Monetary Trust Initiative
Discussion
Proposed Monetary Plan for the US, by Uli Kortsch:
"There is an increasing but vaguely defined malaise in the general public that all is not as it should be with our banking and monetary system. First we had the Great Recession of 2007/2008, then followed by various attempts at stabilization and stimulation, including bouts of Quantitative Easing, Zero Interest Rate Policies, and now, in what can be perceived as almost panic, many countries experimenting with Negative Interest Rate Policies. Experts around the world are starting to look at structural alternatives, as it seems that the “silver bullet” no longer exists – if it ever did.
The shortcomings of the fractional reserve banking system have been known for a long time, and various implementations of reforms continue to be proposed. Among others, former Governor of the Bank of England [Lord Mervyn King, 2010] has called it the worst of all possible monetary systems and has called for urgent reforms. Lord Adair Turner, the former chairman of the UK’s Financial Services Authority, agrees, although he has not stated it as strongly.
For the generally accepted properties of money (medium of exchange, unit of account, store of value, and standard of deferred payments to function properly, the monetary system in which money is issued and circulates through the economy must adhere to the fundamental principles of honesty, integrity, and justice. Such a system creates trust between the people using the system and those administering it. It provides a foundation upon which prosperity is available to all and inter-generational savings can be built and sustained.
The problem is that we have a money system that is debt-based instead of value-based. When a private bank makes a loan to an individual or company, the money constituting that loan does not come from previous savers but instead is created ex nihilo by the bank for that particular loan. This process is called “deposit creation”. Conversely, when a loan is repaid, money does not remain on the bank’s balance sheet, it disappears. As counterintuitive as it seems, loan repayments (as also defaults) are the antithesis of money creation. Just as banks punch numbers into computers to create money, they do the same to destroy it when loans are repaid. As Robert Hemphill of the Atlanta Federal Reserve observed in the 1930s: “We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money, we are prosperous; if not, we starve.” The fact that the general population does not understand this, but instead thinks that banks simply intermediate funds from savers to borrowers, creates deception among the general populace and routine misdiagnoses among legislators.
Because in our present system debt creates money, the increase in the money supply needed for price stability (or to generate the mild inflation the Fed claims to want) always demands an increase in debt. This means therefore that a country that has a larger money supply must also have more total debt (i.e., governmental and private combined). Excess debt has been, and always will be, a drain on the productive capacity of individuals as well as nations, as it has to be serviced out of funds that otherwise would be available for purchases of real goods and services. Our present system thus requires the perpetuation of debt on such a scale that it threatens the very fabric of society. It therefore stands in direct opposition to the principles that should be inherent in any monetary system.
To have continuing price stability the amount of new money creation needs to be in a rough equilibrium with the increase or decrease in our total production of goods and services. This is currently controlled through a number of factors, the largest of which during normal times is the management of interest rates by the national central bank, in the US case the Federal Reserve Bank. A decrease in interest rates tends to stimulate the economy by encouraging the issuing of more loans, because the price of the lent money (in terms of interest payments) decreases. This increase in loan volume increases our money supply. As the economy comes close to overheating, the opposite is achieved through an increase in interest rates, slowing the economy down.
We routinely find ourselves in unsustainable situations, as the fractional reserve banking system inherent in its functioning triggers and/or amplifies business cycles both in the expansionary and contractionary phases. For instance, in order to create banking stability and forestall runs on banks, collateral is demanded for loans, some of which is rated better than others from a regulatory perspective. One of the more highly rated types of collateral is real estate, and therefore banks lend extensively by way of mortgages. The difficulty is that in the business cycle upswing house values increase, leading to higher levels of mortgage borrowing against the same properties, which in turn implies additional money creation and higher prices, leading to yet higher mortgage debt, leading to yet higher prices and so on in a continuous spiral until the debt payments become unsustainable. As banks sense this, they pull back on the mortgage levels they are willing to fund, tighten the credit criteria, and thereby cause a decrease in mortgage funding liquidity. Although this process is completely rational from an individual bank’s perspective, in the aggregate the resultant shock tends to become systemic leading to sharp drops in house prices, foreclosures, bankruptcies, and general economic mayhem.
