I've been thinking about the implications of Fractional Reserve Banking for the current Eurozone crisis. Total government debt within the 27 EU countries is close to 10 trillion euros. Clearly, all governments have been guilty of taking on excessive debt - with the Germans top of the list (over 2 trillion euros of debt). The Greek government's debt is "only" 317 billion euros. But of course, their problem is that they are currently being charged 17.78% interest, whereas the Germans only pay 1.84%. Very unfair....
So, I was wondering what would happen if the European Central Bank did what the Positive Money website seems to be proposing, and took command of money creation. They could "print" the 317 billion euros that the Greek Government owes, and lend it to the Greek government under a very strict repayment scheme where the Greeks would repay over 10 years (say) at the ECB's key interest rate of 1.25%. The Greek government would then use the loan to repay the entire debt owed to the markets. Normally, everyone should be happy. The banks who are currently panicking because they have tens of billions of money in Greek government bonds will be happy. The Greeks will be happy (it's nicer to have a fixed interest rate of 1.25% than a variable rate that goes through the roof). And, (this is the question for the Positive Money specialists), even the Germans should be happy if it turns out that a large proportion of the "money" lent to the Greeks was the result of fractional reserve banking.
If I've understood correctly, and if it turns out that 90% of the money lent to the Greeks did not correspond to deposits that had been made by savers (I've just guessed the 90% number, because I'm not sure that anyone really knows), when the Greeks pay the money back, the debt and the money will just disappear into thin air (in the same way as it was produced). Thus, virtually no inflationary pressure, and no need for the Germans to block the move.
If the same operation was done for each of the Eurozone countries, the trick would have the effect of shifting government debt from the markets to the Central Bank, where it can be handled in a more rational and controlled way.
It's effectively Quantative Easing, but very unlike the QE2 mechanism proposed by the Bank of England in which the £75 billion effectively goes straight to the banks and other actors in the financial sector with absolutely no control over what happens to it. Indeed, I think that no-one has the foggiest clue what happened to the last £200 billion of QE. In contrast, when Quantitative Easing by Central banks is used exclusively to pay off government debt, it seems to me that the effects are very beneficial. Indeed, there is a case for saying that this should be the only use for the mechanism.
Finally, could the same trick be used by the Bank of England to shift the UK national debt from the markets to the Bank of England? If the government only paid the 0.5% interest rate that the BoE proposes to private banks, there would be one hell of a lot more money around. The government could reduce the massive austerity plan and get the economy moving again.
All comments very welcome!
12 Nov 2011
Using Positive Money to solve the Debt Crisis
There's an interesting forum on the Positive Money website which is open for debate on a wide range of topics. I've just posted the following topic in the hope that it might generate some replies from the knowledgeable people who are interested in the site. It's essentially a rehash of the ideas that I've been pushing recently, but here it is again for those who need a reminder of what I'm proposing.