Full-reserve banking
Encyclopedia
Full-reserve banking, also known as 100% reserve banking, is a bank
ing practice in which the full amount of each depositor's
funds are kept in reserve
, as cash
or other highly liquid assets. In other words, funds deposited are not lent out
by the bank as long as the depositor retains the legal right to withdraw the funds on demand.
A few proposals have been made where 100% reserve could be combined with investment accounts, where a saver could entrust their money with a bank for investment in the full-reserve equivalent of time deposit
s or savings account
s, which in a full reserve system would represent loans made to the bank rather than deposits. This would allow banks to continue to act as an intermediary between investors and borrowers.
Full-reserve banking was practiced historically by the Bank of Amsterdam and some other early banks but was displaced by fractional reserve banking after 1800. Proposals for the restoration of full-reserve banking have been made by various economists. However, proposals for full-reserve banking are generally ignored by mainstream economists.
, Chicago economists suggested monetary reform
s, including a call to end the fractional-reserve banking
in two 1933 memorandum that came to be known as the "Chicago plan
". After an apparent recovery in the mid-1930s, America was again in recession and in 1939 economists circulated a draft proposal titled A Program for Monetary Reform
calling once more for an end to fractional-reserve banking.
Mainstream economists seldom discuss the merits of full-reserve banking, some who have examined the issue have argued that the costs and inconvenience of a full-reserve banking system would outweigh any benefits. However, monetarist and Nobel Prize
winning economist, Milton Friedman
once supported a 100% reserve requirement for checking accounts. And, well known for his advocacy of simple reforms, economist Laurence Kotlikoff
has also called for an end to fractional-reserve banking
. Austrian economists, such as Murray N. Rothbard
and Jörg Guido Hülsmann generally support full-reserve banking and hold the view that fractional-reserve banking is "fraudulent and inflationary". Following the recent financial crisis, some economists have suggested that full reserve banking should be again considered as a serious option.
Mainstream economists generally believe that the costs and inconvenience of full-reserve banking would outweigh any benefits. Since banks would not receive profits from lending out deposits, depositors would have to pay banks for keeping their money safe and providing checking and other banking services. Such a system would be difficult to implement and would likely be rejected by the public. Additionally, 100% reserve banking would prevent banks from lending funds deposited into demand accounts. This would displace lending activity into unregulated institutions, potentially destabilizing the financial system. Unregulated institutions include high-yield debt
issuers and the businesses themselves (from retained earnings
or from issuing additional shares of stock
).
of economics, full-reserve banking would eliminate (or at least greatly reduce) the financial risks associated with bank run
s, as the bank would have all the money
in reserve needed to pay depositors, regardless whether depositors actually claimed their money.
According to proponents, full reserve banking would also eliminate the need for a lender of last resort
, such as a central bank
, which is normally needed to support the banking system in times of systemic risk
or financial contagion
, as these financial risks would not exist in a full-reserve banking environment. This requires that the resources available to the banks issuing credit money and demand deposits would be sufficient to convert all currency at once if so required. It was a central component in Social Credit
proposals.
Were the United States
to adopt full-reserve, all currency would be created by the federal government, and as a result all seigniorage
revenue would also accrue to the federal government. This is in contrast to the current US system, where a large proportion of the currency supply is in the form of demand deposits created by private banks. When the Federal Reserve creates currency and uses it to buy treasury bills, it collects seigniorage revenue in the form of interest payments which it then returns to the United States (for example, in 2002 the United States earned $24.495 billion in this manner). When a private bank creates currency, the government cannot collect any seigniorage from it. Since the Federal Reserve has a target for the size of the currency stock, any currency created by private banks is currency that is not created by the Fed and thus constitutes lost seigniorage. Some consider this an illegitimate "privatization" of what should be a public good, with these profits (i.e. taxes) being retained by the government to finance essential social services and capital works.
Because fractional-reserve banking necessarily increases the money supply
, which arguably causes monetary inflation
, a few economists (most from the Austrian School
) consider this aspect of fractional-reserve banking to have deleterious and destabilizing effects on the economy over time. It is argued by these economists that, in contrast to fractional-reserve banking, full-reserve banking guarantees a stable money supply, which ensures that the means of exchange is not debased over time. This improves the efficiency of the price mechanism, promotes saving and the deferral of consumption, provides much greater confidence in the financial system and in the integrity of all commercial transactions and therefore encourages sustainable, non-speculative, productive investment.
s operating in such a system would be 100%, making the deposit multiplier equal to one (1xM=M). This contrasts with fractional-reserve banking
, in which the bank would hold only a fraction of all client deposits as reserves with the remainder used to supply loans and create credit.
