History of Monetary Reform in the Context of the Commons

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Excerpted from a draft paper in which Pat Conaty situates land and money reform in the commons. November 2014.

Version without notes, graphs and tables.


Pat Conaty:

Co-operative Interest-free lending models - past and present

"Adam Smith argued for the usury law in the UK to be tightened and the maximum rate lowered to 5%. He felt that higher rates encourage irresponsible lending and excessively reward investors. Jeremy Bentham argued the opposite and for the abolition of usury laws and a free market rate of interest. Usury is little discussed today but it is crucial in policy terms. Lenders work to the Rule of 72 which means that a loan at a compound rate of 24% will double in value in three years compared to a period of 36 years for a loan at 2%.

During the industrial revolution English working people were excluded from bank lending though pawnbroking was rife. Mutual aid savings clubs developed interest-free lending systems for housing. The most successful were the Terminating Building Societies for buying land and building houses. The first was established in 1775 by Richard Ketley, a pub owner in Birmingham and this idea spread rapidly across the Midlands of England. Members who saved for at least ten years received an equal chance to buy a plot of land to and build a house with a mixture of their savings (typically 40%) and an interest-free loan (typically 60%) from the mutual society. Loan allocation was by a draw organised periodically to distribute the pooled funds. A Terminating Building Society usually would operate for 20-25 years until all the member savers had secured a home. Then the society wound up.

By 1870 nearly a thousand Terminating Building Societies were active across the U.K. They had become the core provider of mortgage finance for the skilled working class. However no new terminating building societies were allowed to form in the UK after 1910. By that time though the system had spread to many Commonwealth countries. The system was still legal in New Zealand until 1980.

There were other models that flourished. Dr. Thomas Bowkett introduced a mutual organization in the 1840s to provide housing and smaller loans interest-free. Twenty years later, Richard Starr made some adjustments to the system, and the “Starr-Bowkett” societies spread fast. Each was a registered mutual society. New members selected the amount of the loan for which they wished to apply, were assigned a number and a set amount of time for paying a monthly subscription (generally 0.25% of the loan). Once sufficient funds accumulated from subscriptions, ballot meetings were held and loan recipients chosen by lottery. The lottery feature of the system led to its abolition by regulators in England in the late 19th century. By then the societies had spread to Australia and this approach to lending remained popular for housing finance loans until the mid-20th century.

A system of rotational savings and lending almost identical to those of 19th-century England is active in Brazil today. CoopHab is a major housing federation of co-operative savings societies. Each society is organized to sign up 1000 members. They each commit to save a particular percentage of their household income for ten years and in return are guaranteed an interest-free loan over a ten-year repayment term. One hundred interest-free mortgages are allocated annually by each society until every member is housed by Year 10 (or slightly later). Then the society terminates. Elsewhere, there are other models of mutual, interest-free lending. During the Great Depression, a group of Danish farmers faced repossession of their land by the commercial banks. Building upon earlier practices of interest-free systems in Germany, Christian Christiansen championed the founding of a number of rural savings and loan co-operatives that went by the acronym JAK, short for Jord Arbete Kapital (“Land Labour Capital”) that still operate.

In 1965 the concept spread to Sweden, where it expanded rapidly in the late 1980s and secured a banking license in 1998. Today Sweden’s JAK Bank has 35,000 members, US$163 million in assets, and $147 million out on loan. About 80% of those loans are for home improvements or to refinance high interest loans (e.g., student and consumer loans) originally obtained from commercial banks. The other 20% is invested in ecological and social enterprises of various kinds.

Operationally, JAK is very similar to a credit union, except that members do not earn any interest on their savings or dividends on their shares. Like its Building Society and Starr-Bowkett forebears, JAK also has a compulsory savings element. For foregoing interest and dividend income, members are entitled to fee-based loans at no interest.

The total cost of a JAK loan covers four things:

• loan appraisal and set-up cost at a fee that is 2-3% of the approved loan value.

• an annual administration fee equal to 1% of the loan.

• an annual fee of approximately $30 to support the JAK educational system and volunteer services.

• an equity deposit equal to a 6% of loan value to cover risk on any loan in the portfolio.

Members are strongly encouraged to pre-save in order to qualify for a loan. Members also contract to continue saving while they are repaying their loans. This is called post-saving and it is structured as a separate savings contract that runs alongside the loan contract. By committing to continued savings while the loan is paid down the member can negotiate a larger loan right from the outset.

