Fractional Reserve Banking And Its Discontents

My current plan is to mainly work on a new manuscript with the working title “Fractional Reserve Banking And Its Discontents.” This is a combination of a primer on banking, as well as an attempt to discuss some of the common sources of mysticism about banking.

Please note that I have entered into “summer publishing mode,” and so my output will reduced over the next couple of months. My plan is to keep up a pace of one article a week.

As I have noted before, I have put my inflation primer on the back burner. I want to see inflation rates roll over so that I can offer some kind of a retrospective on the current inflation spike. Publishing a book with inflation rates hitting modern records at the last data point without discussing the situation seems awkward.

I also have been looking a bit at my agent-based modelling code. Whether I can add banks to them is an interesting question.

The rest of this article is how I see narrative of “Fractional Reserve Banking.”

Fractional Reserve Banking

I see two main writing objectives for the book.

1. Basics of how traditional banking works, as well as how banks fit in with the macroeconomy. Since there is already a very large literature of lurid banking collapse narratives, I will lean to the non-alarmist side.

2. Myths about banking, particularly anything involving “fractional reserves.”

I am not going to attempt to describe how to analyse a bank, nor get into all the complex business lines that global banks have entered into.

Explaining how banks work is straightforward in one sense — I just need to cover the facts, and try to explain them. The only real issue for me is finding references. The obvious challenge to this aspect is that it is clear that very few people understand how banks work — so if there are good primers, they were not read or understood.

The myths and controversies about banking is obviously the most interesting, but covering these poses some writing challenges. There seem to be three main areas of myth to cover.

1. The most arcane one is the ongoing debate between conventional economists and post-Keynesians regarding “what limits bank lending?” In this case, I can cite some well-known mainstream economists, and then explain why they are wrong. Although that might be fun, it is very much an issue that only matters to the people who care about economic theory wars. One problem with addressing that audience is that everyone involved has their mind made up on the topic. The advantage I see here is that since I am not an academic, I am free to point out that both sides in this debate have retreated into arguing arcane formulations that have been enshrined in the literature. The formulaic nature of the debate at present explains why there is no progress — both sides repeat their views, and go back to whatever else they were doing.

2. Banks and financial crises allows me to trot out some Minsky-ite analysis. Once again, although I do expect banking systems to periodically blow themselves up, they can go extended periods between crises. As such, I probably want to be less alarmist than a lot of the popular literature after the Financial Crisis.

3. The most “exciting” one would be discussing the loopy theories about “fractional reserve banking” that pervade the internet — courtesy of internet Austrians, and now the crypto crowd. Note that this topic partly bleeds into the previous, since the banks “fractional reserve lending” creates the potential for losses for depositors in a banking crisis.

The problem with the last topic is the issue of finding reliable views to critique. Almost everyone who brings up the topic of “bank reserves” in the context of developed economies that have abolished required reserves (which now includes the United States) do not know what they are talking about. Why exactly do I want to cite someone who knows nothing about banking in my book?

Even if I cite one of the popular fractional reserve worriers, once I dissect what they have to say, it will be clear that their analysis is clownish. An entirely reasonable response would be “Well, you just picked a weak argument! What about {name of another person who also knows nothing about banking}?”

The situation has parallels with that of MMT critics, but with a key difference. If someone based their critique solely upon what some random people on Twitter write, one would have a hard time coming up with a solid version of MMT to critique. The solution in the case of MMT is to read academic articles, and possibly popular articles/books by recognised MMT academics. (If the critic was an academic, it is a rather embarrassing commentary on the state of scholarship in mainstream economics that I need to point out that you should read the academic literature before critiquing a school of thought.)

Well, what about the “fractional reserve banking” worriers, who invariably make Austrian economics-sounding points? The problem is straightforward: if there are academics that have published anything on the topic after 1960, I have not heard of it. And that is not just me ignoring Austrians, I used to read popular Austrian newsletters for entertainment (back when I worked for a firm that was paying for the subscriptions). Why not go back to the pre-1960s Austrian academics? Well, banks in a gold standard operated in a different fashion than banks within modern fiat currency economies.

Perhaps some of my readers can offer suggestions. On my part, I might browse my local library — whoever picks the English economics books loves “fiat currencies are doomed!” books. However, it is somewhat awkward citing a book predicting the imminent collapse of the U.S. dollar that was published in 2006.