Iceland’s Sovereign Money Proposal – Part 1

In a way this blog is being written to stop the relentless onslaught of E-mails coming, which seek to promote so-called positive money. I am regularly told that I need to forget Modern Monetary Theory (MMT) and instead see the benefits of this alleged revelationary approach to running the economy. Other E-mailers are less complimentary but just as insistent. Then there are the numerous E-mails recently with the following document attached – Monetary Reform: A Better Monetary System for Iceland – which I am repeatedly told is the progressive solution to bank fraud and, just about all the other ills of the monetary system. The Iceland Report was commissioned by the Icelandic Prime Minister and is being held out as the solution to economic and financial instability because it would wipe out the credit-creating capacity of banks. It has been endorsed by the British conservative Adair Turner, who formerly was the chairman of the UK Financial Services Authority and who recently advocated so-called overt monetary financing (OMF) as a way to resolve the Eurozone crisis. I agree with OMF but disagree with his view that it is the credit-creation capacity of banks that caused the crisis. The crisis was caused by banks becoming non-banks and engaging in non-bank behaviour rather than their intrinsic capacity to create loans out of thin air. A properly regulated banking system does not need to abandon credit-creation. Further, I am aware that in holding this view, I and other Modern Monetary Theory (MMT) proponents are accused of being lackeys to the crooked financial cabals that hold governments to ransom and brought the world economy to its knees. Let me state my position clearly: I am against private banking per se but consider a properly regulated and managed public banking system with credit-creation capacities would be entirely reliable and would advance public purpose. I also consider a tightly regulated private banking system with credit-creation capacities would also still be workable but less desirable.

This is a two-part series given the topic is rather massive.

Please note that I do not want my blog to become a forum for a long discussion on positive money. I hope this two-part series states my position and I plan to end it at that. I will also delete comments that provide links to positive money sites.

Basic MMT

As background, please read the following blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks – for further discussion.

Please also read the following introductory suite of blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3 – for basic Modern Monetary Theory (MMT) concepts.

Please also note that the term ‘money’ is quite difficult to pin down given that it is a social construct with embedded power relationships. For us to understand the history of money requires us to also be sociologists and anthropologists among other things to penetrate the broader relationships that govern the use of a ‘thing’ which might be called money.

We have a tendency to think of money in numerical terms and construct additions and subtractions when talking about it. But we should always be mindful that underlying these ‘transactions’ (or the “arithmetic problem” as Randy Wray calls it in his work – The Credit Money and State Money Approaches) are complex social relationships.

Economic exchange is always embedded in a power hierarchy, which determines, among other things, how the surplus production is generated and how it is distributed.

Note also that:

  • Modern monetary economies use money as the unit of account to pay for goods and services. An important notion is that money is a fiat currency, that is, it is convertible only into itself and not legally convertible by government into gold, for instance, as it was under the gold standard.
  • The sovereign government has the exclusive legal right to issue the particular fiat currency which it also demands as payment of taxes – in this sense it has a monopoly over the provision its own, fiat currency.
  • The viability of the fiat currency is ensured by the fact that it is the only unit which is acceptable for payment of taxes and other financial demands of the government.

In a modern monetary economy, the consolidated government sector (central bank and treasury) determines the extent of the net financial assets position (denominated in the unit of account) in the economy.

The only way the non-government sector can increase its stocks of net financial assets is if there is a transaction with the government sector (for example, if the government spends).

As a matter of accounting between the sectors, a government fiscal deficit adds net financial assets (adding to non government savings) available to the private sector and a fiscal surplus has the opposite effect.

Treasury operations which may deliver surpluses (destruction of net financial assets) could also be countered by a deficit (of say equal magnitude) as a result of central bank operations. This particular combination would leave a neutral net financial position.

However, most central bank operations merely shift non-government financial assets between reserves and bonds, so for all practical purposes the central bank is not involved in altering net financial assets.

The exceptions include the central bank purchasing and selling foreign exchange and paying its own operating expenses.

So we are clear – the government is the only entity that can provide the non-government sector with net financial assets (net financial savings).

In general, the government deficit (treasury operation) determines the cumulative stock of net financial assets in the private sector. Central bank decisions then determine the composition of this stock in terms of notes and coins (cash), bank reserves (clearing balances) and government bonds.

A net financial asset created in this way provides the non-government sector with the capacity to spend without any offsetting liability being created.

This is not the case, however, in private credit markets, which involve the leveraging of credit activity by commercial banks, business firms, and households (including foreigners).

Many economists in the Post Keynesian tradition consider this activity to define the endogenous circuit of money.

The theory of endogenous money is central to the horizontal analysis in MMT. When we talk about endogenous money we are referring to the outcomes that are arrived at after market participants respond to their own market prospects and central bank policy settings and make decisions about the liquid assets they will hold (deposits) and new liquid assets they will seek (loans).

The essential idea is that the ‘money supply’ in an ‘entrepreneurial economy’ is demand-determined – as the demand for credit expands so does the money supply. As credit is repaid the money supply shrinks. These flows are going on all the time and the stock measure we choose to call the money supply, say M3 is just an arbitrary reflection of the credit circuit.

Please read my blog – Understanding central bank operations – for more discussion on this point.

The supply of money is determined endogenously by the level of GDP, which means it is a dynamic (rather than a static) concept.

Central banks clearly do not determine the volume of deposits held each day. These arise largely from decisions by commercial banks to make loans. The central bank can determine the price of ‘money’ by setting the interest rate on bank reserves.

However, the only way you can understand why all this non-government leveraging activity (borrowing, repaying etc) can take place is to consider the role of the Government initially – that is, as the centrepiece of the macroeconomic theory.

Banks clearly do expand the money supply endogenously – that is, without the ability of the central bank to control it. But all this activity is leveraging the high powered money (HPM) created by the interaction between the government and non-government sectors.

HPM or the monetary base is the sum of the currency issued by the State (notes and coins) and bank reserves (which are liabilities of the central bank). HPM is an IOU of the sovereign government – it promises to pay you $A10 for every $A10 you give them! All Government spending involves the same process – the reserve accounts that the commercial banks keep with the central bank are credited in HPM (an IOU is created). This is why the “printing money” claims are so ignorant.

The reverse happens when taxes are paid – the reserves are debited in HPM and the assets are drained from the system (an IOU is destroyed).

We can think of the accumulated sum of the transactions between the government and non-government sectors as being reflected in an accounting sense in the store of wealth that the non-government sector has. When the government runs a deficit there is a build up of wealth (in $A) in the non-government sector and vice-versa. Budget surpluses force the private sector to ‘run down’ the wealth they accumulated from previous deficits.

One we understand the ‘vertical’ transactions between the government and non-government then we can consider the non-government credit creation process.

Private capitalist firms (including banks) try to profit from taking so-called asset positions through the creation of liabilities denominated in the unit of account that defines the HPM (for example, $A). So for banks, these activities – the so-called credit creation – involve leveraging the HPM created by the vertical transactions because when a bank issues a liability it can readily be exchanged on demand for HPM.

When a bank makes a $A-denominated loan it simultaneously creates an equal $A-denominated deposit. So it buys an asset (the borrower’s IOU) and creates a deposit (bank liability). For the borrower, the IOU is a liability and the deposit is an asset (money).

The bank does this in the expectation that the borrower will demand HPM (withdraw the deposit) and spend it. The act of spending then shifts reserves between banks.

These bank liabilities (deposits) become ‘money’ within the non-government sector. But you can see that nothing net has been created. Only vertical transactions create/destroy assets that do not have corresponding liabilities.

The crucial distinction is that the horizontal transactions do not create net financial assets – all assets created are matched by a liability of equivalent magnitude so all transactions net to zero. This has implications for government spending impacts on liquidity in the economy and central bank operations designed to maintain a target interest rate.

The other important point is that the commercial banks do not need reserves to generate credit, contrary to the popular representation in standard textbooks.

Quantity or price

The money account defined by the government as the unit it will accept in payment to extinguish non-government tax liabilities is issued under monopoly conditions.

The State is the monopolist in the provision of the currency. The private banks cannot issue currency. They can create credit backed by an offsetting debt but not issue the money account.

Basic theory tells us that a monopolist has a choice – it can either control the quantity or the price of the monopoly good.

It cannot do both. So it could ban private credit leveraging (as the Sovereign Monetary Proposal we discuss next advocates) and thus control the quantity of ‘money’ in the economy. But then it would lose control over monetary policy, if we define that in terms of the capacity to set the interest rate and condition the term structure of interest rates (the longer maturity rates associated with mortgages, investment loans etc).

If it then tried to control interest rates, then it would lose control over the quantity of ‘money’ in circulation. This is a point I will return to further on.

