The Emperor’s New Clothes: How to Pay off the National Debt & Give a 28.5% Tax Cut

I offer a £1,000 reward for anyone who can tell me why this logically won’t work, practical politics, for now, being another matter.

What follows is an attempt to show you that this can be done.

Remember the story about the Emperor whose only concern was not the welfare of his people but the state of his clothes?  Lacking a new outfit for his procession, he instructs the finest clothe-makers to propose designs.   Step forward Slimus and Slick, promising that only clever people will be able to see their splendiferous garments; they will be invisible to anyone stupid. In exchange for gold coin – real money – they make something special for the King. The King, seeing nothing when presented with these designs made out of thin air, worries that he must be stupid because he pretended to the fraudsters that they were wonderful. Word goes round that only clever people can see the garments, so everyone cheers the naked King during his procession.  It takes a small child, on top of his father’s shoulders, to exclaim: “the Emperor has got nothing on!” Everyone falls silent. Then, one by one, they start muttering, “the Emperor is naked!”

I am going to tell you that our Emperor – the government – has no clothes and is indeed naked with respect to our money. The sooner we realise this the better.  Then we can make real progress and prevent the imminent misery. Indeed, the realisation of its nakedness should reveal that we have a unique moment in history to do something very special: to make banking secure, pay off the national debt, and even enable a 28.5% income-tax cut.

We all know what notes and coins are: money, or cash.  It allows us to exchange the fruits of our work for the goods of others. When we deposit cash in Bank A – say £100 – we lend this money to the bank. This may come as a surprise to most, as we think what we deposit in a bank actually remains “ours” beyond this point.  But as soon as you make a deposit it becomes the bank’s i.e. “theirs.” They then lend what is called credit of £100 to an entrepreneur, who banks it in bank B. Like magic, we now have you, who have a claim to “your” £100, and the entrepreneur, who also has an equally valid claim to “his” £100. This happens 33 times for every £100 deposited in the UK economy on average, meaning that for every £100 deposited, it is lent out to 33 people. Some of the banks did this up to 60 times. This cash cannot exist in two places at the same time, let alone 60 places at once. So what bank A does, is write you an IOU. Yes, your bank-statement is a mere IOU, the bank saying “ bank A owes you £100 on demand.” This is called a demand-deposit. We now see that demand-deposits are created out of thin air! Indeed, these are just ledger-entries from one bank customer to another.

Tesco groceries can be paid by electronic transfer. All we are doing is moving our bank’s IOU to Tesco’s bank in exchange for their groceries. This is how the world works.  Do we care that we are buying goods and services out of thin air? Like the Emperor, does he care – as long as all believe he is clothed? Well, the customers of Northern Rock did. So when more than a small percentage of them asked for their IOUs from Northern Rock to be repaid – or, as they thought, for “their” money back – it could not be, as the bank had already lent it many times, making it impossible to reimburse all they owed. Indeed, if the government had not pledged to underwrite all deposits, then there would be a very good chance that the whole system would have collapsed.

If we accept that the Emperor is naked then the path to solving all our current financial problems becomes clearer.

Consider this following programme of reform:

  1. Print cash and replace all the demand-deposits/IOUs that exist in the system with that cash. This means the government printing approx £850 billion in cash and injecting it directly into the vaults of the banks and into the accounts of individuals. Thus, if you deposited £100 once thinking it was “yours,” it now really exists in cash, with the bank acting as custodian of your money.
  2. Mandate all banks to hold your cash (100% reserved) on demand at all times.
  3. Wipe from the bank ledgers all the demand-deposits/IOUs as banks would not owe you money anymore. This means the “thin air” money disappears, to be replaced exactly with cash money.  Note: this is not inflationary, as the cash replaces the demand-deposit which acted as money. As we have established, it is only thin-air that the banking system has created to facilitate the multiplicity of lending of the same bit of money, so its total replacement with cash would mean the money supply stays exactly the same.
  4. Require all banks to lend real savings that people knowingly place with banks to lend to businesses to get a return of interest and capital back when the business repays that loan. This is nice, simple and safe utility banking. This is what Mervyn King advocates.
  5. As you are not a creditor of the bank anymore, the banking system will only have its assets and its capital, i.e. no liabilities. This means that there never again could be a bank run.
  6. As for the banks, not having you the depositor as a liability anymore, they will suddenly be £850 billion better off, with no current liabilities and only assets (loans to business etc), post reform. The government can now put those assets into Mutuals, which would then immediately pay off the national debt, and leave the banks in exactly the same position net worth wise as they were prior to the reform, owned by their existing shareholders. As the national debt is still just under the £850 billion, which would be available as surplus assets of the banks, this could still be achieved.
  7. No national debt means no interest costs (currently £40 billion p.a) associated with paying for our borrowing. Therefore, give an immediate 28.5% income-tax cut. Total income-tax raised is £142 billion.

The boy in the story stood on his father’s shoulders. I stand on the shoulders of great men who have advocated part of this reform: Irving Fisher, the greatest American economist, the Nobel Prize winners Soddy, Hayek, Buchanan, Tobin, and Allais. Recently, Kotlikoff of Boston University has published an excellent book, “Jimmy Stewart is Dead” advocating a similar reform. It is endorsed by more Nobel Winners: Akerlof, Lucas, Fogel, Prescott, and Phelps. I count 36 endorsements from the great and the good for the book. All endorse Kotlikoff’s move to what he calls Limited Purpose Banking which is another way to get 100% reserved (i.e. secure) deposits backed by cash rather than thin-air.

The Economist Huerta De Soto, in “Money, Bank Credit & Economic Cycles,” has seen the opportunity that presents itself to reform for 100% money while also paying off the National Debt. Following on from this, I suggest a substantial wealth-creating tax cut for the people. Just like the boy in the story, I do hope that people start to realise that the emperor really has no clothes, and that an enlightened approach can address this.

463 Comments

  • AMcGuinn says:

    It logically won’t work.

    The reason is that you can ban fractional-reserve demand-deposit accounts, but banning maturity transformation is harder.

    There are lots of ways the ban could be circumvented, but the easiest would be something like Money Market accounts that they have in the US. You buy shares in a company, and the shares pay frequent small dividends and keep a constant share price. The company or its associates are always prepared to buy or sell the shares at the fixed share price, and it pays the dividends by investing most of its share capital in short-term debt (30 or 90 day commercial paper).

    Without the competition of bank accounts, such structures would become the norm. In time, for convenience, people would accept transfers of shares in such a fund as a method of payment, to save the overhead of redeeming and reinvesting. They would become the practical currency.

    In itself, that would not be a bad thing, as the funds can write down the value of the “accounts” without going through formal insolvency, since in theory they never had a fixed par value in the first place. The system is a more honest form of fractional-reserve banking. But combined with your buying-out of existing accounts, you would get the inflationary effect that you’re trying to avoid.

    If you ban the funds too, the market will find a more indirect way of achieving the same thing. Formally, the fund is just a public company that has found a way to pay a reliable dividend and keep a stable share price. They could pretend to be carrying on some business other than moneylending if it would help them legally.

    • To AMcGuinn
      I am glad you have understood most of what I have said and I thank you for your comments. You have made a useful contribution by saying that a money market funds would essentially come into being and the shares would trade as a new type of paper money. This could then be a form of a fractional reserve bank you say. So I ask, if mutual issues more shares and takes no funds in, then the value of the existing shares is reduced right? So there is no fractional reserve here, just a dilution of the value of the shares of all the people who have put money in. The underlying cash is still 100% reserved. Over issue of new shares that traded as a money substitute would be short lived as existing shareholders would be up in arms. Competitor funds would have the incentive to “rat” on their competitor and force client redemptions in the competitor fund. The classic fractional reserve advocates called this the “reflux mechanism.” A simple law could be enacted saying new shares only issued at par value when new money is introduced to the fund. Then you will have 100% reserved cash and shares that could not be over issued. This will avoid any inflation. My proposal still works.

  • Current says:

    I’ll take you up on this, I think you know some of my views from my discussion with you on the Coordination problem blog.

    However, it may be best to do this “off the record” with email rather than in blog comments. I would appreciate if you could email me your email address, I won’t pass it on. My email address should be in your blog software because I’ve given it here.

    But, if you prefer I’ll post in these blog comments.

  • Felix says:

    There must be a reason this wouldn’t work. If it did you could simply march into downing street, explain your full proof plan to Mr Cameron, have the plan enacted and be declared a national hero this time next week. There, I’m cynical.

    I seriously fail to understand how printing £850 billion would not be inflationary. Is it because the money is simply used to replace the numbers of the bankers computers with a real store of money? Even if this is the case, if inflation is a monetary phenomenon surely there would be massive inflation.

    2ndly, the problem with ending fractional reserve banking is surely that it entails a massive restriction in the credit available in an economy. If banks can only lend what they have, then they will lose out on 32 more customers as they currently lend 33 times their balance sheets. Surely this would lead to massively lower economic growth?

    3rdly, I fail to see how we can move from a situation were we are massively indebted to being able to pay off the national debt overnight. Is this simply not a clever accounting trick? Real wealth has to be created, it cannot be ‘magicked’ out of thin air (which is surely what printing all this money does), so how can we go from enacting massive public spending cuts to being able to slash income tax?

    • To Felix:

      I appreciate your sense of humour . Thank you for reading and commenting. The Founder of American Monetarism, Irving Fisher and that country’s greatest economist, recommended something similar in 1935. Huerta De Soto did so in 1998. These are not mice in the world of economics, but giants.
      You say “I seriously fail to understand how printing £850 billion would not be inflationary. Is it because the money is simply used to replace the numbers of the bankers computers with a real store of money? The answer to this is Yes. Therefore we start with £850 bn of money and we end with £850 bn of money, we have just changed the mix from being cash and demand deposit to cash only. Not inflationary.

      Concerning your second point, credit is created out of thin air, as we have described, and it leads to boom, followed by bust. It implies that the boom is where entrepreneurs are making error. This is because too much credit is being offered to produce goods and services that people do not want; when this happens and people realise they do not want to pay the new higher prices for the goods on offer, the bust happens. So when borrowing has to be done only out of saved money, or if you like saved purchasing power, you have a match between lending to produce goods and services and making sure there are enough savings to buy the new goods and services. So yes there will be less credit, in fact none and no credit-created boom either. However, there will be real lending based on what people have put away in savings that will eventually buy the goods and services that the lending has initiated the production of. So I like to think of it as a matching of investment to what people want, also an elimination of credit-induced boom and bust. Timed lending represents over 50% of all borrowing in our country today. So no doom and gloom. Yes, less excitement as their will be no Dot.com massive silly money booms, just real enduring entrepreneurs doing real deals to supply real goods and services as they have done throughout history and will do in the future. If you have any doubt that we would not have a dynamic economy – think about the Industrial revolution. This was not built on credit fuelled money.

      Concerning your third point, I would like to encourage you to think that the accounting trickery has actually been played on you already, and that I am just actually proposing a “straightening up.” That is why I use the Emperor’s New Clothes analogy. When you look at your bank statement, it is an indisputable fact that you are a creditor to the bank (it owes you “your” money). If you know credit has been created 33 times with your money, it cannot be in 33 places at once. Therefore, what you see on your bank statement is an IOU from the bank to you. Thus what I propose is yo swap these IOU’s for cash that you think is yours anyway and retire, delete, vamoose the IOU’s from the banking system at a push of a button as they will be very happy not to owe you anything. Thus the bank only has assets and its capital now. With that newly revealed uplift in the balance sheet net worth, you have the opportunity to pay off the national debt.
      Please get back in touch if this does not answer your questions.

  • Tom says:

    Wait a minute! There is no value store in cash. Cash is itself an IOU. The value is on the balance sheet. Or not, as the case may be.

    Unless you dig gold out of the ground, your cash deposits themselves come from fractionally guaranteed bank disbursements. Would you buy them for cash at full value, or at their spurious fractional rate?

    Banks fractionalise other assets too, like mortgages. These are also used to back demand deposits. Would you accept the face-value of balance sheet assets of each bank? Do you believe the valuations? If dodgy values are offered as fractional reserves, how do we escape inflation just by exchanging them for printed cash?

    By offering low base-rates, the Bank of England is giving banks an opportunity to accumulate cash from their customers. This enables the banks to write off debt and build up their balance sheets. It is not quite as dramatic as your suggestion, but does it not move things along in the same direction? And if the currency loses value at the same time, well, that only eases the burden of debt too.

    Interesting suggestion and thread. Ten years ago almost nobody knew where money came from. Now it is discussed like football.

    • To Tom:

      Cash has value; I can go with the printed cash to a store and use it as the final good in exchange for other goods and services. I can do the same with a demand deposit created out of nothing. So it has real value to me.

      If the legal tender law was abolished, within days paper money and demand deposits I am sure would be competed away by people wanting to hold some tangible value i.e. some kind of commodity(s). In a 1200 word article, I chose not to talk about this, however I do think the tried and tested way to secure purchasing power and to stop governments devaluing our purchasing power is to have some commodity-based money.

      If you are suggesting that a bank may have in its balance sheet a series of CDO’s, CDS’s and a whole host of other things that have been used as security to back up the creation of all demand deposits, then I would still say swap for new minted paper money and let whatever these assets are worth contribute to paying off the national debt. Only time will tell how many “wonky” securities are in the system backing demand deposits.

      I would also like to point out, our very own Bank of England owns just under £200 bn of the national debt, so at a flick of a computer key that could be wiped out of existence.
      We as tax payers are paying interest to the Bank as another way for the government to extract wealth from us without us knowing about it! This could give a cushion should the assets not do what they say they will do on the tin.

      If we let the banks over time move to a total cash reserve at the rate they are going, it will certainly not be in your or my life time. Also, credit-created boom and bust will still exist. Governments being able to monetise debt will still exist, etc.
      Thank you for your comments.

  • Bill Woolsey says:

    The plan is needlessly complicated.

    It amounts to printing up currency to pay off the national debt. This increases the quantity of base money tremendously. Ceteris paribus, it would create hyperinflation. But requiring 100% reserves for all transactions accounts increases the demand for currency. Baxendale reports that the numbers happen to work out so that the increase in the the quantity of currency would match the increase in demand.

    The 100% reserve requirement would require all the banks to sell or collect on all their existing earning assets and replace them with currency. However, all of those people who used to hold the government bonds now have money to lend. They will put the money into these new “mutual” institutions, purchasing the liabilities of these institutions, and those institutions will make the loans the government used to make.

    The problem with the scheme is that holds money in a bank will have to pay fees to the bank for storage. Since currently, at least some earn interest on there bank deposits, the demand for those deposits will fall. And so, the effect of the policy will be inflationary. To counteract that, the government would need to sell government bonds. The buyers of the government bonds will pay for them with transactions accounts and the banks will give up currency to the government–withdrawing it from circulation. How much this must be done depends on the elasticity of the demand for money for its own interest rate which is going from slightly positive to slightly negative.

    There would be much stronger incentives for banks to develop highly liquid assets that pay interest. Regulators would have to constantly fight financial innovation aimed at avoiding this draconian regulation. For example, in the U.S., we have eurodollar accounts and repurchase agreements. Basically, a “non bank” or “shadow bank” holds a transactions account at an offiicial bank to have access to the payments system. It issues interest bearing overnight debt. When its lenders need to make a payment, the nonbank or shadow bank transfers funds to the official bank depostor just in time to cover the balance. The overnight funds (coming due every day) are paid off the needed amount.

    In the U.S., these schemes were developed to avoid the burden of the minimal reserves and the zero interest ceiling on transactions account. To avoid 100% reserves and negative interest (storage fees) the process would stronger.

    Of course, the government could ban this sort of activity. If it is not banned, then the demand for “official” bank transactions account would drop a great deal more. The government would have to sell bonds and retire currency to avoid inflation even more.

    In my view, prohibiting this activity would be a wrongful interference in freedom of contract. In my view, before long, “nonbanks” or “shadowbanks” would simply replace the existing banking system. The demand for currency held by “official banks” would fall to something like current bank reserve balances. The “shadow banks” would have all of the real monetary liabilities for the public. They would hold deposits in the “official banks.” The “official banks” would hold all of their currency on deposit in clearing banks. The national debt would be exactly where it would have been.

    But that depends on allowing freedom of contract. If, instead, the government suppresses shadow banks, then it can maintain the demand for the liabilities of the “official banks.” And that means the demand for its currency. And that means reducing the amount of bonds it must sell.

    The entire reform amounts to using government regulation to compel zero interest loans to the government by everyone who currently uses banks.

    One final note. I am not familiar with British statistics. In the U.S., banks issue CDs and saving s accounts, as well as transactions accounts. Is the 800 billion figure total bank liabilities? Or is it just transactions accounts?

    • To Bill Woolsey

      Bill, you say that all I would be doing is a big print run to pay off the national debt and this will create hyperinflation, I would like to know how?
      If you swap a demand deposit for the same exchange value as cash, where is the increase in the circulating medium of exchange? I swap £10 of demand deposits for £10 of cash right?

      Remember if the demand to hold cash balances goes up and the same goods and services are still demanded, less cash will compete to buy these goods and services meaning that the purchasing power of those money units will command more goods and services. If it goes the other way, the opposite happens. So no hyper inflation, just the normal adjustments to changes in demand and supply happening in the market economy.

