Mark Joob's Monetary Reform Proposal

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The monetary reform proposal: The Chicago Plan

Mark Joob:

"The monetary reform proposal traces back to the so called Chicago Plan that was proposed by leading U.S. economists in the 1930s in order to end the Great Depression and to avoid the occurrence of similar crises (cf. Yamaguchi 2011: 4f.). The monetary reform envisioned by the Chicago Plan was splendidly elaborated by the prominent macroeconomist Irving Fisher who predicated this plan being “incomparably the best proposal” to remove “the chief cause of both booms and depressions, namely, the instability of demand deposits, tied, as they now are, to bank loans” (Fisher 1936: 9). Accordingly, the core intention of the Chicago Plan was to take the control over the money supply out of the hands of the commercial banks and to restore actual governmental control over money creation by requiring 100% reserve backing for bank deposits. As a result of 100% reserve backing of all current accounts, commercial banks would no longer be in the situation to almost unlimitedly create money by granting credit, but they would be obliged to fully finance their credits by central bank reserves. These reserves which embody legal tender are given as loans to the commercial banks if they deposit appropriate assets as collateral at the central bank. In the case of 100% reserve backing, thus, the total of the money in circulation – cash and current account holdings – would be equal to the amount of legal tender issued by the central bank. And since the central bank works under the mandate of the government, the government would ultimately control the money supply and let the central bank enlarge the quantity of money to a degree which allows for a steady economic development.

In a recent IMF working paper, two experts rigorously evaluate the impacts of 100% reserve backing by applying the recommendations of the Chicago Plan to a precise model of the current U.S. financial system. Their results fully validate the benefits of this plan as claimed by Fisher (cf. Fisher 1936: 19f.):

“The Chicago Plan could significantly reduce business cycle volatility caused by rapid changes in bank’s attitudes towards credit risk, it would eliminate bank runs, and it would lead to an instantaneous and large reduction in the levels of both government and private debt. [...] One additional advantage is large steady state output gains due to the removal or reduction of multiple distortions, including interest rate risk spreads [...]

Another advantage is the ability to drive steady state inflation to zero [...]” (Benes and Kumhof 2012: 55f.)

It is important to note that this conclusion refers to a version of the Chicago Plan which gives the government the exclusive right of money issuance. This result can be achieved in the following way. When commercial banks are obliged to back their outstanding credits to 100% by central bank reserves – instead of the 1%, for example, which is required in the euro zone at present – then they suddenly have to deposit very large assets as collateral at the central bank. If the central bank accepts only domestic government bonds as collateral for reserves, the commercial banks must fund their non-government loans with money which originates from government loans and comes into circulation by public spending or lending. So, the commercial banks are bound in the first round, when creating money, to grant all their credits to the government and deposit all the government bonds that they receive as equivalent from the government, at the central bank as collateral. Then, in a second round, they must collect existing money through income and borrowing in order to be able to grant credits and to facilitate productive investments. This way, money creation by commercial banks would be limited to the amount of loans which is requested by the government. Simultaneously, money would not come into circulation in the economy except through the treasury by public spending or lending according to government policy.

This government version of the Chicago Plan would solve the problem of how to guarantee complete congruency between the credits granted by the commercial banks and their holding of central bank issued reserves, but money would still represent debt and carry interest. Though the government could exercise a monopoly over money issuance, money creation would still depend in part on the willingness of commercial banks to give loans to the government and therefore these banks would have some bargaining power with regard to the interest rate of the government loans. Less rigorous versions of the Chicago Plan that allow the central bank to accept not only government bonds but also non-government securities as collateral for reserves, are even more problematic, since they face difficulties in controlling the money supply by monetary policy. The reason for this is that the commercial banks could take an active role in granting credits to the private sector according to their own interests leaving to the central bank just the reactive role of providing reserves for already existing current account holdings.

