgage loans and debt securities, but not in equities. Banks would be required to offer payment services against their customers' respective transaction accounts in the Depository. They would also be required to issue cash against a maturing term account if requested.

The Fed would implement monetary policy by controlling the interest rate on overnight interbank loans. It would set a target rate and buy or sell securities in the open market to steer the interbank lending rate toward the target. When suitably collateralized, it would offer to lend to banks at 50 basis points above the target rate and borrow from banks at 50 basis points below that rate.

In addition to serving the entire private sector, the National Depository would serve the U.S. government, and offer accounts to foreign banks and governments that need to transact in U.S. dollars. All of the Treasury's funds would be held in its account at the Depository where it would deposit its receipts from Federal taxes and the sale of its securities. Likewise all government spending would be paid out of the Treasury's account at the Depository. To avoid impacting the money supply, the Treasury would sell or redeem securities as needed to balance on average its inflows and outflows, as it does in the current system.

 

The computer used by the National Depository would be an extension of the Fed's computer system. Payment orders would be accepted by electronic means via plastic cards, the Internet, Fed wire, or telephone. Paper checks would be phased out, after which verifying balances and making payments would all be done in real time. Payments would be executed by simply transferring funds between accounts. The only exception would be transactions with the Fed which would involve a transfer of funds in or out of the Depository.

One should not confuse the National Depository with Federal Reserve Banks. The latter would continue to implement monetary policy through open market operations and provide loans to banks. All such transactions would result in credits or debits in accounts at the Depository. The Fed would continue to purchase notes and coins from the Treasury and maintain a stock sufficient to meet the public's demand for currency. Local offices of Reserve Banks and ATMs would provide currency in exchange for deposits and vice versa. The Depository itself would hold no currency.

William Hummel

[John Hermann]

On 30/04/2013 7:25 AM, William Hummel wrote:

A Single National Depository

Described here is a functional equivalent of a full reserve system, which is simpler and more efficient. It would consolidate the transaction deposits of the many thousands of banks into a single National Depository run by the Fed. The deposits would be actual base money rather than claims on base money, in effect the digital equivalent of cash. The term reserves would no longer be relevant and could be dropped from the financial lexicon.

The National Depository would offer accounts to all who need the payment services of a traditional bank. It would only hold transaction deposits and would pay no interest. The Depository would neither lend nor borrow. It would simply execute payment orders of its depositors and handle the accounting. The accounts at the Depository together with the circulating currency would comprise the entire supply of legal tender denominated in U.S. dollars. The Fed would have control over the total amount of deposits but would normally use it to manage the short-term interest rate rather than the total amount of money. The money supply would therefore vary as a function of demand for bank loans, just as in the fractional reserve system.

Implementation of the system would start after the full reserve system was in operation. All the reserve accounts of banks at the Fed would be transferred to the National Depository. Bound reserves would become deposits in the accounts of the respective owners. Free reserves would become deposits in accounts of the respective banks. At their option, banks could exchange their vault cash for free reserves at the Fed to be included in the transfers. The balance sheets of banks would be downsized by the transfers, but the net worth of each would remain unchanged.

 

Banks could no longer create or accept transaction deposits. However a bank could offer term accounts of various maturities and pay interest on them.  The term accounts would be insured by the FDIC up to specific dollar limits, as in the current system. The funds paid by investors in those accounts would belong to the bank and credited to its account in the Depository. As long as the bank maintained a balance in its account of at least 10% of its insured liabilities, it could invest in mortgage loans and debt securities, but not in equities. Banks would be required to offer payment services against their customers' respective transaction accounts in the Depository. They would also be required to issue cash against a maturing term account if requested.

That's fine, however one needs to consider the limitations of the insurance scheme.  It would be desirable to have a supplementary risk-free investment option for mutual and pension funds etc which are obliged to have risk-free components within their investment mix.  This could include government securities and infrastructure bonds.  The latter makes sense from a national economic perspective.

The Fed would implement monetary policy by controlling the interest rate on overnight interbank loans. It would set a target rate and buy or sell securities in the open market to steer the interbank lending rate toward the target. When suitably collateralized, it would offer to lend to banks at 50 basis points above the target rate and borrow from banks at 50 basis points below that rate.

In addition to serving the entire private sector, the National Depository would serve the U.S. government, and offer accounts to foreign banks and governments that need to transact in U.S. dollars. All of the Treasury's funds would be held in its account at the Depository where it would deposit its receipts from Federal taxes and the sale of its securities. Likewise all government spending would be paid out of the Treasury's account at the Depository. To avoid impacting the money supply, the Treasury would sell or redeem securities as needed to balance on average its inflows and outflows, as it does in the current system.