      The 100% reserve requirement suggested here DOES NOT SUGGEST THAT BANKS HAVE TO COLLECT IN THEIR INTEREST EARNING ASSETS! The whole thrust of what I say is that these surplus assets, that would be created by deleting bank current liabilities can be placed, as they are, with all their different maturities in a mutual to run alongside and be administered by the said banks to instead of paying off the bank, it would not need to, as it does not have the corresponding current creditor, but to pay of the national debt. The banks net worth stays EXACTLY THE SAME.

      I take your point re “shadow banks” but if the normal commercial law is enforced that I and all other business people work to, that you need to always provide for your current creditors, then they will only be allowed to function so long as they get an audit sign off that they are solvent. I am happy with that on the whole.
      The £800 bn plus is demand deposits only. Timed deposits are £900 bn

    • Current says:

      I agree pretty much agree with Bill Woolsey. I’ve written a longer description of the problem and sent it to Toby Baxendale by email.

    • Current says:

      Bill,

      Is there a book or paper that deals with the criticisms you’re giving?

      I can’t remember having read exactly the argument you’ve put above, but I’ve read something similar.

  • Bill Woolsey says:

    Oops. An error.

    The people who used to lend to the government will lend to the mutual institutions. They will in turn lend to the people that the banks used to lend to.

    Those who used to lend to the government will now lend to businesses and households who used to borrow from banks.

    Those who lend to banks (by holding their deposits) will instead be lending to the government.

    The interest rate they get from the government will be zero. And they will now pay storage fees to banks, and so they will earn a negative rather than positive yield.

    Exploiting people like this will require regulations to prohibit alternatives. To obtain the zero interest loans, the government will have to prohibit competition.

    The regulations could be directly on the official banks. Suppose, for example, that financial institutions that regulators deem to be borrowing in ways that seem too “deposit like” would be prohibited from making wire payments from “official bank” deposits.

    • To Bill Woolsey

      Once again, I struggle to detect the error suggested.

      So, the good news is that you agree that instead of lending to the government, which is a massive beast sitting in the debt market soaking up money and crowding out parts of the private sector; the private sector will get more money for investment. This is a fantastic part of the banking reform process. More to the private sector, less to the Leviathan government!

      You then say people will have to lend to government to get an interest rate. Why would they not lend to a bank to lend to business to get an interest rate? I am not understanding where you are going here? A 100% reserve bank is very much a lending and interest paying bank. I think you seem to think it would be some static safe deposit box type bank and this does cloud your mind with every comment you have ever made on this site. With lending the lender relinquishes immediate ownership to the borrower in exchange for interest and capital back at a later date. What is wrong with this? Why would this not exist in a 100% world?

      Once again in a 100% reserve world;

      1. You can deposit money and keep it in a safe. There will be limited appeal to this, only for people who really want no risk whatsoever. I would think this would be a small part of the business of the bank.

      2. If depositors want a little interest, they invest in short dated timed deposits. If they want a bit more, then in medium dates. If they want a lot, they invest in long dated timed deposits.

      3. Depositors want big risk and potential big upside, invest in a mutual structure, run by the banks, insurance companies, hedge funds, etc where you own shares in the vehicle that invests in more risky enterprise, insulated from 1 and 2 above, so if it goes bust it only goes bust on itself. No system-wide bank runs are possible.
      100% reserved banks can do pretty much everything they can do currently except create credit ex novo!

  • Dave says:

    I’m generally in favour of your argument, but there is one flaw that I can see, which is based on people’s psychology so I’m not sure whether you’d class it as ‘logical’.

    As Felix mentioned, and you acknowledged, the plan would involve a restriction in available credit. As you mention, this would largely be a good thing since credit would come from savings deposits. Credit would still be available for entrepreneurs, but less credit for speculation and the sort of credit-fuelled booms we’ve experienced in the past. The problem comes down to the housing market. The reduced credit would mean significantly less mortgage lending, and this would result in large house price falls.

    Psychologically, people in the UK equate potential housing profit in the future with wealth now. Under your system, this psychology would change but not overnight. Unfortunately, the house price crash would happen much sooner than a psychological change. As people see the value of their house diminish, their assessment of their financial being will fall too. The outcome would be a crisis of consumer confidence, and almost certain recession as a result of demand contraction (people who think their net worth has just crashed aren’t going to spend). The material benefit of a tax cut and eliminating national debt is not going to outweigh the psychological impact of the house price crash. The house price crash would be exacerbated by the necessary higher interest rates to encourage increased saving deposits required to provide enough capital for lending to entrepreneurs etc.

    A major recession would actually be necessary to avoid inflation, because if housing costs reduced whilst wages remained stable (or increased) the extra disposable income would certainly be inflationary. The recession would be required to hold wages down in the short to medium term.

    I am not saying that the system won’t work in the long term, or even that the house price correction and elimination of property speculation aren’t to be welcomed (as someone yet to get on the housing ladder and without wealthy parents to help me I’d be delighted!), but the impact on house-prices and interest rates in the short to medium term (before people adjust to the new system) would almost certainly create a recession so surely this is a flaw?

    • To Dave

      Thank you for taking the time to read and the thoughtful comments.

      The benefit of doing this reform is that the money supply is then static i.e. no money deflation can happen unless you physically start burning the cash and not replacing it! This means what the money supply is holding up i.e. one example being house prices, stays as is. We could adopt a Friedman style money supply + 2 % each year to keep it growing. I do not support that by the way long term, but it could be a good interim measure.

      As no asset prices can fall via a money deflation, the prices can only fall if there is less demand for the available supply. As I do not think there is a demand and supply problem in the UK on houses, I believe this event would not happen logic or psychologically. Stopping money deflation is a big plus point of this reform. It allows us to almost press the “reset” button on the whole system.

      The converse of this argument is that you should allow a deflation before you do this and a realignment of capital (this would favour you who is not on the housing ladder yet), however this will ruin many innocent people. I could not countenance that. It is very hard indeed, but not blowing people away now or letting a money deflation, which we are in now, is not acceptable to me.

      • Dave says:

        Toby,
        Thanks for your response. Apologies if I am being dense, but I’m not sure you’ve addressed the main issue re house prices. I agree that under your system there would be no monetary deflation, and in the medium term this would act to stabilise house prices.
        But on day one, the money in demand deposit accounts (which banks can lend on if they choose) is now held as cash reserve accounts (which banks can’t lend on). This will immediately cause a credit crunch. Since demand for housing (in terms of house purchases) is dependent on the supply of credit, this can only result in fall in demand for housing, which results in falling house prices. Over time, people will adjust and at least some of the cash previously held in demand deposit accounts will under the new system move to savings accounts where the banks can lend it on, but i guess the average joe will be more risk averse than banks, so I think there would still be less credit available under this system even in the medium and long terms. Before people can adjust to the fact that their house isn’t worth £600k, or even close to it, there will be a consumer confidence crash.
        Also, interest rates would have to rise at least in the short term, to encourage people to deposit cash in savings accounts (to be available for lending), but this in turn will affect demand for credit. I’m very much a free marketeer, and trust the market to find its equilibrium, but it’s going to take time, and during that time there will be pain.
        I don’t think there’s any medium or long term reason NOT to switch to your system, but people have been living for so long under a radically different system, that essentially causes them to treat access to debt as a measure of wealth (which is really the huge flaw in the current system) so the switch away from that is bound to cause some short term pain.

        • Evening Dave,

          No dense comments from you at all, far from it.

          To be clear, from the very second of reform, there is no money deflation, so it is not a medium term or long term fix, it fixes it there and then.
          Demand deposits will not exist, custodian accounts and timed lending will. Many years ago, before they were crowded out by fractional reserve lending, insurance companies, life companies , mutual companies, friendly societies, building societies etc used to be the source for mortgage funds and they had long term savings (for life in the case of life companies) to maturity match with long term mortgage lending. You cannot compete with a fractional reserve lender. Why? With legal privilege to not have to provide for his current creditors, he can spend that money, coupled with lender of last resort and no reserve requirement, he can create money out of thin air many times over and seem to offer it out cheaply etc. So the former system has been replaced over time by the latter system.

          With a stable money base, change will hopefully be smooth. Needless to say, I could not guarantee it. One thing for sure is that if you are a credit worthy borrower, you will be able to borrow funds as someone will want to live off the interest. I suspect people at the margins, those with low incomes, bad credit ratings etc will find it harder. This by the way is quite right as they will not be responsible enough to discharge the debt burden that currently fractional reserve lenders are happy to bolster them up with.
          Transition is never painless that I know, but a dam sight less painful than living through a credit fuelled bust I suspect.
          With regards to interest rates going up I would suggest you think about this;

          1. Human beings act.
          2. Humans act purposively. If they tried not to, they would be acting with purpose. This is the starting axiom of economics for the great teacher of Hayek, L von Mises.
          3. We all act to satisfy our most urgent needs; indeed we rank these and do the most urgent things first.
          4. We demand present goods now more than we do in the future. There is thus a spread between what we are prepared to pay now today for our present goods and what were are prepared to pay for future goods.
          5. Each one of us has a different time preference for jam now or jam tomorrow.
          6. I may have accumulated many goods, and have surplus money or purchasing power to have command over more goods that I do not need now, so I lend them to someone like you who has a thirsty time preference to buy a house to have now in exchange for that purchasing power and interest back (more purchasing power) at a later date.
          7. This spread between goods now or people savings for goods later IS the interest rate.
          8. The money market rate is one part, the most obvious part of what the interest rate is.
          9. I as an entrepreneur offer my current goods, meat and fish in exchange for money as we all offer what we do for money, the profit being the interest for which I do this and everyone else does.
          10. The rate of profit in society is interest.

          So if we have a base rate of 0.5% and inflation at 5.3% as we have today (RPI) then we have negative real money rates of interest. This would seem to reverse the logic of above!!! This means people are happy to put money away today, forgo consumption now and get back less later!

          Continuing a policy as daft as this will encourage less lending and more consumption only. This is the perversity of letting a government decide what an interest rate is.

          The reality is the money rate should approximate to the rate of profit in society. Better still, with no money deflation or money inflation, finally we may well be able to get government out of doing things like setting the money rate of interest. As you say you are a free marketer, you will be against the state planning of the money supply and its attempts to control the rate of time preference (interest) in society. Yes, interest rates will rise and more money will be available for lending and society’s average rate of profit, or the natural rate of interest.

          • Dave says:

            Toby,

            Thanks for your response. I agree with most of what you’re saying, my only disagreement is about the time it would take for people (and by extension the system) to make the adjustment, and the pain involved in the short term.
            Yes, people want interest so will put money into accounts that can be used for lending, but will they be sufficiently aware of the way the new systems operate to deposit in those accounts straight away, and don’t you think it’s likely individuals will be more risk averse (with their own money) than the banks? And the insurance companies and other potential credit providers will take time to enter the new market. Either way, short term at least, you’re looking at a credit crunch.

            Also, you’re right that under the present system non-credit-worthy people are getting mortgages and this would be eliminated under your system and that this is a good thing. However, because its a good thing in that it reduces some of the systemic risks, it doesn’t mean it’s not going to have some negative short-term impacts too. The access to mortgages these people is part of housing demand, and if they no longer have this access demand (and thus prices) falls. The price fall is exacerbated by the reduction in property speculation that would itself be a product of the new system (and another good thing in the medium and long term, but not without short term pain to some.)

            As I say, I’m a supporter of your system, and my objections may not be enough to land me a grand, but i do think you’re under-estimating the short term pain the adjustments would cause, and over-estimating the speed and ease with which individuals would make the practical and psychological adjustments to the new system. (It’s a long time since I studied economics, but I have always been struck that the ‘rational actor’ of economics textbooks doesn’t quite tie in with the living breathing humans around us!)

            • To Dave

              It might be helpful if you hold in your mind the government has sucked £400 bn in the last parliament out of the system by its insatiable appetite for debt. The investors in this debt , insurance companies, life companies, pension funds, clients of investment bank etc would no longer have a “risk free” debt provider. All this money will look to be placed where it can get a return.

              Why would not the granting of mortgages become a good opportunity for the former lenders to the state?

              Income tax raises £142 bn this year, so I hope £400 bn does look like a big number to you for potential available lending.
              So I do doubt very much a lack of funds to support business and individuals.

              Also, with a fixed at the point of reform money supply you cannot have a money deflation or inflation.
              I accept that credit worth people have been bid up by banks intoxicated with credit providing funds to sub-prime borrowers so then yes, post reform, prices will come down as these people will not be there anymore for the type of property they were looking at.

              I would see a lower degree of disruption than you for the above reasons.

              I agree – the rational actor is a fiction by lazy economists who should know better. He makes their mathematical models look elegant as he only does the rational thing. We all do not act that way.

              • Dave says:

                Toby,

                sorry to keep posting but I just spotted your response to my last reply.

                “Why would not the granting of mortgages become a good opportunity for the former lenders to the state?” – I’m not saying they won’t but the key is ‘become’ I’m not convinced the switch will be as quick or as painless as you, but ok I’ll give you the benefit of the doubt of that one.

                I still don’t see how you’re going to deal with the 97% of the salary paid in my current account each month, which is currently available for lending as soon as it reaches my account. i’m never going to put all of this into a savings account, because i need it. yes it will re-enter the system but not so quickly, and the velocity of circulation is as important as the money supply in terms of inflation/deflation isn’t it (or am I mis-remembering Friedman?) There can only be a credit-crunch and short term pain.

          • Dave says:

            I think, in more technical monetarist terms, i think your proposals focus too much purely on the money supply, and underestimate or ignore the short term impact on the velocity of circulation.

            even if the money supply remains stable, if the velocity of circulation decreases (which i am certain it would in the short term) this is still deflationary.

            • Dave I think we have answered this in other posts when we debated this with you and the commentator Current – do get back to me if you are a different Dave and need further information, I will be happy to supply.

          • Current says:

            Dave, why do you think V would decrease?

          • Current says:

            Dave,

            Ah, I see why you think V would decrease, I’ve read your other posts now. I quite agree that V is the problem.

            The problem is more that it will increase though, rather than decrease. In you example you are paid at the beginning of the month. Under the current system your balance is a loan to the bank which then loans on to someone else. Because of the income generated by these loans the bank can provide its services to you without cost and it can provide interest.

            Now, after the reform you must invest in a bond (or some sort of term investment, or equity) to get interest. So, you
            exchange money for a bond. You will exchange the money for an investment certificate much more quickly than you did under the previous system. That money then goes from the bank into the deposit account of a business that needs it. Like the other deposit account this account pays no interest. So the managers of the business are in the same position you were in. They must spend the money or continue to pay a cost to hold it, just like you. Just like you they now have more reason to spend it than they did formerly.

            So, the system creates an increase in V.

          • Dave says:

            @Current,

            sorry, but i don’t see how the velocity of circulation could increase.

            if i’m paid 1000 a month, immediately 970 can be loaned on under the current system

            under the new system, nothing can be paid on unless I specifcally move it to a savings account (or bond). but i’m not going to do that. i need it to cover current (i.e. between one salary and the next) expenditure. so this 970 pounds will circulate much more slowly. Ok, I might save 300, but there is still another 670 that is available for immediate lending under the current system that is only going to become available over time (as and when i spend it).

            hence a decreased velocity hence deflation even with a stable supply of money.

            • Evening Dave,

              Velocity is a meaningless concept. To a mainstream economist , if I sell you my house and you sell it back to me and we do this for 10 times, the mainstream economist will say velocity has gone up, this means more economic activity is happening! This means recovery or boom, yipeee!

              Velocity if anything is a derivative of demand, it can not be defined as a separate variable. Mises called this the Money Relation. If your demand to hold cash goes up, it implies that your ability to spend money on real goods and services goes down.

              During the month under the current central bank fractional reserve system your money relation is the same and under 100% reserve your money relation stays the same .

              If you do a search for my articles on explaining the errors of Quantitive easing on this web site , which is routed in the Quantity Theory of Money, which is just a tautological proposition, you will see that when you bin this from your mind and use the centuries old Equation of Exchange favoured by the likes of Mises, the clouds of mist may start to part for you concerning this one and your concern re a fall in velocity. This happened to me in my mid 20’s when I decided to uneducate myself from all the rubbish they tried to teach me at Uni on this matter.

          • Current says:

            I agree with your concerns. I think there are some problems with the details of your analysis.

            The fractional reserve banking system works like this. The depositors provide a large pool of liquidity to the bank. Transfers happen into the accounts of the banks depositors and transfers happen out of those accounts. There is a difference between the two that must be rectified by the bank by transferring money (reserves or assets) to other banks. But, mostly, the pool of funds remains a similar size. When you are paid £1000 that doesn’t mean that the bank then lends £970 out after that. Rather, the bank has a large pool of depositors, it estimates how much of that pool it can rely upon at any given time, and from that estimate uses those funds to make loans. There is no direct mechanical connection that implies that £1000 of deposit leads to £970 of loans afterwards. When you deposit £1000 in your bank account on monday and take it out on friday the bank doesn’t respond to this by lending £970 on tuesday and ending a loan on friday. Rather it estimates over all of its clients how much in funds it will have at any time. It sets up loans with repayment times that are quite independent of what’s going on with the depositor side.

