These procedures are seen as perfectly satisfactory within the banking and Treasury circles of most western countries.  Self regulation of such a complex mechanism is perceived not as an option but as a necessity.  The bodies which regulate banks render lip service to the Legislature but essentially they are independent and run by professional bankers for professional bankers.  No government in its right mind would want to nationalise the banks, but as long as we base our means of exchange on ‘notional money’ it’s value will be abused by those in a position to control its issuance.

We hear much about this word ‘confidence’ required to maintain stability in financial markets.  One need not look far to understand why – neither the best illusionists nor confidence tricksters  can conduct confidence tricks without it.  But when such performances become so built into the fabric of society that the State agrees to participate in maintaining the illusion then there is something very much amiss.  Writing in 1936, Keynes noted, "It is enterprise which builds and improves the world's possessions.... Speculators may do no harm as bubbles on the steady stream of enterprise. But the position is serious when enterprise becomes the bubbles on a whirlpool of speculation". 

At this point we should refine the term ‘borrowing.’  If we borrow from a friend, a relation, a pawnbroker or a moneylender they open their wallet and hand us their money.  We can now spend that money but they can not – they have foregone the use of it until such time as we repay it.  And for that sacrifice it is not unreasonable to pay interest. This process adds nothing to the ‘pot’ of money in circulation and nothing to the total ‘real wealth’ of the community;  some purchasing power has changed hands – nothing else.  That is how the 151 registered Building Societies worked prior to 1986 when mortgages and investments totalled £132 bn and members shares & savings also equalled £132 bn.

 For many years now all commercial banks have churned out credit at a rate between three and four times the real rate of economic growth.

The UK GDP grows in real terms by three per cent a year at most, whilst the National money supply grows at a net 10% per annum.  In 2007 the figure was an incremental  £327 million a day.  This additional credit money can attach only to existing goods and services and  inflation occurs primarily when money enters circulation in volumes greater than the goods and services being traded.  Like a pot of good soup, if you keep diluting it with water it ceases to be good soup.  That is why inflation will continue at a rate equal to tthe   difference between these percentages for as long as ‘notional’ money competes with ‘'real’ money.  

A further symptom is the inexorable growth of unrepayable personal and public debt and the associated interest burden which absorbs an ever increasing share of income.  Banks manufacture two products – credit and inflation.  The more credit they produce the more profit they earn and remember, a steady rate of inflation does not harm banks.  It facilitates the payment of interest and guards against a drop in collateral values - no bank wishes to risk its security falling below the value of the loan, and no borrower would borrow 125% of equity value in the absence of inflation. 

In terms of the value of money, inflation does not concern banks either, because they live on interest.  The principal - the notional money they lend does not exist in the first place, so when it is repaid at a later date its depreciated valued is academic.  Nor is inflation significant to Big Business - they just put up prices.  It is of some significance to small businesses because they suffer a lag between cost rises and selling prices.  It is more painful to employees because wage rises are usually at least a year in catching up, and of greatest significance is the impact upon the retired generation trying to live on the fixed income of a pension. 

  Credit is an inexhaustible spring, a cornucopia – a licence to print money - which only backfires when a loan goes sour and the bank has to find real money to cover the loss.

 So much for credit.  Conversely, the long established process whereby new cash money comes into circulation is very different and best described by actual historic events.  Prior to, and until just after the end of WW2, cash was the primary means of exchange among all populations.  Bank accounts and financial credit were primarily for commerce and industry, and for the salaried managerial classes.  In the UK one half of all money in domestic circulation was cash. As the standard of living rose so also did the need for ever more cash.  This demand came via the commercial banks and the State provided them with all the cash they asked for.

Fig 1

 Fig 1

Graph prepared from Abstracts of National Statistics

Fig 2

(then)

Up until the 1960’s the State maintained a large fleet of armoured vans and delivered huge sums of new cash money to the banks for distribution - matching the monetary demands of the Economy.  Each delivery was credited in full to the Government Seigniorage account and thus all this currency was spent into circulation as wages and salaries for services rendered in the provision of Public Services.  No interest or repayment was involved.