Our goal is to see the monetary and banking system changed so that the system of money creation harnesses the value of a nation’s production and minimizes human manipulation of our money supply. This methodology was first proposed by Frank Knight, Henry Simons, Irving Fisher and others during the Great Depression, and supported by almost 100% of all American economists. Recent academic literature exists to mold this into our modern framework. It can be shown to result in lower taxes, higher productivity, lower aggregate debt, shallower business cycles, and greater wealth equality. How would this work and has it ever been done before?
?In short, money creation would become value-based instead of debt-based. Value-Based Money? is also often called “sovereign money” in the literature. Based broadly on an objective of price stability (and as explained further below, controlled by a Monetary Commission), Treasury would issue money for deposit into its account at the Fed, which would be used for part or all of the following: payment toward the federal budget, payment for per-capita-based transfers to states, and payments directly to citizens (e.g., a negative income tax could be used). As Thomas Edison famously observed in an interview reported in The New York Times in 1921: “If the Nation can issue a dollar bond it can issue a dollar bill. The element that makes the bond good makes the bill good also. The difference between the bond and the bill is that the bond lets the money broker collect twice the amount of the bond and an additional 20%. Whereas the currency, the honest sort provided by the Constitution pays nobody but those who contribute in some useful way. It is absurd to say our Country can issue bonds and cannot issue currency. Both are promises to pay, but one fattens the usurer and the other helps the People.”
Our proposed solution is a Trust Banking System, under which the creation of money would be safeguarded by a transparent entity, the Monetary Commission. Although independent, it would be operated by the Federal Reserve Bank but owned by Treasury (which is equal to being owned by the citizens). In essence, the creation of money would be democratized. The money created by it would be injected into the economy as broadly as possible. This means that rather than pull the public and country further into debt, that money would work in the public interest to create jobs and fuel the “real economy,” which is the part of the economy that is concerned with producing goods and services, as opposed to the part of the economy that is concerned with buying and selling on the financial markets.
In a Trust Banking System, when a deposit is made at a deposit bank into the depositor's account, through the Depository Window, the funds continue to belong to the depositor (rather than becoming an IOU of the bank as under the current system). This would all be covered under the standard depository agreement between the bank and the customer. 100% of the depository base will at all times be covered by cash in the vault or deposits at the Fed. The only source of income for a bank from the Depository Window would be for payment services. No deposit creation would exist in this system and thus no new money could be created by private banks. Further, because all deposits would at all times be fully covered, the needed oversight would be minimized as the system is autonomously stable and ruinous bank runs would be impossible, as cash would always be available for withdrawal.
Additionally, under the Trust Banking System, lending banks would be separate institutions from deposit banks. They would be true intermediaries (as most think that banks are today) that offer investment products to those with cash wishing to have it invested, and then invest this cash, by lending it out or purchasing securities. This would be done through the Credit Window of banks but none of the funds under the Depository Window would be available for this purpose. Instead, savers and investors would subscribe to a series of offered mutual funds in say, car loans, or mortgages, or commercial loans of various kinds, and so on. These could be open or close-ended funds as desired with maturities, risk levels, and expected return levels published by the bank in advance. Thus credit would now be driven by savings rather than by deposit creation. Savers would again be rewarded for savings and interest rates would be controlled by the market rather than largely by Fed edict and actions as they are now. Has this been done before?
Early into the American Civil War President Lincoln realized that the costs associated with that war would be unsustainable if funds were to be borrowed through the issuance of federal government bonds. In looking for alternatives legal under the Constitution, the government enacted the Legal Tender Act of 1862. This created $150 million of non-redeemable and non-interest bearing notes. There were a number of additional acts increasing the issuance to about $450 million and several to withdraw them as private banks increased money in circulation. It is interesting to note that this represented about 40% of the monetary aggregates at the time, which would make it equivalent to the Treasury creating about $5 trillion today. According to the Federal Reserve Bank, there are still about $240 million in circulation today as worn notes were replaced by the Fed until 1971. They were identical in purchasing power once in circulation and were distinguishable only in that the serial numbers were in red.
