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A Problem with the Baxendale Plan?

On this website Toby Baxendale presented his plan for monetary reform. He offered a reward of £1000 for anyone who can provide a logical reason why it won’t work; naturally this provoked a lot of discussion. In my opinion Toby’s plan has a major problem, and I discussed this with Toby and the Cobden Centre team over email. Toby doesn’t agree that I’ve found a major flaw in his plan. However, we both think that the debate should be opened up. This article summarises the discussion we’ve had so far.

The Cobden Centre recognize the need for monetary reform, as do I. Reform of money and banking is urgently needed to avert future economic crises. I also agree that Austrian Economics provides a sound understanding of the issues. However, I doubt that the Baxendale plan could be successful.  In my opinion if the plan were enacted there would be a burst of price inflation immediately after. The reasons for my concern come from simple economic theory.

What Task Does Money Perform?

Ludwig von Mises described the job of money as follows:

“What is called storing money is a way of using wealth. The uncertainty of the future makes it seem advisable to hold a larger or smaller part of one’s possessions in a form that will facilitate a change from one way of using wealth to another, or transition from the ownership of one good to that of another, in order to preserve the opportunity of being able without difficulty to satisfy urgent demands that may possibly arise in the future for goods that have to be obtained by way of exchange. So long as the market has not reached a stage of development in which all, or at least certain, economic goods can be sold (that is, turned into money) at any time under conditions that are not too unfavourable, this aim can be achieved only by holding a stock of money of a suitable size.” [1]

What Tasks Do Bank Accounts Perform and How Do They Work?

The economics of banking is important here because bank accounts are pivotal to the Baxendale plan. A balance in a bank account that provides on-demand payments and transfers provides services that are similar to those of note and coin money. Again, Mises gives a good description of the situation:

“The cash balance held by an individual need by no means consist entirely of money. If secure claims to money, payable on demand are employed commercially as substitutes for money, being tendered and accepted in place of money, the individuals’ store of money can be entirely or partly replaced by a corresponding store of the substitutes.” [2]

In Mises’ terminology notes and coins are money-in-the-narrower-sense. A bank balance in an on-demand account is a money-substitute. Money-in-the-broader-sense is the sum of money-in-the-narrower-sense and money-substitutes such as bank account balances.

A balance in a bank account is a debt that the bank owes to the account holder. As Toby writes in his article “… your bank-statement is a mere IOU”. Banks invest the money deposited into accounts, often in loans and mortgages. Banks keep only a small amount of “reserves” of money-in-the-narrower-sense. The diagram below shows the situation:


Entries marked in blue on the diagram are money-substitutes. Entries marked in green are money-in-the-narrower-sense.

The Baxendale Plan

Toby Baxendale’s plan is based on a similar plan by Jesús Huerta de Soto, an economist of the Austrian School from Spain. The essence of the Baxendale plan is that it makes all money-substitutes into money-in-the-narrower-sense.  Lorry loads of notes are shipped to banks to make this happen.  After the plan is enacted a bank statement that says £550 means that the bank is holding a corresponding £550 in notes and coins.  The legal relationship between the customer and the bank is altered, after the plan the customer is no longer lending to the bank, instead the bank is acting as custodian of the customer’s cash.  The bank becomes a “money warehouse” [3]. Since the balances of on-demand accounts become possessions of the customer, not debts, they no longer appear on the bank’s balance sheet.  So, after the plan the banks will have an asset surplus.  Rather than allow the banks to profit from this Toby intends to use these assets to pay off the national debt.  Specifically, Toby proposes that the asset surplus be removed and put into a mutual body to pay off the national debt.

Bank Services and Interest Payments

A balance in an on-demand account isn’t just a money-substitute, it entitles the account holder to extra services from the bank. In Britain banking services such as payments and transfers are free, some on-demand accounts also pay interest. A balance in an on-demand account provides the holder with two things. Firstly, it provides a reserve of wealth that may easily be exchanged, just as notes and coins do. Secondly, it provides access to banking services and in some cases interest payments.  Toby plan is that the banks’ assets will be used to pay off the national debt. That should lead us to ask: what role are those assets currently employed in? The answer is that they provide the income that is used to provide free banking services and interest.

It’s the income from a bank’s assets that funds free services and interest-bearing accounts. If the Baxendale plan were enacted then this stream of income would dry up. Banks would have to start charging fees for services and stop paying interest on balances in on-demand accounts. It’s difficult to estimate what the effect of this change would be. Some people would be indifferent to the change, those who use few banking services and don’t qualify for interest-bearing accounts, for example. It’s doubtful though that every account holder will fall into this category — if they did then these extra services would never have been commercial successes in the first place. Many other account holders will be sensitive to this change. I myself have been a user of interest-bearing on-demand accounts for more than a decade; I’ve always used a portion of my balance as savings.

Let’s suppose the plan is enacted and interest payments cease. Those savers like me who hold balances in on-demand accounts in order to receive interest will have to change our ways. The change will be permanent: the type of saver who once held a large balance in an on-demand account as an investment can no longer exist. Consequently, there will be a fall in the demand for these accounts’ balances when the plan is enacted. This is a fall in the demand for money. The savers in question will invest elsewhere, in interest-bearing bonds for example. Banks today offer notice accounts where the account holder must give a few weeks notice before they can withdraw. The Baxendale plan doesn’t extend to timed savings, so these accounts will operate as before; they are the obvious alternative to on-demand accounts.

Higher charges for banking services will also have widespread consequences. Businesses and individuals will have an incentive to avoid using banks for payments and transfers. Alternative methods of payment will become more attractive.  Businesses will be more likely to use debt agreements and reciprocal cancellation. Suppose two wholesale companies A and B regularly trade with each other. Before the plan they make payments using bank services. After the plan they decide this method is too expensive, so they each keep a record of the debt that is owed to them by the other. Then at a regular interval they settle the net debt using money or bank transfer [4]. This will also cause a reduction in the demand for money.

The purchases of alternative investments will trigger what is called an injection effect. The type of saver I mention above will withdraw a part of his or her balance and put it into other investments.  That extra demand will raise the price of such investments. The sellers of these investment products will receive that money and spend it themselves causing further price rises elsewhere. The sellers of these investments are not required to store the money they receive, they can spend it on investment projects. In time the money will spread through a large swath of the economy and price inflation will result. It’s a very similar situation to an injection of money by the central bank. These price rises will impair the planning and economic calculations of all individuals and businesses.

To recap, my opinion is that the Baxendale Plan would lead to damaging price inflation. By removing the extra services that bank accounts provide the plan will cause a fall in demand for money. If the stock of money remains the same while the demand for it diminishes then the value of each unit of money will fall.

Toby Baxendale’s Responses

Toby doesn’t agree with my criticism, we discussed this by email. Toby gave four counter-arguments:

Bank Services

Toby suggested that after the plan banks will use free services and possibly interest payments to attract customers. Toby wrote:

“Banks should charge for services rendered, why not? Maybe they will choose to subsidise the custodianship of cash storage. I sell fish for a living and to get hotels and restaurants to buy all of our fish species we sell, we have to discount the fastest moving lines, for example the salmon, and sell for virtually nothing. We are happy to do this as we work our margin in on the less important lines to our customers. Tesco sell cans of beans at £0.07p. This can not be even covering direct costs, but it gets people to walk into their store to buy other things that they make a full and sustainable margin on.”

This is called “loss leading”, a business offers a product or service at a loss in order to attract customers and build up a relationship with them. This hopefully gives the business an opportunity to sell them other products and services that are profitable. I agree that banks are likely to do this.

But, on-demand accounts attract customers to use other banking services now under the existing banking laws. What we should examine is the change: how would things change if the Baxendale plan were implemented? The situation at present is that a bank gains in two ways from offering on-demand accounts. Firstly, the bank can lend out the funds it receives from account holders, secondly, the account services can be used to attract customers towards other services. If the plan were enacted then afterwards only the latter incentive would apply. So, I think that if the plan were enacted then the provision of free banking services would decline, all other things being equal.

The Scale of the Problem

In Toby’s opinion the size of the effect I’ve described here would be small. If the total sum of balances in interest-bearing on-demand accounts is small then the cessation of interest would not have a great effect on the wider economy. Toby found some statistics on this from the Bank of England [5], these show that in March there was £386 billion in on-demand accounts that pay interest. As discussed above quite a large proportion of that amount would remain in on-demand accounts after the plan is enacted, though it’s impossible to accurately predict the proportion.  However, I think it’s still useful to compare this figure to the stock of money-in-the-broader-sense.  Anthony Evans and Toby Baxendale have made a measure of the UK money stock that’s consistent with the concepts of Austrian Economics [6]. By this measure the money stock is presently about £1 trillion. So, interest-bearing balances make up approximately a third of the total. The Bank of England use a different measure – “M4″ – which is based on different principles. According to that measure the money stock is about £2.2 trillion. I’ll concede that if the arguments put forward by Austrian economists against the M4 metric are wrong then I’m wrong about interest-bearing accounts. But, I think the arguments make by Frank Shostak [7] against the M metrics are persuasive.

However, interest payments are only one part of the issue, the cost of banking services is the other. If the banks were to significantly raise the fees for their services then the demand for balances in their accounts would fall.  This depends, to some extent, on how the banks decide to charge. If the banks were to charge a monthly storage fee proportional to the account balance then that would be akin to a negative interest rate. That would be a strong incentive not to hold a large balance, but other charging schemes would have a similar albeit lesser effect. There are several historical precedents for this, Irving Fisher wrote about some of those in his booklet “Stamp Scrip” [8]. Fisher thought that reducing “hoarding” of money could be economically beneficial, I disagree. But, he provides evidence that charging for storage of money reduces the amount of it that people hold.

Price Deflation Afterwards

Toby writes:

“With a fixed money supply, the ongoing productivity gains by the entrepreneurs means that more goods will be offered for sale at better prices, this means the purchasing power of money has gone up. As this is the only way that we have economic progress with a fixed money supply, people will be more fixated on what their money buys rather than what the numerical value is supposedly going up by.”

In the long run Toby is correct, but, in the short run the purchasing power of money is affected by the demand for money. Steady price deflation could occur in the long run after the short term effects I’ve discussed here have played out. But, the stumbling block is the period directly after the plan is enacted. If I’m right and price inflation occurs then the government may call a halt to the plan and reintroduce the current banking system.

Effect of the Plan on Production

Toby writes:

“I concur with you that price realignments will take place as people adjust to the brave new world. This is wholly right and good, as what consumers want will be more aligned with what producers produce. What producers produce will correspond more closely with what savers want to buy when they spend their money. Only bubble based activity will be deprived of credit.”

Here Toby is referring to the Austrian Theory of the Business Cycle. That theory indicates that if the quantity of money and the demand for money remain stable then unsustainable bubbles become much less likely to form. But, like the price deflation argument this is a long term theory. It can’t tell us what will happen while the demand for money is settling down from the initial disturbances caused by the implementation of the plan.

Further Discussion

I’m sure lots of people will have opinions about this, and there are many more questions that remain to be explored. I think it’s likely that there is no way of transitioning to a better monetary regime without disturbances. However, we should endeavour to predict what disturbances may occur and plan for them. For now we can continue the discussion in the comments thread below.

References

[1] Ludvig Von Mises “The Theory of Money and Credit” Liberty Fund Edition, p.170.

[2] ibid, p.154.

[3] Murray Rothbard “The Case Against the Fed”, p.34.

[4] Ludvig Von Mises “The Theory of Money and Credit”, p.314-315 describes cancellation in more detail.

[5] Bank of England “Monetary & Financial Statistics May 2010″ table A6.1 column BF96 p. 52.

[6] Anthony J. Evans & Toby Baxendale “The monetary contraction of 2008/09: Assessing UK money supply measures in light of the financial crisis

[7] Frank Shostak “The Mystery of the Money Supply Definition” The Quarterly Journal of Austrian Economics vol.3, no.4 (Winter 2000).

[8] Irving Fisher “Stamp Scrip” this booklet is no longer in print. It is available here.

70 comments to A Problem with the Baxendale Plan?

  • Gu Si Fang

    Thanks for this well-laid criticism. Here are a few thoughts siding with Toby:

    Would the demand for money change, and would price inflation (or other price changes) ensue? Yes. I think the main point is that a change in the demand for money is unavoidable in any free market monetary reform.

    The main destabilizing interventions on the market for money are the legal tender laws, lender of last resort and public deposit insurance. Austrian economists of all varieties would agree that these interventions should be seriously curtailed, if not totally suppressed.

    Any money backed by the power of government is bound to be more easily marketable than without this backing, other things equal. Menger states this clearly in his principles: “The sanction of the state gives a particular good the attribute of being a universal substitute in exchange, and although the state is not responsible for the existence of the money-character of the good, it is responsible for a significant improvement of its money-character.”

    Depriving a paricular good from the sanction of the state will therefore alter the demand for it. QED

    This means that the consequences described by Robert Thorpe can be expected to occur in virtually all monetary / banking reforms. In my view, this would be the case for Keving Dowd’s free-market money “button-pushing” reform, and even for a remotely free-market reform such as John Kay’s narrow banking proposal. The question is whether the sanction of the state ought to be removed or not, in spite of these disturbances.

    Robert Thorpe writes: “price inflation will result. It’s a very similar situation to an injection of money by the central bank.” I’m not quite sure. With our present institutions, the causal chain is C.B. printing causes bank credit expansion causes malinvestment. The market is driven away from consumer preferences by distorted signals. In the case of a monetary reform, the causal chain would be interruption of state intervention causes change in the demand for money causes price changes causes adaptation of the structure of production. Thus, the market would be allowed to adapt to consumer preferences. I guess the point here is that not all price changes are “destabilizing”.

    • Robert Thorpe Current

      For those who didn’t guess from the previous thread, I am Rob Thorpe.

      > I think the main point is that a change in the demand for money is
      > unavoidable in any free market monetary reform.

      I agree. But we can do something about the magnitude of that disturbance.

      > The main destabilizing interventions on the market for money are
      > the legal tender laws, lender of last resort and public deposit
      > insurance. Austrian economists of all varieties would agree that
      > these interventions should be seriously curtailed, if not totally
      > suppressed.