 This money was not however a free issue to the banks – they had to account for every penny by crediting the government’s account (Fig2).  The procedure is of long standing and is called seigniorage.  This principle is key to restoring our money to both democratic accountability and to economic realism.

Following post war austerity in Europe the availability of household goods and consumables gradually increased faster than incomes and it became apparent that whilst these goods were available to buy there and then, most people didn’t have enough ready cash to buy them.  Consumer credit – notional cash – became accepted as real cash. 

As with ‘fiat money’, a credit contract with a bank (or credit card provider), was a promise to pay cash at a future date and that was enough to secure the purchase.  The first Diners Club charge card appeared in America in 1950 and the first Visa and Master Cards a few years later.  Hire purchase companies prospered, borrowing credit cheaply from the banks, securing their advances on the goods purchased and charging higher rates of interest than they paid. 

The ascendancy of credit over cash is widely heralded as a natural evolution, just another modern convenience superseding an outdated means of exchange.  This is the view of the commercial banks and, quite remarkably, also that of The Treasury.

The change  however obscured a much more insidious factor – not just the demise of seigniorage but the displacement of real National money with ‘notional’ money - issued by private companies called banks. 

Fig 3

Well, virtually closed.  Once a source of half our money supply and provider of a substantial slice of government revenue in the nineteen fifties, cash is now some than three pence in every pound in circulation.  Adding to the irony, the Royal Mint has been reduced to a metal bashing operation, selling coins, medals, jewellery, gifts and collectables under the Royal Mint Classics brand.  Expected to operate commercially the Mint regularly turns in a modest loss.

 This was a double edged sword.  First it cut government revenues and forced the introduction of new value added taxes and excise duties, and then it cut any democratic restraint or control over inflation by handing over the National money creation function to the banks.

The banks prospered as never before as more and more credit money was churned out.  The State however was unable to participate in the credit boom financed by this change.   Budget deficits and public debt escalated steadily and interest payments on the UK National Debt grew to exceed £25 bns per annum.

Obsessed with how to finance deteriorating public services successive administrations raised yet more indirect taxation, excusing themselves with euphemisms like ‘modernisation’ and ‘competition’.  And surely the ultimate insult to all intelligence was the ‘Private Finance Initiative’.  Here we have the public borrowing credit from the selfsame banks to which they have granted this credit monopoly.

Even our most senior politicians seem unable to rationalise the relationship between their constitutional obligation to provide a fair and neutral money system and the role of banks in providing a modern payments system.  If they sat down to a game of Monopoly would they permit the banker to issue ‘notional’ money and at the same time compete with the other players?

Nor are these phenomena influenced by Party politics – administrations of all political stripes are equally affected.  Note the steep rise in debt sparked by Mrs. Thatcher’s ‘freeing up’ of the moneymaking activities of the City of London in 1980 (Fig 4).  A government ostensibly dedicated to expanding enterprise and cutting public sector excesses – and not withstanding selling off a raft of public assets to the market - has ratcheted up even greater debt.  Arithmetical certainties are not deleted by creative accounting or political zealots.

The bulk of Private Sector debt was, and remains, of the rotating variety – consumers pay off earlier purchases and apply their ‘creditworthiness’ to new ones.  Despite a steadily increasing casualty rate in the form of bankruptcies and repossessions, carefully managed debt remains a satisfactory arrangement and consumers appear to be willing to pay the credit charges involved.

The National Debt (Public Sector debt) however is a different matter.  It is the cumulative sum of all government deficits.  It is represented by Gilt Edged Securities which are IOUs from the State for notional money borrowed from the bondholder who in turn has borrowed it from the banking system which is authorized to create notional money by the State which is the issuer of the National Currency and the ultimate monetary authority in the first place.  Better read that again – it’s a long sentence in either sense.

