CAN
ICELAND
SAVE THE WORLD?
The
2008-09 financial crisis forced ICELAND to come up with profoundly new banking
and monetary systems.
By Daniel Stelter
THE
ROLE OF MONEY, CREDIT AND BANKS
Just a few years ago,
ICELAND became a focal point in the global financial crisis, when the small
country’s banking system collapsed.
Sometimes, a profound
crisis leads to great new insights and strategies. Such is the case with Prime
Minister SIGMUNDUR DAVÍÐ GUNNLAUGSSON’S decision to have a commission of
economists come up with a proposal for a fundamental reform of ICELAND’S banking
and monetary system.
Background
Information:
WHAT
HAPPENS WHEN BANKS CONTROL THE ECONOMY?
RATING
AGENCIES, THE FEDERAL RESERVE, THE PARIS CLUB, THE IMF, BROKERS AND SPECULATOR
The solution they came up
with — the introduction of “sovereign money”– has applications far broader than
just for tiny ICELAND. Why? Because it would strip banks of their ability to
create money and instead would concentrate this power with the central banks
only.
This is an ambitious
goal, no doubt – but it is hugely important. In today’s world, banks can create
nearly unlimited quantities of money out of thin air – that’s why we speak about
“fiat money.”
Note then, when you get
credit from your bank, the bank does not lend you money, which was saved before
by someone else. Instead, the bank just creates the money by the act of
crediting your account. Accordingly, most of the money we use was actually
created by private banks. Only a small proportion was created by central banks
such as the Fed and the ECB.
Please
move to 1hr:16min:00 to watch related topic: The International Monetary System
Since 1973, when the last
link of money to gold was given up, we have seen an unprecedented credit boom
leading to more financial crises. The report prepared for ICELAND counts 147
banking crises in 114 countries since that year.
Credit growth has been
significantly higher than economic growth, leading to the current debt problems
of private and public sectors.
CENTRAL
BANKS WITH LIMITED POWER
In spite of all the
headlines around quantitative easing in EUROPE and tapering in the UNITED STATEs,
not to forget ABENOMICS in JAPAN, we have to keep in mind that in today’s
world, central banks have only a limited and indirect way of influencing the
process of money creation in the banking sector. The Bank of ENGLAND pointed to
this fact just recently.
The only means of
influencing the process of “credit = money creation” is by setting standards
like minimum reserves and interest rates: Measures like “quantitative easing,”
where central banks buy assets like bonds and stocks, hoping to influence the
real economy via the so called “wealth effect.”
Up to now, quantitative
easing has not worked, as we can see in the UNITED STATES. Yes, asset prices
have gone up and the U.S. stock market is trading at lofty levels.
But real economic
activity is still below pre-crisis trend and the labor force participation rate
is significantly lower. In the case of another recession, the central banks
have no ammunition left to fight it.
NO
TRUE REFORM OF THE BANKING SYSTEM
In spite of all the
soothsaying, seven years after the crisis we have made no real progress in
fixing our monetary system.
It can
hardly be counted as progress that banks have gotten even bigger and that they
thus have even more potential to blackmail taxpayers to rescue them in case of
a new crisis.
Governments have tried to
tighten relevant regulations, but with limited effect. In the 1930s, the GLASS
STEAGALL Act put the entire set of regulations onto 37 pages.
Today’s version, the DODD
FRANK Act, tries to accomplish the same on 848 pages and the implementing
regulations run an estimated 30,000 pages. That is a clear sign that banks
still engage in way too many and far too complex activities — and will always
look for loopholes.
BANK
SYSTEM: PROFITS REMAIN PRIVATE - WHEREAS
LOSSES ARE BORNE BY THE PUBLIC
For all their often very
public wailing, banks continue to live in the best of both worlds. Profits
remain private, whereas losses – cast as the costs of an unfortunate “accident”
– will be borne by the public.
Only
if banks could actually go bankrupt in case of mismanagement is it possible to
envisage a continuation of today’s world of private money creation. Otherwise,
it is time for a change.
It is not the first time
in economic history that banks have overused their ability to produce money —
and that over-indebtedness leads to significant economic problems.
Facing the Great
Depression, a group of professors, including HENRY SIMONS and IRVING FISHER,
drafted in 1936 the “CHICAGO PLAN.” According to them, banks should be deprived
of the ability to create money on their own and rather only lend out money that
is truly deposited with them by savers.
