You cannot escape an
all-pervasive sense of crisis these days. Impending doom does not only announce
itself in actual events but also via the proliferation of ever more
hair-raising schemes that claim to solve our problems. Maybe it should not
surprise us if, at a time when the world’s most powerful central banks keep
interest rates at zero for years on end and keep printing quantities of money
that are simply outside the facilities of human imagination (trillions?
quadrillions?), bravely hoping it will end differently this time, people get
the impression that economics holds no certainties, that it is merely an
exercise in limitless creativity. In his excellent speech to the New York Fed, Jim Grant reminded
us that when the Financial Times first explained to their readers what QE was,
back in 2009, one of those readers wrote in a letter to the editor: “I can now
understand the term ‘quantitative easing, but . . . realize I can no longer
understand the meaning of the word ‘money’.” – This gentleman is not alone. The
basics of monetary economics have been tossed out the window and a merry
‘anything goes’ of policy proposals has descended on us. Otherwise sane-looking
men and women now propose that, although years of zero interest rates have not
solved our problems, everything will change once interest rates are negative.
We should all get checks from the central bank with free money to spend, and
government bonds at the central bank should be cancelled. Grown men dream of
money from helicopters and money buried in bottles in the ground.
“Whom the gods would destroy, they first make mad.”
Just when you thought it
could not get any madder there comes a policy proposal that sets a new low in
monetary policy discussion. Of course, in the current climate it is being
hailed as ‘epic’ and ‘revolutionary’. The easily excitable Ambrose
Evans-Pritchard, a tireless campaigner for man’s exploration of the unknown in
the field of money, could not believe his eyes: “So there is a magic wand after
all,” he writes in
the Daily Telegraph, “one could eliminate the net public debt of the US
at a stroke and, by implication, do the same for Britain, Germany, Italy or
Japan.” It gets better all the time. No longer are we confined to debating
arduous strategies for crawling slowly back to sustainable growth, no, we can
now simply wipe out all our debt.
Harry Potter meets Irving Fisher
The proposal under
discussion is the IMF’s Working Paper 12/202 by Jaromir Benes and Michael
Kumhof (a link to a PDF version is provided in this article). It is titled “The Chicago
Plan Revisited” and presents itself as a restatement of the ideas of Irving
Fisher and Henry Simons of the University of Chicago from the 1930s and 40s,
and an application of these ideas to the present crisis. It suggests the
following:
‘Private money’ creation is
the root of all economic evil. Most money today is created by ‘private’ banks
through fractional-reserve banking. This means money-creation is linked to loan
creation and debt accumulation. A hundred-percent reserve system is to be
established by the state and the state will forthwith crack down on any attempt
by the private sector to issue liquid financial instruments – near monies –
that could be accepted by the public as cash equivalents. Money creation is put
under the full control of the state. The new system is to be implemented right
away in one big swoop: The banks are forced to borrow the needed reserves from
the government (Treasury) to achieve the new 100 percent reserve ratios
instantly. The government creates these reserves – as is usual in a fiat money
system – out of thin air. In the US, this plan would amount to new reserves to
the tune of 184 percent of GDP, according to Benes/Kumhof, which means $27.6
trillion or 15 times the combined size of QE1 and QE2. With the new 100%
reserve requirement, this money will not circulate and not allow for further
bank credit creation, which – it is expected by the authors – makes this
intervention not inflationary. (A portion of the new reserves will also be
cancelled in the next step.) The new reserves allow the government/central bank
to ultimately transfer ownership of the bank assets to itself.
Importantly, these new
reserves are issued in a process very different from how reserves are issued
and placed with the banks today, for example through ‘quantitative easing’, and
how it was suggested by Irving Fisher in 1935 (“100% Money”), or Milton
Friedman in 1960 (“A Program for Monetary Stability”). These more
‘conventional’ procedures do not allow for any large-scale elimination of debt.
Central banks acquire bank assets by exchanging them for newly created reserve
money, which they issue as a claim against themselves (a liability), and under
normal accounting principles, any write-down of the new assets (debt
‘forgiveness’) would necessarily cause the extinction of the bank reserves as
well. Writing down debt shortens the balance sheet of the central bank and thus
reduces the central bank’s liabilities, which are the banking system’s
reserves.