The diagram below depicts how post-savings are calculated and combined with pre-savings to match the overall sum that is to be borrowed. Pre-savings of $2,000 during a 12-month period prior to applying for a loan (the light green triangle) entitle a member to borrow only a maximum of $2,000 over a similar term (the light purple triangle). However, the member could borrow an additional $3,000 if s/he agreed to continue saving (“post-saving”) while repaying the loan over a 48-month term.

The implications of a $20,000 loan over 10 years make these benefits very clear. (See Table 1.) The JAK borrower enjoys net savings of $6,669 over someone who gets a loan from a conventional bank.

... (table here)

While the JAK borrower saves a large amount of money in interest costs, the monthly payments are higher than those of a conventional bank customer (see Table 2). The reason is monthly loan payments have to be matched by a post-savings payment: the member pays $166.79 in the monthly loan payment, an amount that is matched by an additional $166.79 in compulsory savings.

... (table here)

Monthly payments of $355.84 compared to $241.18 means the annual servicing of a JAK loan is about $2,000 more than a conventional bank loan, or about $20,000 over the 10-year loan term. However, it all comes back. It is the member’s money. Thus a 10-year loan of $20,000 saves $6,669 in interest and creates for the member $20,000 in savings. In addition the 6% equity deposit required at the front end of the loan is also returned, another $1200. Together they represent a nice little nest egg for the borrower.

JAK banking, CoopHab and Community Land Trusts work well but are below national policy radar. This is not entirely the case for co-operative commonwealth systems. The JAK founders in Denmark inspired the development of the Swiss WiR (the ring) in 1934 that today operates as a co-operative bank providing interest-free finance though a mutual credit currency for about one in four small and medium businesses in Switzerland.

How might the co-operative commons make a breakthrough more widely? This has happened in the past. Indeed the history in North America and Germany is insightful for how to implement a public-social partnership strategy between citizens and the state.

From Co-operative movement action to Public banking solutions

In 1862 during the Civil War, to prevent gold and silver from draining out of the Union and bringing about a banking collapse, President Lincoln took two emergency measures. He suspended the convertibility of banknotes to precious metals and then approved the issue in 1862 of what expanded to $450 million of interest-free Greenback dollars. The administration relied upon borrowing to finance the war effort. But as debt levels soared, printing Greenbacks became a war measure.

Faced with a post war debt mountain, as well as the impending costs of reconstruction at the end of the civil war in 1865, Lincoln indicated his intent to expand the use of Greenbacks in peace time. As President he had led the introduction of a paper money not backed by gold or silver, and had shown that the government could create, issue, and circulate by fiat the currency and credit needed to satisfy the spending power of the government and the buying power of consumers. By issuing Greenbacks, Lincoln demonstrated that the privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government’s greatest creative opportunity. The taxpayers through a well managed fiat currency could be saved immense sums of interest.

Following Lincoln’s death, the Greenbacks were withdrawn. The federal lenders of Wall Street secured a reintroduction of hard money policies linked to gold. This led to severe deflation causing business to fail and unemployment to soar. The Bank Panic of 1873 set in train a 20-year depression.

One feature of the Long Depression was falling prices for agricultural goods. Farmers got credit by using their crops as collateral. With merchants and bankers typically charging interest rates of 50-200%, this led to debt peonage. In 1887 the National Farmers Alliance (NFA) emerged as a rural agricultural co-operative movement to combat these practices. Co-operative solutions developed in Texas and Kansas attracted several million members across the USA. The traditional consumer co-operative model relied on cash purchase but most farmers under the crop lien system had no cash. To overcome this usurious credit monopoly, the National Farmers Alliance and Co-operative Union, led by Charles Macune, developed the Sub-Treasury Plan. NFA branches offered votes to either Democratic or the Republican politicians in exchange for agreement to vote for a reintroduction of the Greenback. The Greenbacks would not be backed by gold, but by the farmers’ crops, which would be stored in sub-Treasury warehouses paid for by the government.

So this was not simply a co-operative currency. It was a new national currency under a co-operative and state partnership to expunge the debt peonage imposed by merchants and bankers. Farmers under the sub-Treasury plan could draw down Greenbacks for up to 80% of the crops they pledged to produce and store in the sub-Treasury. Finance was to be secured at 2% interest plus a charge for storing, grading, and insuring their crops in the warehouses. The established political parties withheld their support from the sub-Treasury Plan. Opposition from bankers, merchants and their lobbyists was just too great. Infuriated, farmers and workers created their own party in 1891 to carry forwardmonetary reform and a co-operative economy. The new Populist party won some local, state and Congressional elections before falling into decline after 1895.

