Table of Contents Acknowledgements A note for readers outside the UK Foreword Summary of Key Points INTRODUCTION The structure of this book A SHORT HISTORY OF MONEY 1.1 The origins of money A textbook history The historical reality 1.2 The emergence of banking THE CURRENT MONETARY SYSTEM 2.1 Commercial (high-street) banks The Bank of England 2.2 The business model of banking Understanding balance sheets Staying in business 2.3 Money creation Creating money by making loans to customers 2.4 Other functions of banking Making electronic payments between customers 2.5 Money destruction 2.6 Liquidity and central bank reserves How central bank reserves are created How commercial banks acquire central bank reserves 2.7 Money creation across the whole banking system The money multiplier model Endogenous money theory WHAT DETERMINES THE MONEY SUPPLY? 3.1 The demand for credit Borrowing due to insufficient wealth Borrowing for speculative reasons Borrowing due to legal incentives 3.2 The demand for money Conclusion: the demand for money & credit 3.3 Factors affecting banks’ lending decisions The drive to maximise profit Government guarantees & ‘too big to fail’ Externalities and competition 3.4 Factors limiting the creation of money Capital requirements (the Basel Accords) Reserve ratios & limiting the supply of central bank reserves Controlling money creation through interest rates Unused regulations 3.5 So what determines the money supply? Credit rationing So how much money has been created by banks? ECONOMIC CONSEQUENCES OF THE CURRENT SYSTEM 4.1 Economic effects of credit creation Werner’s Quantity Theory of Credit How asset price inflation fuels consumer price inflation 4.2 Financial instability and ‘boom & bust’ Minsky’s Financial Instability Hypothesis The bursting of the bubble 4.3 Evidence Financial crises Normal recessions 4.4 Other economic distortions due to the current banking system Problems with deposit insurance & underwriting banks Subsidising banks Distortions caused by the Basel Capital Accords SOCIAL AND ENVIRONMENTAL IMPACTS OF THE CURRENT MONETARY SYSTEM 5.1 Inequality 5.2 Private debt 5.3 Public debt, higher taxes & fewer public services 5.4 Environmental impacts Government responses to the boom bust cycle Funding businesses Forced growth 5.5 The monetary system and democracy Use of ‘our’ money The misconceptions around banking The power to shape the economy Dependency Confusing the benefits and costs of banking PREVENTING BANKS FROM CREATING MONEY 6.1 An overview 6.2 Current/Transaction Accounts and the payments system 6.3 Investment Accounts 6.4 Accounts at the Bank of England The relationship between Transaction Accounts and a bank’s Customer Funds Account 6.5 Post Reform Balance Sheets for Banks and the Bank of England Commercial banks Central bank Measuring the money supply 6.6 Making payments 1. Customers at the same bank 2. Customers at different banks A note on settlement in the reformed system 6.7 Making loans Loan repayments 6.8 How to realign risk in banking Investment Account Guarantees The regulator may forbid specific guarantees 6.9 Letting banks fail THE NEW PROCESS FOR CREATING MONEY 7.1 Who should have the authority to create money? 7.2 Deciding how much money to create: The Money Creation Committee (MCC) How the Money Creation Committee would work Is it possible for the Money Creation Committee to determine the ‘correct’ money supply? 7.3 Accounting for money creation 7.4 The mechanics of creating new money 7.5 Spending new money into circulation Weighing up the options 7.6 Lending money into circulation to ensure adequate credit for businesses 7.7 Reducing the money supply MAKING THE TRANSITION An overview of the process 8.1 The overnight ‘switchover’ to the new system Step 1: Updating the Bank of England’s balance sheet Step 2: Converting the liabilities of banks into electronic state-issued money Step 3: The creation of the ‘Conversion Liability’ from banks to the Bank of England 8.2 Ensuring banks will be able to provide adequate credit immediately after the switchover Funds from customers Lending the money created through quantitative easing Providing funds to the banks via auctions 8.3 The longer-term transition Repayment of the Conversion Liability Allowing deleveraging by