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‘Positive Money’ may not be a complete answer to the problem of debt

September 9, 2013

The monetary reform devised by Prof. Joseph Huber and James Robertson, and further developed and promoted by the UK campaign group Positive Money is (it seems to me) being sold as a means of preventing excessive debt. Although the introduction of this reform would provided real and lasting benefits, it is not, in my opinion quite sufficient to prevent excessive debt build up. I wish Positive Money would acknowledge this. Let me explain:

Under the existing system (misleadingly called a ‘fractional reserve system), ‘money’ in my bank account is not something I legally own; it is something the bank owes me. However it is the nearest thing to money you will get; I can pay my taxes with it, rather more easily than trying to pay with bank notes. This is in spite of the fact that some argue that it is credit I have allowed to my bank, and that I could insist on the debt being settled with cash on demand.

The Positive Money Reform, hereinafter referred to simply as PM, introduces the concept of Transaction Money. The money in a customer’s accounts would be  his or her property, although high street banks act as custodians. High street banks would hold their own stock of transaction money, and the Bank of England would act as custodian. Under PM all transactions conducted through the banking system involve the transfer of transaction money from one party to another. High street banks cannot create or destroy transaction money; only the Bank of England can do that.

Whereas under fractional reserve banking banks can create the money they ‘lend’, and there is no limit to this provided banks keep their lending in step, under PM they can only lend to the extent of the existing stock of transaction money. Right? No! Consider a house sale. The buyer’s bank lends out transaction money. This money passes to the vendor. The vendor may then invest it in an investment account with her bank. The ‘saver’ parts with transaction money in return for her investment. Thus the transaction money passes back into the banking system, which allows further loans to be financed. Thus the volume of savings and debt is not limited by the amount of transaction money in circulation but only by the willingness of people to save. Thus in theory at least, there is no reason why an asset price bubble should not develop under PM.

This is not to deny that PM would dampen excessive lending to an extent. Under the existing system lending is limited by just two factors: the demand for loans, and banks’ assessment of risk. The supply of loans generates its own demand via rising asset prices, and thus risk assessment becomes the only limiting factor, and we have seen how banks got this wrong and always will while the tax payer picks up the tab.

By contrast PM would do three things to restrain excessive lending:

  1. prevent banks using money in customers’ transaction accounts to fund lending
  2. end the need for tax payers to bail out failed banks, whilst protecting the payments system, thus achieving in a neater way the objectives John Kay had in mind when proposing ‘Narrow Banking’
  3. induce those with money to invest to consider options other than putting it into an investment account with a bank.

All these things will tend to restrain the volume of lending, but may not be sufficient at times of undue optimism, or when there is a serious housing shortage. To cater for such conditions, monetary authorities need weapons other than the control of the supply of transaction money, such as those proposed by Richard Werner and actually in use in Britain up to the mid 1970s.

In our current situation of debt deflation, PM would of course provide a vital tool to get investment in the real economy going.

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