Some advocates believe that full-reserve banking should only apply to demand not fixed loan deposits. The distinction that full reservists make is that demand deposits such as checking and some modern savings accounts are available for immediate use by the owner of the account, whereas a traditional savings account is restricted.
in banks making investment and lending decisions, as they have access to knowledge and expertise which individual investors or lenders generally do not. Under full-reserve banking, a great deal of money would sit idle, as savers stored up their money, while entrepreneurs went without much-needed capital.
The criticism that full reserve banking prevents banks from performing financial intermediation would not apply to full-reserve proposals that allow for unbacked accounts that are essentially loans to commercial banks, as for example the proposal described in "A Program for Monetary Reform
". Otherwise, banks could only perform financial intermediation with funds from a time deposit
account such as a certificate of deposit
.
s have several methods of controlling the money supply. For one method, they set the reserve fraction (either explicitly or through the use of monetary policy tools like the paying of interest on excess reserves). In another method, they buy and sell assets on the open market. Full-reserve banking removes the need for setting a reserve fraction, as the effective reserve fraction is one. Some supporters of full-reserve banking also support a gold standard. The combination of the two would eliminate the need for open market purchases and related policy tools, as the money supply size would then be fixed by the amount of the commodity; the value of money would also be tied to the value of one commodity. This creates additional criticisms that do not apply to full-reserve banking with fiat money
.
Among criticisms of a full-reserve banking system is the argument that full-reserve banking combined with commodity money
(e.g. a gold standard
) implicitly means that there is no government-controlled "monetary policy
" at all. Critics also argue that a full-reserve, commodity money system leaves us with an inelastic currency. Proponents argue that the lack of a government-manipulated currency (the lack of a "monetary policy") and the presence of a sound currency (as opposed to an "elastic" one) are advantages to a full-reserve, commodity money system. More subtly, since full-reserve banking combined with commodity money means that during periods of high demand for money, the prices of other goods must fall, the broader real economy may bear adjustment costs that are (in principle) no different from those it would bear during periods of moderate inflation (that is, if the cost of adjusting to absolute prices is low or negligible, moderate inflation should be no more problematic than moderate deflation). However, this subsequent deflationary effect is likely to have deleterious consequences if some prices are stickier
than others; in particular, wages are often significantly stickier than other prices. Most economists believe that given wage stickiness, the adjustment costs of deflation are significantly higher to employers than an equivalent inflation.
Pascal Salin
, former professor at the Université Paris-Dauphine and former Mont Pelerin Society
president, opposes such regulation of banking and disputes Murray Rothbard's characterization of fractional-reserve banking as a simple form of recursive embezzlement
. He argues that a situation of perfect certainty doesn't exist even in a full-reserve banking system. He also argues that in a perfectly free banking
system any customer must be free to choose the kind of notes and the system of payments for services he prefers since optimality cannot be defined independent of the wants of the individual.
Advocates of full-reserve banking do not necessarily advocate that the government lay down regulations stipulating a full-reserve system. In fact, some economists, such as Murray Rothbard
(of the Austrian School
) believe that government intervention sustains fractional-reserve banking, as governments have formalized the practice by making it legal and supporting it through the creation of central banks. Murray Rothbard argues that in doing this they have prevented periodic bank runs and other natural checks that would otherwise be placed on banks by astute customers, anti-fractional-reserve consumer groups, and other such organizations. Rothbard expresses this concern, and argues the case for 100% gold or silver-backed money, in his book What Has Government Done to Our Money?
and other prominent published works. Austrian monetary theorist George Selgin
disputes the Rothbardian account, arguing: "Those self-styled Austrian economists, mostly followers of Murray Rothbard, who insist on its fraudulent nature or inherent instability are, frankly, making poor arguments. I don't think the evidence supports their view, and that they overlook overwhelming proof of the benefits that fractional reserve banking has brought in the way of economic development by fostering investment."