            You are thinking here of the description of the money multiplier. The point of the money multiplier is to establish what happens when the money supply is increased by the central bank. In that case £1000 enters someones account. We then say that the bank can lend £970 out. That’s because the money injection that the central bank applies is normally so large that it immediately affects the pool of liquidity that each bank possesses. The money multiplier is a way of understanding how the movement from money stock X to money stock Y occurs. It doesn’t describe how banking operations occur on the day-to-day level. The money multiplier process isn’t a major cause of velocity of circulation V.

            Now, after the change there is no fractional reserve banking. Previously there was what monetarists call “M1”, what Toby calls demand deposit money and what the Austrians call “fiduciary media” or “money subsitutes”. After the reform there is only fiat money, there is only what the monetarists call “base”. This fiat money is nobodies liability it is just token. It is unlikely demand deposits, those act as a pool of liabilities which match a pool of assets.

            Your complaint is that if this is done then the funds available for lending will be seriously decreased. I agree entirely and this is a big problem, it will seriously decrease funds available for lending. But, it isn’t going to cause a decrease in velocity of circulation of money.

            Currently people are incentivised by interest to keep money in demand deposits. When the reform occurs though no interest will be paid, fees will be paid instead. But, interest bearing bonds will still be available. So, people must pick times when they want to invest in bonds. In many cases this won’t be difficult. But, much potential investment will be lost because there are many times when people are not aware that they are able to make an investment, or the costs of doing so directly are too high. You give the example earlier of the time period between recieving £1000 in salary and spending it. The loans that could be made with that forgone consumption cannot be made under the new system. The individual is forced to make the maturity matching decisions that the banker once made for him. This is a real loss, but I don’t think it’s the biggest problem.

            Because of the storage fees deposits must have after reform, large amounts of money will be spent on bonds. When that money enters the bond market investors recieve it they will be in the same situation as the previous owners of the money. In any case, when any agent owns the money they will realise that it pays less interest than the old interest-bearing demand deposit money did, and act accordingly by spending it (on investments or goods) more quickly than they would have done otherwise. It’s essentially a different type of money. These non-interest bearing deposits will circulate much faster than the old deposits did for the reasons I mention, that will drive price inflation higher.

            • To Current

              I agree with all you say except re velocity. I would urge you to consider the other comments I just made re the Quantity Theory and QE.

          • Dave says:

            I’m sorry Current, but I really think you’re getting the choices people would make under the new system wrong.

            ok, so right now if i get 1000 in my account the 970 isn’t guaranteed to be lent, but it’s available to be lent, and thus forms part of the pool of liquidity.

            under the new system, 1000 is put in my account and isn’t available to be lent and thus isn’t part of the liquidity pool. now, say i pay 300 into a interest bearing saving account, this does form part of the liquidity pool and is available for lending.

            of the remaining 700, under the old system there would be 670 of it forming part of the liquidity pool but no longer doing so. i need this to cover my rent, travel, food etc, and no incentive to make it available for lending (in the form of interest) or disincentive to leave it unavailable for lending (in the form of fees) is going to persuade me that i don’t need a roof above my head, or food on the table, or to travel to work. so this money is out of circulation until i decide (or need) to spend it. instead of forming part of the liquidity pool straight away, it’s going to drip into it over time.

            every time i spend some money, the recipient is going to have to make the same considerations, and with the average individual almost certainly being (a) less well informed than banks about available use of their money, (b) almost certainly more risk averse than banks in terms of where they’ll put there money, (c) taking time to adjust to the new reality and getting used to having to make such decisions and (d) leaving money in current accounts from apathy, the only logical outcome is a decreased velocity of circulation.

            • Dave this is what I wrote to you earlier

              Submitted on 2010/05/21 at 6:12pm
              Evening Dave,

              Velocity is a meaningless concept. To a mainstream economist , if I sell you my house and you sell it back to me and we do this for 10 times, the mainstream economist will say velocity has gone up, this means more economic activity is happening! This means recovery or boom, yipeee!

              Velocity if anything is a derivative of demand, it can not be defined as a separate variable. Mises called this the Money Relation. If your demand to hold cash goes up, it implies that your ability to spend money on real goods and services goes down.

              During the month under the current central bank fractional reserve system your money relation is the same and under 100% reserve your money relation stays the same .

              If you do a search for my articles on explaining the errors of Quantitive easing on this web site , which is routed in the Quantity Theory of Money, which is just a tautological proposition, you will see that when you bin this from your mind and use the centuries old Equation of Exchange favoured by the likes of Mises, the clouds of mist may start to part for you concerning this one and your concern re a fall in velocity. This happened to me in my mid 20’s when I decided to uneducate myself from all the rubbish they tried to teach me at Uni on this matter.

              AND

              “Submitted on 2010/05/21 at 6:17pm
              Dave and Current

              I would suggest you are going down a wrong path here.

              See the answer I gave Dave at 6.12 pm today and see here re velocity.

              http://www.cobdencentre.org/2009/09/qe-errors/

              This may help to debunk the QT of Money old chestnut and some of the monetary policies that flow from it.”

          • Current says:

            In what you’ve written above you are right until the last paragraph.

            Your first three paragraphs are all quite correct. The problem that you are pointing to is that after the reform money is “barren”. It forms no part of a liability pool. That decreases the funds available for lending by banks, I agree with all this.

            However, in the current system that pool of liabilities does not directly influence the velocity of circulation. It is demand deposits and currency that have velocity. These sit on the liabilities side of the bank’s accounts, not the assets side. You could define a velocity of circulation of debt, but that would be something completely different.

            In your last paragraph you write:
            “every time i spend some money, the recipient is going to have to make the same considerations, and with the average individual almost certainly being (a) less well informed than banks about available use of their money, (b) almost certainly more risk averse than banks in terms of where they’ll put there money, (c) taking time to adjust to the new reality and getting used to having to make such decisions and (d) leaving money in current accounts from apathy, the only logical outcome is a decreased velocity of circulation.”

            This is mostly right until the last four words. What you describe above will seriously reduce the amount of liabilities that banks have for backing loans. However, that won’t lead to decreased velocity. In fact, what’s keeping velocity low currently is that banks pay interest on savings. If banks stopped doing this then people would adjust, I agree they would adjust slowly, they would buy more bonds and the process I described above would occur.

          • Dave says:

            but if i need the remaining 700 (my initial 1000 less 300 savings) to fund current expenditure (i.e. outgoings from one salary to the next) i cannot purchase bonds with that, regardless of any interest on bonds or fees on my current account. the incentives or disincentives are moot, or at best opportunity costs (i forego interest so i can pay my rent).

            so that money must circulate slower under the new system than it does under the current system, where it’s available the whole time.

            in the medium and long term this is going to balance out, as people get used to system (though i think for the various reasons outlined in (a)-(d) above it’s going to settle at a lower velocity than at present). but my whole point has been the short-term deflationary(or recessionary or credit crunching, or whatever you wish to call it) impact. Toby has stated several times that there is no money deflation because the money supply is stable, but I can’t see where he has dealt with the velocity issue (if he has, could you direct me to it?)

            to turn this around, if i accepted your assertion that the velocity would increase (which i don’t) that would still be inflationary according to MV=PQ.

            but as i am convinced velocity would decrease, MV=PQ would state that the short term outcome is deflationary.

          • Dave says:

            Also, under the new system most savings would still pay interest (because you would agree to forego the purchasing power of that money to get interest).

            So there would be less investment in bonds than you think (especially given apathy, risk aversion and all the other issues i mentioned).

            Only the current accounts (which are the demand deposit accounts now) won’t pay interest, but for the reasons i’ve recounted, these funds simply aren’t available to be invested in bonds or other savings.

          • Current says:

            Dave, I think I see where the disconnect is now.

            Let’s consider the present system and let’s say you are paid £1000 and you have to keep £700 around for bills like you mention. Under the current system that £1000 is a liability that supports bank loans.

            Now, you mentioned the money quantity equation:
            MV=PT

            In that equation transactions against any salable thing are considered, that is what T is. T is anything that’s traded against M except M itself. M is the sum of notes and bank deposits that are money subsitutes. (Friedman gives another form of this equation that concerns only GDP products, but this needn’t concern us here).

            As far as I can tell, what you are thinking is:
            1) Money is paid from Dave’s employer to Dave – 1 transaction.
            2) Money is transferred by the bank from Dave’s account to a debtor – 1 transaction.
            3) Later money is transferred from that debtor back to the bank – 1 transaction.
            4) Money is transferred from the bank back to you when to pay for something – 1 transaction

            Let’s call this Scenario A. That’s 4 transactions.

            Then we change to the system Toby proposes. In this case no cash is lent. Let’s call this Scenario B:
            1) Money is paid from Dave’s employer to Dave – 1 transaction.
            2) Money stays in bank vault.
            3) Money is transferred from the bank back to you when to pay for something – 1 transaction

            That’s 2 transactions. So, your view is that velocity decreases in going between Scenario A and B.

            Now, the problem here is that according to conventional definitions #2 and #3 are not really transactions. As I said earlier a bank has a large pool of continuously shifting liabilities, it balances these against a large pool of assets. To the bank your bank account is a set of lines on an electronic ledger, lines on the liability side. M in the money quantity equation refers to those lines.

          • Current says:

            Dave: “Also, under the new system most savings would still pay interest (because you would agree to forego the purchasing power of that money to get interest).”

            Savings accounts are mostly demand deposits. Toby’s plan is to convert all demand deposits into cash fiat money. So, savings accounts could no longer exist. Bonds and mutuals could though and that’s what Toby proposes.

          • Dave says:

            the main point is this:

            the current system allows for 97% of the amount in my current account to be available for lending, this is esentially straight back in circulation.

            under Toby’s proposed system, i choose how much is available for lending (by making the conscious decision to move it into a savings account or bond).

            given that i need more than 3% of the amount in my current account to fund my expenditure, there HAS to be less than 97% available for lending under the new system

            the difference between the 97% and what i choose to invest in savings or bonds must therefore circulate slower in the new system. ceteris paribus, it’s deflationary.

            so the only way it can’t be deflationary, is if the money supply increases proportionately. but Toby has stated that the money supply is stable.

  • JohnRS says:

    Am I being very simple or is this really just turning all the entries on bank statements etc into solid objects (ie paper currency) and pretending that there is now a fixed number of these objects (notes) so that you can only borrow money if someone is willing to hand you the actual physical notes? A bit like going back to gold and silver coins where the money supply is fixed?

    Not sure how point 6 works though. Seems like black magic somehow.

    • To JohnRS

      John, you are not being simple, it is converting bank journal ledger entries into physical cash. If this was 100 years ago, it would be gold/silver etc. Cash today, functions as gold did yesteryear.

      Point 6. At the moment, if you deposit money, you are lending the bank money. This comes as a surprise to many. Indeed our very own hapless former Chancellor of the Exchequer, Alistair Darling was always confused by this in his period of office, regularly referring to deposits as assets of the banks. They are liabilities from the bank to the depositors. The assets are the loans. This is “O” Level economics and accountancy. So, if cash is replaced (a virtually costless act by the government) and put in the depositors’ accounts and swapped for or converted the demand deposits and/or the demand deposits just cancelled, the banks would no longer owe their depositors anything. They would be custodians of their clients’ cash, with a fiduciary responsibility to protect it. Post reform, with no liabilities, a banks will only have its capital that started it and assets, i.e. its loan portfolio. So the net worth of all banks has gone up to the exact extent that the banks liabilities have gone down. Why make the bank shareholders suddenly £850 billion better off by this action on converting demand deposits for cash? I say do not let the shareholders have the £850 bn benefit; let those assets (the loan repayments) go to paying off the national debt.

      Please get back to me if this does not explain or is not helpful. Many thanks for getting involved in the debate.

  • James says:

    surely the problem is that when £850 billion of debt is paid off the current holders of that debt will receive cash which they will want to put into bank accounts – so another £850 billion will have to printed. Thus the project did prove inflationary

    • To James

      This is a very good point that I struggled with some years ago when I was thinking about this.
      This is what I concluded.

      The bond holders have forgone the consumptive use of their money when they lent it to the British government for repayment of it at a later date. This is a credit transaction. Command over the purchasing power of money has moved from the bond holder to the government to spend. Thus the money is spent and in the system i.e. in the money supply already.

      There is an obligation from the taxpayer to pay the bond holders of the national debt already existing right? The government pays nothing in itself as it does not create wealth so it extracts it via tax on its citizens.

      As we are committed to eventually extracting £850 billion from our taxpayers over the next 14 years (the current average time period of maturity of the debt) to pay this off, then we will not be required to enforce this extraction of wealth to give to the bond holder at the expense of the taxpayer. This extraction is in fact going to be effected by the taxpayer who is currently paying off his / her loans. So the bond holders get repaid their money that has already been spent by our government and is in the system already.

      No inflation.

      I hope this is helpful.

      Please get back to me if it is not.

      Thank you for contributing to the debate.

    • Current says:

      Toby is correct here, this part of the plan isn’t inflationary. I have problems with other aspects of the plan, but this particular part is feasible.

      Consider a situation where no new money is being made. A government pays off loans with tax revenue. For every pound paid in interest or principle another is taken in tax. There is no inflationary net effect.

      Now, what happens here is that there are £X of assets taken by the government from the commercial banks. There are £Y of liabilities in the form of government debt. X and Y are similar.

      The government sell off the assets of the banks (this would have to happen over several years), with the resulting money they pay off government debt. There is no inflationary effect here. Every pound paid to a government bondholder has come from a pound paid by an investor to buy the assets formerly owned by the banks. No new money need to created.

  • Paul Dean says:

    I don’t profess to really know what you’re talking about, but… off the top of my head…

    1) The £850bn printed money really is just IOUs from the Bank of England. It seems like the BoE should have commodities in a vault equal to the value of printed money or else it’s all still an illusion. Could that be done? It seems to me the national debt would have to increase to buy those commodities and then all you’d have done is moved the debt from corporate banks to the BoE.

    2) Are you suggesting actually physically moving the notes from one bank to another? What happens with international transfers if other countries are not using the same system? I guess paper money would have to be printed or burned to match the transfer!

    3) Even if you could have a scheme to print and burn money on international transfer, it couldn’t work unless the whole world did it because the initial replacement of demand deposit with printed notes would have to be international because a lot of the debt is international. Even then you would have to close down the whole system when you perform the switch while the exchange rates were nailed down precisely which I submit is not a political problem but a practical one to change overnight an extremely complex system.

  • Paul Dean says:

    Oh, by the way, the RSS feed for comments doesn’t seem to work. My feed wasn’t updated for all the comments preceding mine.

    • Paul, do you want me to reply to point 1-3 that you have made or are you now content with the answers in other parts of the comments?

      • Paul Dean says:

        I don’t see the international issues (points 2 and 3) addressed elsewhere.

        • For Paul Dean

          Your point 2 is interesting.

          Money is currently changed around the end of each day as all transactions are settled. With more cash, there would be more of that happening like there was many years ago. So we would be doing more of what we do today and more akin to what we used to do.

          With regard to the international element, if I bought a car off a Spaniard, I would either pay him cash in Sterling, or sell Sterling in exchange for Euro to give him. So Mr Spaniard gets either Stirling cash or Euro cash or if the Euro zone does not do this and we do it on our own, he may well get a Euro bank demand deposit. No negative consequences can I see here for the UK.

          If we reverse the transaction and the Spaniard buys a car from me and sells his Euro for Sterling, whoever he is selling the Euro to, if in the UK, would demand if it is offered as a demand deposit for it to be turned into Euro cash or just receive cash in Euros. I see no problems here either.

          I believe your point three is mostly addressed in the above. However, cash settlement for fractional reserve paper currencies would put demand on those countries that did not adopt the reform such that physical cash would be leaving their vaults putting pressure on them to do the same.

          Naturally an international solution is better than a local one, but we could still do it as a stand-alone nation and be a beacon to others.

          If Sovereign debt default becomes a reality, we may well be forced to do this.

          Public spending => deficit => monetise debt => sovereign debt default. How far are we down that chain of events??

  • Tedgo says:

    It comes down to a law in Thermodynamics, that is a system has only so much stuff in it. If it’s all in one place then it cannot be anywhere else.

    If the bank has to keep cash for all its depositors, then it has no spare cash to lend to business, as they too would become depositors.

    With no loans to business etc, the bank has no assets, so it cannot help the government out.

    • To Tedgo

      I regret you miss the point.

      Post reform, banks will have your cash as custodian (not as your debtor) . Most people want interest, so they are happy to have their money lent for a return on their money at a later date. So you relinquish your rights to you purchasing power and the bank lends it to someone else who then pays the bank back with interest, who then pays you back less their cut for organising it.

      So just as in the pre reform world, banks can do non credit creating lending via a timed deposit where real savings are lent out. The only change being not able to lend our demand deposit money, in fact demand deposits – bank IOU’s will cease to be.

      The excess loans that will exist post reform are exactly the same amount as the former demand deposits i.e. £850 bn. There is the money to pay off the national debt.

