Licensed to Print Money

Inclusive Economy01 Oct 2015Wim Nusselder

Private banks create most of our money. The rest – coins and banknotes – make up only a small percentage. Several recent developments challenge this historically-evolved arrangement. Monetary reform could be as urgent as preventing the next banking crisis and the breakdown of the Euro zone. According to monetary reformers, better control of money creation could remove a major cause of economic crises.

According to a popular metaphor, money is the life blood of the economy: ‘If a nation’s economy were a human body, then its heart would be the central bank. And just as the heart works to pump life, giving blood throughout the body, the central bank pumps money into the economy to keep it healthy and growing.’ Money is trust – or at least a proxy for it. And trust is key to prosperity. The core of the economic system, of the way in which we organize our prosperity, is the financial system, which organizes that trust. Financial crises are the main trigger for broader economic crises. Monetary reform – or reform of the way in which money is created and its value guarded – could prevent financial and economic crises of the sort we saw in 2008, according to the International Movement for Monetary Reform (click the info icon for more background).

When an economic crisis causes unemployment, migration and other woes, it undermines trust in the political leaders and in the economic system. Economic stability is also based on the trust organized by the financial system. Lack of trust is the key factor causing the downward spirals that we experience as ‘economic crises’.

The financial system is rapidly changing because of technological developments, including alternative ways to organize trust (click the info icon for more background on ICT-based emerging alternatives). According to New York Times Magazine columnist Adam Davidson , ‘technology is changing the very nature of money’. Such developments pose stability risks as well as offering opportunities for reform that could resolve the stability issue.

Financial crises tend to trigger relatively small-scale debate among experts and campaigners on monetary reform as a way to stabilize the economy. However, financial crises and technological change together open up a window of opportunity for broad public and political debate about how our economy is organized and on whose behalf.

The worst economic crisis in European history, even if only because it triggered the Second World War, was the Great Depression of the 1930s. The Great Depression also triggered a debate about monetary reform. In 1933, University of Chicago economists spread what is now referred to as the ‘Chicago plan’. In 1935, leading monetary economist of his age, Irving Fisher, published his ‘100% money’ proposal. The banking crisis of 2008 and the subsequent Euro-crisis triggered a comparable debate about monetary reform (see the earlier info icon on International Movement for Monetary Reform). The essence of this debate is whether banks should continue to create money and to what extent the alternatives either put our prosperity at risk or reduce the risk of recurrent economic crises.

The 1930s did not see meaningful monetary reform. However, the Great Depression did teach economists and politicians a lesson, namely, that the government has a crucial role to play in the economy. Unfortunately, it seems that this lesson may have to be repeated with every economic crisis (click the info icon for more background on the History of Economic Thought). A key factor improving the prospects of achieving monetary reform this time, compared to in the 1930s, may be developments in ICT.

Trust as the essence of money

Another idea that is often repeated, like the metaphor of money as the life blood of the economy, is that money is debt. 1 Money may even have originated as such. The other side of the coin is that money is also credit – a word that originates from the Latin verb ‘credere’, ‘to believe’, which is not accidentally closely related to the concept of trust. Money can even be said to be based on faith. The famous, but questionable, story of the stone money of the Pacific island of Yap claims that even a giant stone believed to be at the bottom of the sea can be trustworthy money. Both stone money and everyday coins and banknotes are evidence of the fact that money can be based on tokens, which may not have sufficient intrinsic value to merit trust in their value, instead of in promises to repay a debt. Bitcoin, which consists of encrypted numeric values in a peer-to-peer computer system, is a modern example of virtual token money.

That money is debt and originates in credit, a concept stressed by both left and right wing critics of the present monetary system, is definitely true for the money created by banks in the form of bank account balances. The full picture is that there is credit-based money (e.g. bank money) and token-based money (e.g. coins and banknotes, giant stones, Bitcoin etc.). 2Token-based virtual money like Bitcoin, organized by private or central banks, may even be money’s most likely future. 3

Monetary systems require and organize trust. Trust in credit being repayable and tokens retaining their arbitrary value can be based on public or private arrangements, with a limited and occasional role for the intrinsic value of commodity money. Trust in strangers repaying their debts, not creating common token money out of thin air and not debasing commodity money is essential for any large-scale economic system to function. In our modern global economic system, almost everyone has essential needs (e.g. for food, clothing, housing) that are partly met by producers on the other side of the globe. Our prosperity requires that debts are repaid, that property retains its value across time and space, that claims can be exercised when and where needed (‘liquidity’), and that the cost of being in debt or otherwise dependent on other people’s property is sufficiently predictable and reliable.