Iceland’s Sovereign Money Proposal – Overview

The Iceland Sovereign Money Proposal (SMS) claims the regulatory changes to the financial system since the 2008 financial crises have been substantial (“increasing bank capital and liquidity requirements, developing bank resolution plans, and requiring derivatives trading to go through central clearing houses”).

In his introduction to the Icelandic Monetary Reform report, Adair Turner then claims:

But they have still failed to address the fundamental issue – the ability of banks to create credit, money and purchasing power, and the instability which inevitably follows. As a result, the reforms agreed to date still leave the world dangerously vulnerable to future financial and economic instability.

The Monetary Reform report goes to this “fundamental issue”.

It concludes that the:

… the fractional reserve system may have limited the Central Bank’s ability to control the money supply while giving banks both the power and incentive to create too much money.

This is the nub of issue for this group. They somehow consider that all the major ills of the capitalist system can be traced to the ability of the private banks to create loans without necessarily having the reserve backing in advance.

A whole host of proposals come under this umbrella – “100% Reserves, Narrow Banking, Limited Purpose Banking” etc. They have nuances with differentiate them but they are essentially united in their desire to stop banks creating credit.

The so-called “Sovereign Money proposal” says:

… only the central bank, owned by the state, may create money as coin, notes or electronic money. Commercial banks would be prevented from creating money.

The document then proceeds to justify that proposal. It is a long document so I will only summarise the salient points inasmuch as they apply to all these ‘positive money’ proposals.

In modern monetary economies, the central bank clearly does not control the money supply. It controls the interest rate. Please read the following blogs for more information:

1. Money multiplier and other myths.

2. Money multiplier – missing feared dead.

The Report acknowledges that:

The Central Bank of Iceland must provide banks with reserves (money in accounts at the CBI) as needed, in order not to lose control of interest rates or even trigger a liquidity crisis between banks. The Central Bank of Iceland therefore had to create and provide new central bank reserves to accommodate banks as they expanded the money supply nineteen fold between 1994 and 2008.

This is clearly valid. But it also conflates several points. First, the CBI did have to supply reserves on demand to ensure the clearing system worked each day. All central banks have to do that and as we will see that capacity would not really change under this proposal.

The central bank operations might be called something different and the fancy names given to accounts but essentially the money supply would still be endogenous under this proposal unless the central bank was willing to tolerate the interest rate going beyond its control or a lack of funds available for borrowing. I will discuss that more in Part 2.

Second, this is not the reason that the privatised banks went crazy. The provision of reserves as Lender of Last Resort can be easily supplemented with other legislative powers either vested in the central bank or a related prudential authority to ensure that banks behave as banks.

Consider the following case study of the Icelandic banking explosion before we go on.

It is clear that the capacity to create credit was not the reason Iceland’s banking system went overboard.

Case study: The Iceland Parliament’s Special Investigation Commission (SIC)

The Iceland Parliament’s Special Investigation Commission (SIC) published a major report in 2010 – The Report of the Investigation Commission of Althing – covering the Icelandic Banking collapse in 2008.

An English language version of aspects of the – Report of the Special Investigation Commission (SIC) – covers Chapters 2, 17, 18, 21 and Appendixes 3 and 8. There is also an English version of the main conclusions of the Working Group on Ethics available.

We learned that:

1. “The main cause of the failure of the banks was the rapid growth of the banks and their size at the time of the collapse” – the “big three banks grew 20-fold in size in seven years”.

2. The “quality of the Icelandic banks loan portfolios eroded under these circumstances” and internal incentive structures drove the growth rather than commercial risk analysis.

3. The rapid expansion of “global debt financing markets drove the growth of the banks”.

4. The “Icelandic banks received high credit ratings, which was mostly inherited from Iceland’s sovereign debt rating” – the three banks issued more than Iceland’s GDP in 2005 into foreign debt markets and most of the debt was relatively short-term (3-5 years), which meant it required refinancing around 2008.

5. The international debt funding markets dried up as early as 2006 and by 2007, “foreign deposits and short-term securatised funding became the main source of funding for the three banks”. This was highly market-sensitive funding.

6. Massive repayment burdens emerged in 2008 while funds available to refinance had dried up.

7. The prudential regulator was inexperienced and understaffed given the massive foreign exposure of the banking system.

8. The Central bank of Iceland did not have sufficent foreign currency reserves relative to the foreign deposits in the banking system (more than 8 times the forex reserves) and the short-term, foreign currency liabilities (more than 16 times the forex reserve).

There was no chance the central bank could underwrite the banking system at that stage. It is clear that the central bank was aware of the massive exposure of the system to increased risk and warned the neo-liberal government accordingly. The government chose to talk up the safety of the banking system rather than intervene.

There was a massive rise in foreign deposits (in Dutch and British branches of the banks) from late 2006 to the middle of 2007. Ridiculous deposit rates were being offered to shore up the funding bases. From mid-2007, there was a huge outflow of wholesale deposits from the banks “much more than the inflow rate of retail deposits”

9. Things get murkier when you consider that the corporations that owned the three main banks – Kaupthing, Landsbanki and Glitnir – “were the banks’ principal owners”. Was lending done “at arms length”?

It was found that the owners had created a sequence of shelf companies with fictitious transactions to hide what was going on.

The SIC found that:

The operations of the banks were in many ways characterised by their maximising the benefit of majority shareholders, who held the reins in the banks, rather than by running reliable banks with the interests of all shareholders in mind and to show due responsibility towards creditors.

10. The “banks risks exposure due to funding of own shares was excessive”. That is, they financed the equity of the owners based on borrowing from foreigners.

As a result, the capital structure was dodgy in the extreme and “did not reflect the real ability of the banks nor of the financial system as a whole to withstand losses”.

The inflated (but essentially fictitious) capital allowed the banks to grow further than they could if the equity was stronger.

11. Several large Icelandic investment companies (non-bank financial speculators) borrowed huge amounts in foreign currencies and gained securities from the Icelandic banks, who utlimately had to take “over the financing so that loans to foriegn banks could be paid up”.

What did these investment companies do with the loans? The:

… loans were largely made in order to finance the purchase of shares in the banks themselves. To prevent sales of the shares the banks overtook the financing in an effort to maintain the value of the shares.

Again, to maximise the wealth of the banks’ owners!

The banks were also buying up their own shares to maintain value for the owners.

12. By November 2008, the asset values of the three big banks which were on the books as IKR 11,764 billion were adjusted downward to IKR 4,427 billion – a 60 per cent write-down.

The SIC said that in 2008, Iceland’s GDP was around IKR 1,476 billion, which means “that the write-down of the assets of the financial companies” was equivalent to around 5 years of GDP – five years of national production and income. Massive, in other words.

I know there is debate about the role that neo-liberalism played in Iceland. The free market lobby claim that the period of market liberalism which began in the early 1990s, ended around 2004. After that, Iceland should be better described as being a ‘crony capitalist’ nation, and it was this period that coincided with the massive credit growth.

But it was the market liberalism that gave birth to the crooked bankster class.

A coherent left view of the crisis in Iceland is presented by Martin Hart-Landsberg in the Monthly Review, 2013 (Vol 65, Issue 3) – Lessons from Iceland: Capitalism, Crisis, and Resistance.

He argues that:

In 1991, the Icelandic government began an aggressive program of liberalization and privatization which gave rise to the hyper-expansion of three Icelandic banks.

He provides an interesting historical account of the transition from the large, state-owned banks that rationed capital between industries and home-owners” with the central bank setting nominal interest rates under the control of the government.

The system was not perfect but “by the 1980s [Iceland] had attained both a level and a distribution of disposable income equal to the Nordic average.”

The privatisation of the banking system which began in the 1990s and was complete by 2003, favoured those with political influence in the new free market-oriented government.

The banks became cash cows for the owners who used the funds, in part, to fund the political parties that gave them favour. In this sense, the liberalisation was really reinforcing the crony nature of the state-corporate nexus that dominated Iceland in the Post World War 2 period.

We learn that:

While the banking elite used their access to funds to purchase control of many Icelandic businesses, they also engaged in heavy investing outside of Iceland. Major targets were fashion outlets, toyshops, soccer teams in Britain, and supermarkets in the United States and throughout Scandinavia.

They used their influence within the Icelandic government and Chamber of Commerce to build a smokescreen of stability. In this blog – Wrong is still wrong and should be disregarded – I traced the role of the credit rating agencies and consulting reports provided by hired academics, which waxed lyrical about the solid state of the economy.

One of those academics was Columbia University’s Frederick Mishkin, who featured in the 2010 movie Inside Job and was paid a considerable sum by the Iceland Chamber of Commerce in 2006 to produce the report the – Financial Stability in Iceland.

At the same time that Mishkin and his co-author were giving the financial system in Iceland a clean bill of health, the Icelandic banks were engaged in elaborate and not so elaborate growth schemes based on refinancing debt with extra borrowing using both accounting mirages and illegal manipulation of markets to allow them to become many times bigger than they could justify on fundamentals.