Benes and Kumhof circumvent
this by simply claiming that the new fiat reserves are not just a new liability
of the central bank but that they are assets as well, Treasury Credit or
‘commonwealth equity’. Through this accounting gimmick, the state can issue new
assets, simply as an administrative act. Thus, the new reserve money lengthens
the balance sheets of BOTH central bank and ‘private’ banks in a first step,
that is, the new reserve money is simultaneously an asset AND a liability for
both. This novel approach then allows balance sheet reduction later on and debt
forgiveness without elimination of the new reserves that now back bank deposits
by 100%. (See model balance sheets on pages 64 to 66 of the Benes/Kumhof paper
and compare them to the model balance sheet presented by Irving Fisher on page
57 of “100% Money”, 1935, which is much more conventional.)
At the end of this process,
not only has a lot of debt disappeared, the separation of the ‘credit’ and the
‘money’ sphere of the economy is now total, and so is the state’s control over
the monetary economy. This, Benes and Kumhof, make perfectly clear, is the
ultimately goal of the exercise, and they claim it is to our benefit. Why? Here
they do not argue as economists (and very differently from Fisher and Friedman
or, for that matter, any monetary theorist) but quote anthropologists and
certain monetary historians who claim that
1) money originated not spontaneously from direct exchange but is a creation of the state, or rather the state’s early precursors, such as priests and religious masters of ceremony; this is deemed important because the origin of money determines the “nature of money” (quote Benes/Kumhof, page 12) and therefore determines who should best control its issuance.
2) They argue that thousands of years of monetary history confirm that the state can be trusted fully with the monetary privilege. (If you remember history somewhat differently, then, so Benes and Kumhof, you have to rethink. The paper follows a select group of maverick anthropologists and monetary activists that have simply rewritten monetary history. Needless to say, none of this was ever claimed by Irving Fisher or Milton Friedman, and to my knowledge, not even Henry Simons.)
Finally, the paper presents
an elaborate econometric model that shows that all of this will work in
reality.
In this essay I will do four
things: I will put the proposed paper in the context of ‘Austrian ’ and
Monetarist monetary theory, and show that it is not only outside these
intellectual traditions but that its main argument is not even economic in
nature. I will show that the core problem Benes and Kumhof claim to have
identified is bogus, and that they do not understand money creation in our
economy. I will then look at the paper’s peculiar historical, and non-economic,
justification of complete state-control of money, and show that this
argumentation is highly dubious but also irrelevant. I will then show that the
proposal presented relies on unprecedented forms of state intervention and
crucially advances the notion that the state can create vast new assets –
commonwealth equity – by decree, which allows it to claim to have no net debt
and thus engage in loan acquisition and ‘debt forgiveness’.
What this paper is not: it is neither ‘Austrian’ nor
Monetarist
Benes and Kumhof, early in
their paper, claim that fractional-reserve banking increases the risk of bank
runs, causes boom-bust cycles, and that a 100 percent reserve system would
ensure greater stability. These observations are, in principle, correct. But
this is, sadly, where it stops. Benes and Kumhof do not build on these
insights. In fact, for their further argument these insights are completely
irrelevant. Their paper does not bother to investigate the full range of
effects of bank credit expansion, and ask, for example, if the expansion of
base money by the central bank under a 100%-reserve system could not have
similar or even the same adverse effects that deposit-money expansion has in a
fractional-reserve system.
The Austrian School has
provided the most comprehensive analysis of the effects of bank credit
expansion and has shown most conclusively why more inelastic (‘harder’)
monetary systems offer greater stability. Expanding the money supply always has
disruptive effects as the inflow of new money must distort interest rates, and
interest rates are crucial for the coordination of investment activity with
voluntary saving. The question the ‘Austrians’ ask is not, who should control money creation, but should anybody control money creation? Should anybody even create money on an ongoing basis? Once a commodity of reasonably
inelastic supply, such as gold, is widely accepted as money, any quantity of
this monetary asset – within reasonable limits – is sufficient, and indeed
optimal, to satisfy any demand for money. Demand for money is demand for
purchasing power in the form of money, and can always be met by allowing the
market to adjust the price of the monetary asset relative to non-money goods.
No money creation is needed, and any ongoing money creation is in fact
disruptive.
