Victory! The Bank of England admits that commerical banks create money out of thin air!

This is truly an event worth celebrating. The Bank of England has just published two articles in its Quarterly Bulletin that lay bare the truth of how the money system works. There's one called "Money in the modern economy: an introduction" which was written by Michael McLeay, Amar Radia and Ryland Thomas of the Bank's Monetary Analysis Directorate.

Try this for starters:

“Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves…  When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created…”

You can actually watch Ryland Thomas from the Bank of England, the author of the article, in a video on Youtube say the following (at 0m50s):

"Broad money... includes all the bank deposits of households and companies. And one of the key points of the article is that banks create additional broad money whenever they make a loan.  Now while this is nothing new, it is sometimes overlooked as the main way in which money is created. And it runs contrary to the view sometimes put forward that banks can only lend out deposits that they already have. In fact loans create deposits - not the other way round. "

Here's the bit where he reveals all:

The other paper, also by the same three authors is called "Money creation in the modern economy".
There you can find the following statements:

"Whenever a bank mades a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money.

 The reality of how money is created today differs from the description found in some economics textbooks:

• Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits

 Later on in the article you can read:

"Broad money is made up of bank deposits - which are essentially IOUs from commercial banks and companies - and currency - mostly IOUs from the central banks. Of the two types of broad money, bank deposits make up the vast majority  - 97% of the amount currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themsleves."

 And how about this?

"Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created. "

 Not bad eh? Anyone out there still doubting that commercial banks can create money out of thin air?

They also make it very clear how money can be destroyed.

"Just as taking out a new loan creates new money, the repayment of bank loans destroys money.  For example, suppose a consumer has spent money in the supermarket throughout the month using a credit card. Each purchase made using the credit card will have increased the outstanding loans on the consumer's balance sheet and the deposits on the supermarket's balance sheet... If the consumer were then to pay their credit card bill in full at the end of the month, its banks bank woudl reduce the amount of deposits in the consumer's account by the value of the credit card bill, thus destroying all of the newly created money."

The Bank of England also lays to rest another long standing myth - that Central Banks can control the money supply by the so-called Money Multiplier mechanism.

“…the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks. Banks first decide how much to lend depending on the profitable lending opportunities available to them…It is these lending decisions that determine how many bank deposits are created by the banking system. The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England.”

All this is really a remarkably victory for the people at Positive Money - and they are rightly claiming some credit for progress in this area. When they started out in 2010 arguing that the vast majority of the money in the economy is created out of thin air by commercial banks, many people ignored them, saying that it couldn't possibly work that way. But they published the book "Where does Money come from?" which has now become a standard text at some universities.

And now, the Bank of England has essentially said that, yes, they were right.

Congratulations Positive Money!

Positive Money's Annual Conference

I had an excellent day yesterday at Positive Money's annual Supporters conference here in London. It was very well organised, with around 400 participants. There were about 40 people from outside the UK, with strong contingents from  Denmark, Sweden and  Portugal, but also representatives from France (there were 3 of us), Germany, Luxemburg, Switzerland, Croatia, Spain, Iceland, Greece and the USA.

Ben Dyson gave a very convincing presentation of Positive Money's proposal for Sovereign Money Creation. He compared the £375 billion of Quantitative Easing that the Bank of England has injected into the  financial markets with what could have happened if newly created money had been injected directly into the economy. The fact is that there has been almost no serious analysis of where the £375 billion went. But it would appear that one of the main effects has been to produce a 20% increase in the stock market. Has that done anything except make some rich people even richer? When money gets used to inflate bubbles, does this do anything to help the real economy?  He provided some figures suggesting that every £1 of quantitative easing leads to just 8 pence of extra spending in the economy - in other words almost nothing.

He then compared that pathetic effect with what would have happened if the Bank of England had simply allowed money to be spent directly into the economy. Independent figures (from the Confederation of British Industry I think) suggest that every £1 of spending into the real economy results in about £2.80 of extra spending. Those figures suggest that Sovereign Money Creation is 35 times more effective than quantitative easing - which is effectively equivalent to throwing money at bankers and praying.

The argument is devastating. Can Mervyn King please explain why he agreed to waste £375 billion - more that half the entire UK government spending for an entire year - in this futile way? And can the banks prove that a substantial proportion of that £375 billion wasn't used to pay the £60 billion in bonuses that the City has handed out since the financial crisis?

At the end of the meeting, I was even more convinced that the number priority should be to introduce debt-free money creation somewhere in the world. It almost doesn't matter where. I talked with a guy from Iceland which might be a good place to start, because the Icelandic people have already shown that they are prepared to stand up to the banks.

But it could almost be done at any level. Obviously, my current preference would be to convince the ECB to inject new debt free money directly into eurozone citizens' accounts. But it could also be done at the national level using a sort of N-Euro system. Or it could be done at the regional, or even local levels. 

Ben Dyson and Positive Money's position is sensible. While we all agree that the aim should be to remove the ability of commercial banks to create new money, there is a strategic question of how to achieve this. It may  well be better to first demonstrate that debt-free money creation and direct injection into the economy is doable. In this way, you can leave the banks with their money creation licence until it has been demonstrated that there is an alternative.

Malcolm Torry : Money for Everyone - Why we need a citizen's income

I've just finished reading Malcolm Torry's 2013 book intitled "Money for Everyone - Why we need a citizen's income". I can thoroughly recommend it.

Here's what the book says about the author. "Dr Malcolm Torry is Vicar of Holy Trinity, Greenwich Penisula, in the Church of England Parish of East Greenwich. He is Director of the Citizen's Income Trust, and was a visiting research fellow  at the London School of Economics and Political Science from May 2011 to April 2012".

He clearly didn't waste his time at the LSE. The book is very well documented, with over 700 references, and makes a totally convincing case for introducing an unconditional Citizen's Income. 

I was fascinated to learn that they have had such an unconditional Citizen's income since 1982 in Alaska using a fund that was set up using money obtained from selling oil drilling rights. It's not quite perfect, since the amount paid to each citizen varies depending on the amount money earned by the investments. But, as you can from the official figures for the past 30 years, the best year was in  2008 when the vast majority of Alaska's 680,000 inhabitants received over $2000 each - no questions asked.  The effect seems to have been very beneficial. As Torry notes, "Alaska is the only state in the US in which inequality has decreased during the past twenty years. Whereas in 1980, Alaska's net income inquality was the highest in the United States, now it is the lowest".

He also describes the details of a pilot study run  in Namibia between 2007 and 2009 in which each of the 1000 inhabitants of two villages was given a Citizen's Income of about $12 a month. The results looked amazingly good - with across the board improvements in health, education, crime rate and other measures.  Particularly impressive was the finding that "average income rose a staggering 200 per cent in the lowest quintile, excluding the Citizen's income, because people could now purchase the means of making an income, and they did."

I was pleased to see that Malcolm Torry mentions the possibility of using a Financial Transaction Tax to finance the Citizen's Income. But it looks like he might not have thought about combining the Citizen's income with a change in the way that money is created and introduced into the economy - the sorts of reforms proposed by Positive Money in the UK and Monnaie Honnête in France.

I'm more and more convinced that a combination of the two ideas - debt free money creation by a central publicly accountable authority and injection into the economy via a Citizen's income - provides a truly effective way to fix many of the problems we face.

You can find a neat poster that presents the main arguments for a Citizen's Income here.

Why we should give free money to everyone

My thanks to my sister Caroline for pointing me to this excellent article about the basic income idea, written by Rutger Bregman.

A shortened version of the article was published in the Washington Post - here's the link.

Highly recommended. It's amazing how few people have heard about this excellent idea.

For me, it is quite simply the best way to put debt-free money into the economy. An independent central bank authority would simply decide how much debt-free money can be injected into the economy. It would do it by directly injecting money into citizen's accounts. And at the same time, that authority should remove the same quantity of debt-based money from the system using a flat-rate universal Financial Transaction Tax on all electronic transactions involving the currency in question. No risk of corrupting politicians. No possibility of using the mechanism for personal enrichment.

