Dave Grimmond wonders why one of the best banking reform ideas isn't even being debated; he suspects entrenched interests and innate conservatism

Dave Grimmond wonders why one of the best banking reform ideas isn't even being debated; he suspects entrenched interests and innate conservatism

By Dave Grimmond*

Economic downturns are never pleasant events, yet it is the booms that often generate the destructive power of the downturns.

The combination of sales growth and easy credit promotes an investment boom that further fuels economic growth.

The problem with easy money is that too many investment ideas get financial backing.

Everything looks like a winner, and the more cautious investors look like mugs.

Although fewer frivolous investment mistakes are made during the downturns, excessive caution causes the damage of missed opportunities.

Part of the solution to avoiding the worst problems associated with economic downturns is maintaining the discipline and so containing excesses during the good times. 

It may be time to re-look at an old idea that would revolutionise the banking system by separating the monetary and credit functions of the banking system.

Promoted by American intellectuals like Henry Simons and Irving Fisher during the Great Depression of the 1930s, the so-called Chicago Plan called for the 100% backing of bank deposits by government-issued money and ensuring that the financing of new bank credit could only take place through earnings that have been retained in the form of government-issued money or through the borrowing of existing government-issued money from non-banks.

Crucially, the approach would remove the ability of banks to leverage the creation of money by lending money in excess of their deposits.

In other words, banks would become pure intermediaries that depend on obtaining outside funding before being able to lend.

The proponents of the Chicago Plan claimed four major advantages:

1. Having to obtain outside funding rather than being able to create it themselves would reduce the ability of banks to cause business cycles due to potentially capricious changes in their attitude towards credit risk.

2. Having fully reserve-backed bank deposits would completely eliminate bank runs, thereby increasing financial stability and allowing banks to concentrate on their core lending function without worrying about instabilities from the liabilities side of their balance sheet.

3. Allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances.

4. Allowing a reduction in private debt levels as money creation would no longer require the simultaneous creation of mostly private debts on bank balance sheets.

A recent IMF Working Paper investigated the veracity of the claims for the Chicago Plan with use of a state of the art monetary dynamic stochastic general equilibrium model of the US economy.

They found strong support for all of the claims, with a Chicago Plan banking system likely to result in “much smoother business cycles, no possibility of bank runs, a large reduction of debt levels across the economy, and a replacement of that debt by debt-free government-issued money” (p6).

Further the authors, Jaromir Benes and Michael Kumhof, claim that their modelling indicates two additional advantages of the Chicago Plan:

1. It generates long term output gains from a lower interest rate profile, lower tax rates (as the government can earn more from seigniorage), and lower credit monitoring costs for banks. 

2. It can allow steady state inflation to drop to zero without posing problems on the conduct of monetary policy. A critical underpinning to this result is the greater ability to avoid liquidity traps as the quantity of broad money would be directly controlled by policy makers and not dependent on bank’s willingness to lend, and because the interest on Treasury credit would not be an opportunity cost of money for asset investors, but rather a borrowing rate for a credit facility that is only accessible to banks for the specific purpose of funding physical investment projects, it could become negative without any practical problems.

These are pretty heady claims.

It smacks of “if it sounds too good to be true, ... ”.

However, there are many other examples of low lying fruit in the policy domain where a combination of entrenched interests and innate conservatism inhibits movements to welfare enhancing changes (eg a flat tax/guaranteed minimum income tax benefit system, redesigning GST on a origins basis, and global free trade).

The claimed benefits of adopting the Chicago Plan are truly profound, and if true would have a larger impact on the welfare of New Zealanders than most other issues that dominate political debate.

It would seem to be a good use of government resources to have this issue investigated thoroughly to, either put to bed the claims if they are illusory or to begin implementing a change if they are indeed genuine.

Some potential areas of investigation would be to see whether there are:

  • any foreign exchange ramifications,

  • issues around whether New Zealand could unilaterally adopt such a system or whether it would first require adoption in a major currency areas (eg US or the Euro zone), and

  • risks that government management (or the Reserve Bank as its agent) actually result in increased instability or other problems.