  • Charles Adair says:

    Maybe I have not understood this correctly but your argument seems to me to be that by depositing your money in a bank which then lends it out to someone else who deposits it in another bank who lends it out etc. you have effectively created 33 times the amount of money that was originally there but now “exists”. Therefore by printing this vast amount of money we would simply be replacing this “new” money. If I have misunderstood the rest of my post will probably be nonsense.

    However I think there is an element of double counting here, in depositing your money in a bank you are effectively lending the bank that money and so the system just reduces to a very long “chain” if you like of lending.

    If you had an economic system with only two people in, Person A and Person B and Person A had £100, would lending this money to person B create “new” money? I believe not, you are simply transferring command of the resources until some point in the future, only one person can have command of these resources at once. Now if we complicate things with the chain of people, as I see it at least, it is simply money being leant from one to another to another and at any one time only one person will actually have command of the resources the rest will simply be middle men who have borrowed money and leant it on.

    Apologies if I have missed the point or something fundamental.

    Charles

  • DominicJ says:

    My Name is Dominic Johnson and I’d like my £1000 – I felt like smashing apart everything you wrote, but the worked example is at the bottom.
    “This may come as a surprise to most, as we think what we deposit in a bank actually remains “ours” beyond this point. But as soon as you make a deposit it becomes the bank’s i.e. “theirs.” ”

    Many things come as a surprise to the ignorant, I’m not sure why thats relevent.
    Why did you think the bank paid you for the privelage of securely storing your money?

    “This cash cannot exist in two places at the same time, let alone 60 places at once”
    Indeed, it does not, the cash exists in one place.

    “Tesco groceries can be paid by electronic transfer. All we are doing is moving our bank’s IOU to Tesco’s bank in exchange for their groceries. This is how the world works. Do we care that we are buying goods and services out of thin air?”
    We arent buying the groceries out of thin air, we are exchanging the right to demand £0.47p from our bank at any time for 2 litres of almond flavoured diet cola drink.

    “Indeed, if the government had not pledged to underwrite all deposits, then there would be a very good chance that the whole system would have collapsed.”
    No there was not, there was a very good chance that Labours support in Newcastle would have collapsed, but thats not the same thing.
    Had the government done nothing, Northern Rock would have entered bankruptcy, its assets would have been sold and used to pay of the creditors in order, depositors, taxman, bondholders, shareholders.
    If the amount wasnt enough to cover all the bond holders, they would have lost money and the share holders would have lost everything, if the amount wasnt enough to pay off the depositors, the government would have had to step in and pay all deposits up to £50k, and the bond holders would have lost everything.

    Anyway, onto your “program”

    Point 1
    Why would the bank want to be custodian of my money?
    Why would the bank want to PAY ME to be custodian of my money?

    Point 2
    Sort of implied in point 1, but ok…

    Point 3
    This is not inflationary, hahahahahahahaha.

    Point 4
    This is what happens now, you lend the bank money, the bank lends it to someone else, the bank collects interest from the third party, keeps a share for itself and then lends the rest to you.
    Theres nothing to stop anyone forming a 100% reserve bank and taking deposits right now this second.

    Point 5
    How is the person in point 4 not a creditor of the bank?
    Person lends bank their savings, banks lends them to somone else.
    Are you argueing that banks should instead become bond salesmen? Acting simply as a place for people who want to lend and people who want to borrow to meet and discuss terms?
    I’ve currently got a £7 overdraft, I’m not sure theres many grannies who are going to want to go through the effort of setting up a debenture to cover that, until Mondy when I get paid.

    Point 6
    How are the banks £850bn better off?
    Either the money is printed and it has become the property of the depositor, or the money has been printed and it has become the property of the bank.
    Are you arguing that BOTH happen?
    And this STILL is inflationary in your view?

    Point 7
    At least the maths is almost right

    Why wont this work?
    MORAL HAZARD! (it always has to be moral hazard)
    On Monday, I start The Bank of DominicJ
    On Tuesday, I take a deposit of £100,000
    On Wednesday, I make a loan of £100,000
    On Thursday, you pass your printer law and put £100,000 of real money into my depositors account.
    On Friday, my depositor collects his £100,000
    On Saturday, I close my bank to new deposits and wonder what I’m going to buy with the interest payments of £400 a month on the £100,000 loan I still own.

    • To DominicJ

      Point 1

      Because in most cases you would use other banking services that it can make money out of you.

      Point 4

      I know many 100% reserve banks in Switzerland for example where there is a much sounder banking system. It is very hard to compete with a fractional reserve bank who had legal privilege to spend their current creditors money. In my business I have £9m of current creditors, if I could use that money rather than making sure I can always pay it back, I would be £9m better off in my pocket. I could race ahead with that advantage.

      Point 5

      He is a creditor and he has agreed to be a creditor as the act of entering into a timed savings account is that he relinquishes his right to his purchasing power to the borrower . There is no multiplicity of lending. The other side of the transaction is the borrowers liability to repay with interest. He is not a current creditor but a timed / long term one.

      A pass though bank is very sensible, this is advocated very well here by Kotlikoff, http://www.cobdencentre.org/2010/04/jimmy-stewart-is-dead/ , but there is no reason why they cannot account for long term creditors as the normal commercial law allows you to do today.

      Like some of your other rather trivial points not answered, on your granny point, you surely do not suggest in all seriousness this point, as you know these things are all collated together in massive lumps and dealt with!

      Sorry no £1,000 and very debatable as to letting this comment go up, but as this is the only one not in keeping with considered and informed debate, I will approve and allow up so no one has not been not answered.

      • DominicJ says:

        As before, important bit you didnt answer first time is at the end, feel free to gloss over the rebuttal.

        Point 1
        Thats already the case, and in the most part, doesnt work, which is why banks are so reliant on charges on the incompetant and if they’re blocked, will move to direct charges already

        Point 4
        “I know many 100% reserve banks in Switzerland for example where there is a much sounder banking system”
        As I said, you could set up a 100% reserve bank in the UK today, its not illegal, banks dont have to maintain less than 100% reserve. (They might have to make a deposit with the Central Bank, but I’m not sure on that, and it doesnt change anything, since the BoE couldnt default.)

        “In my business I have £9m of current creditors, if I could use that money rather than making sure I can always pay it back, I would be £9m better off in my pocket. I could race ahead with that advantage.”
        Why dont you then, I’ve worked in Purchase Ledger and Credit Control.
        Frankly I find the idea that you have £9m due in the next 30 days so have £9m in the bank, I’m not sure of the word, I was going to go with laughable, but also quite like impressive, also think its a bit odd and would consider it a pretty unique circumstance

        Point 5
        “He is a creditor and he has agreed to be a creditor as the act of entering into a timed savings account is that he relinquishes his right to his purchasing power to the borrower.”

        Which is exactly what happens now, my money in my bank is lent to the bank on a rolling 10(ish) second agreement.
        Or would all timed loans have to match exactly with all timed savings, presuma bly there could be no untimed loans of any kind?

        “Like some of your other rather trivial points not answered, on your granny point, you surely do not suggest in all seriousness this point, as you know these things are all collated together in massive lumps and dealt with!”
        How could you collate together millions of pounds worth of overdraft spending?
        I have a rolling £1000 overdraft, I very rarely use it, but under your system, it sounds like the bank would have to line up a creditor prepared to lend me £7 for a week, but without any idea if I’m going to withdraw another 20p from my account, or even get paid in a week.
        I suppose the bank could maintain a pool of savings available for use as overdraft, but that would be a very inefficient use of resources, because I could withdraw £1000 for only a few hours, but the bank would need to maintain that pool at all times.
        Or simply stop offering me that facility.

        “Sorry no £1,000 and very debatable as to letting this comment go up, but as this is the only one not in keeping with considered and informed debate,”
        Your article read like it had been written by a girl from “my super sweet 16” after her first term at college.
        Appologies if thats not the case, but thats how it read, thats how I treated it.
        This is all accademic anyway, because the actual arguement was below.

        “On Monday, I start The Bank of DominicJ
        On Tuesday, I take a deposit of £100,000
        On Wednesday, I make a loan of £100,000
        On Thursday, you pass your printer law and put £100,000 of real money into my depositors account.
        On Friday, my depositor collects his £100,000
        On Saturday, I close my bank to new deposits and wonder what I’m going to buy with the interest payments of £400 a month on the £100,000 loan I still own.”
        That, is why I would like my £1,000.
        Unless of course I’m wrong, which is quite possible, in which case please explain why and I’ll tender my sincerest appologies.

        • To DominicJ
          You say “

          1. “On Monday, I start The Bank of DominicJ
          2. On Tuesday, I take a deposit of £100,000
          3. On Wednesday, I make a loan of £100,000
          4. On Thursday, you pass your printer law and put £100,000 of real money into my depositors account.
          5. On Friday, my depositor collects his £100,000
          6. On Saturday, I close my bank to new deposits and wonder what I’m going to buy with the interest payments of £400 a month on the £100,000 loan I still own.”

          That, is why I would like my £1,000.
          Unless of course I’m wrong, which is quite possible, in which case please explain why and I’ll tender my sincerest apologies.”

          For the sake of simplicity I have numbers your series of deductions.

          So 1 – 5 runs all with the program I have suggested.

          Between 5 and 6 , let’s say I add a new 5.a. which would make this consistent with the reform plan suggested by me.

          5.a. The Bank of DominicJ is mandated by law to place that £100k asset, the loan that is paying £400 per month in a mutual you own whose sole function is to pay off the national debt.”

          Your point 6 then never happens. Your point 6 should say “ I as a bank will now take deposits on a timed saved basis and I will lend to entrepreneurs on a timed basis, any maturity mis matching I will be able to access the centuries old clearing markets”

          Sorry DominicJ, no need to apologies, we all make mistakes , me included.

          I will not address your other points unless you really want me to, none are critical to this debate I feel.

  • Russ Williams says:

    Hi Toby!

    Full-Reserve banking is a nice idea, but step #2 conflicts with #4 – if the money has to be available on demand, it can’t be lent out, which further means that there’s no way for it to generate income to be paid as interest on savings. Essentially it’d be a paper equivalent to “lazy” gold.

    I do think we need a reform in this sort of direction – Broad Money has massively outgrown Narrow Money, in all major economies, leading to a huge leverage trap and exaggerated boom/bust cycles when it unwinds even slightly.

    Russ

    • Russ Williams

      Thank you for your comments Russ.

      If you elect to safe keep then your money can not be lent, it is 100% reserved with itself i.e. cash.

      If you elect to lend it out to a borrower, as you relinquish your money to another, the cash has moved from you, who does not want the use of it to the borrower who does want the use of it. Note there is still only £100 in the system of purchasing power. You want to do this so you get the money back at a time in the future with interest. This is perfectly OK in a 100% reserved world.

      If you deposit £100 and think you have it in a demand deposit , in reality £3 is kept in cash and £97 lent out – so now £197 in the system when there was only £100. When this £97 is lent out, the whole process starts all over again. This is what is outlawed under a 100% reserved system. Indeed you only have to subject banks to the same commercial law as all other business and it would not be allowed anyway. Just as I as an entrepreneur cannot lend or multiple lend out my current creditor money, neither should banks be allowed to.

      • Russ Williams says:

        Thanks for the reply, Toby!

        Yeah, the amount of money is unstable under Fractional Reserve – over £3000 if people are lending freely, down to just the original £100 if they’re not. It’s absurd. The Monetarists seem to think that the solution to reduced lending is to print more in a recession so that the total is the same, but that inevitably dilutes what’s left. Far more sensible just to have a fixed amount that’s passed around – be it physically or electronically.

        Hadn’t realised that you meant #2 and #4 as different options for people to choose. That will obviously work, though the fraction choosing not to lend will reduce the supply of credit and hence increase its price. Perhaps that’s no bad thing, though: just means some low-margin business plans aren’t viable.

  • Rob Havard says:

    Toby,

    While I agree with you I still don’t think that you have really answered Dave’s question on house prices.

    The whole point of this reform is that we get away from credit fueled bubbles and return to a world where the market prices assets inline with their value. Unfortunately any rebalancing of our current crazy system will require a re-adjustment of asset prices to their real values.

    1. This is called a recession.
    2. This is a good thing.
    3. I know you said practical politics aside, but recessions are difficult politically.

    This is where the opportunity lies. We all know that the current Govt. measures are a merely putting of the day of debt reckoning. When the riots start I think that negative equity would be a price that ordinary people would be willing to pay to put the country (and the world) back on its feet. After all with money stable along with with their wages they should still be able to pay the mortgage on their house. For those who invested in overprices assets (rented houses) – these are the risks of investing and although they will lose any capital gain they had hoped for they should gain in cash flow from an increase in demand for rented houses due to the scarcity of credit.

    P.S.

    Toby – I’m a young entreprenuer starting out in the food business and stumbled accross the Austrian school a couple of years ago. I admire what you have done in the Food business – would you be prepared to offer me some of your time as a business Mentor? – even if it was just half a day to a day per year to help me asses progress of the business and my personal development. A bit cheeky but you get nothing if you don’t ask. You should have my email from this site.

    Cheers.

    Rob.

    • To Rob Havard

      Thank you for your comments; I have emailed you offline, very happy to help a fellow entrepreneur.
      Under this reform proposal there is no need for a money deflation as the money supply will be fixed at the point of reform. So no asset price readjustments need to take place there and then.

      Rothbard would say the deflation is a good thing and look at the early 20’s as a point of reference and a lightning fast deflation will produce the realignment of assets and a recovery will set in pronto. I would normally agree with this approach.

      The banking reform suggested above does have the advantage of not requiring this immediate and painful re adjustment of assets as the money supply does not shrink. Once the system has been “reset” we will then be able to let market forces operate un-influenced by rampant credit creation which creates bubbles. This rest button is a one off button we can press to reform. Do it now and we do not need to go through a deflation to get the desired result of no credit fuelled boom and bust and a secure banking system.

      Thank you for joining the debate.

      • Dave says:

        Toby,
        I think your comment here ‘no need for a money deflation as the supply of money will be fixed at the point of reform’ backs up my point above, that you are overlooking (or at least not paying sufficient account) that the issue is not just the supply of money but, in classical monetarist terms, the velocity of circulation as well.

        even with a stable money supply, if the velocity of circulation decreases this is deflationary (and vice versa, if the velocity increases it’s inflationary). i am convinced that your proposals would in the short term result in a decreased velocity of circulation (or credit crunch or whatever you want to call it) before people adjust to the idea that they need to specifically move money into different accounts to allow it to be leant.

        Also, not all of the money is going to be able to be put into accounts to be available for lending.

        Put it this way, my salary is paid into into my current account and under the current system, 97% of that is (available to be) lent on, making me current creditor to the bank for that amount. Under your system, my main current account will be 100% reserved, so none of that is available to lend. Now, every month I move some money to a savings account (and this will be available to be lent on under the new system).

        But I don’t move 97% or anything like it. So the only outcome can be a deflationary credit crunch, because the velocity of circulation of the 97% of my salary under the current system (less the money I move into the savings account) is massively slower than before.

        So I get a grand, right?

  • Tony says:

    Toby

    I am afraid your plan does not work.

    Your description of what I always called a “real money” banking system is correct. While I personally see flaws in the system which I think out weigh the benefits I would never suggest the system is impossible to operate.

    I am, however, afraid your plan to move to a “real money” system is fundamentally floored. Let me explain the problem.

    Your first step is to have the Government print £850bn.

    The next step is a bit confused since you suggest the bank deposits the notes with the banks so the bank has no liabilities. You then suggest the Government can sell these assets into a “mutual”. I am not sure I know what you mean the assets are the assets of the shareholders of the banks not the Government.

    I assume what you mean is the banks issue share to the value of the liabilities which the Government buys with the notes. An easier way is for the Government to use the notes to buy the assets of the banks.

    Again one of these options would be practical.

    The problem is the next step “The Government can now put those assets into Mutual’s, which would then immediately pay off the national debt”.

    Now I assume you mean the Government sells the assets of the banks to a Mutual. The question your plan does not answer is how does the Mutual raise money to buy the assets?

    There are only 2 options:
    1. The depositors at the banks decide they do not want there money doing nothing so take out the notes and give them to the mutual to invest, the mutual then buys the assets of the banks from the Government for the notes. So the notes have now gone full circle and are back with the Government. The Government could not use the notes to repay debt because the notes themselves have no value they are only a promise to pay.
    2. The Mutual could raise money from international capital markets. A jumbo CDO! Now even if such an issue was possible the issue is a CDO so it is much riskier than a UK Government issue or an bank issue, since a bank is subject to strict regulation, and has equity. Lets say:
    Government raises money at X%.
    Bank raises money at X + 25bp
    The yield on the banks assets are X +100bp
    Mutual raises money at X +75bp
    If the Mutual issues a CDO to non UK investors the Government will get money which it can use to pay off national debt.
    The problem is that while the Government would save money by having less interest payments The money paid by the Mutual to its investors goes out of the country just like interest on Government debt.
    The only difference is the flow. If a Government pay then it collets the money in tax or if the mutual pays it goes directly from the assets, i.e. loans to me and you.
    At best the position would be the same or if I am correct and the CDO had to pay a far higher rate of interest then the cost would not be X the rate the Government borrows but X+75bp.
    3. Some combination of the above.