After the crisis broke, Mishkin was caught changing his CV by renaming the paper ‘Financial Instability in Iceland’.

When the Inside Job challenged him about this during an interview, he stumbled, in a dissembling fashion and eventually managed to get it out that it must have been a ‘typo’.

The following year (2007) LSE Professor Richard Portes co-authored a 65-page consulting report – also for the Iceland Chamber of Commerce – The Internationalisation of Iceland’s Financial Sector which the NLR says he was paid £58,000. It was actually co-authored by Icelandic economist in collaboration with the Iceland Chamber of Commerce.

It also said that the banking system in Iceland was “highly resilient” and that “Overall, the internationalisation of the Icelandic financial sector is a remarkable success story that the markets should better acknowledge”.

There were many cases documented of that sort of behaviour and deception.

What the Icelandic experiment demonstrated was that the instability of capitalism and its tendency to promote dishonest behaviour by the owners of capital will lead to breakdowns more quickly and more profoundly in an unregulated environment.

It also demonstrated that if the State intervenes as it did in 2008 and 2009 when the banking system collapsed stability can be restored relatively quickly.

Ask yourselves whether the problem was the credit-creation capacity of the banks or other factors that drove Iceland’s banking crisis.

What other factors?

1. Banks speculating in foreign-currency debt and assets and no longer behaving like banks.

2. The ownership of the banks engaging in devious and self-serving behaviour.

3. A lack of prudential control.

4. Neo-liberal government serving the interests of the wealthy and ignoring their responsibilities to advance general well-being.


In Part 2, I will consider the mechanics of the SMS in more detail and tell you why it is not an improvement on the current system.

I will also outline why broader, quite radical reforms are needed to the banking and financial sectors, which do not involve restricting the capacity of ‘banks’ to create create credit.

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.

This Post Has 66 Comments

  1. Great article.
    I’ve always thought though that it would provide more clarity if we were to push the idea of government bonds as currency. The total currency extant would then represent the net financial assets in the system and there is a clear distiction between bank (or private) money and government money i.e. currency and the true nature of government financial liabilities is made clearer.

  2. Perhaps over and above splitting up the big banks banking functions such as money creation and storage should be removed from banks entirely. Banks used to necessarily be large imposing buildings, necessarily as they used to have to be able to physically protect financial assets stored therein and also to sustain the illusion that the money they were lending was existing money they already had in storage, not brand new stuff they were knocking up on the cheap in the basement (kind of thing). Money creation, once understood to be that and not some some sort of loan, could be achieved by a guy in a tent in a field with a wifi terminal and computer. There’s no need to continue to pretend existing money’s being loaned. Asset storage could be carried out in physical terms in storage units built for the purpose such as we saw in the tv show ‘Breaking Bad’ where the physical dollar notes gained in exchange for the blue meth were stored apparently securely in just such a facility. Storage of digital money can be performed on an individual basis, on a phone or a watch maybe. Sub-dermal implants, perhaps, for the absent-minded. You’d probably want to be backing up to specialist locations on the internet too – isn’t this what happens already with Bitcoin? What else do banks do? Normal daily banking transactions could easily be carried out by software, I doubt the open-source community would have a problem coming up with something suitable. What of the likes of investment banking and other boutique finance? I’d suggest they aren’t really banking, just associated endeavours. Let’s get rid of banking altogether then, by separating banking operations.

  3. My comments…

    1. Positive Money is an organisation. A capital P and M should be used (minor point I know).

    2. I’m surprised at Bill’s claim that “I am regularly told that I need to forget MMT”. Reason is that there is no big clash between the basic claims of MMT and advocates of full reserve banking like Positive Money. Put another way, MMT is not primarily about bank regulation, though obviously there are INDIVIDUAL MMTers who express view on banking: most notably Warren Mosler who actually runs a bank.

    Indeed on the subject of the non-clash between PM and MMT, there was an article on the PM site recently about whether PM and MMTers shouldn’t work together. In fact they have something important in common, namely that both think that given a need for stimulus, the state should simply create base money and spend it into the economy (certainly Roger Erickson on Mike Norman’s MMT site is always going on about the need to “create fiat”, as he puts it, and spend it in a recession).

    3. Bill, I suggest you haven’t got the basic merit of of full reserve banking (FR). It’s that if commercial banks can’t create money, they then no longer have money on the liability side of their balance sheets: they just have shares. It’s therefor IMPOSSIBLE for them to go insolvent. As to money or “deposits”, those are lodged at state run entities or entities which invest just in base money and short term government debt. So those entities cannot fail either.

    In view of the CATASTROPHY caused by bank failures recently, there’s something to be said for a fail safe system, I suggest.

    4. Note that the latter rules of FR are actually being imposed on money market mutal funds in the US. The sky is not falling in the US.

    5. Note also that it’s not just PM or Iceland that advocates FR. Milton Friedman also did, as did Irving Fisher, Lawrence Kotlikoff, the Nobel laureate economists Merton Miller and James Tobin and a host of other people who are not totally stupid.

  4. Bill Kruse,

    Your suggestion that we should “get rid of banking altogether” certainly seems to have something in common with a Bloomberg article by Matthew Klein about Laurence Kotlikoff’s version of full reserve banking. The article title is “The Best Way to Save Banking is to Kill It”. See:

    In fact it’s quite common for opponents of full reserve banking to make complaints along the lines that “full reserve” destroys banking as we know it. To which my response (and presumably also the response of Klein and Kotlikoff) is: “well spotted”.

  5. “It’s therefor IMPOSSIBLE for them to go insolvent.”

    If loans go bad, banks can go insolvent in any real world situation. Changing the definition of ‘money’ so it excludes bank funding doesn’t change how banks work. It just alters the price.

    It’s entirely an illusion, put forward by people who don’t actually understand how banking works. Anybody who works in banking chuckles at the positive money people. From a bankers point of view they are useful fools, distracting the debate from the real problem – banks doing things banks shouldn’t be doing.

    You can’t fix the problem by altering a few definitions and changing the price a bit. Banks need to be narrowed by regulation.

  6. Ralph,

    Suppose, under your proposed system, I take out a loan to start a food-packaging company and receive the bank’s ‘equity’. I pay my employees’ salaries using this ‘equity’. My bank settles with their bank by issuing bonds to it. My employees now hold ‘equity’ in their own bank, backed by the bonds issued by my bank. They use this ‘equity’ to go shopping at Supamart, the local supermarket, making purchases using their debit cards. Their bank settles with Supamart’s bank, again by issuing bonds. Supamart now holds ‘equity’ in its own bank, backed by bonds of my employees’ bank, themselves backed by bonds of my own bank. Now Supamart pays me for food-packaging products, again using its bank ‘equity’. I use this income to repay my loan to my bank. It uses the income to settle its loan from the employees’ bank, and the employees’ bank uses that income to settle with Supamart’s bank. Profits and interest add a layer of complexity, but those are the basic mechanics.

    Other than a purely linguistic change – that which runs through the payment system is now called ‘equity’ rather than ‘deposits’ – what is the operational difference between this system and the current system? Just like under the current system, if I default on my debt to the bank, it must find other means of settling with other banks – or if it fails then the other banks must find other ways of settling their own debts. Just like under the current system, if this happens on a large enough scale the central bank can either let the whole payments system collapse (not likely!) or issue emergency loans to banks.

  7. Ralph
    “they just have shares.”
    This is extremely naive. The rich people who “own” banks must be laughing – all the way to the bank.

  8. Thanks, Bill.
    I’ve been somewhat deluged with PM people telling me I don’t understand banking, and the intensity of the deluge has been rising. When I endeavour to explain the flaws in their reasoning, I generally find they don’t know enough about banking to understand what I’m saying, and are often not interested in learning. You explain things so much more thoroughly and clearly than me that I’ll just point people in the direction of this blog post from now on. Up to them whether they read it. I’m finished with engaging with PM.

  9. Ralph
    \”\”\”It’s that if commercial banks can’t create money, they then no longer have money on the liability side of their balance sheets: they just have shares. It’s therefor IMPOSSIBLE for them to go insolvent.\”\”\”

    In order for them to remain solvent the vertical channel of money would have to be very reponsive to activity in the economy or the \’shares\’ would indeed make banks insolvent. Playing with HPM or the monetary base and not adopting a pro-active fiscal policy would end up with a worse system than the current one. (fresh dose of monetarism thinking in the world would not work out so well 😉

    Where Bill says:
    \”\”\”The central bank operations might be called something different and the fancy names given to accounts but essentially the money supply would still be endogenous under this proposal unless the central bank was willing to tolerate the interest rate going beyond its control or a lack of funds available for borrowing.\”\”\”

    Banks creating deposits has been around for a long time now. There are black and white videos of deposit creation on youtube so to say the mechanics of the system at this level of abstraction needs to be fixed is just bad systems engineering.
    Spiralling private sector debt levels (too much easy finance wound up in ponzi schemes) sits on top of the functionality of deposit creation.
    In much the same way that turning off a tap/(regulating banks) at the right time will stop the bath from overflowing. Its all about controlling the bath tap not diagnosing the water as the fault and removing it from the system.