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David Grimmond is a senior economist at Infometrics. You can contact him here »

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This type of regulation is needed , but because of lobbying by the Banks , its unliklely to ever happen .
 
The GFC was not a cyclical downturn , it was an event of cataclysmic proportions , becasue US Banks had chipped away at all regulation .
 
So any new regulation seen by Banks as stifling their "growth" will be fought vigourously
 
There is no question that Banks should have regulation in place to prevent a repeat of 2008 , even on a smaller scale , but getting there is going to be near impossible .

Great quote from Machiavelli, The Prince
There is nothing more difficult to execute, nor more dubious of success, nor more dangerous to administer, than to introduce a new order of things; for he who introduces it has all those who profit from the old order as his enemies, and he has only lukewarm allies in all those who might profit from the new. This lukewarmness partly stems from fear of their adversaries,.. and partly from the scepticism of men, who do not truly believe in new things unless they have actually had personal experience of them.
I've written about this a couple of times, most recently last year.
http://unframednz.wordpress.com/2013/04/19/how-we-should-fund-our-economy-public-credit-not-debt/
Raf Manji who used to comment here (he's now busy on the Christchurch Council) was also a strong advocate for public credit. Dave Grimmond is right. Reform of this sort would do more for NZ than any of the tinkering proposed by Labour or National but the level of the debate is such that Russel Norman got attacked for proposing a couple of billion for Christchurch.

From what I can see of public credit its nothing more than a fancy term for printing, and that from the 19670s we should be able to see was a disaster.
regards

the 19670's?

1960s~1970s.
regards

Actually, the one time in the 1930s that we had a government simply printing the money it needed it was a great success. I really have no idea why we stopped doing it.

The GFC was a symptom of peak oil, its not so much cyclic as the start of a see saw down trend.
regards
 

That was certainly a part of it but there are many other parts. The exessive interest that can't be paid was another large part and the fact that there's around four times more money in the world than there is productivity probably also had a hand.

4 times more money? and how much debt on top? all under-written by what?
ie isnt a dollar bill a promise note for work?
and work is joules/second?
which is a watt, which comes back to energy and fossil energy.
and where i sthe fossil energy to pay back this debt?
no where...
regards

"and work is joules/second?"
No, it isn't. (Shows again how much of a scientist or engineer you are...).

and work is joules and per second is watts.
A watt, is energy which comes back to energy and fossil energy.
Re-read it, or dont bother as you are obviously biased against what I write anyway.
http://en.wikipedia.org/wiki/Work_(physics)
Is that simple enough for you?
regards

Cut the cr#p, work is NOT joules/second.
And do not ever claim to be an engineer, because you are not.

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

W = J/s

Oh yes it is,,,

In that equation W stands for a watt, which is a unit of measure of power, not work. So, you could say that power is joules/second, but work is NOT joules/second.
It’s okay for a cowboy to mix these things :-), but not okay for somebody who wants to be called “an engineer”.

Yeah they didn't let me finish my BE or my NZCE (electronics and Communications) so only got part way through both.

It was clear from steven's context when he said work that he was talking totals, and just connecting work to energy to time.  When you talk totals you're talking summation and thus intergral.  f(x) = J/s (Watts)   F(x) bys = J (Energy).   Which is what he was saying before you took it out of context.

Energy is work - or in the orginal context, no matter how much work is done, or whaty method is applied, or how it's categorised, the total available work cannot ever exceed the energy available.   
 And what has been stated before, is that life always works with the easist  (eg cheapest) energy available first.  Some say technnology makes energy go futher - but it is actually this fact that proves the energy crisis will occur.  Technology takes work, which is energy, thus an expense.  To make technology worthwhile, therefore requires increase yield beyond the cost of the energy.  So we get into things like fracking (or re-sluicing gold pile leavings) where scarity of cheap resource means that technology is afford...even required...to meet demand.
 So we end up in the case where more Energy is spent to free up the little Energy that is left.  More work is done...but the original situation of easy eneregy and expensive energy is not changed.  No matter how much work or effort is invested.

