IMF Study Supports Public Money Creation

My post earlier this month reporting that Adair Turner, one of the front runners for the post of Governer of the Bank of England, has suggested that the financial assets the Bank bought in return for its quantitatively eased money should be simply cancelled felt fairly shocking at the time. Around the same time my attention was brought to a paper emanating from the IMF that has the even more surprising proposal that we should return to an effective 100% reserve on the creation of credit. In layman's terms this removes from banks the power to create money and reduces their role to re-lending money that has been deposited with them.

The paper is couched in terms of a re-examination of the proposal from Henry Simmons of Chicago University and later summarised by Irving Fisher in 1936 and is thus called The Chicago Plan Revisited. The report has two authors, a Czech economist named Jaromir Benes who works for the Reserve Bank of New Zealand and Michael Kumhof who is a staffer at the IMF. While the report states clearly that its findings do not represent the policy of the Fund it has been approved for publication.

The authors summarise the Chicago Plan as follows:

'The key feature of this plan was that it called for the separation of the monetary and credit functions of the banking system, first by requiring 100% backing of deposits by government-issued money, and second by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks.'

Fisher argued that such a policy would remove the ability of banks to introduce instability into the monetary system. More crucially in view of the highly damaging consequences of the massive public debts being carried by a number of developed economies, the Plan would allow for the elimination of these debts, since money would be created by public authorities rather than borrowed from banks with interest, which creates a corresponding debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt'. Fisher forecast a similar reduction in private debt.

The authors of this report test Fisher's theories using an econometric model. Their conclusions are striking: 'We find strong support for all four of Fisher’s claims, with the potential for much smoother business cycles, no possibility of bank runs, a large reduction of debt levels across the economy, and a replacement of that debt by debt-free government-issued money.' They suggest that banks would continue to exercise their role of allocating money between lenders and borrowers and providing high-street banking functions, but they would lose the role of creating money.

The authors write that 'We take it as self-evident that if these claims can be verified, the Chicago Plan would indeed represent a highly desirable policy'. Since their modelling suggests that the claims can be verified in terms of the current economic crisis we must await further policy moves from the IMF with interest, and the kind that doesn't bring debt crises in its wake.
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Ignoble Strife

There was a difficult choice of entertainment for me on Thursday night. We had a meeting about the cuts here in town organised by the the Socialist Workers Party while Channel 4 was advertising a professional butchery job on the green movement. The first would be the talk of our town, and the second was bound to play the same central role amongst the e-debates I am party to. I think I made the right choice: I spent Thursday evening watching John Schlesinger's 1967 film version of the Hardy classic Far From the Madding Crowd.

I suppose it is an advantage of being involved in politics for a number of years that you pick your battles. I now choose those where I think I can make a difference and avoid those that will only frustrate and depress me. We know that our vision of the future does not include dominant media corporations, so we cannot expect to receive a fair hearing from them. To suffer frustration as a result of one's own naivety is an unnecessary loss of energy that we can ill afford. The reason Mark Lynas is given so much air-time is not because he is smarter or better informed than we are, but because his views do not challenge the status quo.

For me, the most serious impact of an unresponsive and biased media - as with an unresponsive and biased political system - is that if you spend too much time immersed in it you begin to believe that it is the central point of public opinion. My visit to Plymouth University yesterday to give the staff research seminar made me realise how I had misjudged where most people are in their thinking about the state we're in.

I went in my role as ideas merchant, with my barrow resplendent with bioregional economics, community farms, and other local produce from Stroud, and attempting to convey conviviality with every fibre of my being. There was the inevitable 'Are you a communist?' question, but for the most part the responses from the audience (and three quarters of the packed room was made up of students) were sensible questions about power and tactics.

Encouragingly, I was asked about the fractional reserve banking system, and my answer, during which I pulled no punches ideologically or intellectually, was clearly understood by a significant minority of the audience and received a smattering of applause. I left feeling encouraged, and that the thinking people of this country are on the move. We are struggling with a monopolistic information system dominated by one hegemonic idea: that the market system is supreme. But out in the country this is not believed, the information is not trusted, and its purveyors are losing credibility.