‘Austrians’ tend to be
critical of fractional-reserve banking but they are equally critical – in fact,
even more critical – of fiat money and central banking. The problems they
studied would also occur – and are even more likely to occur – if the
fractional-reserve-banking system was replaced with one gigantic state central
bank.
But Benes and Kumhof did not
call their paper ‘The Austrian Plan Revisited’ but ‘The Chicago Plan
Revisited’. The approach and the goals of the Chicago School were different.
But it is still worth mentioning that in his 1935 book “100% Money” Irving
Fisher suggested that his plan could be combined with the gold standard,
something that is impossible with the Benes/Kumhof plan and that Benes and
Kumhof show no interest in. Here is Fisher, page 16:
“Furthermore, a return to the kind of gold standard we had prior to 1933 (before the domestic gold standard was abolished by Roosevelt and private gold confiscated, DS.) could, if desired, be just as easily accomplished under the 100% system as now; in fact, under the 100% system, there would be a much better chance that the old-style gold standard, if restored, would operate as intended to operate.”
This would indeed be the
100% gold standard that many ‘Austrians’ propose, and a system immeasurably
more stable than what we have today. However, it was certainly not Fisher’s
primary objective to restore the gold standard. Fisher wanted to maintain the
fiat money system and consolidate the control of the central bank over the
banking system by eliminating any remaining discretion by ‘private’ banks.
Fisher was a big proponent of price index numbers. He believed the purchasing power
of money could be measured accurately through statistics – a fallacy that is
still widely believed today and still causes confusion and harm – and he was an
early advocate of inflation-targeting. (For an Austrian School response to
Fisher’s original plan see Ludwig von Mises, Human Action, 1949, Chapter XVII,
12. The Limitation on the Issuance of Fiduciary Media.)
25 years later, Fisher’s
fellow Chicagoan Milton Friedman also proposed a version of the 100% plan, this
time with even less reference to boom-bust cycles or the potential for a gold
standard. Friedman was an advocate of central banking because he believed that
monetary and economic stability could be achieved by guaranteeing a stable,
persistent and moderate expansion of the money supply, which is at the core of
Friedman’s Monetarism. In a 100% system the state central bank – so he argued –
can make sure that this would happen.
Importantly, both Fisher and
Friedman had an asymmetrical view of monetary expansion. The ongoing expansion
of the money supply – and therefore persistent injections of new money into the
economy – were not considered harmful (quite to the contrary), as long as the
money inflow remained moderate, but any contraction of the money supply
(shrinking of bank balance sheets and destruction of money) was seen as a major
problem and to be avoided at almost all cost. Their plans for full reserve
banking was largely motivated by a desire to avoid the destruction of
previously created deposit money. Of course, ‘Austrians’ see this very
differently. The expansion of money – even if moderate and controlled – must
already cause problems (capital misallocations), and when these problems come
to the surface they cannot be suppressed with yet more money creation, at least
not forever (although this is attempted under Friedman’s proposal for very easy
monetary policy in crises).
It should now be clear why
the Austrian School is enjoying a revival in the present crisis, not the
Chicago School. Fisher and Friedman did not get their 100%- system with
complete control over money creation for the central bank but whatever power
central banks had in recent decades – and that power was formidable – was used
in ways that were strongly influenced by the Chicago School. Fisher and
Friedman have shaped modern central bank orthodoxy to this day. As long as
inflation is moderate central bankers believe that no monetary problem exists,
in line with Fisher. Even in the run-up to the present, spectacular financial
crisis, inflation remained moderate in most major countries, at least in the
common (and dangerously narrow) CPI definition. And for the past two decades,
any crisis that, if left unchecked, could have caused bank balance sheet
deleveraging and credit contractions was aggressively fought with low interest
rates and base-money injections from the central bank, according to Friedman.
In fact, the Bernanke-Fed has repeatedly referred to Friedman’s policy
descriptions as a blueprint for its own actions. However, none of this has
prevented major financial imbalances to build, and these policies have even
helped create these imbalances, as Austrian theory would suggest.
But I digress. None of this
makes any impression on Benes and Kumhof. In fact, Benes and Kumhof seem
decidedly uninterested in monetary theory, business cycle theory, or the
Austrian School. There is no mention of Mises or Hayek, and only Carl Menger is
mentioned – in a footnote and disapprovingly.