Power (unit Watt, W) is rate of use energy. 1watt = 1 joule of energy used per second, i.e 1 watt= 1 j/s.
 
Energy is the potential to do work.  Power is the rate at which the work is done, or rate at which the energy is used.

Actually I am an Engineer, clearly though you are not.
"The International System unit of electrical, mechanical, and thermal energy.

a. A unit of electrical energy equal to the work done when a current of one ampere is passed through a resistance of one ohm for one second.

b. A unit of energy equal to the work done when a force of one newton acts through a distance of one meter.

 

 

regards

Cut the irrelevant cr#p.
Work (and energy) is measured in joules.
Power, on the other hand, is work per time and is measured in joules/second.
If you were a real engineer (rather than somebody holding a piece of paper saying that you are an engineer), you would never say that "work is joules/second". You have - again - discredited yourself.

I actually said,
"....joules/second?
which is a watt"
I will keep it simple for you as that is clearly what's needed,
http://en.wikipedia.org/wiki/Watt
example,
"A person having a mass of 100 kilograms who climbs a 3-meter-high ladder in 5 seconds is doing work at a rate of about 600 watts. Mass times acceleration due to gravity times height divided by the time it takes to lift the object to the given height gives the rate of doing work or power."
Really it is you who cannot even understand this.
In terms of discreadited, well in your sad little life, sitting there hoping to discredit someone else because you cant put up a rational argument to hold up your weirdo extremist economic viewpoint well who cares.
regards

d(x) = work
d(x)/d(s) = work at a rate = power

I thought it was obvious from your original context what you were meaning.  after all the dollar is spent per job, but doesn't vanish, neither does the work done.  (if anything ...you've proved money = power :) )

Indeed that was the context.  However its pretty obvious that we have a contingent in here who are unable to see any reason, nor display any and will attack anyone who stands in their way.
regards

... nah , you're completely wrong ... 100 % wrong ...
 
The GFC was a consequence of financial chicannery , Mortgage Backed Securities , Credit Default Swaps , and the other mega-leverage  instruments of financial destruction .. .. and the subsequent  freezing of the banking industry when Lehmann Brothers Bank was allowed to collapse ....
 
 
... nothing in the slightest to do with " peak oil " ... Peak Oil doesn't exist !

Stupid comment. 

... unstupider than your comment !

I think he means peak oil no longer exists

 I completely agree this should be at least considered and looked at properly.  Especially in New Zealand where our banks are Australian owned.

Question:  How could you get this to be taken seriously considering that most of the population would not understand the issues and the banks would be ready to launch propaganda scare campaigns if it ever did come up?

   I think most people response to finding out that banks have the power to create money would be one of disbelief and the banks would work hard to keep it this way.

  However the result: a more stable richer economy with less booms and busts really is a big deal.

How do we get people to realise the truth? Keep pointing them to it and don't let up. Eventually they will accept it.

Personally I think you start with a separation of current accounts; savings and cheque, and the payments system from trading bank control. The RB would take responsibility for and guarantee them. This removes the Aussie banks armageddon threat of bringing down the payment system and day to day economic activity.
 
Secondly you incrementally increase trading bank capital requirements or reintroduce formal reserve requirements, eventually to 100%. Would crimp bank profits but make them safer. Banks can only intermediate existing money not create their own credit.
 
Thirdly you let the RB slowly introduce public credit to the government for spending into the economy, offsetting the reduction in credit creation coming from the banks but at a level that is not inflationary either. Christchurch rebuild is the obvious place to start. Low cost housing is another. Labour used it for state housing in the 30's.
 
Fourthly you radically alter the tax and transfer system to move tax off income; personal and company; and onto land and financial transactions. Replace welfare transfers with a Universal Minimal Income. Work towards a steady state, low debt, sustainable economy

I'll give you 9 out of 10 for that prescription.