      Yes, I’d add to that some tax laws.

      > This means that the consequences described by Robert Thorpe can be
      > expected to occur in virtually all monetary / banking reforms. In
      > my view, this would be the case for Keving Dowd’s free-market money
      > “button-pushing” reform, and even for a remotely free-market reform
      > such as John Kay’s narrow banking proposal. The question is whether
      > the sanction of the state ought to be removed or not, in spite of
      > these disturbances.

      Yes and No. Many of the other plans for monetary reform have the problem that they entail a large disturbance at the start. I could have critiqued many of them on that point. I know that in the long-term this may be a minor problem. My concern though is how do we get to the long term?

      It’s not a trivial question. The Peel act caused major disturbances when it was initiated and likely exacerbated the Irish famine. If possible we don’t want that to happen again.

      I realise that we can be overcautious in what we suggest. But, in my view some caution is needed. The transition could never be perfect, but we have to work out how to do it reasonably well.

      > In the case of a monetary reform, the causal chain would
      > be interruption of state intervention causes change in the demand
      > for money causes price changes causes adaptation of the structure
      > of production. Thus, the market would be allowed to adapt to
      > consumer preferences. I guess the point here is that not all price
      > changes are “destabilizing”.

      We all make economic decisions in a particular local environment. That can be elided from simple discussions of ABCT. In those simple discussions the monetary injection reduces the interest rate in a way that’s not consistent with the amount of real savings. The longer and more precise theory is that this effect is distributed. It doesn’t just happen in the centralised market for interest. It happens all across the economy wherever calculation is being done.

      • Gu Si Fang

        The post-war German economic miracle did start with a major monetary disturbance. The article below mentions a 93 percent contraction in the money supply! Yet this did not prevent a remarkable economic growth thereafter (arguably attributable to many other factors).
        http://www.econlib.org/library/Enc/GermanEconomicMiracle.html

        As an aside, I wish I could learn more about the Peel Act’s effect on the Irish famine. Where can I find some literature on the subject? Thanks.

        • Robert Thorpe Current

          > The post-war German economic miracle did start with a major
          > monetary disturbance. The article below mentions a 93 percent
          > contraction in the money supply! Yet this did not prevent a
          > remarkable economic growth thereafter (arguably attributable to
          > many other factors).

          But, how would something like that play in the present world? After WWII Germans could expect a period of upset and hardships. What we’re talking about here is something quite different, we’re talking about

          > As an aside, I wish I could learn more about the Peel Act’s
          > effect on the Irish famine. Where can I find some literature
          > on the subject? Thanks.

          I don’t really know about it myself. I remember reading it somewhere, but I don’t remember where. So, I won’t push that point too far.

    • Thank you for your comments Gu Si Fang. I agree with them all!

  • Sean Corrigan

    I have also raised some difficulties with Toby’s plan – not least relating to banks’ non-sterling assets, to the treatment of bank capial and to the need to make the new fully-backed money conveniently transferrable.

    I also agree that the banks should now charge to recoup the costs of the new warehousing services, though – despite the illogicality of the current situation – this may be wholly offset by obviating their existing need to PAY interest on what are suppposed to be demand accounts – i.e. a payout one way becomes a cost incurred another, from the banks’ perspective.

    I am even more uncertain of your other argument since, to the extent that I wish to earn interest on my surplus means, I must henceforth exchange my money for a suitable asset – but this does not imply the creation of any extra aggregate demand being expressed for these (as a class, as opposed to specifically) since, as you point out, the banks already use my demand liability for that express purpose!

    Equilibration will soon occur!

  • Robert Thorpe Current

    > need to make the new fully-backed money conveniently transferrable.

    The whole thing could be done with computer databases rather than notes. I think that would be much more feasible.

    > I also agree that the banks should now charge to recoup the costs of
    > the new warehousing services, though – despite the illogicality of
    > the current situation – this may be wholly offset by obviating their
    > existing need to PAY interest on what are suppposed to be demand
    > accounts – i.e. a payout one way becomes a cost incurred another,
    > from the banks’ perspective.

    I don’t know what part of the current system you are criticizing as illogical.

    But, I don’t think you’re right. Certainly banks don’t have to pay interest after the reform. That creates a saving that could fund services.

    However, the only reason for subsidizing 100% reserve on-demand accounts would be as a loss leader. That is, they would do it so people would invest more in fixed-term or timed assets than they do. If people did invest more in timed assets then the price inflation problem I mention would occur.

    On the other hand if people didn’t generally move to investing in timed assets then banks would stop the loss leading. If they stopped the loss leading then they would have to start charging fees for account services. That would drive a move away from holding money from the other side.

    > I am even more uncertain of your other argument since, to the
    > extent that I wish to earn interest on my surplus means, I must
    > henceforth exchange my money for a suitable asset – but this does
    > not imply the creation of any extra aggregate demand being
    > expressed for these (as a class, as opposed to specifically) since,
    > as you point out, the banks already use my demand liability for
    > that express purpose!

    Remember the national debt repayment mutuals. After the plan the assets of the banks that backed on-demand accounts are put into those.

    Because of the principle of substitution we can talk about a demand for “either A or B”. Using this we can consider the demand for savings that is indifferent to the exact form. Suppose X is the demand for interest bearing on-demand accounts or timed savings. Those demands are satisfied by the supply of assets Y, which is some portion of the national stock of assets.

    After the reform that demand X continues to exist. However there is also an added demand Z created by the debt repayment mutuals.

  • Paul Green (aka. Traktion) Traktion

    An interesting debate. I would like to add a few points:

    1. As has already been pointed out, banks lend out a high percentage of deposits anyway. I’m not sure if this change would result in more money being spent, although the *mix* of what it is being spent on may change…

    2. However, storage of alternatives would cost money too. Sure, you could buy gold coins instead of a banking fee, but then you would probably want a safe and insurance for peace of mind. As companies such as GoldMoney and BullionVault already have a business model based on providing safe storage of precious metals, people must value security.

    3. Just because we are used to “safe” (well, perceived as safe) storage, at no cost, I don’t think people will be aghast if this situation changes. We get very little interest anyway, with every opportunity to charge taken advantage of – one OD charge would wipe out several years of current account interest, I suspect.

    4. If people buy ‘stuff’ instead of hoarding fiat, this situation should be enviable. IMO, part of the reason we are in a mess, is because all savings are another’s debt. If fiat was treated as a pure neutral currency, purely to aid in the completion of transactions, but not considered worth holding on to, then the circuit would have fewer blockages. It should be preferable for ‘savings’ to be in assets, not fiat.

    5. As assets such as gold/silver etc don’t yield a return (bar speculative gains), I would still expect many people to invest in traditional ways (loans, shares etc).

    6. If there was a transitional process, couldn’t people decide whether their money was either ‘timed savings’ (and returning interest) or just stored (with fees as required)?

    7. If a limited purpose banking type model was used, it should be relatively easy to sell on shares in mutual funds, if the ‘timed savings’ terms were undesirable.

    The problem seems to be over predicting how people will react to the changes. If current accounts start to charge a fee, people may change their habits. People may buy hard assets, people may lend out more money in ‘timed savings’ or the situation may remain unchanged. Unfortunately, it’s impossible to predict how people will react, so IMO, you can only reasonably plan for the medium/long term and try to ease the transitional process.

    • Robert Thorpe Current

      > 1. As has already been pointed out, banks lend out a high
      > percentage of deposits anyway. I’m not sure if this change
      > would result in more money being spent, although the *mix*
      > of what it is being spent on may change

      I’m not sure I understand your point here. I know that banks lend out most of what they get in deposits. That’s one of the points I
      was making with the balance sheets I put in the article.

      My point here is that demand for bank-account money will fall. That is, people will hold a lower stock of it. Or, equivalently, they will spend down their stock of money more often.

      > 2. However, storage of alternatives would cost money too. Sure,
      > you could buy gold coins instead of a banking fee, but then you
      > would probably want a safe and insurance for peace of mind. As
      > companies such as GoldMoney and BullionVault already have a
      > business model based on providing safe storage of precious metals,
      > people must value security.

      Yes, I know. If people switched to holding notes rather than using bank accounts then that would have different costs, such as the costs of security.

      > 3. Just because we are used to “safe” (well, perceived as safe)
      > storage, at no cost, I don’t think people will be aghast if this
      > situation changes.

      I’m not saying that they’d be “aghast” and that would be problem. My point here is the macroeconomic effects of the change. That it would cause inflation.

      > We get very little interest anyway, with every
      > opportunity to charge taken advantage of – one OD charge would
      > wipe out several years of current account interest, I suspect.

      Banks provide a lot for free. Mostly there is no charge for opening an account and no monthly fee for keeping one open. Normally banks provide the following for free: standing-orders, direct debits, cheque books, statements and paying in.

      I’m English, but I live in Ireland, I moved in 2006. At the time I moved the banks were just changing over to the “no fee” policy that has prevailed in Britain for decades. Before that there were charges for cheque books, deposit books, direct debits, standing orders and statements. Even now fee-free banking is often only available to customers who promise to pay their salary into that bank account.

      > 4. If people buy ’stuff’ instead of hoarding fiat, this situation
      > should be enviable. IMO, part of the reason we are in a mess, is
      > because all savings are another’s debt.

      I have a small business. Let’s say I want to expand, so I go to my friend Bruce and he agrees to lend me £10K at an agreed rate of interest and repayment schedule. Alternatively, Bruce could give me £10K and buy 20% of my business and therefore become eligible for 20% of the profits.

      Why is the latter situation enviable but not the former?

      I’ve read loads of stuff that debt-relationships are exploitative and economically unproductive, whereas equity-relationships are noble and economically productive. But, there is no good argument for this. Which is best comes down to the particular situation.

      > If fiat was treated as a
      > pure neutral currency, purely to aid in the completion of
      > transactions, but not considered worth holding on to, then the
      > circuit would have fewer blockages. It should be preferable for
      > ’savings’ to be in assets, not fiat.

      What do you mean by “savings” here? Above I quoted Ludvig Von Mises view on the purpose of money. It says that an individual holds a portion of wealth in money to deal with the uncertainties of the immediate future. I think that’s a very reasonable way of putting the point. So, beyond that immediate future an individual “saves”.

      Now, in a pure fiat system that Toby suggests it is certainly beneficial if people do invest their savings. As you say people will have every reason to do that.

      But, you’re not comparing the situation clearly with the present day. Under the current system all money balances in on-demand accounts are providing funds for investment through loans. In the modern FRB system only the monetary base is pure fiat money. The rest is matched to assets. This isn’t a problem we need to fix.

      > 5. As assets such as gold/silver etc don’t yield a return (bar
      > speculative gains), I would still expect many people to invest
      > in traditional ways (loans, shares etc).

      Yes, so do I.

      > 6. If there was a transitional process, couldn’t people decide
      > whether their money was either ‘timed savings’ (and returning
      > interest) or just stored (with fees as required)?

      That would be a modification to the plan, but I think it would be a wise one. Let’s say the plan kicks in on date X. If the government gave them time the banks could declare beforehand what their fee structure would be like after the plan was implemented. They could then give customers the option of timed-savings and storage before the implementation date. That would allow the amount of money-in-the-broader-sense to fall before the plan implmentation date. Then there would be much less of a problem afterwards.

      > 7. If a limited purpose banking type model was used, it should be
      > relatively easy to sell on shares in mutual funds, if the ‘timed
      > savings’ terms were undesirable.

      Yep.

      > The problem seems to be over predicting how people will react to
      > the changes. If current accounts start to charge a fee, people may
      > change their habits. People may buy hard assets, people may lend
      > out more money in ‘timed savings’ or the situation may remain
      > unchanged. Unfortunately, it’s impossible to predict how people
      > will react, so IMO, you can only reasonably plan for the
      > medium/long term and try to ease the transitional process.

      I mostly agree. Though it’s not impossible to predict how people will behave. As I said in the article there have been several historical examples to draw on. Those support what I’ve written in the article.

      • Paul Green (aka. Traktion) Paul Green (aka. Traktion)

        I’ll respond to the points of contention:

        1. My point is that assuming people will volunteer to keep a similar amount of money invested in timed savings, as is lent out from timed savings and FRB combined currently, then I’m not convinced that buying habits will change. Maybe I am missing your point too though?

        3. Just to add, business accounts are rarely free of charges, even in the UK. There are usually fees of some sort for most transactions. Clearly, there are costs involved in maintaining the account, but I would imagine that simple accounts could have very low costs; most people are paid their wages electronically and many people do their banking online, so the main costs would surely be ATM usage (and any charges for going OD, bounced cheques etc).

        4. The point I was trying to make (badly) is that those currently with savings are the direct result of others going into debt. If we have excessive debt, then we also have excessive savings. While FRB may distribute investment very well in the good times (too well, it seems!), now that banks are hoarding the savings, it has created a blockage in the monetary circuit, making at hard for borrowers to repay loans. As a result, it has become difficult for the banks to meet their liabilities to the savers.

        If people had spent more of their money on assets, maybe the banks wouldn’t have invested so much on their behalf (they would have less on deposit). I suppose giving people control over the size of their savings (safe deposits) and investments (timed savings) prevents this being a problem (if we both agree with Ludvig Von Mises here). With that in mind, in a full reserve banking system, it would likely make this a non-issue.

        • Toby Baxendale Toby Baxendale

          To Paul Green

          Post reform, some people may choose to place more cash in timed deposits than keep them in a safe. This will move more money into timed deposits, from bank vaults. This will mean there will be more lending available for business. This is great news. The business that gets lent funds will invest in what they invest into to make more goods and services that can be bought with the money once paid back to the original owner. This will mean that popular assets classes / businesses that are making things people want will go up in value, at the expense of those that do not, and have formally relied on credit money created out of thin air to exist. This will be painful to some and beneficial to others i.e. those that sell things that people really do want and are not bubble based = happy days. Those that have relied on bubble based credit = unhappy days.

