“#PosMonWrong” – Mike King’s campaign against Positive Money

A few weeks ago, a paper entitled “Why Positive Money is Wrong: An Obligations Analysis of Broad Money Growth” was published by Mike King, a writer and academic whose book “Quakernomics: An ethical capitalism”, was published in 2014.

The thesis of King’s paper is that any increase in the stock of money must be due to an increase in the value of goods and services provided for sale by productive individuals and enterprises. Money, he says, is created as the counterpart (the reflection) of the creation of value by producing goods and services and making them available for purchase, which people are prepared to buy for more than the cost of producing them. It is this added value that provides backing for the money it creates.

This analysis is a version of the Real Bills Doctrine which can be loosely paraphrased as “the value of the goods and services produced for sale provides backing for the means of payments needed to purchase them.” In effect, to the best of my understanding, King partitions bank deposits into (1) those which represent the savings of debt-free depositors and (2) those which represent the counterparts of borrowers’ loan obligations. King argues that only the former class as money, since this is money which has been earned free of debt and been deposited with the bank. The latter represent promises by banks to make payments on the borrower’s behalf from money that the borrower has committed to repay.

In principle, the value-backed money could be considered as transferring, payment by payment, from account to account and the accounts of debt-free depositors would therefore serve as depositories for the money transferred, with their aggregate balances forming a true reflection of the amount of value-backed money available for circulation. The money spent on the borrowers’ behalf, however, would not be spent by borrowers themselves but by the banks in settling their net obligations to each other after all the payments initiated on behalf of borrowers had been cleared. This recirculating banking system money would transfer only from bank to bank, and the accounts of the intended beneficiaries of the underlying payments would record only the amounts with which they had been credited, but would not be money unless the recipients qualified as debt-free depositors.

Applying this classification he argues that positive credit balances net of bank debt arise as a consequence of the provision by the holders of more value to the market than has been received from the market, and these net balances are thus money backed by that excess value. The implication is that those who have received more than they have spent, and therefore have a positive net balance, have been paid more for their contributions to the market than it cost to provide them, and the net balance thus reflects the additional value they have contributed.

Account holders who are currently net debtors to banks, however, must continue to provide value for sale to the market in order to acquire the means of paying off their loan obligations to the banks, and any credit balances they do hold are therefore encumbered by these obligation and do not count as money. King argues that M4, which does not distinguish between balances in this way, is therefore not a correct measure of money.

In summary, King’s thesis is that money is the holder’s claim on the output of the market and is backed by the surplus value contributed to the market by the holder. Balances which are not backed by surplus value are not money but promises of money. Only when a payment by a bank (to another bank), in the course of fulfilling a promise to a net debtor, results in a credit to the account of a net creditor will this represent an increase in the money stock. Thus the money stock will increase only if the surplus value contributed by net creditors increases. Only if the ‘true’ money stock increases will money have been created. Only if the owners of that new money chose to deposit it with banks will bank deposits be created.

Consequently King redefines ‘money’ to exclude any deposits held by net debtors of the banking system (currently included without differentiation in the M4 measure of the money stock). Under this thesis, a bank loan merely creates a promise by the bank to make payments on the borrower’s behalf, and when those payments are made they only result in an increase of ‘true’ deposits if the account that is credited with the payment is held by a net creditor of the banking system.

According to Mike King, therefore, bank lending does not create deposits and neither, unless the recipient is debt-free, does the spending which arises from bank lending.  These are his grounds for saying that Positive Money is wrong to claim that bank lending creates money, and that bank deposits are debt-based money. All his other points of opposition arise from these. In reality, as things stand legally, all deposits are acknowledgements of the acceptance by account holders of the banks’ promises of deferred payment and all payments are the transfers of these promises.  Deposits are promises and acceptances of promises, not receipts for or claims on money deposited. It is the fact that these promises are transferable and acceptable in payment that makes them money.

