The Case for Sovereign Money
This account by Professor Joseph Huber, chair of economic and environmental sociology at Martin Luther University of Halle-Wittenberg, Germany, has been abridged and divided into two parts for the blog format but may be read in full by those who download this paper as a PDF.
Sovereign money is legal tender issued by a state body such as the national central banks and the ECB in Europe and Japan, or the Treasury in the United States. Other terms include public money (Yamaguchi), constitutional money (Morrison), and state money (Werner).
Sovereign money in public circulation (among nonbanks, including households, companies and government) takes the form of government coins and central-bank notes.
Sovereign money in interbank circulation takes the form of reserves (money-on-central-bank- account). The opposite of sovereign money is bank money. Bank money takes the form of deposits created by banks’ primary crediting of customer accounts. At 82–97% of the money supply (depending on country and monetary aggregate) bank money represents the lion’s share today.
(Table taken from an interesting FT account with a Raghuram Rajan link: http://blogs.ft.com/money-supply/2011/11/24/why-banks-hold-their-own-sovereigns-debt/)
A plain sovereign money system would come into existence by completing the monopoly of creating coins and notes with money-on-account, while phasing out bank money. The monetary aggregates M0–M3 would no longer exist. There would be just one integrated money supply M flowing within a single circuit among banks and nonbanks alike.
Today’s savings accounts, certificates of deposit, or similar, would be regular customer loans to a bank, documented in banking statistics, not however as ‘money’, but as short-term capital.
Sovereign money is just as constitutive for a nation’s sovereignty, or the sovereignty of a community of nations, as the prerogatives of legislation, state administration, jurisdiction, taxation and the use of force. Monetary sovereignty includes
1. determining the currency of the realm, i.e. the unit of account
2. creating and issuing the money,
3. taking the benefit from money creation, i.e. the seigniorage.
The present system is based on bank money created at the banks’ own discretion
Is the present two-tier banking system not one of sovereign money, in that the banks’ credit and deposit creation is carried out under the control of the central bank? No, not at all. The present system comes fairly close to ideas of free banking on the basis of bank money created at the banks’ own discretion.
Central banks and legal-tender laws are not what some economists assume them to be and what supporters of free banking suspect them to be. Legal tender – i.e. means of payment by state fiat, in particular by central-bank fiat – does no longer lead in today’s fractional reserve system. At source, deposits are not created by depositing sovereign cash, but by banks’ primary credit creation. Cash comes into circulation as a technical sub-amount that is exchanged out of and back into those ‘deposits’.
By pro-actively extending bank credit when making loans and asset purchases, banks create the entire quantity of money, thereby also initiating the residual re-active creation of coins, notes and reserves. The central banks always re-finance the facts the banks have created in advance. If a central bank refused to do so, the flow of payments―and thus the economy—would come to a standstill.
In order to maintain 100 currency units, banks in the euro area at present need about 3% central-bank money, of which 1% is the minimum reserve requirement, 1.4% notes for the ATM, and 0.1–0.6% are excess reserves for the settlement of payments. In the US, the need for fractional re-financing may be slightly above 10%, because of a minimum reserve requirement of 10% from which the cash in vault can be deducted . . .
What remains from the state’s monetary prerogatives today is the currency unit – dollar, yen, yuan, etc (no.1). The money supply, however, is fully determined by the banks’ credit and deposit creation (no.2). Equally, the genuine seigniorage from coinage and the interest-borne central-bank seigniorage from residually re-financing banks and managing the national foreign reserves (no.3) are rather limited in comparison to the gainful advantages banks enjoy from being the primary creators as well as the first users of the money, which they provide at a 3% or 11% fraction of the full funding costs. The banking industry thus has far-reachingly captured the monetary prerogatives.
Dysfunctions of fractional reserve and the advantages of sovereign money
The creation of bank money is out of control . . . The consequences are:
- consumer price inflation (more importantly before the 1980s)
- asset inflation
- debt bubbles
- banking, debt and currency crises in migrating hot spots around the globe.
Such crises have increased in terms of both numbers and severity since the 1970s, with knock-on effects on the entire economy of the nations involved. At such times, bank money proves to be unsafe and not coverable by deposit insurance, while government and the taxpayer have to bail out systemically relevant banks or other financial corporations in distress. Moreover, the disproportionate build-up of interest-bearing monetary and financial fortunes creates a distributional bias in favour of capital income to the detriment of earned income.
Adherents to banking-school thinking assert that markets cannot fail, and if they do it must be due to government or central bank interference. Banking doctrine thus refuses to acknowledge any monetary causation of financial problems.
In actual fact however, rather than limiting themselves to some point of ‘equilibrium’, money and capital markets do overshoot. The reason is that markets not only have crowd intelligence, but also crowd foolishness and – which makes for a dangerous combination – modern money has no natural anchor of scarcity.
Part 2 – Transition from bank money to sovereign money