Last week saw another major breakthrough in the monetary reform debate as leading UK economics commentator, the Financial Times’ Martin Wolf, argued that the power to create new money should be stripped from private banks and returned to the state.
Our monetary system isn’t working. As Wolf argues, and as is shown in chart 1 below, only around 10% of new credit creation by banks goes to productive activity (the blue bar) excluding commercial real estate. The current ‘recovery’ is being driven by increased and unsustainable lending for household consumption and mortgage lending (the light blue and purple bars below). UK bank lending to businesses continues to shrink, five years after the financial crisis.
NEF’s Creating New Money: A Monetary Reform for the Information Age, published in 2000 and written by NEF founder James Robertson and Joseph Huber, was the first detailed study of how we might reform the UK’s dysfunctional monetary system. Far from being backed by gold or created by the Central Bank , Huber and Robertson revealed how 95% (now 97%) of UK money was created by private banks when they make loans, via simple computer entries.
In arguing for the transfer of such money creation powers back to the state, they emphasized the potential gains from ‘seigniorage’. Seigniorage is the difference between the cost of manufacturing notes and coins by public authorities and its face value when it is bought by banks (and the interest they pay to the central bank for holding it). Huber and Robertson calculated the reform would save the Treasury £47bn a year. Between 2000 and 2009 private banks created £1 trillion of new money for ‘free’ – enough to wipe out most of the national debt.
The original proponents of sovereign money were mainly concerned about the instability of private bank money creation than lost revenues. 1930s Chicago school economists, very different from the 1970s founders of still-dominant neo-liberal policies, believed that risky lending activity and the creation of money for transactions should separated. Combining the two broke the rules of the free market since it requiredgovernment insurance to be stable and led to damaging boom-bust cycles. Such warnings fell on deaf ears.
Following the crisis of 2007-08, the largest since the depression, NEF submitted an updated version of Creating New Money to the Vickers Commission on banking reform, along with Professor Richard Werner at the University of Southampton and campaigning group Positive Money.
Civil servants we were invited to speak with back in 2011 didn’t understand that banks create money and the final report fell in to the ‘banks as intermediaries recycling our savings’ myth.
But three years on, the Bank of England has now clearly stated that banks do indeed create money, backing completely the analysis in our 2011 book "Where Does Money Come From?" Taking as his cue the Bank’s publications, Martin Wolf is the latest influential voice to come out in favour of full-reserve banking.
His article last week also represents a breakthrough for our close friends Positive Money, whose book Modernizing Money is heavily referenced. This is the most detailed examination of the how reform could be carried out in the UK today – at virtually no cost to the taxpayer – and complements Michael Kumhoff’s IMF working paper for how it could be implemented in the United States.
Wolf’s article has led to something of an explosion in economics circles with many expressing concerns that sovereign money creation would lead to a drying up of credit. But we need to be careful here. Sovereign money proposes simply that the unit of account – £sterling – that most people prefer to use for payment transactions (a result of it being the unit we must pay our taxes in) should not be created by private companies. It would not stop people from issuing private credit contracts nor stop companies issuing lines of ‘trade credit’ to each other in lieu of sterling for the exchange of goods and services. Many estimates suggest this industry is a more important source of financing than bank credit. Sovereign money reform might encourage the emergence of a range of peer-to-peer and complementary currency systems which would no longer have to compete with heavily subsidized behemouth banks for customers.
More research is needed to further explore these questions. But the sands may be shifting against the current model, once described by Mervyn King as ‘the worst possible way of organising banking.’ Martin Wolf’s conclusion seems to agree:
“Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.”
Money image via epSosde-flickr. Creative Commons 2.0 license.