This type of currency called US Notes (USN) came to be colloquially known as “Greenbacks”. As debt represents the acquisition of current purchasing power in exchange for future liabilities, USNs are seen as “notes of credit” as they do not create any future liability. They are quite distinct from Federal Reserve Notes (FRN) in that FRNs are created through the issuance of debt (personal, corporate, or governmental), and create more of the same as the underlying debt demands interest payments. USNs on the other hand are issued directly by the Treasury (through the Federal Reserve) and although they are legally listed as debt (there is no formal equity accounting with the government) they are not redeemable by anything other than themselves and accrue no interest payments. They are in a category one could call "no-debt debt" as they create no future obligation. This is acknowledged by today's federal debt legislation which explicitly exempts them.
USNs were tested in a Supreme Court decision, Knox v. Lee, May 1, 1871, which established that the federal government through the Department of the Treasury had the right to issue money as legal tender for the payment of all debts and that this did not conflict with the Constitution. This has never been overturned. See 79 US 457. Some have argued that the Constitution's Coinage clause (Article 1, Section 8, Clause 5) only applies to physical coins in spite of this Supreme Court decision. A lengthy historical review of that debate was published in the Harvard Business Review, volume 31 called “Understanding the Coinage Clause” by Robert G. Natelson which comes to the conclusion that Treasury was meant to have the right to create (paper) money. The history of US Note emissions is well documented in A Monetary History of the United States, 1867-1960 by Milton Friedman and Anna Schwarz, considered to be the definitive book on the era.
How to do this? Once all factors are planned in advance, the transition from our current system would occur over a weekend. The value of the bank top-up needed to convert from a 10% reserve system to a full trust system could cover much of the federal and state debt without creating any inflation. Without today’s interest payment on federal debt, plus the increase in government income through the Monetary Commission, about $850 billion per annum would be available, reducing or eliminating deficits. Although this would significantly ease our country’s debt, it is by no means a panacea. This transition would bring us to a state of financial stability, but measures would have to be taken to maintain that state. It would mean that as a country we would have to accept and live in financial responsibility. The flexibility granted by the Fractional Reserve Banking System would no longer exist under a Trust Banking System, but it is this flexibility and untenable system that has led us to this state of crisis, time and time again.
The result would be a banking system that functions as a structure sustaining the whole of society. In conjunction with the mores of a democratic society, the power previously held by the banks would belong to the people and would be held within a far more accountable and transparent framework with full disclosure. In contrast to the Fractional Reserve Banking System, a Trust Banking System would be innately stable because all deposits would be covered by real money within a real economy. Money creation through new monetary policy would become steady, predictable, accountable, and effective; investments would be driven by savings and not by money creation, and it would result in an overall enhancement of economic performance."
References
1 Bank of England: Money Creation in the Modern Economy
2 We are well aware that the velocity of money is an integral part of this equilibrium, but because velocity is mean reverting, we are leaving it out of this discussion for sake of simplicity.
3 Among others, see Kumhof, Michael and Benes, Jaromir https://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
4 As per Limited Purpose Banking, Dr. Laurence Kotlikoff, see https://www.aeaweb.org/aea/2012conference/program/retrieve.php?pdfid=568
5 See the FRED information from the Federal Reserve Bank of St. Louis Economic Research here: https://research.stlouisfed.org/fred2/series/M2/
6 The Congressional Research Service states that US Notes are not part of current debt limitation legislation. See The Debt Limit – History and Recent Increases which states in page 1, Note 1 "Approximately 0.5% of total debt is excluded from debt limit coverage. The Treasury defines “Total Public Debt Subject to Limit” as “the Total Public Debt Outstanding less ...and ... United States Notes, as well as ..." The debt limit is codified as 31 U.S.C. §3101.