          To the extent of what this realigning of the economy is, we do not know. I welcome it anyway as it will align savers with investors , consumers with producers much more so that we have today. What we have today is an economy replete with Malinvestment i.e. capital lopsided to support activity for which there is no demand . This is the bust part of the economic cycle. Robert has concerns that it will be too disturbing. I think that is the nub of the matter here.

        • Robert Thorpe Current

          > 1. My point is that assuming people will volunteer to keep a
          > similar amount of money invested in timed savings, as is lent
          > out from timed savings and FRB combined currently, then I’m not
          > convinced that buying habits will change. Maybe I am missing
          > your point too though?

          I think this is the crucial point where we disagree. I’d be able to explain it better to you if I know what economic framework you’re most familiar with.

          You mention the monetary circuit below, are you a Post Keynesian? If I explained it in a Monetarist way would you understand it better?

          In my article I explained the problem in a quite Austrian way, and I expect that’s confused those who aren’t so familiar with the Austrian POV.

  • I am not sure if the original thread is alive or not, but I will restate my view here but after I comment on this exchange first.

    1. Businesses already pay through the nose for banking services. Every cheque, deposit, transfer, statement and even the fact that an account is open with no transactions costs money. This happens because as a ltd co, one MUST have a bank account, so the ability for companies to avoid using banks is not possible. As to the suggestion that companies will try and nett off, well, I can imagine HMRC’s response to that, and the shock from the accountants. I am unclear as to how many companies sell to the same entities they buy from. I do not think it is a significant number.

    2. I do think the interest revenue stream aspect of this plan is not a key flaw, it will cause adjustment of what a bank account is and much grumbling and irritation. In Europe, the concept of subsidised current accounts is quite rare, or was about a decade ago.

    3. On-lending will still go on and this will increase the broad money supply.

    But, on to my main point:

    I do believe there is a flaw in this plan. It is an odd one, not immediately seen on the face of it, but very much a problem.

    Primarily, you appear to be basing your position on the mistaken premise of “out of thin air” which is patently not true. FRB is an interlinking set of dominoes, a chain of lending obligations, not “out of thin air”. I know it can be used to “explain” FRB to others, but I think it is not explaining, but misleading[1].

    You next suggest that current business lending assets held by banks are to be moved to a mutual and all deposits converted to cash. You must move ALL lending out of banks, not just business lending, otherwise what @Tyler May 23rd, 2010 at 23:04 says could occur [2].

    If you move those loans out to a Mutual, how can you “immediately” pay off the National Debt? That would presume the Mutuals SOLD those loans on and used the receipts to erase the National Debt[3]. But that is a side issue to the plan and I think we could see the debt being “rapidly” paid off as those loans mature. Again, this is not a deal breaker, but useful to point out.

    While the Mutual does not appear to increase the money supply, for it just diverts money that comes from one section of the economy to pay off another, this arrangement does not, in fact, have the same consequences due to what I believe is a fundamental misunderstanding of the Fractional Reserve system as it operates over time.

    When loans are paid off currently, the money is either

    a) returned to a “depositor” if they decide to, contemporaneously, withdraw cash
    OR
    b) used to replenish reserves if a) had already happened
    OR
    c) the bank on-lends the amount again.

    In terms of money supply, your proposal is not the same.

    When repayments are made in your proposal, the money

    a) goes to the mutual
    b) Is used by the Mutual to pay off National Debt
    c) Those repayments are then BANKED by the erstwhile holder of that debt

    Back at the bank with its depositors, the proceeds from the repayment of the Gilts will be banked. In the past, the repayments were to the loans and if a depositor withdrew any money, then on-lending would have to be curtailed by the amount of the depositor withdrawal. But not now.

    If a depositor withdraws £100 to buy something eventually from a company that had borrowed money, the £100 leaves the bank, is moved to the company account, used to repay the loan lodged at the Mutual, is on-passed to the Gilt holder and is then re-banked.

    Now, this seems to be ok, but what used to happen is that when the depositor withdrew the money to buy from the company and the company paid off its loan? I will tell you – that £100 disappeared. Completely. Gone. Finished. Ended. (Except for a small percentage). THAT is the only “thin air” that exists around here. It was NOT on-lent or available to the economy because the Bank had to replenish its reserves to the point at which it was just before the depositor took out their cash to spend and so enable the repayment of the loan.

    I will say that again: because the Bank had to replenish its reserves to the point at which it was just before the depositor took out their cash to spend.

    It is thus not available to the economy. It is dead, in a vault.

    In your proposal, the depositor spends, the company pays off, the money goes to the mutual to buy back the Gilt and the ex Gilt owner banks the cash and it still exists to be spent at will. All of it.

    THAT is how your proposal inflates the money supply.

    I claim my £1000.

    [1] I do wonder if much of the energy towards 100% reserve is based upon just the mistaken premise of “out of thin air” and the outrage it would generate, and in fact generated in me until I worked out how FRB operates.

    [2] If all loan assets are converted to cash, I want to set up a bank just before you switch over, please. I will open a string of accounts, lend myself money, deposit it back, lend it out, deposit it back until I can do so no more, then you convert all the deposits to cash and then I use that to pay the (i.e. my) bank back, shut up shop and retire.

    [3] Fact is, who is going to buy all those loans, or are you planning to create an SIV to sell them or the mutual that contains them? Do you think a ratings agency would be needed and some insurance in case of default? In a way I am joking, but I am also serious. One could say that the interest payments should balance out the loans that are defaulted on, also.

    • Paul Green (aka. Traktion) Paul Green (aka. Traktion)

      Interesting post, but isn’t that the point of printing the money? That is, to sustain current level of broad money supply, rather than allowing it to contract through credit repayment. In other words, rather than inflating the broad money supply, it would just be maintaining the current levels.

      I’m not convinced the paying off the national debt part of the proposal is a good idea or workable. I could imagine it going rather pear shaped if something wasn’t considered (perhaps the above point, perhaps another). It just seems too close to a free lunch, which usually suggests consequences.

      I would be more inclined to take a gradual approach to reform, by letting some existing obligations run their terms (such as bonds), while drawing a line between instant access and timed savings. People would also get to define their contractual terms of either safe keeping or investment (which could gain or lose), along with the advantages/drawbacks of each. This would clear up the legal contentions and remove the instability and moral hazard which FRB can result in. If more people wanted instant access (rather than timed savings) than reserves could cover, the difference could then be ‘printed up’. This amount may be a relatively small, limiting any unpredictability of hitting the presses.

      BTW, at the risk of straying off topic, I would suggest that as part of the process of moving to having more timed saving accounts, the market was opened up. The limited purpose banking idea of them being shares in mutual funds, which could be traded is compelling. Making timed savings less restrictive would surely go a long way to easing the transition.

    • Actually, I am going to suspend my “flaw”, as I think it may well be in error, so right now I hold with my other views that the bank charges are not a fatal flaw.

      What I am concerned about, though, which was dropped from a longer version, is that banks will seek to create again de facto on-demand arrangements to leverage the money supply up again.

      • Toby Baxendale Toby Baxendale

        Tim, you say “is that banks will seek to create again de facto on-demand arrangements to leverage the money supply up again” That may well be the case. As you know, if there is a tax change say like we have just seen here from capital gains tax of 18% to 28% and top income tax a 50%, there will still be “income shifting” as people have an incentive to make income look as much as possible like a capital gain. Cat and mouse is played between the revenue and the private accountants employed by people. So this reform must nerve be done unless there is a constitutional amendment enacted that stops the government from abusing the system and stops banks from doing the same. Sir Isaac Newton when Master of the mint hanged people. I would not suggest this but just keeping on top of the law and enforcing it.

    • Robert Thorpe Current

      > 1. Businesses already pay through the nose for banking services.
      > Every cheque, deposit, transfer, statement and even the fact that an
      > account is open with no transactions costs money. This happens
      > because as a ltd co, one MUST have a bank account, so the ability
      > for companies to avoid using banks is not possible.

      Yes, and I think the situation would be pretty much the same for customers. They would have to use banks and pay the associated fees. But, both can take steps to reduce their exposure to fees.

      > As to the suggestion that companies will try and nett off, well,
      > I can imagine HMRC’s response to that, and the shock from the
      > accountants.

      AFAIK netting off is entirely legal in the UK. I’d appreciate clarification from anyone who know more though.

      > I am unclear as to how many companies sell to the same entities
      > they buy from. I do not think it is a significant number.

      Think about how many could if there were banking fees to avoid.

      An example…. I was talking to a barman a few weeks ago, he worked in pub X, I met him taking beer out of pub Y. I asked him what he was doing. It turns out the pubs have a kind of exchange deal. If pub X runs out of some type of beer then it has the option to draw on the stock of pub Y. This agreement is reciprocated by pub Y. I found that one pub that serves Heineken has no contract with the brewery for that beer. It buys Heineken from the other pubs using both cash and other beer.

      Now, imagine how pubs would behave if the charges for bank transfers were raised. Rather than pay the extra charges they would instead collaborate in this way more often. They could do what was done in the 19th century and allow bills to be passed around.

      > I do think the interest revenue stream aspect of this plan is not
      > a key flaw, it will cause adjustment of what a bank account is and
      > much grumbling and irritation. In Europe, the concept of subsidised
      > current accounts is quite rare, or was about a decade ago.

      When the changes in bank charges occurred in Europe they happened during a period of central banking. So, the central bank could compensate for the change. This is one of the things that central banks do, it’s implicit in the currently-fashionable idea of interest rate targeting. The amount of monetary injection that’s needed to hit a particular rate target varies from time to time because of changes like this. The central bank compensates by adjusting it’s levers. Though it isn’t often talked about this is being done all the time.

      Under Toby’s system though there is no central bank to do this after the plan is implemented. Now, I certainly believe that “no central bank” is a good thing long term. But, the short term is different in this case.

      > 3. On-lending will still go on and this will increase the broad
      > money supply.

      If the government ban creating money-substitutes then I think that ban would be effective. A money-substitutes is something that must be widely accepted. In most cases that means that it cannot be underground, it must be done openly. That can’t occur without the state’s consent.

      However, debt contracts are a completely different matter. States have periodically tried to legislate against debt contracts for centuries and it often hasn’t worked. And, as I explained earlier debt contracts can be used to reduce the need to hold money.

      > Primarily, you appear to be basing your position on the mistaken
      > premise of “out of thin air” which is patently not true. FRB is
      > an interlinking set of dominoes, a chain of lending obligations,
      > not “out of thin air”. I know it can be used to “explain” FRB to
      > others, but I think it is not explaining, but misleading[1].

      Yes, you’re right about that. And I agree that the 100% reservists have used to accusation to fan the flames of discontent.

      Rothbard sometimes infers that not holding 100% reserves is equivalent to insolvency, which it isn’t.

      > You next suggest that current business lending assets held by
      > banks are to be moved to a mutual and all deposits converted to
      > cash. You must move ALL lending out of banks, not just business
      > lending, otherwise what @Tyler May 23rd, 2010 at 23:04 says could
      > occur [2].

      That’s true temporarily. Just before the reform – specifically in the period between when it is certain to occurs and when it occurs – many perverse incentives occur. People have a great incentive to set up dodgy banks so they can acquire the 100% reserve later. So, the government would have to do something about that. Such as banning the formation of new banks. The more difficult problem would dealing with how the existing banks would behave. However, afterwards once 100% reserves are established that period ends.

      What you go on to describe sounds like a theory that in the 19th and 18th century was called the “Real Bills Doctrine”. It’s the idea that debt and money have an organic relationship. Adam Smith and the “British Banking School” pioneered this view.

      The problem with this view is that it doesn’t really describe how banking systems with central banking and fractional reserves work.

      In a modern central banking system the central bank authors *both* sides of it’s balance sheet. That is, the state says what reserves are and it says what assets are. It does this by fiat using its forces of coercion and (as Post-Keynesians point out) the enforcers are taxmen.

      Now, in normal circumstances it works like this. There are £X billion of good loans, this amount it endogenous, the state do not push in one way or another. (Except through ABCT, but that’s another story). The state require that the banks keep a particular level of reserves against on-demand accounts (a required reserve ratio). The state don’t normally require this for other sorts of liability like bonds. So, there is £Y billion of balances in on-demand accounts, which is quite a bit lower than £X billion. The difference between the two of them is made up using timed-savings such as bonds, which don’t require reserves.

      Lets say some proportion of loans to a bank are paid back using notes. Now, since these are reserves the bank can expand it’s liabilities in on-demand accounts. However, this can’t happen systematically, since the amount of circulating reserves is limited by central bank. Unless someone finds a dusty pile of notes in their attic the reserves that one bank gains are always being removed from a different bank. Second, lets say some proportion of loans to the bank are paid back using inter-bank transfer. This means that normally reserves and the required-reserve ratio determines the total amount of on-demand liabilities.

      As I mentioned earlier this situation is breaking down currently due to the strange decision of the Fed to pay interest on excess reserves. But, that’s a separate issue.

    • Toby Baxendale Toby Baxendale

      Tim, all of this has been answered in your original post. I do not intend to do it all over again. If there are not sufficient answers, please get back to me.

      • Toby.

        This reply is in two halves. The latter refers to your response at the old post. The first talks about the idea in other terms.

        In your plan you say there is no Central Bank and that banks hold the cash on deposit in their vaults, matching deposits at the branch level?

        If so:

        a) Interbank settlements will still require central clearing accounts to enable painless netting off between banks or we could see a huge rise in Armoured Car heists. A central clearing vault bank or banks will be sensible, but where would the capital come from? Banks are not free to take deposit cash away from the home branch, surely, for then those accounts are not on demand.
        b) Even if cash is held for interbank settlements from the bank profits, a form of interbank lending will still need to occur to cater for extraordinary interbank transfers or expected events known to those who understand chaos theory. But banks cannot lend that easily, can they? To me any currency needs a lender of last resort, that being the issuer of that currency, even in the world of Free Banking, which would see multiple LoLR, one per currency.
        c) Bank branches themselves would nett off against each other, but at some stage large amounts will need to be moved each day if you truly say that the bank holds your money in cash on demand.
        c) I can envisage limitations on cash balance withdrawals, which I suspect will be little different from those that apply now (one needs to call if one is withdrawing over £5k or so in cash). This will push people towards new accounts and instruments such as forms of overnight settlement. Leave to bake and you will increase the defacto money supply massively.
        d) I think your move will push banks to move away from, or, penalising the use of, cash, for it will be difficult for them to manage. They could ask for people to have “cashless” accounts and so not need to keep any cash in the branch for their accounts, and keep it all safely at the central clearing vault.
        e) End the use of cash and we are, frankly, dead meat in a number of ways.