The escalation of the National Debt – still rising each year from these budget deficits, worries central bankers.  So much so that within the European Union, States are constrained to keep annual deficits to within 3% of GDP and their total National Debts to within 60% of GDP.  Each year this arbitrary constraint provides a bigger and bigger challenge to State spending on infrastructure and public services and the results are clearly apparent.  The prognosis is an arithmetical certainty – at the accelerating rate indicated by Fig 4.  The National Debt at 2008 stands at over £600bns.

 For the self interested individual in a free and democratic society consumer debt is a matter of individual choice –

Fig 4

No matter which political party is democratically elected, none makes any serious effort to reign in the private sector debt machine.  The unchallenged   outcome is a mathematical certainty – the entire population and its government will remain permanently and increasingly in debt to a privately owned ‘Credit Industry’

certainly a matter to be regulated by the State, but fundamentally a personal decision and responsibility. 

Affordability too is a constraint which will always condition the way in which  individuals behave, and using credit is part of that freedom of choice.

The State – representing this collection of self interested individuals also has a choice.  It can delegate its monetary responsibilities to the private banking sector virtually as a self regulating entity, as at present, or it can elect to retain its constitutional authority over the means of exchange.

Not unnaturally, this latter option is unfashionable among banking and financial circles.  They prefer the State to maintain its responsibility for the National Currency only insofar as enforcing the law protecting the banks’ monopoly and punishing counterfeiters and fraudsters.  They also expect the State to guarantee the currency and its stability so that  when trouble looms they will be bailed out by the taxpayer.  This ‘bailing-out’ process might benefit from comment.  As we all know, the State is permanently broke and on the ragged edge of balancing its budget - the Treasury has no vaults stuffed with reserves for such emergencies.  A Treasury bail-out is a straightforward dilution of the money supply,i.e. inflation of the currency and is reflected in a deteriorating rate of exchange.  That’s how the taxpayer pays for it.

High taxes limit and dictate public investment and financing charges dominate the private sector.  At almost 30% of GDP the financial sector now governs the real economy[1].  Everyone, except the financiers, would like to see debt capped at manageable levels, inflation eliminated and a greater focus upon what can be achieved rather than what can be afforded.

The overarching principle is that all money must be real again.  There are two elements to the proposal which follows.  The long term objective is that all bank lending will eventually be 100% backed by the deposits of savers and investors.  The second is to empower Government to finance public investment where dormant economic capacity exists. 

From Day 1, the issue of notional money will become illegal.  Monetary policy will require that all future increases in the National money supply will be in the National Currency and denominated in values of one million pounds sterling.  Whilst the demand for additional financial credit continues, so the Bank of England will issue notes to the corresponding value.  Instead of creating inflation by issuing unlimited credit money generated out of thin air, future increases in the money supply will be accounted and vouched by these interest free Seigniorage credits. 

The million pound Treasury Notes will not however enter circulation, but will be retained by the commercial banking sector as non interest bearing securities underwriting all new (incremental) issues of financial credit – Fig 5.  Under the well established seigniorage protocol the banks will credit the current account of the Bank of England with this deposit. There should be no more State borrowing  for capital investment, nor resorting to PFI ploys.  It is however restricted to domestic investment and cannot be used to finance imports without additional considerations of the Balance of Payments.  That however is a quite separate issue.

The proposed ‘New Credit Money’ would come into circulation only in step with a corresponding increase in real wealth – in the form of the public assets internally created.  This is the key factor in restraining inflation – no increase in money supply without an equivalent value added to the National wealth. 

Fig 5

Fig 5

(in future)

The change from cash to credit should not change the principle of money as a means of exchange issued free of interest by the State.  The re-introduction of Seigniorage by the Treasury would once again attach a physical asset to the creation of all new credit money thus reducing debt, the interest burden and asset inflation.

