The IMF on no-reserve banking

Karl Denninger digs up the document:

In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits. Because additional bank deposits can only be created through additional bank loans, sudden changes in the willingness of banks to extend credit must therefore not only lead to credit booms or busts, but also to an instant excess or shortage of money, and therefore of nominal aggregate demand. By contrast, under the Chicago Plan the quantity of money and the quantity of credit would become completely independent of each other. This would enable policy to control these two aggregates independently and therefore more effectively. Money growth could be controlled directly via a money growth rule. The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business. Rather, banks would become what many erroneously believe them to be today, pure intermediaries that depend on obtaining outside funding before being able to lend. Having to obtain outside funding rather than being able to create it themselves would much reduce the ability of banks to cause business cycles due to potentially capricious changes in their attitude towards credit risk.

Read that however many times you need to until it sinks in folks, because this is what I and a few others have been saying now for a long time — and our ideas are not only not really new, they’re also factually correct.

The “extraordinarily privilege” referenced above, were you or I to engage in it, would be called what it is — counterfeiting. “Generating their own funding, deposits”, is exactly that — creating money out of “thin air” though the unbacked emissions of credit. It is exactly identical in form and effect to you running off $100 bills on your office copier. And for every other entity other than a bank, it is a felony.

But it is Congress that has this power according to our Constitution. A commercial institution that operates for profit should never have the right to literally steal from you at its whim, but that is exactly what unbacked credit creation empowers a bank with — the ability to take everything you have by debasing your purchasing power to the point that you are forced to hock, or even sell and abandon, any asset you possess.

This is important if you want to understand the financial crisis and the inflation/deflation issue. Contra what you’ve been taught, loans don’t come from deposits. The loans come first. This is the “credit money” of which Mises wrote and is the reason that the mainstream economists are so confused by their continual focus on M1/M2, which are just a small fraction of the real money supply, which is Z1+M1/M2.

So, the inflationistas are correct in one sense. Inflation has been worse than is reported by the CPI-U. Vastly worse. However, this also shows why the central bank has been talking about the need to fight off deflation via “quantitative easing” despite the fact that M1/M2 have continued to increase; Z1 has been flat for four years despite the heroic efforts on the part of Washington to prop up spending by taking on a larger share of it.

As I showed in RGD, the USA is closer to a no-reserve banking system than the textbook ten percent fractional-reserve one. The credit money is pure digital counterfeiting, but it spends as readily as legal tender.