TARGET2 transactions for 2013 : Down 22%?

I've been tracking the level of financial transactions in Europe for some time. One useful place to look is on the European Central Bank's website where you can find all the figures for the TARGET2 and EURO1/STEP2 systems month by month. Target2 stands for Trans-European Automated Real-time Gross settlement Express Transfer system, and you can see a five minute video about it here.

I've just calculated the totals for each country in 2013 which I have put in the following table.

As you can see, the overall totals are down around 22% on 2012 - a mere €493 trillion. Euro 1 transactions were also down about 16% at around €49 trillion, to make a total of €542 trillion.

What's going on? Do you think that the traders have started calming down?  After all, 2013 was the year when some European countries started to introduce a small Financial Transaction Tax on some sorts of trading. Perhaps it is starting to have an impact?

I rather doubt it. The fact is that while 23 of the 27 EU countries use TARGET2, one country in particular does not - namely, my dear compatriots in the UK. And the UK is the world leader in off the record book transactions - so called OTC (Over the Counter) trading. They are also very keen to provide their customers with a way to trade that avoids anyone seeing what it going on.

I bet you that the real amount trading hasn't dropped at all. It's just going through the City of London's deliberately opaque settlement systems. Systems like the one handled by LCH ClearNet Ltd which handled  £862 trillion in 2008 but strangely has not reported any numbers to the BIS at all since 2010.

A solution : Central Bank generated Basic Income balanced by a flat rate Financial Transaction Tax

I've been thinking more about how best to fix the system.

I've already argued that Central Banks could inject debt-free money directly into the economy via an Unconditional Basic Income for all citizens. I've also argued that Central Banks should have the ability to remove excess money from the system via a universal flat-rate transaction tax on all transactions that use their currency.

Take the example of the European Central Bank. In this case, the idea would be for the ECB to create electronic accounts for every citizen in the Eurozone, and then to add a fixed amount per month to the accounts of every man, woman and child. With 333 million citizens in the Eurozone, a budget of €1 trillion a year would allow everyone to receive around €200 a month - i.e. €800 for a family of four.

In parallel, the ECB would also be given the right to impose an FTT on all Euro-denominated electronic transactions, wherever they occur in the world. Similar mechanisms would apply for the Bank of England (in the case of Sterling transactions), the Federal Reserve (for transactions in US dollars, and so forth). The rate of the FTT would be continuously adjusted to remove the desired amount of money every month. With around €2 quadrillion in euro-demoninated transactions a year, an FTT of 0.05% would allow the ECB to remove €1 trillion a year.  Note that it would be trivial to continually adjust the rate month by month, day by day, or even hour by hour to ensure that money was removed at precisely the rate required.

Here's the new idea. I propose to fix things so that the Central Bank is required to set the FTT rate at whatever is required to completely balance the injection via the citizens' accounts.  Thus, if the ECB injects debt-free money at €1 trillion a year (i.e. around €200 per month per citizen), it would be required to set the FTT rate such that the same amount of money is removed every month.

The result would be that the system would be totally safe. There would be zero possibility of causing inflation, because the money supply would actually be unaffected.   This would effectively demolish the standard argument invoked by the banking lobby that money creation without debt could run the risk of generating inflation.

It would also totally demolish the other main argument that you hear - namely that allowing politicians to get their hands on the money creation process would be an invitation to corruption. It's true that if a central bank were to hand hundreds of billions of money directly to governments, it would be difficult to ensure that the politicians would not be tempted to buy votes, or pay the mafia.  That argument completely disappears if the Central Bank is used to push new debt free money directly into the economy via citizens. It would be extremely difficult, even impossible, to manipulate that system in favour of particular interest groups.

You might be asking yourself, what's the point of injecting €1 trillion into the economy every year if you immediately remove that money via a universal financial transaction tax? Well, think about it.  Although the FTT would be absolutely universal, and paid by absolutely everyone whenever they make a Euro-denominated financial transaction, the main people who would be paying the tax would not be the ordinary man in the street. When the €200 arrives on his or her account, they would pay 0.05% (i.e. 10 centimes) to the ECB. Likewise, when that money is spent (by drawing out cash, paying with a credit card or cheque, or by using a direct debit), they would pay another 10 cents - a total of 20 centimes.  In contrast, the high frequency traders who are shifiing $5.3 trillion around the foreign exchange markets every day would end up paying proportionately far more.

In other words, without rigging the system, it would naturally be those in the financial sector who have nothing better to do with their money than speculate that would end up paying the lion's share of the €1 trillion a year in FTT. But of course, the move would not make speculation illegal - just slightly less profitable.  The traders (and their computers) would simply have to add the extra costs into their algorithms. No big deal.

But the real beauty of the idea is that, although on the face of it, you might think that pushing €1 trillion a year of money into the economy at one end, and then removing the same amount at the other is neutral, it is not neutral at all.

The point is that while the money that is being removed at the top end will currently be almost entirely debt-based money - created by commercial banks out of thin air, and for which we are all forced to pay interest - the new money being injected via the Citizens' income will be debt free. 

Progressively, over a period of several years, the money in the system will gradually change from being debt to what I would call real or honest money.

We know that the Eurozone countries debt levels currently exceed €24.5 trillion (taking together household, business and public sector debt). You might think that the situation would only be fixed once €24.5 trillion of debt-free money has been injected. But this would be wrong. The fact is that a €100 note can be used to pay off hundred of thousands of euros worth of debt by using it over and over again.

So, I suspect that even a relatively modest €1 trillion a year of new money could actually allow debt to be reduced far more quickly. Remember that Mario Draghi (president of the ECB) created over €1 trillion in the space of a few months a couple of years ago, so there is actually no real problem here. He could do it. It wouldn't even break the terms of the Lisbon treaty.

Why don't we do this straightaway? The answer is simple. The financial lobbyists who defend the interests of the commericial banks and who want to keep their monopoly on money creation will do everything in their power to keep their gravy train on the rails for as long as possible. When the financial sector can suck over 3% of GDP out of the economy every year in the form of interest payments on public sector debt alone, they will not be at all happy with the idea that anyone could introduce a way to inject debt free money into the system.

But I can see no reason whatsoever for not introducing a system where Central Banks inject debt-free money into the economy as an unconditional basic income for all citizens and then remove the exact same amount of money by imposing a universal financial transaction tax.

Fixing the ratios so that the total money supply remains stable removes one of the few remaining objections that the financial lobbies could raise.

If you can think of any other problems, do let me know.

And if there is anyone out there who would like to defend money creation as interest-bearing debt by commercial banks, feel free to post your defense here. I'll be happy to read your arguments.

Fixing the system with a basic citizen's income

I've been very quiet for the last month. Sorry about that.

Let me take the opportunity to wish us all the very best for 2014.  We will certainly need to work hard if we are to fix the mess that we are in.

However, I'm actually pretty optimistic. I really think that there are ways to improve the way the system works, and to break the stranglehold of debt that is crippling all of us - individuals, businesses and governments - except of course for the tiny minority who have been profiting from the insane monetary system that we have inherited.

To recap on the essential point, the fundamental reason why we are in such a mess is that the money that we all need to live and do business is created out of thin air by commercial banks when they make loans. They then charge us all interest for effectively renting this money. But because the commercial banks don't create the money to pay that interest, the whole system is doomed to accumulate more and more debt as time goes on. And the so called growth in GDP that is starting to appear in countries like the UK is nothing more than an increase in debt.

The truth is that in the Eurozone (for example), the level of debt  had reached 24.5 trillion euros at the end of 2012 - a value that is 2.5 times the total amount of money in the system (as measured by M3). There is no way that austerity can fix this. Nor can we get out of debt by borrowing yet more.

