LPUK Policy: Monetary Reform
Why Do We Need Monetary Reform?
The monetary reform proposals of the Libertarian Party consist of three central planks. However, and before we can talk about what we'd like to change, we need to take a brief look at how the current banking system works, and expose the flaws that our policies seek to address.
Where Does Money Come From?
Most people think that the government creates all of our money by printing banknotes, and minting coins. But that is not the case. Let's start by looking at where the government gets its income from.
Government Income
Banknotes
are printed by the Bank of England (BoE) on behalf of the government.
The BoE then sell those notes at face value to commercial banks, who
use them to fill their cash machines and to hand over to us when we
withdraw money from our bank accounts. The profits from the sale of
these notes by the BoE (known technically as seigniorage) is passed straight back to the government, and netted the Treasury the sum of £2.3 billion in the tax year 2007/081.
The second source of government income is well known and hated by us all—taxes.
Finally,
the government gains income through borrowing. If insufficient funds
have been brought in through seigniorage and taxation to meet the
government's spending commitments, it sells bonds. Bonds are the
equivalent of a government IOU, and promise the holder that the
government will buy them back at a future date for the value of the
bond plus some predetermined interest.
Raising money through
selling bonds has a huge downside, though. It means that the government
incurs debt. And, like the rest of us with debts (on a credit card, for
example), the government ends up paying a sum of money each year simply
to service those debts. Government estimates for 2007/08 put the figure
that it will have spent on servicing its own debts last year at a
staggering £30 billion2—over 20% of the total amount of income tax that we all paid!3
Money From Thin Air
Currently,
around 97% of the 'money' in our economy isn't in the form of notes
that you can fold, or change that weighs down your pockets—it's in the
form of credit (or debt, depending upon which side of the transaction
you are standing). So the real question to be asking if we want to
understand where our money comes from is how all of this debt appears?
Our commercial banks create money as debt, effectively from 'thin air'.
Imagine
a person paying, to keep the example straightforward, £100 in notes or
coins into their bank account. Now, bankers know that most of the time,
most people leave their money in their bank accounts; we tend to pay
for goods with our debit cards, or by writing cheques to one another.
Consequently, if a bank has just received £100 in cash it knows that
there is little chance that the depositor is going to come along and
ask for it back at any moment.
Knowing this, banks only keep on
hand a certain proportion of deposited funds; the amount that they
reasonably expect they will need to cover any requests for withdrawals.
The amount is termed the reserve ratio, and for any funds
deposited, a bank will solely keep the amount of the reserve ratio on
hand, and lend out the remainder. The whole process is known as fractional reserve banking (FRB).
So,
to carry on our example, if the bank that person paid his £100 into
maintained a reserve ratio of 10%, the bank would accept the £100
deposit, keep £10 on hand, and lend out the remaining £90.
But
what happens to that £90 loan? The individual or business who takes it
from the bank will probably not just spend it straight away, but
deposit it into their bank account. If they do so in cash, the whole
process can start again. Assuming that their bank also maintains a 10%
reserve ratio, the bank will accept the £90 deposit, keep £9 on hand,
and lend out the remaining £81.
And so the process continues. In
fact, if fully worked through the system, that original £100 deposit
will end up having 'created' a total of £1,000 that can be spent in the
real economy.
In accounting terms, no money is actually
created. If each borrower were to pay back their loan in sequence, the
debts would unwind until we were left with our original £100 deposit at
the first bank. This is why those who defend the existing system will
tell you that no new money is really created.
What these folks conveniently overlook, however, is that in real terms, as opposed to accounting niceties, new money has
appeared—it's in your hands, and you can spend it. And as long as new
bank deposits are being made, the process above can continue.
Keeping The Merry-go-round Turning
And
what allows the entire process to continue is our central bank—the Bank
of England. Remember the bonds that the government sells to raise
additional funds, the Treasury IOUs? Well the BoE will, from time to
time, buy bonds in the market. To pay for its purchases, the BoE
genuinely does create money from thin air, and credits the seller's account with money that it has just decreed should exist.
This
process injects new money into the economy, which spreads about and
ensures that the fractional reserve system described above never grinds
to a halt.