        Now to the previous reply…

        Well, you may have missed that I had suspended part of my objection and that was to do with a slip-up I made in the reckoning of reserves as the money flowed, that is all. No excuses from me, I raised my hand to that error right here.

        Still, in your reply at the original post you do yourself present errors*.

        TimC said: ““When loans are paid off currently, the money is either
        a) returned to a “depositor” if they decide to, contemporaneously, withdraw cash
        OR
        b) used to replenish reserves if a) had already happened
        OR
        c) the bank on-lends the amount again.”

        TobyB said: “If a) happens, it does not go back to the depositor as the loan originated from the bank itself and was created ex novo or ex nihilo , out of thin air. So when repaid back it goes back from whence it came, to thin air, unless c) happens.”

        Wrong. There is no thin air. Things being equal, if a depositor withdraws £100, the bank would use the next £100 of nett cash deposits to rebalance reserves and would not on-lend. Had the depositor NOT withdrawn, then the next £100 of nett cash deposits would result in £90 of lending (given a 10% reserve ratio). No money was “created”. If it were, show me when it appears together in the same place. Note: a statement is not sufficient!

        You then go on to say:

        TobyB said “Consider A deposits at the bank B £100, B lends Entrepreneur C £100 who deposits at bank B. There are now £200 units of money when there was only £100 to start off with. When Entrepreneur pays back his loan i.e. the £100 to Bank B, then money supply is then £100 again, unless the bank creates it out of nothing again and re lends.
        The problem today is there is more paying back and less lending i.e. a “credit crunch.””

        There is NOT “£200 units of money”. Show me where they are. Lets try and find them…

        If the borrower took the £100 out in cash before it deposited in BankC, BankA would have to not on-lend the next £100 in deposits it receives to rebalance their reserves (as above). If the borrower used a cheque or electronic means, still, £100 would have to be transferred from BankB’s account at the BoE and sent to BankC’s account at the same place. As you should know, these accounts are hard money, not your “IOUs”.

        If everything occurred in the same bank, the depositors money was lent to the Entrepreneur who borrowed then deposited it in that same bank, there is still only £100 of money, as in £100 of reserves, that the bank can on lend again, for the Entrepreneur has, de facto, lent their borrowings back to the bank. If demands on either of those accounts occured, if both tried to withdraw, for example, then you will see that there is only £100 units of money and not £200.

        BTW, the Bank does not issue IOUs at all. I don;t have one from my bank. All I have is a statement. If I had an IOU, I could sell it on, but I cannot for they do not exist. If I transfer money from one bank to another,IOUs are not passed around, but cold hard cash.

        This “IOU” meme is another reason why people get hot under the collar about FRB, for it is often used to segue from the “goldsmiths” story into modern banking. Remove the conceit of the IOU and then people are not so easily tricked into thinking that there is more money about.

        What FRB does is turn stills into movies. The money flickers by so fast it appears to be motion, but is always, in truth, still pictures.

        And the final point you made

        TobyB: “If £100 is owed to gilt holders ”

        At no stage did I say this flow was inflating the money supply, for it is just a flow from debtor to creditor. Your complication misses my point and serves no purpose.

        * it is not helpful to assert that people do not understand FRB “at all”. Absolutes are rather dangerous things.

        • To Tim Carpenter

          Your point a) as discussed on these comments section, the govt could undertake to print cash and not actually print it unless it is demanded. If it did, I would think clearing house services were the net movement of interbank money is physically moved at the end of the day could take place as existed for many centuries when gold was money.

          Your point b) I do not understand what you are suggesting here.

          No lender of last resort is needed in a full reserve environment. Just like with all companies that are full reserve , except banks which have legal and accounting privilege to operate on a fractional reserve , a full reserve bank would go bust and have no LoLR bailing them out. As a liberal free marketer, I can’t tolerate grants of legal privilege or state involvement in something so serious as money especially when the State has failed so badly.

          Your point c) If all cash is printed which is what I suggest; I would hope that it would be in my vault so no “calling” necessary.

          Your point d) yes they could, it would be interesting to see what solutions in a free market people come up with.

          You say this “TobyB said: “If a) happens, it does not go back to the depositor as the loan originated from the bank itself and was created ex novo or ex nihilo , out of thin air. So when repaid back it goes back from whence it came, to thin air, unless c) happens.”

          Wrong. There is no thin air. Things being equal, if a depositor withdraws £100, the bank would use the next £100 of nett cash deposits to rebalance reserves and would not on-lend. Had the depositor NOT withdrawn, then the next £100 of nett cash deposits would result in £90 of lending (given a 10% reserve ratio). No money was “created”. If it were, show me when it appears together in the same place. Note: a statement is not sufficient!”
          There is now £100 of original money in the system which sits as a bank IOU and £90 of lending and £10 in reserve which does sit in cash in the above e.g. right or wrong? So the £100 of bank IOU is made up of £10 reserve cash and £90 of bank journal entry or bank IOU. So £100 has become £200. You do not like calling this “out of thin air,” I do not know why, it sure as hell looks like it. Also, form my old “A” Level text book to my undergraduate text books to all things that I read and observe in the world, I believe this is not a contentious point at all. When the £90 loan is paid back, we then have the £90 money taking the place of the bank IOU of £90 and £10 of reserve. So we are back to £100. This is the worst case scenario for the banks, so most of the time they make sure they lend it out again.

          The situation we have today is more is being paid back and less being lent out than is being paid back. This is a money deflation.

          With respect, I do believe you need to go back and re read some basic text books on the bank credit creation multiplier, I am saying nothing controversial here at all. Your misunderstanding clouds all what you say.

          I am sorry I can’t be more polite in the matter.

          • Toby,

            If, as you say, all your cash is in the vault and so no need to have a call, what if you pay a company that has a bank account in another branch elsewhere in the country?

            Even with netting off, each day one may have to move sums, potentially, from each bank branch to each branch of all the other banks in the country or at least to their regional distribution centres one for each bank from which it would need to be distributed. One would have to work out the ideal cash transfer arrangements between each counterparty to branch level or some other arrangement. Any attempt to make efficiencies via clearing and settlement intermediaries would, I suspect, still require significant sums of dead money from bank profits sitting about in vaults to reduce the need for physical movements of cash intra bank. This would not solve the inter-bank transfers.

            In the past we could operate with hefty reserves parked at the Bank of England, but we cannot do that now because we need to keep EVERY branch fully stocked with hard cash. Any “reserves” at a central clearing location would have to be from bank collateral and profits and even so, they cannot solve everything and probably solves far less than we expect. You might find that a bank is unable to actually distribute vast amounts of its profits.

            This is a major hurdle. I would suspect that in solving this problem, banks would devise mechanisms that might undo your scheme in terms of money supply.

            On to the next issue.

            TB “There is now £100 of original money in the system which sits as a bank IOU and £90 of lending and £10 in reserve which does sit in cash in the above e.g. right or wrong?”

            I disagree mainly because you think this “Bank IOU” exists. Where is it? If it is mine, I should hold it or be able to sell it on. I cannot. Banks do not sell on these IOUs you speak of to other banks, the transfer (but mainly nett off) cash between their accounts at the BoE.

            If £100 is paid in, the bank can lend £90 of it, keeping £10 in reserve. Certainly.

            If the borrower or the person they spend the money on deposits it in the same bank, the bank can on-lend £81 of that £90 and so on. All the time we have £100 of original real money in the vault until almost£900 is lent out. If at any stage money lent is transferred out of the bank or withdrawn, the lending mutliplier has to stop until fresh cash is deposited. The “IOUs” you invent are not money. Nobody wants them. I cannot use them. I cannot see them. Other banks will not take them.

            They, the IOUs you speak of, in terms of “money”, do not exist in any practical or meaningful way. Ergo they are not “money”.

            Of course there is a journal entry under my account saying they owe me £100, but that is all. Hardly an IOU. This “IOU” meme comes from the story about goldsmiths, when they issued their bearer scrip. Banks running FRB in modern Britain do NOT issue bearer scrip when you deposit. They just say thanks and send you on your way empty handed.

            So today if the bank took my deposit, lent it, the borrower foolishly kept it in the same bank and then the bank lent it out again to someone who withdrew it, we have:

            £19 in the vault (10% reserve on my £100 and the re-deposited £90) (asset)

            £90+£81 in loan agreements (assets)

            £190 in liabilities (what they owe me and the depositing borrower)

            19+90+81 = 190.

            These liabilities are not IOUs, not money. They cannot be used by the bank or by me to exchange it for money, goods or services. they are on the other side of the equation – they are DEBTS.

            Just because this “IOU” explanation is all over the internet and even in A-level schoolbooks does not make it correct and does not give you the justification to accuse people of not knowing what they are talking about.

            So, again – please show me where your IOU is that can be treated as money. Do not say “your deposit account”, for that is not true. Any transfers are funded from reserves until fresh deposits or netting off restores it as I have outlined. The reserves are a buffer to smooth out transactional flow over time.

            I know you cannot show me these IOUs, for I know they do not exist in terms of “money”.

            Your plan exchanges your misunderstanding for hard cash.

            No deal.

            • Morning Tim,

              Your first point which I will summarise as “is it practical to have each bank full of physical cash so that each day interbank settlements will need to take place physically?”

              As said in many of the Emperor comments, a clearing house system may emerge and/or you do not even have to use physical cash if the government has just pledged to produce the cash i.e. have it all done electronically as most of it is today.

              As said at the start of the Emperor article, it seeks to establish theoretical possibility not practical possibility first. No point in even moving to the practicality of the whole scheme if in theory it falls at the first hurdle.

              I believe it passes the theory test. I thank you for your contributions to that debate. The practicality test is another matter (thank you for your contributions here if premature!), then post that test is the political will test and that is another matter in itself.

              Your next contention is simply wrong. A demand deposit is money. I can write a cheque to pay for my newspaper; the newsagent takes it and banks it, a journal entry from my bank to the favour of his bank happens. Thus it is money!

              Enshrined in banking law , I reach for my 1991 edition of “The Law and Practice of Banking, Vol 1, Banker and Customer, J Milnes Holden, ” Pitman Publishing. Granted, this may be out of date.

              Page 55 discussing Foley V Hill “In the result, the implied terms of the contract between banker and customer in the ordinary course of business when a current account is opened, may be stated as follows.

              2.10 The banker must receive cash and collect the proceeds of such items as cheques, postal orders, money orders and bills of exchange for his customer’s account.

              2.11 the money so received becomes at once the property of the banker, and he is thereupon indebted to his customer for an equivalent sum; hence the banker does not hold the money as his customer’s agent or trustee.”

              This is an agreement of debt from the bank to the depositor. In plain layman English, this is an IOU.

              A journal entry is passed from bank to bank as you the depositor exchanges goods and services and do not seek to redeem your debt in cash. The bank has no obligation to redeem its debt in cash until you demand it (this is why banks are exempt from the Statue of Limitations Act). If you do not demand it in cash, it has no choice but to swap a journal entry in its bank for that in another. This is money; it is a very important component of the money supply. Economics, banking and accountancy law are happily unanimous on this matter.

  • There is a certain amount of wheel-reinventing going on above. Karl Marx, Abba Lerner (born: 1903, died: 1982), and Milton Friedman all advocated at some time or other monetary systems which involved no national debt. For Friedman’s contribution, see http://www.jstor.org/pss/1810624

    Such a system is perfectly workable, in my view, thus a move from our present system to a zero (or much reduced) national debt should be easy enough, and indeed it is. Governments wanting to do this should proceed thus.

    1. Print money and buy back the debt. 2. That would be too inflationary, so mix “1” with a deflationary method of buying back the debt, i.e. get some of the money for the buy back from raised taxes and/or reduced government spending. Q.E.D.

    Incidentally that has nothing to do with whether the commercial banking system should be fractional or full reserve. The above national debt reduction system would work if there were no commercial banks at all and people held the bulk of their cash and gilts under their mattresses (with the rest being held in accounts at the central bank).

    • Robert Thorpe Current

      > 1. Print money and buy back the debt. 2. That would be too
      > inflationary, so mix “1” with a deflationary method of buying back
      > the debt, i.e. get some of the money for the buy back from raised
      > taxes and/or reduced government spending. Q.E.D.

      Ralph, using that Post Keynesian logic there is no reason to worry about the national debt at all. The national debt doesn’t have any real economic significance, it’s level is a tool of policy.

      • Current: I think there IS something to worry about if the debt just goes on expanding ad infinitum.

        Re your phrase “the national debt doesn’t have any real economic significance”, I rather agree. Taking the simple case of a closed economy, national debt arises where a government chooses to borrow from its citizens in place of taxing them. There is not a HUGE difference between the two: that is, the national debt is not of huge economic significance. In fact I’d describe it as one big nonsense.

        I put a paper on the net in January which attacks the whole idea of government borrowing:

        http://mpra.ub.uni-muenchen.de/20057/

        Also I’ve just done an updated version of the latter which I’m submitting to an economics gathering in Greece in a month’s time. This updated version should be on the latter “uni-muenchen” site in a week or two.

        • Robert Thorpe Current

          Have you read about Austrian Capital theory?

          • I’ve never read anything about the Austrain Capital Theory. So I Googled it and read a couple of papers, and wasn’t impressed. I then came across a third paper which concludes with a similarly jaundiced view of this theory.

            http://www.utas.edu.au/ecofin/hetsa/HETSA%20ABSTRACTS%202003_files/pdf_papers/Lynch.pdf

            Don’t think I’ll take my studies much further!

          • Robert Thorpe Current

            Well, I would argue that the author of that paper hasn’t taken the time to study Austrian Capital Theory properly. His critiques are really quite ranty. I can’t comment on the other articles you’ve read since you haven’t actually mentioned what they were.