Depositors under gold standard / full-reserve banking pay for banking services through one or more fees: metallurgical assay
, deposit, transfer, storage, and withdrawal. Storage fees are the most problematic. If money, but not the gold, is transferred outside the bank (e.g. cheque
, Automated Clearing House
, wire transfer
), the depositor would be paying to store the recipient's gold.
is often synonymous with full-reserve banking, with banks achieving a 100% reserve ratio. In practice, however, this is not the case, and no examples of 100 percent reserve banking are observed. According to Islami Bank Bangladesh:
called digital gold currency
has been in circulation. Many of these currency providers claim to act like full-reserve "private bank
s" with a one-to-one ratio of the currency they issue and the hard asset, usually gold
or silver
, that they store as reserves. The most prominent example is e-gold
, which is encountering various legal issues. Also available are physical gold exchangers and storage providers, such as BullionVault
.
Some monetary reform
ers believe a new free market will emerge in money production and distribution, as the Internet
allows renewed decentralisation and competition in this area, eroding the central government
's and bankers' old monopoly
control of the means of exchange. Some monetary reformers believe that in a genuine free market, where government did not impose a monopoly currency on the populace, a predominantly full-reserve banking system, backed by a gold standard
or silver standard
monetary system, would arise spontaneously out of the free market
.
Others argue, and cite current digital gold services as examples, that the free market favors fractional reserve banking and that 100% reserve banking can only meet the needs of a small, extremely risk-adverse, niche market.
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
ing practice in which the full amount of each depositor's
Deposit account
A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the...
funds are kept in reserve
Bank reserves
Bank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in the bank's vault . The central banks of some nations set minimum reserve requirements...
, as cash
Cash
In common language cash refers to money in the physical form of currency, such as banknotes and coins.In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately...
or other highly liquid assets. In other words, funds deposited are not lent out
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
by the bank as long as the depositor retains the legal right to withdraw the funds on demand.
A few proposals have been made where 100% reserve could be combined with investment accounts, where a saver could entrust their money with a bank for investment in the full-reserve equivalent of time deposit
Time deposit
A time deposit is a money deposit at a banking institution that cannot be withdrawn for a certain "term" or period of time...
s or savings account
Savings account
Savings accounts are accounts maintained by retail financial institutions that pay interest but cannot be used directly as money . These accounts let customers set aside a portion of their liquid assets while earning a monetary return...
s, which in a full reserve system would represent loans made to the bank rather than deposits. This would allow banks to continue to act as an intermediary between investors and borrowers.
Full-reserve banking was practiced historically by the Bank of Amsterdam and some other early banks but was displaced by fractional reserve banking after 1800. Proposals for the restoration of full-reserve banking have been made by various economists. However, proposals for full-reserve banking are generally ignored by mainstream economists.
Debate over full-reserve banking
During the Great DepressionGreat Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
, Chicago economists suggested monetary reform
Monetary reform
Monetary reform describes any movement or theory that proposes a different system of supplying money and financing the economy from the current system.Monetary reformers may advocate any of the following, among other proposals:...
s, including a call to end the fractional-reserve banking
Fractional-reserve banking
Fractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves...
in two 1933 memorandum that came to be known as the "Chicago plan
Chicago plan
The Chicago plan was a collection of banking reforms suggested by University of Chicago economists in the wake of the Great Depression. A six-page memorandum on banking reform was given limited and confidential distribution to about 40 individuals on March 16, 1933. The plan was supported by such...
". After an apparent recovery in the mid-1930s, America was again in recession and in 1939 economists circulated a draft proposal titled A Program for Monetary Reform
A Program for Monetary Reform
A Program for Monetary Reform is a July 1939 first draft proposal to repair and rebuild the American economic system following the Great Depression which began with the sudden, devastating collapse of US stock market prices on October 29, 1929, known as Black Tuesday and after apparent recovery in...
calling once more for an end to fractional-reserve banking.