A generation later the spirit for monetary reform resurged again in North Dakota with a determination to bring banking into public ownership and to abolish corporate land ownership. In 1915, the Socialist Party organiser A.C. Townley launched the Non-partisan League (NPL) to promote state control of flourmills, grain elevators and banks. At the time, corporation interests based in Minneapolis, operating in collusion with the Northern Pacific railroad, dominated bank lending in North Dakota and the grain trade. The NPL campaign was so successful that its slate of independent Republicans swept the state elections of 1916 and won more seats in the legislature two years later.

Armed with this mandate the NPL set up three major state-run enterprises: North Dakota Mill and Elevator, a state railroad company, and the Bank of North Dakota as a public bank. The benefits of the Bank of North Dakota for the farmers and citizens of the state are notable.

In 2011, the BND [Bank of North Dakota] $5.3 billion in assets made it North Dakota’s second largest bank……. BND does plenty of bank business. Mostly, however, it makes loans – to students and small businesses, farmers and ranchers, affordable housing developers and disaster stricken farmers. The loans are designed to serve public need, so the terms of the loans are generally more favourable than private banks. BND loans aren’t a handout, they actually profit the state. The bank has been in the black every year since 1971, earning $70 million in 2011. More than half the profit goes back into the state’s General Fund offsetting North Dakotans’ taxes. The rest goes towards more loans, not CEO bonuses, because BND ‘execs’ are modestly paid public officials.

The public banking and other reforms of the NPL continue a century later to yield ongoing social dividends for both the public finances and for all North Dakotans. Unfortunately only one US state has established this model. However there are other legacies and precedents for the common good.

100% money and Social credit arguments against debt-based money

In 1920 the US, Germany, Italy, France and the UK were saddled with huge levels of public debt. There was an urgent need to fund reconstruction, housing for the troops returning home and to change production over to civilian purposes. Henry Ford and Thomas Edison suggested a novel solution. To fund infrastructure projects that would generate an income stream, they proposed that new money be created by issuing interest-free government bonds. In 1921 they argued to Congress that the principal on the interest-free credit could be repaid from the income generated by say a hydro-electric dam or a toll bridge or from general taxation. Thinking in the UK probed more deeply.

After an initial issue of debt-free treasury notes, the UK funded its war effort mostly through war bonds. The national debt grew eight-fold from 1914-1918. The Nobel Prize chemist, Frederick Soddy pointed to the cumulative costs of debts in the economy and the instability this creates. In the 1920s he made the first case for an ecological economics free of debt. To achieve monetary reform, Soddy advanced the first case for what became known in the 1930s as “100% money.” He proposed an end to debt-based money by progressive increases towards a 100% reserve requirement. Thereby all money would be created debt-free by the government. He showed that debt-based money runs counter to nature because it violates the laws of thermodynamics.

Clifford H Douglas, a British engineer, made a direct link between monetary reform and a universal income. He argued that economic instability was due to a gap between aggregate demand and supply, which in turn was caused by an insufficiency of money as the circulating medium. Debt money could close this gap only temporarily. More and more debt would mean higher and higher compound interest payments by households, businesses and government. This in turn would reduce national demand to meet goods and services in the real economy. He argued that a clear-cut and labour-saving solution would be for Government to create new money, interest-free as “Social Credit.”.

The Douglas argument had two aspects. First all citizens would receive a National Dividend. This would pre-distribute income without the need to tax and redistribute. It would also reduce debt by eliminating the growth of instalment credit that was being developed by corporations and banks. Second, Douglas proposed that publicly-owned producer banks be set up in each region of the UK to provide finance debt-free to industry and enterprises. From 1929 monetary reform attracted a wide audience In the UK, Australia, New Zealand, the USA and Canada with growing grassroots calls ranging from public banking to universal basic income. The New Deal of Franklin Roosevelt took inspiration from John Maynard Keynes.

‘Cheap money’: Keynes and monetary reform to curtail usury

In 1931, Keynes concluded “that interest – or, rather, too high a rate of interest - is the villain in the economic piece”. He called his public policy antidote “cheap money”: intervention by the Treasury and central banks in the bond markets to ensure the long-term maintenance of low interest rates in order to curb the usurious practices of bankers and provide low-cost capital for housing, welfare services and industry.

