Thursday 29 January 2015

A moral case for bank money

Finance is a skeleton that supports the development of a healthy society, not a utility that plumbs the economy together. The justification for this observation is historical. Richard Seaford has argued that the culture that emerged in Greece some two and a half thousand years ago, creating a unique approach to science and democratic politics, was a consequence of a peculiar Greek invention; money, a token that signifies trust between citizens. The flowering of European culture, and the genesis of modern science, in thirteenth century Europe followed, and some argue was a consequence of, a period of rapid monetisation of society that initiated the end of feudalism. Similarly, western Europe’s development accelerated ahead of the rest of the world in the seventeenth century powered by financial innovations in the Netherlands and Britain.

Charles Mackay in his classic comparison of England’s South Sea Bubble and France’s, almost simultaneous, Mississippi Bubble, emphasises the different reactions in France and Britain to the credit bubbles. In the aftermath of the crises, the French inhibited the development of private banks but maintained the autocratic political system, whereas the British reformed the political system and enabled the development of finance. The results of Britain’s Financial Revolution were Agricultural and Industrial Revolutions along with the eclipse of France as a global power. For France, dependent on taxation to fund the state, there was the ultimate collapse of the political system in bloody revolution.

Getting the structure of our financial system right is not a trivial matter.

One argument gaining support is that the root of recent problems in finance is the private creation of money by banks, and so the solution is to strip banks of this ability. What this would entail is not clear but a core theme is that transactions would involve minted cash (physical or electronic), not bank money. We can visualise the practical consequence of this in little brown envelopes on pay-day containing coins and Bank of England notes. No bank transfers, certainly not in the foreseeable future, meaning no debit cards at the supermarket checkout and the replacement of cyber-crime by good old-fashioned robbery. This makes concrete part of the problem  Martin Wolf identifies when he makes the observation that "The transition to a system in which money creation is separated from financial intermediation would be feasible, albeit complex."   It might prove impossible to get through the Christmas binge, when there is widespread short-term demand for cash.  Could a computer system cope with the funds transfers associated with Black Fridays and Cyber Mondays without the ability to create money? Banks, in this environment, would come to resemble peer-to-peer lending facilitators and the consequence would be that people who have wealth, or are connected to wealthy networks, could buy expensive things, but for the majority it would be harder to get a mortgage.  While this might sound a bit draconian to the British, Germans still have a preference for cash and traditionally live in rented accommodation, having long connected debts (schulden) and guilt (schuld) and, after all, they have done well economically.

Unfortunately it is not certain that German economic success rests on the German preference for cash. An equally plausible explanation is the structure of the German banking system, which, unlike the British and U.S. systems, is not dominated by private profit seeking banks but has a significant sector of not-for-profit, regional, financial institutions. An IMF paper highlights how countries with this type of financial system, including France and Spain, did not require the massive government bailouts that British and U.S. banks did in 2008-2009. Mutuals and public banks create money in the same way as privately owned banks and so preventing banks from creating money seems to be a rather extreme solution when the problem might be elsewhere.

Calls to prevent banks from creating money to ensure financial stability resemble calls to ban the internal combustion engine to prevent climate change. It would clearly go a long way to solving the problem, in theory, but is totally impractical. One group who would like to see the debate on banking reform focus in on money creation are the banks themselves, because they can be confident that if this is where the debate is centred, nothing will change. Most voters need bank credit just as they need cars.

I cannot offer a straightforward alternative to preventing banks, or anyone else, making money. I do have an alternative idea of where the problem lies though. If you read about eighteenth century finance it is striking how engaged people were with financial innovations. Well before the South Sea Bubble Daniel Defoe wrote about the problem of banking

Money has a younger sister, a very useful and officious Servant in Trade ... Her name in our Language is call'd CREDIT… This is a coy Lass ... a most necessary, useful, industrious creature: ... [and] a World of Good People lose her Favour, before they well know her Name; others are courting her all their days to no purpose and can never come into her books. If once she is disoblig'd, she's the most difficult to be Friends again with us … for as once to want her, is entirely to lose her; so once to be free from Need of her, is absolutely to posses her.

Lady Credit was seen as a coy mistress, much as Boethius had perceived Fortuna

I know how Fortune is ever most friendly and alluring to those whom she strives to deceive, until she overwhelms them with grief beyond bearing, by deserting them when least expected

Right up until the mid twentieth century credit was represented in this way, with John Strachey writing

The banks are essentially feminine institutions. They create the new money which sets the wheels of production turning again. But they cannot procreate without a spouse. The newly born money must have a father as well as a mother. Someone must take the active, positive role of borrowing, spending, and employing, or the banks will remain barren.

