100% money

Usually associated with the work of Fisher (1935), although supported by other promi- nent authors (most notably Friedman, 1960), "100% money" refers to a full-reserve backing of bank deposits by a commodity (silver or gold, for instance) or an asset (such as government-issued money, to wit, "outside money"). As it is expected to contribute to the stability of the economic system as a whole, "100% money" is the Gordian knot of some proposals aiming at reforming the monetary system, such as the "Chicago Plan" and the "narrow banking" proposals. In the aftermath of the 2008-09 global financial crisis, "100% money" has become very popular among several civil society movements across Europe (Positive Money in England, for instance), which argue for giving the State the monopoly over the issuance of money.

Fisher (1935) suggests a monetary reform that is inspired by the Bank Charter Act of 1844, although it does not reproduce its mistakes. For instance, the Act imposes a strict connection between the notes issued by the Bank of England and its gold reserves, in order to ensure monetary stability. Yet, as the Banking School argues, money, as a means of payment, is not restricted to the notes issued by the central bank, but covers a wide range of credit instruments, such as bills of exchange. Against this background, the 1844 Bank Charter Act was not able to prevent the occurrence of monetary crises in the nine- teenth century. This is so because the issuance of notes does not allow the central bank to control the quantity of other credit instruments, which are endogenously determined by the needs of trade.

Fisher's (1935) reform, however, takes into account bank money, notably checking deposits. According to the author, the problem with a fractional reserve system is the "fact that the bank lends not money but merely a promise to furnish money on demand - money it does not possess" (ibid., p. 7). In other words, the credit instruments issued by banks are partially backed by effective money, to wit, government-issued money. Accordingly, the implications of a fractional reserve system are twofold: (i) banks are subject to a liquidity risk, which represents a major threat for financial stability, notably in the case of a bank run; and (ii) this system exacerbates business-cycle fluctuations, because bank money is issued during periods of expansion and destroyed (when banks demand the reimbursement of loans) during phases of contraction, which may initiate a debt-deflation spiral.

For these reasons, Fisher (1935) suggests separating the issuance of bank money from the granting of credit, thereby transforming banks into purely financial intermediar- ies. To achieve this, "100% money" advocates a full-reserve backing of bank deposits by government-issued money, whereby the supply of money is governed by a monetary growth rule. In this framework, money will be injected in the economic system by the government, so that a given bank cannot grant any credit to a non-bank agent or another bank, unless it has collected deposits in the form of government-issued money. Among the advantages pointed out by the tenants of "100% money", two stand out. First, as the credit instruments issued by banks are fully backed by the government-issued money in a full-reserve system, the central bank has complete control over the supply of

money - which is not the case under a fractional reserve system, whereby the level of the money multiplier is unstable. Against this background, "[t]he true abundance or scarcity of money is never registered in the loan market. It is registered by the index number of prices" (ibid., pp. 166-7). Secondly, the full backing of bank deposits by government- issued money reduces banks' liquidity risk, since the demand for government-issued money by the public is always served. Hence, according to its proponents, "100% money" contributes to both monetary stability and the stability of the economic system as a whole.

However, "100% money" is not immune from critics. From a conceptual point of view, one of its major shortcomings stems from its dichotomous conception of the economic system. As a proponent of the quantity theory of money, Fisher (1935, pp. 166-7) determines the value of money on the product market. This is tantamount to confronting an already-existing quantity of goods, to wit, an initial endowment, with a given quantity of money, which circulates in the opposite direction of these goods. In this respect, as Patinkin (1965) notes, the value of money is the relative price of a composite good exchanged against money at equilibrium. Now, a term of the relative equivalence between goods and money is not defined: the composite good refers to a collection of heteroclites objects, which are not homogenized by money, since the latter is only confronted to goods at the very instant of the exchange. Against this background, the value of money cannot be determined before the exchange takes place. Consequently, economic agents have no reason to hold money during a positive period of time.

As the value of money cannot be determined on the product market, Fisher (1935) imposes an arbitrary scarcity on the market for loanable funds, which renders money a commodity and, thereby, favours a dichotomous conception of the economic system. In other words, since the supply of money required in a real-exchange economy is unde- termined, Fisher (ibid.) tries to limit the risks caused by the over-issuance of money by implementing a full-reserve backing of bank deposits and a monetary growth rule, both of which rest on a flawed conception of money.

A more relevant reform of the monetary architecture has to take into account the specificity of the purchasing power of money, which is not an ordinary price, as the value of money is not determined during the market session but has to be assessed before the exchange takes place. In this respect, money is a bookkeeping entry devoid of any (intrinsic or extrinsic) value, unless it is associated with output through the payment of wages, as the monetary theory of production explains (see Graziani, 2003). Such an objective relationship between money and output determines, through the remunera- tion of labour, the supply of money that is necessary to dispose of the whole output in a monetary economy. All in all, any monetary reform has to distinguish two kinds of banking intermediation: a monetary intermediation, which generates a new income through the monetization of firms' production (when banks issue money for the payment of wages); and a financial intermediation, whereby an existing income - that is, the bank deposit resulting from the remuneration of labour - is lent for non-productive purposes. Contrary to the reform ensuing from "100% money", such a reform will rest on a coher- ent association of money and output, in line with the circuitist approach (see Rochon, 1999, for a discussion on that subject).

See also:

Banking and Currency Schools; Bank money; Central bank money; Chicago Plan; Endogenous money; Fiat money; Financial crisis; Financial instability; Fractional reserve banking; Free banking; Glass-Steagall Act; High-powered money; Money crea- tion; Money creation and economic growth; Money multiplier; Money supply; Narrow banking; Reserve requirements; Settlement balances.