Instead, the paper sets up
an entirely new and I believe bogus problem based on the premise that in our
monetary system money is supposedly provided ‘privately’, that is, by ‘private’
banks, and ‘state-issued’ money only plays a minor role. From this rather
confused observation, the paper derives its key allegation that ‘state-issued
money’ ensures stability, while ‘privately-issued money’ leads to instability.
This claim is not supported by economic theory and certainly not by anything in
the Austrian School or, for that matter in Friedman’s Monetarism or Irving
Fisher’s original plan. Monetary theory does not distinguish between
‘state-controlled money’ and ‘privately produced’ money, it is a nonsensical
distinction for any monetary theorist. An attempt to give credence to this
distinction and its alleged importance is made in a later chapter in the
Benes/Kumhof paper but, tellingly, this attempt is not based on monetary theory
but on an ambitious, if not to say bizarre, re-writing of the historical
record.
Benes and Kumhof create an artificial problem
For any analysis of the
present financial system a distinction between state-created money and
privately created money is entirely artificial and of no help whatsoever,
because in our system money is created in a process in which ‘private’ banks
are intimately connected with the state central bank. Any distinction between
‘private’ and ‘state’ is thus arbitrary and for an analysis of the economic
consequences of such a system meaningless. Yes, most money in circulation today
is deposit money and sits on the balance sheets of nominally ‘private’ banks,
but the reserves are state fiat money, only to be created by the state central
bank, which the nominally private banks have to have an account with in order
to receive a banking license. Fractional-reserve-banks rely crucially on
state-sponsored and state-controlled central banks that have a
lender-of-last-resort function and that can – in a fiat money system – create
bank reserves at will, no cost, and without limit, and are, under normal
circumstances willing to do so to backstop the banks. Without this crucial
backstop fractional-reserve banking on the scale on which it has been practiced
in recent years and decades would be inconceivable. In their description of the
present system, Benes and Kumhof take no account of any of this. Frankly, they
do not appear to understand it.
Here are two statements from
the IMF paper that may at first appear sensible but that on closer inspection
reveal the grave misunderstanding of our present system by Benes and Kumhof:
“In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits.” (page 5)
But what determines
the willingness of the banks to supply deposits? Fractional-reserve banking
(supplying deposits) is lucrative but also risky for the banks as the public
can demand redemption of deposits in cash or in transfers to other banks, and
banks cannot create cash or the reserve money required to facilitate transfers.
These forms of money remain the prerogative of the state central bank. It is
the certainty, or high probability, under present institutional arrangements
that the central bank will support the banks and continue to supply whatever
amount of cash and reserves is needed, that allows the banks to supply – very
profitably, of course – vast amounts of deposit money on the basis of small
reserve money. Should the public demand payment in cash, the central bank can
reasonably be expected to stand by the banks and supply the needed cash.
In recent decades, the
global banking system found itself on numerous occasions in a position in which
it felt that it had taken on too much financial risk and that a deleveraging
and a shrinking of its balance sheet was advisable. I would suggest that this
was the case in 1987, 1992/3, 1998, 2001/2, and certainly 2007/8. Yet, on each
of these occasions, the broader economic fallout from such a de-risking strategy
was deemed unwanted or even unacceptable for political reasons, and the central
banks offered ample new bank reserves at very low cost in order to discourage
money contraction and encourage further money expansion, i.e. additional
fractional-reserve banking. It is any wonder that banks continued to produce
vast amounts of deposit money – profitably, of course? Can the result really be
blamed on ‘private’ initiative?
Fractional-reserve banking
on today’s scale requires two things: 1) a state-sponsored central bank that
has the monopoly of bank reserve-provision and that has a lender-of-last resort
function for the banking industry; 2) the central bank must have complete
control over bank reserves and be able to create them at no cost and without
limit. In short, the precondition for large-scale fractional-reserve banking is
a complete, unrestricted fiat money system. By contrast, the ability of the
central bank to create reserves is fundamentally restricted under a gold
standard.