In this conception commerce is a marriage between credit and opportunity with the objective of producing growth. However, Lady Credit is attractive and, as Defoe observed in 1709, sometimes her relations are not so benign

The first Violence they committed was downright Rape ... these new-fashion'd thieves seiz'd upon her, took her Prisoner, toss'd her in a Blanket, ravish'd her, and in short us'd her barbarously, and had almost murther'd her

If women run the risk of sexual assault, the civilised response is not to lock them away out of harm’s reach, but focus on the perpetrators. The problems of finance are not in creating money but in lending money to unsuitable projects.

Through the nineteenth century science became confident that it had tamed fortuna and a consequence was the mechanisation of finance. Credit was no longer a prize to be wooed but a servant to be controlled. As finance became de-humanised the morality of the Quakers, who established many of Britain's financial institutions, was replaced by the profit maximising principle. In the process, people have become alienated from finance and lost the capacity to make their own financial judgements; we need to employ professionals to plan our future.

I have argued that profit maximisation should not be at the heart of commerce, rather the norms (virtues, if you prefer) of reciprocity, sincerity and charity. In this framework mutual mechanisms, including peer-to-peer and crowdfunding, are as legitimate as profit maximising private banks. I believe the advantage of this approach is that it takes as given that the economy is capricious and beyond the control of wise men observing nature and pulling controls. Preventing banks from creating money reflects a desire to freeze the economy in order to stop it becoming chaotic. This is a forlorn hope, to which the collapse of Bretton-Woods is testimony.

If you feel my claim that reciprocity, sincerity and charity should be, or even could be, at the heart of finance is as absurd as preventing banks creating money I would point you to Shakespeare’s The Merchant of Venice. One reading of the play is as a study of the four classical loves: friendship (philia), affection (storge), romantic (eros) and unconditional (agape/caritas/charity). Shakespeare personified charity in the form of Antonio, the Merchant of Venice; why did he do that?

I wrote this piece, arguing against removing banks' ability to create money,  for Res Publica's Disraeli Room blog in response to a post Money Creation and Society: The beginning of the debate on how money is created

The case I present is not technical but moral,  in the sense of mores/moeurs.  I admire Izabella Kaminska's review of the case to strip banks of their money creation powers, and agree with her analysis of the issues, in particular I support the trilateral monetary system, based on sovereign, bank and private money, that she describes.  Specifically, I like her comment that
A more prudent path [to stripping banks of their ability to create money]might just be encouraging both the central bank and the market to get better at identifying over or under issuance where and when it happens, something which could be made easier if private money’s price signal was detached from the state peg.
This lays the foundation, in part, for presenting a moral case, I don't think the solution to credit bubbles lies in how finance is plumbed together, rather the ethical context under which finance is conducted

A further motivation for presenting a moral case originated in my experience of the Scottish Independence referendum, particularly the dismal performance of Alistair Darling, leader of the unionist campaign, in the final TV debate with the leader of the nationalist campaign, Alex Salmond.  A central issue in the campaign was the currency an independent Scotland would use, and Salmond advocated retaining the pound, controlled by the Bank of England. Darling, as a former Chancellor of the Exchequer had a deep understanding of the technical problems this presented, but Salmond, relying on the public's indifference to these problems and Darling's inability to articulate them, won the debate. 

A common irritant with the Independence Referendum debate was that both parties claimed a vote for them would change everything, but change nothing.  It struck me that the case presented by Positive Money was similar; stripping the bank's of their ability to create money will end the boom and bust cycle, to the benefit of the public, without changing individuals' experience of banking.  The recent Greek election, similarly, centred on the claim that the Greeks can re-negotiate their rescue package, to the benefit of the electorate, without the negative consequences of leaving the Eurozone.  Personally I feel the chance of this turning to tragedy or comedy are about equal, but the most likely outcome will be a yawn: the debt will be re-negotiated, the ECB having had five years to ring-fence the problem.  However, in the context of discussions of bank money it is worth highlighting that the Greek bankruptcy was a consequence of Greek government mis-management, and the austerity was imposed by a troika of public institutions.  Boom and bust is as likely to be caused by public bodies as private banks.

So, my aim in this piece was to side-step the complex technical problems and present a moral argument that might be more accessible to a general audience.

