The Grexit Proposal

It is no secret that tensions are high between Greece, Germany, the Troika, and the rest of Eurozone creditors. There is a lot of posturing from both sides, and much has been said about a potential ‘Grexit’ (Greek exit). Indeed, renewed fears of a Grexit have been shaking the financial markets as chairman of the Eurogroup, Jeroen Dijsselbloem, accused Greece of time wasting, while Greece’s Finance Minister Yanis Varoufakis has hinted at the possibility of a referendum regarding Greece’s membership of the Euro. A Grexit might never happen, but it also might be just around the corner.

So what type of monetary framework should the Greeks adopt if they were to part ways with the Eurozone? Here is what we would suggest to Yanis and the rest of the Greek people, should a Grexit come to fruition.

The Problems of Current Monetary Systems

Firstly, if the Greeks were to establish their own currency there would be little sense in basing it on a monetary framework that has failed time and time again in the UK, Europe, Asia, Latin America, and North America. The countries that have permitted the banking sector to create money out of nothing have been subjected to pro-cyclical booms and busts, making millions unemployed and wiping out years of growth. For the following reasons, there is virtually no point in replicating a system that history has shown does not work:

A. The amount of money in the economy is determined by the confidence of private banks

Banks are private sector entities that are naturally profit-maximizers. Yet, they are special in that the vast majority of their profits come from creating money by issuing loans. In periods of relative economic stability, they therefore have an incentive to create vast sums of money, normally for pre-existing assets in the financial and property sectors that do not directly contribute to GDP. The prices of these assets then quickly increase. However, as the majority of lending is used to buy pre-existing assets that do not enhance GDP growth, the majority of incomes do not increase in line with the proportion of debt in the economy. The growth in private sector debt vastly outpaces growth in incomes.  The rate of lending and new money creation eventually slows down. Prices start to decrease, but the value of the loans stay the same (i.e. the value of assets decline while the value of liabilities go unchanged) and a crisis unfolds.

This however, is just the tip of the iceberg. Just as banks can create money through lending, money is destroyed when loans are repaid. Thus, when the rate and value of loans being repaid exceeds the rate and value of new loans being extended, the stock of money decreases. When a crisis begins to unfold, banks that have lent too much to people or businesses that can’t repay become concerned about the solvency of their balance sheet. Consequently, they limit their lending to households and businesses, spending is diminished, and prices go down even further, leading to a recession.

Indeed Greece should be all too familiar with this last process, as the Greeks have been forced to deleverage and pay down their debts by the Troika, and run a primary budget surplus 4.5% of GDP per year. According to Steve Keen this effectively means that roughly 4-5% of the Greek money supply (or 4-5% spending power) is being withdrawn from the economy every year.

B. The economy can only be stimulated through encouraging further indebtedness

All of the above implies that the only effective way to get the economy going again and the only way to get businesses and consumers to spend more is by encouraging more borrowing. But if excessive levels of debt (specifically private sector borrowing) were the source of the crisis, then is this not the recipe for the next crisis?

C. The revenue generated through money creation (seignorage) is acquired by the banking sector instead of the general public

Central Banks sell the money they issue, in the form of notes and coins, at face value. Yet creating this money only costs a fraction of the face value of the notes and coins. The Central Bank therefore makes a significant profit when creating cash (called seignorage), and then passes this profit on to the treasury.

However, as banks are able to create money in the form of electronic bank deposits, they also acquire a certain amount of seigniorage. The difference is that private banks issue between 95-97% of all money, while only 3-5% of money is created by central banks. Therefore, the vast majority of seignorage profits are captured by private banks and not the general public.

D. Banks are too big to fail

Under the current monetary system, banks are too big to fail. If we did let them fail, the entire payments system would collapse. This is because banks perform three functions, which are currently inherently interconnected: 1) They provide a payments system, allowing money to be transferred as well as received, 2) They offer savings and investment schemes which allow savers and investors to grow their money over the long-term, and 3) They provide loans and mortgages.

The deposits that banks create – i.e. the electronic money that makes up the majority of the total stock of money – are essentially the liabilities (promises to pay) of private banks. Because we use these liabilities (or promises to pay) as our primary form of money, an irresponsible bank that has issued too many loans of poor quality must be rescued just so that the entire system of payments doesn’t collapse along with it.

The Solution: A Sovereign Money System

A.

In a Sovereign Money system, the power to create money would be removed from the banking sector and transferred to a public body, such as the Bank of Greece. The Bank of Greece would be solely responsible for creating new money, which would then be transferred to the government, who could use it for public spending, tax cuts, or direct transfers to citizens. Current account customers would hold the electronic money issued by the Bank of Greece, rather than holding the liabilities of the private banks.

Banks would still have the important function of matching savers with borrowers, and would act as intermediaries. The difference being that a bank could only lend out money that a saver made available through an investment account.

Such changes would allow the Bank of Greece to make sure that money creation would correspond to growth in the real economy. Money creation would therefore not depend on the willingness of the banking sector to lend. If inflation rose above the targeted level, then the Bank of Greece would slow the rate of money creation. Conversely, if there was deflation, then the Bank of Greece could speed up the rate of money creation. The newly created money would be transferred to the government to spend directly into the veins of the real economy. The  Bank of Greece would be able to influence the wider economy much more effectively and directly than under the current system.

B.

Instead of having money created through the process of lending, Sovereign Money would be created free of debt. When new money would be created, the Greek Treasury would issue a certain amount of ‘perpetual zero-coupon bonds’. These would be interest free and would never need to be repaid. The Bank of Greece would then purchase these bonds by crediting the Treasury account with new Drachmas.

So that the Bank of Greece’s balance sheet would balance out, the newly created money would appear as a liability of the Bank of Greece and an asset of the Greek treasury. The bonds would be an asset to the Bank of Greece and a liability of the Greek treasury.

C.

Giving the Bank of Greece a monopoly on issuing all new currency would mean that new money could be created even while businesses and households are paying down their existing loans. No one would have to take on more debt for there to be an increase in spending in the economy. The supplementary spending by the Greek government would counter any reduction in spending caused by the private sector trying to pay down its debts. It would permit debt reduction without increasing risks of a future crisis.

D.

Allowing the Bank of Greece to have a monopoly on all new money creation, would mean that all the profits from creating electronic money and bank notes would go to the Greek government. With 95-97% of current money created by banks, transferring this prerogative to the Bank of Greece would increase public revenues massively, allowing for more public spending or the repayment of public debt.

E.

A separation of investment accounts and current accounts would mean that the payments system would not be jeopardized when a bank fails. Instead of having current accounts with money that is composed of uncertain promises to pay issued by banks, such accounts would hold risk-free and debt-free money issued by the state. If the customer’s bank were to fail, the money in the current account would still be safe and the customer could still access it and spend it. Customers that made their money available for lending in an investment account, would need to wait while the bank was liquidated in order to get their investment back. Payments could only be made via a current account and not an investment account.  Accordingly, it would not be necessary to bail out an irresponsible bank in order to protect the payment system.

Ultimately, Greece could have a much brighter future ahead, with money creation under democratic control. The Bank of Greece would have more direct and better means of influencing the economy when necessary, not to mention a sounder and less complex banking system.

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Creating a Sovereign Monetary System

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Download Spanish translation here:

Creando un sistema monetario soberano