As for Mark Lynas, I recently debated the issue of climate change policies with him on a public platform. He was relentlessly arrogant and disparaging and I had to call on all my Quaker training not to respond in kind. He explained how he had solved the CO2 problems of the Maldives - apart from the tourist flights that underpin the country's economy, which will require a little more techno-fixing.

During the panel discussion we clashed over figures for emissions of CO2 per head and, after we had finished, I asked Mark where his were from, knowing that my own were pretty out-of-date and China is moving fast. He told me he uses Wikipedia as his source. There is pride amongst ideas merchants, and this immediately told me he is the intellectual equivalent of Delboy, interested in the deal rather than the quality of the product.

The title of the Hardy novel comes from Gray's Elegy, a poem whose theme is redolent of the balanced sense of the modesty and lack of self-importance that country living brings, and whose whole tenor is the antithesis of the modern media culture. I like to think that my decision to watch the film rather than watching the documentary represents a decision to be reminded of the deeper wisdom of our ancestors rather than pure escapism.
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Follow the money

Any intelligent observer who was paying attention must have learned since 2008 that the money system is the trick that facilitates the control of the global economy in the interests of a tiny but powerful minority. So when any proposals are made to change the way that money-banking system works we should pay great attention.

On Tuesday Mervyn King, the Governer of the Bank of England and therefore the man responsible for both banking in the UK, monetary policy and the pound sterling itself, gave a speech in New York (aka Capitalism Inc. HQ) where he said explicitly that 'Of all the many ways of organising banking, the worst is the one we have today.' (Full text available here.) This is the clearest indication yet that capitalism is in the course of a major adaptation: the key to who will gain and who will lose will be in the design of the money system that will emerge.

King's central point in terms of critique seems to be similar to that made by my good friend Mary Mellor in her book The Future of Money, namely that it is simply unfair that a system so unstable as that of fractional reserve banking should be guaranteed by the public so that, in the now familiar cliche, the losses are socialised while the profits are privatised.

According to Robert Peston's summary of the speech, King argued that the hastily agreed Basel III accords are insufficient guarantee for publics who still stand behind their banks. For those do not spend their time watching the pin-stripes, Basel is the place where international bankers go to decide amongst themselves what is the least they can agree to tinker with their business model to keep the world's politicians happy (again: note the location).

What Mervyn King was arguing for, in the heart of the banking beast, was the abolition of banking as we know it. He proposed two alternative models. The first is already the subject of wide debate and would require a complete separation of retail and investment banking. The second is more interesting and known as 'limited purpose banking'. It works on the insurance model inherent within mutual approaches to finance and, as far as I can understand, leads to a situation where we really are ‘all in it together’, since the risks between capital and personal investments are pooled, with businesses and households sharing risks, but within different kinds of 'banks', operating with different degrees of risk.

Mervyn King places his hope in the Independent Commission on Banking, whose members are all well-steeped in the capitalist money and banking system, and are sure to recommend an adaptation that does nothing to change the status quo in terms of the sharing of economic power within global capital. Perhaps it is time to launch our own People's Commission on Banking in response. This could propose that the creation of money should be in the public, not the private sector, thus solving all King's problems at a stroke. I propose Mary Mellor for Chair. Tweet

Capitalists Defend Capital Against the Banks?

Now here is something you didn't expect to see: a link from my blog to a Conservative one. Although, given the recent suggestions that I am incapable of using the word 'capitalism' in a critical way, perhaps you wouldn't be surprised. Although this post on Conservative Home begins with a childish and laughable indication of the blind hegemony of the pro-market ideology, this is to reassure readers who may be shocked by what follows.