  10. Neil,

    You claim, “If loans go bad, banks can go insolvent in any real world situation.” The answer to that is that where a bank is funded just by shares, it owes nothing to anyone. It certainly doesn’t owe anything to shareholders. And insolvency is an inability to come up with money owed to someone.

    Thus for a bank funded just by shares to go insolvent, it wouldn’t be enough for its assets to decline in value to nothing: it would have to be even worse than that. Assets would need to decline in value to nothing, PLUS the bank would need to have incurred liabilities OTHER THAN the “liabililty” to shareholders. (I put inverted commas there because that liability is not really a liability at all.)

    Now far as I know there has NEVER been a case of bank’s assets falling in value to nothing. The worst ever case was a bank (in Chicago) where assets fell to 10% of book value. It’s common for banks closed down by the FDIC to have assets that are 90% or 80% of book value. But 0%, like I say, is unheard of.

    Lehmans is a nice illustration. When it failed, it’s assets had not actually fallen below book value at all. It’s problem was that it couldn’t sell its assets quick enough to keep up with creditor’s demands for cash.

    Incidentally, there’s a difference between Positive Money’s version of full reserve and Friedman and Kotlikoff’s which is relevant here. PM’s version has lending banks funded by shares AND DEPOSITS, but with the capital ratio far higher than was normal before the crisis. So those banks can indeed go insolvent (as PM admit). In contrast, Friedman and Kotlikoff go for a 100% capital ratio, which means the chance of insolvency is vanishingly small. I prefer the F/K arrangement.

  11. ” Institutions exist to serve the interests of individuals, not the other way around. That is, individual consumers must control financial policy, not the government, the state, or the private banks. There is no point in “restoring the right to create and issue money to the state” if the state is then going to control the purposes for which producer and consumer credit are to be issued. This is the great trap of which certain monetary reformers, who are rightly concerned about the hegemony of private banking, are blissfully unaware. If, God forbid, such reformers get their way, and the state were to obtain total monopoly control over the money supply, I think they will find to their horror that the same people who levy a great deal of control over the private and partially decentralized monetary system will be in complete control of the state system.”

    Monopoly is the name of the game; let us not be ‘useful idiots’.

    Oliver Heydorn.

  12. OK, Bank A loans out money to buy shares in bank B. Rinse and repeat.

  13. They’ll loose control of interest rates?
    Since when have interest rate really controlled/affected banking lending anyway???

    With new Bail in legislation across the world.where customers deposits will get confiscated to balance books.these reforms providing customers with safe secure checking account will be popular and timely.

    Banks control Capital.Through controlling\issueing debt and receiving cash flow.

    @Neil when loans go south only the depositors who placed there money in a banks “Investment account” money in the “transaction account” will still safe ~held at the CB.

    The payment system will still be safe and well functioning despite any credit bust/modern day tulip mania.No need to bail out banks for short term stability.

    ….still think having Govt spending potentially limited by some unelected CB council of “experts” unwilling to finance a deficit is a terrible idea on Sovereign Money system/Positive Money.That’s a nod too far to the antidemocratic instincts of the Neo-liberals; the idea that our elected representatives shouldn’t be trusted with spending.If parliament/congress/althing determines that x amount of deficit spending is required;there should be no bureaucratic barriers; the CB should immediately comply.It’s called Democracy.

  14. “…this blog is being written to stop the relentless onslaught of E-mails coming…” Which explains why you didn’t respond to my email. I did rather imagine you get so many you can’t possibly respond to them all.

  15. There will be no endogenous money creation under PM.

    Only the state creates money.

    Depositors place money in secure ” transaction”accounts or in at risk “Investment” accounts.

    Bank lending is 100% financed by deposits in Investment accounts.Banks act as Financial intermeditories.

    And thats’s pretty much it.

  16. Good to read a clear critique of SMC proposals, but I am confused as to why the restrictions on debate and censoring of links…? This is a debate that needs to happen, no?
    I think that it is fair to say that there has been an amount of recognition within the PM literature of the role of non-bank activity in contributing to the crash, and I think I am right in saying also that this is a subject of current research by members of the PM team( in terms of how it relates to SMC reforms).

  17. edit-when loans go south only the depositors who placed there money in a banks “Investment account” is at risk when a bank becomes insolvent. money in the “transaction account” will still be safe ~held at the CB.

  18. Dork of Cork,

    Re your concerns about the state controlling the PURPOSES for which money is created, the state already wields that power, and the electorate is quite happy with that. That is, public spending already accounts for 30-50% of GDP in most countries. Thus when stimulus is needed under a PM / Iceland system and the state creates $X and spends 30-50% of that on public sector stuff, there’d be no reason for the electorate to object..

    In contrast, and assuming a government obeyed the wishes of the electorate, it would direct most of the new money at the PRIVATE sector (50-70%). And if it didn’t, the relevant political party would risk being chucked out at the next election.


    Re “The rich people who “own” banks laughing – all the way to the bank”, shareholders in Lloyds and other UK banks had to take quite a hair cut in exchange for government rescue during the recent crisis. I doubt they were “laughing”. Of course that’s not quite the same thing as full reserve banking, but the principle is the same: when a bank makes silly loans under full reserve, the share price drops. Shareholders won’t laugh at that.

  19. Jake,

    ‘when loans go south only the depositors who placed there money in a banks “Investment account” is at risk.’

    The thing I wrote to Ralph above was meant to explain how that can’t be true. When a firm borrows from an investment bank, the loan has to finance its payments to workers, suppliers, etc. Those workers, suppliers, etc. are thus paid in financial assets backed by the loan. As they spend, those assets then circulate through the payments system. If the original loan goes bad, the shock is carried through the whole payments system, unless the banking system has shock absorbers in place – bank equity buffers, overdraft facilities at the central bank, etc.

    It is categorically untrue that the damage from the bad loan is visited only upon the bank’s equity investors, unless you include everybody whose income has been financed from the original loan among the equity investors.

  20. Of course you can say that the recipients of payments from the original loan can always put their earnings into 100% safe ‘transaction accounts’. But then what happened to the claims that: (1) only what is in the ‘transaction accounts’ will counts as ‘money’ and (2) banks won’t be able to create ‘money’ under this system?

  21. Credit creation needs to be ‘dis-aggregated’?

    “Importantly for our dis-aggregated quantity equation, credit creation can be dis-aggregated, as we can obtain and analyse information about who obtains loans and what use they are put to. Sectoral loan data provide us with information about the direction of purchasing power – something deposit aggregates cannot tell us. By institutional analysis and the use of such disaggregated credit data it can be determined, at least approximately, what share of purchasing power is primarily spent on ‘real’ transactions that are part of GDP and which part is primarily used for financial transactions. Further, transactions contributing to GDP can be divided into ‘productive’ ones that have a lower risk, as they generate income streams to service them (they can thus be referred to as sustainable or productive), and those that do not increase productivity or the stock of goods and services. Data availability is dependant on central bank publication of such data. The identification of transactions that are part of GDP and those that are not is more straight-forward, simply following the NIA rules.”

  22. Bob,

    Re banks lending money on condition the money is used to buy shares, that trick was used big time by Barclays (assisted by Sheikh Mansour) during the crisis, as you probably know. However, any idea that that represents a problem for full reserve banking is wide of the mark.

    First, that trick can be used by banks under the EXISTING SYSTEM to fiddle their capital ratios.

    Second, banks don’t normally lend except to borrowers who have have decent net assets that the bank can grab when problems arise, and/or a secure income that can be grabbed. Thus the likelihood is that Sheikh Mansour had plenty of assets that Barclays could have grabbed. Indeed, why did Barclays do that deal with a billionaire sheikh rather than someone picked at random off the dole queue?

    Third, one of the advantages of going for a 100% capital ratio (as per Friedman and Kotlikoff’s systems) is that even if say 20% of that capital is dodgy and the EFFECTIVE capital ratio is 80% rather than 100%, its still highly unlikely the bank will go insolvent. 80% is way way above the (roughly speaking) 10% the regulators currently insist on.

    Fourth, WHATEVER rules are imposed on banks, one thing is certain: they’ll try to circumvent the rules. Thus the above fiddle is not necessarily any worse than fiddles that banks can get up to under any alternative set of rules.

  23. Axdouglas,

    Re your 20:06 comment, your first sentence reads “Suppose, under your proposed system, I take out a loan to start a food-packaging company and receive the bank’s ‘equity’. I pay my employees’ salaries using this ‘equity’.”