If it wishes to, the BoE can use the same process in
reverse; selling Treasury securities and destroying the money the
purchaser pays. In this manner, the BoE has a crude control mechanism
available for determining how much money exists in our economy at any
one time.
The BoE also sells money to the commercial banks.
These banks buy money at one rate, then loan it out to their customers
at a higher rate, pocketing the difference.
The above is, of
necessity, a simplified explanation of how FRB operates, and the role
played by the central bank. The Bank of England do not appear to have
ever produced a layman's guide to these processes, but the US Federal
Reserve has. Although several years old now, this document
is still a good guide to the operation of a fractional reserve system,
and largely applicable to the regime in the UK as well as the US. If
you wish to look at the technical detail for the UK system, the Bank of
England's Handbooks In Central Banking series of publications, and in particular Handbook #24 (Monetary Operations), is a good place to start.
And
whilst the above is a simplistic version of the processes at work,
remember that much of the complex language and obscure practice of the
banking industry is designed to mask its operations from public
scrutiny. At its heart, it is a simple fraud: central banks genuinely
creating money from thin air, and commercial banks lending money that's
not rightfully theirs to loan. As the famous economist JK Galbraith
once noted: "The process by which banks create money is so simple that the mind is repelled."
Why Have We Got This System?
The short answer is because bankers profit from it!
Remember
the seigniorage that the government receives from the printing of
banknotes by the Bank of England? That brought £2.3 billion into the
Treasury last year. Estimates by Huber and Robertson back in 2000
suggested that the loss in seigniorage to the government by allowing
commercial banks to create money was in the order of £49 billion per
annum4. And, of course, the more money there exists within the economy, the greater this loss is to the government.
The
big driver for commercial banks is the interest that they charge on
loans. Obviously, the more loans that they have on their books, the
greater the potential amount of interest that they can earn. Simply by
being able to loan (effectively) the same money over and over again,
they are able to develop multiple interest income streams from a single
deposit. Banks also profit from the business of actually arranging
loans. Most will charge a small percentage of a loan's value simply for
allowing you to enter into the loan contract with them.
We've
enjoyed this system—largely unchanged—since the Bank of England was
first established in 1694. Seeing the obvious benefits to themselves,
bankers around the world have, over the centuries, embraced a model
first imposed upon the people of our nation.
But it's a flawed model. It's one built to serve the interests of the few, not the many. It's one that results in the scourge of inflation. It's one whose time has long passed.
Libertarian Monetary Reform: Three Necessary Planks
To build a strong bridge from our unfair and failed banking system to an honest and prosperous future one requires some sturdy materials. The Libertarian Party's monetary reform proposals consist of three central planks.
Plank One: Sterling — A National Currency That Belongs To The Nation
Our
first key proposal is to wrest the privilege of creating money from the
private banking industry, and to return it to where it rightfully
belongs: the Crown.
Where an increase in the money supply is
required to maintain monetary value—because of a growth in the
underlying economy—government will spend the newly created debt-free
money into the economy in the form of financing capital works, paying
the salaries of public sector workers and so on.
This money will
be the money that we are all familiar with: pounds Sterling. Our
national currency, it will once again become the property of the
nation. Out of control inflation caused by feckless bank lending will
become a thing of the past, as we will demand that all Sterling be 100%
reserved. All income from seigniorage will end up in the public purse,
to provide funds for necessary government activities.
Should a
particular government abuse its position and create more money than the
economy requires, all of us—as the electorate—will have the opportunity
to do something about the situation at the ballot box. This is in stark
contrast to the current position, where inflationary pressures are
created by unelected private bankers; people who actually have a vested
interest in causing such pressures in the first place—the more money
that they create, the greater their profits.
Nobel Prize winning economist Milton Friedman once said: "Money is too important to be left to central bankers".
This is a position that we wholeheartedly endorse. The private banking
industry needs to be removed from involvement in the creation of our
national currency and, as US President Thomas Jefferson remarked over
200 years ago: "The issuing power should be taken from the banks and restored to the people to whom it properly belongs"; to the government of the nation, on behalf of the entire nation.
How To Prevent The Fractional Reserving Of Sterling?
A
key point of these proposals is to prevent the fractional reserving of
pounds Sterling in the future. As banks must be allowed to continue
taking deposits and making loans in Sterling, this raises a potential
problem.