The interesting news you can read between the lines of what follows is that the debate on monetary reform is on the move. This is one of those issues where the old left-right, capital-vs.-labour argument gets thrown into disarray, because those who own the capital appear to be becoming disgruntled about those who 'create' money undermining their holdings. Clearly, I have wildly different reasons for wishing to take the power to create money from banks, and in fact I doubt many Conservatives would agree that this right should lie with the people. But, as this Carswell makes clear, a minority are resuscitating arguments for a return to the fractional reserve system.

On a less cheery note, the policy motion on monetary reform to this year's Green Party conference was not passed, and cannot now be brought back for another two years. The US Greens, by contrast, have included in their policy platform for 2010 a full commitment to monetary reform and for political authorities to reclaim the power over money from the banks.

After the large number of responses to my last post, some of them rather forceful and a little unfair, I wonder whether I dare encroach onto this territory. I will be responding to the interesting debate that ensued in a later post. In the mean time perhaps I should take Harry Enfield's advice and 'know my limits'? Tweet

Time to Stir it up

My friend Barbara Panvel posts weekly at The Stirrer: 'campaigns that count in Birmingham, the black country and beyond'. Her latest post is addressed to Helicopter Ben - Ben Bernanke of the Federal Reserve who is now following up on Milton Friedman's suggestion that dropping money from helicopters might be a way to deal with deflation.

Nothing could better illustrate the desperation of policy-makers than such an arbitrary and aimless dumping of money into the economy. The language of strategic injections has been abandoned. There never was any attempt to direct the money towards those who might need it.

As Barbara points out, why not simply create money for public projects, along the lines of the proposal from Robertson and Huber? This would allow governments to invest in all the services their citizens need without the need to pay back the debts.

There have been a whole string of Early Day Motions calling for money creation in this form. Such a monetary reform could also pay for the shift towards a low-carbon economy that we so urgently need. It appears to be implicit in the Green New Deal proposal, which is perhaps why that has not gained the attention it deserves.

As Barbara identifies, a key mover in favour of this radical revision of the money creation system has been Austin Mitchell MP. For this he was given the Thomas Atwood Award earlier this year. The reason this proposal is not taken up is purely political, and the political consensus rests of public ignorance. The financial crisis has lit the fuse under this debate. Tweet

You only give me your funny paper

The really mysterious thing about the operation of central banks around the world is how they can - as if by magic - 'inject' money into failing banks and finance businesses. Where does this money come from? (Here is what Richard Douthwaite has to say about this.)

Although the Bank of England is officially apolitical, it is in fact deeply political. It can create money by selling government bonds, in other words mortgaging the country in order to create money. At present it is creating money in this way to bail out banks and investment houses who have bought worthless assets. They took the risk but we are paying for it. They took their bonuses when they made the deals, but those bonuses are being paid by ourselves and future taxpayers.

I confess the workings of the central banks are highly arcane and deliberately obscure, so I may have this wrong. If so, I would be glad to be informed of where BoE can find a hidden stash of gold that is not available to others.


The nature of money creation is a shared scam by the commercial banks. They create debts which other banks accept as credits, and this allows the banking system as a whole to create money from nothing, which they share between themselves to create their massive profits.

The problem is that the reverse also applies. In troubling times a bank will refuse to accept another bank's paper but will rather ask for something of real value. Since the very nature of the system of money creation means there is nothing of real value there, the circle which was once (at least if you are a bank) virtuous, will very rapidly become vicious.

This explains the anomalous situation that, as the central bank cuts its own interest rate (meaning we are getting less back for our bonds), banks are actually charging us higher interest rates. They have become more risk-averse which means they have less trust about whether we (or other banks) will repay, which they reflect in making money more expensive. This also has the handy side-effect of increasing their profits at a time when their traditional means for doing this has folded up.

In the face of such disastrous mismanagement of the financial system the obvious solution is for political authorities to take back the power to make money. I predict that any suggestion along these lines will be met with some worthy bank stooge (my money would be on the Ken Clarke-Denis Healy double-act) waffling on about inflation. A shame they forgot to mention that when they allowed the banks to create worthless paper money. Tweet

Political, not banking, crisis

The world's central banks have made it easier for the world's commercial banks to increase the amount of debt circulating around the world economy. They began by concertedly reducing interest rates, making it cheaper for commercial banks to lend money. This had little effect, so yesterday they acted together to actively create new money.