So, how can we get out of this mess?

What we need is a way to inject debt-free money into the system to allow the debt to be progressively written off.

The Positive Money movement in the UK has been arguing strongly for the idea that central banks such as the Bank of England should be given the responsability of creating the nation's money supply. And they propose that that money should be provided directly to the government who could then use it in a variety of ways. For example, they could spend the money into the economy in the form of infrastructure projects (transport, education, health, energy etc). Or they could reduce taxes. Or they could pay of public sector debt. Or they could provide money directly to citizens in the form of  a basic income payment.

These are all perfectly valid ways of getting debt free money into the system. But of course, you can imagine that the commercial banks and their lobbyists will complain that giving politicians "free" money would be opening the door to corruption. What would stop the politicians using the money to buy votes etc.

The more I think about it, the more I am convinced that there is an even simpler method. I think that the Central Banks should short-circuit the politicians and put the debt free money directly into the economy via direct payments to citizens. It's an idea I originally mentioned back in August of 2013.

How might this work?

Well, imagine that the European Central Bank decided that it was prepared to put an extra trillion euros of debt-free money into the economy every year for at least a decade. Creating a trillion euros is actually no problem for a central bank - after all, Mario Draghi did precisely that when in December 2011 and February 2012 he created money that was provided to hundreds of commercial banks in the hope that this money might encourage the banks to create yet more money.

With a population of 333 million, the ECB could provide €3000 per year for every man woman and child in the Eurozon. That would be €250 per month for each citizen, and €1000 for a family of four.

The idea is that this money would be provided in an unconditional way - irrespective of whether or not the citizen was looking for work, and indeed of whether the citizen was actually in need.  It's the idea that been promoted by the European Citizens' Initiative for an Unconditional Basic Income, which organized a petition to force a debate in the European Parliament. They needed 1 million signatures, but missed the target because when the petition closed on the 14th of January 2014 at which point there were just over 285,000 signatures. I signed the petition, and I have also signed a new petition that is being organized using the AVAAZ site.

Why is an unconditional basic income such a good idea? There are a number of reasons but, in particular, it could radically change the current situation where people receiving benefits are often criticized for sponging off the system. If everyone received the same amount, this source of conflict would cease overnight - because everyone would be treated fairly.

Having an unconditional payment would greatly simplify administration costs because it would no longer be necessary to employ large numbers of people to check that claiments were really entitled to the benefit payments. 

An unconditional basic income would also mean that people to easily do the large number of useful activities that are currently difficult to finance by paid work. For example, child care and looking after the elderly are all vital activities that currently cost a great deal to finance. But many people would probably be happy to do it themselves if they could simply afford to do it - but they are literally obliged to work full time just to keep income levels at the minimum levels needed for survival. 

It would also free people to make their own choices about how they use their time. Some people might want to invest far more in voluntary and charitable work. It could allow school leavers to go into higher education without necessarilly running up massive levels of debt. It would also allow people to spend time developing cultural and artistic projects, as well as spending time developing their own projects for starting up businesses.

You might argue that providing an unconditional basic income would remove the incentive to work. In fact it would be quite the opposite, since any additional paid work would go directly in the citizen's pocket. Ideally, there would be no loss of benefits at all, meaning that the classic poverty trap in which people are actively encouraged to stay at home because they would lose their means-tested benefits if they find work would be eliminated.

Importantly, it would make the work market far more flexible. Currently, if you want to get enough money to survive by working, you almost have to work full-time. Any less than full-time, and you will probably not get enough income to pay the bills. In contrast, in a system with a unconditional basic income, people would be able to adapt the amount of paid work the do to fit their own requirements. If they can survive on just the basic income, then they would have the option of doing zero hours of paid work - thus allowing to devote all their energy to doing unpaid work such as child care, looking after elderly parents or voluntary work. But if they want additional income, they could do 5 hours, 10 hours, 20 hours or work full-time as required.

Imagine how things would be for employers. Currently, an employer is effectively obliged to pay a salary that is enough to provide a living wage irrespective of their family conditions. Thus an employer is obliged to pay the same to a single person with no children to someone who is the family breadwinner - it would be "unfair" to do otherwise. But imagine what would happen if a single person was getting €250 a month of basic income, and a father with three children was getting €1250. It would mean that the employer could provide a standard salary that was better adapted (and lower!) than would currently apply. In other words, the basic income payments would effectively act as a boost for business because they could provide a living wage at lower cost.

The change in the relationship between employees and their employers would have other highly beneficial effects. If the basic income meant that citizens actually have a real choice because they could (by being very frugal) survive without paid work, it would mean that the most menial and ungratifying jobs that are currently poorly paid would start to be paid at a better rate that reflected the real value of the work. People would choose to collect dustbins or clean sewers not because they are the only jobs around, but because they are sufficiently well paid to be attractive.

Another enormous advantage of an unconditional basic income is that it would reduce the pressure on housing in the places where work is easiest to find. Currently, many people are forced to move to cities because it it difficult to find jobs in more rural areas. The result is that housing, transport and other facilities in the cities are over-stretched. With a basic revenue, people could more easily live in the rural areas that are currently disadvantaged. And with the increase in the number of people who can work via the internet, this would make perfect sense.

This rebalancing would certainly apply to different regions within a given country. For example, in France, the basic income would have the effect of reducing the strain on the major population centres, because people could have the option of moving to places with low population densities and low demand. Two families with three children each could easily share one of the many inexpensive properties in the more remote parts of France without needing highly paid jobs.

But imagine what would happen if the ECB financed Citizens Income was the same throughout the entire Eurozone. This would mean that there would be a clear incentive for people to live in the parts of the eurozone where the cost of living is lowest. There are currently 8 European Countries that are currently obliged to join the Eurozone as soon as the convergence criteria have been met. These include Bulgaria and Romania, two countries which have been in the news recently because of fears that there could be a mass exodus of their populations to other EU countries following their change of status on the 1st of January 2014.  But if the citizens of such countries were assured of getting the same basic income payments from the ECB, irrespective of their country of residence, it is clear that they would be much less keen to delocalise, given that it would be much cheaper for them to live at home.


I hope that this list of advantages will have gone someway to convincing you that the idea of an unconditional basic income is a truly interesting idea that deserves close attention. But less me stress that while there are many people who are starting to realize that the idea is interesting, I'm actually proposing something additional.

My argument is that the first place to introduce such a system could be via direct payments made by Central Banks to citizens using truly debt-free money. The Central Bank would need to create individual accounts for all Citizens - this would be little more than a vast Excel Spreadsheet with 333 million entries in the case of the Eurozone. Providing a citizens' income would simply involve adding a fixed amount to each account every month. Each citizen would be able to link their ECB account to their normal bank account so that they could use the money.

Of course, you could argue that if Central Banks started injecting money directly into the economy in this way, there could be a risk of inflation. But this too would be easy to avoid by simultaneously giving the Central Bank the power to remove excess money from the system by imposing a simple flat rate financial transaction tax on all electronically mediated transactions in the relevant currency.

Financial transactions in the Eurozone are currently at least €1.6 quadrillion a year. And those numbers don't even include the massive quantities of Euro denominated transactions occuring outside the Eurozone. For example, around one third of the $5.3 trillion in Foreign Exchange that takes place every day involves euros - that's something like €350 trillion a year - 40% of which involves trading based in the UK. Taxing those transactions at just 0.1% could easily remove  €1 trillion a year from the system - plenty enough to remove any real risk of inflation caused by injecting €1 trillion of debt-free money into the economy every year.

But it is important to realize that the money injection at the level of individual citizens does not even need to balanced by removal at the top end. The fact is that we actually need something like €14 trillion of new debt-free money if we are to fix the debt crisis. So there is clearly plenty of scope for increasing the amount of debt free money in the system before causing problems.

