A Chicago plan for reforming banks

This week I came across a couple of articles about the Chicago  Plan for reforming banks and I like it because it proposes changing the way in which we create money and gets rid of the evils of fractional reserve money.

This plan was proposed in the 1930s by some economists from  Chicago and suggests banks be reorganized into two separate identities.  One type of bank would only accept deposits which would be kept 100 per cent with a central bank.  This type of bank would probably have to charge fees for looking after the deposits but they would be safe (except from inflation which would probably be less of a problem – or haircuts.)  No more fear of bank runs.

bankThe second type of bank would be a financial intermediary in that it would make loans based on 100 per cent equity deposits of its customers.  As all deposits would be equity, customers would know there are risks of a loan not being repaid.

As most, if not all,  bankers would see immediately, this would be the end of outrageous Wall Street profits.  Under the current system bankers make huge profits by taking for themselves  the premiums from risky loans but when the risk becomes reality somebody else takes the losses because the money creation feature of banks makes them too important to fail.  People putting money into a loan making business would know the risks and expect the returns to compensate.  The end of fractional reserve money creation would also do away with the leverage which allows bankers the profits from creating money on which they charge interest.

According to the Chicago Plan governments would create the money supply at zero interest.  This would be good in that interest charges would not be built into money creation thereby  reducing the potential for inflation.       My concern is that governments make decisions for political rather than economic reasons.  To me a national LETS (local exchange trading system)  would be preferable way to create money because the amount of money in use would depend upon the collective decisions of individuals.  For the sake of price  stability it is essential that the money supply should be flexible up and down.

When I wrote my essay “LETS go to market: Dealing with the economic crisis” I didn’t put a lot of thought into how to organize banking with a national LETS money system.  I didn’t know it then but the creators of the Chicago plan had already done that.

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2 Responses

  1. I definitely agree with you that we need a flexible money supply that can go up and down. A scientific method under public scrutiny to provide an approximate cost of goods and services that could be adjusted would make inflation and deflation a thing of the past. We need an economic summit to bring us into the 21 century.

  2. This idea is wacky. Does it come from the University of Chicago?

    Certainly the US, indeed the world banking system should be reformed. Retail banks should be separated from the investment banks, and there should be no incentive for the retail banks to lend cheap to the investment banks. Essentially where Goldman Sachs gets its high profits from, aside for dubious amd dishonest activities, is that it sources very cheap loans and re-lends the money in some form at a much higher rate of interest.

    Back to basics. What are the compnents of interest? These are 1 The risk free or ‘natural’ rate which is sufficient to induce people to save. Plus 2. The inflation premium. The amount the lender has to be compensated for inflation. And 3. The risk premium. This is an ‘insurance premium’ which the lender should impose to compensate for the liklihood of loss of th amount lent.

    In recent years the major banks have not been charging the investment banks the full risk premium. They should be compelled to do so. Or alternatively, as the government is the ultimate insurer it should charge a risk premium on every dollart lent.

    This will 1. Reduce specualtive activity. 2. Increase government revenue. And 3. Compensate governments for the risk they are underwritng.

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