28 Sep 2014

Yet another solution to public sector debt - use the Magic Money Tree

I'm surprised that I didn't think about it before. After all, I originally suggested the idea of a sort of public bank that would get the government out of debt back in May 2012 - see my post on "How to cancel all government debt in 10 easy stages".  There the idea was to use the fact that banks have the right to lend out around 10 times as much money as they have in capital to make loans. They could therefore make loans  to people who would reinvest the money in the bank via another person. Do that around ten times, and you can create collosal amounts of "money" out of thin air.

Later on,  I realized that the Basel Banking regulations mean that when banks lend to sovereign governments with a credit rating between AAA and AA-, those loans have a risk weighting of zero, which means that they don't have to have any capital at all - they can effectively loan infinite amounts of "money" to governments with no capital to back it up. I explained that one in my post back in March 2014 called "The biggest Bank scam of them all - Banks lending non-existent money to governments and charging interest". I had even realized that this wonderful system was almost certainly the reason why, despite the Basel banking regulations, the 50 largest banks in the world have $67.6 trillion in assets, but only $772 billion in capital so that, on average, they have around 87 times more assets than capital. Indeed, several banks have assets to capital ratios of over 1000 to one - with one bank - the Wells Fargo Bank having succeeded in reaching an assets to capital ratio of 2647 to 1. Impressive.

But for some reason I didn't put 2 and 2 together to make 4.... trillion.

Why don't we just start a citizen's bank, and use that bank to lend unlimited amounts of interest free money to our governments?

For example, the French government was in debt to the tune of €1,925 billion at the end of 2013 - a figure that has certainly increased substantially. Interest payments on all that debt cost French taxpayers €47.3 billion last year.

Suppose that we start a new citizens Bank that would have French citizens as shareholders. We could sell shares in the Bank for say €100 and get millions of French citizens to sign up. This would give the bank a respectable capital base. France is currently rated AA and so that means that banks that lend money to the French government don't have to include those loans when calculating their exposure - the loans have a risk weighting of 0%. As a consequence, whenever the French government needs to borrow money on the markets, it could go to the French citizen's bank and get as much money as it wants - with no interest to pay. Indeed the Bank could sign a loan deal where the money only needs to be repaid after 1000 years.

In principal, our friendly bank could lend the French governemnt the roughly €2 trillion needed to pay off ALL its debts. But actually, I think that it would be better just to pay off the Banks who have been purchasing French government debt with non existant money. When those sorts of loans are repaid, the money simply disappears into thin air, thus eliminating any risk of inflation.

So, there you have it. A way to achieve "debt forgiveness" without running the risk of triggering a massive revolt from the financial sector. After all, they could not complain. The citizens bank would be doing no more that what commercial banks do all the time - creating massive amounts of government debt by making loans with non existent money. The only difference is that the citizen's bank will not be requiring tax payers to pay the interest charges.


  1. Simon, this is a great blog and I'm delighted to see you tackling the issue of government debt. Some other people have already come up with a different solution which doesn't involve using fractional reserve banking against itself.

    What is government debt?
    When a government needs more money than it can collect through taxation, it will issue bonds. These are sold on the open market and will pay interest to whomever holds
    them. So, government debt is typically in the form of bonds which are often bought by banks.

    What would be the difference between a government printed bond and government printed currency?
    Both are promises to pay and the elements that make a bond good would make
    government printed currency good also. The difference is that bonds pay interest to whomever holds them. This is one of the drivers of inequality - wealth is transferred from the hands of the many (taxpayers whose taxes repay the interest) into the hands of the few (bond holders who receive the interest).

    How can government debt be eliminated without destroying the financial system?
    Here are the steps:
    1) Government issues currency (no debt).
    2) Government begins buying back the bonds it has issued.
    3)As bonds are bought back from banks, the reserve requirement (reserve ratio) is raised proportionally. This continues until all bonds are bought back from the banks and their reserve requirement is 100%. In other words, fractional reserve banking would be replaced with full reserve banking.

    This would leave the banks with enough money to continue lending. This big difference for the banks would be that, as the reserve requirement would be 100%, they would no longer be able to create money. This means that banks would behave the same as any other business, providing services which people need and using money which they actually have on deposit.

    It's all simple and fair. Many people, such as the Occupy movement, campaign for the benefit of the 99%, but it's perfectly feasible to have a system which works in a fair manner for the 100%.

  2. Very nice comment Damian.

    I am absolutely 100% convinced that allowing direct money creation by governemnts (via their central banks) would be wonderful. And yes, it is totally stupid that governments emit bonds that are bought up by banks with fictitious money, and using the Basel rules that means that they don't even have to have any capital (since lending to AAA to AA- sovereigns has a risk-weighting of 0%). Those banks can then sell those bonds to third parties who can sit back and cream off 3% of GDP for doing nothing.

    The question is, how to get there? The main problem is that there are massive vested interests that will try and keep the gravy train on the rails. My proposal to set up a public interest bank to use fractional reserve money creation is just a way to get there. It's a stupid system, so lets just prove it. It's called hoisting the banks by their own petard.


  3. Positive Money has produced a document which explains their vision for implementing monetary reform in the UK. It's very good and even debunks the main arguments that have critics have used against it.


    At the end of the day, the solution is going to be a political one. Simply take away from banks the right to create money. It's really a win-button for whichever government implements the reforms, so it's a matter of getting them to pay attention so that we can explain how reform would result in a significant increase in government spending power (without the need for increased taxation or spending cuts elsewhere).

  4. Damien, I'm a big fan of Positive Money - I donate them money every month and couldn't be more enthusiastic. But they do consider that reducing government debt is not a priority (Ben Dyson has told me that directly). Personally, I think that we should also be trying to reduce the massive drain on taxpayers that is caused by the 3% of GDP that is wasted paying interest on public sector debt.

    I also believe that while it would be enough to "take away from banks the right to create money", something tells me that there may just the odd one or two vested interests who might resist. That's putting it mildly.

    We need to have a multi-stranded approach if we are to make progress.