In summary, I believe strongly that debt-free money injection via an unconditional basic income paid to citizens directly by the central bank may be the simplest way to fix the system for good.

Comments very welcome.

Gabriel Zucman : The hidden wealth of nations

I've just finished reading a book by Gabriel Zucman called "La richesse cachée des nations : Enquête sur le paradis fiscaux" ("The hidden wealth of nations : an inquiry into tax havens"). Gabriel Zucman is a young assistant professor at the London School of Economics and a visiting scholar at Berkeley.

He has done a remarkable job at trying to get some hard numbers about the amount of wealth that is hidden in tax havens using previously untapped data.

Here are his basic conclusions that are given on page 45 of his book.

Global Financial Assets in 2013 : €78.0 trillion

• "Onshore" Financial Assets : €67.2 trillion (92%)
• "Offshore" Financial Assets : €5.8 trillion (8%)

Of the €5.8 trillion in tax havens

• 30% (€1.8 trillion) are in Switzerland
• 70% (€4.0 trillion) are in other tax havens (Singapour, Caymans....)

The €5.8 trillion figure is substantially smaller than another figure that was proposed in 2012 by James Henry who estimated the value at somewhere between $21 and $32 trillion - see his article entitled "The Price of Offshore Revisited".

Zucman's figure is probably safer because he obtained it by adding together all the bonds, stocks and shares and subtracting the amount that can be localised using the standard methods. The gap is the amount that he considers must be hidden in tax-havens.

He makes full use of the detailed information which is provided by the Swiss authorities, who provide a detailed breakdown of the €1.8 trillion managed by Swiss banks. Here is the breakdown from page 39 of the book:

• Europe (€1 trillion)
• Germany (€200 billion)
• France (€180 billion)
• Italy (€120 billion)
• UK (€110 billion)
• Spain €80 billion)
• Greece (€60 billion)
• Belgium (€60 billion)
• Portugal (€30 billlion)
• Others (€160 billion)
• Gulf states (€160 billion)
• Asia (€170 billion)
• South America (€170 billion)
• Africa (€120 billion)
• North America (€90 billion)
• Russia (€50 billion)

 The €1.8 trillion held on Swiss accounts can be broken down as follows in terms of where it is invested:

• Investment Funds based in Luxembourg (€600 billion)
• Investment Funds based in Ireland (€150 billion)
• International Stocks (eg. US etc) (€400 billion)
• International Bonds (German etc) (€450 billion)
• Others (term deposits etc) (€200 billion)

Based on these figures, Zucman estimates that the loss of tax revenue per year is around €130 billion. He gets this from the €5.8 trillion figure for all taxhavens, subtracts the 20% (€1.1 trillion) that is declared, and then estimates that the three main types of evasion would amount to the following :

• Tax fraud resulting from failure to declare revenues from dividends and interest payments : €80 billion
• Fraud resulting from failure to pay inheritence taxes : €45 billion
• Fraud resulting from failure to pay wealth taxes : €5 billion

In the case of France, he estimates that the losses in tax revenue are about €17 billion a year.

It's an impressive piece of detective work. He then proposes some concrete proposals for fixing the system. The first step would be to create a complete global registry of all financial holdings. Such registries exist already at the national level with organisations like the Depository Trust Corporation in the USA. The problem is that there is nothing equivalent at the international level. Once this registry is in place, Zucman proposes that taxes could be imposed at the global level and then redistributed.

It could work. But it will need a lot of coercion and lobbying to get the taxhavens to give in.

Those who have been following my blog since the beginning will perhaps know that I have another way out. The solution could be to abolish all the conventional taxes such as income taxes, taxes on company profits, inheritance taxes and wealth taxes of all sorts.Those taxes could in principle be replaced by a single variable rate financial transaction tax on all electronically mediated transactions. With at least $9 quadrillion in transactions per year at the global level, there is plenty of scope there. With such a system, the idea of a tax haven would no longer have any sense. 

It might be easier to move to a pure transaction tax based system that to try and fix the current loophole ridden system. I'd be interested to know what Gabriel Zucman would think about such a suggestion.

Byron Dale : A true pioneer in the fight for monetary reform

I've been reading up on the economy for just over three years now. But I'm still just beginning to discover the long list of people who have been trying to get the system fixed. Byron Dale is one of those people. He's the key person behind the WealthMoney website, and is the author of the book "Modern Money Secrets". He also wrote "Tales from the Treasury", which tells the story of how he asked the US Treasury to explain how money is created in the US.  As you can read on the Wealth Money website, the answer was remarkably revealing:

"The Treasury answered, “The actual creation of money always involves an extension of credit by private commercial banks.”  John B. Hendrickson Specialist in Price Economics Congressional Research Service and Library of Congress stated: “Money is created when loans are issued and debts incurred; money is extinguished when loans are repaid.”  Anyone who has ever borrowed from a bank knows that when interest is added to your loan your debt has grown but your money supply has not.

When he  wrote back to ask “If all money is created as interest-bearing loans how is the money created to pay the interest on the loans?”,  the Treasury answered: “The money that one borrower uses to pay interest on a loan has been created somewhere else in the economy by another loan.”

Together with Gregory K. Soderberg, Byron Dale sued the Federal Reserve Bank in Minneapolis in a small claims court.

"When they filed their claim they were told that they could not file the claim because the Federal Reserve Bank of Minneapolis was part of the government and one can’t sue the government. They told the clerk, “We understand that one can’t sue the government but we believe the Federal Reserve Bank of Minneapolis is a private bank. However, we don’t want to argue with you. If you will be kind enough to file the case, if we’re wrong and they send it back saying it can’t be filed, we will come back and pick up our papers. If we’re right, they will file the case and set a hearing date.” They were right. A date was set. A Federal Reserve attorney showed up and testified that the Federal Reserve banks are privately owned banks."

Byron Dale proposes something that is somewhat different to the standard view that we simple need to replace the current debt-based money system by debt free money. He argues that an optimal way to get debt free money into the system is to use newly created money to directly pay for building the transport infrastructure that is essential for the economy. He does this because this is something that is a constitutional responsability of the US government.

It's pretty close to my own suggestion that debt free money should be spent into the economy by the government for projects that receive the approval of 90% of the population since building and maintaining the road system is just one of the many activities that everyone would support.

Great stuff! If you want to see Byron Dale in action, I can thoroughly recommend his lecture at last year's Public Banking Institut Conference that you can watch on Youtube. He's down to earth, very funny, touching, and has spent 30 years fighting the system. He's been in jail four times for his beliefs.

We need more people like him.

A solution for France's debt crisis

France has just been downgraded to AA status by Standard and Poors and François Hollande is now France's most unpopular president ever according to a BVA poll. The French government has been trying to avoid cutting back on Public spending, attempting to fix the public debt crisis by increases in taxation. But clearly this is not working - and the French public are getting increasingly desperate.

But, as I hope you realise, any attempt to fix the debt crisis by austerity CANNOT WORK. There is 2.5 times more debt in the Eurozone than money to pay off the debt. The belief that you can pay off this debt by borrowing more money from the commercial banks is clearly ridiculous. Even a 10 year old can understand that.

We need to try something radically different.

Here's my proposal, which mixes a number of ideas that I have been working on for the last couple of years.

1. The French government should introduce a parallel money system that could be called an N-Euro for National Euro.

2. It would open an N-Euro account for every French Citizen, and every French business. It would be a purely electronic system, with no N-Euro notes and coins, and could use publicly available software systems such as Cyclos.

3. The critical point is that citizens and businesses would have the option of using N-Euros to pay tax bills. It is this ability to pay taxes that would instantaneously give the N-Euros real value.

