Commentary: On June 10th, the Swiss will vote on moving their economy to “Vollgeld”. This referendum asks whether the Swiss banking system will be converted from a traditional fractional reserve system to 100% reserve system and establish debt free money. Many are skeptical as Vollgeld represents a radical change, but Vollgeld is a viable alternative.
Fractional reserve banking involves banks lending deposits up to a given level of required reserve. For example, in the United States, banks are required to hold of 10% against most deposits. This means that a bank can lend 90% of deposits, allowing for a massive expansion of credit from just a small base of reserves.
Under the Swiss Vollgeld proposal, Swiss banks would be required to hold 100% reserves, dramatically banks’ ability to create credit.
Proponents of the system argue that 100% reserve banking would dramatically reduce the potential for financial crisis. A 100% reserve requirement would eliminate bank runs as depositors would know that their deposits were fully covered.
There is also a subtler way in which Vollgeld would improve stability. Bankers, so the argument goes, tend to lend too freely in good times, acerbating the boom, and are too tight in downturns, contributing to the recessions. By requiring 100% reserve, bankers’ ability to lend in boom times and the incentive to pull back in recession would be greatly curtailed.
The major argument against Vollgeld system is that it would impede banks’ ability to lend, hence, provide funding for small business, who after all, are the main loan customers of banks. This need not be the case, however. In principal, a 100% reserve system can operate in the same way as a fractional reserve system. Calculating the desired money supply are the same, just with a “1” substitute into the appropriate places instead of a fraction. The amount of loans issued by banks would be the same. What would be different is that the reserves issued by the Swiss central bank would be much greater.
Most countries already have 100% reserve banks. They are called money market mutual funds. They work by holding 100% reserves in the form of highly liquid short-term debt. The debt backing these is often U.S. government securities, but privately issued commercial paper is also common as backing.
The more controversial aspect of the Vollgeld proposal is to move to “debt free money”. Traditionally, central banks increase money supply by purchasing government securities and issuing base money to pay for it. The Vollgeld proposal would have the Swiss central bank issued directly to the Swiss Confederation government, to the Cantons, or even directly to Swiss residents, perhaps in the form of a guaranteed income.
Running monetary policy this way would be different from how things are done now, but again, in principle, it can be done. The difference is that instead of creating money out of thin air to pay for assets, money would be created out of thin air to give away.
The main issue is loss of independence of the central bank as monetary policy will be more about funding governments and checks for families than about stable prices and low unemployment. How the political economy of this would work out is uncertain.
Christopher A. Erickson, Ph.D., is a professor of economics at NMSU. He has taught money and banking for 34 years. The opinions expressed may not be shared by the regents and administration of NMSU. Chris can be reached at email@example.com.