This ‘real’ money would return to the banking system in increasing volumes as wages, salaries and company profits, replacing an equivalent amount of notional bank credit and debt.  Thus, all money would progressively become ‘real’ again and retail banking would return to the status of a responsible privately owned Institution.  As notional money disappeared greater stability would progressively return across all sectors of the economy.

Banks would no longer require a special charter to create credit, but they would remain subject to authorisation under an Act similar to that governing Building Societies.  They would  however also participate in a collective guarantee for their ordinary depositors which they would fund from their own resources and which would be administered by the Regulators..

Much of the complexity surrounding the present banking system is due to mixing the Payments System with literally hundreds of other banking activities for profit. The true cost of the payment system is therefore obscured. The term ‘free banking’ (for those in credit) is of course subsidized by borrowers.   The downside of this is that the ‘real’ economy is impacted by the inherent volatility of financial markets.
It is therefore recommended that retail banks be required to hive off their satellite businesses and concentrate exclusively upon retail banking operations.  There is neither justification nor equity in a  State banking charter which provides any private company with a financial advantage over its competitors (the Monopoly syndrome). 

Retail banking will progressively return to attracting sufficient retail savings deposits to fund its retail loan book – just as Building Societies did in the recent past. The strength of Building Societies lies not in their Mutual Status or that they lend specifically for mortgages – it is that they lend ‘real’ money.  Confidence will return and ‘runs on the bank’ will be greatly reduced when the public realize that ‘real’ money exists to cover their deposits.

Look again at Fig 1 on page 6.  That blue line is the real increase in GDP when inflation is stripped out.  Adopting this proposal would mean that the annual increase in money supply would once again be shared between bank credit and state investment – just as it has been in the past.

The disastrous pattern of excessive bank credit has been consistent since the seventies – typically in the ten years to 2003 the UK money supply increased at an average of over £53 bns a year – an average of over 7 ½ % per annum.  In the same period real GDP had risen 2½ %, the result was real inflation of  5%.  Over the past four years to 2007 that rate has increased to an average of 10% pa  - over £100 bns a year and real GDP  remains solidly stuck at less than 3% pa.

This is a game of real life Monopoly with the bank competing as a player.  The bank must be neutral.  Inflation will never be defeated until credit growth is controlled to match that of the real economy.  Investing any increase in credit into public assets instead of pumping up private asset and house prices would be a first step along the road to keeping it in check.  

A healthy banking and financial sector is desirable in any economy but the State must now recognise that it has become a monopoly dominating the very core of the democratic process.  Our means of exchange is a key facilitator of trade, but it has become the genie out of the bottle.  The day that we - the State – stop treating the banks as privileged private businesses will be the day capitalism and free enterprise recaptures ts roots.

A proposal of this nature would require restriction of foreign banks from circumventing the legislation and would require negotiation within the Basel Agreements on EU banking.  The knee jerk reaction of the Financial Establishment will doubtless follow the usual pattern of at first ignoring the proposal, then ridiculing it, then citing at as dangerous, fascist or communist, and then threatening to up stakes and remove the entire financial sector from these shores.  That does not affect the logic of the basic academic argument.

Many books and learned papers have been written on Banking and Monetary Reform;  many conferences addressed and even worthy efforts to introduce legislation in Parliament and Congress.  Nothing has happened because the corridors of power are stuffed with lobbyists and special interest groups resisting change.  Many economists, even Milton Friedman believe it or not, have advocated reform of this nature.  In his own words, like so many, he found himself ‘tilting at windmills’.  He concluded that career prospects were better within the ivory rowers of Academia and the fortresses of the Establishment.

As with the abolition of slavery or votes for women, banking reform will only happen when there is a large enough swell of public opinion demanding it.  Until then democracy will continue to be driven by the power of money rather than the will of the majority.

End

If you would like to know more or find out how to join a campaigning group, type in 'money as debt’ into your search engine.  It’s an animated video with lots of links to international Banking Reform organisations.  For the serious student go to the links page on this site for a free download of Creating New Money by James Robertson.