            The issue here is that many economists accept the “homogeneous” theory of capital which considers all capital goods to be the same. If you accept that theory then what you say above is quite right, debt and taxation become closely related. However, this doesn’t make any sense if you have an inhomogeneous theory of capital.

            If I interpret your views about correctly you are a type of Post Keynesian. Have you read about the Cambridge Capital controversies? Do you know the difference between Post Keynesian and Post-Keynesian?

            In his criticisms Lynch says that Bohm-Bawerk lost his argument against Clark and Hayek lost his against Knight. That isn’t really correct, there was no general agreement at either time. The same is true of the later Cambridge capital controversy.

            How do you look at it? Do you agree with the homogeneous theory of capital?

      • Quite – you are both right.

        Though it is well worth remembering that QE is really forward starting debt, as when the debt you buy with the newly printed money matures, you either have to issue more debt to cover the repayment (hence forward starting debt) or you have to withdraw the QE.

        QE can go on forever in thoery, but at the cost of ever increasing moeny supply.

  • I’ll come to my constructive criticism in a second, but first let me just state that Toby will never pay out the 1000 GBP, despite the obvious and quite massive flaws in his argument.

    His plan is nothing more than money printing on a massive scale.

    The banks are effectively gifted money, which is then used to pay off the national debt, and reduce taxes. If only it were that easy, surely?

    Toby states that this injection of money into the banks actually increases their net value, yet does not increase money supply.

    Apart from the laughable idea that you can actually fix the money supply (apart from in a closed system, which our economy is not), he ignores basic principles of accountancy and economics.

    In simple terms, you can either print the money, back up all customer deposits and pay off all national debt etc, but by doing this you are giving banks a license to print unlimited amounts of sterling. Your money supply in this case will not so much increase as go atmospheric.

    Your other case is to inject moeny into banks, but that money must be repaid. That can be a temporary increase to the money supply, but thanks to a bit of basic accountancy, the bank would not be worth any more, thus you couldn’t use that money to pay off national debt etc.

    let me demonstrate. I run bank A, which has X in capital, all from demand deposits. I then set up a property company B, and lend capital X from A to B. The government then comes and gives me X to make my demand depositors whole. I repay all of them from bank A. I then have company B repay bank A, so now we have a situation where I have legally tapped the government for X, in the process “doubling” the money supply.

    What Toby misses is that I can do this trick legally ad infinitum, tapping the government for as much money as I want. In the process inflation would go through the roof.

    Yes, it would pay the national debt off – by inflating it away. Toby seems to be confusing Keynesiansim (via this cash injection, which is nothing more than QE) and the Austrian school by draping an overlay of bank credibility over it…..so lets now deal with his other main point – 100% demand capital to cover demand deposits.

    100% demand deposits simply turn a bank, whose job is to group credit and lending facilities and alter their effective maturities to match borrowers and lenders, using the wirder credit market to meet the difference in cash flows. In Toby’s world, the bank becomes nothing more than a safety deposit box, given they are no longer allowed to lend out their demand deposits.

    This would have a massive effect on all lending and investment. It would kill the mortgage market at a stroke, as those demand deposits would not be able to back mortgage lending. He argues that this function would be provided by timed deposits, but in reality, this would not happen to any great extent.

    Mortgages are too illiquid. Why would I allow a bank to convert my demand deposit into a timed deposit which they would invest in a very long dated, credit risky and totally illiquid product – someone else’s house. I wouldn’t be able to unwind the investment if needed the money, without the bank finding someone able to step into my position. Instead, I’d go and invest in liquid assets such as equities or bonds. Mortgage markets would be killed.

    Current makes many good points in his piece above, which I see no need to reiterate, but let me finish with this;

    Toby – you are trying to attempt two different things. Firstly, making a fiat currency “good” by trying to limit credit exposure and the money supply. Straight from the Austrian school. You try and pay for it by printing money – undoubtably Keynesian, with the effect on the money supply and inflation that would entail.

    • To Tyler

      Error 1.

      “The banks are effectively gifted money, which is then used to pay off the national debt, and reduce taxes. If only it were that easy, surely?”
      Wrong, the Plan says that the people who are current bank demand deposit holders are given the money. This means that the banking system has no demand deposit current liability. This means their net worth has gone up by the exact same amount that their current liabilities have gone down by. The surplus assets thus created can then be packaged up into Mutual’s or a special purpose vehicle whose only purpose is to pay off the debt.

      Error 2.

      You say “this injection of money into the banks actually increases their net value, yet does not increase money supply.
      A swap of one type of money a demand deposit for the same cash value can’t increase the money supply. You swap one demand deposit money unit worth 1 money unit (with is in fact a bank IOU to the depositor) for a cash money unit also worth one money unit. To put it in even simpler language 1 is swapped for 1.

      Mistake / Misunderstanding 1.

      Your say “Apart from the laughable idea that you can actually fix the money supply (apart from in a closed system, which our economy is not), he ignores basic principles of accountancy and economics.”

      I am comfortable I know more than you do about economics and accountancy. I accept that for most people I am making them aware of something they have not thought of before and have indeed been encouraged to think about very differently indeed, hence the Emperor’s New Clothes reference in the article. This however is just an ad hominem attack by you not an error.

      Error 3.

      You say “In simple terms, you can either print the money, back up all customer deposits and pay off all national debt etc, but by doing this you are giving banks a license to print unlimited amounts of sterling. Your money supply in this case will not so much increase as go atmospheric.”
      You repeat error 2 and then make a new error, I say the government prints up the money , not the banking system.

      Mistake / Misunderstanding 2.

      You say “Your other case is to inject money into banks, but that money must be repaid. That can be a temporary increase to the money supply, but thanks to a bit of basic accountancy, the bank would not be worth any more, thus you couldn’t use that money to pay off national debt etc.”
      What other case is this? I mention no “other case” in the Emperor article.

      Error 4.

      “Yes, it would pay the national debt off – by inflating it away. Toby seems to be confusing Keynesiansim (via this cash injection, which is nothing more than QE) and the Austrian school by draping an overlay of bank credibility over it”

      Errors 2 and 3 repeated again. QE created new money / new purchasing power, my proposal creates new money and swaps for existing money therefore no increase in purchasing power.

      Error 5.

      You say “let me demonstrate. I run bank A, which has X in capital, all from demand deposits. I then set up a property company B, and lend capital X from A to B. The government then comes and gives me X to make my demand depositors whole. I repay all of them from bank A. I then have company B repay bank A, so now we have a situation where I have legally tapped the government for X, in the process “doubling” the money supply.”
      A demand deposit is not capital of the bank but liability, I will leave that aside. Anyway, you say essentially A lends B X money. The government gives A bank deposit holders X so they are whole again. In my plan and not what you suggest above , B does not pay back the debt to A and double the money supply as it would do if that is how it was described, but it is not, he works hard and sells something to the former deposit holders of A who pass some of their cash to B, who pays off some of the national debt and other things with = no increase in the money supply = no inflation. You make a grave error by stating this otherwise.

      Mistake / Misunderstanding 3

      “In Toby’s world, the bank becomes nothing more than a safety deposit box, given they are no longer allowed to lend out their demand deposits.”
      I seem to recall writing safe deposit and lending via timed savings for starters.
      Mortgages would be fine to maturity match for via the long term money committed via pension funds (long time) and life policies (long time) .

      • Error 1:

        You are giving the banks money to cover their liabilities.You are NOT giving depositors any money, as they already have the corresponding assets at the bank.

        Your surplus “assets” are just printed money – QE.

        Error 2:

        See my example of how this would immediately increase the money supply. You make an assumption that all demand deposits would be fixed, yet you ignore that you are creating “new” assets, which would be turned into mutuals and used for investments.

        Again, you have created new money, which is QE, which increases money supply.

        M/M 1: I am pretty comfortable thinking that you don’t have a clue what you are talking about really. If you did, it would have been done before, and the UK would have no debt and no taxes. If nothing else, I’ve been working in banks as an interest rates trader for the last 10 years, and you are essentially a fishmonger. I kind of have to know what I am talknig about just to do my job.

        I’ll tell you agian – you cannot fix the money supply apart from in a closed system. Even if you bar credit expansion style transactions the money supply can still change through fx transactions. There is simply no way of stopping it.

        Error 3:

        Yes, the government prints the money, but by the fact you are backing up demand deposits, you give the banks a means to decide how much the government is to print (see my example). As such, it may as well be the banks printing money, and your idea of “honest money” goes straight out the window.

        M/M 2:

        The two cases boil down to naked QE, or government gtees of demand deposits (which is similar to what has happened in real life). The first case wouldn’t have to be repaid, the other would.

        Error 4:

        How do I spell this out for you? You can’t pay off the national debt and reduce taxes without creating new money. You CAN protect demand deposits without new money, but you are saying that banks will be worth MORE after your idea takes effect….because the government has printed NEW money.

        Though in one sense you are correct…you have created new money, but not new purchasing power. QED inflating debt away.

        Error 5:

        We do not live in a little utopia. B might produce something. B might not and might just be a holding company. A and B can be the same person. Your idea can be abused to increase the money supply and infinte amount, and there is NOTHING you will be able to do about it.

        The point I was really making though, was that your process is not limited to a once off. I could set up hundreds of shell companies, bounce a single deposit between them and print as much cash as I desire, tax free and with no obligation to put them in a government mutual.

        M/M 3:

        I work a lot with pension funds. The vast majority can’t invest in mortgages, especially if you can’t repack mortgages into MBS or similar. The credit rating simply isn’t good enough. Individuals will not be able to maturity match (or afford) to lend peer to peer. The only solution would be a FNMA style government backed agency. Tha twouldn’t solve al the other lending which goes on – it would become too hard to match things up without a pool of liquid cash.

        Trust me on this one – my bread and butter is ALCO (asset/liability) hedging for financial institutions. Your version simply wouldn’t be able to function without massive government intervention as a liquidity provider.

        ———————————————————-

        When it comes to it, you cannot reconcile this;

        You are telling me you are NOT increasing the money supply yet you ARE suddenly able to pay off the national debt.

        That, my friend, is simply not possible.

      • Toby

        “You swap one demand deposit money unit worth 1 money unit (with is in fact a bank IOU to the depositor) for a cash money unit also worth one money unit. To put it in even simpler language 1 is swapped for 1.”

        Not so, this is the “IOU” fallacy. Depositors only have a statement of what they have lent the bank, not an IOU. You are basically saying that we convert the latest statement, which is just an inventory record, a worthless tally stick, into a valuable, exchangeable security.

        • Tim, my bank statement is very real, it is not a worthless tally stick (if it is a worthless tally stick, if you are in credit, I would gladly take it from you!). It allows me to use it as the final means of exchange , therefore it is money. I pay my mortgage from it, buy my groceries , do direct debits and standing orders from it etc, etc. So that IOU is money. I say , like the 5 Nobel Prize winners mentioned, swap these IOU’s which are money for cash.

          • OK Toby, as I say above, answer this simple question;

            In your plan, how do you pay off the national debt, without increasing the money supply?

          • Toby,

            Please explain how you would take your bank STATEMENT, and convert that piece of paper, the STATEMENT, into cash, considering that the Bank issues one to you each month and will continue to issue you statements each month.

            • I go to a hole in the wall, look at my statement, if it is credit, I demand £X and £X comes forth in cash. My bank statement is very real and functions as money , although what I am doing is trasfering my bank IOU to the party who I am transacting with if I do a DD or SO or write a cheque. With a cash withdrawl I redeem part or all of my debt.

              • Not so.

                When you go to the hole in the wall, if you are in credit, you are told the bank owes you money.

                When you withdraw, the cash is taken from reserves (in the bank ATM) and the bank owes you less. The bank will seek to replenish that withdrawal on its reserves via future deposits.

                Your “IOU” meme does not work when the counterparty is in another bank, because banks only take hard cash transfers via the accounts lodged at the BoE.

              • Morning Tim,

                I truly do not know where you are coming from here.

                There is approx £60bn of physical cash in all bank accounts.

                There is approx £900 bn of demand deposits.

                This implies that 6.67% of cash is in the system at all points in time. If we all went to get our bank IOU’s paid in cash all simultaneously, then only that % would get paid out.

                This is non controversial.

                I use the language that all use to describe this. The IOU is not a meme, it is an accurate description of legal fact that when you deposit, you are granted back a debt instrument aka in laymans language the bank owes you the money or IOU!

  • Tyler: I’ll try to defend Toby’s scheme against your criticisms.

    First, note that there is not a big difference between Toby’s proposal and mine. Mine is (to oversimplify) “print money and buy back the national debt”. Toby’s is “do the latter at the same time as going for full reserve banking” – if I’ve got Toby’s scheme right.

    Re your claim that “this is nothing more than printing on a massive scale”, my answer is that you are quite right. But there are several reasons for thinking this won’t be too inflationary, as follows.

    1. Both my scheme and Toby’s involve giving those holding government debt cash for their Gilts. Those holding government debt regard that chunk of their wealth as SAVINGS. If that chunk is converted to cash, they will see this chunk in much the same light. That is they won’t suddenly blow the lot and cause a sudden rise in demand and inflation: they will place the money in the next best thing to government debt and for the most part that will be a bank deposit account.

    2. The above piece of theory was nicely born out in 2009. In that year there was an unprecedented and astronomic increase in the monetary base in U.S. and U.K. in 2009. Far from resulting in a big increase in demand or inflation the result has been disappointing – at least politicians are tearing their hair out at the FAILURE of banks to lend.

    3. Banks are “capital constrained, not reserve constrained”. There are plenty of articles on the internet which explain this point and which can be found by Googling the latter phrase in inverted commas. In other words giving banks more reserves ought not to increase their lending. Put another way, a commercial bank ought not to lend just because it has money in the kitty. If it does, it is incompetent. A bank ought to lend only where it sees a credit worthy customer and where the bank has adequate capital.

    However, banks arguably ARE run to a significant extent by incompetents, fraudsters and criminals. The mere fact that they hand out Ninja mortgages is good evidence of this. But for more evidence (particularly as regards the U.S.) Google “William K.Black”. To the extent that this is the case, the logical and appropriate solution is (unfortunately) strict bank regulation, e.g. outlawing 90% or 80% mortages.