    I am not sure if this was a serious suggest or just an test. I hope I have passed and proved why the plan does not achieve anything unless the Mutual can fund itself at a lower price than the Government. Which I hope you will agree is impossible.

    • To Tony

      Thank you for your most stimulating and valuable contribution.

      Confusions to clear up.

      I would urge you to read my response to William Norton in the comments section re the non liability of the government minting £850 bn of new cash money. If you understand this, I think you will understand why I call this “The Emperor’s New Clothes.” The non liability point is “the Emperor is Naked” point!

      “The next step is a bit confused since you suggest the bank deposits the notes with the banks so the bank has no liabilities. You then suggest the Government can sell these assets into a “mutual”. I am not sure I know what you mean the assets are the assets of the shareholders of the banks not the Government.”

      It is costless (except for the minting costs) for the government to put £850 bn into the bank vaults of our banks wherever there is a demand deposit. The government should just do this now. This means when you look at your bank statement which says you have £1k in it, you actually do have £1k of cash in it.

      If the bank had not liabilities now as it did not owe you the £1k, it would only have assets and no liabilities. So the shareholders of the banks, by this act of largess by the government, now have the net worth of their shares increase exactly by the same amount that the government has put into the system i.e. by a staggering £850 bn.

      I say “why should the bank shareholders be enriched by £850 bn by this act?” My answer is that they should not; they should be left in exactly the same position post reform as they were pre reform. So the government can then take these excess assets, which value £850 bn, and put them in Mutual funds, owned by the same shareholders or even by the same bank, quite frankly I could not care who owns them as their only purpose would then be to discharge the national debt then wind themselves up.

      You say “An easier way is for the Government to use the notes to buy the assets of the banks.” I agree, this could work as well and the government, in ownership of the assets could then discharge the national debt. This is another way of saying what I am saying.

      You say “Now I assume you mean the Government sells the assets of the banks to a Mutual. The question your plan does not answer is how does the Mutual raise money to buy the assets?” See above , it takes the excess assets created by doing the £850 bn print run, leaving the existing net worth of the banks and the shareholders exactly intact. No raising of any money required.

      Your options in your 1 and 2 I think fall away if you understand that when the government prints new cash it does not create any liability at all on itself or us as taxpayers.

      So yes this is a very serious suggestion and you have said nothing that makes me believe it is not possible, however you have added another way in which it can be done.

      I thank you for that Tony.

      • Chris says:

        When the government runs a deficit and builds up a debt, you are right in saying that it just makes up money and spends it – but it doesn’t add to the total amount of money.

        The reason it doesn’t cause inflation when a government runs a deficit is because for every pound it makes up it also makes up one ‘unpound’ ie. one pound of national debt.

        You are proposing that the government create £850billion without creating -£850billion.

        This is will, unfortunately, cause inflation, which is basically taxing everyone.

        Looks like we’re going to have to pay of this debt the hard way, ie. see all those 850,000,000,000 made up pounds currently in circulation wind their way through the money supply and eventually back into the 850,000,000,000 little holes they came from.

        So about that £1000…

        • To Chris

          I regret you have not understood what I have said, so perhaps I have not made it clear enough, for that I apologise.

          If the money supply was £1.5 trillion prior to Quantitive Easing and then £1.7 trillion, this is a money inflation of £200 billion, the amount of new and additional money created. The price inflation is just starting to hit us now in terms of RPI and CPI moving into heights not seen since the early 90’s.

          When a government runs up a deficit it borrows money from real savers, so this will not be inflationary. Borrowers lend the governments money. Money supply stays the same. If it creates new money itself, i.e. via QE, then as per above illustration it will be inflationary. This is called monetising the debt. This is what they are doing now.

          I am proposing that out of nothing, the bank demand deposits which were created out of nothing and function as money get converted into cash – a virtually costless act of the government. So the £850 bn is new and is not a debit in anyway.

          Think of a glass filled full 5 units of cash at the bottom and 95 units of air. The glass is full of cash and air. Replace the air with cash and the class is still full. As demand deposits are just air in this example and just a journal entry in a bank ledger book, but they function as money as any “o” level or “A” level or undergrad text book will tell you, they can costless be swapped for cash and money supply stays the same.

          So, sorry, not £1,000 for you, you need to do better than that.

          • Chris says:

            If you create £850b cash, without creating £850b debt, then you have added £850b to the money supply.

            To avoid inflation the debtors have to be paid off with money already within the money supply, ie. their money that they leant to the goverment that was spent and is currently swashing round the economy.

            What happened is this…
            1. Debtors give £850b to government
            2. Government spends £850b

            What needs to happen is this…
            3. Government takes back £850b (in taxes)
            4. Government gives £850bn to debtors.

            You are proposing this…
            3. Government invents £850bn
            4. Government gives £850bn to debtors

            Now there is £850bn back in the pockets of the debtors AND still in the pockets of the public.

            Everything else is a distraction, the salient fact is this – your system ends up with the public still having the £850bn spent by the government AND the debtors getting the £850bn back.

          • To Toby:

            You say: “I am proposing that out of nothing, the bank demand deposits which were created out of nothing and function as money get converted into cash – a virtually costless act of the government.”

            Why covert them into cash? Why not convert them into gold – send to the bank vaults gold of the same value as the value of the demand deposits in the books?

            We don’t have to even print gold – save the cost of printing – and just pay for shipping the gold.

  • GrassyKnollington says:

    Tony

    Points 4 & 5- by lending the money to businesses you are faced with the same, albeit smaller-scale, liability scenario. This would not stop a run on the banks because if money is lent on, regardless of the terms, it will result in a reduction from the overall £850 billion pot. Therefore this would mean that meagre sums from each person’s deposits would be removed from the overall total, and then lent on. Quite simply this would mean that there is £850 billion of in-theory savings (still a bank IOU), and slightly in less tangible money stocks. In the event the savers wish to call on their deposits, and if business lending continues on any great scale, if the money lent to business is not immediately called up then there will be a run. This suggests that commercial, and indeed residential, lending of any type will not be feasible.

  • GrassyKnollington says:

    Tony

    Points 4 & 5- by lending the money to businesses you are faced with the same, albeit smaller-scale, liability scenario. This would not stop a run on the banks because if money is lent on, regardless of the terms, it will result in a reduction from the overall £850 billion pot. Therefore this would mean that meagre sums from each person’s deposits would be removed from the overall total, and then lent on. Quite simply this would mean that there is £850 billion of in-theory savings (still a bank IOU), and slightly less in tangible money stocks. In the event that all savers wish to call on their deposits at the same time, and if business lending continues on any great scale, if the money lent to business is not immediately called up then there will be a run. This suggests that commercial, and indeed residential, lending of any type will not be feasible.

    • To GrassyKnollington

      My point 4 is

      “Require all banks to lend real savings that people knowingly place with banks to lend to businesses to get a return of interest and capital back when the business repays that loan. This is nice, simple and safe utility banking.”

      At the moment they do this with £910 bn of timed deposits. They will continue to do this.

      If any of the owners of the new money, cash money, of £850 bn as opposed to the former demand deposit money of £850b, that are converted into cash wishes it to be lent out, that is being custodianed for the banks customers, then they can open a timed deposit / savings account and it can be lent out. So someone relinquishes their claim to money now and lends it to someone who can now use that purchasing power. The borrower then spends / deposits it. No change in the money supply just who owns the right to the immediate purchasing power that money confers to the title holder.

      If all timed savers wished to breach their contracts and say “I know I said I would commit to saving for 3 months in exchange for X rate of interest, but I want it back now” I think it would be reasonable grounds for the bank to decline to force the borrower to repay.

      Thank you for your contribution to the debate.

  • William Norton says:

    OK, let’s work through this. The starting point is that this is described as non-inflationary so the overriding constraint must be that it does not increase money supply. Hence the various points must be read in that light.

    STEP ONE: “Print cash and replace all the demand-deposits/IOUs that exist in the system with that cash. This means the government printing approx £850 billion in cash and injecting it directly into the vaults of the banks and into the accounts of individuals.”

    COMMENT: Thus: depositors remain flat (swap debt owed by Bank for cash held in Bank); Bank presumably remains flat (swap debt owed to depositors for a debt owed to HMG); but what about HMG? The only way you can argue that HMG remains flat is that the asset it acquires (£850 billion injected into the Bank) is balanced by a liability (£850 billion new money created which has to be witthdrawn from circulation – cf. quantitative easing) – if not, it’s inflationary.

    STEP TWO: “Mandate all banks to hold your cash (100% reserved) on demand at all times.”

    COMMENT: So what you’re doing is creating a second type of money: the original citizen-cash which people can deposit or withdraw from Bank and spend in shops and now state-cash which goes into the Bank every time someone deposits citizen-cash. Presumably, every time someone withdraws citizen-cash from the Bank, the Bank has to return some state-cash to HMG and withdraw it from circulation otherwise you have infinitely expanding money supply.

    STEP THREE: “Wipe from the bank ledgers all the demand-deposits/IOUs as banks would not owe you money anymore. This means the “thin air” money disappears, to be replaced exactly with cash money. Note: this is not inflationary, as the cash replaces the demand-deposit which acted as money. As we have established, it is only thin-air that the banking system has created to facilitate the multiplicity of lending of the same bit of money, so its total replacement with cash would mean the money supply stays exactly the same.”

    COMMENT: Noted – as I say, this must imply some return of state-cash to HMG by the Bank at some stage, to pay down its liability on creating the state-cash injected into Bank. Otherwise all you’ve done is invent an unnecessarily complicated form of fractional reserve banking.

    STEP FOUR: “Require all banks to lend real savings that people knowingly place with banks to lend to businesses to get a return of interest and capital back when the business repays that loan. This is nice, simple and safe utility banking. This is what Mervyn King advocates.”

    COMMENT: I follow it so far. Bank can only lend up to the amount deposited, which because it must always stay in the vaults has to be matched by state-cash injected by HMG. I’m not sure that Mervyn King is really advocating this.

    STEP FIVE: “As you are not a creditor of the bank anymore, the banking system will only have its assets and its capital, i.e. no liabilities. This means that there never again could be a bank run.”

    COMMENT: Not really. What happens when everyone decides to withdraw their citizen-cash from the Bank? It will have to cover it by withdrawing state-cash from its borrowers so that it can be returned to HMG for withdrawal from circulation. So there would be a total liquidation of all bank lending, and I’d be surprised if you fully realised all the value that had been lent out. I agree you’d avoid a bank run, but you’d simply replace it with a credit crunch and wholesale recession, which seems an odd solution.

    STEP SIX: “As for the banks, not having you the depositor as a liability anymore, they will suddenly be £850 billion better off, with no current liabilities and only assets (loans to business etc), post reform.”

    COMMENT: No, the Banks now owe HMG £850 billion to cover the state-cash injected into them.

    STEP SIX (CONT’D): “The government can now put those assets into Mutuals, which would then immediately pay off the national debt, and leave the banks in exactly the same position net worth wise as they were prior to the reform, owned by their existing shareholders. As the national debt is still just under the £850 billion, which would be available as surplus assets of the banks, this could still be achieved.”

    COMMENT: So, what you’re doing is to nationalise £850 billion of Bank assets to cancel out the liability from Bank to HMG to cover the injection of state-cash. You are then proposing that HMG apply these assets to pay down £850 billion of national debt. These assets are in a non-cash form at present (either as securities or debts owed from borrowers) and it is unlikely that bondholders would accept a straight swap of these assets in exchange for their gilts. So you’d have to conduct a fire sale to realise cash to pay off the gilts and (see comments above) that would probably trigger a credit crunch and/or recessionary contraction of commercial activity by the borrowers.

    Even if none of these happened, however, HMG has liquidated its asset of the £850 billion owed to it by Bank (to cover the injection of state-cash) in order to liquidate its liability to bondholders (the national debt). That still leaves the £850 liability to withdraw cash from the economy to cover the initial injection of state-cash into Bank. Net result: HMG still carries a liability of £850 billion.

    STEP SEVEN: “No national debt means no interest costs (currently £40 billion p.a) associated with paying for our borrowing. Therefore, give an immediate 28.5% income-tax cut. Total income-tax raised is £142 billion.”

    COMMENT: No it doesn’t. Assuming you avoid trigerring a recessionary crash at best all you have achieved is to double the national debt to £1,700 billion (by the creation of £850 billion of state-cash plus a liability to withdraw the same amount of citizen-cash from the economy) in order to get it down to £850 billion again.

    HMG still has the same cashflow problem that led it to borrow £850 billion of national debt in the first place, so the real nationald ebt would have to start increasing from zero again almost immediately. I agree that HMG doesn’t have to pay interest on a liability to withdraw £850 billion of citizen-cash from the economy, but by cancelling out the debt from Bank to HMG you’ve hit a problem in that you’ve eliminated the mechanism for withdrawing the citizen-cash.

    So HMG would have to put up taxes to run a cash surplus in order to gather up £10 notes so that they can be thrown on a bonfire – or you trigger galloping inflation, which reduces the real value of the citizen-cash in people’s hands and achieves the balance that way.

    • To William Norton

      1st of all, are you the William Norton who was at City Uni when I was at LSE 1988-91? If yes, a big hello after 20 odd years.

      Step 1 comment:

      It is a fiction now that our cash money is a liability of the government. If you take a note out of your pocket and read it , it says ” I promise to pay the bearer on demand the sum of twenty pounds” as £20 is the bit of paper, they are saying you can come into the bank of England with a £20 note and I will give you a new one for your old one. This is a virtually costless activity. Since we have been a currency by government decree ( if gold, they would need to deliver up £20 worth of gold) this has always been the case. That is why I use the Emperor’s new clothes story to illustrate. So the government is neutral in this to all intents and purposes.

      Step 2 comment:

      No just one type of cash.

      Step 3 comment:

      I think this is answered by point 1.

      Step 4 comment:

      Mervyn King has advocated 100% reserve banking. See his endorsement here ,

      http://www.kotlikoff.net/-statement-mervyn-king
      http://www.cobdencentre.org/2010/04/jimmy-stewart-is-dead/

      Step 5, 6, 7 Comment:

      I think this is answered by referring you to step 1 and 2.

      William, I would urge you to think and read again. If you are the same William Norton, my wife (Catherine – of LSE at the same time) and I wish you well.

      Thank you for taking the time to read and comment.

      • William Norton says:

        Actually I was at UCL, but otherwise, yes I am the same William Norton. I think you’ve missed the various points I’m making.

        I’m not saying that a £10 note (“I promise to pay the bearer” etc) equals a liability of HMG or whoever to provide £10 of value. That has no bearing on this. My point is that when at your Step One in your words HMG “prints cash” then either (a) that is hyperinflationary OR (b) HMG accepts the liability to withdraw an equal amount of legal tender from the economy. The terms of your experiment rule out (a), so therefore the only alternative would seem to be (b). Under quantitative easing, for example, the authorities accept that they will have to claw back the injection at some point in time, they’re just being very vague about when and how.

        At your Stage Two you have outlawed fractional reserve banking. If the Bank has received deposits of £X, it is limited to lending £X and equally has to stand ready to pay all of £X to its depositors at any point. To overcome the inconvenience of this HMG provides Bank with an equal amount of new cash £X. To keep things in balance the liability of Bank to its depositors transfers to a liability to HMG. At this point Bank holds £2X, and the second tranche of £X is the funds which Bank extends to its borrowers. Whether this second tranche of £X is printed in different coloured bank notes, or is just maintained as a notional computerised balance is immaterial: to all intents and purposes it represents a different category of money in the hands of Bank because it has to be handled differently: out of its gross £2X, one tranche of £X must be held available for depositors and the other tranche is available for borrowers or liable to surrender to HMG if a depositor makes a withdrawal out of the other tranche. If this is not the case you’ve either doubled the money supply or you’re just running another form of fractional reserve banking – either way you’ve violated one of the terms of your experiment.

        Mervyn King thinking out loud about the merits of 100% reserve banking, or preventing the creation of universal banks, does not amount to an endorsement of the idea floated in this article.

        You’re impaled on the fact that once HMG has created the additional/second type of money to inject into the banks, it has to claw back an equal amount from the money supply at some point to avoid creating inflation. If you nationalise Bank assets to repay the national debt it does not avoid an interest payment and free up scope for tax cuts: it creates an obligation for HMG to run a deflationary budget surplus to withdraw that new cash from the economy by another means.

        Printing money is not a cost-free activity and its value is ultimately underpinned not by fiat but by growth in the real economy.

        • Morning William,

          You say

          “I’m not saying that a £10 note (“I promise to pay the bearer” etc) equals a liability of HMG or whoever to provide £10 of value. That has no bearing on this. My point is that when at your Step One in your words HMG “prints cash” then either (a) that is hyperinflationary OR (b) HMG accepts the liability to withdraw an equal amount of legal tender from the economy. The terms of your experiment rule out (a), so therefore the only alternative would seem to be (b). Under quantitative easing, for example, the authorities accept that they will have to claw back the injection at some point in time, they’re just being very vague about when and how.”