The question of which came first – loans or deposits – was dealt with in 1873 by Walter Bagehot in his book “Lombard Street.” He wrote: “no nation as yet has arrived at a great system of deposit banking without going first through the preliminary stage of note issue,” and his explanation was simple:

“The reason why the use of bank paper commonly precedes the habit of making deposits in banks is very plain. It is a far easier habit to establish. In the issue of notes the banker, the person to be most benefited, can do something. He can pay away his own ‘promises’ in loans, in wages, or in payment of debts. But in the getting of deposits he is passive. His issues depend on himself; his deposits on the favour of others. … A paper circulation is begun by the banker, and requires no effort on the part of the public; on the contrary, it needs an effort of the public to be rid of notes once issued. … When a private person begins to possess a great heap of bank−notes, it will soon strike him that he is trusting the banker very much, and that in return he is getting nothing. He runs the risk of loss and robbery just as if he were hoarding coin. He would run no more risk by the failure of the bank if he made a deposit there, and he would be free from the risk of keeping the cash.”

Notes issued by private banks were promises to pay written on paper, with payment deferred so long as the notes remained in circulation. When they were returned to the bank they would be replaced by deposits, which were promises of deferred payment written in ledgers. But the promises had to be made, written on paper and distributed (as loans, wages or to settle the banker’s own debts) before they could be deposited back into the bank. Only once the bank became established would the public trust the bank with coins that the bank hadn’t created. These days, the intervening stage of circulating paper is omitted. Loans are made simply by issuing new deposits.

From his previous writings on this subject, it can be inferred that  Mike King is concerned that the creation of money, other than by the state acting responsibly,  would amount to counterfeiting. If this is so, then to permit the idea to persist that banks create money would be to undermine the Quaker reputation for integrity. King states: “In researching the Quaker industries I became convinced that capitalism is not in itself unethical. What makes for an ethical capitalism is its regulation for the greater good and not solely for profit” and he sees this as the contribution of the Quakers to the success of capitalism in the 17th to 19th centuries, especially in the field of banking.

But deposit banking isn’t about counterfeiting – the creation of monetary instruments that pretend to be those issued by the state. Deposit banking is about the expansion of the purchasing power of the public through the medium of the transferable promises of bankers to make payments to or on behalf of account holders. It is in the issuing of promises that integrity matters. That is what the Quakers brought to the evolution of deposit banking. As early as 1688 Quakers were told that none should ‘launch into trading and worldly business beyond what they can manage honourably and with reputation; so that they may keep their word with all men,’ sentiments which were to be repeated frequently throughout the following centuries.

The problem with Mike King’s attack on Positive Money’s position is that it is based on an easy acceptance of an elementary narrative which equates deposit banking with goldsmith banking. Goldsmiths were indeed repositories of coins, bullion and other valuables deposited with them by their customers, and the tale of goldsmith banking is the tale of the lending out of claims on these deposits. But the demands on the services of goldsmith bankers were primarily from those who needed gold and silver coins or bullion to pay foreign merchants and soldiers stationed overseas. 17th century deposit banking arose alongside goldsmith banking to meet the needs of domestic commerce and was not concerned with the lending of gold and silver but with the extension and transfer of credit. Credit does not require prior deposits. Credit requires a good reputation and, given that, credit can be conjured up out of thin air. King’s analysis, therefore, might be relevant if we still had the goldsmith banking system of the 16th century, but it is inapplicable to the banking system we have today.

According to James Walvin, author of “The Quakers: Money and Morals” from which the above 1688 quote was taken, Quaker banks were established largely on the basis of the accumulated profits from other trades: millers and corn merchants, drapers, ironmasters, hosiers, grocers, tea merchants, etc. On the strength of the reputations they had built up in the conduct of their main businesses, these merchants began issuing loans in the form of notes: promises to make payments inscribed in paper. But these notes were not claims on the coins held in their vaults; they were claims on the persons of each and every partner in the firm and on their ability to keep their promises, from whatever source. Early banks were partnerships with unlimited liability and they remained so until 1855 when the Limited Liability Act was introduced. It was no reflection on the integrity of bankers, Quaker or otherwise, if they issued notes in excess of the coins currently to hand so long as they were careful to ensure that they were always able to fulfill their promises when the time came to do so.

The current banking system is one based on the making and keeping of promises and it evolved during an age of integrity. But such a system is one which is open to abuse by those who lack integrity. A system which depends on integrity in an age when integrity is no longer the norm, and where breaches are no longer punished, is a system which no longer serves. Experience has shown that the economic costs are too great of relying on a system which depends on banks settling our payments out of their resources. Positive Money’s proposals will ensure that it is the resources of those who wish to pay that are used to settle those payments, and the fragile dependence on banks’ promises will be severed.