    4. The total of the national debt (or monetary base) is sometimes small compared to the total of all assets which are effectively used as money (even though they are not called money). See a Credit Suisse paper for more on this: http://faculty.unlv.edu/msullivan/Sweeney%20-%20Money%20supply%20and%20inflation.pdf

    5. If extra monetary base DOES prove inflationary, there is nothing to stop the government central bank machine (amongst the various anti inflationary measures at its disposal) demanding “special deposits” as the Bank of England used to a few decades ago (starting around 1960). The Chinese authorities have recently done something of this sort to damp inflationary pressures.

    You say “but by doing this you are giving banks a license to print unlimited amounts of sterling.” Neither Toby’s scheme nor mine gives commercial banks licence to print “unlimited” amounts of money. Bank’s reserves ARE increased by the amount of the national debt, but to repeat the point made above, if banks behave in a commercial and competent manner, they won’t make loans and create money willy nilly.

    Also, long before the credit crunch, Fred the Shred went mad and loaned billions to no hopers, so the problem of so called commercial banks doing daft things is with us ANYWAY.

    6. My scheme is better than Toby’s (sorry Toby) in that it has a built in element to deal with any inflation. That is, in addition to printing money and buying back the debt, government also gets money for the buy back from raised taxes (and/or reduced spending). The latter element is infinitely variable.

    • Ralph, forgive my ignorance on your plan, I am not aware of it. Please feel free to FWD it, we are interested in banking reform as you can see on this site.

      Prof George Reisman in this article shows how the USA can move to 100% reserve banking and pay off the National Debt using reserves that will not be inflationary

      http://www.cobdencentre.org/2010/04/a-pro-free-market-program-for-economic-recovery-by-george-reisman/

      The essential difference is that he prefers to put the cash in the reserve line of the bank in a similar way you describe, I prefer to lift out the demand deposit liabilities off the bank , convert into cash and replace with an income generating safe deposit customer to the bank.

      Both our proposals are not inflationary at all.

      I will address Tyler’ s separate points on his thread.

      Thank you for your thoughts.

      • Ralph,

        I don’t know your scheme, but I will make one point, regarding your point 2. The UK and US governments are jsut replacing their own credit for corporate and consumer credit. Net money supply hasn’t really been expanded. All the QE has basically been used to plug the gap between the value of houses in the midwest and the dodgy mortgages behind them. You can’t use the credit crunch as evidence for QE not increasing the money supply or being inflationary.

        If not for other factors, money supply would be increasing given QE. That is the WHOLE POINT of it. It is mortgages, credit standards and higher reserve requirements, as well as both corporates and individuals paying down debt (at a faster rate than any time in the last 10 years) which is offsetting the money created by QE.

        Toby’s scheme is nothing more than QE, and as I explain above it gives banks control over the amount, rather than the BOE through bond buybacks. Your scheme is also QE, and is effectively what is in place at the moment.

        Toy CAN NOT explain how he will pay back the national debt overnight whilst at the same time not increasing the money supply. Not surprising really, given it is impossible.

        • Tyler: far from claiming that my scheme is not QE, I fully admit that does more or less equal QE. Thought that probably wasn’t clear from my above ultra brief exposition of my scheme.

          Also, as I understand Toby’s scheme, that also more or less equals QE. That raises the $64k question as to why the consequent big money supply increase will not be too inflationary. My answer to that is the six points just above.

          As to EXACTLY how inflationary it would be, probably only God knows the answer to that. My hunch is that Toby’s scheme IS A BIT INFLATIONARY. That is why my scheme includes two elements: an inflationary way of paying off the debt and a deflationary way. So in principle paying off the debt in neutral way (neither inflationary nor deflationary) is easy. But of course things that are easy in principle are usually more difficult in practice!

          You also say “You can’t use the credit crunch as evidence for QE not increasing the money supply or being inflationary.” It strikes me that QE by definition increases the money supply. That is QE equals “central bank hands out cash to bond holders”. That inevitably means more cash (or monetary base to be more exact) in the private sector.

          Re your suggestion that I should not use the credit crunch as evidence of QE not being inflationary, I think you’ve got a point. The effect of QE in a recession could be very different as compared to the effect in more normal times.

          • Ralph;

            I agree with your logic, and also that you state that your scheme is QE (whilst Toby for some reason beleives his is not). I personally don’t think QE is a long term solution, for a variety of reasons – not least political (politicians don’t just print moeny once) but thee are severe financial repercussions which can arise.

            Your scheme would not be as inlfationary as Toby’s. Your scheme, as I understand it, uses Gilts (a fixed supply) as the purchase measure whilst his uses demand deposits (an infinite supply).

            Your scheme would pay off the national debt. BUT, it isn’t that simple….the liquidity injection would cause inflation/asset devaluation. It would also still have to be repaid at some point, so long term interest rates would probably explode higher whilst short term rates would basically be zero.

            The QE would basically take todays debt and move it into the future…which would have a massive effect on the crediit rating of the country. The lack of stable long rates would also cause trouble in mortgage markets but also for pension investors…what do you invest in if there are no 10y bonds to buy, but in 20 years timethe country could be in a terrible debt trap/crisis.

            QE in small amounts has a place, but I think it is important to remember the law of unintended consequences, and also that the only way out of debt is to pay it off or to default.

            ((remember also that inflating away debt is the modern equivalennt to default for a sovereign))

            QE is expansionary. The credit crunch is deflationary…..the two aren’t mutually exclusive.

          • mrg mrg

            @Tyler (June 29th, 2010 at 14:44)

            I think you’re missing the legal change that happens as part of Toby’s plan.

            The supply of demand deposits is not infinite. The transition to 100% reserves is a one-off. You can’t repeat the trick without first reintroducing Fractional Reserve Banking.

            The cash that is printed under Toby’s scheme *replaces* an equal amount of “cash substitutes”, so the effect on the broad money supply should be nil.

            When you consider the repayment of the national debt, I can see why this seems like having your cake and eating it too. Really the banks would be the losers, because although on paper the demand deposits are liabilities, they’re not liabilities that the banks are particularly concerned about. They quite enjoy being able to manipulate the money supply.

      • Toby: I just finished reading Reisman’s article. I am sympathetic towards his basic point, namely that we need 100% reserve banking. But I disagreed with several of his subsidiary arguments. There is a lively exchange of views on 100% reserve here (if you’ve got two hours to spare to read it!): http://bilbo.economicoutlook.net/blog/?p=7299

  • Paul Green (aka. Traktion) Paul Green (aka. Traktion)

    I’m not formally educated in any particular school, but the common sense approach of the Austrian school has appealed to my way of thinking. My background is in software engineering, not economics, with the latter being self taught over the years.

    The reason I talk about a circuit, is simply because one person hoarding, can lead to another having difficulties making repayments, when using a single currency. Whether substantially more will be hoarded when switching to full reserve banking, would depend very much on people’s attitudes towards their money. Considering that banks are currently considered to be hoarding too much, perhaps individuals would hoard less?

    My opinion is that those with little money will not have much to invest in timed savings, but I doubt their humble situation would add much to the lending capacity of banks via fractional reserve banking anyway. Alternatively, those with lots of money would likely only keep a small percentage as safe deposits, with the rest invested in timed savings (and other assets). With this considered, I don’t think the change would cause huge changes in available credit. I don’t have any numbers to back this up, but logically, it holds IMO.

    That said, this is more a general point about full reserve banking, rather than the repayment of the national debt issue. As I’ve said in the comments already, I’m not convinced this is a good idea. To highlight another angle, isn’t the government taking the assets from banks (in terms of their loan book) and repaying them with ‘something else’ (related to the national debt repayment mutuals) akin to the confiscation of gold in the US around the time of the Great Depression? Will it cause problems for pensions (which often include gilts in the investment mix, I understand) or other financial services? Is it even morally right or fair? I simply don’t know, which worries me, although I’m keen to understand further. Perhaps this part of the plan could be expanded on by Toby in another post?

    From my current understanding of the national debt repayment plan, I would rather government borrowing was just reduced and debt was paid down. Putting in laws to prevent such unbalanced budgets in the future would also seem wise. Each less pound of government borrowing needed, should result in one more pound of potential private sector borrowing. As government borrowing is ‘regressive’ (wealth transfer from taxpayers to the wealthy gilt holders, via interest) and restricts free choice for individual investment, this would be a thoroughly good idea. I just don’t think that we need to be too clever in getting there, with these sort of national debt repayment ideas.

    However, switching to full reserve banking, by way of switching some accounts to safe deposits and others to timed savings, would have my full support. This could be done (as I mentioned below) with consultation with account holders – the less changes to narrow money needed, the more confident I would be that there would be fewer side effects.

    I am probably rambling on here, but hopefully some of it is of value to the debate.

    • Paul Green: when you say “one person hoarding, can lead to another having difficulties making repayments” you’ve inadvertently struck gold. You make a point which an Australian Prof of Economics has been banging on about for years (Bill Mitchell). Plus there is an American economist / banker and former Wall Street trader who has been saying the same (Warren Mosler). These two claim (and I think they are right) that failure to understand the above point is at the heart of our failure to escape the recession much sooner, and will probably be at the heart of the coming double dip. Their blogs are respectively:

      http://bilbo.economicoutlook.net/blog/ and http://moslereconomics.com/

      Happy reading.

      • Robert Thorpe Current

        > one person hoarding, can lead to another having difficulties making
        > repayments

        That has been known for decades. It certainly wasn’t a point invented by Post Keynesians.

        Hayek discusses it in his work in the 30s. Fisher discussed it well before that. Fisher called it the problem of debt-deflation. It’s one of a general set of problems called “fallacies of composition”.

    • Robert Thorpe Current

      > I’m not formally educated in any particular school, but the common
      > sense approach of the Austrian school has appealed to my way of
      > thinking. My background is in software engineering, not economics,
      > with the latter being self taught over the years.

      Fair enough. I’m an electronic engineer myself, and like yourself I don’t have any formal qualifications in economics.

      > The reason I talk about a circuit, is simply because one person
      > hoarding, can lead to another having difficulties making
      > repayments, when using a single currency.

      I see. The term “monetary circuit theory” is used for a particular theory created by Post Keynesian economists.

      You are basically right in your theory. Let’s suppose there is a fixed quantity of money. And, let’s suppose that the demand to hold it (or “hoard” it) from a particular set of people rises. If the demand for money elsewhere is falling then this can be accomodated to some degree. But, if it isn’t then adjustment of prices must take place.

      This creates two problems. Firstly, adjustment of prices is a difficult process – for various reasons prices are “sticky”. Secondly, debt repayments and other contracts are denominated in money, they don’t move with prices.

      If the amount of money can be varied to accomodate changes but do no more then these problems would be much minimized.

      Despite what Ralph Musgrave says this is all quite well known.

      > My opinion is that those with little money will not have much
      > to invest in timed savings, but I doubt their humble situation
      > would add much to the lending capacity of banks via fractional
      > reserve banking anyway.

      Let’s start a little earlier in the debate first. Do you agree with me that if the demand to hold money falls then as a consequence prices will rise? Are we only discussing the magnitude of the effect?

      If banks began charging fees then I think poorer people would hold even less money than they do now. Before bank services were free many people had no bank account at all. I think if fees were to be reinstated then at least some people would go back to use or cash. I think it’s quite likely they would hold less cash too for fear of crime.

      But, as you say, poorer people are unlikely to have that much effect.

      > Alternatively, those with lots of money would likely only keep
      > a small percentage as safe deposits, with the rest invested in
      > timed savings (and other assets).

      Yes, that’s exactly my point!

      As things are those people can keep their money in on-demand accounts, which provide interest and services. However, after the change the funds for providing interest and services will dry up. So, it is likely those services will too.

      When that happens people will spend their money on timed savings and other assets. That will cause price inflation.

      > With this considered, I don’t think the change would cause huge
      > changes in available credit. I don’t have any numbers to back
      > this up, but logically, it holds IMO.

      What you’re missing here is Toby’s proposal to pay-off the national debt. That proposal relies on moving the assets of the banks into the “national debt repayment mutuals”. At present those assets are held on the balance sheets of the banks against the on-demand liabilities.

      After the reform all on-demand bank accounts will be what some economists call “outside money”. They are fiat money that has been declared money by the government, they have no matching asset at all. This situation is stable and price inflation zero or low as long as the demand for money remains the same before and after the reform. However, if the demand for money rises after the reform then price inflation will result.

      The national debt repayment mutuals are demanding the same assets that the banks once were demanding. After the change though we have the demand from the mutuals _and_ the demand from people moving into timed-savings products.

      > That said, this is more a general point about full reserve banking,
      > rather than the repayment of the national debt issue. As I’ve said
      > in the comments already, I’m not convinced this is a good idea.
      > To highlight another angle, isn’t the government taking the assets
      > from banks (in terms of their loan book) and repaying them with
      > ’something else’ (related to the national debt repayment mutuals)
      > akin to the confiscation of gold in the US around the time of the
      > Great Depression?

      Yes, I think this is dubious too. However, government intervention in banking has a long history. And it seems unlikely that the government could be removed from it’s entanglement with banking without some further interventions.

      That said, I don’t think this removal of assets is necessary.

      > Will it cause problems for pensions (which often include gilts in
      > the investment mix, I understand) or other financial services?

      I think it might. But, I don’t know if that’s a big issue.

      > Is it even morally right or fair? I simply don’t know, which
      > worries me, although I’m keen to understand further. Perhaps this
      > part of the plan could be expanded on by Toby in another post?

      I don’t think it’s very just to people who are planning on things continuing as they are. I don’t think that fractional reserve banking is intrinsically immoral, though I do think banks should be more explicit about what they do.

      I think that any reform would be unjust to someone – that’s one of the problems with changing the law. Similarly, keeping things as they are is unjust to everyone.

      There are some ways of managing the transition that will be less troublesome than others.

      I agree with you that national debt is generally economically destructive and a regressive form of taxation. And I agree that measures are needed to cope with it in the future.

