Home > Uncategorized > Negative interest rates or 100% reserves: alchemy vs chemistry – Herman Daly

Negative interest rates or 100% reserves: alchemy vs chemistry – Herman Daly

Negative interest rates or 100% reserves:
alchemy vs chemistry

Herman Daly   [University of Maryland, USA]

The close connection of fractional reserve banking with alchemy was recently emphasized by Mervyn King, former head of the Bank of England, in the very title of his recent book, The End of Alchemy: Money, Banking, and the Failure of the Global Economy. He refers to the more thorough development of this connection by Swiss ecological economist H. C. Binswanger in his brilliant study, Money and Magic. Given this connection to alchemy, it is more than a coincidence that the earliest and most thorough critique of fractional reserve banking came not from an alchemist but from a real chemist, Nobel Laureate Frederick Soddy (See H. Daly, “The Economic Thought of Frederick Soddy”, History of Political Economy, 1980, 12:4). Soddy’s advocacy of full reserve banking was later picked up by Irving Fisher, and by Frank Knight and others of the Chicago School. Mervyn King stops short of advocating full reserve banking, but clearly is unhappy with the fractional reserve system.

Most Central Banks, however, seem to favor the alchemy of fractional reserves as a key part of their hyper-Keynesianism: the quest to stimulate real growth by increasing monetary growth, first by low, then by zero, and now by negative interest rates. Why hasn’t it worked? Because real growth today is constrained by real resource shortages, while in the 1930s traditional Keynesianism’s assumption of unemployed resources was reasonable. There is still unemployed labor to be sure, but not unemployed natural resources, which have become the limiting factor in today’s full world. As growth converts more of nature into economy we see that these newly appropriated natural resources were not unemployed at all, but were providing ecological services that often were more valuable than the extra production resulting from their enclosure into the economy. Aggregate growth has become uneconomic – a condition unrecognized by economists long fixated on growth as panacea – but which ironically is logically implied by their absurd new policy of a negative interest rate! (http://steadystate.org/the-negative-natural-interest-rate-and-uneconomic- growth/)

Borrowing at a negative interest rate makes it profitable to invest in projects with a slightly less negative rate of return. Investing in uneconomic projects promotes uneconomic growth. We already have uneconomic growth at the macro level thanks to the mis-measures built into our System of National Accounts (http://steadystate.org/wealth-illth-and-net-welfare/). With negative interest rates we will in addition induce uneconomic growth at the micro level, compounding the collective idiocy. Savers at some point will prefer cash to paying the banks a fee to keep their money, and that will lead the banks and their politicians to push for the elimination of cash in favor of electronic deposits that the banks can control, thereby strengthening the death grip of centralized finance on the real economy.

Better than a policy of hyper-Keynesian negative interest rates is the policy of 100% reserves on demand deposits, first advocated by British Nobel chemist and underground economist Frederick Soddy, and then by the leading American economists of the 1920s, Irving Fisher and Frank Knight, among others. It dropped out of discussion with the Great Depression and the Keynesian growth cure, because it was correctly considered a constraint on growth. The tradional Keynesian growth cure worked in the empty world with unemployed natural resources as well as unemployed labor, but in today’s full world growth has become uneconomic and needs to be constrained. So it is time to reconsider 100% reserves.

What are its advantages?

  1. The private banking system could no longer live the alchemist’s dream of creating fiat money out of nothing, pocketing the seigniorage, and lending the created money at interest. These enormous privileges would be transferred to the public treasury. Money would be a public utility – a medium of exchange, a unit of account, a store of value. The idea is to nationalize money, not banks. http://steadystate.org/nationalize-money-not-banks/
  1. Every dollar borrowed would be a dollar saved, and unavailable to the saver for the life of the loan. This restores the classical discipline of balancing investing and saving, rather analogous to chemistry’s law of conservation of matter-energy. Savers and Investors cannot both claim the same dollar at the same time. Banks are intermediaries, charging interest to borrowers and paying interest to savers. The interest rate exists as a price equating savings with investment, but not as a price paid to the banks for their unnecessary and expensive “service” of creating money as private interest-bearing debt. That the public utility of money should be the by-product of the private activity of lending and borrowing is no better than when it was the by-product of the private activity of gold
  1. In the absence of fractional reserves there would be no possibility of bank failure due to a run on the bank by depositors, and therefore no need for deposit insurance and its consequent moral hazard. The entire debt pyramid would no longer collapse with the failure of a few big banks, bringing down the basic system of payments with it. The bargaining power of the banking system to extort large bailouts by taxpayers would be
  1. No longer would the money supply expand during a boom and contract during a slump, reinforcing the cyclical tendency of the economy. And the reserve ratio could be raised
  1. Money would be issued by the Treasury, and spent into existence for public goods and services. The amount of money issued would be limited by the amount of money that people are voluntarily willing to hold instead of exchanging it for real wealth. If the Treasury issues more than that amount, people will spend it on real goods, driving up the price level. That is the signal to the treasury to print less money and/or raise taxes. The Treasury’s policy target is a constant price index, not the interest rate, which is left to market forces, and would thus never be negative.