Money is not itself property or wealth, but undifferentiated purchasing power, a store of value that we can use to claim property and wealth from others. In addition to being a store of value, money is a medium of exchange and a unit of account. In these roles, money can contribute to the growth of collective property and wealth by enabling trust, thereby facilitating large-scale cooperation, task division, specialization and, in more complex societies, credit intermediation, maturity transformation and risk transfer. In order to play that role, money must also be trusted.

Creating new money (additional stored value) enables claims on a larger share of property and wealth. Trust in money and, thus, in the stability of our claims on property and wealth can be eroded by governments, independent expert bodies and private banks alike when they create money ‘out of thin air’ and use it for own purposes.

It is the dependence of our globalized economy on trust and the fragility of that trust that can be seen as the basic source of economic cycles. Building trust is more difficult than losing it, which is why we experience downward phases of economic cycles as ‘crises’. We can entrust guarding the value of money and of the stability of our prosperity to the government, the interplay of private actors, an independent supranational body like the European Central Bank, some new arrangement or a combination of these. The type of money we use (credit- or token-based, tangible or virtual) and how we guard its value and the stability of our economic system should not be considered a historically-evolved, immutable given. We can, and should, debate the options.

It was the Bank of England, quite remarkably, being at the centre of the British financial system and crucial to the global economy, that cast some doubt on the appropriateness of the life blood metaphor with a central bank as the heart of the body. It did so in March 2014 in its publication ‘Money creation in the modern economy’. According to David Graeber in The Guardian, this publication unmasked a ‘fantasy-land version of economics’. It revealed that it is not the central bank that creates almost all money, but private banks, and pointed out that ‘in normal times, the central bank does not fix the amount of money in circulation’. This raises the question: Can we trust a collection of mostly profit-driven private banks to do so properly and responsibly? For that matter, can we trust a government led by politicians who are primarily after power or status or a closed body of experts, like a central bank, whom no-one understands?

The stability issue

Before we can answer the question whom to trust, we should discuss the main issue: the stability of our economic system and how it is threatened. What exactly are we entrusting to them?

The latest global economic crisis, which evidently started with a banking crisis in 2008, is teaching economists not to treat the financial system as separate or separable from the ‘real economy’. There is no such thing as a ‘real economy’ behind a ‘monetary veil’. In hindsight, past economic and monetary crises have often come together. The stability of the financial system is crucial for the stability of the economic system as a whole. So, how are economic and monetary crises caused and linked?

As explained by the Bank of England, most of the money in modern economies is created by commercial banks when they make loans and held as bank balances in bank accounts. By the end of 2013, only 3% of British pounds were coins and banknotes. Only part of bank account balances (a fraction) is backed by cash or reserves held by central banks, which provide cash. Hence, the term ‘fractional reserve banking’ is used for this monetary system. Under fractional reserve banking, lack of trust in banks can cause a ‘bank run’. When there is a run on a bank, clients reclaim their deposits (bank account balances) in a hurry and on mass, in anticipation of fractional cash reserves running out. This is what happened in Greece when the Greeks feared a ‘Grexit’ and that their Euro bank account balances would become worthless overnight or converted into much less valuable ‘new drachmas’. When there is a run on a bank, the bank can be forced to default (fail to convert their client’s deposits to cash) and go bankrupt, unless the central bank acts as ‘lender of last resort’ (i.e., provides cash to the bank, despite insufficient reserves) or the government intervenes. The Greek Central Bank’s capacity to provide cash Euros to its clients had to be backed up by the European Central Bank, which did so only up to a point.

During the financial crisis of 2008, comparable bank defaults (banks failing to meet their financial obligations) resulted from a lack of trust among banks themselves. This lack of trust was caused by banks having issued too many loans to clients (e.g. mortgages), which subsequently proved to be unrepayable. This left the banks with insufficient assets to meet their obligations to other banks. It was the so-called ‘sub-prime mortgage crisis’ in the USA that started the 2008 global banking crisis. There is ongoing legal debate about the role of sub-prime mortgage lenders Fanny Mae and Freddie Mac in causing this crisis. Fanny Mae and Freddie Mac are the main US government-sponsored financial enterprises and provided funding for up to 50% of all American housing mortgages. This debate illustrates that the blame game is often reduced to whether to blame the government or the lack of restrictions on free enterprise for economic and financial crises.

