Money and reform : Competing schools of thought
Notes from a talk given by Peter Verity 27/1/14
to the Sheffield Group of Positive Money Supporters
Personal views – not speaking as an economist, or as a representative of PM
Will attempt to give unbiased pros and cons of various schools
1. Money = Credit
Status quo: Banks create money out of thin air and lend it to us at interest.
This is ‘fiat’ money = “let it be”
Pro:
Unbiased (positive) slant on this – money is created on demand. It drives the modern
economy. If an entrepreneur needs a new machine, new money is created; when the
machine is in production and creating new wealth, the original money is no longer
needed so can be removed. With unlimited credit there is no limit to our ability to
create real wealth (other than physical constraints of labour and resources). Ann
Pettifor described this as “a wonderful thing”.
Con:
The downsides are familiar- boom and bust
- 75% of new money goes into housing and financial markets
- banks can charge a usurious rate of interest (ie. a rate which exceeds the risk
element)
- money only exists due to high levels of private debt
- misalignment of risk and reward
Keynes – a key premise of Keynesian economics is that, where there is spare
capacity, an increase in money supply will lead to an increase in production. As he
said “we can do what we can do”.
The idea of borrowing to stimulate the economy has traditionally been associated with
the political left.
2. “Real” Money
I’m using the term ironically – money is whatever we accept as money, but the term
reflects a commonly held view.
In this view, money is not credit, it exists independently and is permanent. Savers put
their money into banks who lend it out. Banks can only lend what has been saved, and
the interest rate is determined by market supply & demand. This is the “loanable
funds theory” and is a totally wrong description of modern banking.
“Real money” can also imply that money has intrinsic value. It is, or is at least based
on, some physical commodity such as ‘precious’ metals. This is a key feature of the
Austrian school.
There is therefore a fixed (or at least limited) supply of real money.
Fiat money is “funny money”
Monetarism – a key premise of monetarism is that the economy will always tend
towards a ‘natural’ level of activity, and that prices and wages will adjust in the long
run. Money is neutral. Therefore increasing money supply will only serve to increase
prices in the long run (but as Keynes said, “in the long run we are all dead”).
Concern about inflation, and maintaining the long-term asset-value of money, has
traditionally been associated with the political right.
Gold:
Support for a gold-backed currency is strong, especially in republican America.
eg. Ron Paul quotes the American constitution and argues that all fiat money is
unconstitutional. Most economists define inflation as an increase in the overall level
of prices, whereas some ‘gold bugs’ define it as an increase in the quantity of money.
In Islam, the Gold Dinar is the only sanctioned form of money (though Moslems
would agree with PM about the usurious nature of modern Western banking).
There are many Youtube videos about “real” money – and get far more hits than the
Positive Money channel! Some of these are very slick eg. ‘The hidden secrets of
money’.
Pro:
Popular and intuitive. Demand for some sort of ‘real’ money is a natural first reaction
when people hear that banks create money ‘out of thin air’.
Con:
Limited supply constrains growth. History shows that attempts to revert to a gold
standard always result in economic stagnation.
Who owns most of the gold? (80% is in private hands)
3. Public Money
Notes and coins
Created debt-free, resulting in £2-4bn per year of ‘seigniorage’ ie. public benefit.
Notes and coins are permanent, so in that sense are “real” rather than “credit” money.
Positive Money
– has aspects of both “credit” and “real” money (best of both worlds?)
- It is ‘fiat’ so can be created on demand, in sufficient quantity to catalyse a
growing economy up to physical limits.
- It is ‘permanent’ so loanable funds theory applies : banking the way most
people think it already works
- it is created for public benefit and subject to democratic control: around £4080bn of new public money could be created each year (my estimate based on
2% growth and 2% inflation)
Pro:
As per the introductory chapter of Modernising Money
- stable money supply based on the needs of the economy
- reduced burden of personal, household and govt. debt
- alignment of risk and reward
- allows banks to fail without jeopardising the payments system
Con:
- Too radical a change?
- Hoarding of money in transaction accounts. The interest rate will adjust to
match supply and demand. cf. the rapid growth in Peer-to-Business lending
where interest rates are currently 5-15%
- Restricts growth. How much growth is the ‘right’ level? After reform it would
be the responsibility of a democratic regulatory body rather than the market
(but we might still not agree with the answer!).
- The neutrality of the Bank of England and Monetary Policy Committee is
sometimes questioned.