The internal value of the currency is determined by maintaining a constant price index, and thus the dollar ceases to be a “rubber yardstick” of value. The external value of the currency would be determined by freely fluctuating exchange rates.

This is too big a policy issue to decide in 1000 words. But I hope at least to raise the suspicion in reasonable minds that a 100% reserve requirement makes far more sense than a policy of negative interest rates.

 

Author contact: hdaly@umd.edu
___________________________
SUGGESTED CITATION: Herman Daly, “Negative interest rates or 100% reserves: alchemy vs chemistry”, real-world economics review, issue no. 76, 30 September 2016, pp. 2-4, http://www.paecon.net/PAEReview/issue76/Daly76.pdf

  1. October 4, 2016 at 6:25 pm

    Herman:

    You’re right, this is a lot to put forth, analyze and comment on in 1,000 words. This early comment of yours caught my attention, and I couldn’t go along with it without commenting:

    “Why hasn’t it worked? Because real growth today is constrained by real resource shortages, while in the 1930s traditional Keynesianism’s assumption of unemployed resources was reasonable. There is still unemployed labor to be sure, but not unemployed natural resources, which have become the limiting factor in today’s full world.”

    The huge divide between economists and ecologists almost always impedes full understanding; most on the left would say – Yanis Varoufakis, for example, a prominent one, and I’d love to see Heiner Flassbeck weigh in – would say the dismal growth rates in the West in general are due to poor distribution of income and lack of spending income (let’s add Thomas Piketty to this camp, surely) , and I agree with that: the Federal Reserve’s own studies showing that 50-60% of the American public does not have $400-$1,000 to meet of personal financial crisis without borrowing (no savings) I think is a good demonstration of that…meanwhile the ecological left isn’t too troubled by a drop in demand…

    You’ll also have to spell out for me the constrained resources a bit more…certainly not oil and gas…what else in the category of natural resources is holding back growth?

    Maybe Richard Smith can weigh in as well…

    • October 4, 2016 at 9:51 pm

      I suggest pollution disposal and recycling is used as a free resource and at this time among the most rare resources causing economic growth to be uneconomic using standard accounting procedures as the only analytical math.

  2. October 4, 2016 at 8:46 pm

    You are right but for the wrong reasons. Having 100% reserves means that every money token created has the same value. Today when a bank gives me a loan the money token it creates and gives to me is said to be the same value as the money the government created. The money given to me is not worth as much as I am less likely to repay it than the government.

    The financial system has become an enormous machine trying to cope with the variations in the value of the money tokens. The cost of operating it – through no fault of their own – is where the increases in productivity have gone. See Michael Hudson’s Killing the Host: How Financial Parasites and Debt Bondage Destroy the Global Economy.

    Others being able to create money is still a good idea. Governments are not good at innovation and picking investments.

    Here is a description of how to allow any entity, including banks, to issue new money tokens.

    https://kevinrosscox.me/2016/10/01/dont-blame-the-bankers/

    We do it loan by loan where the money created is tracked reliably with a complex adaptive system. The direct savings for converting each loan is the cost of interest plus the cost of inflation. The cost saving is shared between the savers, who supply the money and the borrowers who issue the money. The price of the money is set – as it should be – by negotiation between the issuer and the saver.

  3. October 5, 2016 at 9:50 am

    “Why hasn’t it worked? Because real growth today is constrained by real resource shortages, while in the 1930s traditional Keynesianism’s assumption of unemployed resources was reasonable. There is still unemployed labor to be sure, but not unemployed natural resources, which have become the limiting factor in today’s full world.”

    So, unless ‘we’ can find ‘unemployed natural resources’ {or increase the productivity of available natural resources}, then neither monetary or fiscal policy will be ‘effective’ or desirable?

  4. October 10, 2016 at 8:25 pm

    “There never was an idea stated
    that woke men out of their stupid indifference
    but its originator was spoken of as a crank.”
    — Oliver Wendell Holmes, Sr. (1809-1894) American Poet

    .*** BUT, why not read and challenge a Noble Laureate for Physics and challenge ? ******Excerpt from http://en.wikipedia.org/wiki/Frederick_Soddy

    “In four books written from 1921 to 1934, Soddy carried on a “quixotic campaign for a radical restructuring of global monetary relationships”[this quote needs a citation], offering a perspective on economics rooted in physics—the laws of thermodynamics, in particular—and was “roundly dismissed as a crank”[this quote needs a citation]. While most of his proposals – “to abandon the gold standard, let international exchange rates float, use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort” – are now conventional practice, his critique of fractional-reserve banking still “remains outside the bounds of conventional wisdom”[this quote needs a citation]. Soddy wrote that financial debts grew exponentially at compound interest…”

    http://archive.org/stream/roleofmoney032861mbp/roleofmoney032861mbp_djvu.txt

    Why do you deny SODDY his just due?