          I can not be making myself clear, so I will try again.

          If the money supply is made up for say (hypothetical e.g.) 5% cash and 95% demand deposits, which are created out of thin air and are bank journal ledger entries (totally non controversial part of economics). This is the total money supply of 100%. As it is virtually costless (ink, paper electricity and manpower) to do this reform, then HMG with no liability could print 95% more cash and simply cancel all the demand deposits. Total money supply is still 100% i.e. exactly the same = not inflationary.

          You say…

          “At your Stage Two you have outlawed fractional reserve banking. If the Bank has received deposits of £X, it is limited to lending £X and equally has to stand ready to pay all of £X to its depositors at any point.”

          Again, I will try to be clearer. If a bank receives a deposit for safe keeping it can not lend it out. If a bank receives a deposit for saving, the depositor relinquishes the rights to this purchasing power and the bank lends it to a borrower. In the former the bank has to pay nothing as it does not owe anything, in the later it does not have to pay anything until the borrower repays.

          “Mervyn King thinking out loud about the merits of 100% reserve banking, or preventing the creation of universal banks, does not amount to an endorsement of the idea floated in this article.”

          Mervyn King has endorsed Limited Purpose Banking along with 5 current Nobel Price winners mentioned in the article (5 deceased ones also – Soddy, Hayek, Tobin, Buchanan, Allias, not mentioned) and 36 other distinguished economists and glitterati in the introduction to Kotlikoff’s 2009 book Jimmy Stewart is Dead, including Jeffery Sachs. So not thinking out loud, but actually endorsing 100% reserve or what they call Limited Purpose Banking which amounts to the same thing.

          That by the way is only part of my proposal. I also sit on the shoulders of the founder of American Monetarism and probably the greatest mainstream economist the USA ever produced, Irving Fisher, who recommended something very similar in 1935. More recently the great Austrian Economist Jesus Huerta De Soto in 1998 recommended the same i.e. swap or convert demand deposits for cash. As no bank has current creditors anymore, take the exact equivalent value in assets and use to pay off the national debt. They had / have great vision.

          You say …

          “You’re impaled on the fact that once HMG has created the additional/second type of money to inject into the banks, it has to claw back an equal amount from the money supply at some point to avoid creating inflation. If you nationalise Bank assets to repay the national debt it does not avoid an interest payment and free up scope for tax cuts: it creates an obligation for HMG to run a deflationary budget surplus to withdraw that new cash from the economy by another means.”
          There are many errors of understanding in what you say. I hope I have helped clear them up. I am not impaled by anything you suggest. I to had these errors in my head for many years. I hope I have shown you where these errors are and encourage you to look at the system in a different way and declare with me that the Emperor does indeed have no clothes on.
          You say…

          “Printing money is not a cost-free activity and its value is ultimately underpinned not by fiat but by growth in the real economy.”
          I agree that if you print and add to the existing money supply it serves no purpose and would never recommend it. This reform is virtually cost free as it keeps money supply the same and secures the banking system and provides a good stable platform for entrepreneurs to take the existing factors of production and make better use of them to provide better goods and services to us all. This is the only path to economic growth that is sustainable.

          Thank you for joining the debate William.

          • William Norton says:

            This article is entitled “How to Pay Off the National Debt & Give a 28.5% Tax Cut”. Thus, whether Mervyn King has made nice noises about 100% reserve banking or limited purpose banking is rather beside the point. He hasn’t, so far as I’m aware, publicly and explicitly supported the nationalisation of bank assets in order to pay off the Public Sector Net Debt. It’s a bit naughty to slide one into the other – lots of people are in favour of Ferraris without supporting them being driven off a cliff.

            The heart of your idea is the suggestion that HMG accept assets from the banks in return for printing and injecting into the banks £850 billion of something-that-looks-awfully-like-money but which you say isn’t money. Fine, we’ll call them “baxendales” then. So what do the banks do with this pile of baxendales? If they can use them to lend, or pay wages/dividends etc then they are money. If they are useless, then HMG has expropriated assets from the banks for essentially zero payment. Anyone can pay off the national debt if they go around confiscating private property. That’s not a new idea.

            So baxendales are some form of money. Just creating £850 billion of them from nowhere is a rather Argentinian solution to the national debt. The only way to avoid inflation is if HMG has a balancing liability to withdraw an equal amount of cash from the economy, with a liability from the banks to HMG replacing the initial liability from the banks to their depositors. I’ve sketched how that might work in my previous posts – you say I’ve misunderstood how your idea works; actually I’m suggesting necessary consequences in order to make your idea work.

            The sticking point, however, occurs once HMG gets assets out of the banks and uses them to pay off the national debt. Ignore any practical difficulties in such an operation, or the high probability that a new national debt would immediately arise because HMG has a cashflow problem. Once the assets leave the banks it extinguishes the liability from them to HMG to cover the issue of the baxendales. The only way left open to HMG to withdraw cash/baxendales or whatever from the economy is to run a budget surplus and to destroy the funds raised, cancelling out the residual liability. In other words, a massive tax HIKE, not a cut.

            If HMG does not run such a surplus, all you’ve achieved is to print money in order to pay off the national debt, which you can do directly without fiddling about with the banks, and which will result in galloping hyperinflation which isn’t really a solution to the problem.

            QED. I claim my £1,000 prize.

            • the Evening William

              If a bank has £100 demand deposits only and £100 loans, do you accept that the government , with no liability to itself or the taxpayer or any Tom Dick or Harry could costlessly say to the bank “bank I will relieve you of the burden to redeem £100 in cash to your depositors by gifting you £100 in cash” ?

              The government could then say in exchange for cash given , all bank demand deposits are null and void.

              If you do not, why not? Where does it create any obligation on anybody?

              Is the money supply still £100?

              How can it be anything else but £100?

              So cash becomes the property of the depositor.

              The bank only has assets.

              The assets can be given to HMG or better still to be placed in mutual’s owned and run by the current banks to pay down the debt as described.

              In the real world, the bank has the same again in savings deposits that are lent to business, life and lending goes on the same basis as before.

              I know of no other way to explain this.

              There is 100% no inflation as the supply has not got bigger.

              No prize for you William. Get past the logic of the first question then maybe, but I am confident it is fool proof.

              Good luck and thank you for taking the time to read and digest and respond.

              New Point

              Current said at 6.40 pm tonight “Now, after the change there is no fractional reserve banking. Previously there was what monetarists call “M1″, what Toby calls demand deposit money and what the Austrians call “fiduciary media” or “money subsitutes”. After the reform there is only fiat money, there is only what the monetarists call “base”. This fiat money is nobodies liability it is just token. It is unlikely demand deposits, those act as a pool of liabilities which match a pool of assets.”

              I agree with this. Not understanding this will prevent you from understanding the proposal.

              Further New Point

              William, I have not addressed the point where by you suggest that I am not being totally straight when I list the big supporters of 100% reserve banking or Limited Purpose Banking.

              Just to be clear that is what the main bulk of my proposal is: to set up a system just like that.

              What most people do not see is the intellectual opportunity to do this reform at the same time.

              What is 100% undeniable is that the Founder of American Monetarism, in the Book 100% Money 1935, Irving Fisher did write such a proposal: I stand on his shoulders.

              What is 100% undeniable is that Frank Knight (Founder of the Chicago School and “Chicago Plan”), Henry Simons, Lloyds Mints and one of their pupils, the future Nobel Winner, Milton Friedman did advocate something very similar: I stand of their shoulders.

  • Swiss Bob says:

    I see a problem, though it isn’t a technical one.

    If banks are reduced to lending what they’ve got instead of fantasy multiples, where’s the profit in that?

    • Swiss Bob

      God forbid those poor bankers, like me and every other entrepreneur, they will have to sell something that someone wants and at the price they want and when they want!
      This year I have £5m of equity capital employed in my business (all a matter of public record) and will make £7m return on it this year i.e. more than a 100% return.

      A bank in the good old bad old days lends money lent to it out many times over and will return much less, so dull and incompetent they have become.

      If they spend their depositors money building big buildings to glorify their ego’s and pay themselves money out of their current creditors and unrealised cash profits ( see here http://www.cobdencentre.org/2010/03/more-on-banking-and-the-barclays-2009-results/ http://www.cobdencentre.org/2010/03/why-all-banks-are-insolvent/ ) and concentrate little on the matter of lending to real businesses with good management and good product, what a surprise, they go belly up.

      Pity those poor dullards.

    • Current says:

      It’s not so different. Instead of a saver putting £1000 in a savings deposit account the saver has to buy a bond. Thay bond gaurantees him an income. The money the saver pays for that bond is transferred through the bank to a borrower who wants it to buy something such as a house. These are standard savings & loans activities.

      Banks have worked this way using bonds on one side and fixed mortgages on the other for hundreds of years. The essential difference with Toby’s plan is that they wouldn’t be able to use demand deposits too.

  • harry fredericks says:

    Nice story. I have seen a version of this, where a fellow leaves a £100.00 deposit on a hotel room. An unlikely series of £100.00 debts are repaid leaving the hotel with the £100.00 back to reimburse the customer should he decline to take the room.

    This would work of course. In fact it was proposed in the US some years ago.

    The only flaw would be greed. Goldman sachs or some other member of Hells cartel would start to securitise their reserves and restart the casino. Off balance sheet finance is a necessary evil for these people so that they can buy the political influence needed, up to and including the politicians themselves.

    Northern Rocks troubles started I am told when a customer paid up her mortgage early and requested the deeds. Northern Rock were unable to comply as said deeds had been illegally securitised.

    We need good men to act. Then your plan will work, or at least have a chance.

    • To Harry Fredericks

      Thank you very much for your comments.

      100% reserve by law was enforced by Sir Isac Newton (this was the norm for most of mankind) , then Master of the Mint, by hanging anyone who abused their creditors by creating fractional reserves. I would not go that far, but I am sure a good dose of porridge would do the trick.

  • Rich T says:

    You mention at point 3 in your plan the idea that if we replaced all the ‘IOUs’ with actual cash, the banks with whom we’re saving would no longer have a liability to us – as far as I can see, that’s simply not the case. If we take a very simple example:

    Toby: Assets £100 (cash): Liabilities £0

    If Toby places that £100 in the bank, who then simply place the cash in their vault, they’ll have £100 of assets, but they’ll also have £100 of liabilities, as they’ll need to pay that money back to you.

    Toby: Assets £100 (bank savings) : Liabilities £0
    Bank: Assets £100 (cash) : Liabilities £100 (Toby’s savings)

    However, as currently happens, the Bank will typically loan that money out, who may then lend it again…

    Toby: Assets £100 (bank savings) : Liabilities £0
    Bank1: Assets £100 (loan to bank2) : Liabilities £100 (Toby’s savings)
    Bank2: Assets £100 (mortgage) : Liabilities £100 (loan from bank1)
    Rich: Assets £100 (house) : Liabilities £100 (mortgage)

    All these assets and liabilities effectively net themselves out, reflecting the fact that in our (extremely simple) example, there’s only the original £100 in existance. Toby’s £100 is effectively in Rich’s house. If we printed a lot of extra money so that Toby’s £100 was also in the bank vault, Rich’s house would still exist, so we would be creating new money, and the bank’s liability to Toby would still exist as it would still need to pay him back. We would probably have hyperinflation though.

    • To Rich T

      In a pre reform world Toby places £100 on deposit with a bank. The bank issue Toby an IOU called a bank statement saying I have £100 on deposit that I can withdraw on demand in cash. Toby is now a current creditor to the bank.

      Post reform, Toby places £100 in storage for the safe custody of the bank. The banks charge a fee for this. Toby is a customer producing an income for the bank for the safe keeping charges it levies to Toby for the service. Toby is not a current creditor. The bank will not have current creditors at the point of the reform. That is the salient point of the reform. That allows the other parts of the reform to happen.

      If you go into Harrods and place £100 in its deposit box you rent, it does not become the property or a liability of Harrods.

      If Toby places £100 in the savings part of the bank and they on lend, and if the bank is a pass though bank as Kotlikoff has suggested here http://www.cobdencentre.org/2010/04/jimmy-stewart-is-dead/, it just charges a fee for intermediating and returns the lent amount and interest earned at the point of maturity . This is how it could look post reform. Or it could look like this, the £100 is lent to the bank if Toby wanted it saved, Toby becomes a current creditor. The bank lends it out and the borrower becomes the debtor. All of this is what would continue to happen as it does today. The key point is when current liabilities are extinguished; you have a one off moment to replaces these with cash at no cost to anybody except the cost of the paper and ink etc to print up the money.

      I hope this is helpful.

      • Current says:

        > The key point is when current liabilities are extinguished

        That’s right. But, as I wrote elsewhere, the current liabililities of banks pay interest to depositor. They do so because the banks are paid interest by their borrowers.

        The sort of Bank account deposits we have currently are interest bearing or at least there is no fee for using the bank services. Converting all this into base money means changing it into something very different.

      • Rich T says:

        Toby

        A couple of points. Currently, banks effectively charge savers a fee by paying a lower rate of interest than they receive by loaning on the money (I believe economists call this FISIM). If all Banks don’t loan the money on, they won’t receive interest and therefore won’t pay interest. I’m not going to pay banks a fee to store my £100 in a box under the bank managers bed – I’d therefore invest in equity or government bonds instead.

        Furthermore, if we said that savings in physical cash that were placed in the bank are no longer treated as a liability of the bank to the saver then neither can they be treated as an asset of the bank. The bank would therefore not have any money to loan onwards to individuals/businesses.

        If you’re saying that the Bank is effectively acting as an intermediatary, charging a fee for its services, then this doesn’t substantially change the picture from what we have currently with FISIM.
        I therefore can’t see how your proposals would help with anything. The net/asset liability situation across the economy would be identicacl.

        Pre-reform
        Toby: Assets £100 (bank savings) : Liabilities £0
        Bank: Assets £100 (mortgage) : Liabilities £100 (Toby’s savings)
        Rich: Assets £100 (house) : Liabilities £100 (mortgage)

        Post-reform
        Toby: Assets £100 (loan to Rich made through bank) : Liabilities £0
        Bank: Assets £0 : Liabilities £0
        Rich: Assets £100 (house) : Liabilities £100 (mortgage – from Toby’s savings)

        • Current says:

          “A couple of points. Currently, banks effectively charge savers a fee by paying a lower rate of interest than they receive by loaning on the money (I believe economists call this FISIM). If all Banks don’t loan the money on, they won’t receive interest and therefore won’t pay interest. I’m not going to pay banks a fee to store my £100 in a box under the bank managers bed – I’d therefore invest in equity or government bonds instead.”

          Exactly. Deposits become a very different thing when they don’t pay interest. The only reason to keep them in a bank is security.

          “Furthermore, if we said that savings in physical cash that were placed in the bank are no longer treated as a liability of the bank to the saver then neither can they be treated as an asset of the bank. The bank would therefore not have any money to loan onwards to individuals/businesses.”

          Yes. Banks would have to sell bonds.

          • Current says:

            Incidentally, during the long stagnation of Japan in the 90s and 00s the interest rate was ~0% and there were some bank failures. As a result many people decided to withdraw their money and keep it in safes at home.

        • Rich T

          Savings are a liability from the bank to the saver.

  • Soreofhing says:

    I am no banker of financial expert therefore my comments will seem somewhat superficial; however, here goes:

    When I deposit £100 in the bank, surely the person/company who borrows “my money” does so not to deposit it another account but to use the money to purchase something…a new car, a deposit on a house, a holiday, a machine tool or raw materials for his business.
    It would make no sense to borrow “my money”, pay interest on it, only to receive less interest from his deposit.
    He might deposit it momentarily, but that’s all; he needed it so he borrowed it to spend it.

    Therefore I fail to understand this cascade of deposits (from one deposit) that you mention.

    I really don’t have much more to say on the subject but when I receive your £1000 prize I might deposit it and make it “my money” but then it won’t be “your money”, will it.

    • For Soreofhing

      http://en.wikipedia.org/wiki/Money_creation

      See the link above. Go to “Re-lending” and “Money Multiplier” section – all very basic uncontroversial economics that no one disputes . Read that and you might find it helpful. Then if you have time, re read the article and it might shed some new light on it for you.

      Thank you for taking the time, but no £1,000 for you.

  • Jon Baldwin says:

    The one thing that I am struggling with is whether, following the switch from “funny money” to cash, the bank is actually left with any assets.

    Let’s say that we have 30 “claims” on each “actual” £1.

    Aren’t you assuming that the only “valid” claim is the depositor’s, and therefore we will print £1 in cash for each £1 owed to a depositor.

    If a bank will be left with outstanding loans to businesses as its assets, how are those businesses ever going to repay those loans? Each £1 that they thought they had would actually be one of the 29 false claims on a depositor’s £1.

    So, in a country where you have nothing unless it is backed by cash, wouldn’t those businesses be left with nothing with which to buy stock or pay staff?

    In that case, the businesses would not be able to repay their loans, and the banks would surely have no assets?

