Interesting news announced yesterday, Christmas Eve: Switzerland is to have a referendum on stripping the private banks of their power to create money. All money would be created only by the Central Bank and this would somehow make kittens gambol again in the sunshine, create vast wealth for the citizenry and possibly even give middle aged men the stamina of teenagers (a horrifying thought if there ever was one). There's a certain amount of truth to the basic ideas behind this campaign. However, for some reason, monetary and banking economics really does attract very much more than its fair share of flat out loons. And that's who we've got behind this campaign I'm afraid, a group I've locked horns with before from my native UK called Positive Money. Some parts of their analysis are entirely correct: and then they jump off into the deep end of simple ignorance of the subject under discussion. I am not using the word loon here merely as a pejorative: I'm sorry, but they really are off with the fairies on this one.
The basic news is reported here:
Switzerland will hold a referendum to decide whether to ban commercial banks from creating money.
The Swiss federal government confirmed on Thursday that it would hold the plebiscite, after more than 110,000 people signed a petition calling for the central bank to be given sole power to create money in the financial system.
The campaign - led by the Swiss Sovereign Money movement and known as the Vollgeld initiative - is designed to limit financial speculation by requiring private banks to hold 100pc reserves against their deposits.
"Banks won’t be able to create money for themselves any more, they’ll only be able to lend money that they have from savers or other banks," said the campaign group.
There's a fun little Q&A from the FT on the subject here:
OK, so most money isn’t physical. Welcome to the modern world. Now are you going to explain what this Swiss initiative is about?
Wait — you’re not trying to tell me banks are actually doing this, are you?
It’s all related. As you say, of course banks don’t have their own printing presses. But what if they can create electronic money at will?
That would be crazy. Just like physical counterfeiting, except they could forge much more money in much less time. And without getting ink on their fingers.
Well, that’s what this Swiss referendum is about.
That’s just what I’m telling you. Where do you think the deposits come from?
To give the economic background here. Generally when we talk about money we distinguish between base money, also known as M0, and broad money, of which M4 is an exemplar. Base money is the cash and coin, that sort of thing, created by the central bank. Broad money is that plus all the credit, bank accounts, loans and so on floating around the economy. That latter is of course very much larger than the former and is very largely (90-95%) created by the banking system itself, not by the central bank. So, the basic claim that the private banks create money is true: as long as we overlook this distinction between broad and base money. Another way that we distinguish is between money and credit: it's the banking system that creates credit, the central bank that creates money. So it's also entirely possible to look at this the other way around: the banking system creates credit, not money.
Which words you want to use are really up to you: but do note that this is an important distinction. You can say the banks create money if you like but you're still meaning credit, not base money.
This is all closely related to two other thought streams in monetary economics, Modern Monetary Theory (L Wrandall Wray and Warren Mosler sort of stuff) and full reserve banking. Again, there's a lot of truth in both analyses and some of the enthusiasts do take such analyses too far. But, for example, full reserve banking would stop the sort of banks runs that made Lehman Brothers and Northern Rock collapse but as this is Christmas, let's have that scene from A Wonderful Life:
Sadly, full reserve banking would also stop maturity transformation, which is one of the major things that we want from a banking system in the first place, so that's probably not a good idea. Even Adam Smith was pretty lenient on fractional reserve banking, the system we use today.
This piece would be many thousands of words if I were to describe in detail the truths and problems with both MMT and full reserve, or 100% reserve banking. Suffice it to say that they do both contain great truths, yet most of the world and establishment is unconvinced about the desirability of the full systems in either case.
These people behind the Swiss referendum however manage to leap over all of that into full blown nonsense and gobbledygook, thus my use of the word loons. They make claims which simply cannot possibly be true: and if their analysis leads to claims that simply cannot be true then there's an error, a fault, in said analysis. It's like doing some math and ending up with the result 1=0. When that happens you know that you've made a mistake earlier up the line.
What's worse is that I actually pointed out one of their errors to one of these people some years ago in The Guardian. And yet they're still making that horrible, gross, error.
The referendum campaign page is here, the Vollgeld Initiative. To all intents and purposes they are the Swiss arm of these people in the UK, Positive Money. Which is where our loons reside. For example, this statement of theirs is not only impossible it doesn't even make internal sense:
1. The Proceeds from Creating Money
The Bank of England still prints paper money (e.g. £10 notes). Because it only costs a few pence to print a £10 note, the government makes a profit on every single bank note that it prints. Between 2000 and 2009, this profit on newly-created money added up to £18 billion – enough to pay the salaries of around 90,000 nurses over that time.But the Bank of England only creates the paper money, and leaves it to banks to create the electronic money that we also use every day. When banks create money, they – not the government or the taxpayer – get the benefits of creating that money.