The gold standard was abolished
and replaced with a system of entirely unconstrained state fiat money through
an act of politics. The state established monopolistic central banks that have
a lender-of-last-resort function for the banking sector. The state did thus
create the infrastructure that allows banks to supply vast amounts of deposits,
and over the decades has repeatedly subsidized this activity and socialized its
risks.
Here is the second statement
by Benes and Kumhof:
“The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business.” (page 5)
But what exactly
constitutes the privilege? – In a free society, you are, of course, free to
issue your own fiduciary media – just issue checks against yourself and have
them circulate as money surrogates. You will probably have to convince the
public that you will convert these checks into money proper on demand in order
to persuade the public to use the checks as money equivalents, and even then
you may not succeed. But if the public believes you and your endeavor is
successful, you have indeed become a money-producer and can fund your own
lending with your checks. In fact, this is pretty much how
fractional-reserve-banking originated. So far no privilege. It only becomes a
privileged business, and possible on the scale we see it today, once the state
supports it. The ‘Austrian’ solution is straightforward: remove the privilege!
Without fiat money, central banks and state-sponsored deposit insurance, let us
see how much ‘private’ money creation there really is!
No theory but revisionist history
That the distinction between
‘privately produced’ money and ‘state-produced’ money is meaningful and
important, Benes and Kumhof try to argue in a separate part of the paper. Here,
they completely depart from any traditional analysis of money or even any that
could still be called ‘economic’. An economic analysis of money understands
money as a useful social institution and thus starts with an inquiry of what
money is used for in general, including today by today’s money users (that
includes you and me), and tries to explain, based on reasoning, what would
therefore make for good money in a general context, including the present one.
Benes and Kumhof, however, do not argue conceptually as economic theoreticians
but as (re-)interpreters of history. History can tell us what is good money and
how it comes about. The anthropologists and monetary historians Benes and
Kumhof quote claim that because money originated – supposedly – with the state
its issuance is best controlled by the state. Again, no economic – conceptual,
logical, theoretical – explanation is given for why that should be the case and
why this could be upheld as a general rule. Allegedly, history tells us that
the state is a responsible issuer of money and the private sector an
irresponsible one. And that’s that.
The interpretation of the historical
record that is provided in support of this allegation ranges from the
adventurous to the outright bizarre. Instances in which the redeemability of
deposit money in gold and silver was abandoned by official decree and vast
amounts of fiat money were created to fund wars, revolutions or other state
expenditures, such as during the Revolutionary War in America, the Civil War in
America, or 1920s Weimar Germany, are reinterpreted to show that the ensuing
inflations and outright currency disasters cannot be blamed on the state but
are entirely the result of the involvement of ‘private’ money issuers.
“Colonial paper monies issued by individual states
were of the greatest economic advantage to the country…The Continental Currency
issued during the revolutionary war was crucial for allowing the Continental
Congress to finance the war effort. There was no over-issuance by the
colonies,… The Greenbacks issued by Lincoln during the Civil War were again a
crucial tool for financing the war effort, (Hooray! Another war courtesy of
paper money! DS)… The one blemish on the record of government money issuance
was deflationary rather than inflationary in nature.”
Really? – The
‘colonials’ that were issued to fund the war with Britain ended up worthless,
and to this day there is the idiom “worthless as a continental” in the American
language. The period of the Civil War, too, was one of unusually high
inflation, and in 1879 the USA decided to go back on a gold standard, at which
point a period of considerable growth and rising prosperity set in.
While the enthusiasm for
paper-money-funded wars on the part of Benes and Kumhof is already a bit
disturbing, what is particularly striking is that Benes and Kumhof, and the
‘historians’ they quote (in particular the activists David Graeber, an
anthropologist and leading figure of the Occupy Wall Street movement, and
Stephen Zarlenga, founder and director of the American Monetary Institute), try nothing short of a
complete re-writing of economic history and suggest conclusions – not only in
one instance but throughout ALL of monetary history – that not only fly in the
face of the generally accepted historical record but also common sense. The state
as a monopoly-issuer of money with no restriction whatsoever becomes a trusted
guardian of the common weal – simply qua being a state!
Their whole argument gets
kooky in the extreme when they address more recent instances of fiat money
currency disasters, for which we not only have ample documentation that
supports the opposite interpretation but which some of the most distinguished
monetary theorists actually lived through themselves and experienced first hand
– and which they explained succinctly.