    • To John:

      This might help, there is approx £60 bn of cash, of a £1.7 trillion money supply. So approx 3% of the total money is cash, the rest demand and timed deposits. The timed deposits are real savings i.e. you as a saver give your money to a bank to on lend. You relinquish ownership of it and now you will get it back on X date in the future with £Y interest added on. Demand deposits are what you might call “funny money.” As this is real i.e. from your bank IOU or bank statement you can by Tesco groceries, it is money, albeit created out of nothing by the banking system. So replace all of this demand deposit money with cash.

      A demand deposit is not an asset of the bank, it is a liability to you the depositor i.e. it owes you the money. Remove the banks liability to depositors by replacing with cash and the bank then only has assets.

      Its assets are its loans. Post reform, it carries on lending out timed deposits to borrowers and does the traditional bank intermediation role we expect a bank to do with REAL savings as opposed to credit created out of thin air.

      I hope this is helpful.

      • Jon Baldwin says:

        Hi Toby

        Take a start-up business. In money terms, typically they owe more than they own. Some of what they own is merely ideas and hope.

        Therefore, most of the purchasing power that the business thinks it has is actually a claim on someone’s demand-deposit. This means that, pre-reform, it is “sharing” each £1 it thinks it has with the original depositor and, say, 20 other businesses.

        If you’re saying that we should print £1 for every £1 that the original depositor deposited, then surely in moving to a real-cash economy we wipe out the value of what was given to the start-up business? In this case, the start-up has liabilities but no assets and will go bust.

        But if you’re saying that we should print £21 for each £1 that the original depositor deposited, then surely the bank is paid regardless of whether the start-up business repays the loan. If the start-up business does manage to repay the loan, the bank gets the cash twice. Once from the print-job and once from the loan repayment. That is inflationary.

      • Tedgo says:

        Yes but you have not explained that as soon as you lend money to a business, the loan becomes a demand deposit. The time deposit bank notes will soon disappear into the demand deposit vault.

        The bank will rapidly not be able to lend money unless it can persuade more demand depositors to transfer to timed deposits.

        I do not see the loans as being an assets the bank can do anything with, the cash in the vaults belongs to the demand depositors.

      • Tedgo says:

        Further you seem to be assuming that the £850 billion matches the total amount held in demand accounts which is probably not true. You would have create two types of demand accounts, those backed by notes and those that are not.

        If you do not then you seem to be limiting the size of the economy to £850 billion, so theres no growth etc.

        • To Tedego

          The demand deposits are approx £850 bn. You can get the exact number off the Bank of England Web site to the penny if you are so inclined. Timed deposits are just a bit higher.

          If the money is fixed like this plan would do, should there be more productivity in the economy i.e. more entrepreneurs making more and better things with the same amount of resources , then the existing amount of fixed money will command more goods and services at those existing prices, there will be more purchasing power for the given money unit.

          This means a benign price deflation will be a symbol of good growth. Think of a computer 20 years ago at £3k and today x zillion times more powerful at £300 today. Everyone happy.

          Pause for a moment and think, I as an entrepreneur have only one goal to make better and cheaper things for my customers, this is the whole point of capitalism, however we have only upward moving prices on the whole. Do we all fail or is something else going on behind the system like state manipulation of the money supply??

          If people feel unhappy with falling prices and more purchasing power in their pockets as a good sign of material progress, then we can adopt a Freidman style money supply plus 2% a year rule and print more to offset against productivity gains. Naturally I would favour more purchasing power.

          Thank you for your continuing interest.

          • Tedgo says:

            You do not seem to have answered my earlier point.

            In your new world I have £10,000 in a demand current a/c. I decide to put it into a timed saving account. The bank transfers my bank notes to the timed a/c vault. The bank has brief access to those notes.

            Later in the day my business brother comes in for a £10,000 loan. The bank agrees to the loan and puts the money into his business current demand a/c. With your system the bank now has to move the bank notes back from the time vault to the demand vault.

            The bank will only have access to the timed vault bank notes if it does not lend any money out, but it then has a problem paying interest to the time depositors.

            Unless its into pyramid banking. Mind you you have created a business opportunity in running armored bank cars.

          • Current says:

            “I decide to put it into a timed saving account. The bank transfers my bank notes to the timed a/c vault. The bank has brief access to those notes.”

            As I understand Toby’s proposal this is wrong.

            When you invest in a timed savings account the bank doesn’t put the cash in a vault. It lends the cash out, and pays you your interest with the interest it gets from the borrower.

            Under Toby’s proposal the only thing that changes is the operation of demand deposits, such as checking accounts and most savings accounts. Bonds, equity and debts with maturities continue to work as before.

  • I have no clue about economics but I am uncomfortable with “Print cash and replace all the demand-deposits/IOUs that exist in the system with that cash”. I don’t like when printing presses create new money – it is like thin air.

  • Finally, I’ve been banging on about this for several years, glad to see someone more eloquent than me is getting the message out that we are all being stiffed.

    If anyone still thinks we as a nation shoul borrow our money instead of coining it free to lubricate our economy, please Borrow it from me.
    I’ll offer s special dwal and undercut the Banksters, Borrow £100 Billion from me and all I will demand back is the interest at 5%, no wait, forget 5% make it 1%.
    That’s right Borrow £100 Billion from me and all I want in return is £1 Billion.

    I like to think I;m good at explaining things, but try as I might, I cannot get most people over the inflation hurdle.
    They keep going round in semi logical circles.

    I believe you have to try to make the argument as simple and logically concised as possible, leave them no room but to come to the correct conclusion.

    I’ve refined and condensed the argument thus far as.

    If, over the past 100 yrs, we had coined EXACTLY the same amount of money at EXACTLY the same times as we had borrowed, and issued that FREE into our economy,
    what would our National debt be.

    There is no way out for them, they have to say ZERO.

  • What happens when the depositors withdraw their cash? Their cash that is a claim on the time and resources of others. Previously, the bank would have had to redeem claims on goods and services it had lent on to others in order to pay the depositors. This ensured the nominal demand for goods and services netted off. Under your scheme, all that extra capacity to demand goods and services can be handed back to depositors drawing down their deposits without an equivalent amount taken back from debtors. There’s your inflation, created essentially by diverting foreign debt to banks’ assets and printing money to balance their books.

    Am I missing somemthing? The plan would ‘work’. It would just be highly inflationary and the ‘tax cut’ would be paid for by trashing the value of the money in the system.

    • Oh – it would also be inflationary when the government spent the extra cash it had saved itself (either itself or by taxpayers via a tax cut) due to the same principle: more nominal demand chasing the same supply.

      • To Ideal pen pusher

        If you mean all the bank reserves that sit on the BoE balance sheet, then yes, there is a massive inflation waiting to happen if it is all spent. They can make a law saying you can not spend it. This might be an “exit route” for them.

        Or do the money reform proposal I suggest.

        Thank you for your comments.

  • Winston (deceased) says:

    I can’t see where the money is in it for the banks.

    Lending out the money 60 times in my simple arithmetic means a load of interest (and some business failures). Sitting on it and not being able to ‘capitalise on its value ratio’ would seem to prejudice bank earnings.

    • Dear Dead Winston,

      Gid forbid, they would have to earn money like any other business, the hard way by selling a product that someone wanted , when they wanted it and for a price they wanted it!

      If they can’t do that , they do not deserve to be there.

      • Winston (deceased) says:

        Accepted and agreed. My point is that your idea won’t logically work as you are proposing a ‘completely new business model’ for the banks without any suggestion as to how they might stay in business. I also accept that it isn’t your job to give them a business plan – but in effect you have done exactly that by ripping up current practice.

        I see much to admire in your suggestion, but I can’t see the banks doing this without laws/litigation.

        Then we arrive at politics.

        • Thank you Winston

          It stands up in logic as far as I see still with many people trying to show otherwise.

          This is an old and tested system. For most of mankind we have had 100% reserves and commodity money – the latter where I would like to end up.

          Yes, then it is a matter of politics which is a very trickey business as we know……

          • Winston (deceased) says:

            So how do we lend money to other countries if we can’t cover the loans with reserves? Is the answer we don’t? Kind of shuts us out of international finance and we may be left pondering that our ‘banked asset value’ is entirely dependant on our ethereal notion of how much our own assets are worth. Surely a dangerous course.

            I wouldn’t want to see anything which prejudiced our ability to operate internationally. It’s where we, all of us in the United Kingdom have excelled.

            Whilst your logic offers a way to get rid of the national debt and remove crippling loan interest charges it may also offer a way to isolate and stagnate our economy. So it looks like I won’t be winning the £K (FX: Blast!) but I am not convinced that your logic leads directly to success either.

            It reminds me of an attempt a long time ago to re-instate the gold standard. I can tell you that move was not a success.

            I can see you’d have top flight industry scrambling to work here for tax reasons, that’s a big plus.

            On a selfish note, I’d be happy too.

            • Winston Deceased

              I would rather the UK government lent no one money unless mandated to by their representatives.

              We can lend money to other countries. We lend sterling and they pay back in sterling, why would anything be different?

              I accept the assets in the Mutuals will be potentially wonky. We have seen billions written off; you would hope they are at the bottom!

              Also remember we have this fiction when we have the BoE itself owning £200 bn of the national debt, that is exactly like you owing yourself money and paying yourself on the other side, whilst charging the taxpayer an interest rate for the privilege – another extraction. This could stop right now with no effect on us.

  • Mladen Matosevic says:

    One interesting question… In the current situation, there is lots of money paid as salaries and they sit on accounts of people every 1st of month (for the sake of discussion). During that month that money is spent and goes to accounts of companies where you buy things (say, your supermarket chain). At the end of month you do not have any more cash, therefore you cannot lend your money to businesses. Your supermarket chain has plenty of cash near end of month but once they pay employees, that pile is greatly diminished. If you share same bank, bank watches how money goes from one account to another, yet neither of you can give consent to lent it on reasonable term. However banks gives each of you IOU and lent money anyway. Have fun!

    • Current says:

      Though it depends on where you live your checking account contract probably says on it somewhere that you’re making a loan to the bank. As will the contract that businesses sign.

  • MrHackit says:

    can someone tell mr cameron and mr clegg to do this right now i have read through this several time to understand the gist of it and it makes perfect sense get on with it you numptys its a no brainer :)

  • Current says:

    This business of banks creating money “out of thin air” is a bit tricky. Rothbard exaggerated his case here.

    Firstly, it is quite true that commercial banks get special priveleges from government. The central bank protects them by providing cheap credit if no other bank will. The deposit insurance schemes (such as FDIC) protect the banks customers and thereby allow the bank to be careless.

    They fractional-reserve aspect is different though. I was discussing this on the Mises blog yesterday, and I may as well use the same example here. Let’s say that I go into the Shoe manufacturing business and sell shoes. I make an agreement with a shoe distributor that every friday I will have 1000 pairs available in my warehouse if the distributor wants them. It is an availability contract. The distributor pays me for this.

    I am paid for it before I ever deliver anything. You could say, I have created that contract “out of nothing”. But, I must have the shoes available, if I don’t then I’m in breach and I can be sued.

    Essentially the same sort of thing is true of demand deposits. A bank lends out money and simultaneously creates a demand deposit. Now, to the ordinary person that seems like a win-win. To the ordinary person a loan is an asset and a demand deposit is an asset. To the banker things are different, a loan is an asset, but a demand deposit is a liability. To the banker his demand deposits are not a store of wealth, quite the reverse. When the money in a demand deposit account is transferred to another bank then the first bank is called upon to make good that liability through inter-bank clearing. The more debts a bank issues the larger the amount it must transfer through the clearinghouse.

    There are two things the banker must think about… Firstly, he must be certain the debts he owns are good. Secondly, he must be estimate when the deposits he has created will be redeemed and have money on hand when that happens. Now, the central bank “assist” with this, and that modern day situation is corrupt, but if that assistance were not there then there would be nothing unusual about the transaction.

    The situation is, in fact, quite like it is with fixed term debts such as loans. The only difference with bonds is that the time of redemption is known.

    This is all strictly from the accounting point of view of the bank. With regard to the macroeconomic effects of money the situation is genuinely different between fixed term savings and loans banking and demand deposit banking. That’s because demand deposit banking creates money subsitutes but fixed term loans don’t.

    • To current

      I agree with all of the above. As a classical liberal, I cannot fight a trade union legal privilege and not fight a bank legal privilege to use its current creditor money at will. This puts one class of person at the advantage of all of the rest of us. Not a good system to build a free society from!

      Many thanks for your contribution.

      • Current says:

        I agree. My aim here was to clarify exactly what the legal privelege is. It isn’t the privilege to create banknotes or demand deposits, that’s similar to other sort of business operations.

        The privileges are the lender-of-last-resort facility of the central bank and the deposit insurance schemes.

        In Scotland in the 18th and 19th century the free banks there had no such privileges. Some of those ran a 2% reserve ratio.

        • To Current

          I very much disagree. The privilege is granted so that it can run its affairs and not keep its current creditors whole as every other business working under the normal commercial law has to. This privilege works exactly like a closed shop with only bankers being able to do this and no one else. I, in business need to keep my current creditors whole. If I did not, I would be able to take a £9m dividend today and that would be a very big advantage to me! The banker has this advantage, protected by privilege.

          • Current says:

            Your situation is not that different to a Scottish free bank. Those also worked under normal commercial law with no special privileges. Being able to run fractional reserves isn’t a special privilege. (The central bank and deposit insurance are).

            Think about the example I give of the shoe manufacturer above.

            Also, I would reply to your posts about the money quantity equation and velocity. But, for some reason they are appearing in my RSS feed, but not on the web page.

  • Adrian says:

    I think you need to explain in more detail how the government uses bank assets to pay off public debt bond holders:

    “…with no current liabilities and only assets (loans to business etc), post reform. The government can now put those assets into Mutuals, which would then immediately pay off the national debt…”

    Demand deposits aren’t the banks only liabilities. They have securities, deferred compensation, long-term debt, etc… all of which will need to be serviced.

    The cost of money would go up because you are restricting supply or access to finance from DD accounts(imaginary or not), while money markets seek a higher rate of return than demand deposits provide. Increasing the cost of money would lead to price inflation on any business that needs credit. The additional production/service costs would eventually be passed on to consumers at a rate higher than if there was more finance available from DD accounts. i think someone made a similar point.

    So the gov’t effectively nationalises bank DD liabilities. Do you mean the gov’t no longer has any net debt? If so the gov’t isn’t really paying off the debt and the interest burden does not go away. How do the mechanics of this work?

    Interesting post.

    • Morning Adrian

      “The cost of money would go up because you are restricting supply or access to finance from DD accounts(imaginary or not), while money markets seek a higher rate of return than demand deposits provide. Increasing the cost of money would lead to price inflation on any business that needs credit.”

      I money inflation is when 100 money units exist then 101 money units exist. Money stays the same in this plan.

      If the price of money is more i.e. goes us, those who demand more of the services of money they do not have, the borrower , pays more to use the services that money provides. No inflation, just a wealth transfer from the borrower to the lender.

  • Adrian says:

    Correction “So the gov’t effectively nationalises bank DD liabilities” should be the gov’t effectively nationalises bank assets.

  • Steve Holland says:

    Hi Toby,

    I read your list thinking ‘that sounds great’, but £1000 is £1000. (Unless it’s leveraged 60 times I guess)

    I suspect that your proposals would solve one problem (the national debt) and create a far worse one; stagnation of the economy for the foreseeable future.

    The main problem I see, and it’s from a pragmatic perspective, rather than a financial one, is that the banks are now holding a physical asset rather than numbers in an electronic ledger.

    The newly printed cash would require enhanced security, which the banks would be forced to supply. This would lead to the bank’s costs rising significantly, which would in turn lead to these costs being passed on to the consumer in charges or diminished interest rates. For small depositors, the cost would not be worthwhile, and we would return to a cash under the mattress model of saving.

    This money is effectively ‘dead’ economically, and all the good that could have been done with the bank deposits (imaginary or not) would not get done. I think you are essentially breaking the ‘most powerful force in the universe’ i.e. compound interest.

    To use an analogy, I think you’re advocating pressing a giant ‘reset’ button on the economy, making everything seem rosy, but in effect you’d be rolling back the financial system to the gold standard days, if not before, with all the problems that this entails.

    Also, the legal framework required to enforce this would be all but totalitarian in order for it to work. The slightest cheating would bring the value of the currency crashing.

    Having said that, if you could agree to get the BoE to do it, I’d vote for you anyway!!

    cheers,
    Steve Holland

  • JP says:

    My question is this. People invest money…sourced through capital or loans to gain a return on this money. In this instance interest on the loan.

    If I were one of the people you suggest were to deposit my money in bank with the intention that it is lent to someone as a loan, then I would expect a return i.e. interest.

    I maybe misreading, but if the scenario states that the same amount of money £850m is in the system then it seems no wealth can be created. If this is the case, then money may as well not exists as the net gain in the system is zero.

    Because of this, some people may become richer…at the expense of others and eventually all of the countries wealth exists with a few people. However the economy never grows.

    • Morning JP

      I would like to point you to the answer I gave on May 20th, 2010 at 22:10 in reply to Tedego. I will recycle it for you.

      “The demand deposits are approx £850 bn. You can get the exact number off the Bank of England Web site to the penny if you are so inclined. Timed deposits are just a bit higher.