In the run up to the crisis of 2008, the inherent risk of excessive credit had been hidden by various practices. One of them was the ‘packaging of loans’ and reselling of these ‘packages’ to other financial institutions. Fanny Mae, Freddie Mac and their non-government-sponsored competitors packaged mortgages as so-called ‘mortgage-backed securities’, and the term ‘securitization’ was coined for this practice. Another practice that passed on risk and made credit less transparent was the use of complex financial products (‘derivatives’) as insurance against the uncertainty of interest rates, prices and currency exchange rates.

Bankruptcy following the default of huge financial institutions like Fanny Mae and Freddie Mac could not be allowed because of its effect on the economy as a whole. In 2008, and later, many governments had to rescue financial institutions that were considered ‘too big to fail’ or too essential to the financial system to be allowed to default, including Fanny Mae and Freddy Mac. Nonetheless, securitization and the use of derivatives continue today, although awareness of the risks involved is more widespread.

Banks that default after a period of excessive credit are forced to limit or revoke loans to non-financial entities, like farmers, factories and filmmakers. When these firms, in turn, default they have to dismiss employees. Unemployment and income loss due to unemployment make demand drop, pushing even more firms over the edge. The economy only recovers after sufficient financial losses have been incurred by owners and investors, including pension funds.

The resulting economic cycles of growth and decline are an important, maybe even inevitable, characteristic of market economies. Such economic cycles, including recurrent crises, became global when markets for crucial commodities like fossil fuels, staple foods, and metals and their ores became global. Global markets necessitated the creation of a global financial system. However, cyclical economic growth and decline can be traced much further back than the existence of financial systems. Before that time, such cycles resulted from the interplay between human societies and their natural environment, i.e., largely from under- and overpopulation. Since the creation of financial systems, economic cycles in market economies are caused primarily by endogenous (internal) factors. This implies that they can be rectified by politics – by the way in which we organize our society.

Can monetary reform cure economic instability?

Would organizing whom we entrust with money creation and guarding its value in another way prevent economic crises? Financial crises are not generally accepted by economists as cause for economic crises. From some perspectives, other causes are more fundamental or more politically relevant. However, the obvious link between the banking crisis of 2007/2008, Euro-crisis and global economic downturn in recent years makes debate about the need for monetary reform unavoidable.

If ‘fractional reserve banking’ is a main factor in enabling bank runs and defaults when public trust fails, the logical alternative is ‘full reserve banking’. Under this system, private banks would be legally required to back bank account balances fully with cash in their vaults or with account balances at the central bank that can provide them with cash – ‘100% money’, as Irving Fisher called it. In full reserve banking, most money is still bank money, while cash is still experienced as ‘the real thing’ to fall back on when trust in banks breaks down. Cash being ‘the real thing’ implies that its issuer, the central bank, always merits more trust than private banks.

Joseph Huber offered a more radical alternative in his 1998 book ‘Vollgeld’ (which translates as ‘(plain) sovereign money’). This alternative requires all money to be held (at least formally) in accounts at a central bank or public institution like the treasury. If most money is now (private) bank money, all money (not just cash) would then be central bank money. Sovereign money is fundamentally different from full reserve banking. It is easier to control by monetary authorities and easier to understand for people who are not aware that most of their money is created by private banks. Under this system, sovereign money bank accounts could still be organized by private banks on behalf of the central bank.

A less radical alternative than full reserve banking is Laurence Kotlikoff´s ‘limited purpose banking’, which requires owners of financial firms with a limited liability licence to refrain from risky forms of banking. Various other proposals also imply narrowing the activities of banks in order to reduce stability risks. More recently, proposals by the World Future Council and Positive Money suggest that a partial or hybrid private/sovereign money system, not requiring large institutional changes, may be sufficient to cure economic instability.

Monetary reform does not necessarily limit the availability of (bank) credit or the endogenous creation of money (creation on the basis of need for it). Both the full backing of commercial bank money with cash and central bank reserves and the creation of additional money in central bank accounts can be made into an automatic result of private banks deciding to make a loan on the basis of their assessment of the creditworthiness of a client. These options then merely increase the control of monetary authorities on a cumulative level and better enable political authorities to channel new money in directions deemed socially desirable.