My piece survived on the Res Pubica blog for around two weeks and then was pulled at the request of Ben Dyson, the author of the original piece.  Mr Dyson objected to two 'inaccuracies' in the piece. Since both relate to what might happen if banks are prevented from creating money, and given these are contingent events, I don't think they can, in fact, be described as inaccurate; we have differing opinions. I invited Mr Dyson to engage in public deliberation on the points, through the Disraeli Room blog, but his response was to persuade Res Publica to pull my piece.  An interesting outcome given the claim that the original article was to be the the start of a debate.  What follows, not perfect but an honest attempt to continue the debate, is my original piece. The points of contention were the following in the original,
No bank transfers, certainly not in the foreseeable future, meaning no debit cards at the supermarket checkout and the replacement of cyber-crime by good old-fashioned robbery.  People who have wealth can buy expensive things, but for the majority it would be difficult to get a mortgage and impossible to use a credit card to get through the Christmas binge. While this might sound a bit draconian to the British, Germans still have a preference for cash and live in rented accommodation, having long connected debts (schulden) and guilt (schuld) and, after all, they have done well economically.

which has been clarified in this version.


  1. Tim Johnson clearly hasn’t even begun to study this subject as is evident from numerous mistakes he makes.

    First there is his sweeping criticism of stripping private banks of the right to create money, namely that “What this would entail is not clear…” On the contrary: the numerous advocates of the above “stripping” (e.g. Irving Fisher, Milton Friedman, Laurence Kotlikoff, James Tobin, the economics Nobel Laureate Merton Miller, etc etc etc) have spelled in great detail “what this would entail”. And the fact that Johnson doesn’t cite any of the latter economists is good evidence he hasn’t studied the subject.

    Next (and in the same sentence) Johnson makes the bizarre claim that “a core theme is that transactions would involve minted cash (physical or electronic), not paper money.” Well hang on: paper money IS PHYSICAL MONEY. So is Johnson saying that physical / paper money is or isn't produced under a “strip” system? (Incidentally that system is more commonly referred to as "full reserve" banking. Friedman called it "100% reserve".)

    In the next sentence but one, Johnson claims the system would involve “No bank transfers” and no debit cards.

    Jesus. Does Johnson SERIOUSLY THINK that the likes of Milton Friedman and the other above mentioned household name economists would advocate a system in which it is not possible to make “bank transfers”?

    I’m only a quarter of the way thru this article. I may have time to go through the rest in search of more nonsense. But I’m tempted not to bother.

    1. Thank you for taking time to point out the issues you have with my article.

      I have spoken to retail bankers who have told me, possibly in error, that the UK clearing system implicitly assumes banks can create money. When I write a cheque, am I creating money? I might not hold reserves to cover the cheques as my wife might simultaneously written a cheque and the account might be negative so it is not backed by reserves. In this situation I rely on my credit at the bank . This was the case a retail banker presented to me - it made sense to me at the time - and suggested the whole banking system rested on the same principle. I do not claim a 100% reserve system is not feasible, just not immediately practical.

      If you persevere I give an explanation of why I wrote the piece and explain I support the idea of a trilateral monetary system based on central bank money supported by private money (crypto currencies) and bank money (semi-official crypto currencies). I agree with neochartalists - that the state can do what it likes with its money and they do not have to "balance the books". But I also believe individuals should have the right to create their own money, if society is amenable.

      I am unlikely to quote Friedman, I doubt the author of The Methodology of Positive Economics would not accept the validity of a moral argument. I also wonder how relevant the views of dead economists are in an age when bitcoin, and other crypto currencies, seems to be challenging conventional theories of money (and I do appreciate that bitcoin is "100% reserve" that allows instantaneous transfers without money creation, but it has its own issues).

      When I said "paper money" I meant "bank money".

    2. “I have spoken to retail bankers who have told me, possibly in error, that the UK clearing system implicitly assumes banks can create money.”

      That point is widely accepted. I have an economics text book written 20 or so years ago which makes that point. And the Bank of England recently published an article making the point.

      “When I write a cheque, am I creating money?”

      No. No one best of my knowledge has ever said that. Writing a cheque just TRANSFERS money. What creates money is a bank granting a loan (as pointed out time an again by Positive Money, and by the above text book, and by the BoE and many others).

      “I also believe individuals should have the right to create their own money, if society is amenable.” OK, how about counterfeitors? The problem with counterfeitors is that turn out bits of paper, use them to acquire real goods and services at near zero cost to themselves.

