How to Handle the payments system

The commenter suggests,

simply nationalize the “deposits taking and transaction processing” function of the banking industry? Everyone gets a zero-service-fee fully electronic (no paper checks) account at the Federal Reserve

Picture this as a retail version of the Fed Funds market. To simplify, I would not have any interest on Fed Funds.

Let’s say that I keep most of my liquid assets with a money market fund. But when I want to add to my Fed Funds, I sell money market fund shares and the money market fund transfers Fed Funds out of its account and into my account. When I want to buy things, I send money from my Fed Funds account to the Fed Funds account of the seller. Maybe I use a debit card to execute the transaction. Maybe I use my phone.

The idea is that this insulates the payment processing system from the solvency of financial institutions. These Fed Funds accounts would not be vulnerable to runs.

There would still be financial institutions doing bank-like things, including holding long-term risky assets and issuing short-term riskless (supposedly) liabilities. They could still get in trouble. And the government probably would still want to regulate them, in order to steer credit toward its preferred uses, including financing its own debt.

But it is an interesting thought-experiment.

23 thoughts on “How to Handle the payments system

    • No, it doesn’t have anything at all to do with cash, which is an independent issue.

      For instance, companies could still operate ATMs that accept FedFunds debit cards and charge a small fee. Those companies would be responsible for getting fresh notes from the Federal Reserve. The same or other companies could also take cash deposits at those ATMs (like putting bills and coins in a vending machine) and convert them into FedFunds, also probably for a minor convenience and processing fee. (There used to be similar cash-deposits-converted-to-Bitcoins private ATMs in Boston)

  1. A centralized, nationalized database of every electronic transaction for every citizen? Don’t we have to assume that the chances that those records would never be used or leaked for nefarious political reasons are pretty much zero?

    • That’s a reasonable worry, though with hacking risks, the ability of the government to get at bank records, and the manner is which the electronic transactions processing system works right now, the current situation shouldn’t be seen as much better.

      If it helps to think about the thought experiment, one can imagine private companies performing the same services, but only those services, that is, no lending. You could call these Debit-Banks.

      When accounts are getting near zero interest, and a lot of that money is parked at the Fed in the form of excess reserves, then a lot of people have near equivalents to Debit-Banks already.

      • Handle,

        Why not nationalize all the existing (now defunct) bank branches and give out “basic jobs” to the now unemployed tellers? They could be federal employees who dispense/collect physical dollar bills for free conversion into your Fed account.

  2. I’ve been telling people this for years now (not trying to one-up Handle, who is one of the best commenters here). Yes, maturity transformation is a great thing, but it’s not the only thing. Consumers want simple payments/transactions/settlement services too, and these are classic utilities that the Fed takes care of anyway! Why not carve them off explicitly?

    Monetary policy then gets more interesting too. “This week Janet Yellen put an extra $1000 in every citizen’s FedAccount”. Basic income here we come.

  3. I have had similar thoughts.

    While we’re at it:

    1. Fractional reserve banking is now illegal – the only instant demand accounts are with the Fed. The only instruments that can be called “cash or cash equivalent” are those deposits, and physical currency.

    2. The Fed no longer tries to manipulate the money supply by changing lending to large banks and then hoping they’ll lend into the economy. Rather, if it wants to grow the money supply, it just deposits money in everybody’s account. Helicopter drops become direct injection. But since it never ever removes money, it must only add money very carefully. It would be required to add money exactly evenly for all citizens – explicitly forbidden to subsidize the poor (or the rich.)

    3. All banking is now 100% commit investment funded, not demand deposits. So you can lend money to a bank (or through a broker like lendingclub) and get it back on some time schedule set in a contract. Or you can buy securities on the market, some of which might be based on such contracts. But there are no fractional reserves – only pure cash, currency, and investments that move with the market over some time scale.

    4. All actual lending to citizens is done by banks, brokers, entities like lending club, NOT the Fed. Your checking accounts and debit cards apply to your Fed account, your credit cards, credit lines, car loan, etc., are all borrowed from somebody else.

    Most ordinary banking crises are now impossible. There could be credit crises where banks folded up their credit card businesses, and that caused grief. But massive defaults of demand deposit accounts would now be literally impossible.

    Growing the actual money supply by direct action to consumers is now possible.

    Controlling interest rates requires other mechanisms.

  4. By the way – I think it’s impossible to be “cashless” – at least in the sense of suppressing “crime” by controlling “currency”.

    Why? Because the underworld markets will find other mediums of account and exchange, as they already have. There was a story in the main stream media in the last few years about a very poor county in Appalachia.

    One of the main mediums of exchange is cases of pepsi. Why? Because you could acquire it with food stamps, and then use it as general currency (which food stamps are not supposed to be) and trade it for various products, most of them illicit. The article reported on market prices in units of cases of pepsi for such things as a woman providing sexual favors. It was unclear if any of the soda was ever actually drunk.

    See also bitcoin….

      • “Tide bottles have become ad hoc street currency, with a 150-ounce bottle going for either $5 cash or $10 worth of weed or crack cocaine.”