    Frederick Soddy has in one book answered….all concerns.

    Why do you not challenge ?

    “It is concerned less with the details of particular schemes
    of monetary reform that have been advocated than with the general principles to which, in the
    author’s opinion, every monetary system must at long last conform, if it is to fulfil its proper role
    as the distributive mechanism of society. To allow it to become a source of revenue to private issuers is to create, first, a secret and illicit arm of the government and, last, a rival power strong enough ultimately to overthrow all other forms of government.”

    Frederick Soddy writings, namely “The Role Of Money”

    (Entire book as a free download) http://archive.org/details/roleofmoney032861mbp

    ***** “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha[Gautama Siddharta] (563 – 483 BC),

    ******added 10/04/2016

    After 5000 Years; An Answer. Yes Virginia, Banks Do Create Money “Out Of Thin Air.”
    AFTER more than 80 years-Vindication for the “crank” Frederick Soddy.
    September 28, 2016
    After 5000 years; an answer.
    Yes Virginia, banks do create money “Out of Thin Air.”
    “Verified by Empirical Evidence” by JUSTALUCKYFOOL
    ****Can banks individually create money out of nothing? – The theories and the empirical evidence ☆***by Richard A. Werner

    http://www.sciencedirect.com/science/article/pii/S1057521914001070

    ” This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, “out of thin air”.
    AFTER more than 80 years-Vindication for the “crank” Frederick Soddy.

    FREE DOWNLOAD: “The Role Of Money” (Entire book as a free download…)http://archive.org/details/roleofmoney032861mbp ;
    As Soddy would say, “So elaborately has the real nature of his ridiculous proceeding been surrounded with confusion
    by some of the cleverest and most skilful advocates the world has ever known, that it still is something of a mystery to ordinary people, who hold their heads and confess they are ” unable to understand finance “.
    It is not intended that they should.”(The Role Of Money)

  5. jlegge
    October 22, 2016 at 10:13 am

    This proposal does not solve anything because banks simply don’t work the way the author assumes. They do NOT need a deposit before they can make a loan: the loan creates a balancing deposit. More, it would be ILLEGAL for a bank to lend from its deposits: these are assets of the depositors and liabilities of the bank. The conventional/Krugman view of fractional reserve banking not only requires (as distinct from tolerating) banks to engage in wholesale theft, it violates the most basic laws of accounting.

    Loans are a bank’s assets; deposits are its liabilities; the difference is its equity, part of which is held in cash or central bank deposits and constitutes its reserves. The BIS rules state the permitted multiples of loan values to reserves, differing from class to class of borrower. The reserves are part of the bank’s equity, not a fraction of the deposits accepted.

  6. October 22, 2016 at 11:42 am

    I could go along with Herman’s view if by “reserves” he meant natural resources and rate [plus or minus] of recycling relative to usage, but I would work on a much larger margin – say 500%, along the lines of Nature’s way of mass reproduction as insurance against catastrophe – and like Nature, make the best of economic cycles by taking time off to rest, enjoy the abundance, bury the dead and get the machinery of living back in good order.
    This won’t happen with banks wanting to continually make money, though.

    Hence my argument for making money ourselves as and when we need it, as in the credit card system. That would leave the banks still keeping us informed of our usage, advising us on its management and (what would be different) making public any evidence of gross mismanagement. A similar role is required for local government or business management: informing us about what needs doing as a result of our activities, advising on how to do it, and if it doesn’t get done, bankrupting the unjustifiably idle. More far-reaching government would advise us on infrastructure, policy and infra/international coordination. We’d all be in the same boat, responsible for our own expenditure and the recycling of goods we have had own use of, so no covert buying of those taking on jobs in management and government.

  7. October 23, 2016 at 7:33 pm

    ” This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, “out of thin air”. Now FACT, no longer Theory. Zero reserves or 100% reserves if the new money is not a replacement of money already issued: It is alchemy.
    As for a Federal Bank Credit Card system, fantastic but if only it were “real money” BORROWED from the community with no tax attached that would complete a perfect circle when the loans would be paid off.
    Now; however, we must heed the warning of Frederick Soddy, “… every monetary system must at long last conform, if it is to fulfil its proper role
    as the distributive mechanism of society. To allow it to become a source of revenue to private issuers is to create, first, a secret and illicit arm of the government and, last, a rival power strong enough ultimately to overthrow all other forms of government.”
    MAYBE, PERHAPS, We will return to “In God We Trust”, no longer the private for profit banks.
    ” Reverse, .. an economic recovery program that has privileged the recovery of financial markets and corporate profits has fueled the increase in wealth inequality, in the United States and across the world.”(THEATLANTIC.COM|BY MEHRSA BARADARAN)
    Reverse that program, make the money FLOW to “…help form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…”

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