Anne Pettifor has an interesting article criticizing positive money/full reserve banking. I don’t wish to dwell on that – I have published similar criticisms here. But one passage made me slap myself for missing something obvious.
As Douglas Coe and I explain in a recent PRIME report, the UK monetary system – complete with the power to create money ‘out of thin air’ – was established back in 1694 with the goal, among others, of facilitating commercial transactions and the financing of the king’s wars. But there was an additional and just as important goal: to mimic the Dutch in reducing the rate of interest facing commercial interests. British firms, households and individuals were keen to bring rates down and into line with those that prevailed in the financially more advanced Netherlands.
Of course it did,the Amsterdamsche Wisselbank (Bank of Amsterdam) though starting off as a pure full reserve bank only for bills of exchange, and as an alternative to Italian credit based fractional reserve banking, soon found it could leverage its vault to lend money to the Dutch East India Company at much lower interest rates than full reserve ‘loanable funds’ type lending.
There were complex reasons for this. In part because specie was often clipped and depreciated and cost money to transport and insure against loss at sea. Therefore paper money attracted an ‘agio’ over specie – a premium on price. But researchers have found this premium is less than the interest rate differential. There has to be another cause of ‘agio’.
What this shows very starkly is that the pure-time preference theory of interest, favored by Austrians, cannot be a full and complete theory of interest. There has to be an additional cause. One which Bohm Bawerk , adopting the term, called Agio.
That cause is that creating money ‘out of thin air’ finances real economic activity – potentially real growth – potentially asset speculation – than in turns finances the amortiziation of loans and increases the profits of banks. Bank lending is profit constrained not reserve constrained. This is the ‘banking agio’ the additional real production created by the fractional reserve system.
Therefore the pure time preference theory of interest is false, it cannot explain this lower interest rate under the fractional reserve system. It is a partial not a pure theory of interest. For those that argue that even physical productivity increases must have a subjective expression where is the cause and effect? It is not like the 17th C Dutch woke up one day and simultaneously changed there subjective preferences, rather it reflected a deep structural change in capitalism.
Put more formally the supply of ‘lending power’ increased through the factional reserve system, lowering the equilibrium price of lending (interest) see my paper here.