Reserve banking

Is this the end of fractional reserve banking?

Vollgeld “Full Money Initiative” of Switzerland

I can pretty much guarantee you that the biggest story that isn’t covered by the mainstream business press right now is that Switzerland to hold referendum to consider ending fractional reserve banking (!).

Yes, you read that right. This paragon of the banking sector votes on the advisability of deconstructing banking as it has been practiced for centuries. In case you can’t read German, let me share a few details with you:

  • Swiss law demands a popular referendum on any petition that receives at least 100,000 signatures verified as affirmed by the Swiss Federal Chancellery.
  • On December 24, 2015, the Federal Chancellery confirmed to that it had received 110,955 valid signatures on a petition to end fractional reserve banking.
  • The effort is officially known as the Vollgeld, or “Full Money Initiative”.
  • The date of the vote has not yet been set. But given the complexity of the issue and the fact that Swiss law allows counter-arguments, it will likely be a long process before the official referendum date is set.

In the heart of the Great Depression

How did this state of affairs even come about? The answer, it turns out, is shrouded in history. Concretely, it is hidden in the fog of the economic profession of the Great Depression. On March 16, 1933, a group of economists developed an idea known as “Chicago map“The leader of these economists was one of the grandfathers of the profession, Irving Fisher. Their obsession was to identify the causes of the Great Depression and the business cycle. Among the culprits they identified was fractional reserve banking.

In fractional reserve banks, banks keep only a small portion of the deposits they receive in their vaults and are otherwise free to lend the rest. A typical ratio is 10: 1 loans / reserves. This means that commercial banks share the responsibility for creating money in an economy with central banks, and the bank’s credit and monetary functions are intimately linked.

Yet commercial banks have a variable and volatile appetite for money creation. Chicago Plan economists believed the business cycle was directly linked to these appetites, with recessions (and the Great Depression) among the consequences. Their solution? A 1: 1 loan-to-reserve ratio, with every dollar of loans backed by deposits of $ 1. Although it generated a lot of interest at the time, the plan has been forgotten. It resurfaced briefly a few years later, following the American recession of 1937-1938, after which it faded from history again.

Chicago plan revisited

In the wake of the Great Recession, many began to reconsider Chicago’s plan. But the biggest review came after Jaromir Benes and Michael Kumhof – two economists at the International Monetary Fund (IMF) – published an article titled “Chicago plan revisitedIn August 2012. Benes and Kumhof not only revisited the Chicago plan, they tested it with modern econometric models of the economy. Before discussing the results of their modeling, what were the claimed benefits of the original Chicago plan as enunciated by Fisher in 1936?

  1. Better control of a major source of fluctuations in the business cycle, including the unpredictable expansion and contraction of bank credit and, therefore, the money supply created by banks.
  2. The complete elimination of bank runs.
  3. A dramatic reduction, if not a complete elimination, of the net public debt.
  4. A drastic reduction in private debt since money creation is no longer linked to debt creation.

These are certainly interesting claims, and if you know anything about the financial system, then you also know that the Chicago plan is nothing less than a radical overhaul and overhaul of the global financial system. But will it work? According to Benes and Kumhof, the answer is an astonishing and unequivocal ‘yes’:

“We find strong support for Fisher’s four assertions, with the potential for much smoother business cycles, no possibility of a bank run, a significant reduction in debt levels in the economy, and a replacement of that debt with debt.” public debt-free. money. Furthermore, none of these benefits come at the expense of diminishing the essential useful functions of a private financial system. Under the Chicago Plan, private financial institutions would continue to play a key role in providing a state-of-the-art payment system, facilitating the efficient allocation of capital to its most productive uses, facilitating intertemporal smoothing by households and companies. Credit, especially socially useful credit that supports real physical investment activity, would continue to exist. What would cease to exist, however, is the proliferation of created credit, almost exclusively on the initiative of private institutions, for the sole purpose of creating an adequate money supply that can easily be created without debt.

Iceland takes over

On March 20, 2015, Iceland released the results of an intensive study that explored the viability of ending fractional reserve banking. The report, commissioned by the Prime Minister, is titled: “Monetary reform: a better monetary system for Iceland. “In the words of the author, Frosti Sigurjonsson:

“[The report] offers a radical structural solution to the problems we face. The feasibility and merits of this specific solution must be debated. But whatever the precise policies pursued, they must be based on the philosophy proposed by the report: money creation is too important to be left to the bankers alone. “

What does all this mean?

By now you must be asking yourself many questions about the ramifications of ending fractional reserve banking. What does all this mean? There are several good sources of necessarily speculative answers (since no one has ever lived under a full reserve regime):

  • The papers of the IMF, Iceland, and Switzerland.
  • Learn about the Chicago map and assess the potential impacts yourself.
  • My colleague Ron Rimkus, CFA, is writing a follow-up article to discuss the ramifications. So come back here on The enterprising investor.

Editor’s Note: An early version of this article indicated that the Vollgeld referendum would take place this year. It’s not correct. The date for the referendum has not yet been set.

If you liked this article, don’t forget to subscribe to Enterprising investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.

Image credit: © / william87

Jason Voss, CFA

Jason Voss, CFA, is relentlessly focused on improving the ability of investors to better serve end customers. He is the finalist for Foreword Reviews Business Book of the Year, The intuitive investor and the CEO of Active Investment Management Consulting (AIM). Voss also subcontracts for the well-known firm Focus Consulting Group. Previously, he was a portfolio manager at Davis Selected Advisers, LP, where he co-managed the Davis Appreciation and Income Fund with outstanding returns. Voss holds a BA in Economics and an MBA in Finance and Accounting from the University of Colorado.

Ethics statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all ethics systems distil from this simple statement. If you think I have deviated from this standard I would love to hear from you: [email protected]

Leave a Reply

Your email address will not be published.