Ludwig von Mises wrote a
seminal book on monetary theory in 1912 (Theories des Geldes und der
Umlaufmittel), in which he laid the foundations for the Austrian Business Cycle
Theory and in which he predicted (!) the European hyperinflations of the 1920s.
He lived through the hyperinflation in Austria in 1923, and, as the chief
economist of the Vienna Chamber of Commerce, was in direct contact with the key
players in government and central bank. He later wrote his memoirs.
Benes and Kumhof now claim
that all these accounts are simply wrong. The main culprit was not the state
but the private sector. We only have to ask state officials (!) and they can
tell us what really happened. Here is the IMF working paper, page 17:
“The Reichsbank president at the time, Hjalmar Schacht, put the record straight on the real causes of that episode in Schacht (1967).”
According to
Benes/Kumhof, Schacht blames the inflation on aggressive money creation by the
private sector but his account also suggests that this was only possible
because the Reichsbank generously redeemed deposit money in Reichsmark, that
is, the central bank provided essential support for money expansion. With a
generous backstop from the state the private sector will, of course, create
money. But does that mean the state had nothing to do with the whole debacle?
Kumhof, Benes and their prime source, Zarlenga, seem to not understand the role
of central banks and the essential ingredient of state-backing for large-scale
fractional-reserve banking. Furthermore, Schacht is a source of a somewhat
dubious reliability in this debate. Schacht became a Hitler supporter later on,
introduced socialist New-Deal-type policies in Germany, and helped the Nazis
with re-armament and plans for German autarky. I am not saying this to
discredit Schacht as an economic observer, only to highlight that he had – and
this is probably an understatement – a considerable pro-state bias in all his
economic views and is just hardly an objective observer on the question if the
state can be trusted with money. (As an aside, all totalitarian ideologies are
anti-gold and pro-paper money and central banks. The Socialists, the Communists,
the National-Socialists, the
Fascists – they all hated to see the state restrained in its maneuverability by
a gold standard.)
Benes and Kumhof’s case
simply ignores the numerous historical accounts that paint a very different
picture, such as the work by English historian Adam Ferguson whose seminal book
“When Money Dies” has recently found a wide new readership. It ignores the
eye-witness reports of one of the most distinguished economists of the 20th century, Ludwig von Mises, or the work
of Swiss monetary historian Peter Bernholz.
I am not a historian and I
want to be careful in dismissing challenges to the established historical
record out of hand, but the account presented here strikes me as simply ridiculous,
as unscientific, mystical pro-state propaganda. As a scientific argument it is
without merit.
But almost the worst aspect
of it is this: where are the economics, where is conceptual analysis and
reasoning? Even if we accepted – simply for argument’s sake and contrary to the
overwhelming evidence to the contrary – that the state has more often than not
been a good guardian of the money privilege, what are the explanations for
this, what are the theoretical and conceptual arguments that underpin this
historical pattern? Could we rely on this always being the case? If it is in
the “nature of money” (Benes/Kumhof) to be provided by the state, is it
therefore in the “nature of the state” to always provide good money, or would
we need specific institutional arrangements, legal frameworks, or some
‘good-money’-culture or tradition for this to be the case? Of course, Benes and
Kumhof provide no answers.
This part of the paper is
simply unscientific because the argument is essentially mystical. The whole idea
that a socially useful institution such as money can only be understood if we
understand its “nature”, which does not derive from how people use it
(including you and me today) but from how it came into being thousands of years
ago, is nothing if not rooted in mysticism.
Money is a tool, and so are
hammers. If I asked you to tell me what a hammer is for, what makes for a good
hammer and a bad hammer, and what type of hammer I need for a specific purpose,
would you tell me that I first have to understand the “nature” of the hammer,
and to do so I would have to ask anthropologists how the first hammers came
into being and what the first hammers or hammer-like tools were used for?
Mystical assets
Remember what I said above
about circulating your own checks as fiduciary media? That is a pretty good
description of paper money issuance. The newly circulated paper money is
accounted for as a liability on the balance sheet of the paper money creator,
and the things he acquires through issuing/spending this new paper money become
the corresponding assets. By issuing paper money the money creator lengthens
his balance sheet, while those who transact with the money-creator neither
lengthen nor shorten their balance sheets but exchange positions on the asset
side of their balance sheets, they replace other, previously held assets with
new money.