In such a system, all
money would be created by the central bank only. The goal they hoped for was a
smoothing of the business cycle and fewer banking crises. In addition, a shift
from the old to the new monetary system would allow reducing the debt overhang
significantly:
■
Banks would have to back all lending with central bank money. As they
don’t have the central bank money right now, they would have to borrow this
money from the central bank.
■ In
order to reduce their debt with the central bank, banks would hand over the
government debt that they own to the central bank, which would effectively
cancel it.
HIGHLY
PROFITABLE BUSINESS OF CREATING MONEY
A financial system that
is more stable and less crisis-prone, where debt problems are solved? That
sounds too good to be true. And indeed, the proposal was not implemented when
it was proposed in the 1930s, due to significant counter-pressure by banks.
They did not want to lose the highly profitable business of creating money.
This makes it even more
interesting that, a few years ago in 2012, two economists from the IMF, JAROMIR
BENES and MICHAEL KUMHOF, revisited the CHICAGO Plan of FISHER and colleagues
and calculated the effects with today’s technology.
The paper is a good read
and includes a brief look into the history of money.
Money was always a result
of credit transactions and not a means to barter. Boom and bust cycles as well
as a tendency to wealth concentration are inherent in this monetary system.
Debt restructuring and a ban on interest were already well known in ancient
times as described in the Bible.
Even the idea of
sovereign money is not new. Luminaries such as BENJAMIN FRANKLIN, DAVID
RICARDO, THOMAS JEFFERSON and later Nobel Prize winner MILTON FRIEDMAN (1967)
were supportive of the idea.
The econometric analysis
of the Chicago plan with today’s tools came to a convincing result:
■ A
switch to sovereign money would work and the benefits would be higher than
envisaged by IRVING FISHER and colleagues.
■ In
the case of the UNITED STATES, it would even be possible to reduce parts of the
private debt load as the balance sheet of the banking sector equals about 200%
of GDP – more than the outstanding government debt.
■
According to the research, the growth rate in the UNITED STATES would be
higher due to lower real interest rates, lower taxes and lower costs for
monitoring the credit quality of banks. The core function of banks, the
efficient allocation of capital, would continue to function well.
Basically, such a switch
would equal a monetization of existing debt. This does not have to be
inflationary, as the money was already created in the past and would not lead
to additional credits and demand.
This view is shared by
experts such as ADAIR TURNER, the former Chairman of the UK Financial Services
Authority and MARTIN WOLF, chief economist of the FINANCIAL TIMES.
NOT
A SYSTEM FOR ALL
But would such a system
enjoy the trust of the public? After all, central banks have contributed to the
crisis by pursuing a continuously one-sided monetary policy of lowering rates
at every minor crisis. And since 2009, this has had the effect of boosting
asset prices with limited benefit on the real economy.
In addition, the central
banks’ actual degree of independence from governments can well be doubted. It
is too tempting for politicians to use easy money to boost government spending
and short-term economic growth.
In the view of JAROMIR
BENES and MICHAEL KUMHOF, these risks do not speak against a shift to sovereign
money. Of course, one should not let criminals like JOHN LAW be in charge of
the central bank or finance wars with it. He was the infamous Scot who invented
a paper monetary system to solve the financial problems of the FRENCH king in
1717.
In both cases, the growth
rate of money would be too high, leading to devaluation.
I still believe that, in
spite of the justified criticism of central banks, especially given their poor
performance in light of the financial crisis, it is worthwhile to take a deeper
look at sovereign money:
■ It
might be the best and most efficient way to deal with excess debt levels in the
western world.
■ It
would be an efficient way to limit the risks of the banking sector.
■ It
would break the link between governments and banks.
ICELAND
IS NOT ALONE IN DRIVING TOWARDS A SHIFT TO SOVEREIGN MONEY.
In SWITZERLAND a group of
activists is preparing a referendum. The supporters calculate that the
government would earn seven billion SWISS Francs from depriving private banks
of the right of money creation and giving it to the central bank.
Applied to the U.S.
economy, this would equal about $180 billion – per year!
Irrespective of the
outcome of the discussions in ICELAND and SWITZERLAND, both admittedly small
countries, it is an encouraging sign that we start to discuss the fundamental
principles of our economic system and the role of money, credit and banks. It
is time to change the system.
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