What does Brexit mean for monetary reform in the UK?

The UK voted to leave the European Union by 52% to 48%. The referendum is being treated as binding by politicians, so once article 50 of the Lisbon treaty is enacted, the UK will have two years to negotiate its withdrawal from the European Union.

There’s a huge amount of speculation in the press at the moment, and we don’t want to add to it. There’s also a different kind of speculation in the financial markets, but traders typically react first and think later, so there’s no point drawing conclusions about the UK economy until things calm down in a week or two.

But what is Brexit likely to mean for the prospects for getting monetary reform in the UK? Will we be more or less likely to be able to transfer the power to create money back away from the banks and back to the state, to be used in the public interest? The short answer is that in the long term, it probably doesn’t make much difference, but in the short-term there are some real dangers that we need to be alert to.

1. We already have our own currency, and monetary policy

For a country in the eurozone, leaving the single currency would undoubtedly increase the chances of monetary reform in that country, since they could make changes to their monetary system without the agreement of another 18 countries. But the UK already has its own currency and independent monetary policy. The European Central Bank had no power over how the UK monetary system works. So there’s no significant change here: we could implement sovereign money in or outside the EU.

2. But the Maastricht/Lisbon Treaty could have been an obstacle to reform

Article 123 of the Lisbon Treaty (originally Article 104 of the Maastricht Treaty) prohibits central banks such as the Bank of England from providing ‘credit facilities’ or purchasing bonds directly from the Treasury or any government agency. It’s been argued that this prohibits the central bank from creating money to finance the government directly:

“Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.”

 

But we shouldn’t overstate how big an obstacle this is. Central banks have already found ways to circumvent Article 123 through Quantitative Easing, in which they purchase bonds from financial institutions, and those financial institutions then (typically) buy new bonds from the government.

More blatantly, many of the other requirements of the Maastricht and Lisbon Treaties have been simply ignored. For instance, ever since 1998 Germany has seemingly ignored – or at least been unable to conform to – the requirement for public debt to be no more than 60% of GDP. France has been in breach of that requirement consistently since 2002.

Laws are written because they seem like a good idea at the time. But they can be changed if they later turn out to be poorly thought out. Of course, changing Article 123 would require a new treaty and agreement by 28 member states – quite unlikely given the German government’s fear of public money creation.

So Brexit may make this one obstacle to monetary reform that we no longer need to worry about. But it’s far from the most significant obstacle.

3. EU regulation was about to break the banks’ cartel on payments services

The EU has recently finished preparing “Payment Services Directive 2” (PSD2), a 200-page piece of legislation and regulation covering the payment systems provided by banks and non-banks. The legislation goes a long way in tackling the near-monopoly that banks currently have over payment services, by forcing them to provide access to information and payment functions to their competitors from the fintech sector (more detailed explanations here and here). This is important, because banks get a large part of their power to create money from combining payment services with lending (see this blog for explanation).

PSD2 was scheduled to come into effect in late September 2017. I’m sure significant preparation has been done by banks, other financial institutions and the regulators in the UK, so it’s possible they’ll simply implement the legislation as-is. Putting it on hold or cancelling it would be a benefit to the large UK banks, and to the disadvantage of consumers.

However, it’s reassuring that the new Payment Services Regulator has been extremely proactive in shaking up the payments industry in the UK, so I don’t think they’ll bow down to the banks simply because we’re leaving the EU.

UPDATE: A recent publication from the Payments Strategy Forum states that “The Payment Services Directive (PSD), and subsequently PSD2, are substantial pieces of payments related European legislation that introduces new services and players to the industry and enhances security and authentication measures. The industry is committed to delivering these requirements despite the UK’s vote to leave the European Union.“

4. Banks are in a more powerful position to lobby government

The big danger now is the so-called ‘bonfire of red tape’, or deregulation. Banks will spend the next 2 years threatening to leave the UK as soon as it formally exits the EU. The government will want to prevent that (and the job losses and tax revenues it entails), which means it may cave into lobbying pressure. There’s a real risk that if we don’t end up joining the EEA free trade area (which would require us to comply with all the existing EU legislation anyway) then the government will offer banks and financial institutions whatever they want to get them to stay. This could lead to a  ‘race to the bottom’ to weaken regulations and give banks more freedom to do what they want.

So we have to be extremely alert to this, and keep an eye on lobbying by the banks during the period of renegotiation, when EU directives and legislation may be replaced by home-grown regulation that could favour big banks.

5. Government might go for short-term economic stimulus

All the talk of a potential post-Brexit recession might encourage government to go for a short-termist economic stimulus. We need to make sure that it doesn’t take the form of another lending bubble, otherwise we’ll lay the foundation for another financial crisis.

Luckily the Bank of England seems to be increasingly aware of the risks of greater household and personal debt. More importantly, they’re out of tools to encourage another rise in debt: interest rates are at record lows and QE has been shown to be ineffective at stimulating either bank lending or the real economy.

This might be the time for the Bank of England to start looking at new monetary policy options, such as public money creation (for example, helicopter money, Green QE, or Strategic QE).

Conclusion

There are many social and economic implications of leaving the EU, most of which we’re not qualified to assess, so we won’t. But where it relates specifically to monetary reform over the next few years, the anticlimax answer is that it’s unlikely to make too much difference.

However, we need to be very aware that for the next two years, banks will have a much stronger position to lobby government, and we need to keep our eyes open for signs that the government is caving in to lobbying pressure.

And if the next two years becomes a period of political debate in which we discuss what type of country we want to be post-Brexit, it would be a perfect time to establish a Money Commission to ask what kind of monetary system we want.