It is not clear how this money was 'created' but it was probably by the selling of government bonds, in other words increasing the value of the public debt that we will have to pay off through taxation. Since there is no asset to balance this debt the central banks are guilty of just the sort of monetary inflation that the government says is impossible when policemen want a pay rise. Such action is defensible, it seems, when it is financial investors who want a pay rise.

Is it the fact that the word 'inject' is always used about the creation of debt-money by central banks in this way that leads journalists to use the metaphor of a drug pusher, encouraging debt-addicted banks to go back for another fix? To me the more appropriate metaphor is that of the weak parent.

The role of the central bank is to ensure what the jargon calls 'fiscal probity', which means not lending in an irresponsible way. But how could banks judge what is responsible or not when lending to people to gamble on the future value of unplanted cocoa crops is acceptable? No clear boundaries here. And when the unruly children see their playfully created 'financial instruments' blow up in their faces they are not punished or even reprimanded but simply payed off and allowed to continue. No tough love in the world of banking.


Since the reserve ratio (the proportion between bank lending and assets of real value held in the banks) was abandoned, central banks have only required that commercial banks act with prudence. The purchase of junk assets, such as mortgages held by people with no incomes to pay them back, is a clear example of imprudent behaviour. But do the central banks punish banks for this? Of course not, they just enable this sort of lending to continue.

Central banks, and the governments they answer to, are in an uneviable situation of their own making. Following the ending of credit and exchange controls, the deregulation of financial markets, and the ceding of control of monetary policy to banks by governments, political control over money has been abnegated. The role of politicians was to ensure a money system that served the real economy and our interests as citizens. The role of banks was to maximise profits for shareholders. If things are as bad as they currently seem, and the whole monetary system fails, this will be a disaster for us all.

To see what happened when Argentina experienced a 'credit crunch' see my article.

For more on the creation of money see Richard Douthwaite's excellent (and short!) book The Ecology of Money.

Or you could buy Market, Schmarket where this is covered in Chapter 6. Tweet

Schemes and Dreams on the Mosquito Coast

Over the past couple of months I have been posting intermittently about money and have had some interesting comments. I understand that reordering your understanding of this issue is hard to take. As Galbraith so eloquently put it: ‘The process by which banks create money is so simple that the mind is repelled. Where something so important is involved, a deeper mystery seems only decent.’ But as is so often the case in economics, as well as home economics, the proof of the pudding is in the eating. So for those who are not yet convinced by this account of the nature and instability of the money-banking system some examples from history can be used to illustrate the theory in practice.

Such periodic disasters are inevitable, indeed symptomatic of capitalism as an economic system. They are the boom-and-bust cycles that are generated because the capital that lies at the heart of the system is created in such an illogical and unstable way. In the words of Galbraith again: ‘As banking developed from the seventeenth century on, so, with the support of other circumstance, did the cycles of euphoria and panic. Their length came to accord roughly with the time it took people to forget the last disaster’. One cautionary tale follows. I'll post more over the next month or so.

The establishment of the Bank of England was the other side of the coin of the creation of the national debt called a ‘fund for perpetual interest’, rather like a perpetual motion machine. Initially the Bank was established privately by Scottish entrepreneur William Paterson who persuaded the government to raise £1,200,000 by selling the national debt to citizens who would redeem their share with interest in a fixed number of years. The scheme was accepted in 1694 and from then until the following year Paterson served as a director, when he fell out with the other members of the Court (or board) and was sacked. Paterson was an entrepreneur and the Bank of England was merely one of his many schemes to create money from thin air. He is probably most famous for the subsequent disastrous Darien project.



