The advantages of the full reserve banking system, when compared to the current fiat system, will become all too clear to students of monetary economics in the years ahead, but you might not hear much about it until our current financial system collapses.
Our predicament of unserviceable debts, insatiable government spending programs, and ever-increasing budget/trade deficits are all terrible omens of a forthcoming global financial crisis the like of which we have never before seen.
The full reserve banking system will not prevent the coming collapse, but it may emerge from it as a better way forward once the collapse is upon us.
As the name implies, a full reserve system would force our banks to hold in reserve all of their customers’ current account deposits (also called ‘demand-deposits’ i.e., not including savings deposits or ‘time-deposits’).
The system would be initiated by the central-bank printing new money with which to purchase interest-bearing assets from the commercial banks. This process would continue until the banks had raised enough money from the sale of these non-liquid assets that they have enough money to backup their entire demand-deposit liabilities.
They would be prevented from loaning out a single penny of this backup money, and they would need to maintain a 100% backup in future in order to cover any increase in the size of their customers’ current account money.
When the economy enters a growth period, and both consumer & business confidence improve, our current fractional reserve system encourages banks to rapidly accelerate their lending in an unsustainable way. This lending is fueled by loaning out a larger multiple of the money deposited in current accounts.
As history has repeatedly proven, this leads to a rapid expansion of the entire money supply, with inevitable overheating that leads to the boom-bust business cycle. See my page about the money multiplier for more explanation on this.
Keep in mind that savings deposits are excluded from the 100% reserve requirement. This is because any increase in aggregate spending by borrowers is completely offset by reductions in aggregate spending by savers. Money saved in time deposits cannot be loaned out multiple times, because it does not circulate multiple times, it is tied to investments.
In a full reserve banking system, it is only when person A saves more (and thereby spends less) that person B can borrow more (and thereby spend more). Total spending remains the same, the total money supply is unaltered, and therefore this type of lending creates no impetus for a new boom-bust cycle to begin.
A near elimination of the business cycle would result, because no malinvestment during boom-periods, and no increase in unemployment or bankruptcies during bust-periods, can occur.
Another pleasing side-effect is that there can be no excessive profits for greedy bankers, or huge golden-handshake pension rewards, as they walk away from the catastrophic recessions that they themselves cause.
The full reserve banking system is a much fairer system.
Similarly, with no business cycle caused by periodic excessive bank lending, it would be virtually impossible to ever have another serious financial crisis. Even if a bank-run were to somehow begin, with people rushing to get their money out of the banks, those banks would be able to immediately repay every single penny that they owe – because everything that they owe, at any point in time, is held in reserve!
A full reserve banking system has never been tried before… and so there is significant risk and uncertainty involved.
We can’t be sure that the banks would not be able create excessive credit via some other means. People are extremely resourceful and the free-market has a way of creating supply whenever there is a demand.
For example, some other medium of exchange, one that’s outside of government and the banking system’s control, might be used to increase lending when economic circumstances are primed for a new boom-bust cycle.
Perhaps cryptocurrency could somehow fulfill this role, although it is difficult to see how this could happen without a complicit government.
For the full reserve banking system to work, it is an absolute necessity that the authorities are wholly committed to making it work. The simplicity of the system would make it much easier for the government to avoid its customary incompetence with such matters, but no system can succeed without a firm commitment towards making it work.
If the current fractional reserve banking system is to end, a full reserve banking system is not the only candidate to replace it. Many proponents favor a return to ‘sound money’ i.e., a system of representative money backed by gold or silver, or possibly some other precious commodity.
The classical gold standard that operated from the late 1870s until the outbreak of World War 1 in 1914 was a system that presided over unprecedented growth and stability, and there is much to be said for such a system. It would certainly be far better than what we currently have, and it may well be that if faith is lost in our fiat currencies, then only something like a gold-backed representative money could restore confidence.
An amalgam of a new gold standard with a full reserve system is another option.
Objections from the west will no doubt counter the arguments in favor of using gold (or silver) in any way, because so much of it is owned and produced by China and Russia, and any adoption of gold as backing for our currencies would require a massive increase in its price, thereby enriching these rival countries.
The current focus of policy for our political elites is clearly on the development of CBDCs, but these are unlikely to restore confidence in our currency once it is lost. There is simply no reason to imagine that people who have lost faith in a paper dollar will somehow be content to accept a digital form of that dollar.
A CBDC would actually mimic some of the properties of a full reserve currency in that the commercial banking system would become somewhat obsolete, and unable to stoke the boom-bust cycle via expanding the money supply. This is because we would all be banking directly with the central-bank, and the authorities would have total control over the money-supply.
This, of course, raises its own very serious concerns regarding our personal privacy and freedoms. It would represent a massive power-shift into the hands of the government, and that alone should give anyone cause for concern.
Only time will tell how this will unfold, but I predict that a full reserve banking system is likely to receive a great deal more attention in the years ahead, as a possible replacement for our current failing monetary system.
To get my latest updates sent straight to your inbox, just add your details below: