Sovereign Money Creation vs Modernising Money

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Sovereign Money (Final Web)-1We’ve just released our new report, Sovereign Money: Paving the Way for a Sustainable Recoverywhich explains why the current debt-fuelled recovery is not sustainable, and how using the state’s power of money creation can make it sustainable.

The problem with how our money is created

There are currently two sources of money into the UK economy:

  1. Money created by banks, when they make loans. This currently makes up the majority of money in the economy.
  2. Money created by the Bank of England on behalf of the government. Currently this makes up a tiny percentage of the money in the economy.

The problem we currently have is that the government isn’t willing to use its power to create money in the public interest. Instead, it relies on the same banks that caused the financial crisis to create money. But most of the money created by banks goes into house price bubbles (40% of all new money created in the 10 years running up to the financial crisis) and financial markets (37%), whereas only a minority (13%) ends up in the real economy.

So right now, we see banks still reducing their lending to businesses, whilst increasing their lending for mortgages and business. If household debt is rising, but businesses aren’t able to increase salaries, then sooner or later, some of the debt becomes unpayable and people will default. The government’s strategy for getting the economy growing again could actually lead us back into another financial crisis.

The differences between Sovereign Money Creation and Modernising Money (the book)

In our book Modernising Moneywe argue that we should completely remove the power of banks to create money and force them to work on the same basis as the rest of the financial sector – actually having to borrow the money they lend, rather than being able to create it in the process of lending. The changes required to do this would make it possible for banks to be allowed to fail, and would mean that all the benefits of creating money would go to the taxpayer rather than the banking sector.

In Sovereign Money: Paving the Way for a Sustainable Recovery, we don’t go quite so far. Instead, we’ve outlined the reasons why the government is making a dangerous mistake by relying on further bank lending to boost spending and help the economy grow. We explain how a process called Sovereign Money Creation (SMC), which involves allowing the Bank of England to create money, which would be granted to the government and spent into the real (non-financial) economy would boost spending and employment but without requiring households to borrow even more. Rather than increasing the total amount of debt in the economy, SMC actually lowers it. It would make the current ‘recovery’ into a sustainable one, rather than one fuelled by credit cards and mortgage lending.

Importantly, the creation of sovereign money through SMC can be done without having to stop banks creating money, so it’s something the government and Bank of England could do right now without having to face the counter-lobbying and political battle of trying to remove subsidies and privileges from the banking sector.

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Ultimately, we still believe that the economy would be more stable and society better off if we completely remove the power that banks have to create money. That’s still what we’re campaigning for in the long-term. But it’s unrealistic to think that a government would be willing to make the overnight switch from allowing banks to create almost all of the money in the economy, to allowing them to create none. The approach of SMC allows the government to put the first toe in the water, and see the benefits of having money created in the public interest and spent into the real economy. 

The use of sovereign money would also break the dependence we currently have on the banks to create money, and mean that lobbyists for the banks could no longer claim that any type of regulation or limits on what they can do will ‘restrict credit and harm the economy’. If banks aren’t willing to create money for the real economy,  then the Bank of England can do so instead.

The Sovereign Money report shows that there are better ways to create money than relying on the same banks that fuelled the crisis. We can then move to a discussion of which is better for the economy and society:

  • Money created by banks when people go into debt, and pumped into the housing or financial markets, in the hope that some of it ‘trickles down’ into the real economy, or
  • Money created by the state and spent directly into the real economy, without requiring anyone to go further into debt.

You can guess how we’d answer this question, but believe it or not, most economists and politicians haven’t given it much thought, so it’s time to create a public debate.

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  • vince

    This is a big switch in emphasis for Positive money but a good idea.Current QE has not worked as well as it might and as you point out the Coalition will not countenance public spending or tax rises.We have run out of tools.

    Maybe this is something Mark Carney should be made aware of.Seems to me the BoE limits itself unnecessarily on the way it tries to stimulate the economy.There are plenty of interested parties warning the BoE that the current Help to Buy scheme is only causing a housing bubble and it is about to be extended in January.Surely someone at the BoE can come up with some better ideas.Why are we paying them huge salaries/pensions for sitting on their hands?