This can also be observed in
the creation of base money (extra bank reserves) by central banks today. When
the Federal Reserve creates an extra $1 trillion as part of ‘quantitative
easing’ and decides to buy mortgage-backed securities from its member-banks,
then the Fed’s balance sheet expands by $1 trillion dollars. The new bank
reserves are on the liability-side of its balance sheet, while the
mortgage-backed securities are on the asset-side. The balance sheets of the
banks do not expand as a result of the Fed operation. The banks simply replace
mortgages with new reserves. Both are on the asset side of their balance
sheets. Their asset-mix has changed. They now have more reserves.
This process could be
extended until almost all bank assets have moved to the central bank and the
banks are fully reserved and thus cease to be fractional-reserve banks. This
was precisely the process that Irving Fisher had in mind when he wrote “100%
Money” in 1935 (see page 57), and Milton Friedman when he wrote “A Program For
Monetary Stability” in 1960.
At no point did any of these
economists suggest, nor does any central bank today suggest, that the creation
of new paper money enhances the overall wealth of society, that there is now
more property in this society. It is also clear from this process that ‘debt
forgiveness’ by the central bank is difficult. The central bank can issue
enough reserve money to acquire all bank assets but whenever it writes down the
book value of any of these assets it also has to shrink the liability side of
its balance sheet, it has to destroy reserve money.
Benes and Kumhof now come up
with an entirely novel approach. The state simply declares that its new reserve
money is also an asset in its own right. Per decree the state creates wealth:
Treasury Credit or commonwealth equity. The central bank books the new reserves
on its liability side, just as in a conventional money creation process but now
does not book existing assets against it that it acquires from whoever books
the new reserves as assets (the banks). The corresponding asset is now
‘Treasury Credit’, which did not exist before but now comes into being per
government decree. At this stage, the central bank’s balance sheet lengthens
without any acquisition of new assets – the offsetting asset is created
simultaneously with the reserve money liability!
The balance sheets of the
banks now also lengthen: the banks book the new reserves on their asset side
without (at this stage) transferring other assets to the money-issuer. The
asset-side of their balance sheets lengthens. The corresponding lengthening of
the liability side is achieved by booking ‘Treasury Credit’ as a liability.
It is this slight-of-hand
that allows, in the following steps, various bank assets to get written off
without a corresponding shrinking of reserve money. Only via the accounting
gimmick of creating central bank assets out of thin air (and not just new
central bank liabilities) and thus claiming that overall wealth – new assets –
have been created administratively by the government can the large-scale debt
write-off that is the paper’s allegedly strongest selling point, proceed.
All of this is state
intervention in private contracts and property rights on a gigantic scale. The
state may have the power to rewrite accounting rules and simply claim the
existence of mysterious ‘government wealth’. Stranger things were claimed by
governments in the 20th century.
But what are the consequences? How will the public react? What confidence will
it have in the new 100% state controlled monetary system?
Simply writing off all
household debt is a mixed blessing. How would you feel if you worked hard and
saved and did pay down your debt to give your family financial security, only
to find out that your irresponsible and reckless neighbors, living high on the
hog on credit cards, just saw all their debt wiped out by the Benes/Kumhof
plan?
All power to the state!
This whole plan is nonsense
on the greatest scale. Benes and Kumhof have thoroughly embarrassed themselves.
Maybe we should simply look the other way and ignore this ill-conceived
rubbish, maybe excuse it as the confused musings of two state-worshipping econometricians
who fell under the spell of the New Age historicism of Graeber and Zarlenga,
which they saw as a great opportunity for some fancy econometric modeling. But
this comes with endorsement from the IMF, a major state-organization. Could it
be that those who benefit from the accumulation of more state power feel that
all the widespread banker-bashing and the erroneous but skillfully planted
notion of the failure of capitalism can be turned even more to their advantage?
Even the otherwise intervention-happy Ambrose Evans-Pritchard has his doubts:
“Arguably, it would smother freedom and enthrone a Leviathan state. It might be even more irksome in the long run than rule by bankers.”
Ambrose, for once I agree.
In the meantime, the
debasement of paper money continues.
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