      If the money is fixed like this plan would do, should there be more productivity in the economy i.e. more entrepreneurs making more and better things with the same amount of resources , then the existing amount of fixed money will command more goods and services at those existing prices, there will be more purchasing power for the given money unit.

      This means a benign price deflation will be a symbol of good growth. Think of a computer 20 years ago at £3k and today x zillion times more powerful at £300 today. Everyone happy.

      Pause for a moment and think, I as an entrepreneur have only one goal to make better and cheaper things for my customers, this is the whole point of capitalism, however we have only upward moving prices on the whole. Do we all fail or is something else going on behind the system like state manipulation of the money supply??

      If people feel unhappy with falling prices and more purchasing power in their pockets as a good sign of material progress, then we can adopt a Freidman style money supply plus 2% a year rule and print more to offset against productivity gains. Naturally I would favour more purchasing power.

      Thank you for your continuing interest.”

      JP I hope this gives you enough food for thought.

    • To JP

      Wealth is created when an entrepreneur gets existing factors of production and puts these together in different and better combinations, by investing in longer and more timely capital intensive combinations to make more products or goods and services that satisfy even more people at cheaper and better prices.

      Why would this not continue?

      If you are thinking that the money unit itself has anything to do with wealth creation you are mistaken. If more money units was the answer to wealth creation, Zimbabwe would be the beacon of hope and world poverty would have been eradicated many years ago.

      Any level of money is the right level of money in the economy.

      If we had 100 units to by 10 goods and services this would suffice. If entrepreneurs had been productive and now created 12 units of goods and services, the 100 money units would compete to command control over those 12 units. Prices would go down and purchasing power of the 100 units would go up.

      The world would not end, do not worry JP.

  • Christopher says:

    The government can now put those assets into Mutuals, which would then immediately pay off the national debt, and leave the banks in exactly the same position net worth wise as they were prior to the reform . . .

    The plan appears logical in terms of book value, but what about the real value of the assets put into Mutuals? Who chooses which assets at each bank are the “surplus assets” to be placed in the Mutual? Wouldn’t this plan, in essence, subsidize some banks for bad assets or, alternatively, penalize banks with good assets that may be undervalued in the current market? What happens if the assets taken in exchange for paying off the banks’ liabilities are in the end worth less (or, perhaps, more) than £850bn?

    • To Christopher

      These are very good questions that need to be answered as they get into the detail of the matter. For now forgive me if I pass on this one and address at a later date. The first point to get out there in the big world of the internet is to see if there are any objections in logic only to the scheme i.e. “is it theoretically possible?” To me that is very much still a yes. The devil in the detail does need to be worked out.

      Thank you for contributing to the debate.

    • Very good point Christopher, the point of getting this article up and out is to road test it in theory. In practice these points all need to be worked on. You make very valid point and I will be seeking to address them shortly… watch this space.

  • Ramon says:

    Hi Toby

    Interesting plan, great reading. Obviously the banks won’t like it. Not my field but I think it works. Was having trouble with Point 6 also.

    You explained point 6 to a certain degree but I still wonder – despite the government already spending the “national debt”, thus it exists in the money supply already, surely the bond owners being repaid will also spend or invest their 850 bn back into the system (creating an over-supply of pounds leading to inflation)?
    I think you are saying that under this plan the repayment of national debt is effectively being done via the repayment of loans made against the pre-reform demand deposits and therefore is coming out of the money supply before the bond holders return it into the money supply.
    If so how long will it take to wind down the loans and repay the national debt? Surely if the loan assets are transferred into “Mutuals” and they repay the national debt “immediately” before they have realised the assets then there is over-supply?

    • To Ramon

      I am may refer you to the answer I gave to the comment from James on May 19th, 2010 at 18:36 ·

      I do not know the maturity profile on most bank assets (loans) , I would expect 5 years would do the trick. If this reform “gets legs” I will spend some time and work it out.

      Thank you for your comments.

    • To Ramon
      If you lend your Mum £100, she now can spend it. Let say she does, someone else has the £100. She works and does something productive for the person who she has spent the £100 with and then pays you back.
      This is going on all the time and is no different in the proposal. When a debtor pays back a creditor, there is just a movement in the money from the debtor to the creditor from whence it came in the first place.

  • If you say that the printed cash has value, but the credit is made out of thin air, then why do you want to cover thin air with real cash.

    You should just call it thin air and let everybody who is engaged in trading thin air – live on thin air – and if they can’t – then file bankruptcy.

    • To Ellie

      Thank you for your comments. Printing new money is bad , I very much agree with you as it reduces the purchasing power of the existing money. People who are poor and on fixed income find this hardest to adjust to.

      This proposal says swap one type of money (demand deposits) for another type, cash (notes and coins), so the net effect is no new money.

      The radical deflation you propose, whilst academically robust will cause a very painful reallocation of capital. Nobody in the world knows if their demand deposits are cash or thin air. No one knows for sure what if any parts of their business are bubble or not bubble activities.

      I think of the economy like a fine glass of wine, which has some vinegar put in it. It mixes with the wine, then how can you separate it. It is very hard.

      Why punish everybody for the sins of our policy makers when we can press the reset button (with this reform) and forbid the system to ever get like this again?

      • You admit you will cover funny money with real cash.

        What if the money supply is more like vinegar with few drops of wine.

        So you will make the fat cats bankers filthy rich, but just one time – after that they will not be able to make funny money any more.

        And your excuse is that making the irresponsible bankers fail will hurt the poor people. Nice.

        So you have “The philosophers’ stone” that will turn all crappy money into gold, but it is going to work only once.

        And my Monopoli money will stay fake, but the Bank’s fake money will turn real.

        • Evening Ellie,

          No, bankers will no longer be able to create funny money and earn funny money. They will have to sell a product for a price that we all want, when we want like any other business. This removes all their protected legal status to benefit at the expense of you.

          • You say that nobody knows how much of the demand deposits are cash or thin air. So my question is – when you swap printed cash for the part of the demand deposits that is thin air – how come you don’t create inflation. Seems like those are new money with only thin air behind them.

            Forgive my Layman questions, but to sell your plan you got to be able to explain it to all kinds of loonies.
            So here is a chance to practice.

            • Evening Ellie,

              I like your style. Made me laugh.

              If you had a glass full of cash at the bottom 5 % and air for the remaining 95%, the glass is 100% full of cash and air right?

              If a full glass represents 100 money units, the total money supply is 100 money units.

              If we added 10 more money units to the glass to sit on top of the 5% cash and to sit on the 95% air (if it could) then 10 extra would go on the full glass. This would be a 10% money inflation as there would be 100 + 10 money units.

              If we went back to just 100 money units of which 5 we call cash and 95 we call thin air, if we take the 95 out of the glass and “bin them” and replace with 95 money units of cash, we still have 100 money units. No inflation possible. One type of money has been converted into another type.

              I hope this is clear.

  • dangerdog says:

    Is the the interest paid on the debt enough to cover the existing government deficit?

    • To Dangerdog:

      The interest we pay is £40 bn per year at the moment. During this Parliament, I will move upwards to £60 bn , or 60% of what we spend on the NSH – what a waste. Also, this year alone, we need to find £38 bn just to pay the redemptions that are due.

      Sooner or later we will be eaten up by the level of the debt interest and repayments and or go bust unless something is done, not tinkering with £6 bn of expenditure cuts.

      • dangerdog says:

        Is there some mechanism in your plan to try to prevent the government from consistantly running a deficit?

        • Current says:

          That’s a very good point. Because, if money supply if fixed then the government will not be able to print it’s way out of debt in the future.

          In the time of the international gold standard there was a sort of international discipline that ensured this. If deficits became too large then countries were forced off the gold standard, or forced to reform.

        • dangerdog says:

          I ask because although your proposal goes a long way in addressing the current national debt and the credit situation that created it but your proposal doesn’t deal with future debt that would be gained in deficit spnding in the future. Perhaps a law requiring a balanced budget, I don’t know what the best solution to government fiscal problems might be, but unless something is done at this other source this symptom of national debt will only surface again in the future.

          All in all your proposal seems like an interesting way to prevent the credit situation that brought on this last recession in the future.

          • To dangerdog

            You are very right and hit on a critical point. There is no point indoing this unless you have some kind of constitutional restriction on Parliament. I would suggest the following;

            If any £1 needs to be raised a majority vote , 50%+1 of both House needs to take place to approve it.

            A balanced budget requirement.

            That would be a start.

        • To dangerdog

          See the link…

          http://www.mps2009.org/files/Buchanan.pdf

          James Buchanan is now 90 years old. He is a Nobel winner and the founder of the Public Choise School. He is a supporter of 100% reserves and has some constructive suggestions on stopping governments running a deficit.

          We could learn a lot from him on this matter.

          A very good question. Many thanks.

    • To Dangerdog

      Another good point. I do not know. Back of the fag packet..

      £850 bn x 6% interest repayments back to the Mutual to pay off the debt = £51 bn per year, so it should do it. Currently it is £40 bn PA.

      Thank you.

  • DominicJ says:

    Main argueent still not answered

    “On Monday, I start The Bank of DominicJ
    On Tuesday, I take a deposit of £100,000
    On Wednesday, I make a loan of £100,000
    On Thursday, you pass your printer law and put £100,000 of real money into my depositors account.
    On Friday, my depositor collects his £100,000
    On Saturday, I close my bank to new deposits and wonder what I’m going to buy with the interest payments of £400 a month on the £100,000 loan I still own.”

    Under your system I would be able to pay off my depositors and still be owed £100,000.
    The rest was irrelevent anyway

  • Chris says:

    You’re complicating it unneccessarily.

    The point is, at the end of your reforms, the government’s £850bn is both still out there in the pockets of the public AND paid back into the pockets of the debtors.

    You haven’t addressed this.

    • Chris, I think you are confused on this, I am sorry I do not make clear.

      £850 bn sits in vaults.

      £850 bn of money that has been lend to HGG is repaid by the repayments of the assets of banks held in Mutuals. Money moves in this case from debtor to creditor. Nothing new and it is alway only £850 bn in total.

  • Steven Farrall says:

    There’s another excellent reason to implement your proposal. The bankers (well, to be fair the existing breed of bankers – not the new ones that would spring up) would hate it.

  • If the Bank of England is going to print some cash for my Monopoly money too – I am all for your plan!

  • Jon says:

    You haven’t really changed a thing. All loans are still just digital credit if all cash must remain in the bank. If there are defaults, the system just crashes again. Otherwise you are just advocating banks making money out of nothing, thin air. Why can’t I do that? Hey buddy, I have just loaned you 10 grand at 5 per cent. Enjoy. All this is is another “creative accounting” scam that resolves nothing. Another Enron.
    The immediate answer is to get rid of printing money out of debt. There is no need pay interest to the fraudulent Bank of England. (All Central Banks, including the IMF and World Bank are huge scams used to steal resources).
    Cancel all outstanding debt.
    The long term answer, if society is to catch up with technology is to get rid of the monetary economic system altogether, it is prehistoric.
    http://www.zeitgeist-movement.com

    • To Jon, I have written this for a number of others, I repeat here as it applies to you. You will observe, cash moves from saver to borrower and back again. No digital movements and no credit.

      “In brief, over half of all lending today is via timed deposits i.e. when you as the depositor relinquish your money to the bank to on lend to a borrower who pays you back the capital and interest at a later dates or dates as the case may be. This will continue to be the majority way bank intermediation is done and once again become the preferred majority way to intermediate between saver and borrower.
      Credit created out of thin air that causes boom and bust will stop.
      Lending real savings, important as it is today, will become even more important.”

  • Jihn Bowman says:

    If the bank is mandated to hold the £100 real money on deposit at all times for return on demand, how can it lend it to anyone? Thus how can commerce be capitalised?

    We would be back to bartering things at the cross-roads.

    • Thank you Jihn Bowman, this is a response I gave to Dan that applies now to you as well.

      To Dan
      This has been answered in many ways on the comments to the site.
      In brief, over half of all lending today is via timed deposits i.e. when you as the depositor relinquish your money to the bank to on lend to a borrower who pays you back the capital and interest at a later dates or dates as the case may be. This will continue to be the majority way bank intermediation is done and once again become the preferred majority way to intermediate between saver and borrower.
      Credit created out of thin air that causes boom and bust will stop.
      Lending real savings, important as it is today, will become even more important.
      Do not worry; the economy will not grind to a halt.

  • Political referrers, 21 May 2010, 09:20:

  • Dan Hannan MEP
  • Douglas Carswell MP
  • Steve Baker MP
  • Dan Bowett says:

    I will not claim to understand everything you are talking about. I can however see one major hurdle.

    Currently you say the banks lend on a 33:1 ratio. You are proposing moving to 1:1. In theory this is a great idea but what happens to the millions of businesses up and down the country that rely the credit created by the current system. Will that not dry up on the day your system comes into effect and therefore destroy these businesses?

    • To Dan

      This has been answered in many ways on the comments to the site.

      In brief, over half of all lending today is via timed deposits i.e. when you as the depositor relinquish your money to the bank to on lend to a borrower who pays you back the capital and interest at a later dates or dates as the case may be. This will continue to be the majority way bank intermediation is done and once again become the preferred majority way to intermediate between saver and borrower.

      Credit created out of thin air that causes boom and bust will stop.

      Lending real savings, important as it is today, will become even more important.
      Do not worry; the economy will not grind to a halt.

      Think of how they lent in the hey day of the industrial revolution.

      Thank you for your comments.

    • To Dan
      This has been answered in many ways on the comments to the site.
      In brief, over half of all lending today is via timed deposits i.e. when you as the depositor relinquish your money to the bank to on lend to a borrower who pays you back the capital and interest at a later dates or dates as the case may be. This will continue to be the majority way bank intermediation is done and once again become the preferred majority way to intermediate between saver and borrower.
      Credit created out of thin air that causes boom and bust will stop.
      Lending real savings, important as it is today, will become even more important.
      Do not worry; the economy will not grind to a halt.

  • alastair says:

    It looks good to me. I wonder what you would propose regarding the lending risk, though. For instance, if I let the bank lend my money and the person it lends to doesn’t pay it back, who was it taking the risk? Me, the bank, or some combination? I’m sure the bank would very much like it to be me :-)

  • Sue Doughty says:

    I claim that £1000 reward for spotting the fault in the system – printing money devalues money so you end up with the same spending capacity.
    Adding fresh cash to bank vaults equal to the value of uyour deposit does not mean “not having you the depositor as a liability anymore”. No matter how they store it or make it work it is still your money held in your name so they are liable to give it back to you on demand regardless of origin and is therefore a liability.
    The main symptom or cause of the credit crunch was that many people now do not hold deposits in banks but are overdrawn and in debt so to equalise deposits with freshly printed cash means removing money from bank vaults, not adding it.
    I demand that £1000.

    • To Sue Doughty

      Sue , like Stephen in the above comment it is a shame you have not understood why this is not inflationary. I wrote this to the Commentator Ellie, it may change your mind;

      “If you had a glass full of cash at the bottom 5 % and air for the remaining 95%, the glass is 100% full of cash and air right?
      If a full glass represents 100 money units, the total money supply is 100 money units.
      If we added 10 more money units to the glass to sit on top of the 5% cash and to sit on the 95% air (if it could) then 10 extra would go on the full glass. This would be a 10% money inflation as there would be 100 + 10 money units.
      If we went back to just 100 money units of which 5 we call cash and 95 we call thin air, if we take the 95 out of the glass and “bin them” and replace with 95 money units of cash, we still have 100 money units. No inflation possible. One type of money has been converted into another type.
      I hope this is clear.”

      Perhaps if you have time to re read this article with this understanding in mind, it may well appeal to you in another way.

      No £1,000 reward for you I am sorry to say.

      • If Toby the Great, the ruler of the sorcerer stone, has to make an educated guess how much of the British demand deposit currently is thin air – what would the percentage be?

        I assume the 95% cited here is just for illustration purposes.

        I like the futuristic part, but still don’t understand in what world it is OK to swap printed cash for that 95% of thin air.

        If you separate the real money from the thin air and then print cash for the real money and impose the new strict rules of lending – it is OK.

        But if you don’t separate them – it is called money laundering – is it not?

        • To Ellie

          Approx Money Supply = £60 bn of notes and coins + £850bn demand deposits and £910 bn of timed deposits.

          Creating money out of thin air is called fractional reserve banking. Counterfeiting is another word that comes to mind.

          • Do you mean that all money supply in UK is thin air?

            And it is all legally done I assume.

            So you are calling for everybody to accept at one point in time: let’s accept the thin air to be our currency and promise (enforce regulations) that from now on we will not make any more thin air (the way we cannot print gold).

            You are calling for consensus for everybody to accept the thin air as our gold standard as long as we make sure no more thin air is created.

            I am sure I am confused, but thank you for your patience!

          • Thin air is our currency – is there any part of the money supply that is backed by something of real value?

            What percentage of the money supply in UK are backed by something of real value?

          • Will the USA accept the British thin air to be the new gold standard?

            We have here certain amount of created thin air money supply of our own too. If we promise not to create any more new American thin air money would the UK accept the US dollar as the new gold?

            That way you can put in your vaults US dollar notes to back your demand deposits balance sheets.

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