      It’s exactly the same if I manage to persuade “society” to accept my home made money (e.g. uncrossed cheques). I get real goods and services in exchange for bits of paper. (Incidentally, that's not to suggest that every time a bank grants a loan for £X, £X is stolen by the bank and/or borrower from society at large. Reason is that the amount repaid by borrowers every week is approximately equalled by the amount of new loans. I.e. banks for the most part RECYCLE existing money. It's the EXPANSION in total amounts loaned that the theft arises (and even there, not all of that new money is theft, for reasons which are too complicated to go into in a blog comment)).

      Re Bitcoin, that doesn’t change the BASIC PRINCIPLES of money creation (e.g. the distinction between central and commercial banks one iota). Likewise, the fact that banks do book-keeping on computers nowadays rather than on physical ledgers changes nothing. That is the PRINCIPLES of doubtle entry book-keeping remain in place when it’s all done on computers.

      In the para starting “Calls to prevent…” you make the claim (made by many others) that banning private banks from creating money stops them lending or “creating credit”. Positive Money, Laurence Kotlikoff and other advocates of banning private money creation explain in detail in their literature how lending would carry on much as before under such a ban. Lending WOULD BE constrained A BIT, but given the HUGE expansion in debt relative to GDP in the last 20 years or so, that’s no big deal.

    3. The results of Britain’s Financial Revolution were Agricultural ......REVOLUTION....that begin's before the jethro tull implements or the turnip rotation ....and is more a revolution caused for demography than for finance ,,,
      and Industrial Revolutions

      and the demise of france have more causes than....

  2. Tim, the fact that governments have gotten it wrong in terms of how much currency they create isn't a valid argument against democratizing the money-creation system. The reason I say that is because it appears to me that you are defending commercial banking as if it alone is an option, sort of the way Margret Thatcher spoke about turning to laissez-faire capitalism as the only option.

    Why should private bankers (licensed as such) be such arbiters of who's funded and for what while taking a cut for it in the form of interest? Why shouldn't the people decide such things democratically via representatives constrained by laws to prevent runaway inflation and such and without paying interest to wealthy bankers (some say banksters) and bank shareholders and government bond holders, etc.?

  3. I am defending the principle of private commercial banking, not necessarily the practice. I bank with the Co-op and my mortgage is with a mutual, both organisations are private (as distinct from nationalised) commercial operations. I highlight the difference in banking structures in the UK/US (profit maximising) and continental Europe (widespread mutuals). I see the "solution" as being in a re-balancing away from profit maximisers towards mutuals (which are democratic institutions). As such I believe I am arguing in favour of democratising finance. The fact that governments do get it wrong, repeatedly, is, in my mind, irrelevant to the question of democratising finance, though it is a valid argument against vesting all power in a quasi-governmental organisations (such as the "Money Creation Council" advocated by Positive Money.

    Two UK political parties support the aims of Positivie Money; the British National Party (represented by Mr Musgrove who has commented here) and the Greens. Both parties have limited democratic support and a tendency to advocate extreme and draconian policies. I believe the policy of nationalising money creation is similarly extreme, draconian, unlikely to solve the problems it claims to address and open to short term political manipulation.

    1. I'm glad to hear you're "in favour of democratising finance."

      I understand and share much of your concern. I don't subscribe to Positive Money's "Money Creation Council" either. I'm looking for the money supply to be pegged to the real economy in terms of growth and to be done so via not humans but a computer program fixed by law that cannot be tampered with for "political" purposes in the sense you've used the term. In the US, it would be an amendment to the US Constitution.

      This would be an all-items basket of goods actually extending to all transactions run through one public bank (in the case of the US, the US Treasury).

      Spending and money creation would not be decided by loans issued by commercial bankers but as a result of the democratic process where the people would decide through representatives and often directly at the grassroots, which decisions would filter up as best practices given the locale: town, city, state of province, country, global region (where such a public bank would be supranational), and even entire world.

      The supply would rise or fall (I think it wouldn't really fall, as growth or dealing with catastrophes would probably always prevail) across all accounts proportionately. No individual or group would take an inflation or deflation hit. There would simply be funding and defunding: approval or cancellation or rejection.

      A strong welfare state would be funded so there would be no poverty. True democracy rather than the controlled democracies we have now would insure it at a minimum. There would be no plutocrats or oligarchs and for the same reason.

      By the way, for those who might be tempted to mistakenly conclude, this would not inherently do away with all private enterprise. That would also be a matter of democratic decision.


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