From 2002 to 2009, banks increased the amount of money in the UK by £1 trillion through lending (with every new loan creating new money). Because this money was created by banks, it’s the banks that get the benefit from it (in this case, the interest received on £1 trillion of additional loans).
If the government had created this money instead of the banks, taxpayers would have been able to pay up to £1 trillion less taxes: approximately £33,000 for every person who pays income tax over just 7 years.
Note how they move from the benefit to the banks being the interest on £1 trillion (not actually true but we'll leave that aside, banks pay interest on deposits as well as collect it on loans, it's the spread that makes their profits) to the benefit to the taxpayer being the entire £1 trillion. Sorry, that just doesn't work, that's not even internally logical.
But the basic statement is also impossible. That the banks created £1 trillion in credit, yes, fine. But that does not mean that if the central bank created it instead then taxpayers would have to pay less tax. Partly this is to do with our above distinction between money and credit, base and broad money, M0 and M4. This talks to the basic monetary equation, MV=PQ, money, times the velocity of its circulation, equals prices times quantity. It's not exactly right but hugely useful to think of the M there as being our M0, base money, and MV as being M4, our total money supply after the influence of the banks on creating credit and so on. And one thing we really do know is that the creation of M0, base money, has a much greater effect upon P (that is, inflation) than M4 or broad money creation. Thus if the central bank had created £1 trillion in new base money inflation would have taken off into the stratosphere.
To which the usual MMT answer is, great, so raise taxation levels in order to reduce aggregate demand and thus inflation. Which is entirely true, that can be done. But that's not actually a reduction in the taxation that must be paid by the populace, is it? If we print more central bank money then tax back the inflationary effects the end result is higher government spending and higher taxation: this isn't any different, in final effect, from tax and spend, is it?
But it's worse than that I'm afraid. Because we have this thing called GDP that we can call into evidence.
Start with their contention again: if the central bank just printed the money then that's £1 trillion that can still be spent without the taxpayers having to cough up for it. This obviously means that the private banks, who actually did that money creation, created that £1 trillion of value when they made that private money. This must be true: if money creation produces value, if one person producing money creates value that can be spent, then another person creating money that can be spent must also create the same value.
Thus, if the central bank can create £1 trillion by nationalising the production of credit, then it must also be true that the private banking system was creating £1 trillion of value by creating credit. Which brings us to GDP: that's the value of everything created in an economy in a year. So, where is that trillion the banks produced?
UK GDP is, to a reasonable level of accuracy, £1.5 trillion a year over this period. They saying that £1 trillion was created over 7 years, that's, close enough, £150 billion a year or 10% of GDP. So, what's the size of the UK banking sector?
Britain's financial services sector grew rapidly between 2006 and 2009. The UK economy has long been a dominant player in financial services, along with the US, but growth in the sector between 2006 and 2009 was particularly rapid. By 2009, the sector accounted for 10% of UK GDP, the highest of all G7 economies. The second highest was Canada at 6.7%, and the lowest was Germany at 3.9%. The dominance of the sector in Britain meant it was hit harder by the financial crash. Its share of the economy fell by 2.9 percentage points, while it remained roughly stable in other major economies. Output in the UK financial services sector is still 13.6% below pre-crisis levels according to the latest ONS data.
Note that that's financial services: insurance, pensions, everything, on top of banking itself. And that also includes The City, a lot of which isn't dealing in sterling and thus has nothing to do with the creation of sterling as money.
And as to GDP, that value of all that is produced. One way to measure the value as GDP of a company or business sector is simply to add up all the profits made by the company or sector plus all the wages paid by it. For the entire economy is always an income to someone: rent, interest, profits, wage income and so on all add up to 100% of GDP.
Our banking sector is thus, at very much less than 10% of GDP, smaller than the amount of value that Positive Money claims is simply magicked into existence by the creation of money by the private banking sector. This just cannot be so. If that value is being created then it must go somewhere. And the banking sector just isn't large enough for that value to be there: and thus, of course, if the value isn't being created then it cannot be appropriated by the nationalisation of credit creation into the central bank.
Positive Money's central claim about the effects of private bank credit creation is thus simply wrong. Not only is it not internally consistent within their own argument it's simply not possible for the economic argument itself to be true.
Which is why, while I'm perfectly willing to agree that there's interesting insights to be had from Modern Monetary Theory and even the consideration of 100% reserve banking, I insist that this specific campaign is being run by the loons. They're Fonzi doing that Selachimorpha jump I'm afraid, leaping from interesting and possibly even amusing right off into the sterile wastelands of their own misunderstandings and absurdities.
