by From Joseph Huber Impaired ability of banks to lend and invest? One of the concerns that have been expressed about the introduction of digital currency (DC) is that with a growing share of DC “deposit-funded bank credit might be undermined” and that “with too widespread a DC, it might threaten the banks’ lending activity, if banks cannot use deposits for that purpose”. Such statements are totally missing the point. Under fractional reserve banking, deposits are not loanable funds for the banks, and banks are not financial intermediaries but creators, de- and re-activators and extinguishers of bankmoney. The proposals published so far do not intend to strip banks of the privilege to create themselves the money on which they operate in their business with nonbanks. The banks’ ability
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from Joseph Huber
Impaired ability of banks to lend and invest?
One of the concerns that have been expressed about the introduction of digital currency (DC) is that with a growing share of DC “deposit-funded bank credit might be undermined” and that “with too widespread a DC, it might threaten the banks’ lending activity, if banks cannot use deposits for that purpose”. Such statements are totally missing the point. Under fractional reserve banking, deposits are not loanable funds for the banks, and banks are not financial intermediaries but creators, de- and re-activators and extinguishers of bankmoney.
The proposals published so far do not intend to strip banks of the privilege to create themselves the money on which they operate in their business with nonbanks. The banks’ ability to create bankmoney at their discretion will fully be maintained rather than impaired – and this is what creates problems in the first place.
A new problem that could arise, however, is a temporary shortage of eligible securities if customers demand too much bankmoney to be converted into DC in too short a time. This is analogous to a bank run, representing a run on DC rather than traditional cash. In either case, the problem continues to be the in-built lack of bank liquidity and easy-to-liquidate assets in any bankmoney regime based on fractional reserves.
Fractional reserve banking and bank runs
Not surprisingly then, the biggest concern of DC designers is mass migration from bankmoney to DC, that is, a veritable bank run. This remains a problem – not, however, a problem with DC (that is, central-bank money, representing safe sovereign money in most currency areas), but the fundamental problem of bankmoney based on fractional reserves. It is irksome when the bank run problem is attributed to the introduction of DC, when in actual fact it is a persistent threat inherent in bankmoney.
The continued creation of bankmoney will remain a major source of instability. In substantial volumes, DC can mitigate the dynamics of monetary overshoot and proneness to crisis inherent in the bankmoney regime, but DC cannot prevent those dynamics, particularly because, in the current proposals, it is not the central bank but the banks themselves who in the first instance decide whether and how much money to create.
The long existing problem of bank runs in the bankmoney regime is normally much played down, whereas when discussing DC it is unduly exaggerated. Bank runs do not occur in a situation of business-as-usual; they arise when banks get into trouble. Sovereign money and bankmoney have coexisted for over three hundred years, at first in the form of precious metal coins coexisting with private banknotes, and subsequently in the form of central-bank cash (notes and coins) coexisting with bankmoney (deposit money). What would overall be different if this problem-ridden coexistence were to continue with DC used side by side with bankmoney?
Crises of various kinds will recur. The demand for cash and safe DC then will increase
accordingly, and the banking sector will not be able, in the short run and in standard ways, to procure enough eligible securities to take up enough money to fulfil its largely empty promise to convert bankmoney into cash or DC. Such a situation would indeed be destabilising. Central banks would have little choice but to resort again to Quantitative Easing (QE). However, if DC devices and currency accounts were available, central banks could do QE in a more effective and sensible way than has hitherto been the case.