Mainstream economists seldom discuss the merits of full-reserve banking, some who have examined the issue have argued that the costs and inconvenience of a full-reserve banking system would outweigh any benefits. However, monetarist and Nobel Prize
Nobel Memorial Prize in Economic Sciences
The Nobel Memorial Prize in Economic Sciences, commonly referred to as the Nobel Prize in Economics, but officially the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel , is an award for outstanding contributions to the field of economics, generally regarded as one of the...
winning economist, Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
once supported a 100% reserve requirement for checking accounts. And, well known for his advocacy of simple reforms, economist Laurence Kotlikoff
Laurence Kotlikoff
Laurence Jacob Kotlikoff is a William Warren FairField Professor at Boston University, a Professor of Economics at Boston University, a Fellow of the American Academy of Arts and Sciences, a Research Associate of the National Bureau of Economic Research, a Fellow of the Econometric Society, a...
has also called for an end to fractional-reserve banking
. Austrian economists, such as Murray N. Rothbard
Murray Rothbard
Murray Newton Rothbard was an American author and economist of the Austrian School who helped define capitalist libertarianism and popularized a form of free-market anarchism he termed "anarcho-capitalism." Rothbard wrote over twenty books and is considered a centrally important figure in the...
and Jörg Guido Hülsmann generally support full-reserve banking and hold the view that fractional-reserve banking is "fraudulent and inflationary". Following the recent financial crisis, some economists have suggested that full reserve banking should be again considered as a serious option.
Mainstream economists generally believe that the costs and inconvenience of full-reserve banking would outweigh any benefits. Since banks would not receive profits from lending out deposits, depositors would have to pay banks for keeping their money safe and providing checking and other banking services. Such a system would be difficult to implement and would likely be rejected by the public. Additionally, 100% reserve banking would prevent banks from lending funds deposited into demand accounts. This would displace lending activity into unregulated institutions, potentially destabilizing the financial system. Unregulated institutions include high-yield debt
High-yield debt
In finance, a high-yield bond is a bond that is rated below investment grade...
issuers and the businesses themselves (from retained earnings
Retained earnings
In accounting, retained earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends. Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or...
or from issuing additional shares of stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
).
The case for full reserve
According to the Austrian SchoolAustrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
of economics, full-reserve banking would eliminate (or at least greatly reduce) the financial risks associated with bank run
Bank run
A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent...
s, as the bank would have all the money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
in reserve needed to pay depositors, regardless whether depositors actually claimed their money.
According to proponents, full reserve banking would also eliminate the need for a lender of last resort
Lender of last resort
A lender of last resort is an institution willing to extend credit when no one else will. The term refers especially to a reserve financial institution, most often the central bank of a country, intended to avoid bankruptcy of banks or other institutions deemed systemically important or 'too big to...
, such as a central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
, which is normally needed to support the banking system in times of systemic risk
Systemic risk
In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by...
or financial contagion
Financial contagion
Financial contagion refers to a scenario in which small shocks, which initially affect only a few financial institutions or a particular region of an economy, spread to the rest of financial sectors and other countries whose economies were previously healthy, in a manner similar to the transmission...
, as these financial risks would not exist in a full-reserve banking environment. This requires that the resources available to the banks issuing credit money and demand deposits would be sufficient to convert all currency at once if so required. It was a central component in Social Credit
Social Credit
Social Credit is an economic philosophy developed by C. H. Douglas , a British engineer, who wrote a book by that name in 1924. Social Credit is described by Douglas as "the policy of a philosophy"; he called his philosophy "practical Christianity"...
proposals.
Were the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
to adopt full-reserve, all currency would be created by the federal government, and as a result all seigniorage
Seigniorage
Seigniorage can have the following two meanings:* Seigniorage derived from specie—metal coins, is a tax, added to the total price of a coin , that a customer of the mint had to pay to the mint, and that was sent to the sovereign of the political area.* Seigniorage derived from notes is more...
revenue would also accrue to the federal government. This is in contrast to the current US system, where a large proportion of the currency supply is in the form of demand deposits created by private banks. When the Federal Reserve creates currency and uses it to buy treasury bills, it collects seigniorage revenue in the form of interest payments which it then returns to the United States (for example, in 2002 the United States earned $24.495 billion in this manner). When a private bank creates currency, the government cannot collect any seigniorage from it. Since the Federal Reserve has a target for the size of the currency stock, any currency created by private banks is currency that is not created by the Fed and thus constitutes lost seigniorage. Some consider this an illegitimate "privatization" of what should be a public good, with these profits (i.e. taxes) being retained by the government to finance essential social services and capital works.
Because fractional-reserve banking necessarily increases the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
, which arguably causes monetary inflation
Monetary inflation
Monetary inflation is a sustained increase in the money supply of a country. It usually results in price inflation, which is a rise in the general level of prices of goods and services . Originally the term "inflation" was used to refer only to monetary inflation, whereas in present usage it...