The academic credibility of monetary reform proposals was much enhanced by the 2012 International Monetary Fund (IMF) working paper entitled ‘The Chicago Plan Revisited’, by Jaromir Benes and Michael Kumhof, even though working papers do not necessarily represent the IMF’s position. Their starting point is the (rephrased) claim by Fisher that his ‘100% money’ proposal (and the comparable ‘Chicago Plan’) would: 1) enable better control of the expansion and contraction of credit and bank money as the cause of economic crises, 2) completely eliminate bank runs and 3) reduce government and private debt. Better control of money creation is supposed to take away a major source of economic cycles. Debt reduction can reduce cycle amplitude and impact.

Using orthodox macro-economic modelling techniques, Benes and Kumhof find support for all these claims. However, like academic ahistorical macro-economics in general, they do not take into account the political requirements and obstacles to such proposals. A relevant question here is: Why did the Great Depression debate about the Chicago Plan not result in meaningful monetary reform?

Prospects for monetary reform

Mainstream economics tends to follow economic developments, but with a time lag that is too slow for monetary reform proposals to originate. Its critics even suspect that mainstream economics primarily serves the needs of the powers that be and will never support meaningful reform. The prospects for monetary reform would thus be slim without technological change as a co-driver and heterodox economic thought and experiments. The present rapid ICT-based developments provide alternatives and oblige existing financial institutions to review their business models and practices. Technological developments were the stated reason for ‘The future of money’ being the subject of the annual meeting of central bankers at the Bank of England in May 2015.

The primary example of a potentially disruptive technological development is the ‘block chain technology’ that underlies Bitcoin and other ‘cryptocurrencies’. Bitcoin implies creation of a non-backed (0%) digital currency and validation of encrypted payment information by a peer-to-peer network of computers. It is a form of ‘near money’, because it performs some of the functions of money, but cannot be used to pay taxes or buy large amounts of crucial internationally-traded commodities.

Major regular financial institutions like Goldman Sachs, NASDAQ and The New York Stock Exchange have considered applying block chain technology. According to a 12 September 2014 analysis by The Economist, this technology could cause a fundamental change in the financial system, because peer-to-peer networks of computers undo the need for payment intermediation (e.g. by banks).

The Uniform Economic Transaction Protocol holds even more potential for change than cryptocurrencies, because it involves all aspects of economic transactions, not just payments. It is comparable to the TCP/IP network communication protocols that enable the regular Internet.

The technological trend is towards people (or their computers and other things) dealing directly with each other without a need for trusted third parties, like banks, to manage assets, claims, liabilities and obligations for them in ‘vaults’ and ‘accounts’. Computer software can increasingly do the credit intermediation, pooling and splitting that is needed for loans between the ‘haves’ and ‘have nots’, for the sharing and passing on of risk (‘risk transfer’) and for the translation of short-term loans into long-term loans (‘maturity transformation’). This means that financial professionals could limit themselves to advising those who contemplate participating in, or otherwise financially enabling, enterprises run by others about the risks involved, rather than posing as an intermediary and taking the financial risk themselves.

Political perspectives

Monetary reform is a political process. The power to create and allocate new money and to guard its value can only be redistributed in the political arena, ideally in a democratic way. Nowadays, political processes are largely shaped by political perspectives that are driven and modified by public debate. The challenge is how to organize political processes around money democratically, when the financial system is global in nature, but democracy is primarily nationally organized. Dani Rodrik described this as the ‘political trilemma’ or ‘globalization trilemma’, with, even in 2010, Greece and the Euro zone as an enlightening example.

The One Bank Research Agenda of the Bank of England (see the earlier info icon on International Movement for Monetary Reform) represents the typical monetary authorities’ perspective, namely: concern that the financial system will get out of control. Governments tend to share that ‘control perspective’. They may take slightly different perspectives dependent on financial sector lobbying for less regulation or public campaigning for monetary reform. Political parties and economic scientists can be quite diverse in their perspectives, but, generally, they do not diverge much from the control perspective either.

In the medium term, the control perspective with its concern for stability is, therefore, crucial for monetary reform to be achieved. Public opinion can tip the balance in the short term, especially in countries like Iceland with a rough monetary history – as can the financial sector, especially in countries like the UK or USA, which have strong financial sectors because of their crucial role in the global financial system.

