Taking Money Creation back into Public Hands

The current banking and sovereign debt crises are rooted in the monetary system as it stands today. The financial causes of the crises have a common monetary cause: excessive credit creation within the system of fractional reserve banking. This inevitably feeds speculative bubbles, asset and consumer price inflation, and results in over-indebtedness, particularly of governments and the banks themselves. In order to work properly, the economy needs to rely on a stable and just monetary system. That is why we call for
1. full re-establishment of the public prerogative of creating money as a responsibility of the independent central bank
2. putting an end to the creation of bank money
3. spending new money into circulation debt-free through public expenditure.

Money makes the world go round. Who makes the money go round?

Everybody uses money as though it were self-evident. But the actual functioning of the monetary system remains just as nebulous as its characterisation as ‘fractional reserve system’. This works to the benefit of the banks. They have in effect usurped the prerogative to create money by crediting 80-95 per cent of the means of payment into circulation in the form of demand deposits on current accounts.

An increasing part of the money supply has of late fueled mere financial transactions which had no benefit for the real economy, but have caused much real damage to it. The barely restrained creation of credit drives business cycles and the stocks and securities markets into irrational exuberance – wildly overshooting in boom periods, while resulting in over-indebtedness and severe undersupply of money in ensuing crises. If banks themselves go bust, their customers’ deposits and savings are at risk. If the state then intervenes to bail out the banks and vouch for deposits, governments in effect privatize banking profits, while passing the losses on to the public.

Banks act as individual companies. They are duty bound neither to macro-economic goals nor to the common interest. Leaving to them the weighty prerogative of creating the official means of payment is untenable. Money and the monetary order represent concerns of constitutional importance.

Nationalization of money, not of banking

All money should exclusively be created by an independent public authority. In the European Monetary Union this role falls to the European Central Bank and its national central banks. They ought to be seen as the fourth power in the state: the monetary power, to complement the legislative, executive and judicial powers. As with the latter, the monetary power must be independent and answerable only to the law – independent from governments’ and parliaments’ appetite for money as well as from self-serving interests of the financial sector and other industries. In such a monetary regime, local complementary currencies and co-operative clearing systems can co-exist.

The monetary reform envisaged here is simple: Bank-money on account (today’s demand deposits) would be declared to be legal tender just like coins and banknotes. The system of public central banks – the monetary power – would exclusively be authorized to create these official means of payment and regulate the quantity thereof. Money on account would thus be nationalized in the same way as banknotes were nationalized over a hundred years ago. At that time, privately issued banknotes were phased out in favor of public banknotes issued by the central bank. Today the crux of the matter is to replace the debt-laden, unstable and unsafe bank-created demand deposits by a public money supply which consists of central-bank money only – plain money, be it in cash, or on account, or on mobile storage media. Today’s partially nationalized money base (5-15% coins and banknotes) would again fully be nationalized, not however the banks.

Government and parliament would have no say in the central bank’s independent decisions on how much money it deems necessary. The discretionary additions to the money supply would be transferred free of interest from the central bank to the government that spends it into circulation under normal budgetary procedures. In recent years this has involved 200-350 billion euros p.a. within the European Monetary Union, amounting to about 4-8 per cent of total national budgets. This represented an overshooting supply, but even less money still represents very much money foregone to the public purse.

Banks and financial markets should be able to pursue all but one of their current activities: that of creating money in the form of demand deposits by crediting them out of thin air into customers’ current accounts. Banks would have to operate purely within the means which they have obtained as earnings or taken up at the money market or from their customers. Banks would hold that money in cash or in their account with the central bank.

Putting an end to the banks’ ability to create demand deposits can be achieved in a technically rather simple and smooth way: Customers’ current accounts would be taken off the banks’ balance sheet and run separately in their own right.

Making money creation fit the public interest

Such a monetary reform would bring about five big advantages. First, money on account could no longer disappear and would thus be safe. If banks failed there would be no reason for a run on those banks, and cashless money transfer would not be in jeopardy. Governments and the public would thus no longer be at the mercy of the banks’ survival as is the case today.

Second, bounds would be set on the banks’ procyclical over- and undershooting of the money supply. Before running into a stage of ‘irrational exuberance’ markets would run short of fuel in the form of all too cheaply available credit. Money flows would be steadier, and business cycles and financial investment cycles more moderate.

Third, the central bank would have full control of the quantity of money and would thus be able to prevent asset inflation and consumer price inflation by managing the money supply in accordance with real economic potentials – unlike today’s highly inflationary credit creation by the banks.

Fourth, seigniorage would fully benefit the public purse and no longer be an undeserved banking extra profit. A non inflation-accelerating growth rate of the money supply is in line with the expectable growth rate of the real economy. By today’s standards 1-2 per cent of GDP growth in the European Monetary Union (currently about 9.100 billion euros) involves an additional money supply, and thus seigniorage, of about 90-180 billion euros. This amounts to about 2-4 per cent of the total budget of EMU member states.

Fifth, and of particular importance today, governments would have the one-time chance of reducing public debt by half in a no-noise no-pain transition to the new system. The reason is that the reform substitutes plain money (i.e. central-bank money) on current accounts for banks’ demand deposits. Most of the replacement would happen within a time span of about three to five years as old bank credits are paid back and replaced by new loans fully made out in central-bank money. The necessary means for this one-time substitution can originally also be brought into circulation by way of transfer from central bank to government. Governments in turn can use the corresponding amounts of one-off transition seigniorage to redeem public debt. Demand deposits within the EMU amounted to 3.910 billion euros in the middle of 2011, in fact half of total public debt at about 7.850 billion euros.

Measures such as financial transaction taxes or higher bank equity cannot be very effective as long as the fundamental monetary cause of the banking and financial crises is not removed. What we now need is monetary reform: replacement of bank-created demand deposits by central-bank-created plain money, in finally establishing public central banks as the independent fourth power, the monetary power.