Will the Swiss adopt 100% reserve banking?
By Scott Sumner
The answer is clearly no, because they are not being asked to adopt 100% reserve banking. However there is an upcoming referendum for creating a system of 100% reserve backed demand deposits in Swiss banks. I read the literature in support of this referendum, and I’m having trouble figuring out what problem this is supposed to solve:
3) What are the fundamental advantages of sovereign money?
Sovereign money in a bank account is completely safe because it is central bank money. It does not disappear when a bank goes bankrupt. Finance bubbles will be avoided because the banks won’t be able to create money any more. The state will be freed from being a hostage, because the banks won’t need to be rescued with taxpayers’ money to keep the whole money-transaction system afloat i.e. the “too big to fail” problem disappears. The financial industry will go back to serving the real economy and society. The money and banking systems will no longer be shrouded in complexity, but will be transparent and understandable.
Unless I’m mistaken, this is simply false. Even under this proposed regime, the 100% reserve requirement would only apply to demand deposits. Banks could still lend out funds in saving deposits, and hence the same risks to the system would still exist. I don’t know about Switzerland, but in America demand deposits are only a small share of bank liabilities. More importantly, if 100% reserve requirements were adopted they would become an even smaller share of liabilities. So no, this doesn’t solve the fundamental problem of financial instability, which is mostly caused by government policies that create moral hazard, such as deposit insurance and “Too-Big-To-Fail”. It would not prevent another “Lehman moment”.
That doesn’t mean this is a bad idea, just that some other justification is required. Right now, the US has a weird banking system. It looks private, but it was effectively socialized in 1934. You might think you are lending money to banks when you open a saving account. But what you are actually doing is lending money to the Treasury, which turns around and lends that same money to your bank. If the bank cannot repay the loan to the Treasury, it has no effect on your savings account–which is guaranteed by the Treasury. (FDIC is just a middleman.)
So how could the government’s footprint on the financial system be reduced? One option would be for the government to stop re-lending demand deposits to commercial banks. Instead, the Fed would provide checking account services, rather than providing the reserves that back up commercial bank checking accounts. That’s equivalent to 100% reserve banking (for demand deposits), except the Fed handles the paperwork instead of commercial banks handling the paperwork.
I have no opinion on which system is best, as I don’t know enough about the Fed’s ability to provide efficient transactions services to the public. If this form of socialized checking accounts is superior to our current system, then I suspect it’s on standard “second best” grounds—it slightly reduces the moral hazard created by other government programs. At the same time, it takes us even further from my ideal, which is a completely unregulated financial system. The first best solution is to reduce moral hazard.
Moral hazard is extremely difficult to address for various political reasons. At a technical level, it’s easy to get rid of deposit insurance. There is plenty of public debt around, so even saving accounts up to $250,000 could be made virtually 100% risk free. The real problem is political. Both the banking industry and people who borrow money from banks like the current set-up, where credit is subsidized by the Treasury. Moral hazard would be slightly easier to address under NGDPLT, however, as at least we’d no longer have to worry about bank failures causing nominal spending to decline. Crony capitalism would be the only concern.
PS. Here is the title page of my copy of 100% Money. The frontispiece is actually signed by Irving Fisher. I bought the book in Madison, Wisconsin, for $3.50. 🙂