 

The computer used by the National Depository would be an extension of the Fed's computer system.

For a system organized on a national scale, and in order to remove the risk arising from having everything residing in a single computer system, I would suggest having an integrated arrangement in which there is a separate computer system operating within every state and territory.  The federal computer system would simply act as a back-up for each state system.

Payment orders would be accepted by electronic means via plastic cards, the Internet, Fed wire, or telephone. Paper checks would be phased out, after which verifying balances and making payments would all be done in real time. Payments would be executed by simply transferring funds between accounts. The only exception would be transactions with the Fed which would involve a transfer of funds in or out of the Depository.

One should not confuse the National Depository with Federal Reserve Banks. The latter would continue to implement monetary policy through open market operations and provide loans to banks. All such transactions would result in credits or debits in accounts at the Depository. The Fed would continue to purchase notes and coins from the Treasury and maintain a stock sufficient to meet the public's demand for currency. Local offices of Reserve Banks and ATMs would provide currency in exchange for deposits and vice versa. The Depository itself would hold no currency.

All of this is fine in theory, however the possible limitations of a full reserve system (or its equivalent, such as this) have not been addressed.  These include criticisms based on the supposed deflationary tendencies of such a system, and the problem of capital accumulation.

John

William Hummel

[William Hummel]

My comments in red.

 

John Hermann wrote

Thursday, May 16, 2013 7:43 PM

On 30/04/2013 7:25 AM, William Hummel wrote:

A Single National Depository

Described here is a functional equivalent of a full reserve system, which is simpler and more efficient. It would consolidate the transaction deposits of the many thousands of banks into a single National Depository run by the Fed. The deposits would be actual base money rather than claims on base money, in effect the digital equivalent of cash. The term reserves would no longer be relevant and could be dropped from the financial lexicon.

The National Depository would offer accounts to all who need the payment services of a traditional bank. It would only hold transaction deposits and would pay no interest. The Depository would neither lend nor borrow. It would simply execute payment orders of its depositors and handle the accounting. The accounts at the Depository together with the circulating currency would comprise the entire supply of legal tender denominated in U.S. dollars. The Fed would have control over the total amount of deposits but would normally use it to manage the short-term interest rate rather than the total amount of money. The money supply would therefore vary as a function of demand for bank loans, just as in the fractional reserve system.

Implementation of the system would start after the full reserve system was in operation. All the reserve accounts of banks at the Fed would be transferred to the National Depository. Bound reserves would become deposits in the accounts of the respective owners. Free reserves would become deposits in accounts of the respective banks. At their option, banks could exchange their vault cash for free reserves at the Fed to be included in the transfers. The balance sheets of banks would be downsized by the transfers, but the net worth of each would remain unchanged.

Banks could no longer create or accept transaction deposits. However a bank could offer term accounts of various maturities and pay interest on them.  The term accounts would be insured by the FDIC up to specific dollar limits, as in the current system. The funds paid by investors in those accounts would belong to the bank and credited to its account in the Depository. As long as the bank maintained a balance in its account of at least 10% of its insured liabilities, it could invest in mortgage loans and debt securities, but not in equities. Banks would be required to offer payment services against their customers' respective transaction accounts in the Depository. They would also be required to issue cash against a maturing term account if requested.

That's fine, however one needs to consider the limitations of the insurance scheme.  It would be desirable to have a supplementary risk-free investment option for mutual and pension funds etc which are obliged to have risk-free components within their investment mix.  This could include government securities and infrastructure bonds.  The latter makes sense from a national economic perspective.

 

Those investment options already exist in the non-bank sector, and would continue to exist under the proposed National Depository system. I don't see the need for banks to fund themselves in that way. Perhaps I may have misinterpreted your point.  

The Fed would implement monetary policy by controlling the interest rate on overnight interbank loans. It would set a target rate and buy or sell securities in the open market to steer the interbank lending rate toward the target. When suitably collateralized, it would offer to lend to banks at 50 basis points above the target rate and borrow from banks at 50 basis points below that rate.

In addition to serving the entire private sector, the National Depository would serve the U.S. government, and offer accounts to foreign banks and governments that need to transact in U.S. dollars. All of the Treasury's funds would be held in its account at the Depository where it would deposit its receipts from Federal taxes and the sale of its securities. Likewise all government spending would be paid out of the Treasury's account at the Depository. To avoid impacting the money supply, the Treasury would sell or redeem securities as needed to balance on average its inflows and outflows, as it does in the current system.