reducing household debt Forcing a deleveraging of the household sector UNDERSTANDING THE IMPACTS OF THE REFORMS 9.1 Differences between the current & reformed monetary systems 9.2 Effects of newly created money on inflation and output 9.3 Effects of lending pre-existing money via Investment Accounts Lending pre-existing money for productive purposes Lending pre-existing money for house purchases and unproductive purposes Lending pre-existing money for consumer spending 9.4 Limitations in predicting the effects on inflation and output 9.5 Possible financial instability in a reformed system A reduced possibility of asset price bubbles Central bank intervention in asset bubbles When an asset bubble bursts 9.6 Debt 9.7 Inequality 9.8 Environment 9.9 Democracy IMPACTS ON THE BANKING SECTOR 10.1 Impacts on commercial banks Banks will need to acquire funds before lending The impact on the availability of lending Banks will be allowed to fail The ‘too big to fail’ subsidy is removed The need for debt is reduced, shrinking the banking sector’s balance sheet Basel Capital Adequacy Ratios could be simplified Easier for banks to manage cashflow and liquidity Reducing the ‘liquidity gap’ 10.2 Impacts on the central bank Direct control of money supply No need to manipulate interest rates A slimmed down operation at the Bank of England 10.3 Impacts on the UK in an international context The UK as a safe haven for money Pound sterling would hold its value better than other currencies No implications for international currency exchange Would speculators attack the currency before the changeover? 10.4 Impacts on the payment system National security Opening the door to competition among Transaction Account providers CONCLUSION APPENDIX I: EXAMPLES OF MONEY CREATION BY THE STATE:ZIMBABWE VS. PENNSYLVANIA Zimbabwe Other hyperinflation Pennsylvania Conclusions from historical examples APPENDIX II: REDUCING THE NATIONAL DEBT What is the national debt? Who does the government borrow money from? Does government borrowing create new money? Is it possible to reduce the national debt? Is it desirable to reduce the national debt? Paying down the national debt in a reformed monetary system Is this 'monetising' the national debt? APPENDIX III: ACCOUNTING FOR THE MONEY CREATION PROCESS The current 'backing' for bank notes The process for issuing coins in the USA The key differences between US coins and UK notes The post-reform process for issuing electronic money Ensuring that electronic money cannot be forged Reclaiming the seigniorage on notes & electronic money Modernising the note issuance An alternative accounting treatment Balance sheets: alternative treatment (with money as a liablity of the Bank of England) BIBLIOGRAPHY About the Authors First published in the UK in 2012 by Positive Money Copyright © 2012 Andrew Jackson and Ben Dyson All rights reserved The authors have asserted their rights in accordance with the Copyright, Designs and Patents Act 1988 Positive Money 205 Davina House 137-149 Goswell Road London EC1V 7ET Tel: +44 (0) 207 253 3235 www.positivemoney.org ISBN: 978-0-9574448-0-5 Kindle version produced by Herman Mittleholzer and Henry Edmonds ACKNOWLEDGEMENTS We would like to thank Graham Hodgson for his numerous contributions to this book, as well as Mario Visel and Mariia Domina, for their work on historical episodes of state money creation and international finance respectively. The discussion of the existing banking system in the first two chapters of this book is based on research and thinking by Josh Ryan-Collins, Tony Greenham and Richard Werner and Andrew Jackson for the book Where Does Money Come From? (published by the New Economics Foundation) and we are very grateful for their input and considerable expertise. We are also grateful to the team at Positive Money: Mira Tekelova for holding the fort while the book was written, Henry Edmonds for his work on the design and layout, and Miriam Morris, James Murray and a number of other tireless volunteers who have helped with the editing and proofing. We are indebted to Jamie Walton for the numerous conversations in 2010–2011 that led to the development and strengthening of these proposals, and Joseph Huber and James Robertson for providing the starting point in their book