    First, none of the advocates of full reserve propose that under full reserve, those seeking loans get shares: they get cash as under the existing system. The only difference is that under full reserve ALL OF THAT CASH is central bank issued money, not commercial bank issued money.

    Second, ordinary employees under full reserve, as under the existing system, are very unlikely to want to be paid in shares (which rise and fall in value). As we all know, senior executives are sometimes paid in part with shares. But even then, it’s shares in your food-packaging company they’d be paid in, not bank shares. 99% employees want CASH. And if they weren’t offered cash, they’d quit their jobs and find a job and find an employer who does pay cash.

  24. “It certainly doesn’t owe anything to shareholders.”

    I think you’ll find it does – both legally and morally. Those shareholders will take a wealth loss when banks fail – just as bank capital funders do now – or should do.

    The whole concept falls into a fallacy of composition. An in specie system will have *vastly* bigger numbers in it than an insured system. So you will have vastly bigger shareholdings than you do now all wanting a return.

    You’ll also find that most businesses go bust due to cash-flow issues – not because they’re assets have completely expired. If you get a load of bad loans then the interest received will likely be insufficient to pay the staff and the costs of the business and it will fold.

    Which is how building societies and the smaller banks in more distributed banking systems tend to fail – cash-flow failure.

    The lack of understanding of the dynamic interactions within banking is legion in the Full Reserve fraternity. It’s almost like none of them have ever dealt with the actual running of a bank…

  25. Ralph,

    I think I just don’t understand what you mean. You said that ‘if commercial banks can’t create money, they then no longer have money on the liability side of their balance sheets: they just have shares.’ Now you say that ‘under full reserve, those seeking loans get shares: they get cash as under the existing system’. How can commercial banks only have shares on the *liability* side of their balance sheets if people taking loans ‘get cash’? The borrower’s asset is the bank’s liability, and vice versa. So… ??

    I think terminology is just a distraction here. Forget what we choose to call ‘money’ or ‘cash’, the point is that a bank has to fund its lending somehow. All that matters from the bank’s point of view is that it can cover its funding costs through its lending operations.

    With a 100% capital requirement, the bank is funded entirely from equity. Since it can’t gear up its balance sheet with bonds, repo, etc., it has to pay the rate that equity investors demand and will charge borrowers a high enough rate to stay profitable and cover risk.

    A 100% reserve requirement means nothing by itself since, as Bill explained elsewhere, banks aren’t reserve constrained; all that matters is how much they have to pay to borrow reserves when necessary, which will go into the interest rate they charge borrowers. If you cut off their credit lines both to the central bank and to the interbank lending market, the overdraft penalty charged by their creditors will determine the price of reserves, and thus the cost of borrowing.

    These at best offer ways of pushing up funding costs for banks, which in turn can raise borrowing costs. They can certainly result in a lower volume of lending, but I don’t see how they in any way change the risk structure.

    So I’m just not sure what you mean.

  26. There are a number of advantages to publicly created money:
    1. The Process will be transparent
    2. The people who decide how much money to create will not be the same people who allocate the money.
    (unlike with the current system where Private Banks create money and decide how it should be invested)
    3. Bank Deposits will not require depositor insurance.
    4. individual Banks would be allowed to collapse without bringing the rest of the system down.
    5. There will be less of an advantage being a big bank as the greater percentage of total accounts a Bank has, the more likely that internal transfers will be required meaning that the less Central Bank Reserves are required, whereas a small Bank trying to compete with the Larger Banks has a greater need for more Central Bank Reserves as a percentage of it’s Deposits.
    6. More public say in how new money is allocated
    7. Greater control on stabilising the Money Supply and maintaining a high degree of confidence in the Markets.
    8. Less need for Interbank Lending
    9. A greater degree of control by the Public on what Banks invest in.
    10. The end to Banks investing Current Account Bank Deposits into risky and damaging activities.

    Ultimately what I am looking for is a system that requires less regulation and less public support to allow the Private Banking Firms to face the same risks that other Private Firms Face in a capitalist system.

    Hopefully part 2 of this article will explain exactly how MMT is going to achieve that goal.

  27. @axdouglas

    Re your example;A bank lends Money to a firm.the money was created by the state .People deposited some of their profits/wages in their Investment account for the bank to lend so that they can get a return.
    Firm pays worker their salaries in state created money.
    If the firm then fails that then has zero affect on the worth/value/validity of the money.its all just currency in their bank account.

    Its like everying one being allowed to have a bank account at the BoE and everyone uses reserve.

    @Neil in the comment above are you referring to Banks as opposed to businesses .Businesses don’t suffer cash flow problems from making bad loans…they don’t make loans,they take out loans.the whole angle of PM etc is too allow banks to fail.Deposits in “transaction” accounts will effectively have their accounts held by the Bank of England,like banks do now.The money will be still be the depositors property.Doesn’t need to be insured by the government.

  28. Neil,

    In your first two paras just above you claim that corporations owe money in some (not defined) shape or form to shareholders. Then you say “those shareholders will take a wealth loss when banks fail”. Well which is it then?

    When a corporation does badly and the shares drop in value (perhaps to nothing), does the corporation legally owe money to shareholders or not? I say not. And I suspect that about 99% of those investing in shares on the stock exchange agree with me: i.e. they’re aware of the fact that they might quadruple their money, or they might lose the lot.

    Next you say that under full reserve, “So you will have vastly bigger shareholdings than you do now all wanting a return.” Yes, obviously. Put another way, under full reserve, and as far as the lending half of the industry goes, banks (or bank subsidiaries) are funded by shares rather than bonds or deposits.

    As to “all wanting a return”, depositors and bond holders also want a return! And that raises the big question which should be second nature for anyone who claims to know anything about this subject, namely: “will the return demanded by shareholders be larger than that demanded by depositors and bond holders”. Well the answer to that was given by two Nobel Laureate economists, Messers Modigliani and Miller. The MM theory states that the TOTAL RETURN demanded by those funding a corporation is not affected one iota by the NATURE OF THOSE FUNDERS, i.e. whether they are shareholders, depositors or whatever.

    Various criticisms of MM have been made, but they’re pretty feeble. See my book on full reserve banking.

    Next, you say “You’ll also find that most businesses go bust due to cash-flow issues..” Yes: I made that point myself above in relation to Lehmans.

    And finally you say “the lack of understanding of the dynamic interactions within banking is legion in the Full Reserve fraternity.” Frankly that’s just a load of flannel. And I’m certainly not fooled by fancy phrases like “dynamic interactions”. But I’ve got a fiendishly clever answer for your point, and as follows. “The lack of understanding of the dynamic interactions within banking is legion amongst advocates of the crimogenic and disastrously failure prone existing bank system.”

  29. @Ralph
    I cannot engage with your argument as Bill selectively censors my arguments to protect the illusions he projects about sov money and the like.

    Suffice as to say the electorate remain ignorant of the forces behind the state given the 100s of years of propaganda it has absorbed.
    The world is a total disaster area as a result.

  30. Can someone who speaks English please explain to me in simple terms how MMT can prevent a wealth transfer from the public sector to the banking sector as currently occurs.

    The Bank of England has estimate that in 2009/10, although the Bakning sector contributed £23.4 Billion to the treasury in Tax Revenues, they received an implicit subsidy of £120 Billion.

  31. I would be interested to know what the strategy is for proposing MMT Concepts to our next batch of MPs and Government Ministers?

    Has anyone here written to their MP to explain the benefits of MMT and what was their response?

  32. Jake,

    ‘Its like everying one being allowed to have a bank account at the BoE and everyone uses reserve.’

    In theory, sure. In the real world, payments aren’t all settled overnight. People buy and sell on contracts, and banks run overdrafts rather than settling all reserve balances in one day. Look at the billions central banks have to spend on intraday overdrafts, just to keep the payments system going. A system with no overdraft option at all couldn’t support the payments system. All that would happen would be that banks would issue overdrafts to each other. There’d still be systematic risk from bank failures. And people who’d sold contracts to holders of bank equity would still lose out if the loans went bad and the equity holders couldn’t honour their contracts. It’s all the same risks. Different prices, perhaps, but the same risks.

  33. “There will be no endogenous money creation under PM.”
    Quite a claim
    You state that as fact. I am sure people will find ways to create endogenous money 😉
    They always do.
    Best thing to do is collect rents via land value tax and limit bank loans to capital development of the economy. That’s the problem – land price bubbles.
    You still have not dealt with Neil’s main points such as elimination of free banking and pushing up the cost of lending.
    There is nothing positive or new about PM – it will lead to a worse banking system where the rich who ‘own’ banks benefit.
    WHY is there a need to change the structure?
    And the main problem with PM’s PROPOSALS is the undemocratic system deciding on “stimulus.”