        I started to say: why wouldn’t this difference be arbitraged away? Then I realized that the $5 difference is a measure of the risk premium…

  5. Kling:
    “And the government probably would still want to regulate them, in order to steer credit toward **its preferred uses**, including financing its own debt.” [** supplied]

    “Its” is presumably the “government,” which as an instrumentality or mechanism has NO “preferences.”

    The preferences are those of individuals (and groups) using that instrumentality for economic, social or (mostly) political objectives, which those whose assets supply the “credit” have no voice in choosing.

  6. What I would worry about is a slow-down in the rate of change. The “unseen” effects.

    For example, imagine if this system had been implemented in 1990. Only we didn’t really have electronic transactions for individuals. Most people would use paper cheques, and the FedFunds allows you to issue paper cheques. Fast-forward to 2017. Would we have consumer electronic transactions? Or would most people still be using paper cheques?

    • In a way you are making my point. What I am saying is that in 2017, network communication technology has now advanced to the point where a universal and secure electronic payments and transactions processing system should be incredibly cheap and fast and (comparably) easy to set up and maintain. That wasn’t the case back in 1990, but it is today, when paper checks could be made obsolete.

      And since that’s true, we no longer require private company discoveries of innovations and market efficiencies. We’ve arrived.

      As such, these Debit-Banking functions should be completely separated and disaggregated Credit-Banking.

      To hold deposits of electronic currency and process payments, I can have a Debit-Bank account.

      To make investments, I can have an investment account with a brokerage.

      And Credit-Banks can issue consumer and commercial credit and loans without needing to get lots of their money from demand deposits. They can just issue debt and equity to the normal financial marketplace, since after all, they are just another investment-making company, like a hedge fund.

      This is like Glass–Steagall done right. GS splits (Debit+Credit) Banking from Investment Banking. Instead, I propose splitting Debit-Banking from (Credit+Investment) Banking. That’s the right line in 2017.

      • Right, but what about the next thing that comes after electronic transactions? The thing we don’t have yet, which hasn’t been invented yet.

        Are we okay with not getting that thing, whatever it may be?

        Kind of honestly, back in 1990 I would have said that paper transactions were good enough, and electronic transfers unnecessary for normal people. But time would have proved me wrong. Heck, I still feel that way about paper bills/statements versus electronic statements.

        • In general, so long as there remains a low cost exchange mechanism between old forms and any new ones, and the law doesn’t prevent it, then there is still is still a good incentive to develop and offer any innovative payment system if it somehow provides some substantial new advantage in the marketplace. If FedFunds was a paper check-only system, private debit-banks would still be able to charge convenience fees for electronic transactions processing. Bitcoin provides us with another, though different example. Thus, the mere existence of a federal debit-banking option need not bother us in terms of major potential costs in forgone future innovation in the field.

          • On the contrary, there remains no incentive whatsoever to create payment system innovations, just as there is no incentive to create physical mail innovations: it’s illegal. When you give a monopoly on payment processing to the Fed, you close off the possibility of innovation almost entirely. Remember when AT&T controlled the phone system? Same thing. We only got phone innovation when the MCI case broke the monopoly. So Roan’s question still stands: are we willing to give up ANY AND ALL potential future improvements in exchange for this safety and efficiency?

  7. We are doing this with one change. You keep both loans and deposits at the Fed.

    The Fed gets a machine called the automatic and optimum liquidity allocator that keeps loans to deposits within specified variance by interest rate swaps between the aggregate loans and aggregate deposits.

    Each of the 6 billion humans in the world get to select their trading bot which runs continuously at the Fed trading pit. Our bot will take a loan when we see a goodie we cannot quite afford, and will make a deposit when we decide not to buy the usual goodie. Each person gets a cash card, tamper proof and allows anonymous secure trading. The cash card supports multiple currencies and guarantees no counterfeits its or double spending.

    There are no humans involved, the Fed board would be swamped trying to set interest rates by committee, all rate swaps happen in an instant, they are asyunchronous, adjustable and automatic.. All HFT trading is immediate;y defeated, all exchanges adopt automatic, fair traded pits.
    That is the plan, anyway,as near as I read the Fintech industry.

  8. I’m a little surprised no one has referenced what is going on in India. Are there any thoughts on that?

  9. Irving Fisher and Milton Friedman and Henry Simons advocated 100% money. All checking accounts would have 100% reserve requirements. The idea never went anywhere because of banker opposition; it would be a heavy tax.

    But things are different now.

    First, as of May, demand deposits and other checkable accounts summed were $2.0 trillion (in M1).

    Second, bank reserves were $2.2 trillion in May. We effectively have 100% reserves now.

    Third, the Fed pays interest on reserves.

    If the Fed continues to pay competitive interest on reserves, banks would earn on the reserves roughly the T-bill rate. And they would have perfectly safe, perfectly liquid assets backing their checking accounts. Low overhead costs. Competition would force banks to pay interest on their accounts.

    So moving instantly to 100% reserves would be painless and easy right now. The Fed would not need to reduce its balance sheet, although it ought to swap its portfolio back into short-term Treasurys.

    Finally, once all checking accounts have 100% reserves, it would be cheap and easy to give all those accounts FDIC insurance.

    We would have a safe, liquid, and run-free banking system at the retail level. Banks would not be taxed nor consumers burdened.

    There is still a problem of runs at the wholesale level, such as repo or commercial paper.

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