To illustrate the problem, cast your mind back to the
person depositing £100 in cash into his bank in our example above.
Currently, the bank taking that deposit has no way of knowing if the
money is government produced (debt-free) money, or if the person
depositing it has acquired it via a loan. Without being able to
distinguish between debt-free and debt-laden money, the bank cannot
determine whether it should be allowed to re-lend that money.
In
the days before computerisation of the banking system, this issue would
have been easily dealt with. When there was a direct one-to-one
relationship between money and the physical representation of it (the
banknote), everybody knew where they were. However, it would be totally
absurd in this day and age to return to the historic system of having
fleets of security vans ferrying physical banknotes around the country
between branches and different banks.
Various solutions to this
problem have been mooted by different experts. Fortunately, the very
technology that has largely rendered banknotes obsolete—computers, with
vast amounts of cheap data storage—offer us the potential for tracking
money through the banking system, to ensure that is only capable of
being on loan to any one person at any time.
Those who run the
banking computer systems have not had cause to give much thought to
these issues to date, as they don't currently require this
functionality. As a responsible political party, we intend to fully
consult with private banking institutions to develop a future system
that is both effective and transparent.
No matter that any such
system would mean changes in the way that banks do business, we need to
remember that what we are talking about here are solely implementation
issues. Whether hard or simple for banks to adapt to, such mere
procedural issues must not be seen as a barrier to prevent the much
needed structural change from occurring. No government fails
to attempt to apprehend criminals simply because it would be easier to
allow them to roam free; and no government should shy away from
monetary reform simply because the changes required might be arduous
for the private banks to implement.
Plank Two: Pounds Sovereign — A 'Hard' Currency
In
addition to reforming how pounds Sterling are created and handled, the
Libertarian Party is proposing the introduction of an additional,
parallel, currency: pounds Sovereign.
What gives our money today
the value that it has is simply our trust that the government, and the
banks, will honour it. There is no physical commodity backing Sterling:
it is what is known as a fiat currency.
Our money was not always like this. In the past, precious metals such as gold and silver (the origin of our pounds Sterling) were kept by banks, and banknotes issued in relation to the amount of precious metals on hand. Such hard currencies
proved remarkably resilient over the centuries, and really only died
off during the 20th century with the explosion in fractional reserve
banking.
Precious metals like gold have held their value—their
real purchasing power—remarkably over the ages. Back in Roman times, an
ounce of gold would have bought you a good quality toga, belt and
sandals. Today, that same ounce of gold would pay for a quality suit,
belt and a pair of shoes.
Metals, and particularly gold, are
still of great value in the world economy. This is never more true than
during times of economic trouble, such as that which we are facing
right now. Whilst fiat money may be refused as a means for financing
foreign trade, gold never is.
Back in 1999, Gordon Brown decided
to sell off over half of the UK's gold reserves via auction—an act
described by Peter Fava, then head of precious metal dealing at HSBC,
as "a disastrous decision"5. Not only was the
decision to sell the wrong one, but trailing it in advance guaranteed
that prices would be depressed prior to the auction. As Martin Stokes,
former vice-president at JPMorgan, said: "I was surprised they had chosen the auction method. It indicated they did not have a real understanding of the gold market"5.
Gold
is still key to the operations of most central banks around the world.
At the end of the financial year in March 2007, the United States held
8,133 tons of gold, Germany had 2,422 tons and France had 2,710 tons.
Britain, currently the fifth largest economic power in the world, at
least on paper, had a pitiful 315 tons5.
The
Libertarian Party is proposing to reintroduce a hard currency, one
backed by gold: pounds Sovereign. Although we would expect it to be
initially used largely to fulfil international trade obligations, such
a currency would have the added advantage of attracting foreign
investors into the UK, as it would provide a secure harbour for their
money in a turbulent world market. Over time, and if both the amount of
gold held by the Treasury and the demand from the public was great
enough, pounds Sovereign could become a commonly used currency in all
our daily lives.
Plank Three: Free Banking
Another approach to banking reform that is advocated by some is the concept of free banking.
Within a free banking system, there is no government control over
currency or banking whatsoever—market forces determine everything. A
free bank would be able to create its own currency, and make its own
decisions as to how it would operate—choosing to embrace FRB if it
wished.
