Winterspeak, meanwhile, responds to my post on duration-matched banking:


1. It would involve a massive, massive credit contraction. Hello, Great Depression.

2. Actually matching pool credit to particular loans would be a much more expensive business than the current banking system.

3. The expansion of credit has historically enabled a lot of things we like, such as homeownership and entrepreneurship.

4. How many people want to pay the bank to hold onto their money?

5. A smaller credit system will not ultimately prevent inflation/deflation. Without interest bearing accounts, savings become a wasting asset.

6. To the extent that it does prevent inflation, this is not necessarily a good thing--a little inflation greases the labor market, mitigating the effects of demand shocks.



1. It sure would. That said, the US$ has lost over 90% of its value in just three generations, and if that's a feature of the system, how great is that system?

2. Matching pool credit would be more expensive than maturity mismatched accounting as you would switch to, essentially, a multiple year cash accounting system. Other costs would be lower though -- no more FDIC. Other costs would be much lower, remember the US taxpayer is on the hook for almost $1T (yes, T) shoring up bad housing loans and the shadow banking system via recent Treasury and FNMA intervention.

3. Entrepreneurship would go on unimpeded. Remember, VC funding (a key driver of entrepreneurship) *is* maturity matched. Speculation would be less well supported though, and that is a feature, not a bug.

4. Suppose money did not lose value such that it became near worthless in three generations? Suppose you were hiring someone to protect gold? If we lived in a world of mild deflation (zero currency dilution + technological improvement) then paying a modest fee to have our cash stashed someplace safe would be fine.

5. You are correct that a smaller credit system will not, in and of itself, impact inflation/deflation. Monetary dilution (or concentration) is what drives inflation/deflation. Credit is part of this, and a bank's ability to extend credit (print money) via brittle maturity mismatched instruments is certainly dilutive. But there is also the government's dilutive ability to run the presses, and that element is quite independent of whether maturity mismatching is allowed or not.

6. The standard line is that some inflation makes it easier to cut wages, which has beneficial impacts on the labor market. I used to believe this also, and I still think it has some truth. I also think that, in an environment of mild deflation, over time people would make their peace with nominal wage cuts in the face of demand shocks.



There is no such thing as a perfect system. The question is whether the current credit system is better than a system without fractional reserve banking. Observationally, societies without banks didn't have great capital systems, but of course, that generally involves societies at a low level of economic development, or Muslim countries.

On the specific points:

1. We both agree that while fractional reserve banking is the current vehicle of inflation, since the invention of the Federal Reserve that is more a matter of convenience than a necessity. If the government wanted to inflate the currency under a full-reserve system, it could simply run the printing presses. So I don't see that this objection holds. Moreover, I don't see why this is such a terrible thing. The Great Inflation of the 1970s was terrible, but the central bank is unlikely to let that happen again. A long, slow erosion of the dollar didn't do anyone much harm--financial assets are priced to cover the erosion, and non-financial assets generally rise along with the broader price index.

2. The bad housing loans are duration matched--they were all securitized. As long as trading firms need working capital, there will never be perfect duration matching in the financial system as a whole. In addition, the US taxpayer is not going to pay anything like $1 trillion; that would require every single borrower to default. The cost to the taxpayer is the default risk plus the opportunity cost of the funds; this is probably pretty small.

3. Lots of businesses get their start on credit cards, mortgages, and bank loans. Moreover, the VC pool of funds is "extra" money. Fractional reserve banking lets us tap the short money pool for longer term projects. Without it, there would be less funding for new businesses.

4. Psychologically, hiring someone to protect your gold is different from loaning it to them at a low interest rate. Many people would store their money in their homes, which would, among other things, up the returns to robbery.

5. We agree.

6. Look at the trouble even industries in deep trouble have securing nominal reductions in benefits, much less wages. Even collective bargaining agents accept plant closures rather than broader nominal wage cuts. Nominal wage cuts would also produce heavy political pressure for government interventions.

Mostly, it's simply not clear to me what the giant problem is that duration matching is supposed to solve. Over time, the banking system has produced a lot of growth and a great deal of convenience. The cost to the taxpayer has been pretty small--even the S&L Bailout had a relatively minor effect on real growth. If it ain't broke, don't destroy it.

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