  • John Morrison

    Money can be issued as national currency by government to mobilise the people and resources of the nation.
    When this is not done well, other peoples debt can be used as money and banks manage this.
    When this is not done well, commodities such as gold and silver can be used as money.

    The first is a democratically managed nation. That is where we think we are.
    The second is a privately managed cartel. That is where we really are.
    The third occurs when there is no management. That is what we fear because it only works for kings and criminals.

    If the issue of sovereign currency is managed well then there is little need for other forms of money. It is only by restraining this function of government that banks have been able to dominate with their credit money.

  • Guggzie

    There are a couple of other options that you should also put on the table. The Bank of England should be re- constituted as a fully publicly owned bank and used as the source for financing the Government, especially as the UK is a monetary sovereign nation and has the monopoly right and responsibility to create the nation’s money supply. The only catch with this is to establish the parameters for defining how much “money” the Government can create to fulfill the “public purpose” for which society creates its Government.

    The general public is rightly concerned about allowing any government the unbridled power to “print money” unless there are controls and limitations in place to prevent this.

    I believe those parameters have to be tied to the productive and consumption capacity of a growing economy. There are two issues relating to those parameters – there is no point in producing anything – goods or services – if they are not going to be consumed – the second issue is – if the money supply is equated to the availability of goods and services, then inflation/deflation would not occur (or at least, become uncontrollable) as there would be no situation of too little or too much money chasing too few or too many products.

    Were a nation to go down this path those controls would need to be emphasised and explained to the public in clear and understandable detail – not just in a theoretical way, but in a truly rational and practical way to clearly define the rules that must, and would apply, to money creation.

    The second option that you should consider, if you are prepared to accept the existence of private banks, is for the Government to create and SELL specific amounts of “credit” to the properly registered and licensed private banks.
    In truth, all credit is the property of the people. A loan is merely a legal agreement, and in the case of advancing credit, it is simply the ‘monetisation’ of future effort. The borrower promises to repay the loan at a later date from the fruits emanating from the advance. In this respect, all credit is really public property because only people are capable of producing products and services that will create the ability to repay the advance. The creation of credit should never have been handed over to the private banks in the carte blanch manner which applies today.

    The private retail banks would be set up in the same manner as presently in place, by obtaining capital from investors through the issuing of shares, debentures or bonds. As legitimate registered businesses, they would be eligible to apply for, and purchase, ‘new money’ from the government at a low rate of interest. The amount of ‘new money’ they request would be set as a ratio of their subscribed capital, and perhaps, any long term deposit money they hold on behalf of their

    In effect, this is a reversal of the fractional reserve system, which is essentially a ‘ponzi’ scheme, but if modified in a properly controlled manner, it can be made to serve the benefit of the society. Obviously, the
    creation of this ‘new money’ would be a simple bookkeeping, or computer
    spreadsheet activity, exactly as it currently applies.

    As a registered business, these banks would operate under standard corporate law and be responsible for their operations without any reliance on the government as lender of last resort. The banks would have to take out, and maintain, appropriate private insurance to cover their customer’s deposits as part of their legitimate registration responsibilities. Every application to purchase ‘new money’ from the government would be made with an appropriate set of audited accounts.

    Under the current system, Governments borrow money from private sources and pay interest on the bonds they issue. This revised system would operate through modifying the role of the publicly owned BofE. Specifically, this Bank’s role would be to monitor the nation’s
    productivity/consumption factors and handle the sale of ‘new money’ to the private sector banks on behalf of the people. This sale of “new money” would actually be the represented as selling the private banks a defined amount of ‘credit’ which they could then pass on to their customers at a higher, but competitive, rate of interest above the purchase price they paid the Government.

  • Ted Carron

    I would love to see some discussion about the reasons the BOE does not indulge in SMC already. I presume there is a general fear of inflation. It will be difficult to convince people about the wisdom of something like SMC without answering those fears.

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