Joseph Huber draws the logical conclusions from the government version of the Chicago Plan when he in the present debate on monetary reform formulates the convincing idea of replacing the unnecessarily complicated two-level banking system by a single-level system, in which money is no longer backed by reserves, but money itself is the reserve (cf. Huber 2010 and 2012). Partially together with James Robertson (cf. Huber and Robertson 2000), Huber has developed further the 100% reserve concept of Fisher by specifying it and adapting it to the conditions of electronic data processing. The work of Huber is the most important theoretical basis for the monetary reform movement that has come into life in Europe in the last years and aims at a fundamental modernization of the current dysfunctional fractional reserve banking system. This monetary reform movement includes the German ‘Monetative’ initiative, the Swiss ‘Vollgeld’ initiative (cf. Joób and Brändle 2012) and the ‘Positive Money’ initiative in the UK. In the following, I will refer to the monetary concept of this reform movement as “public money” – the term used by Kaoru Yamaguchi (cf. Yamaguchi 2011: 21ff.).

In the public money system, both cash and current account holdings are fully valid legal tender and do not need to be backed by reserves because they themselves embody the reserves and are completely safe from a legal point of view. Hence, money on current accounts would not disappear in the case of a bank’s bankruptcy and governments would not have to bail out large banks since a core element of the public money reform is “[...] to take bank customers’ current accounts off bank balance sheets, and recognise formally what they now actually are: accounts containing noncash money which belongs to customers, just as customers’ wallets and purses contain cash money that belongs to them. In other words, customers’ current accounts will cease to be accounts belonging to the banks. They will be containers of money belonging exclusively to bank customers.” (Huber and Robertson 2000: 23f.)

This simple but very effective innovation would lead to a strict separation of money and credit and would end the money creation by commercial banks which would merely hold customers’ current accounts in trust. In the public money system, commercial banks would be nothing more than financial intermediaries and could therefore only grant credits from money which they have previously borrowed from their customers or owners (cf. Huber 2010: 92ff.).

Similarly to Fisher who intended to put a governmental “currency commission” in charge of exclusively issuing reserves in the form of cash (Fisher 1936: 17f.), the public money concept aims to establish a sovereign public authority with total control over the money supply, both cash and current account holdings. This monetary authority would represent a fourth separate and largely independent section of the state besides the legislature, the executive and the judiciary. It would serve the common good as “the trustee of a nation’s currency, defending its exchange value and its domestic purchasing power, creating, if necessary, additional money in accordance with real economic potential, and ensuring full seigniorage from the creation of money.” (Huber 2012: 9) The money created by the monetary authority would be transferred to the treasury and would come into circulation by public spending; thus, it would benefit the public purse and contribute to the reduction of national debt. Public revenue would be especially high in the moment of transition to the public money system when the money owed to commercial banks becomes owed to the monetary authority, which would significantly reduce public indebtedness. So, instead of bringing the commercial banks an extra profit, money creation would serve the whole community. This result is clearly proven by the macroeconomic modelling of Yamaguchi who concludes that in the public money system “looming debt crises to be caused by the accumulation of government debt can be thoroughly subdued without causing recessions, unemployment, inflation, and contagious recessions in a foreign economy.” (Yamaguchi 2011: 26)

Compared with the 100% reserve system, a great advantage of the public money system is that money would be issued debt-free by the monetary authority and would therefore not carry interest – unless, in a following step after being created, it is lent by its owner as an investment, for example to a commercial bank. Debt-free money issuance would considerably alleviate the current social and ecological problems arising from interest, such as forced economic growth and redistribution in favour of capital.

The proponents of the Chicago Plan were aware that their goal of establishing public control over money creation could be thwarted by the emergence of new financial instruments, specially bank-created securities, taking over the function of money (cf. Benes and Kumhof 2012: 18). This is a serious danger also to a public money system, in particular with regard to the interbank market. Financial regulations would be needed to prevent the emergence of near monies which would impair the monetary authority’s control over the money supply, for instance by prescribing a minimal holding period for financial instruments.

Another problem that needs to be resolved in a public money system is how to secure the independence of the monetary authority. Since governments generally seek to increase public revenue in order to enlarge their scope of action, they would be tempted to put pressure on the monetary authority to issue more money than the potential of the real economy and the principle of sustainable development in a given situation allow. In the same way as the independence of the judiciary is guaranteed today, the independence of the monetary authority from short-sighted political interests could be secured by an adequate institutional arrangement which simultaneously warranted complete transparency in monetary decision making and full democratic accountability of those who rule the monetary system. A central aim of the public money concept, after all, is to restore democratic control over the monetary system and thereby over the heart of the economy to make it serve the common good by promoting welfare, justice and social peace." (