I have a sneaking suspicion thatto  allow the government to " public credit to the government for spending into the economy" would very rapidly decay into buying votes and SIG's.

Yes and yes and yes.  I read somewhere that this right for the Banks to create money out of thin air was granted in England in 1840ish.  It is said that Rothschild said he didn't care two hoots for democracy as long as this right continued.  Or something like that.  As much as I would like to see it happen here can you imagine the bank lobbyists allowing any Government to do it. 

" excessive caution causes the damage of missed opportunities."
Not this time, money is being bet every where...any silly place...
and still we stagger.
maybe this time something is profoundly different?
 
regards
 

We don't seem to have defined 'outside funding'.
 
Good article - but we have to get to a no-interest, no-profit, no dividend situation globally, and if any of those are charged, someone else will have to miss out.
 
That's what 'steady-state' means, and steady-state is where you have to end up. That of course may be a 'stste' of lesser activity than we currently indulge in, so the 'steady' rate may well be less fiscally too.
 

steady-state is very much like stagnation.

The goal of old matriarchial Micro-nesian/African villages was continuation.  didn't do them much good.  Maybe their gods were angered?

No it's not. What steady state means is that we use our local resources at a sustainable rate. It doesn't mean that we stop developing the economy.
 
Of course, it also means that we can't have rich people as we simply can't afford them. Not that that means much, we can't afford them now either.

do your homework...then come back.

don't waste your breath/fingers or my time with such "four colour brouchure" bs.

... it was Henry Ellsworth , commissioner of the US Patents Office , who claimed in a report to the US Congress that the era of human improvement must end soon ...
 
He was a " steady state " sort of guy ...
 
... be your own judge whether he was correct or not ...
 
The year was 1843 .

Sure looks like we're reaching the point where standard of living has stopped improving for most. In fact, a lot of people in 'first world' countries are now finding that their standard of living is starting to slip backward. Surely this has no relationship with peaking industrial output!
 
Funnily enough, the man who you mention above existed in a time when the economy was based on real-time energy flows vs half a billion years of stored photosynthesis (of which we have burnt half of within the last few centuries). A steady-state economy makes a whole lot of sense if you are confined by a natural budget. This looks to be where we will be collectively heading over the next 50-100 years.

.

Most peoples' standard of living isn't linked to their work.  makes a mess of the steady-state ideas.  Technology has seen to that as some things are more efficient than others.

"Sure looks like we're reaching the point where standard of living has stopped improving for most. In fact, a lot of people in 'first world' countries are now finding that their standard of living is starting to slip backward. Surely this has no relationship with peaking industrial output!"
Too many people not enough resources.
Resources are not going to suddenly increase, so.................

Actualy he is correct, ty doing yours start with simple math.
Show how expotential growth fits on a finite planet.
Good luck with that.
regards

We are talking about symptoms and outcomes. We are talking about regulating symptoms and outcomes.
 
The expansion of money through Fractional Reserve Banking is not the cause of booms and busts, excessive debt and so on, Interest rates are the cause of those things. If there were no interest rates why would banks create money to lend at 0%
 
Fractional Reserve Banking is a means for banks to maximise profits through charging interest on that money. So Fractional Reseve Banking is a means NOT a cause.
Cause >>> Means >>>>> Outcome
 
Interest rates are the cause >>> Fractional Reserve Banking is the means >>> Debt and booms and busts are the outcome.
 
I do not have time to go into interest rates here - but they are a major problem as all economists should know.
 
 

The expansion of money through Fractional Reserve Banking is not the cause of booms and busts, excessive debt and so on, 
 
All the evidence indicates that it is.
 
Interest rates are the cause of those things.
 
Nope. All interest is is giving a few people money for nothing. It's a scam.
 
 If there were no interest rates why would banks create money to lend at 0%
 
They wouldn't which would be great as then they wouldn't be able to get money for nothing which would be great.
 

Because of the importance of understanding interest rates i have made some time. Here goes.
 
