I am being deliberately cheeky in my post title… But I think a quote on banking reserves from Alchian that David R. Henderson gives (without him necessarily endorsing it in the original context) is not the same as the other two things to which it is supposedly analogous. Let me just give David’s whole post:
“To rely upon a reserve requirement for the meeting of cash-withdrawal demands of banks’ customers is analogous to trying to protect a community from fire by requiring that a large water tank be kept full at all times: the water is useless in case of emergency if it cannot be drawn from the tank.”
Armen A. Alchian and Willam R. Allen give this unsourced quote on p. 708 of the first edition of their modern classic, University Economics. BTW, I lost my copy of the third edition in my 2007 fire and my friend, Gloria Valentine, Milton Friedman’s long-time assistant, gave me Milton’s autographed copy. It’s inscribed, “To Milton, Herein–somethings old, somethings new, somethings good–borrowed straight from you. Armie.”
I was reminded of this when I read Russ Roberts’ post in which he quoted from an article in The Economist. For days, the Japanese government kept to its policy of requiring that oil refiners keep a minimum of 70 days’ supply in reserve. Specifically:
When the crisis hit, there was a law on the books requiring energy companies to keep 70 days of petrol in reserve. This was quickly lowered by three days, but that did not help. And there is the outrage. It was not until March 21st, ten days after the crisis, that the limit was lowered to 45 days.
See the problem?
Yes, I see the problem with mandated reserves on water and petrol, but not on bank deposits. (At least, not for the reasons David is citing; I don’t think the government should have anything to do with banks one way or the other.)
If banks as a rule keep 100% of their customers’ cash in the vault after they deposit it, that doesn’t mean–as Alchian implies–that there will be no cash in an emergency when their customers want to withdraw it. On the contrary, it guarantees that there will be cash in an emergency when their customers want to withdraw it.
Specifically, Alchian’s argument fails because when a customer withdraws his cash, the bank’s reserve requirement (in absolute terms) goes down. In other words, the government/Fed isn’t saying to banks, “Keep $100 billion in the vault at all times.” No, they are saying, “Keep 10% of deposits in the vault at all times.” Those are totally different things, as you can easily see if you bump it up to 100% reserves.
P.S. Yes I know David has leveled a challenge against me. But, uh, I have to go cut the lawn…
(I will try to answer him after I think about it some more.)