      > However, switching to full reserve banking, by way of switching
      > some accounts to safe deposits and others to timed savings, would
      > have my full support. This could be done (as I mentioned below)
      > with consultation with account holders – the less changes to narrow
      > money needed, the more confident I would be that there would be
      > fewer side effects.

      I agree you that Toby’s plan would be better if some balances were converted into timed-savings instead of safe deposits.

      Although I haven’t emphasised the point here, I think there may be other problems too. Let’s say that the transition to 100% reserves is managed without price inflation or deflation. After that I think there could be problems with foreign depressions and disturbances. A recession in the countries that are major trading parties with Britain may cause a rise in demand for money in Britain. That rise can’t be served by a corresponding creation of money.

      Similarly, the interest rate in Britain is strongly affected by foreign interest rates. During the most recent boom there was a great deal of carry-trade between the Europe and Britain. Mostly British banks borrowing from eurozone banks and Swiss banks. This means the recession-creating mechanisms of the Austrian Business Cycle Theory would still be in effect, they would only be lessened.

      • Paul Green (aka. Traktion) Paul Green (aka. Traktion)

        “Let’s start a little earlier in the debate first. Do you agree with me that if the demand to hold money falls then as a consequence prices will rise? Are we only discussing the magnitude of the effect?”

        Yes, I would agree with that.

        “> Alternatively, those with lots of money would likely only keep
        > a small percentage as safe deposits, with the rest invested in
        > timed savings (and other assets).

        Yes, that’s exactly my point!

        As things are those people can keep their money in on-demand accounts, which provide interest and services. However, after the change the funds for providing interest and services will dry up. So, it is likely those services will too.

        When that happens people will spend their money on timed savings and other assets. That will cause price inflation.”

        Right, I think the penny has just dropped for me on your point. Money from timed savings of previous fractional reserve accounts will be *competing* with the money to pay the national debt mutual funds. This would cause the new timed savings to compete (with lower interest rates), making additional borrowing *cheaper*, which would be inflationary.

        It’s the demand for money which is key in setting the interest rates for timed savings, in a free market, which would cause the inflationary gyrations.

        Is this the point you were trying to make? If so, I have pondered it and I now agree.

        “I agree you that Toby’s plan would be better if some balances were converted into timed-savings instead of safe deposits.”

        Yes, I was thinking about this again too. I’m thinking that maybe it couldn’t even be optional, as opting for payment beyond what is held on deposit could cause inflationary issues too.

        Perhaps the only way this could be achieved, would be by assigning up to a ‘fair share’ of the bank reserves as “full reserve” safe deposit accounts, with the rest ear marked as timed savings. These could default to gilts, but there would be a time period for individuals to customise their investment portfolio too. As long as the money being in timed savings matches roughly the fraction which is leant out, then inflation shouldn’t be a problem.

        I just read what Prof. Kotlikoff suggests with LPB. He says that banks now have twice the amount of reserves as there is deposited in demand deposit accounts. Assuming that is the same in the UK (pure guess), then changing all current accounts to full reserve accounts, funded by said reserves, shouldn’t be a problem (not just a ‘fair share’). This does sound potentially inflationary to me though, as those ‘excess’ reserves would no longer be dormant, but ready to be invested in alternatives. However, we could assume that they are in demand deposit accounts as instant access is needed, so perhaps habits would remain unchanged by this?

        “Although I haven’t emphasised the point here, I think there may be other problems too. Let’s say that the transition to 100% reserves is managed without price inflation or deflation. After that I think there could be problems with foreign depressions and disturbances. A recession in the countries that are major trading parties with Britain may cause a rise in demand for money in Britain. That rise can’t be served by a corresponding creation of money.

        Similarly, the interest rate in Britain is strongly affected by foreign interest rates. During the most recent boom there was a great deal of carry-trade between the Europe and Britain. Mostly British banks borrowing from eurozone banks and Swiss banks. This means the recession-creating mechanisms of the Austrian Business Cycle Theory would still be in effect, they would only be lessened.”

        Yes, this is something I have considered too. Unless other countries adopt similar policy, there would have to be ways to counter such disturbances. I think the central banks could buy shares in any timed savings funds (the LPB model works well here too) to soften such gyrations, but I am nervous of any central bank interventions really. While we live in a world of intervention, I suppose we have to make do though until the other countries catch up.

        TBH, I’m a huge fan of Kotlikoff’s LPB ideas and find myself framing many problems in a LPB model and finding it copes better than anything else, particularly in risk appropriation and free market pricing of savings/loans.

        • Robert Thorpe Current

          > Right, I think the penny has just dropped for me on your point.
          > Money from timed savings of previous fractional reserve
          > accounts will be *competing* with the money to pay the national
          > debt mutual funds. This would cause the new timed savings to
          > compete (with lower interest rates), making additional
          > borrowing *cheaper*, which would be inflationary.
          >
          > It’s the demand for money which is key in setting the interest
          > rates for timed savings, in a free market, which would cause
          > the inflationary gyrations.
          >
          > Is this the point you were trying to make? If so, I have
          > pondered it and I now agree.

          Yes, that’s it.

          > “I agree you that Toby’s plan would be better if some balances
          > were converted into timed-savings instead of safe deposits.”
          >
          > Yes, I was thinking about this again too. I’m thinking that
          > maybe it couldn’t even be optional, as opting for payment
          > beyond what is held on deposit could cause inflationary issues
          > too.

          It’s very tricky. Let’s suppose there are timed-savings options put in place before the reform happens. Then people can decide beforehand, that would reduce the problem because long-term savers would move before the plan is implemented.

          The problem though is that if the interest rate on timed savings expected to be higher after the plan. If it’s expected to be higher than those savers may keep their money in on-demand accounts until afterwards, and only transfer it then.

          A better option would be to ask people to choose earlier what will happen on the day the plan is implemented. So, if the plan is implemented on Sept 1st then account-holders can decide on Aug 1st what percentage of their holdings will go into safe-deposit and what percentage into timed-savings. But, the split and transfer is only carried out on Sept 1st. That may help a bit.

          Also, none of this sorts out the problem of fees for services. Predicting there effects quantitatively would be very difficult.

          > Perhaps the only way this could be achieved, would be by
          > assigning up to a ‘fair share’ of the bank reserves as “full
          > reserve” safe deposit accounts, with the rest ear marked as
          > timed savings. These could default to gilts, but there would
          > be a time period for individuals to customise their investment
          > portfolio too. As long as the money being in timed savings
          > matches roughly the fraction which is leant out, then inflation
          > shouldn’t be a problem.

          So, you’re saying that it may not be reasonable to ask people to decide which form of timed-savings they want straight away. I hadn’t thought of that, though you may be right. It depends on how long the time is between when the reform is announced and when it takes place.

          > I just read what Prof. Kotlikoff suggests with LPB. He says
          > that banks now have twice the amount of reserves as there is
          > deposited in demand deposit accounts.

          I think that’s true in the US. But, presently monetary policy is very strange over there. The Federal Reserve are paying interest on all reserves accounts. They are not just paying interest on reserves that must be held to meet the reserve requirement as they did in the past. They are now paying interest on *all* reserves, including reserves in-excess of the requirement.

          The result of this was that during the crisis banks decided to hold interest-bearing reserves rather than possibly-toxic asset. This caused the amount of excess reserves to rise enormously. It’s interest from the reserves that now supports interest-payments and services for on-demand account holders in the US.

          In Toby’s original proposal he didn’t suggest paying interest on reserves at all. If the interest payments on reserves were stopped under the current US system then the banks would have to lend an acquire normal assets such as loans. But, the same couldn’t happen under Toby’s system.

          In a later email exchange with me he suggested paying interest on reserves for a few years after the reform as a transition measure. He suggested doing that by creating money. This is another possible way that transition could be made easier. I’m not sure it would work, I haven’t thought about it enough yet.

          > However, we could assume that they are in demand deposit
          > accounts as instant access is needed, so perhaps habits would
          > remain unchanged by this?

          Toby said something similar, I’m not really persuaded. I had an interest-bearing current account once. I used to leave savings in there sometimes because it was less work than opening a savings account.

          > Yes, this is something I have considered too. Unless other
          > countries adopt similar policy, there would have to be ways
          > to counter such disturbances.

          Yes. This was one of the problems of the original gold standard. Other countries with fiat money or credit money standards would precipitates crises which would spread.

          > I think the central banks could
          > buy shares in any timed savings funds (the LPB model works
          > well here too) to soften such gyrations, but I am nervous of
          > any central bank interventions really. While we live in a
          > world of intervention, I suppose we have to make do though
          > until the other countries catch up.

          I’m not sure that would work, it took a long time for the original gold standard to catch on. I think that the system needs some degree of flexibility. If you read Larry White and George Selgin’s stuff on Fractional-reserve free-banking they discuss how that system is robust to changes in demand-for-money coming from outside. Though it isn’t really robust to changes in the interest rate coming from outside AFAICT.

          > TBH, I’m a huge fan of Kotlikoff’s LPB ideas and find myself
          > framing many problems in a LPB model and finding it copes
          > better than anything else, particularly in risk appropriation
          > and free market pricing of savings/loans.

          I haven’t read this book yet. But I look forward to reading it soon.

      • mrg mrg

        “When that happens people will spend their money on timed savings and other assets. That will cause price inflation.”

        It’s obvious to me that people spending on “other assets” will cause price inflation (particularly of those “other assets”).

        It’s less obvious that ‘spending’ on “timed savings” will have the same effect. Is it based on the assumption that the new recipient of the money (the debtor) will be more likely to spend (vs hoard) than the creditor? That seems plausible.

        But under FRB, depositors’ money (along with money created ex nihilo) is already in the hands of debtors, is it not? So even if we grant that debtors are less inclined to hoard than those in a position to lend money, it’s not clear that the amount of money in the hands of high-spending debtors will increase as a result of the reform. Indeed, one of the criticisms levelled against Toby’s reform is that it would create a further credit crunch (whether this is actually a bad thing in the long run is debatable).

        Paul Green wonders about “money from timed savings of previous fractional reserve accounts” competing with “the money to pay the national debt mutual funds” and thereby “making additional borrowing *cheaper*”, but borrowing is already cheap (rates can’t go below zero).

        I suspect I need to re-read the comments, and think about this further. There are so many factors, and so many unknown subjective preferences, that it’s difficult to reason about these issues.

        • Robert Thorpe Current

          > It’s obvious to me that people spending on “other assets” will
          > cause price inflation (particularly of those “other assets”).

          Yes, if investors spend more on land then it’s price will rise. If investors spend more on shares then their price will rise.

          > It’s less obvious that ’spending’ on “timed savings” will have
          > the same effect. Is it based on the assumption that the new
          > recipient of the money (the debtor) will be more likely to spend
          > (vs hoard) than the creditor? That seems plausible.

          A borrower may borrow for two reasons. Firstly, to spend directly, secondly to hold a larger stock of money. The first case causes price rises, only the second case doesn’t. I agree that at times when the demand for money is high the spending may not be a problem. But, we can’t be sure that the plan will be enacted at such a time.

          > But under FRB, depositors’ money (along with money created ex
          > nihilo) is already in the hands of debtors, is it not?

          That’s more-or-less right. A bank gathers savings and creates loans. It provides funds for borrowers from savers.

          > So even if we grant that debtors are less inclined to hoard
          > than those in a position to lend money, it’s not clear that
          > the amount of money in the hands of high-spending debtors will
          > increase as a result of the reform.

          Remember the part about eliminating the national debt?

          Toby’s plan isn’t to make the banks foreclose on loans they have made. His plan is that those loans *continue to exist* but they are transferred into the national debt repayment mutuals.

          In the future, after the plan has been done, then mortgages and other loans must be backed by timed savings. But, the currently existing stock isn’t liquidated.

          Let’s suppose that currently through the commercial FRB banking system £X worth of loans are being paid off every day. And a corresponding ~£X worth of loans are being made. After the plan is enacted the national debt repayment mutuals own the bulk of the loans. Similarly, ~£X worth of loans will be paid off every day, and a corresponding ~£X worth of loans will be made by the national debt repayment mutuals. Any investment in timed savings will be *over and above* the ~£X that are regularly rolling-over.

          > Indeed, one of the criticisms levelled against Toby’s reform
          > is that it would create a further credit crunch (whether this
          > is actually a bad thing in the long run is debatable).

          In the long run only timed-savings can be used for investment. So, when a person receives an income of money it is fiat money which exists in limbo, it isn’t consumption or investment. Under FRB things are different, any money put into an on-demand account is being invested in the banks assets until it’s spend. Under FRB investment is the default. So, I agree that this may be a problem in the longer run.

          I think foreign investors would bridge the gap. That would cause problems too though.

          > Paul Green wonders about “money from timed savings of previous
          > fractional reserve accounts” competing with “the money to pay
          > the national debt mutual funds” and thereby “making additional
          > borrowing *cheaper*”, but borrowing is already cheap (rates
          > can’t go below zero).

          For how long will they be this cheap though? Since rates are so low have you got rid of your savings accounts? I haven’t and that’s because I think rates will rise in the future. I think it’s realistic to expect that a plan like Toby’s would be implemented in a time of normal interest rates.

          However, even now with the current very low rates there would be problems with implementing the plan. Decisions about investments involve expectations of the future. People aren’t getting rid of their savings accounts because they don’t think low rates will last. Similarly, banks aren’t getting rid of their free services because they don’t think low rates will last. Banks aren’t happy with a business plan that generates a return just higher than the interest rate because they know interest rates will rise in the future.

          The same would apply if the plan were implemented. If banks believe the reform is permanent they would take their decisions about future fees straight away. Timed savings are different. Very low interest rates would put off the shift from safe-deposit to timed-savings until the interest rate rises.

          • mrg mrg

            Thanks for your detailed response. Lots to think about here.

            One point I’d like to clarify … You wrote:

            “Similarly, ~£X worth of loans will be paid off every day, and a corresponding ~£X worth of loans will be made by the national debt repayment mutuals. Any investment in timed savings will be *over and above* the ~£X that are regularly rolling-over.”