  34. “disastrously failure prone existing bank system.”
    Not so much in the 1960s. Only since neoliberal changes.

  35. @ jake

    You wrote, “A bank lends Money to a firm. the money was created by the state.”

    Why not just nationalize banking? Now the money created by banks is created by the State.

  36. I posed the question in the blog regarding the “UKs ridiculous proposal” the other day as to whether the Positive Money Proposal was a necessary reform. I must admit, the response from “Steve” and todays blog are excellent, although a lot to take in! I have a science education, not an economics one, but have been very keen to work out the causes of the 2008 crisis and growing inequality over the past few decades. PM seemed to have an answer in that the excess creation of endogenous money for assets was causing unsustainable debt which along with the the banks other behaviour of selling toxic assets caused the crisis.
    Being inexpert, I thought I noticed a similarity with MMT in terms of the cure being injections of government spending into the economy to achieve full employment and a reduction in poverty.
    I need to keep reading to work out the technical differences!
    MMT has a lot to offer, and this is definitely one of the most rewarding blogs to study.

  37. Dork of Cork
    “engage with your argument as Bill selectively censors my arguments to protect the illusions he projects about sov money and the like.”
    Really? Screenshots or it didn’t happen.
    Just talk to Ralph on his blog – click on his name
    “I would be interested to know what the strategy is for proposing MMT Concepts to our next batch of MPs and Government Ministers?”
    I think on “Think Left” blog they made a letter to local MP.
    Oh by the way Bill, can we have more letters like the ones to Mankiw (is that has name) and Krugman?

  38. Ralph
    Under your system, should dividends be compulsory say at 5%?
    Also, will banks be allowed to swap shares/invest in others or share buybacks?
    There is an ideal that instead of paying capital gains and corporation tax companies issue a \”golden share\” to the government. Could this be part of the system?
    What about preferred shares?

  39. “PM seemed to have an answer in that the excess creation of endogenous money for assets was causing unsustainable debt which along with the the banks other behaviour of selling toxic assets caused the crisis.”
    If you look up Georgism, Georgists such as myself believe it was the land (housing) bubble that drove the crisis.
    Georgism advocates a Land Value Tax on the “location, location, location” part of the land as is created by the community – better schools, public infrastructure, etc.
    Bill has blogged about Georgism in his “Henry George and MMT” series.
    The problem is the other stuff they put out like belief in loanable funds. PM are correct that loans create deposits but wrong on everything else and the idea of giving power to an unelected committee I feel is awful.
    Bill does excellent blogging if you look up Deficit Spending 101 and through Debriefing 101 he sticks it to the neoliberals.
    The best metaphor is the “Some neighbours arrive” and analogies on Billy Blog, 3spoken credit card analogy, etc..

  40. Dear All

    I regularly censor the Dork of Cork but not for the reasons he might imagine.

    First, he seems to think that the comments section is actually the blog section and regularly veers off the topic of the post. I am very happy that he cultivates a readership for his ideas – by starting his own blog.

    Second, he has told us about his pet theory many times and it seems to be advanced every time, whether it is relevant to my post topic or not. I delete the repetition as I am not promoting ideas that I find spurious on my blog.

    Third, he regularly accuses me and MMT to be partners in crime with the banksters, big financial capital and martial states. No logic is proffered for these personal slights. To say such things means he either hasn’t bothered to read the entirety of my work or hasn’t understood what he has read. I delete any ad hominem comments of that variety immediately.

    Fourth, I will not public comments that have links to other sites which I disagree with and serve no purpose in advancing my own agenda. I have a fairly large readership and I don’t think my site should become a free advertising vehicle for stupid economic ideas. That point is not confined to the Dork, I should say.

    best wishes

  41. @Andy
    You can absorb much more information from a person’s censorship preferences then their projected thoughts.
    Direct attacks on MMt religious doctrine is not allowed on this blog.
    (I.E – a centralising vortice and therefore the ultimate expression of capitalism)
    In a similar fashion Greenback and more dangerous social credit like attacks on the Yves Smith site are shut down pronto given her closeness to the New York banking mafia.

    Only fashionable attacks are.allowed ( regulation issues Etc) – never core issues of religious doctrine


    She is not a radical but a very sophisticated propagandist.
    I could be wrong but it seems Bill is.a.true believer.


  42. Ralph,

    You say “Reason is that there is no big clash between the basic claims of MMT and advocates of full reserve banking like Positive Money.”

    Ah, but there is. It’s fundamental. They are into the idea that Govt issues money on a debt free basis. MMT holds that all money is an asset to the holder and a liability , or a debt, to the issuer. The concept of sector financial balances is central to MMT. That doesn’t work at all with so-called debt free money.

    The idea of debt free money is, IMO, a hang over from the days of the gold standard. Then it may have made some sense if all issued money was strictly backed on a 1:1 basis with gold reserves. The asset of the gold would have offset the liability of the issued banknotes and credits.

    It doesn’t make any sense now.

  43. Debt free money is only expressed by the process of bridging the gap created by the Industrial surplus.
    MMt does not deal with the monopoly of credit issue.
    It states we must mobilise to access the Industrial surplus created by machines which is insane or evil ( take your Pick)

  44. @axdouglas that’s an interesting point.although I still don’t see why the payment system can’t move towards immediate and sell on contract..that shouldn’t affect cash transactions.Are we sure a lot of these delay aren’t because banks want to use the money to speculate with.

    @Bob,I suppose people can make agreements with each other.
    But it won’t be through banks at interest.

    As for LVt plus narrow preferably public banking with noncollateral used debt creation towards productive investment and economic development.That’s actually the policy combination which makes the most sense to me and has been for months will control private debt explosion boom asset price inflation.provide the private sector with cheap loans to actually develop good and services and invest,ie real economy.Alongside a government which deficit spends.preferably letting interest rates going to zero.

    That should end private sector boom and busts and equalise access to capital.
    Yes I 100% agree with you land price bubbles are what cause private sector debt collapse and reduction in spending.
    I completely agree about PM proposal being limited as govt spendingamounts will be dictated to by an unaccountable council as you can see in my comment above.I completely disagree withem on this point(and some others )

    But,your other points,whose to say everyone can’t open their own bank if they wanted,have you seen the barriers of entry now?It is a very well protected would banks benefit more minus endogenous credit creation.taking other people’s promises to pay and charging interest on it…persistent failure and state rescue.they manage to extract the entire economic surplus out of the economy and then get celebrated as wealth creators.they are obscenely rewarded for allocating capital…and as you know they do a rubbish job of it.

    The change in structure would mean that they are genuine financial intermediatories.I expect they will fade away in the face of online peer to peer lenders .

    As for free banking…is that referring to the payments system?why would lending be more expensive?

    @JPT state money is vertical money.state controlled banks create horizontal money which has a corresponding debt liability and despite having real purchasing power nets to zero.It’s a different type of money.

    @Bill,much to my amazement/amusement I also have been referred to as a shill for bankers on certain corners of the it I suppose it the hazard of online activity.

    @Dork you should start a blog

  45. None, or few of these proposals will have the time it needs to happen.
    Our civilization is already so dysfunctional that its collapse will take hold well before we can reset any financial and credit agendas. The world’s governments are overwhelmingly incompetent. In a way cannot blame them because our systems are so complex it’s probably a given. However they insist on a neoliberal policy agenda which just compounds the mischief. I think all this talk about reforming banks is just hot air.

  46. “I think all this talk about reforming banks is just hot air”

    I’m sure there will have been plenty of spectacularly inaccurate predictions from previous eras along the lines of “I think all this talk about taking money permanently off the gold standard is just hot air” or even that “no-one will ever accept paper currency -they’ll always insist on gold”.

    We can’t know the future or what will happen. But we can know, or try to work out, the way that future can work better for future generations.

  47. Conrad Jones (3:44),

    You ask how can MMT “prevent a wealth transfer from the public sector to the banking sector as currently occurs.” My answer is that it can’t. In fact the arguments for and against MMT have little to do with the arguments for and against full reserve banking. Indeed I’m not sure why Bill devoted a third of his above article to explaining MMT (which I agree with, incidentally).

    Axdouglas (4:14),

    You claim that a weakness in full reserve is that “All that would happen would be that banks would issue overdrafts to each other.” Well they already do!! Banks regularly lend reserves to each other. Or to be more accurate, they used to before QE: QE has flooded the system with reserves, so over the last three years or so banks may have ceased lending reserves to each other – I’m not sure.

    Indeed, full reserve is also a system which is “flooded with reserves” and where there would also be no crying need for banks to lend to each other (though there is no reason to stop them, if they wanted to). As to the safe half of the industry under FR, that just lodges money with government and transfers it when instructed to do so by depositors. No reason for “loans” there. As to the lending half of the industry, let’s take an example. Bank issues $X of shares and lends $X half of which disappears. Why does the bank then need to borrow reserves? Darned if I know.