To explain the problem with interest rates. Firstly i have used some of the work of Lowell Manning

MV=PQ=GDP
Where
M = the amount of money in circulation
V = the speed of circulation of that money; the number of times M is used over a given period T
P = the price level of goods and services an economy produces during time T
Q= the monetised quantity of goods and services an economy produces during time T.

If the amount of money in circulation (M) is $40 billion
And, if that $40 billion has a turnover (V), as Lowell Manning suggests, of 2.5

Then
MV = PQ = GDP

 $40 billion x 2.5 = GDP = $100 billion

So $40 billion is spent 2.5 times giving us a total spend on goods and services (GDP) of $100 billion

If total debt is 100% of GDP ie $100 billion, at an average interest rate of 7%.

Then total interest paid = $7 billion

The question now is "Where does that $7 billion come from?"

Well it comes out of the actual money in circulation (M). That is, it comes out of the $40 billion.

If the money lenders keep taking their interest money out of the pool of real money ($40 billion). Then in less 6 years (6x$7 billion = $42 billion) the money lenders will have ALL of the real money in existence and so the economy will be starved of money unless it borrows from the moneylenders.. That is, the moneylenders have the economy by the short and curlies.

Lowell Manning expresses it this way

He breaks down M into Mp and Ms such that M=Mp+Ms
Where Mp is the money in circulation and spent to add to GDP
Ms is the interest paid on savings
So we have
(Mp+Ms)V =PQ=GDP
M= $40 billion (Mp+Ms)
GDP = $100 billion
V = 2.5
Total debt = $100 billion (100% of GDP)
Total interest on that debt of $7 billion (Ms)
We have
Mp = (GDP/V) - Ms
Mp = ($100 billion/2.5) - $7 billion
Mp = $33 billion after year (T) one
in the second year another $7 billion is taken from Mp in interest to go to Ms
Eventually M = Ms and Mp = 0
Therefore any loans included in M can never be repaid.

What a disaster interest rates are.
 

M, money in circulation , is often borrowed.  serviced from future projected earnings.  If it is M today, then that means there will be M-interest cost, tomorrow.  How does one make up the shortfall?

Well isn't that wonderful? David Grimmond seems to be an economist with the sense to look at the Chicago Plan Revisited. Great document. Yes it would eliminate sovereign debt crises and banking crashes, but according to Lietaer, Arnsperger, Groener and Brunnhuber in their book Money and Sustainability: the Missing Link, there would still be monetary crises. 

Moreover they say replacing a monoculture with another monoculture is not the way to go, and there could still be the risk of inflation as in Zimbabwe. The bigger reason is that it is not politically realistic as it would be fought to death by the banks. They say "In 2010 for every elected official in Washington, there were three high level lobbyists working full time for the banking system". Their final argument was that it is risky, as nationalising the money creation process cannot be done on a small pilot scale. Any change involves risk and large scale change involves high risk. 

So it is terribly sad that what seems so logical is not possible.
The New Economics Party put a petition before Parliament last year asking for a Parliamentary Enquiry into the best method of making banks stable, but the Finance and Expenditure Committee seems to have quietly ignored it for months and months now.  We believe in land backed currency issued gradually so as not to shock the economy, leading to full land rentals. We are calling it the Land Dollar and are currently working out the best method of introducing it gradually by society (represented perhaps by Treasury) gradually buying up land. Quite radical we know, but do we have to wait for a crisis before we work out what to do? 
As wtf says above "you radically alter the tax and transfer system to move tax off income: personal and company; and on to land and financial transactions."

and there could still be the risk of inflation as in Zimbabwe.
 
Not if the creation of money was carefully regulated. The money would have to be created by the government, directly spent into the economy and removed via taxes. The government would have to run at a near balance. The risk of inflation would be zero.
 
The bigger reason is that it is not politically realistic as it would be fought to death by the banks.
 
Which really means that we need to take the power of the banks away from them not that we shouldn't do it.
 
Any change involves risk and large scale change involves high risk.
 
Actually, there's no risk at all.
 
So it is terribly sad that what seems so logical is not possible.
 
But it is possible.