4. Citizens and business being paid money by the state (public sector workers, pensioners, companies doing work for the government...) would be able to choose to receive a proportion of their payments in N-Euros, rather than conventional Euros.  The proportion of the payments in N-Euros would be decided by the person receiving the funds, and it would be entirely optional. Thus, if someone only wanted Euros, they would fix the ratio at 0% N-Euros to 100% standard Euros. But it would be clear to everyone that accepting N-Euros means that the French government would not need to borrow money from the markets, and it would not need to pay interest. Thus, many people would probably be happy to accept debt-free N-Euros rather than conventional Euros.

5. There would be no direct way to convert N-Euros into Euros. However, someone who had an excess of N-Euros on their account would be able to sell them to another person who had a tax bill to pay. Thus, if I had a "Taxe d'habitation" bill of €1000 to pay, I would be able to buy 1000 N-euros from someone who had a surplus, and use that to pay my tax bill.

These are fairly simple propositions, but I sincerely believe that they could fix France's financial crisis (and indeed, the problems of any government currently forced to accept the austerity "solution" proposed by ex-Goldman Sachs employees like Mario Draghi and Mark Carney who currently run the central banks).  The fact is that the government could inject virtually unlimited quantities of N-Euros into the economy. The amount would be simply limited by the degree to which the French population and businesses would be prepared to accept N-Euros instead of Euros. But logically, individuals and businesses that knew how much tax they would be paying in the future, should be perfectly happy to recieve debt-free N-Euros for at least that sum.

And for every N-Euro that the government can use as a substitute for conventional Euros, the borrowing requirement of the government would be directly reduced by the same amount.

Remember that the Euros that the government currently uses are borrowed from commercial banks, who charge us all interest for renting our money. The N-Euro proposal would end this insanity.

Also note that since the only place that N-Euros can exist is on a government run electronic money system there is no possibility of removing the N-Euros from the system by hoarding them. You can't take N-Euros out of your account and stick them under the mattress. And foreign speculators would not be able to take control of the system either.

François Hollande - are you listening? You said that your true adversary was the world of finance*. That statement was absolutely true. But, so far, you have done virtually nothing to remove their power. It's time to do something.

And as soon as you mention the idea of introducing the idea of a debt-free, interest-free N-Euro system, the squeals of protest from the markets and the banks will be loud. They will not appreciate the possibility that a government could find a way to avoid renting the money system from commercial bankers. It would mark the end of a centuries old scam that has brought misery to millions.  But it will be the proof that you have found the weak link in the system.  Go for it....

*"Je vais vous dire qui est mon adversaire... mon véritable adversaire. Il n'a pas de nom, pas de visage, pas de parti. Il ne présentera jamais sa candidature. Il ne sera donc pas élu. Et pourtant, il gouverne. Cet adversaire, c'est le monde du finance".

*"I will tell you who is my enemy ... my real enemy. He has no name, no face, no party. He will never be a candidate. He will thus never be elected, and yet he governs. This enemy is the world of finance. "

Steve Keen's "Debunking Economics : The Naked Emperor Dethroned?"

I finally got round to reading the Revised and Updated edition of Steve Keen's "Debunking Economics : The Naked Emperor Dethroned?"

It's powerful stuff. Steve Keen really does do a comprehensive demolition job on the standard neoclassical economic models that have dominated economic thinking and policy for decades - models that failed to predict the crash of 2008, and indeed still haven't come up with a realistic explanation of what happened.

The dominant neoclassical view claims that unregulated financial markets will naturally generate situations that optimise well-being. They are ideas that originated with Adam Smith's proposal that a society composed of individuals each acting out of self-interest leads to the highest possible level of welfare for society as a whole - the idea of the 'invisible hand'.

As Keen points out (p268), "The vision of a world so perfectly coordinated that no superior power is needed to direct it, and no individual power sufficient to corrupt it, has seduced the minds of many young students of economics". He should know - because  he was one when he started out as a student.

But he then goes on to say that  "what enabled [him] to break away from that delusional analysis was what Australians call "a good bullshit detector"."  And much of the book goes through virtually all the claims of neoclassical economic theory, demonstrating that his "bullshit" detector is fully operational.

What is particularly impressive is that in many cases, Keen doesn't even have to use his own arguments to demolish the theories - the proofs are often provided by neoclassical economists themselves. But the neoclassical authors who pointed out that the mathematical modeling at the heart of the theory does not hold up when moved into the real world tend to be brushed under the carpet.

Specifically, the first part of the book is called "Foundations : The logical flaws in the key concepts of conventional economics.  Here's the summary of its four chapters - already very devastating.

• Chapter 3 ('The calculus of hedonism") reveals that economics has failed to derivc a coherent theory of consumer demand from its premise that people are no more that self-interested hedonists. As a result, economic theory can't justify a crucial and seemingly innocuous element of its analysis of markets - that demand for a product will fall smoothly as its price rises. Far from being innocuous, this failure cripples neoclassical theory, but neoclassical economists have both ignored this failure, and responded to it in ways that make a mockery of their claims to being scientific.   
• Chapter 4 ("Size does matter") shows that the economic theory of 'the firm' is logically inconsistent. When the inconsistencies are removed, two of the central mantras of neoclassical economics - the 'price is set by supply and demand' and 'equating marginal cost and marginal revenue maximizes profits' are shown to be false. Economic theory also cannot distinguish between competitive firms and monopolies, despite its manifest preference for small competitive firms over large ones.
• Chapter 5 ('The price of everything and the value of nothing') argues that the theory of supply is also flawed, because the conditions which are needed to make the theory work are unlikely to apply in practice. The concept of diminishing marginal returns, which is essential to the theory, is unlikely to apply in practice, 'supply curves' are likely to be flat, or even downward sloping, and the dynamic nature of actual economies means that the neoclassical rule for maximizing profit is even more incorrect than it was shown to be in the previous chapter. 
• Chapter 6 ('To each according to his contribution") looks at the theory of the labor market. The theory essentially argues that wages in a market economy reflect workers' contributions to production. Flaws in the underlying theory imply that wages are not in fact based on merit, and that measures which economists argue would reduce unemployment may in fact increase it. 

The second part of the book is called "Complexities : Issues omitted from standard courses that should be part of an education in economics", and contains the following five chapters.

• Chapter 7 ("The holy war over capital") shows that the theory of capital is logically inconsitent. Profit does not reflect capital's contribution to output, and changing the price of capital relative to labor may have 'perverse" impacts on demand for these 'fators of production.'
• Chapter 8 ('There is madness in their method') examines methodology and finds that, contrary to what economists tell their students, assumptions do matter. What's more, the argument that they don't is actually a smokescreen for neoclassical economists - and especially journal editors, since they routinely reject papers that don't make the assumptions they insist upon. 
• Chapter 9 ('Lets do the Time Warp again') discusses the validity of applying static (timeless) analysis to economics when the economy is clearly dynamic itself. The chapter argues that static economic analysis is invalid when applied to  a dynamic economy, so that economic policy derived from static economic reasoning is likely to harm rather than help an actual economy. 
• Chapter 10 ('Why they didn't see it coming') tracks the development of macroeconomics into its current sorry state, and argues that what has been derided as 'Keynesian' macroeconomics was in fact a travesty of Keynes's views. It explains the otherwise bizarre face thtat the people who had the least inkling that a serious economic crisis was imminent in 2007 were the world's most respected economists, while only rebels and outsiders (like Keen) raised the alarm. 
• Chapter 11 ('The price is not right') deals with the economic theory of asset market, known as the 'Efficient Markets Hypothesis'. It argues that the conditions needed to ensure what economists call market efficiency - which include that investors have identical, accurate expectations of the future, and equal access to unlimited credit - cannot possible apply in the real world. Finance markets cannot be efficient, and finance and debt do affect the real economy. 
• Chapter 12 ('Misunderstanding the Great Depression and the Great Recession') returns to macroeconomics, and considers the dominant neoclassical explanation of the Great Depression - that it was all the fault of the Federal Reserve.