, a few economists (most from the Austrian School
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
) consider this aspect of fractional-reserve banking to have deleterious and destabilizing effects on the economy over time. It is argued by these economists that, in contrast to fractional-reserve banking, full-reserve banking guarantees a stable money supply, which ensures that the means of exchange is not debased over time. This improves the efficiency of the price mechanism, promotes saving and the deferral of consumption, provides much greater confidence in the financial system and in the integrity of all commercial transactions and therefore encourages sustainable, non-speculative, productive investment.
Reserve ratio
The reserve ratio of all bankBank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s operating in such a system would be 100%, making the deposit multiplier equal to one (1xM=M). This contrasts with fractional-reserve banking
Fractional-reserve banking
Fractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves...
, in which the bank would hold only a fraction of all client deposits as reserves with the remainder used to supply loans and create credit.
Some advocates believe that full-reserve banking should only apply to demand not fixed loan deposits. The distinction that full reservists make is that demand deposits such as checking and some modern savings accounts are available for immediate use by the owner of the account, whereas a traditional savings account is restricted.
Criticisms
The most common criticism of full-reserve banking, and by contrast, argument for fractional reserve banking, is the need for financial intermediation. Small savers often cannot lend or invest their meager savings, for want of knowledge and sufficient capital to make a loan. Likewise, without financial intermediaries, borrowers must seek out someone who can loan them the exact amount they need, instead of being able to draw on several loans from different small savers. Savers also face significant risk as individual investors, since if they lend to a single firm or individual, that entity can collapse, with the saver having lost the money they lent. Furthermore, if they act as individual lenders, savers must wait for their loans to mature before recouping their money; a bank can make their deposits available at any time. There are also significant economies of scaleEconomies of scale
Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...
in banks making investment and lending decisions, as they have access to knowledge and expertise which individual investors or lenders generally do not. Under full-reserve banking, a great deal of money would sit idle, as savers stored up their money, while entrepreneurs went without much-needed capital.
The criticism that full reserve banking prevents banks from performing financial intermediation would not apply to full-reserve proposals that allow for unbacked accounts that are essentially loans to commercial banks, as for example the proposal described in "A Program for Monetary Reform
A Program for Monetary Reform
A Program for Monetary Reform is a July 1939 first draft proposal to repair and rebuild the American economic system following the Great Depression which began with the sudden, devastating collapse of US stock market prices on October 29, 1929, known as Black Tuesday and after apparent recovery in...
". Otherwise, banks could only perform financial intermediation with funds from a time deposit
Time deposit
A time deposit is a money deposit at a banking institution that cannot be withdrawn for a certain "term" or period of time...
account such as a certificate of deposit
Certificate of deposit
A certificate of Deposit is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions....
.
Criticisms of full-reserve banking combined with a gold standard
Central bankCentral bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
s have several methods of controlling the money supply. For one method, they set the reserve fraction (either explicitly or through the use of monetary policy tools like the paying of interest on excess reserves). In another method, they buy and sell assets on the open market. Full-reserve banking removes the need for setting a reserve fraction, as the effective reserve fraction is one. Some supporters of full-reserve banking also support a gold standard. The combination of the two would eliminate the need for open market purchases and related policy tools, as the money supply size would then be fixed by the amount of the commodity; the value of money would also be tied to the value of one commodity. This creates additional criticisms that do not apply to full-reserve banking with fiat money
Fiat money
Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.Fiat money originated in 11th...
.
Among criticisms of a full-reserve banking system is the argument that full-reserve banking combined with commodity money
Commodity money
Commodity money is money whose value comes from a commodity out of which it is made. It is objects that have value in themselves as well as for use as money....