The computer used by the National Depository would be an extension of the Fed's computer system.

For a system organized on a national scale, and in order to remove the risk arising from having everything residing in a single computer system, I would suggest having an integrated arrangement in which there is a separate computer system operating within every state and territory.  The federal computer system would simply act as a back-up for each state system.

I envision a system in which individual accounts exist only on the computer of the Federal Reserve district in which that individual or firm is located. The twelve district computers would be networked to the main computer at the FRBNY. Transactions entirely local to a district would be executed and accounted for by that district. When a transaction involves more than one district, the main computer would handle the linkage between districts. Of course all district computers would be continually backed up as needed to ensure safety of the data.

Payment orders would be accepted by electronic means via plastic cards, the Internet, Fed wire, or telephone. Paper checks would be phased out, after which verifying balances and making payments would all be done in real time. Payments would be executed by simply transferring funds between accounts. The only exception would be transactions with the Fed which would involve a transfer of funds in or out of the Depository.

One should not confuse the National Depository with Federal Reserve Banks. The latter would continue to implement monetary policy through open market operations and provide loans to banks. All such transactions would result in credits or debits in accounts at the Depository. The Fed would continue to purchase notes and coins from the Treasury and maintain a stock sufficient to meet the public's demand for currency. Local offices of Reserve Banks and ATMs would provide currency in exchange for deposits and vice versa. The Depository itself would hold no currency.

All of this is fine in theory, however the possible limitations of a full reserve system (or its equivalent, such as this) have not been addressed.  These include criticisms based on the supposed deflationary tendencies of such a system, and the problem of capital accumulation.

 

I fully agree and would like to include a discussion of these issues. However I find it very difficult to make a coherent story out of such a complex issue. With the exception of the Chicago Plan, I think all proposed full reserve systems envision exogenous money growth directly controlled by the government. I don't think an exogenous system is workable in the long run because it is too easily politicized and corrupted. 

 

The IMF wrote a paper analyzing the Chicago Plan by Fisher et al. That paper has been critiqued by a member of the Monetary Realism group, someone who goes by the initials JKH. His excellent critique can be seen at http://monetaryrealism.com/banking-in-the-abstract-the-chicago-plan/  JKH asserts that there is nothing unique about 100% reserves. Banks could still create deposits through lending, and thus money growth in the Chicago Plan would be endogenous. That implies banks could acquire the reserves from the Fed as needed to fully back loans after the fact. In my version of the full reserve system (not the National Depository system in which "reserves" don't exist), the required reserves would have to be available when the loan was made. That distinction between the two systems is of vital importance in terms of the issue you raise about capital accumulation and potential debt deflation.

 

The proposed National Depository system is the functional equivalent of a full reserve system. However it is based on my interpretation of a full reserve system, not the JKH interpretation. There is nothing right or wrong about either interpretation. It would be simply a matter of law which prevailed. Those of us who have proposed monetary reform are also proposing signficant limitations on the type of assets banks hold. Over time, that would result in a large reduction in the aggregate bank balance sheet, and a corresponding shrinkage in the financial sector. However I remain agnostic on whether or not the National Depository system I proposed would negatively impact the real economy. 

 

William 

[Jean Erick]

     I cannot coment on your post because I do not know your definition of transaction accounts.

They might mean:

(1) accounts created by the depositor being the client of the bank (personal or business checking)

(2) accounts created via loan proceedures where the bank creates the account which the client can draw on.

(3) both

 

   If (2) was involved, that appears to me as to be an effective creation of a lot of money.

 

James

[William Hummel]

From: Jean Erick

Sent: Sunday, May 19, 2013 9:47 AM

Subject: Re: A Proposed Full Reserve Banking Equivalent

     I cannot coment on your post because I do not know your definition of transaction accounts.

They might mean:

(1) accounts created by the depositor being the client of the bank (personal or business checking)

(2) accounts created via loan proceedures where the bank creates the account which the client can draw on.

(3) both

 

   If (2) was involved, that appears to me as to be an effective creation of a lot of money.

 

James

 

Another term for transaction deposits is checkable deposits, and there is only one meaning regardless of how the deposit may have come into existence.

 

In the proposed National Depository system, all new money is created by the Fed through open market operations or lending. Banks could only lend what they have borrowed, earned, or received in exchange for bankshares. Bank loans would not increase the money supply as they do in the fractional reserve system. They would simply transfer ownership of a deposit in the bank's account to the borrower's account.