In 1693 he set up the Company of Scotland Trading to Africa and the Indies, which sold shares of a proposed colony on Darien on the Panama isthmus. The Scots were keen to see their own advantage from expanding international trade and so there was no shortage of investors: about half a million, half Scotland’s national capital, was invested. Darien was in fact the original Mosquito Coast and most of the settlers died within the year. The scheme was also sabotaged by English traders and the English governor of Jamaica who did not want any competition. Thanks to Paterson the Scottish economy was nearly bankrupted preventing Scottish entrepreneurs from competing with the ‘British’ empire, and we have lived with the national debt for the past 300 years and more. In its weakened state Scotland agreed to be subservient to the English Crown under the so-called Act of Union just a few years later in 1707.

Galbraith’s conclusion on banking seems most apt: much discussion of money involves a heavy overlay of priestly incantation. Some of this is deliberate. Those who talk of money and teach about it and make their living by it gain prestige, esteem and pecuniary return, as does a doctor of witch doctor, from cultivating the belief that they are in a privileged association with the occult. (Galbraith’s Money: Whence it Came, Where it Went, p. 5). Tweet

Where does money come from?

If you ask people where money comes from they will probably tell you from a bank. Dig deeper and you will find that people believe that the money they take out of the bank has been deposited there by somebody: by the person herself, in which case it is simply a withdrawal, or by somebody else, in which case it is a loan. This is the first big myth of money, because the truth is that all or nearly all (depending on your theorist of choice) the money you take from the bank has been created out of thin air by the bank itself.

When you begin teaching students about the economics of banking you teach a fiction known as ‘fractional reserve banking’ and many who have never taken economics as an academic discipline or worked in a bank have a hazy notion about this system. It is understood, because of Hollywood movies about ‘runs on the bank’,that the bank does not actually hold, or need to hold, as much money as it lends to people. Because it is highly unlikely that everybody will come and ask for all their money, all at the same time, the banks can consider themselves to be acting with probity if they retain only a proportion as ‘reserves’, this proportion being understood to be around 10 per cent. Let us for the time being take this story as a reasonable account of how banks create money; it is the one that is reproduced in most economics textbooks. The first stage is the deposit of some money by a punter, let us say £100. Because banks have learned from historical experience that only one in ten of such punters will want her or his money back at any given time, they feel quite secure in lending £900 on the basis of this deposit, effectively inflating its nominal value, and thus reducing its real value, tenfold.

The second myth about money that is universally believed is that it is, and needs to be, backed by something of real value. Governments create money and this money has credibility because the government has a sufficient store of gold in its vaults to support its value. Like the reserve banking story, according to this fiction governments can create more money than the gold they have, but only up to a certain limit. This story was true for some time, but it was found that the uncontrollable growth of the capitalist economy rapidly outstripped the gold available to support it and maintaining a ‘gold standard’ stifled economic growth.

Eagle-eyed and sharp-minded readers will have noticed that there is an inconsistency between the two stories told so far, in that they disagree about who is responsible for creating the money. They have in common the idea that, while there should be something of real value backing up a currency at least in part, who owns this collateral and who therefore creates the money could be either the bank or the government. This was how things were, both banks and government were entitled to create money: governments created money as fiat issues, whereas banks created it in return for a debt.

So there are several different types of money, distinguishable by the nature of their back-up and by who controls them. Banks can create money on the basis of deposits, as credit. Governments can create money by selling bonds, or just by making a decision to create currency. It may be efficient to leave the job of generating credit for economic activity to banks, so long as they operate within political controls, but it will also be necessary to have money created by government both as credit, to fund public works, and as currency, to facilitate economic activity without the creation of parallel debts. The graph shows how the political attitude to money since the Second World has effectively been the privatization of money creation. It shows the relative proportions of money created by banks and governments over that period. This has had the inevitable consequence of increasing the proportion of money paid to bank shareholders and producing a squeeze on the money available for public investment.

. . . to be continued (when you can bear it!)

If you can bear any more just now you might like to follow this link to a short presentation about money.

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