Keen also illustrates how much of the theory is totally without empirical support. It appears to be an entirely hollow edifice that simply does not stand up when subjected to serious scrutiny.

And yet it is orthodox neoclassical theory that is used by virtually all goverments to determine their policies - or rather lack of policies. Since any government intervention is by definition an interference in the perfect operation of the markets, it has to be banned. And the fact that no neoclassical economists were able to explain the 2008 crisis is still an embarrassment for the entire profession. 

I would be very interested to know if there are any neoclassical economists out there who have read the book and can still look at themselves in the mirror. There is a strong case to be made that their stupidity and refusal to question their own dogmatic beliefs is behind a lot of the problems that we face today.

Note added February 2014 : If you would like to hear Steve Keen talking - there's a BBC radio interview with him from June 2012 that you can find here.

Mary E Hobart had it right in 1891

I'm not sure exactly who Mary E Hobart was, but the book that she published in 1891 called "A scientific exposure of the Errors in out Monetary System. A new chapter in political economy" was truly remarkable. It was originally published by The People's Call Publishing Company in Seattle, Washinston. You can read the text online here, but the list of chapters is already impressive.

Chapter I. OUR FINANCIAL CONDITIONS CLEARLY STATED.
Chapter II. Four financial fallacies.

Chapter III. Financial fallacy of a metallic currency.

Chapter IV. Fallacy of intrinsic value in gold and silver.

Chapter V. Mathematical fallacy of interest.

Chapter VI. Bonded debts.
Chapter VII. The fallacy of awarding to bankers, corporations and private individuals the right to loan and control our medium of exchange.

She clearly fully understood that a system where bankers create the money supply out of thin air by making interest bearing loans cannot be made to work for the general good of the population.

The system needed to be fixed in 1891. It still does. 

$9 trillion of the US governments $17 trillion in debt is interest payments since 1988

Why is the US government $17 trillion in debt? Well, the numbers on the US Treasury's website shows that interest payments on goverenment debt in the last 12 months cost $415,688,781,248.40. Nice to see that they give the numbers to the last cent.

If you add up the numbers for every year since 1988 (the earliest date for which the numbers are provided, you get at total of $8,996,538,991,476 - I hope you don't mind if I round that up to $9 trillion. This number completely dwarfs even the cost of the war in Iraq - around €2 trillion. 

This table shows how those interest payments compare with US GDP for the same period. You can see that these payments have been costing US Taxpayers an average of 3.63% of GDP over those 25 years.

While some of the $9 trillion can be thought as payments to China and countries like Saudi Arabia who have a trade surplus, most of the debt is the result of money creation by commercial banks. Those banks have the right to create money out of thin air to buy government bonds and then charge tax payers interest on those loans. And because of the way the Basel II and III rules work, lending to governments that have a AAA rating doesn't even count for their capital requirements. It's a fantastic deal for the banks, who get to suck in around 3% of GDP for lending governments fictive money.
The whole system is a complete scam. And the same brilliant system has been used by the UK banking system to siphon off 3% of UK GDP since the early 1950s at least.

There is a simple solution. The US Treasury could mint $1 trillion platinium coins and pay off this fictitious debt. Unfortunately, it appears that last monday, President Obama has ruled out that one. Here's what he said :

"I know there's been some discussion, for example, about my powers under the Fourteenth Amendment to go ahead and ignore the debt ceiling law. Setting aside the legal analysis, what matters is is that if you start having a situation in which there's legal controversy about the U.S. Treasury's authority to issue debt, the damage will have been done even if that were constitutional because people wouldn't be sure. It would be tied up in litigation for a long time. That's going to make people nervous.

So a lot of the strategies that people have talked about, well the president can roll out a big coin, or he can resort to some other constitutional measure," he added. "What people ignore is that ultimately what matters is, 'What are the people who are buying treasury bills think?'"

I wonder whether he might have said this because he is under pressure from the Wall Street lobbyists who want to keep their $9 trillion gravy train on the rails?

BIS Transaction Data for 2012 : $9 quadrillion in the 23 countries

I've been looking at the latest transaction data published by the Bank for International Settlements, which provides a relatively complete picture for 23 countries. Using the Excel sheet with comparative tables that provides numbers for each country converted into US dollars, I have come up with the following table that ranks all 23 countries and allows the total value to be calculated.

Total transactions are again around $9 quadrillion - fairly similar to 2011, but substantially lower than the $10.5 quadrillion achieved in 2008.  The USA comes top, followed by Germany. But the relatively low ranking of the UK is illusory. As I noted yesterday, the numbers are way below the real values because of the failure of important players such as LCH.Clearnet to provide numbers since 2009 - hence the numbers in red.

I will try to come up with some more realistic numbers using alternative sources. But in the meantime, the BIS figures seem to about the best that can be found in a single source.

BIS Transaction Data for 2012 : $3 quadrillion in the USA but who knows for the UK

Here are the latest numbers for financial transactions in the US from the Bank for International Settlements, who published their preliminary Statistics on paymnt, clearing and settlement in the CPSS countries.

As you can see, the numbers are similar to those in 2011, with a slight 2.5% drop to reach $2,911 trillion. But I think that we can still call that a round €3 trillion, especially as I previously showed that there a number of major players that don't get reported. Specifically, we can certainly add a large number for CME (Chicago Mercantile Exchange). I downloaded their 2012 report here and found (on page 36) the following useful table showing that in 2012 they handled a notional value of  $806 trillion - down quite a lot from the $1068 trillion in 2011, and way down on the $1227 trillion handled in those wonderful days back in 2008 (!)

Another big player that doesn't get fully reported is the DTCC. Their annual report for 2012 boasts about the fact that they handled $1.6 quadrillion in transactions.  Specifically, they handled $743 billion of equities per day, $1,116 trillion in US Fixed Income Clearing, $110 trillion in Settlement and Asset Services Transactions, and $2.6 trillion in Wealth Management Services, as you can see from the figures on their web page. Of those, the $110 trillion makes it into the BIS report, and probably the Fixed Income Clearing numbers (although there are some differences).

Finally, there is the Options Clearing Company that handled  2 268 097 319 transactions in 2012, with a premium value of $744 328 498 181, although it is not clear what the actual value of those transactions would have been (OCC doesn't appear to publish those numbers).

So, I think that we can probably count on something close to the $5.5 quadrillion figure for US financial transactions that I had reported for 2011.

But for the UK, it is again depressing to see that the City of London has yet again managed to accidentally forget to provide the numbers to the BIS. Here's what I get by looking at the numbers in the BIS report which add up to £217 trillion.

Yet again, there is nothing for LCH.Clearnet Ltd - the company that reported £863 trillion in transactions in 2008 but has not revealed any figures for 2010, 2011 and 2012.  And I notice that the figures from CREST have dropped by 63% to just £48 trillion. I think that my estimate of £1.76 quadrillion for UK financial transactions in 2011 is likely to have been maintained in 2012.

BIS Transaction Data for 2012 : €1.73 quadrillion in 5 eurozone countries

The BIS has just published the preliminary data for its Statistics on payments, clearing and settlement systems in the CPSS countries for 2012. You can get the full 582 page pdf file,  but you can also get the data for each of the 23 countries in an Excel sheet or comparative data, also in Excel format.

I used the Excel sheets to compile figures for the five countries in the Eurozone that are covered by the data set. Here they are, in order of the size of the transactions. We'll start with Germany. Financial activity there has been surging ahead to reach €815 trillion, 8.5% up on 2011.

Next comes Belgium with €344 trillion, which went the other way, since it is 8.5% down on the previous year.

Third we have France with €275 trillion, about 6% down on 2011.

Then comes Italy with €177 trillion, 7% down on the previous year.

And finally, the Netherlands managed €118 trillion, which was a remarkable 25% up on 2011.