This policy was essential to the reforms with which the Roosevelt administration was to circumscribe private banking and vastly extend the reach of public development banking. Roosevelt acted immediately. His first act of office was to declare a three-day bank holiday. An Emergency Banking Act, passed on March 9 closed down and liquidated four in ten banks in the USA. That June, the Glass Steagall Act imposed tighter banking regulation than ever before experienced and rigorously separated commercial banking from investment banking. The new legislation gave the Federal Reserve strong powers to set maximum rates of interest. Deposit protection insurance was introduced. Banking was strictly regulated thereafter for almost fifty years.

Roosevelt’s plan for ending the Great Depression included a public banking model. To address the difficulty that businesses had getting bank loans, the Hoover administration had set up the Reconstruction Finance Corporation (RFC) in 1932. Under Roosevelt from 1933 the RFC introduced mortgage and small business loan guarantee mechanisms. However private bank lending continued to decline. Finally, in 1938, Roosevelt approved direct public lending by the RFC to businesses.

A successful target of low-interest public lending was the rural electricity sector. In 1934 only one in ten rural households in the US had electricity, compared to nine in ten urban households. (Private sector energy companies could make far higher returns on urban than on rural investment.) To resolve this, Roosevelt set up the Rural Electricity Administration (REA) in 1935. Using capital from the RFC, the REA provided long-term, low-cost loans at a 2% fixed rate to enable the co-operative sector to develop a network of rural electricity co-ops. By 1939, 417 rural electricity co-ops had been established and 288,000 households and farms provided with power. By the early 1950s co-operative light and power was being delivered to 90% of farms. Today this movement has grown into a national network of over 850 co-operatives and a membership of 42 million. Long-term public bank finance at low-fixed interest was critical to their success to deliver power and light throughout the rural USA.

The Bank of Canada – A central bank monetary policy for securing the Common Good

Canada also made monetary and banking reform a centrepiece of its strategic response to the Great Depression. While influenced by Keynes, Canadian measures also drew on many more radical ideas. Canadian innovations stand in striking contrast to those of the New Deal. A wave of root and branch change achieved some of the twentieth century’s most significant money and banking innovation.

The crash of 1929 created across Canada a ferment that gave rise to new political parties. The Co-operative Commonwealth Federation (CCF) was founded in 1932 in Calgary as a farmer-labour-socialist party. The CCF manifesto called for public ownership of key industries, universal health care and universal pension provision. The party’s ideas on money and banking were influenced by the public banking success of AC Townley. CCF thinking spread across Canada during the 1930s.

Gerry McGeer, a Liberal Party candidate, was elected mayor of Vancouver in 1934 at a time of huge industrial unrest. In his book, The Conquest of Poverty (1935), McGeer’s plan combined Keynes’ Cheap Money with Lincoln’s Greenback. He presented evidence to bankers, politicians and economists to show how a public bank could work for the common good. His timing was fortuitous. In 1935 Canada had opened its own central bank, the Bank of Canada, but as a privately-owned bank. There was a Government debt crisis with interest charges more than one third national expenditure. McGeer’s proposals were supported by the Prime Minister, fellow Liberal William Lyon Mackenzie King. Graham Towers, the first governor of the Bank of Canada, was also persuaded. Inspiration came from the new Reserve Bank of New Zealand, a public central bank that began life in 1936 advancing loans at 1% to fund a broad range of infrastructure including hydro-power, the railways and public housing. Mackenzie King made a mission statement of political intent in 1935:

Once a nation parts with control of its currency and credit, it matters not who makes the nation’s laws. Usury, once in control, will wreck any nation. Until the control of the currency and credit is restored to government and recognised as its most conspicuous and sacred responsibility, all talk of sovereignty of Parliament and of democracy is idle and futile.

1938 the Bank of Canada was converted into publicly-owned corporation and curtailed private bank borrowing by creating most of the money supply until 1945. After the war, monetary policy was structured to assist long-term reconstruction and job creation. The Industrial Development Bank was set up as a subsidiary of the Bank of Canada. Loans were advanced at a nominal 1% rate and this practice continued until the mid-1970s. In addition to investment for industry and business, cheap money funded Canadian infrastructure including housing, the Trans-Canada highway, the St. Lawrence Seaway and a broad range of social programmes including financial aid for veterans to attend university, assistance for veterans to acquire farmland, the development of federal health care system and to finance as well the Canada Pension plan and Medicare.