 

In principle, a bank could borrow from the Fed to back a loan, but it is the Fed that creates the money, not the bank. In general the Fed frowns upon a bank borrowing from it in order to lend. The borrowing privilege for banks is normally to deal with a short-term liquidity problem and only for a solvent bank.

 

 

 

[Jean Erick]

 

     I'm viewing it from my construct which simply takes one step forward in describing fractional lending and M1.

It says that such lending does not create money.  It says that it is a serial dual process wherein some money is lent plus, out of thin air, drawing rights are created on much more money.  Drawing rights on money are effectively money but are not money structurally.

While some money may be created by the Fed to meet currency demand caused by increased lending, it must be well below the amount lent.

     Only the Fed can create reserves out of nothing and reserves are cash equivalents.  The banks can only exchange extant funds for cash.

     M1, under this construct, is a measure of a little money and drawing rights conflated together.  The drawing rights created are equal

to the multiplier minus 1.  If the multiplier was operating at 3.5 then the amount of real money would be 1 and drawing rights 2.5 times that.

Therefore, operating under this construct, when all those drawing rights were converted to money to set your system up, that would be an act of substantial money creation.  Changing the effective money of drawing rights into real money.

     I agree that it would not be continuous as you evidently assumed I meant.

 

    The difference my construct supplies is again reflected in your comment below about banks increasing the money supply in the fractional reserve system.  Of course they do, by definition.  But M1, the "money supply" is not the supply (tally) of structural (real) money.   M1 is the tally of mostly the

effective money of drawing rights.

 

    To use a metphor,  there is a simple difference between putting more coins in the fountain and allowing more people to take the coins out.

  

James

----- Original Message -----

From: William Hummel

To: understan...@googlegroups.com

[Roger Lin]

It sounds like a very efficient system. Do you have any concerns with the concentration of power that such a system would have?  If I were a clever politician/military faction/hacker/secret society, this would be the first thing I would aim to control. To have all the transactions of the world in one place...consider the possibilities!

[William Hummel]

 

----- Original Message -----

From: Roger Lin

To: understan...@googlegroups.com

Sent: Tuesday, May 21, 2013 5:11 PM

Subject: Re: A Proposed Full Reserve Banking Equivalent

It sounds like a very efficient system. Do you have any concerns with the concentration of power that such a system would have?  If I were a clever politician/military faction/hacker/secret society, this would be the first thing I would aim to control. To have all the transactions of the world in one place...consider the possibilities!

---------------------

What do you mean by "controlling" the Depository?

The Depository accounts would be dispersed in 12 Federal Reserve districts. They would not all be in one physical location. I think the real issue would be protecting against theft via stolen IDs and passwords. A good question is, who would take the hit if an account had been tapped illegally.

Maintaining the integrity of the accounts in the Depository against natural or man-made disasters would require multiple backups in remote locations. The Fed does that now on its own accounts. It would have to do the same with the Depository.

William

[Roger Lin]

By control I mean the power to make the policies and procedures of the depository. Would this be given to the Fed, the President, the legislature? It sounds like it would be under the Fed. Do we worry concentrating so much economic power under one institution? Do we worry about it becoming a giant bureaucracy? Perhaps the pros outweigh the cons. I'm just thinking of potential consequences.

[William Hummel]

The proposed National Depository would be operated as a service by the Fed, as authorized by Federal law in the Congress. The only significant policy issue I can imagine would be how to deal with illegal access and theft of funds. I think your fears of a giant bureaucracy or concentrated economic power is greatly overblown.

 

The Depository would neither lend nor borrow and would therefore makes no judgment calls. It would simply execute payment orders and handle the accounting. Almost all of its operations would be done by computer, including online statements for account holders. The Treasury does this now for those buying Treasury securities online. Aside from management staff and technicians to keep the equipment running, there would be few people involved. 

 

William 

[Mark Bachmann]

Roger,

 

I think you're raising a legitimate concern here, but the same potential for politicized abuse exists with respect to the Fed itself or any modern central bank with the power to create fiat money. It's my own opinion that the Fed's original architects, who were extremely conscious of this issue even in the specie-money days, did a pretty good job of establishing a balance between independence and accountability. Without opining on the viability of William's proposal, I don't see that that it increases the risk from centralization too much beyond what exists now. If the fear is of an extremist government somehow coming to power in the U.S. and gaining control of the monetary system, a National Depositary along the lines that William has laid out probably would not give them much more leverage than they would get already through full nationalization of the Fed and the big banks.

  

      Mark Bachmann