A few months ago we did a few post on monetary reforms. In the first two posts of those series, we argued in favour of debt-free money and full reserve banking. In short our argument can be summarized as follows: since the government can demand that taxation has to be paid in a certain currency, it is able to create a demand for that currency. Hence the government can spend money just by creating its own currency, and this without having to borrow anything. Because the government should be in charge of creating and allocating the money supply, private banks shouldn’t be involved in the creation of money. Instead banks should return to their role of intermediaries between savers and borrowers.
In order to prevent that politicians will manipulate the money supply for electoral gains, we have proposed the establishment of an independent body, the National Monetary Authority. This body will have to authority to determine the amount of money the government should spend, and also has the power to raise (or lower) the general level of the Land Value Tax.
In the third instalment of our series, we introduced another financial institution, the Federal Credit Bank (MFK). The primary objective of this institution is to provide zero-interest loans to the public. The National Monetary Authority would also in this case set a limit on how much money the MFK could lend. In this post we will expand on the function of the MFK.
During our discussion of full reserve banking, we made an implicit assumption that the amount of savings and the demand for loans would be equal. There is of course no reason to assume that this will indeed always be the case. Actually it’s reasonable to assume this will almost never be the case. We will discuss the role of the MFK on this matter, by discussing how banking would look like under full reserve banking.
If a bank wants to lend money to the public, it should attract funds from the public since it cannot create money through fractional reserve banking. The bank could attract funds either in the form of term deposits or by issuing bonds. For the sake of simplicity we will assume that banks will only issue zero coupon bonds.
A zero coupon bond is a bond which does not pay interest. Instead the bond is issued at a lower rate than its nominal value. Suppose that a bond has a nominal value of 1,000. This bond will then sold by the bank for a price less than 1,000, and the buyer of the bond will make a profit when the bank will repay the bond at maturity.
When people want to have a bank loan, the bank should attract funds to lend to them. In order to do this, the bank will sell bonds at the capital market. As long as there are sufficient buyers for these bonds, there will be no problem. If however, the demand for loans would be higher than the demand for bank bonds, problem can arise. Businesses can’t make investments, people can’t get a mortgage loan to buy a house. If this discrepancy becomes too large, the economy might be disrupted.
How can the MFK help in such situation? The MFK can use its lending power to buy bank bonds at the capital markets. By doing so banks receive the funds to lend to the public. But again, the MFK cannot buy more assets than the limit set by the National Monetary Authority.
By raising the MFK lending limit, the MFK can buy more bonds and hence their rates will increase, which equivalent to lowering interest rates by central banks. If on the other hand the National Monetary Authority would lower the MFK lending limit, the MFK will be forced to sell off some of its assets. This will result in a lower rate of bank bonds, and this is equivalent to raising interest rates.
Shifting the MFK lending limit gives the National Monetary Authority an additional tool to adjust the money supply of a space settlement.