So, clearly, the traders have been moving their activity around a fair bit, moving a fair bit of their financial trading from France, Italy and Belgium to Germany and the Netherlands in particular. I However, I note that the total value of financial transactions in just 5 Eurozone countries was still over €1.7 quadrillion (€1 729 070 billion to be precise) - up 1%.

So, I think my suggestion that the ECB could easily use a small FTT on all Euro denominated transactions is still very viable as either (a) a way to raise revenue, or (b) to remove excess money from the economy.  This second option would be a great way to allow direct debt free money injection into the economy without risking inflation.

Two simple rules for lending money that could make a big difference

Hopefully you will all be aware of the fact that banks create money out of thin air when they make loans. I am convinced that the way out of many of the world's most serious problems will involve changing this insane system to one in which all new money creation is debt free, and done by a public authority that is working in the interests of citizens - not personal profit.

But I realise that it is going to be hard work getting the system fixed. Despite their clear and well argued proposals, Positive Money in the UK is still only beginning to scratch the surface. They now have just over 13,700 followers, but they will need a lot more than that before the politicians start paying any attention. And my own Monnaie Honnête website that recently went public has only had a handful of visitors so far. Of course, it is early days... and I haven't given up hope (yet).

Nevertheless when I see the latest news from the US and UK I can't help thinking that there are some absolute basic rules that could be imposed on the commercial banks that would already make a big difference.

Fixed Rate Loans

One remarkable difference between the way that Banks lend money in France and the UK is that in France, almost all mortgage loans are made using fixed rate loans. Currently, you can take out 15 year loans with fixed interest rates as low as 2.60%. You can even get 25 year loans at 2.95% - see this site for examples.

In the UK, for some inexplicable reason, fixed rate loans are difficult to find and all almost always limited to periods of  2 years or 5 years.  There's a site that compares what's on offer and you can see that there is just one outfit (Halifax) that offers 7 year fixed period loans, and it's for first time buyers only. And the rates proposed are pretty terrible - 4.49% for the 7 years, followed by 3.99% thereafter (although I presume that there is no guarantee that this rate will be maintained).

One wonders why UK home buyers can't get the 2.60% 15 year rates available rates to French home buyers. Aren't we all in the EU? Methinks that it is just yet another illustration of the UK banking system ripping people off.

But there is another wierd thing about the lack of fixed term loans. What is going on here? If we accept that the banks do not actually have the money they lend, why on earth should they be able to change the rate of interest during the term of the loan? It's not as if they are going to be forced to go anywhere to find more money half way through the loan period.

It's bad enough that the banks can lend money that they don't have. But if you add to that a license to double the interest rates whenever they like, isn't that just a recipe for disaster??

The US subprime crisis was caused when the people with low incomes who had taken on excessive debt woke up to discover that the rate of interest had changed and they could no longer afford to make their repayments. And in the UK, there are signs that the governments latest "Help to buy" scheme is going to end up with large numbers of people taking on massive amounts of debt. And of course, if at some point in the future, the banks decide to increase the interest rates mid term, then you are guaranteed to have yet another financial crisis.

Wouldn't it be straightforward to massively decrease the systemic risk by passing a law making it illegal for banks to make loans with variable rates? That way, people buying property would know exactly how much they have to find for the entire period of the loan.  Seems simple to me.

Progressive compulsory repayment

The second simple idea that I would like to propose is that any bank that makes a loan would have to have a repayment schedule so that the entire loan plus interest is paid off during a fixed term. Thus if you borrow €120,000 over 10 years, you would have to pay back approximately €1000 every month (plus the interest) for the entire period of the loan. That way, you know that the amount of debt will have to decrease progressively.

It seems perfectly sensible but it's not at all what happens at the present time - particularly with loans made to governments.  The problem is that currently, when a government needs money, it goes to the markets who will kindly loan them whatever they want using money that they create out of thin air. After all, as I showed last week, creating money to lend to governments doesn't even count - the banks can create as much money as they want, and don't even have to have capital to back them up. And once they have made those loans with their fictive money, they can then just sit back and let the interest accumulate.  Easy. You don't have to have a PhD in rocket science to make money that way.

Importantly, the government in question has no requirement to pay anything until the loan term is due, with the result that they will almost never pay off the loan at all. And then, surprise surprise, at the end of the loan term, they now owe the bank not only the money that they bank created out of thin air, but the interest too.

Thus, if a government borrows €10 billion from the markets by selling bonds with a maturity of 10 years, and the interest rate is 7%, at the end of the 10 years it will end up owing nearly twice as much. It's a brilliant scheme - if you are part of the banking industry that has a licence to create money out of thin air. But a total unmitigated disaster for everyone else.

But of course, if you are an elected politician, there is a pretty good chance that you won't still be around after 10 years to pick up the tab! So not much incentive there not to take advantage of all that easy debt.

Is it any wonder that the US government will soon need to  increase its debt ceiling by another trillion dollars just to keep from defaulting on its repayments?

So, here's a straightforward way to prevent this insanity. Make it illegal to make a loan with money that you don't have that doesn't include progressive repayment  over the loan period. That would immediately make it much less tempting for politicians to borrow money from the banking system.

Conclusion

So, there you have it. Two simple and sensible moves that could make debt much less dangerous. Make all loans fixed rate loans, and only allows loans if there is a progressive repayment plan throughout the loan period.

Of course, I still believe that the true solution is simple to ban all loans with fictive money - i.e. ban money creation by commercial banks. But maybe we need to do this by stages.

Changing Banking for good?

In June 2013, the UK's Parliamentary Commission on Banking Standards published a major investigation into the Banking system  called "Changing Banking for Good".

I looked for any discussion of the way that money is created in the current system, by searching through all nine volumes - a total of over 4400 pages. There was nothing at all in the first three volumes.

But in volume four, page Ev 956 ("Written Evidence to the Commission"), there is the following, which was submitted by the "Christian Council for Monetary Justice".

The Christian Council for Monetary Justice.... has advocated, for the UK, ending usury—and fractional reserve banking—by getting the Bank of England to take away from commercial banks the creation of most of the money in use.

This can be achieved in a single step when government instructs The Bank to issue, free of interest, all the money needed for the real economy as repayable debt. Any willing existing agency, such as high street banks, mortgage lenders, or credit unions, could administer the distribution of this interest-free credit for an administrative fee. This single step could be expected to crowd out undesirable features of the current system and to hugely benefit people engaged in healthy economic activity."

Hear, Hear!!

In volume 5 page 1595, Paul Moore, the former Head of Group Regulatory Risk at HBOS, gave a spirited defense of the positions held by Positive Money

14. The Inadequacy of our Monetary System and the need to Investigate what is called “Full Reserve Banking” but which is, in fact, a Wholly New Monetary System

14.1 I have to say, at this point in my paper, that I really do not think we have got anywhere near solving the problem of banking in this country (or the world) or the excessive power the big 4 banks have over our monetary system, economy and lives.

14.2 Over time, I have come to the very firm conclusion that ring-fencing, more capital, stronger corporate governance and regulation simply will not do the trick and that, to solve the huge economic problems we face, the entire monetary system and banking needs fundamental reform by the introduction of a system of “Full Reserve Banking” as proposed by Positive Money.

14.3 The whole idea that 97% of our money supply is created, and its use in the economy is directed, by private commercial banks when they make loans is wrong. It bases pretty much everything we do economically on debt which banks are incentivised to oversell to make interest for themselves. It directly causes a constant transfer of wealth (through interest—about £160 billion per annum) from society as a whole (and particularly the poor) to the banks and so is a direct cause of the inequalities and associated social problems discussed in the great book called The Spirit Level. It means that asset bubbles (property) and boom and busts are inevitable and, most importantly, it cedes far too much power over our economy, our society and our lives directly to the banks and a tiny group of executive directors who are incentivised (and required by Company Law) to generate short-term profit. Of course, only around 10% or so of bank lending is made to the productive economy ie the SMEs with the vast majority going to residential and commercial mortgages and financial intermediation. Indeed, SME's deposit more with banks than they ever borrow. Finally, the big 4 banks control well over 80% of the money supply which means that something like 25 executive directors, with no public duties whatsoever, to a very large extent control our monetary system and economy.

