Some proposals that follow the 100% reserve solution specify that banks hold one physical unit of currency for every unit of currency paid in by depositors. For example, if I paid £100 into my current/checking account, and therefore hadn’t given the bank permission to loan the money out, the bank would be required to hold £100 in physical cash – notes and coins – to meet the ‘reserves’. This was the idea in the original Chicago plan, proposed in the 1930s, when much of existing money was in the form of cash, rather than electronic numbers in computer systems.
This is completely unnecessary. The idea that ‘reserves’ need to be something physical – cash or gold – is a throwback to the days of commodity money (eg. gold coins).
The other reason why some proposals suggest that reserves need to be physical is because they believe it is the only way to prevent the banking system from creating money. In reality, a few accounting rules can prevent banks creating money. While the problem of how to prevent banks creating money has caused some confusion, the answer should also be obvious to anyone with an understanding of computer systems and specifically databases. (To give you an insight, banks will not have the function to make a ‘credit’ or ‘debit’ request to the central bank computer systems – the request will need to be “Transfer $X from Account A to Account B”. The accounting rules would not allow them to ‘credit’ a borrowers account without debiting the account of a depositor (or numerous depositors) by an equivalent amount).
Under the proposal on this site (and those used in the American Monetary & Financial Security Act), there is no need for banks to hold any more cash than customers will actually need to withdraw. The ’100% reserves’ required for checking/current accounts are still simply numbers in a computer system – they have no physical form, and don’t need to have.
After the reform proposed on this site, it will be impossible for the banking system to create money. They will be subject to the same rules as you or I when we use internet banking – they can only move money from one account to another. There is no need for them to hold physical cash in order to make this happen – we simply need to make a few changes to the accounting rules.
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