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Martin Wolf: “When the next crisis comes . . . be ready. Strip private banks of their power to create money”

April 26, 2014

ft.com logoLast week, Martin Wolf – chief economics commentator at the Financial Times – wrote in the Comment section that “the giant hole at the heart of our market economies needs to be plugged.”

He points out that printing counterfeit banknotes is illegal, but creating private money is not, adding, “The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and should – be terminated”. Two weeks ago he explained that banks create deposits as a by product of their lending – in the UK up to about 97% of the money supply.

All this will come as no surprise to those readers of this website who have been hearing the arguments since the 80s. However to see the message coming from such a source – a mainstream authority – is a remarkable breakthrough.

What is to be done? Wolf continues:

A minimum response: leave this industry largely as it is but with tighter regulation and an insistence that a bigger proportion of the balance sheet be financed with equity or ‘credibly loss-absorbing debt’ . . .

A maximum response: give the state a monopoly on money creation. One of the most important such proposals was advanced in the 1930s by a great economist, Irving Fisher. Its core was the requirement for 100% reserves against deposits to greatly reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff also suggested this plan could work well.

Similar ideas have come from Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, and Andrew Jackson and Ben Dyson in Modernising Money:

  • First, the state, not banks, would create all transactions money, just as it creates cash today. Customers would own the money in transaction accounts, and would pay the banks a fee for managing them.
  • Second, banks could offer investment accounts, which would provide loans. But they could only loan money actually invested by customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are.
  • Finally, the new money would be injected into the economy in four possible ways: to finance government spending, in place of taxes or borrowing; to make direct payments to citizens; to redeem outstanding debts, public or private; or to make new loans through banks or other intermediaries. All such mechanisms could (and should) be made as transparent as one might wish.

The transition to a system in which money creation is separated from financial intermediation would bring huge advantages. It would be possible to increase the money supply without encouraging people to borrow. It would end “too big to fail” in banking. It would also transfer seigniorage – the benefits from creating money – to the public as James Robertson has long stressed …

Would the economy die for lack of credit?

Only about 10% of UK bank lending has financed business investment in sectors other than commercial property. We could find other ways of funding this. The giant hole at the heart of our market economies 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. Wolf ends:

This will not happen now. But remember the possibility. When the next crisis comes – and it surely will – we need to be ready.

Read Wolf’s article here – free registration may be required: http://www.ft.com/cms/s/0/7f000b18-ca44-11e3-bb92-00144feabdc0.html#ixzz2zsSLLs8i

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