The idea is that you—the customer—would make your own
decisions as to which banking institutions and currencies to use; with
pure market forces determining which survived and prospered, and which
fell by the wayside.
The Libertarian Party is committed to
allowing a plurality of choice in as many situations as possible for
the citizens of the UK. Consequently, allowing a free banking regime to
be instituted is the third plank of our portfolio of monetary reform
proposals.
If the adherents of the free banking model are proved
right, and such a system is embraced by the consumers of banking
services, then over time free banks will become predominant in our
economic system. If, on the other hand, the system isn't well received
by the public, few, if any, free banks will come into existence or
survive.
That's the real beauty of a truly free market: what is
ultimately available to the consumer are the products and services that
consumers create and sustain a demand for.
Summary
Money
has to come from somewhere. Currently, money is created by the banking
industry and, with the exception of the seigniorage on physical
banknotes which returns to the Treasury, the profits from creating
money stays within this private industry.
Our proposals for
monetary reform address the issues raised above in three ways. Firstly,
we will return the sovereignty of our national currency—pounds
Sterling—to the Crown, with new Sterling being created, debt-free, by
the government, and thence spent into the broader economy. The amount
of Sterling in circulation will be prevented from being expanded
through FRB, stopping bank generated inflationary spirals developing,
and keeping the value of your savings safe.
Secondly, we will
create a new currency, pounds Sovereign, to be 100% backed by gold.
Still vital for international trade, a gold-backed currency will be
immensely strong, and help protect the UK from the storms and squalls
that sometimes rip through international markets. In providing a safe
haven, this currency will attract investment from many overseas into
the UK.
Thirdly, we will legislate to allow for the creation of
free banks. If these prove popular with the market—the citizens of our
nation—they will grow and prosper, with their currencies likely
supplanting Sterling as the primary means of exchange on a day-to-day
basis. However, and should they fail, such failure will not impact on
anyone who chooses to keep their banking facilities purely denominated
in pounds Sterling. In this way a genuine free market in banking will
be able to be tried, without the risks being spread over the general
population.
We believe that the proposals outlined above are
sound and necessary. Our existing banking system has been creaking from
one crisis to the next over many years, and has only remained
unchallenged because of the enormous influence that those who most
benefit from it—the private bankers—wield over our elected politicians.
It's a broken system. And, uniquely amongst the UK's political parties, the Libertarian Party is ready to fix it.
Policy Highlights
- Removal of all legal tender legislation except in [9] below
- Removal of all additional (VAT etc.) taxes on precious metals
- Allow free banks to operate how they like with their own currencies (enabled by [1])
- Only the Government shall be permitted to perform fiat issuance of pounds Sterling. Banks must either use foreign currencies or issue their own Bank Money
- Sterling held in on-demand deposit accounts to be 100% reserved by any bank handling it. Banks have always been free to create investment accounts to enable on-lending
- New pounds Sovereign currency to be introduced, 100% backed by gold
- Sovereign to incrementally replace Sterling as gold reserves allow
- Payments to government (taxes) and payments by Government to be in pounds Sterling or pounds Sovereign
- Only pounds Sterling and pounds Sovereign will be "legal tender" in regards to the obligation to accept as payment for debts
- Existing pounds Sterling fiat debt to be reduced systematically within the first parliament
- The various Bank Money, pounds Sterling and pounds Sovereign shall float against each other
The true value of pounds Sterling will no longer be affected by private lending operations. A "safe haven" of a 100% gold backed currency, pounds Sovereign, will be provided. Pounds Sovereign will not initially to be issued in note form. All deposits of pounds Sovereign must be recorded by the Bank of England to ensure that no fraud occurs (totals should always be as expected by the BoE). Banks will be free to continue FRB operations using their own Bank Money or foreign currencies. We expect pounds Sterling to be the main currency in day to day life.
Sources
1 Bank of England Annual Report & Accounts 2008
2 Debt servicing from table 1.15, HM Treasury Public Expenditure Statistical Analyses 2008
3 Income tax revenue from table T1.2, HM Revenue & Customs Annual Receipts
4 Huber & Robertson, Creating New Money
5 The Sunday Times, April 15 2007
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