14.4 Even Mervyn King has commented that this way of organising our monetary system and banking is not the best way to do it. Martin Wolf summed it up perfectly when he said—“The essence of the contemporary monetary system is the creation of money out of nothing, by private banks' often foolish lending.”

14.5 Positive Money which was set up and is run by a remarkable young guy called Ben Dyson makes the case for reform of the monetary system through the introduction of Full Reserve Banking very powerfully indeed in their new book “Modernising Money”. You can check out what they say on their website here http://www.positivemoney.org/ . I am on the Advisory Committee of Positive Money.

14.6 Policymakers need to look very carefully at introducing “Full Reserve Banking” (see Positive Money about all this) as this will completely remove the need for the State ever to stand behind banks again. The ICB simply ignored the idea of full reserve banking and its recommendations do not achieve this. It is wrong that the taxpayer has to provide a guarantee of £85,000 to each account holder in each bank. Full reserve banking is the best way to resolve this problem and the best way to ensure that banking is carried out in the interests of customers and society as a whole. It means that there can never be a run on current accounts and customers choose savings accounts with the level of lending risk with which they are comfortable just like collective investment schemes and the saver/investor bears the risk.

Hear, Hear!!

In Volume 6 page 185, the New Economics Foundation has this to say

The Credit Creation Function of Banks

5. There is no recognition within the ICB Final Report or the draft Bill of the role played by retail banks in supplying sterling bank deposits through the extension of credit and purchase of assets, and hence creating the bulk of the UK's money supply. Instead reference is made to deposit-taking, which is an established phrase in regulation and describes part of what retail banks do. The far more significant role of banks is the creation of new bank deposits. A full explanation of this process is beyond the scope of this submission, but the selection of quotes below establish that this description is fully supported by central bankers and monetary economists:

By far the largest role in creating broad money is played by the banking sector… When banks make loans they create additional deposits for those that have borrowed. Bank of England (2007)
Given the near identity of deposits and bank lending, Money and Credit are often used almost inseparably, even interchangeably… Bank of England (2008)
Each and every time a bank makes a loan, new bank credit is created—new deposits—brand new money.  Graham Towers (1939), former Governor of the Bank of Canada
Over time… Banknotes and commercial bank money became fully interchangeable payment media that customers could use according to their needs. European Central Bank (2000)
The actual process of money creation takes place primarily in banks. Federal Reserve Bank of Chicago (1961)
In the Eurosystem, money is primarily created through the extension of bank credit… The commercial banks can create money themselves. Bundesbank (2009)
When banks extend loans to their customers, they create money by crediting their customers' accounts. Mervyn King (2012)
Banks do not have to wait for depositors to appear and make funds available before they can onlend, or intermediate, those funds. Rather, they create their own funds, deposits, in the act of lending. This fact can be verified in the description of the money creation system in many central bank tatements, and it is obvious to anybody who has ever lent money and created the resulting book entries. IMF (2012)

6. It is relevant to note that this credit creation function does not feature in most general equilibrium models of the economy used by orthodox economists. Recent academic debate, for example within the Institute of New Economic Thinking, has begun to consider whether this was a factor in the seeming inability of many economists and economic models to predict the financial crisis, and is investigating the role of unconstrained or poorly managed credit creation in maintaining, or rather upsetting, financial stability.

7. The draft Bill would therefore appear to be built on an analytical framework that is incomplete at best, and flawed at worst. We argue that in this key respect the theoretical understanding of banking that underlies he Bill will come to be seen as obsolete. This has implications for, inter alia, arguments for splitting retail from investment banking, stability of the banking system (and indeed broader macro-economic stability) and distortions in the retail banking market that prevent fair and effective competition.

In other words, they were told!

So that's it. 4400+ pages on the Banking System and how to reform it, and just three mentions of the key problem - that of how money is created.

There's clearly a serious need to get the truth out.

Monnaie Honnête is Go!

Back in May, I announced that we had decided to create a new French-based movement that would be campaigning for Monetary reform. The movement would be called "Monnaie Honnête" ("Honest Money") and would be based on the excellent work being done by Positive Money in the UK. We are also part of the "International Movement for Monetary Reform" which currently brings together about 18 different organisations based in different countries - all working towards a radical change in the way our money system works.

Well, I'm pleased to say that Monnaie Honnête's web site is now up and running. You can check it out at monnaiehonnete.net (althoug monnaiehonnete.org and monnaiehonnete.fr also work).

A fair bit of the site currently consists of translations into French of material from Positive Money. And the basic structure of the site is fairly similar.

But there are a some ideas that you won't find on Positive Money's website. To make it easier for those who don't speak French, there is a special section where the key new ideas are presented in English.  Specifically, we argue for the following three principles

• Distribution of newly created money according to population size

• Inject money directly into citizens accounts held with the ECB

• Allow Central Banks to remove excess money using a Financial Transaction Tax

The first two are ideas that are important if this sort of monetary reform is to be imposed in an area like the Eurozone where one Central Bank has to control the money supply for a number of countries. The third idea is one that I believe could be implemented by all central banks.

We would be very happy to have your comments on the site - you can leave comments on all the pages to let us know what you think. And, of course, we would be very happy to see people signing up - you can do that by visiting the "Rejoignez-Nous" part of the site. 

Please pass the word to any French-based or French-speaking people you know that might be interested.

More on the art of Risk-Weighted Assessments

In a system where Commercial Banks have the ability to create money out of thin air, the question of what determines where that money ends up is clearly going to be absolutely critical.

Attempts to regulate money creation by Banks are essentially based on trying to restrict their assets to capital ratios. With the  Basel III system, introduced in 2010,  banks are supposed to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of "risk-weighted assets".

By setting the rules for assessing the risk levels associated with particular loans, regulatory authorities can potentially guide the way that banks use their money creation powers. Since they are required to keep the ratio between risk-weighted assets and capital under control, they will clearly be paying attention to where they put their newly created money. Assets with low risk-weightings will obviously be more attractive options.

So, what numbers do banks actually used for determining "Risk-weighted assets"? In July 2013, the Bank for International Settlements published a 57-page document called  "Analysis of risk-weighted assets for credit risk in the banking book".  On page 18, you can find the following chart that shows the ranges of RWA values for four sectors.

Loans to the corporate sector were rated at around 50%, retail loans at around 25%, loans to other banks at 17.5%, and loans to sovereign governments at around 4%. Clearly lending to governments is seen as a very risk-free venture. It's hardly surprising that banks will be happy to create lots of new money (debt) for governements. And hardly surprising that the 27 EU countries collectively owe €11 trillion to the banking system.

On page 21, there is a graph showing the distribution of exposure according to the various classifications used by ratings agencies.


As you can see, nearly 80% of exposure to sovereign debt was considered to by AAA or AA. But for corporate lending, most lending is made to corporations rated BB.

The whole idea that you can control the way new money is pumped into the economy using these sorts of rules seems absurd. For obvious reasons, commercial banks will create money in the form of loans if and only if they think that they will make a profit.

Surely, there must be a better way. Imagine a system in which commercial banks don't get to create money at all. Where debt-free money can be created by central banks and injected into the economy when and where it is needed.

In such a system, none of this regulatory rules would be needed, and the entire Basel III system could be scrapped entirely. Banks would simply take deposits from savers, and lend them where they thought there would be a reasonable return.  If they screw up, then they, and the savers would lose their investments.  Banks that do a good job would get rewarded by having more people saving their spare cash with them.

It would be a much safer world than the current one in which Commercial Banks can end up creating hundreds of billions of new money, taking massive risks, and requiring tax payer bailouts when they mess up.