NOTE: I no longer know what I meant by saying that banks do/don’t ‘create deposits’ under the current system/Positive Money system. The key difference for Positive Money is that transaction accounts are held at the central bank. But (as this post explains) under the current system all insured deposits are effectively held at the central bank.
Tomorrow there will be a debate in the UK Parliament that may have escaped your notice. It’s a debate on the system of money creation in the UK. Unlike the televised leadership debates, it will feature representatives from all and only the parties voters actually care about: Labour (Michael Meacher), Conservatives (Steve Baker), Greens (Caroline Lucas), and UKIP (Douglas Carswell). And not the Lib Dems. Ha ha ha.
Positive Money UK are happy about this debate, and I have no doubt they played an important role in provoking it.
The debate is over whether banks should be stripped of their ability to create money. Positive Money, of course, think the answer is yes. Their view is outlined in the book Modernising Money. Banks should be allowed to take deposits and lend them out (with the consent of the depositors). But banks shouldn’t be able to create new deposits by lending. New money should instead be created by an independent body, perhaps a part of the Bank of England: the Money Creation Committee (MCC). The members of the MCC would be appointed by Parliament on the basis of their expertise and their lack of vested interests in the financial sector. The MCC would be subject to strict inflation targets – perhaps growth targets as well.
Positive Money should be proud of having put serious monetary reform onto the agenda – even if only in a backbench debate. The turning point was probably when the FT columnist Martin Wolf, under the influence of their work, wrote an article called ‘Strip private banks of their power to create money’. He and they make cogent and penetrating criticisms of the current system. But I no longer agree with their proposed solutions, as I mentioned earlier. Since the debate is coming up, I thought maybe I’d share some of my reservations in more detail.
Basically, I no longer see why it’s a bad thing in principle for banks to have the power to create deposits. When they use that power to inflate asset bubbles, and when the government and the central bank protect them from risk using deposit insurance, bailouts, and the like, that’s obviously a recipe for disaster. And, yes, the banks have colluded to swindle the public out of trillions and trillions. Many of the big financial institutions currently existing are past the point of no return, can never come to any good, and should be shut down right now. But that’s not the point.
The point is that in principle a group of banks competing to make loans, and borrowers competing to get them, would amount to a system more responsive to the general need for new money than an appointed committee would be. The trick would be to keep the money-creating banks honest and out of the markets that generate instability, foster inequality, and all the other things Positive Money rightly complain about. This may not be easy. But the problem with Positive Money’s alternative proposal is that committees of experts are generally about as useful as a soluble anchor.
Why not, as Neil Wilson suggests, give any bank access to indefinite, unsecured, zero-interest loans from the Bank of England, so long as it accepts a regulatory framework that confines it to a very narrow role: ‘capital development lending on an uncollateralised basis – probably in the form of simple overdrafts’? The bank would effectively be an agent of the BoE, creating money on its behalf. It would be the responsibility, and in the interests, of the BoE to make sure it did so safely and in a way that generated sustainable, profitable capital development. The bank would agree to submit to constant auditing of its underwriting practices and to be prohibited from participation in secondary markets, forex speculation, etc. For a bank of this kind, strict regulation on the asset side would be the price of flexibility on the liability side. Warren Mosler says that ‘[t]he hard lesson of banking history is that the liability side of banking is not the place for market discipline’. Banks willing to heed this lesson would agree to play by the rules set by the BoE. They’d compete with each other within those rules.
Banks that didn’t want to play by the rules would give up access to BoE funds. They would have to do all their lending on a maturity matched basis. They could do all the speculation and secondary-market trading they wanted, but they’d have no access to emergency loans from the BoE, no deposit insurance, and nothing else of the kind. Their depositors would know this. In other words, they’d work the way that all banks would work in the Positive Money proposal.
If a bank in the ‘safe’ sector started breaking regulations, it would simply lose its BoE backing and enter the ‘risky’ sector. It would be subject to market discipline on its liability side and would be liable to learn again all the hard lessons of banking history to which Mosler refers: lessons in the form of bankruptcy, insolvency, run-off, etc.
Who would issue mortgages – the safe banks or the risky banks? How about both? You could get a subprime 3/27 ARM from a risky bank, but you’d certainly pay for it, since the creditor would be lending on a maturity-matched basis and would want to be compensated for the long-term risk. Or you could get a low fixed-rate mortgage from a safe bank, but then you’d have to pass extensive credit checks. Needless to say, the safe banks couldn’t sell the mortgages on the secondary market. The risky banks could, but the buyers, knowing from whom they were buying, would have a pretty good idea of what they were buying.
The payments system could be handled in various ways. L. Randall Wray has some suggestions here; Wilson has his own in the post already linked.
Positive Money often claim that their system would allow the state to create money ‘debt free’. But the state already has this power. The fact that the government offsets its spending by selling securities makes it look as though it has to borrow in order to spend. In fact the securities are only sold to maintain interest rates. In other words, the government already does create money ‘debt free’; it pays interest on its spending because it wants to, not because it has to. Thus Positive Money’s MCC would be, at best, a regulatory body overseeing the government’s fiscal policy, a bit like the Simpson-Bowles commission in the US, except that it could stop the government from spending too little as well as spending too much.
Positive Money and their followers have done admirable work in getting their issue onto the agenda. Now I hope they’re willing to listen to some alternative solutions (besides Wilson and Wray, see Mosler and Ann Pettifor).