            I suppose I’d assumed that the national debt repayment mutuals wouldn’t be making any new loans (or extending existing loans); they would just be receiving interest and capital repayments, and using these to pay down the debt, so that the mutuals cease to exist once the national debt is repaid. Is this a misunderstanding on my part?

          • Robert Thorpe Current

            > I suppose I’d assumed that the national debt repayment
            > mutuals wouldn’t be making any new loans (or extending
            > existing loans); they would just be receiving interest and
            > capital repayments, and using these to pay down the debt,
            > so that the mutuals cease to exist once the national debt
            > is repaid. Is this a misunderstanding on my part?

            That’s how I understand it too.

            I was simplifying in what I said earlier which wasn’t completely right. Certainly the national debt mutuals may not have to roll-over much debt. It depends if the dates on UK government debt are longer than those on the commercial bank’s loans.

            Let’s say that the national debt mutuals are periodically paying off debt. What happens when those they have paid receive their money. If those investors had planned to roll-over their money, then they will do so into other investments such as corporate bonds. Their next action will be affected by a change in interest rate. It may be that if the interest rate is low enough then less of those investments will roll-over.

            The crucial point here is that balances in fractional-reserve on-demand accounts are a debt of the bank, some call that “inside money” because they are on a balance sheet. Pure fiat money is “outside money”. It is nobodies debt, and occurs on no balance sheet as a liability. It only appears as an asset, but it’s not like other assets, it’s an asset by government fiat. Fiat money is a sort of pseudo-gold.

            So, when all balance sheets are considered together the total amount of assets has increased. That’s why the national debt can be paid off. The assets and liabilities are shifted around certainly. But, there’s little reason to think that their influence on the savingsinvestment market (which determines the interest rate) will be different than it was immediately.

            This sort of creation of monetary assets is safe only if the demand for them doesn’t change much. My point is I think that it will, I think it will fall due to rises in bank fees and loss of interest on current account. When that happens there will be price inflation.

            • To Current
              The average maturity profile of the national debt is some 14 years. This data is robust and can be got from the debt management office. The commercial debt market i.e. loans to businesses will be substantially less. I do not know what it is , but some researcher I am sure would be able to easily find out. In all my 22 years in business, I have seen little loaned over 5 years commercially. Now of course retail mortgages are assets of banks which generally run up to 25 years maturity, so one would need some research for sure to see if the impact is neutral in the best case, or would lead to roll over implications for former gilt holders who will then seek to place their redeemed money in some other asset class. This is a fruitful area of research that I hope to look into at some point in the future.

              With regards to all the former money that sits in irritatingly called “instant access savings accounts” that are demand deposits which as we have established are some £380 bn of current money supply, as said before, I agree with you that a good portion of it would seek to find a new invested home in timed deposits, corporate bonds etc. This will cause price inflation in those favoured asset classes at the expense of those unfavoured asset classes. This is the painful post boom readjustment that all political parties seek to avoid. This movement of money sets forth the realignment of what the savers want with what the producers will produce . The business cycle is smoothed out. Some people have said this Plan is a “magic bullet” Plan, far from it, pain is involved. This pain is the pain that Japan has been avoiding for 20+ years and we in the UK and USA have the harsh choice now as the 1st stimulus wears off, do we avoid the pain again with an even larger dose of fiscal & monetary irresponsibility? Or take the pain and move on?

              I know you have not said this, but one type of commentator did say that this Plan would be a massive deleveraging process as the 33 x fiat “funny money” is wiped out starving the economy of credit. As you know, with fixing the money supply at the same level as it is today, then there is no deleverage. I am content that what was formerly a demand deposit, quite probably in “instant access savings”, is sufficient saved money to facilitate the ongoing demands of sustainable trade, coupled of course with the existing timed deposits.
              Your argument I see as more a refinement of the Plan and the nagging doubts about “will there be enough loans to fund trade on-going,” is largely answered by this debate.
              Many thanks for your time and contributions.

              I will be looking to close the “Emperor’s New Clothes” comments down as I do not think anything more can be added and the comments are now getting repetitive and tedious. I will write up a summary of points and re – issue at some point in the future.

              • Robert Thorpe Current

                > or would lead to roll over implications for former gilt holders who
                > will then seek to place their redeemed money in some other asset
                > class. This is a fruitful area of research that I hope to look into
                > at some point in the future.

                To be clear. I don’t think that it would make much difference if the national debt repayment mutuals had to roll-over a few commercial loans. I was discussing it above only to explain the implications on the asset market and price inflation.

                > I agree with you that a good portion of it would seek to find a new
                > invested home in timed deposits, corporate bonds etc. This will
                > cause price inflation in those favoured asset classes at the
                > expense of those unfavoured asset classes.

                But how does this happen at the expense of unfavoured asset classes? Certainly, in the long term I agree. Investment would become much more a free-market type of activity again, and that would guide capital into competent hands.

                But, the situation we have directly after the plan is this…. The balance sheet relationship between on-demand-account-liabilities and assets is effectively transferred into the national-debt-repayment mutuals (see the balance sheets in my article). Those mutuals maintain a similar effect on the broad saving-investment market that determines the interest rate as the commercial banks formerly did. But, on the other hand we have a vast number of consumers holding a vast amount of outside money. The plan relies on them not spending too much of it at the start.

                > The business cycle is smoothed out. Some people have said this
                > Plan is a “magic bullet” Plan, far from it, pain is involved.

                Yes. I’m not looking for a “perfect” way of making a change of monetary regime. I don’t think any such perfect change could be made. Any change will require pain.

                One way some of the problems could be averted is by varying the plan a bit. Let’s say that two month before the plan is implemented every private account holder with >£5K in an interest-bearing on-demand account is mailed. They are all mailed by their bank. The mail explains to them after the plan is implemented they can use timed-savings. If they want, they can put a percentage of their balance into timed-savings. This action will be performed on the day the plan goes into operation. So, if I have £10K on deposit, then I can nominate for 50% of the amount above £5K to go into timed savings, so £2.5K would be nominated. Then, just before the plan is implemented this transfer is done. That would make the split between safe deposits and timed savings at the start much more like it’s long-term state.

                This would mean that at the time the plan were implemented the funds available for paying off the national debt would be smaller than otherwise. But, the chances of significant price inflation would be reduced.

                I’m still not sure what to do about the rise in charges for bank services. Incidentally, on this topic I read a bit of a book on the banking business. That book claimed that normal current accounts are often being used as a loss-leader at present.

                I don’t know how to estimate the effect of the change from the banking services side. After thinking about it more I think the effect may be gradual. Every year a few more people find ways to avoid using paid-for bank services by using debt, and reduce their demand for money a bit.

                > I know you have not said this, but one type of commentator did say
                > that this Plan would be a massive deleveraging process as the 33 x
                > fiat “funny money” is wiped out starving the economy of credit. As
                > you know, with fixing the money supply at the same level as it is
                > today, then there is no deleverage. I am content that what was
                > formerly a demand deposit, quite probably in “instant access
                > savings”, is sufficient saved money to facilitate the ongoing
                > demands of sustainable trade, coupled of course with the existing
                > timed deposits.

                I agree with you about that pretty much. But, I think that the fixed nature of the money supply after the plan could be a problem in the long term. Like the fractional reserve free bankers I’d ask: What happens if there is a sharp rise in demand for money? The only response would be painful process of deflation and depression.

                I know I didn’t mention this problem earlier, that’s because I wanted to get my other points out of the way.

                > Your argument I see as more a refinement of the Plan

                Yes, to some degree it is. Still, I’d be more supportive of a free banking type of plan.

                > and the nagging doubts about “will there be enough loans to fund
                > trade on-going,” is largely answered by this debate.

                What I’ve been discussing here is the situation around the start of the plan. I agree that around that time there wouldn’t be a problem.

                But, I’m not so sure about the longer-term situation. The current fractional reserve banking system makes saving the “default”. When a salary is paid into an account it’s saved until someone withdraws it and decides to do something else with it. That’s not the situation after the plan, holding fiat outside money isn’t really “capitalist saving”. It may be that banks and their customers could work with the limitations 100% reserve enforces and bring the savings rate back to close to where it was.

                What worries me though is that the availability of foreign funds will make that unnecessary. Why should banks work hard to creates schemes of timed-savings for their customers in Britain when they can borrow cheaply from the Eurozone or the US? If they did that then Britain would become much more subject to the effects of foreign central banks.

                > Many thanks for your time and contributions.

                Thanks for listening to my arguments and publishing my article.

                > I will be looking to close the “Emperor’s New Clothes” comments
                > down as I do not think anything more can be added and the comments
                > are now getting repetitive and tedious. I will write up a summary
                > of points and re – issue at some point in the future.

                It’s impossible to read that comment thread without an RSS reader and difficult even with one. I don’t think it helps much if people add more to it.

              • Robert Thorpe Current

                I posted a reply to you, I accidentally put it at the bottom of the page, see below.

              • Robert Thorpe Current

                This is strange I can’t get the threading to work, I posted both of the above posts further up-thread.

  • Paul Green (aka. Traktion) Paul Green (aka. Traktion)

    Oops, that was posted to the wrong place – it was in response to Current’s question.

  • @ mrg

    OK, answer this (which you won’t be able to);

    If Toby’s plan replaces cash with cash substitutes, where does the money appear from to pay off the national debt?

    You can do one or the other, but not both without printing money and increasing the money supply, and everyone knows that increasing the money supply, especially in enough size too pay of the national debt, is inflationary.

    Toby states that after his move, the banks are worth more than they were. By inference, they have no liabilites anymore, and therefore he is not replacing assets, he is creating new.

    There is no way around this problem. Toby is simply printing money, then trying to assert it isn’t inflationary becauuse after the move banks won’t be able to create credit. That, my friend, is utter and total nonsense.

  • I’ve emailed the Cobden centre and Toby to ask him how he reconciles being able to pay off the national debt without increasing the money supply (and by inference, without increasing inflation).

    He won’t be able to – the two are mutually exclusive.

    If he answers, I’ll post his reply here. If he doesn’t I’ll claim a moral victory – hiding behind the internet is simply not good enough.

    Either way, I doubt I’ll be paid the 1000 poudns I’m owed.

    • This is the email exhange Tyler mentions. Start from the bottom and work up.

      “Tyler, you have not read the article or you have not understood.

      I will try once more, them I am afraid I will have to cut off the responses as I am just continually repeating myself with you not understanding.

      Non controversial point in economics and accounting

      You have cash which is money and you have demand deposits which are also money. One is the stuff you have in your pocket, the other is a bank journal entry created ex novo or ex nihilo by the bank where by the bank takes your initial cash and gives you and IOU (shown in your bank statement) that you can trade for goods and services. The first is physical and the second of a journal entry.

      Controversial suggestion.

      Swap the liabilities (demand deposits / bank IOU’s) that function for money with cash which is also money and the liabilities of the banks then become extinguished.

      If this is the case, the net wroth of the bank goes up to exactly the same amount that the demand deposits have been converted into cash by.

      With this newly created net worth, place the difference between the old net worth and the new (the loan or surplus assets of the bank) into a special purpose vehicle whose sole purpose is to pay off the national debt.

      Read a very basic economics text book about the money creation multiplier to understand how money is created, then Freidman (Nobel winner) Program for Monetary Stability, Fisher’s 100% Money , Greatest all all American Economists, Huerta De Sto’s Chapter 9 in Money, Bank Credit and Economic Cycles.

      After that, do feel free to get back in touch, otherwise I can not attempt to make you understand anything on this matter anymore.

      Kind regards,

      Toby Baxendale”

      —–Original Message—–
      From: Tyler
      Sent: 30 June 2010 07:54
      To: staff@cobdencentre.org
      Subject: Cobden contact: The Baxendale plan

      This message was received via the cobdencentre.org contact page:

      Dear Toby,

      Please answer the following for me;

      In your scheme, you assert that you will be able to pay off the national debt. You also assert tthat you plan is not inflationary.

      How do you reconcile paying off the national debt without increasing the money supply (which is, by definition, inflationary)?

      I am pretty (by which I mean totally) sure you can’t, given it is impossible. The two are mutually exclusive without some other intervention. As such, I think you owe me one thousand pounds Sterling.

      I await your response with interest.

      Yours Sincerely,

      TD.

      • OK, so you have just printed money to pay off the national debt. You have doubled the asset base by taking the covering the liabilites of the banks.

        This is the only way you can pay off the national debt in your scheme – printing money, which, by definition, is inflationary.

  • OK Toby, given you have answered my previous question (by stating that you would print money, and then that “value” created would be used to pay off the national debt – somehow you think that this isn’t inflationary) now answer this;

    What is to stop people from other countries putting their money here? Would you cover all those demand deposits?

    What about a bank with legal entities in the UK and elsewhere? Can it transfer all it’s demand deposits to the UK from all over the world (legally it can)

    What about non-sterling demand deposits in the UK (of which there are plenty, by the way)?

    Apart from the obvious and previously stated problem with your plan (that it is just printing money, which by itself cannot create new value), you also don’t seem to understand the dichotomy of what you are suggesting – you are trying to fix the money supply and control credit leverage (which is closer to x5 in real life than the x33 number you use) yet you are doing it by *increasing* the money supply.

    You don’t seem to understand that FRB is not the only mechanism which can alter the money supply, and the money suppply is never fixed. As such, you wouldn’t just end up covering demand deposits in the UK, and there would be no way to stop people using the system multiple times to make themselves billionaires overnight.

    Alternatively, you put the newly created money in government controlled mutual funds, which then pay off the natioanl debt. That “now you see it, now you don’t” magic trick doesn’t work either (in real life, it’s called inflating your debt away).

    Very simply, under this system, all demand depositors are still whole, yet now all Gilt holders are also whole, whereas beforehand the Gilt holders were not. If that isn’t creation of new money, and increasing the money supply, I don’t know what is.

    Again, I doubt you will acknowledge it, and I doubt I’ll get my 1000 GBP, but there are so many holes in your idea that it is simply laughable.

  • During the recent financial crisis, real estate loans caused billions of dollars in losses. How are new investments in real estate loans any safer?

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