The Monetary Policy Committee has two elements to its remit
to control inflation to a 2% CPI target
“to achieve strong, sustainable and balanced growth that is more evenly shared
across the country and between industries”
How many people know about the second element? Does this indicate bias by the
MPC or is it the media that is biased?
The remit of the MPC is set by Parliament so should not change post-reform. What
will change is that they will have the proper tool for the job.
Full Reserve Banking
Basically similar to Positive Money, but retaining a 2-tier system of Central Bank
reserves plus Private Bank credit, but with a 1:1 ratio enforced.
See “The Chicago Plan Revisited” lecture to the LSE on YouTube
4. Alternative Currencies
Community-based. They are not legal tender – this does not mean they are illegal or
bad, simply that there is no legal obligation to accept them in settlement of a debt.
Two broad categories –
- backed by Sterling eg. local currencies Totnes, Brixton etc.
- not backed by Sterling eg. LETS, cryptocurrencies, Credit Commons
Pro:
Con:
-
stimulate local demand, eg. reduce food-miles (favoured by environmentalists)
increase community resilience against the big banks, or the state
local currencies are by definition not scalable to national level
whether we like paying taxes or not, we are all dependent on the public sector
and taxation implies a national public money
- even with alternative currencies, we still need to ask where the money comes
from and who benefits from its creation
5. Transitional
Can we move forwards from where we are in small steps rather than “big bang”?
Bank credit is likely to remain tight for the foreseeable future
- Basel 3 : higher capital ratios 2018 (if it’s not watered down)
- Banking Commission – “ringfencing” 2018 (will it happen, will it work?)
- increased competition between banks – smaller banks need bigger reserves
Several schemes have been proposed to inject new money directly into the economy
(rather than the financial sector) without requiring any structural changes
- Quantitative Easing for the People (QEP) : Anatole Kaletsky 2012
- Overt Monetary Finance : Lord Adair Turner 2013
- Sovereign Money : Positive Money 2013
Pro:
- These are (relatively) easy to implement as they do not require structural
changes and can be done progressively
- They are more likely to get the support of Central Bankers
Con:
- Regulation won’t stick; that’s why we need structural changes
Conclusions
There is a strong desire for change, as shown by the growth in support for Positive
Money (Facebook followers increasing rapidly)
Positive Money is one idea among many. There is no perfect system, they all have
pros and cons, so it’s a matter of balance. How we weigh them up depends on our
individual views.
The biggest ‘threat’ to the Positive Money campaign is public mistrust of fiat money.
The natural reaction when people find out that banks create money “out of thin air” is
towards real money solutions.
Our job is to get people onto the first step – where money comes from.
Further reading
(In MS Word, CTRL+click will take you to the website)
The nature of money:
http://www.nakedcapitalism.com/2013/12/essays-monetary-theory-policy-nature-moneycontinued.html
“The Nature of Money” by Geoffrey Ingham ISBN 978-0-7456-0997-3 [a bit hard going!]
Credit money
Ann Pettifor: http://www.primeeconomics.org/
Keynes: http://en.wikipedia.org/wiki/Keynesian_economics
Real money
Loanable funds theory :
http://en.wikipedia.org/wiki/Loanable_funds
http://en.wikipedia.org/wiki/Talk:Loanable_funds
Austrian school: http://mfiles.pl/en/index.php/Austrian_theory_of_money
Monetarism: http://en.wikipedia.org/wiki/Monetarism
Ron Paul: http://mises.org/daily/5926/The-Transition-to-Monetary-Freedom
Gold Dinar: http://en.wikipedia.org/wiki/Modern_gold_dinar
Mike Maloney - hidden secrets of money :
http://www.youtube.com/playlist?list=PLE88E9ICdipidHkTehs1VbFzgwrq1jkUJ
Public money
MPC remit : http://www.bankofengland.co.uk/monetarypolicy/Pages/remit.aspx
Chicago Plan revisited : http://en.wikipedia.org/wiki/The_Chicago_Plan_Revisited
LSE lecture : http://www.youtube.com/watch?v=d6x8RqiAqno
Alternative currencies
Credit commons: http://creditcommons.wordpress.com/
Transitional
QEP : http://blogs.reuters.com/anatole-kaletsky/2012/08/01/how-about-quantitative-easing-for-thepeople/
Overt Monetary Finance : http://www.positivemoney.org/2013/02/adair-turner-debt-money-andmephistopheles-how-do-we-get-out-of-this-mess/
Sovereign Money : https://www.positivemoney.org/our-proposals/sovereign-money-creation/