As said, according to its proponents, monetary reform will reduce instability (bank runs, untenable debts, economic cycles). But, how does this claim fare in public debate?

Positive Money, a leading voice in the monetary reform movement, lists a long series of criticisms of its ‘sovereign money’ proposal, which argues that all money should become central bank money. Its refutations, while at first sight convincing, have only been tested in political debate to a limited extent in the polarized political context of the UK. The Dutch Sustainable Finance Lab (SFL), after analysing international literature and Dutch expert opinions on monetary reform proposals, concludes that these proposals do offer scope for improving the present monetary system. However, the SFL concludes that the monetary reform movement has not convinced leading experts that monetary reform fully solves the stability problems of the current system.

The main criticisms seem rooted in lack of trust in public control among financial sector representatives and economic experts: Can central banks or new public institutions created specifically for that purpose really determine how much new money can be created without adverse effects on the economy? Can governments decide better than banks how to allocate money without being too bureaucratic and reducing credit, innovation and economic growth? Proponents of monetary reform lack trust in a financial sector with only limited monitoring by monetary and political authorities.

Both sides in this ‘public or private’ debate tend to overlook the fact that central banks cannot be identified with government. Historically, central banks are rooted firmly in the private sector (with national differences). They are not, or hardly, subject to democratic control and are so by design. For the Euro, this is particularly true, because the European Central Bank serves the monetary system of 19 European Union member states. The perspective of monetary authorities is, therefore, more representative of economic thought and the interests of economic experts than of political considerations and public opinion. In a real sense, a central bank is neither private nor public, but a closed circuit of experts. Hence, central bank sovereign money would be fundamentally different from treasury sovereign money.

In the long run, it is the underlying trust in the guardians of stability – governments, experts and private enterprises – and in the checks and balances of that stability that determines the prospects for monetary reform, rather than ‘facts’ about stability itself or public or expert opinion. Although long-term trust is the key issue, short-term swings in opinion and perspectives on ‘facts’, such as after the 2008 banking crisis, do provide a window of opportunity for monetary reform, which also entails the risk of ill-considered reform. Not only developments in financial technology, but also the growing volume of public debate since the Great Depression due to the platform provided by the Internet and social media may well give sovereign money and other monetary reform proposals better prospects than the Chicago Plan had back in the 1930s.

An agenda for further debate

If monetary reform is almost unavoidable because of technological change and desirable because it has the potential to solve the economic stability issue (or at least in some of its variants, even if that solution is only partial) – and, if the risks can be mitigated by gradual and partial implementation – how should we proceed with and improve the public debate?

From the point of view of The Broker, the key is to broaden perspectives:

  • on the essence of money: credit- and/or token-based with ‘trust’ rather than ‘intrinsic’ or any kind of ‘real’ value as the common denominator
  • from ‘public versus private governance’ to ‘searching for an optimum combination of government, expert and private arrangements’

A third way to broaden perspectives is to understand money as a claim on a share in the property and wealth that a society produces, maintains and owns collectively. Even if private banks retain a large role in creating and maintaining money, money can be redefined as being really about a relationship with a central bank in which we trust, like the diminutive percentage of ‘the real thing’ (cash and banknotes).

Sovereign money, or organizing money as a direct relation between money holders and monetary authorities, fits the technological trends – beyond financial intermediation and towards token-based money – better than bank account balances, where banks formally intermediate between money holders and monetary authorities and can take risks with money held on behalf of account holders. Money under full reserve or narrow banking is still bank money, still credit-based, with banks still intermediating, even though under closer scrutiny. Further debate 4 should focus on the extent to which a monetary system with less financial intermediation and a larger role for token-based money should be organized publicly, privately and/or ‘expertly’ and to what extent sovereign money can be combined with privately-created money.

The Broker is looking forward to the public hearing in the Dutch Parliament on 14 October, to the ensuing debate about monetary reform in the Dutch Parliament and to comparable political processes elsewhere.


  1. See for instance Charlotte van Dixhoorn’s ‘Full reserve banking’, p 5
  2. See slide 7 in the presentation by Michael Kumhof at the ‘Future of money’ conference at the Bank of England, 17 May 2015
  3. Ibid., slide 13
  4. A forerunner of such a debate was the discussion at the annual meeting of the German IMMR-member Monetative in November 2014 about the possibilities for gradual monetary reform. The presentation on that subject by Joseph Huber is also available in English.