Until the mid-1970s the federal government created enough new money to monetise 20-30% of the national deficit. Moreover, cheap money forced the mainstream banks to keep their commercial rates low in order to compete. As a consequence of a combination of public banking and cheap money Canada had a total national debt of only $37 billion in 1975. The policy underpinned four decades of Canadian security and stability. All this changed in 1974 - the year the Basel Committee on Banking Supervision was set up within the Bank for International Settlements (BIS). Canada was among the committee’s founding members. To encourage monetary stability and fight stagflation, BIS discouraged governments from borrowing from their central banks interest-free. Instead it was recommended that they borrow from the private sector and from international banks.

This was instigated after the election in 1984 of a Progressive Conservative government. Public debt soared to $581 billion by 2012. Interest payments by taxpayers on the debt topped $1 trillion and became the single largest budget item, higher than health care, national defence and senior citizen entitlements. It has been estimated that if Bank of Canada practices had not been changed, there would be no national debt and indeed a surplus of $13 billion.

Public development banking: KfW a ‘cheap money’ system operating in Germany

The Kreditanstalt für Wiederaufbau (KfW) was established after World War II to act as a development bank for reconstruction. It continues to operate today and plays a strategic role in the implementation of German’s carbon reduction and green economy programmes. Germany has been an EU leader in green energy since the 1990s and KfW has been at the core of its implementation practice.

KfW provides capital at 1% to the German retail banks for on-lending. The German municipal savings banks and the co-operative banks comprise the majority of this market. Loans at 2.65% are provided for both homeowners and small businesses to retrofit housing and commercial premises.

Packages of energy conservation and renewable energy measures are tailored to secure rigorous carbon reduction savings. Borrowers are incentivised to achieve the targeted savings by a bonus that reduces the capital sum advanced if the carbon reduction levels are met. The impact of these rebates can reduce the net interest charged to less than 2%. KfW commitments amount to €10 billion a year and attract an additional €17 billion in energy efficiency investment.

KfW programmes have created employment year on year. Today it supports 368,000 construction jobs in both new build and high-standard retrofits to Germany’s housing and commercial infrastructure. Since 2001 more than 2.5 million homes have been upgraded to high-energy savings standards. The current annual upgrade volume is more than 358,000 units. Germany is on target to cut carbon emissions from homes and commercial buildings by 40% by 2020 and by 80-95% by 2050.

100% money and Citizens Income: a Commons Solution

During the Great Depression, it was acknowledged quite widely that banks create money as debt every time they make a loan. In other words they do not lend out their deposits but multiply money in circulation simply by exercising their fractional reserve freedom to expand the level of debt. A 100% reserve requirement enforced by central banks would remove this freedom and the issue of money and liquidity would become a role for governments to reclaim fully. In 2014, The Bank of England officially confirmed in their Quarterly Bulletin 2014 that the banks create money simply by lending.

Former World Bank economist Herman Daly has proposed reconceptualising money as a commons based on the 100% money proposed by Frederick Soddy and later advocated in 1934 by Irving Fisher. Fisher proposed to remove from banks the power to create money as debt by setting up a Currency Commission to provide the money supply debt-free. He argued for a partnership between the Currency Commission, the central bank and the national retail banking network, to act as the delivery system. Fisher and the proponents of the The Chicago Plan and The Program for Monetary Reform in 1939 highlighted that the impact of 100% money would restrict debt comprehensively.

Under the fractional reserve system, any attempt to pay off the Government debt, whether by decreasing Government expenditures or by increasing taxation, threatens to bring about deflation and depression……the fundamental consideration is that whatever increase in the circulating medium is necessary to accommodate national growth could be accomplished without compelling more and more people to go into debt to the banks, and without increasing Federal interest-bearing debt.

To implement 100% banking effectively, Fisher drew the important distinction within commercial banks between checking accounts and saving accounts. The former could and should be operated on the basis of fees for service, not interest. By contrast, saving accounts are not part of the means of circulation. They are loans borrowed from banks from savers. To pay any return to savers as a share of investment, the banks would need to invest these deposit funds in productive enterprises.

Joseph Huber in Germany and James Robertson in the UK have made the case for creating 100% money by extending the government money supply from the marginal areas of coins and banknotes (about 3% of money) by replacing bank generated debt money with a universal basic income that could be spent directly into the economy interest-free. This would be a pre-distribution of income replacing as well the other forms of redistribution by the state, including state pensions, tax allowances and other welfare benefits. Robertson proposes a 3-year period to phase in the transfer from a debt-based national money supply to a 100% debt-free money system. He calculate that the UK government and taxpayers would secure £75 billion in savings annually and a one-off savings of £1500 billion by replacing bank debt money with national, interest-free money. The latter figure could fully repay the UK’s national debt that has continued to rise relentlessly since the 2008 bank bailout."