  48. Axdouglas (2:15),

    Re your first para, here’s an example. Bank starts up by issuing $X of shares and gets $X of base money (aka cash) from shareholders. Balance sheet is then as follows. Assets: $X of cash. Liabilities: $X of shares. Bank then lends cash (base money) out to borrowers. Balance sheet is then as follows. Assets: $X of borrowers or loans. Liabilities: $X of shares. At no point was there any cash on the liability side of the balance sheet. (Base money is an ASSET for a commercial bank, whereas money ISSUED BY that bank is a LIABILITY of that bank).

    Re your claim that “banks aren’t reserve constrained” that point is irrelevant under full reserve, or rather they just aren’t allowed to act in an “unconstrained way” and issue their own “funny money”. Of course there will always be small shadow banks issuing money like liabilities, but it should be possible to make the larger banks (regular and shadow) obey the rules of full reserve.

    Re your point “I’m just not sure what you mean”, the “existing system versus full reserve” argument IS COMPLICATED. It’s taken me about 3 years to get my head round it. But if a dimwit like me can get to grips with it, anyone can…:-)

  49. Bob (7.11),

    You claim “And the main problem with PM’s PROPOSALS is the undemocratic system deciding on “stimulus.”

    If you knew anything about the existing system, you’d have gathered that the total amount of stimulus is ALREADY decided in an “undemocratic” way in that independent central banks have the final say on how much stimulus an economy gets: they have the power to override (via interest rate changes, QE, etc) any fiscal stimulus implemented by politicians. Indeed, market monetarists have a specific term for that “power to override”: they call it “monetary offset”.

    That power to override may be wrong, though I don’t think it is. But the important point is that as far as “undemocratic” goes, PM proposes nothing that’s much different to the existing system.


    You claim there’s a clash between MMT and full reserve because “MMT holds that all money is an asset to the holder and a liability , or a debt, to the issuer.” MMT is simply describing the existing system there (and describing it correctly, I think). That is different to actually saying the existing system is defective and should be replaced with full reserve. Defending the existing bank system against those dreadful advocates of full reserve (like me) has never been central to MMT, though Bill’s above article may change that!

    Re sectoral balances I completely fail to see why that wouldn’t work under full reserve (aka a “debt-free” system). If I give a bundle of £20 notes (a type of base or “debt free” money) to the tax authorities, then money leaves the private sector and enters the public sector, doesn’t it?

    Finally, you seem to argue that gold is necessary for a “base money only” system (i.e. full reserve). Gold hasn’t backed base money for decades. Plus there’s been a HUGE INCREASE in the amount of base money sloshing around as a result of QE. And that’s all happened without gold. Gold is a total irrelevance, I suggest.

  50. Part 1 has several fundamental defects:
    (a) Opening paragraph:
    “The crisis was caused by banks becoming non-banks and engaging in non-bank behaviour”
    Prof. Mitchell rightly explains that the banks’ behaviour was undesirable, but he wrongly dismisses this as merely “non-bank behaviour”.
    They were legally banks. Most of their actions were legal. This is just the latest example in the long saga of dodgy banking practices leading to financial crises. Such practices would be very unlikely or impossible with full reserve banking.
    Contrary to Prof. Mitchell’s assertions, fractional reserve banking and endogenous money/credit creation, coupled with normal bank behaviour, has been an intrinsic element in numerous historical financial crises.
    (b) Opening paragraph: “a properly regulated and managed public banking system with credit-creation capacities would be entirely reliable and would advance public purpose”. Wow! Such faith in the altruism and munificence of state enterprise! Where is the evidence?
    (c) Opening paragraph:
    “A tightly regulated private banking system with credit-creation capacities would also still be workable”.
    This conflicts with the evidence. All historical regulations have been woefully inadequate. Prof. Mitchell does not adduce any reasons to suppose that the voluminous current proposals or alternatives would be more successful.
    (d) Section headed “Quantity or price”
    Prof. Mitchell seems be claiming that with full reserve banking the State would lose control over interest rates and monetary policy. He promises that this key issue will be covered in Part 2. Let us see.

  51. Ralph: Thanks for the explanation re bank balance sheets under FR; sorry for my mistake on that. The real worry, as ever, is that there’s too much faith being placed in this ‘Money Creation Committee’ to act countercylically, particularly during a downswing. If a lot of loans have gone bad, and nobody wants to buy bank shares to facilitate enough lending to soak up excess capacity, the MCC should step in, but where is the guarantee that the experts will have the wisdom to do so? If the MCC were committed to funding a job guarantee, that could be the way to combine FR banking with the fundamental countercyclical mechanism favoured by MMT.

  52. Axdouglas,

    Re the possible lack of competence of the Money Creation Committee, exactly the same possible incompetence exists with EXISTING committees that determine stimulus. On the monetary side at the moment, in the case of the Bank of England there’s the Monetary Policy Committee. Other central banks obviously have similar committees.

    And on the fiscal side there are various committees e.g. the “Office for Budgetary Responsibility” in the UK.

    Next, you point out (I think correctly) that given a serious bout of incompetent loans by banks (perhaps like in the recent crisis), bank shares would fall and there’d be a reluctance to buy further shares for a while. My answer to that is “good”.

    Where an industry has got over-confident and expanded too far, it’s almost certainly a good idea for it to CONTRACT. Bank assets and liabilities in the UK have expanded a whapping TEN FOLD relative to GDP over the last 30 years. Plus private debts are at record levels. And as Adair Turner put it, much of what banks now do is “socially useless”.

    In contrast and since the crises we’ve seen politicians trying everything in the book to get banks back to where they were prior to the crisis. What could possibly go wrong (ho ho)?

  53. Ralph,

    The PM group don’t have things quite right at all. They say (I’m quoting from their website):

    “The proportion of money created free of debt dropped from 46% to less than 3% since 1946.”

    So they are pushing the idea that BoE money is issued debt-free now. It isn’t connected with FRB. That’s clearly incorrect. It’s the liability of the BoE.

    “Currently, banks create money when they make loans, which means that for every pound in your bank account, someone somewhere else will be a pound in debt”

    It’s not “someone somewhere else”. It’s the borrower who holds the debt. Initially he owns the asset before he spends it. The bank own the asset of the loan and assumes the liability for the created money.

  54. “””You ask how can MMT “prevent a wealth transfer from the public sector to the banking sector as currently occurs.” My answer is that it can’t. In fact the arguments for and against MMT have little to do with the arguments for and against full reserve banking.”””

    I dont understand this transfer of wealth. In context of more private sector purchasing power going to service deposits?
    Liability=Repayment obligation+interest+misc_fees
    Credit=Endogenously instantiated loan
    Credit=Repayment obligation of customer+interest+misc_fees
    Liability=Endogenously instantiated loan

    As a successfull loan nets out to zero and the profit made will be interest. Hence by this definition banks creating deposits will take money from the private sector by aggregate?
    If so ANY banking system that extracts fee for service or interest is going to do the same. Note this is not ‘financial sector’ strictly endogenous money issuing banking sector.

  55. Ralph,

    Thank you for your answer to my question. I suspected that MMT is a solution to the problem of Wealth Transfer.

    MMT (General Comment):

    Warren Mosler’s Book “The 7 deadly Sins” does have some interesting views on our Econmnic System. He asserts that everyone has got the System “backwards”. for example: he says that: Imports, & Deficits are Good. In fact, Deficits add to savings? I think this is because Deficits require additional Treasury Bonds to be created which are then available for Pension Funds. He argues that the Government is not like a Household as Government’s do not have a finite amount of money – they can create new money – even though it is in the form of Debt. I think this is where PM and MMT are in agreement. He relates to money creation by Government as similar to points at a baseball game – and gives the scenario of a baseball team doing so well that the Stadium runs out of “Points” – and that in reality, “Points” are just an abstract quantity that can go towards infinity and you can never run out of them. This again is similar to PM who recognise that the Government running out of “Money” is like a Sports Stadium running out of “Points”.

    The problem is that in our Financial Sports Arena – PM argues that the only the Stadium should be able to award and create “Points” and not some of the Teams (i.e Private Firms known as Banks, where as other non-Financial Firms – such as Engineering Companies, cannot create “Points”). not only that, but using Warren Moslers analogy, the Teams which can create “Points” then charge additional “Points” from the other Teams for use of those “Points”.


    “It’s not “someone somewhere else”. It’s the borrower who holds the debt. Initially he owns the asset before he spends it. The bank own the asset of the loan and assumes the liability for the created money.”

    Is it not possible to have no personal debt oneself – i.e. no Car Loan, No Mortgage and no Credit Card Debt.
    So where do the Bank Deposits come from in our Current and Savings Accounts? Those Bank Deposits are mainly created through Banks and Building Societies creating them as Debt to a third party.

