Obama Takes a Big Step Toward Implementing Limited Purpose Banking

Hi there! I heard your LSE talk about Limited Purpose Banking as a podcast. Overall I agree with your premise that a lack of separation between the bank's own balance sheet, deposits, and investments managed by the bank is the core problem. With respect to your solution I would like to ask you two questions, or share thoughts, whatever. I'm not trained in economics so these may be naive.

1. You present cash mutual funds as the preferred implementation of a deposit. But does limited reserve banking create real value? For example many systems such as communication, transport, or restaurant tables, are provisioned to support a fraction of eligible demand and provisioning them to support 100% of eligible demand would be a waste. The low likelihood of a run on these systems results in real value (a saving). When there is contention, these systems run slow.

Could a better formulation of a savings account be a mutual fund that exposes liquidity risk to the shareholders according to some agreed pricing formula? For example if the reserve target is 10-15% and you try to withdraw $100 when the bank has 11% reserve you get $100. If for whatever reason the bank is at 9% reserve you get given an option "You can have $90 now, or $95 next week, or $100 next month, or $105 in a year". The ramp would get steeper as the bank dips into lower reserves.

Of course the fund could still take real losses, but confidence feedback effects would be dampened and hopefully defused. Might this be preferable to small savers over a fixed-term fund or a zero-yield fund.

2. I'm not sure how monetary balance is to be achieved with LPB. If I understand correctly, fractional reserve banking creates a fund called "money" whose portfolio is 10% liquidity and 90% real assets of uncertain risk and value. If most real assets are created against private credit, this balance is maintained and the central bank only has to make small adjustments in the money supply.

In LPB, money is a fund whose portfolio is 100% liquidity, and there are various other funds whose portfolio is 100% real assets of various kinds. When someone grows the real economy by creating an asset, what happens? I can imagine the following scenarios:

- People will use some of the fixed supply of money to buy the new asset's shares, causing deflation equal to the growth, which may be fine.

- The central bank will measure the growth and create money 1:1 to match. How will they diffuse that money without buying (and nationalising) the new asset?

- People will prefer to barter the shares of real-asset funds instead of using money, causing hyperinflation and the collapse of the official currency. That may be fine too in theory, but would surely be disruptive and negate at least some aspects of LPB.

- The value of money will settle at the true value of liquidity compared to real assets, and that may require very little growth of liquidity even for large growth of the real economy (such that money becomes a smaller fraction of total assets).

These scenarios may not be very well constructed, but in any case it would be nice to hear from you how you see money and real asset funds interacting under LPB in the long run.

Mr. Kotlikoff's options for simplifying banking are fascinating. They also put me in mind of is a growing sector of financial services providers that already provide a form of Limited Purpose Banking: Credit Unions. Credit Unions, less well known in Europe than the U.S., are owned by their members who invest savings in return for shares and ‘collectively’ make loans to other members based on the amount of shares invested.

My two cents on the parallels is here: http://thebayberryview.wordpress.com/2010/04/21/the-future-of-retail-ban...

Is the Credit Union model all that far away from what we're talking about here, at least in terms of high-street banking? I haven't come across much commentary in the U.S. on the sector. The point made in your article above about small banks is well-made, but did Credit Unions in the U.S. fall into the same trap?

The clearest indication of the intentions of President Obama to AFRICOM (U.S. Africa Command) and the U.S. military involvement in Africa is provided by the budget requests for the financial year 2010 presented by the Departments of State and Defense Congress in May 2009. The budget request from the State Department - which includes funding for all U.S. arms sales, military training, and other security assistance programs - has proposed a substantial increase in funding for U.S. arms sales . UU. a number of African countries through the Foreign Military Financing (FMF) program. The budget proposes increasing funding for FMF-Saharan African counties more than 300 percent, from just over 8.2 million U.S. dollars U.S. over U.S. $ 25.5 million, with additional increases in funding for the Maghreb countries. The main recipients are slated for increases Chad ($ 500,000), the Democratic Republic of Congo (U.S. $ 2.5 million), Djibouti (U.S. $ 2. 5 million), Ethiopia (U.S. $ 3 million), Kenya (U.S. $ 1 million), Liberia (U.S. $ 9 million), Morocco (U.S. $ 9 million), Nigeria (U.S. $ 1.4 million), South Africa (U.S. $ 800,000) and the Africa Regional Program (U.S. $ 2.8 million). Confidential Conversions

I am not so confident that Obama will follow through on these promises. The rewards for the banks, big or small, are far too great for it to make sense in their business plan to implement processes which lower their profits. After all, if the taxpayer is always there to bail them out, then what incentive is there for them not to go after the greatest rewards, and hence take the greatest risks? Within Obama's cabinet, there is too much invested interest in the financial sector, e.g. lobbyists, for there to be a morally right solution to banking in this new decade. Kind Regards, Tracy from propane fire pit

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