Power & Market

Why Argentina Needs a 100%-Reserves Banking System

argentine pesos

There have been criticisms against Javier Milei´s plan to install a 100% reserve banking system in Argentina. One of the fears is that in a 100% reserve banking system there would be price deflation which would be detrimental to the economy. I have written about the myth that falling prices are to be fought against with inflation of the money supply in my book “In Defense of Deflation” which has recently been recommended by Javier Milei on X.

Now Professor Huerta de Soto has expressed himself on the matter. His comments on dollarization in Argentina, the necessity of a 100% reserve ratio to prevent bank runs, and Milei´s plans are worth reading by everyone interested in the matter.

Jesús Huerta de Soto:

Let me make two comments on the monetary reform plan of Javier Milei: 1.- Dollarization with a 100% reserve ratio for banks (wrongly called "Simons" banking, it should be called "Mises" or "Rothbard" because Simons intended to maintain the Central Bank, when Milei, following Mises and Rothbard—and me—intends to abolish it) would not keep the money supply in dollars frozen in Argentina: the money supply in dollars would grow (and a lot) as the Federal Reserve has persistently decided to do and the increase in dollars would reach Argentina as it reaches the rest of the countries, via chronic trade deficits of the US in its trade with Argentina and the rest of the world;

and 2.- Panama and Ecuador maintain dollarization with fractional reserves because they have the implicit support of the Federal Reserve as lender of last resort and that has become a reality on several occasions in the past, without major difficulties given the small size of their economies. In the case of Argentina, especially due to the large size of its economy, and the bad experiences of the past, the Federal Reserve has made it explicit that it will not act as a lender of last resort in any case, so it is unavoidable to establish 100 percent reserves to avoid such bad memories in Argentina (remember the first law of banking theory: A fractional-reserve banking system cannot prevent "runs" without a lender of last resort—in fact, the "stability" of the system is achieved by "runs" against less prudent banks.)

Therefore, Milei is very clear that dollarization requires a 100 percent reserve ratio (the Argentine collective memory abhors the corralito, which at the slightest breach of trust for any external or internal reason - for example the return in the future of a corrupt socialist government—would ruin the entire system, for the second time!—with a devastating social and reputational cost).

On the other hand, it is feasible for 100 percent to be computed with Argentine bank holding deposits in dollars in other foreign banks if these are "too big to fail" and enjoy the irrevocable support of their respective central banks. Precisely for this reason, dollarizing with 100 percent is only a second best because it would not immunize Argentina from the cycles of credit expansion that the Federal Reserve regularly orchestrates, and the ideal would only be achieved with a classic gold standard and 100 percent reserves (which is not totally rigid since the gold stock has been growing at 2 percent a year).

In any case, Milei has studied the issue very well and is very clear about it (the only thing left is to determine the term below which short-term loans will be considered as demand deposits: I have advised him to use a term of up to 30 days, since there is only a demand for loans in Argentina from 30-60 and 90 days precisely to discount commercial paper). Thus, at least for the current situation in Argentina, dollarization with 100 percent is the most feasible and least risky solution taking into account the context and the background.

In sum, even “free bankers” should under the current circumstances defend 100% reserves in Argentina. Moreover, Professor Huerta de Soto addresses the point that 100% reserves would be somehow anti-libertarian by not allowing banks to create fiduciary media:

What is profoundly illiberal is fractional reserve banking, which systematically violates the right of property, generating continuous financial instability, and being responsible for the creation of central banks (since it cannot survive without them, except by means of "bank runs" and immense damage to those affected). And it violates the right to property that capitalism requires to function no matter what the form in which the fractional reserve banking exercise manifests itself: crime of fraud and forgery in public documents, in the case of the issuance of bank notes without backing (fortunately prohibited by the Peel Act in 1844); or crime of misappropriation, in the case of the appropriation of customer deposits (or the issuance of new deposits, which in the end and at the aggregate level is the same thing). Defending fractional reserve banking at this stage is not only scientifically wrong, but also frivolous and harmful in relation to a country like Argentina that has already experienced a painful "corralito" and is currently debating to end inflation, dollarize and eliminate the central bank. On the other hand, there is no doubt that in an anarcho-capitalist system all banks would tend to operate with 100 percent reserves, because today, with electronic banking and the technological means that exist, at the slightest doubt a bank empties itself of deposits literally "at the speed of light". Debate closed!

 

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