    If we take out a loan and the Bank adds the loan amount to our Account, then the Debt is ours.

    Bank of England Data – going back to 1870 – clearly shows the proportion of M0 Money and M4 Money, but it is up to the individual to create the (M0/(M4+M0)*100) Graph for themselves.

  56. Ralph,

    Thank you for your answer to my question. I suspected that MMT is NOT a solution to the problem of Wealth Transfer.

    sam w,

    Wealth Transfer in the Finanical Systme takes many forms.

    1. Loss of seigniorage (face value of currency) which the public currently received from Notes & Coins but NOT on Bank Deposits.
    2. QE – where those with Finanical and Physical appreciating assets gain the most.
    3. Implicit Subsidies – such as Depositor Insurance (underwritten by the Government) FSCS Funds are not enough to cover loss of Depositors in a Financial Crisis which is why –
    4. Implicit Guarantee of Public Bail Out for Banks
    5. Malinvestment created through Moral Hazard generated by items 3 & 4 above.
    6. Excessive credit creation targetting the Housing Market generating interest by speculators and fueling even further price rises. Refer to a Panorama Program in 2003 showing Financial Advisers openly advising House Buyers to lie about their Salaries from various well known institutions throughout the UK and NOT just in London.

    In addition to Monetary Reform, Regulations will have to be put in place – such as ‘Land Value Tax’ and ‘Loan To Rentable Value’ to direct money towards more Productive Business Investment.

    I cannot agree with Warren Mosler’s view that Exports are bad and Imports are good as it not only ignores the loss of local employment to places like the Far East, it contributes to Civil Unrest and also contributes to Environment Damage and War due to the increased use of Fuel to transport Goods that could be made here , halve way around the World, further contributing to pollution and depletion of Oil Supplies further putting pressure on Energy Resources.

    Iraq, Libya, Iran and Russia were or have been rich in Energy Reserves. Europe, United States and the UK have to import their Energy. Warren Mosler’s views on “Imports” only work in a Fiat System. Both Saddam Hussein and Colonel Gaddafi were attempting to change the means of exchange – from US dollars to EUROS (Iraq) and from US Dollars to Gold (Libya).

    In order to continue Warren Mosler’s view of the World, we have to enforce Military control over those Countries that we need to Import from. We are attempting to do that with Russia, but – thankfully, China is still too scary a prospect to be threatened by the United States or Europe. Even the UK is attempting to join the Chinese led development Bank, despite China’s claims on Taiwan.

  57. sam w,

    “If so ANY banking system that extracts fee for service or interest is going to do the same. Note this is not ‘financial sector’ strictly endogenous money issuing banking sector.”

    If the money was created by a Public Body, the newly created money could be used for the benefit of the Public without the ever increasing extraction of wealth through servicing the interest payments (£52 billion for 2015).

    A Bank that attracts depositors and investors should obtain fees for acting as custodian and intermediary between investors and borrowers, but should not demand the kind of support they currently have as this is the opposite of a fair democratice free market. Banks cannot fail in our system which is why Banks support the current System.

    Banks should assess risk and allocate funds but should not also be allowed to create additional currency, in aggregate to the existing money supply as that also increases inflation to the areas where those new credit funds are directed. Allowing Banks to create money has reduced publicly created money to just 3% of the money supply from 20% in the 1960s. The excessive instability is as a direct result of the policy to allow Banks t do this.

    MMT is right when they say that some of these issues can be corrected through more regulation – the first Regulation that should be put in place is that Banks should not be allowed to create new additional money – only a publcly elected Govdernment – who directs the criteria for new money creation, should do this, in my opinion as a witness of the Financial System over the last thirty years.

  58. “they have the power to override (via interest rate changes, QE, etc) any fiscal stimulus implemented by politicians.”

    No they don’t. That is a complete fantasy dreamt up by academics in their ivory towers.

    The central bank sets the rate and the dynamics of the system decide the quantity.

    Any central banker that tries to offset the fiscal stimulus of the government in a truly sovereign nation would be looking for another job the next day. Or there would be a constitutional crisis.

    Because amazingly they are humans that talk to each other – not robots in a mathematical model of perfection. The ‘independence’ thing is an illusion. In fact in the UK it’s not just an illusion it is a matter of law. The Treasury can always instruct the central bank what to do by deploying its ‘reserve powers’.

    The Treasury lets the central bank do its ‘independence’ thing in the same way that I let my eight year old play at being ‘boss’. If I decide there is a reason to stop that game I can stop it unilaterally. It’s the same with an elected government.

  59. It is frustrating to see how much Positive Money’s proposals can be so thoroughly distorted by selective quoting and reinterpretation by both opponents and supporters into one confusing narrative, but I’ll confine myself simply to the claim that the proposals are undemocratic.
    Jake said:

    the idea that our elected representatives shouldn’t be trusted with spending.If parliament/congress/althing determines that x amount of deficit spending is required;there should be no bureaucratic barriers; the CB should immediately comply.It’s called Democracy.

    Nothing in the Positive Money proposals, nor in the Iceland report, interferes with government spending. Currently governments borrow when their expenditures exceed their revenues from taxes, fines and other direct charges. That will remain. If economic conditions indicate that an increase in the stock of money will be beneficial, that new money will simply be added to the government’s revenues from other sources and may reduce the need for borrowing, depending on how the democratically elected government decides to use it.

  60. “Indeed, market monetarists have a specific term for that “power to override”: they call it “monetary offset”.
    Indeed, I disagree with it and don’t want to give them any more power considering how badly they screwed up in 2008.

  61. Conrad Jones,

    Yes it’s possible to have no debts. So lets consider a hypothetical bank customer, say a newly born baby, who has no debts and no assets. A generous uncle gives him $100 in cash. That goes into his new created bank account and the bank credits the account with $100 just by editing the numbers on a computer. The bank takes the $100 cash and puts it in its reserve account at the central bank. As the cash is the IOU of the central bank there’s no problem there.

    So there’s no third party involved and the money hasn’t been created by issuing any new loans.

    So, later when this young person is old enough to look at his bank account he’ll see $100 plus whatever interest the bank has added. But they’ll be the IOUs of the commercial bank and not the IOUs of the central bank.

  62. petermartin2001,

    Thank you for your comment.

    I agree with most of what you say except that my understanding is that there will still be a third party risk as once the cash is deposited in a Bank Account, it is converted in Bank Deposit money and there will still be a third party risk as there is no distintinction between Cash which has been deposited or Bank Deposits which have been created for a loan. The Bank Deposited are still the property of the Bank who promises to pay back the money at some future date.

    The $100 Cash could indeed be added as cash in their vaults or transferred to the Federal Reserve and stored as deposits in their Central Bank Reserves Account for use in interbank transactions. Either way, it’s no longer allocated to the customer who deposited the $100 Federal Reserve Note.

    Any interest earned – as you correctly say – will be seen added to his Account Balance: $100 + Interest, but the total balance will be in the form of Commercial Bank Deposits and will all be the liability of the Commercial Bank.

    The Commercial Bank IS the Third Party Liability – if the young man goes to the Bank and the Bank has engaged in risky investments which have gone bad, then the Bank Depoists may not be available requiring either FDIC Deposit Insurance to be enacted or (more likely) the Commerical Bank may be able to borrow Central Reserve Funds from other Banks or the Federal Reserve Itself. If not, then the Government may have to Bail out the Bank if it is big enough to casue damage to the rest of the Member Banks who hold Central Reserve Accounts at the FED if it currently owes other Bank Central Reserve Deposits.

  63. There is a third option which does not seem to have been considered by either the PM people, or by the AMI, or indeed by any of the advocates of MMT. This is the monetary reform scheme devised and elaborated on by William Hummel, whose monetary interests have a postKeynesian perspective (see:

    In a nutshell, it is entirely possible to operate a financial system with endogenous money creation and with all money created by state fiat. The two are in no way mutually exclusive. Actually Hummel discussed two possible schemes: (a) a full reserve scheme, and (b) a single national depository scheme. The latter scheme is more radical and interesting than the former, and I will discuss it briefly here.

    The essence of this scheme is that all money used in the economy would be state fiat money created by a central monetary authority (CMA), that there would no longer be a need for reserves, that the CMA would continue to practice open market operations using state fiat money — in order to target interest rates as a reactive response to the economy’s need for credit money and currency (i.e. endogenously), and lastly that all deposits would be made with a single national depository, which would have branches in every state. It would be possible for banks and post offices to act as agencies of the national depository. All monetary deposits — by banks, nonbank businesses, the public, and all levels of government — would be made with the national depository. The national depository would nether lend nor borrow, its primary roles being to store the nation’s monetary savings safely and to facilitate the payment process. Commercial banks would operate as true intermediaries. To obtain further details, I recommend reading William Hummel’s paper referenced above.

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