Because 97% of the money supply currently consists of bank deposits, and these deposits are created by banks making loans, in order for there to be money, someone must be in debt. In the current monetary system, the absence of a state-issued, debt-free electronic money supply means that the money needed for the economy to function must be borrowed from the banking sector. In addition, any attempt by the public to repay debt in any significant amount has the effect of shrinking the money supply, potentially triggering recession, which makes it difficult to further reduce debt.
In contrast, Positive Money reforms would introduce a permanent, debt-free, stable state-issued money supply that is not dependent on banks’ lending. The recycling of money through the Conversion Liability (*) would make it possible to significantly reduce the debt burden of the public without reducing the money supply and triggering recession.
During the conversion to the new system, the bank’s demand liabilities would be converted into state-issued currency and the bank would acquire a new Conversion Liability to the Bank of England, effectively as a charge, at face value, for the state-issued currency used to convert the demand liabilities into real money. As the bank uses the money from loan repayments to pay down this liability to the central bank, the money will be granted to the government by the Bank of England to be spent back into the economy. There is no change in the money supply, as measured by the total stock of state-issued currency at the Bank of England.
When the state-issued currency is injected into the economy via government spending, tax rebates or simply by a citizen’s dividend, there is no debt corresponding to the newly-issued money. In effect the money is ‘debt-free’. Through this recycling of money, it is possible to pay down over £1 trillion of household, consumer and business debt over a period of around 20 years.
Under the current system, money used to repay bank lending sinks without trace – the economy can only continue to function if money is continually borrowed back into existence. Within the reformed system the amount of money in circulation will exist independently of bank lending decisions. What is more, under the reformed system money will predominantly be spent into the economy ‘debt-free’. Thus, money will exist without a corresponding debt – there will no longer be a need for the rest of the economy to ‘rent’ the medium of exchange from the banking sector. Instead, the money supply will be provided to the economy by the central bank for essentially zero cost.
Of course, banks will still lend in the reformed system, and this will result in payments to the bank as a result of the interest that they charge on loans. Likewise people will still need to borrow. However, unlike in the current system the quantity of loans will exist independently of the money supply, and thus the gross quantity of interest payments to banks will likely be lower. Additionally, in order to lend banks will first need to acquire funds from Investment Account holders (**). Because these accounts will carry risk, Investment Account holders will demand a higher rate of return than they currently do on their bank deposits (which are riskless due to deposit insurance). Both factors will lead to lower bank profits, lower staff wages, and as long as Investment Account holders are not overly concentrated in one area, an increase in the geographical dispersion of interest payments.
In the longer term a lower propensity for asset price bubbles will stabilise asset prices, particularly in the housing market. Stable property prices will lower the attractiveness of housing as a vehicle for speculation, increasing its affordability particularly for the lowest earners. In addition, the removal of credit driven asset price cycles should lower the risk of banking/financial crises, and remove the need for bank bailouts should one occur. No bank bailouts mean lower government debt, negating the need for cuts in public spending (which disproportionately affect the poor) during recessions.
This article is an extract from the book Modernising Money (2013) by Andrew Jackson and Ben Dyson. The book explains, in more detail than ever before, exactly how can our monetary system be fixed. These proposals offer one of the few hopes of escaping from our current dysfunctional monetary system. It is written for anybody who wants to know how to create an economy that serves people, businesses, society and the environment.
* Conversion Liability will replace the old demand liability of the banks to their customers with a new liability to the Bank of England. This is explained in detail in the section 8.3 of Modernising Money
** Investment Accounts will be used by customers who wish to ‘put money aside’ or earn interest on their spare money (‘savings’). Your savings account would be replaced by an ‘Investment Account’. We call them Investment Accounts for the sake of clarity and because it more accurately describes the purpose of these accounts – as a risk-bearing investment rather than as a ‘safe’ place to ‘save’ your money.