(e.g. a gold standard
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
) implicitly means that there is no government-controlled "monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
" at all. Critics also argue that a full-reserve, commodity money system leaves us with an inelastic currency. Proponents argue that the lack of a government-manipulated currency (the lack of a "monetary policy") and the presence of a sound currency (as opposed to an "elastic" one) are advantages to a full-reserve, commodity money system. More subtly, since full-reserve banking combined with commodity money means that during periods of high demand for money, the prices of other goods must fall, the broader real economy may bear adjustment costs that are (in principle) no different from those it would bear during periods of moderate inflation (that is, if the cost of adjusting to absolute prices is low or negligible, moderate inflation should be no more problematic than moderate deflation). However, this subsequent deflationary effect is likely to have deleterious consequences if some prices are stickier
Sticky (economics)
Sticky, in the social sciences and particularly economics, describes a situation in which a variable is resistant to change. Sticky prices are an important part of macroeconomic theory since they may be used to explain why markets might not reach equilibrium right away. Nominal wages are often said...
than others; in particular, wages are often significantly stickier than other prices. Most economists believe that given wage stickiness, the adjustment costs of deflation are significantly higher to employers than an equivalent inflation.
Pascal Salin
Pascal Salin
Pascal Salin is a libertarian French economist, professor at the Université Paris-Dauphine and a specialist in public finance. He is a former president of the Mont Pelerin Society ....
, former professor at the Université Paris-Dauphine and former Mont Pelerin Society
Mont Pelerin Society
The Mont Pelerin Society is an international organization composed of economists , philosophers, historians, intellectuals, business leaders, and others who favour classical liberalism...
president, opposes such regulation of banking and disputes Murray Rothbard's characterization of fractional-reserve banking as a simple form of recursive embezzlement
Embezzlement
Embezzlement is the act of dishonestly appropriating or secreting assets by one or more individuals to whom such assets have been entrusted....
. He argues that a situation of perfect certainty doesn't exist even in a full-reserve banking system. He also argues that in a perfectly free banking
Free banking
Free banking refers to a monetary arrangement in which banks are subject to no special regulations beyond those applicable to most enterprises, and in which they also are free to issue their own paper currency...
system any customer must be free to choose the kind of notes and the system of payments for services he prefers since optimality cannot be defined independent of the wants of the individual.
Advocates of full-reserve banking do not necessarily advocate that the government lay down regulations stipulating a full-reserve system. In fact, some economists, such as Murray Rothbard
Murray Rothbard
Murray Newton Rothbard was an American author and economist of the Austrian School who helped define capitalist libertarianism and popularized a form of free-market anarchism he termed "anarcho-capitalism." Rothbard wrote over twenty books and is considered a centrally important figure in the...
(of the Austrian School
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
) believe that government intervention sustains fractional-reserve banking, as governments have formalized the practice by making it legal and supporting it through the creation of central banks. Murray Rothbard argues that in doing this they have prevented periodic bank runs and other natural checks that would otherwise be placed on banks by astute customers, anti-fractional-reserve consumer groups, and other such organizations. Rothbard expresses this concern, and argues the case for 100% gold or silver-backed money, in his book What Has Government Done to Our Money?
What Has Government Done to Our Money?
What Has Government Done to Our Money? is a book by Murray N. Rothbard that details the history of money, from early barter systems, to the gold standard, to present day systems of paper money.- How money developed :...
and other prominent published works. Austrian monetary theorist George Selgin
George Selgin
George A. Selgin is a professor of economics in the Terry College of Business at the University of Georgia, a senior fellow at the Cato Institute in Washington DC, and an associate editor of Econ Journal Watch...
disputes the Rothbardian account, arguing: "Those self-styled Austrian economists, mostly followers of Murray Rothbard, who insist on its fraudulent nature or inherent instability are, frankly, making poor arguments. I don't think the evidence supports their view, and that they overlook overwhelming proof of the benefits that fractional reserve banking has brought in the way of economic development by fostering investment."
Depositors under gold standard / full-reserve banking pay for banking services through one or more fees: metallurgical assay
Metallurgical assay
A metallurgical assay is a compositional analysis of an ore, metal, or alloy.Some assay methods are suitable for raw materials; others are more appropriate for finished goods. Raw precious metals are assayed by an assay office...
, deposit, transfer, storage, and withdrawal. Storage fees are the most problematic. If money, but not the gold, is transferred outside the bank (e.g. cheque
Cheque
A cheque is a document/instrument See the negotiable cow—itself a fictional story—for discussions of cheques written on unusual surfaces. that orders a payment of money from a bank account...
, Automated Clearing House
Automated Clearing House
Automated Clearing House is an electronic network for financial transactions in the United States. ACH processes large volumes of credit and debit transactions in batches. ACH credit transfers include direct deposit payroll and vendor payments. ACH direct debit transfers include consumer payments...
, wire transfer
Wire transfer
Wire transfer or credit transfer is a method of electronic funds transfer from one person or institution to another. A wire transfer can be made from one bank account to another bank account or through a transfer of cash at a cash office...
), the depositor would be paying to store the recipient's gold.
Current examples
There are currently no examples of full reserve banking with an established history of operation. However, a variety of organizations aspire to provide full-reserve banking or claim to do so.Islamic banking
In theory, Islamic bankingIslamic banking
Islamic banking is banking or banking activity that is consistent with the principles of Islamic law and its practical application through the development of Islamic economics. Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees for loans of money...
is often synonymous with full-reserve banking, with banks achieving a 100% reserve ratio. In practice, however, this is not the case, and no examples of 100 percent reserve banking are observed. According to Islami Bank Bangladesh:
Digital gold or silver
Since 1996, a form of private currencyPrivate currency
A private currency is a currency issued by a private organization. It is often contrasted with fiat currency issued by governments or central banks. In many countries, the issue of private paper currencies is severely restricted by law....
called digital gold currency
Digital gold currency
Digital gold currency is a form of electronic money based on ounces of gold. It is a kind of representative money, like a US paper gold certificate at the time that these were exchangeable for gold on demand. The typical unit of account for such currency is the gold gram or the troy ounce,...
has been in circulation. Many of these currency providers claim to act like full-reserve "private bank
Private bank
Private banks are banks that are not incorporated. A private bank is owned by either an individual or a general partner with limited partner...
s" with a one-to-one ratio of the currency they issue and the hard asset, usually gold
Gold
Gold is a chemical element with the symbol Au and an atomic number of 79. Gold is a dense, soft, shiny, malleable and ductile metal. Pure gold has a bright yellow color and luster traditionally considered attractive, which it maintains without oxidizing in air or water. Chemically, gold is a...
or silver
Silver
Silver is a metallic chemical element with the chemical symbol Ag and atomic number 47. A soft, white, lustrous transition metal, it has the highest electrical conductivity of any element and the highest thermal conductivity of any metal...
, that they store as reserves. The most prominent example is e-gold
E-gold
e-gold is a digital gold currency operated by Gold & Silver Reserve Inc. under e-gold Ltd., and allowed the instant transfer of gold ownership between users until 2009 when transfers were suspended due to legal issues. e-gold Ltd...
, which is encountering various legal issues. Also available are physical gold exchangers and storage providers, such as BullionVault
BullionVault
BullionVault is an internet gold and silver bullion exchange, founded in 2005 by Paul Tustain. It is owned by Galmarley Ltd. and based in London, United Kingdom. Purchased gold and silver is held in personally allocated storage with Via Mat International in either London, New York or Zurich...
.
Some monetary reform
Monetary reform
Monetary reform describes any movement or theory that proposes a different system of supplying money and financing the economy from the current system.Monetary reformers may advocate any of the following, among other proposals:...
ers believe a new free market will emerge in money production and distribution, as the Internet
Internet
The Internet is a global system of interconnected computer networks that use the standard Internet protocol suite to serve billions of users worldwide...
allows renewed decentralisation and competition in this area, eroding the central government
Central government
A central government also known as a national government, union government and in federal states, the federal government, is the government at the level of the nation-state. The structure of central governments varies from institution to institution...
's and bankers' old monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
control of the means of exchange. Some monetary reformers believe that in a genuine free market, where government did not impose a monopoly currency on the populace, a predominantly full-reserve banking system, backed by a gold standard
Gold standard
The gold standard is a monetary system in which the standard economic unit of account is a fixed mass of gold. There are distinct kinds of gold standard...
or silver standard
Silver standard
The silver standard is a monetary system in which the standard economic unit of account is a fixed weight of silver. The silver specie standard was widespread from the fall of the Byzantine Empire until the 19th century...
monetary system, would arise spontaneously out of the free market
Free market
A free market is a competitive market where prices are determined by supply and demand. However, the term is also commonly used for markets in which economic intervention and regulation by the state is limited to tax collection, and enforcement of private ownership and contracts...
.
Others argue, and cite current digital gold services as examples, that the free market favors fractional reserve banking and that 100% reserve banking can only meet the needs of a small, extremely risk-adverse, niche market.