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Chapter 10 Registered Money

Chapter 10. The next step: Registered Money, a proposed method for returning the right to create new money to the Government.
 
1.         All text books on economics describe the way retail banks’ ability to create money is limited by having to hold a set fraction of their reserves in the form of cash and balances held at the Bank of England (BoE) known as “base money”. 
 
2.         In order to prevent banks creating money the idea of 100% base money was proposed by Milton Friedman[1] and Irving Fisher[2], amongst others. For a full description of how this reached the stage of being a bill before the US Congress in the 1930’s visit Stephen Zarlenga’s site http://www.monetary.org/ and look for “The Chicago Plan” and later variations
 
3.         Base money has, in fact, never been used as a control on money supply in the UK, Even under the gold standard there was no standard ratio of gold to bank lending. 100% base money control would be complicated and probably unworkable, but the advent of a highly computerised central clearing system, which has allowed money creation to go completely out of control, could itself be the agent of complete control. The combination of the Internet and extremely powerful computers would allow easily what would have been almost impossible a few years ago. The Central Clearing System (APACS), which has done much to facilitate excessive monetary growth, could be used as the way to control it.
 
4.         In a free society it is not possible to prevent anyone lending money, including banks, but it should not be possible for banks to create new money in ever increasing quantities without any obvious limit, especially when the money created can be converted into pound notes at the swipe of a plastic card and is, effectively, legal tender. Anyone can extend credit and in most cases it is for goods, services or money already in existence. However the present banking system allows the creation of new money which is effectively legal tender in vast quantities.
 
5.         Membership of the central bank clearing system (APACS) means that all new deposits created by the member banks (initially as loans) become part of the ever increasing mass of new money circulating in the banking system. Bank money exists only in the form of deposits at banks and is virtually indestructible unless a bank becomes bankrupt, in which case the Bank of England attempts to arrange a takeover by another bank. If this fails the failed bank will be nationalised in order to prevent more bank failures triggered by the first. Deposits at clearing banks are therefore effectively guaranteed and have permanence because the only way they are withdrawn is to another bank account or as cash. The great depression of the 1930’s was caused by the failure of hundreds of USA banks, falling like dominoes with the consequent destruction of a large part of the money supply.
 
The way banks created money.
 
6a.       The money supply as measured by M4 stood at about £2000 Billion at the beginning of 2009. A large part of this money is on time deposits and is therefore not available for transactions. In the case of Building Societies most deposits are time deposits. Only banks who are members of the Central Clearing System can increase the amount of new money in circulation, because their current account customers return both new money and old money when they deposit payments as they receive them. There were 16 full members of the Clearing System at the end of 2009 (not all were able to exchange all types of transaction).
 
6b.       The greater the number of current account customers a bank has the more deposits return to it and the more money it has available to lend. This would lead one to believe that banks would want to get more current account customers and in fact the competition for current account customers shows up clearly in advertisements designed to attract current account customers with financial incentives to join. It also shows in the desire of Building Societies to become banks and above all in the frantic amalgamation of banks to form larger banks.
 
6c.       As a simple example: to illustrate the arithmetic of money creation we will assume that each of the 16 members of the Clearing System have the same number of current account customers. When one of the 16 banks makes a loan of £1000 above the total of its deposits it becomes new money which, when spent, becomes a deposit in one of the 16 and adds to the total circulating in the system. If all 16 banks do the same thing by the same amount the total new money will be £16000 which will return as deposits ready for lending again at a profit. The deposits are not merely ready for lending; there is an imperative to lend them in order to make a profit. Deposits are therefore money which never rests; this money is in constant movement through the clearing system. This money was constantly increasing in volume until it started to fall in 2009 when the amount of loans outstanding began to fall for the first time for many years
 
6d.       The above money creation process started by 16 banks making loans in excess of their deposits of £16000. These loans became assets of the banks and earned interest.  It is obvious why banking is so profitable and why the level of debt became so high. The fatal flaw in what would have been a one way bet for the financiial gambling fraternity and their partners in the banks was the finite limit of suitable borrowers and real assets which led to ever less suitable borrowers being encouraged to join in and the creation of artificial assets of ever increasing complexity  There may well be a sucker born every minute but very few of them have enough real money to keep the game going for ever..       
 
           
 
 
 
The proposal: “Registered Money”
 
7a.       All deposits making up the statistic M4 would be registered in the Bank of England. These would be totals of all individual accounts held: one for each licensed deposit taker. It is assumed that deposits held at other financial intermediaries who are not members of the Central Clearing System can only be moved through the Clearing System via a member bank.  Only Registered Money would be allowed to pass through the Central Clearing System
 
7b.      At the end of each day the net balances at the Central Clearing System would change the registered holdings of the member banks at the Bank of England.  This means that only the Bank of England could create more Registered Money than existed at the end of Registration Day.  
It would be up to the member banks to register all their deposits with the BoE. Overseas deposits denominated in Sterling would need careful examination before being allowed, particularly if held in places like the Cayman Islands.
 
8.         On the day after all deposits were registered there would be no change in the quantity of deposits available to bank’s customers. The present situation seems to be that banks have loaned out most if not more than their total deposits.  The safety of bank deposits depends therefore on the confidence that depositors have in their bank and its assets in the form of loans.  It is essential for stability that banks are forced to hold hold far more liquid assets than they have been allowed to in the last thirty years or so.  The registration of deposits would not make them "Liquid Assets" it is intended simply to prevent a bank from increasing its deposits without getting Registered Money from another bank or borrowing directly from the Bank of England.  Registered Money is simply designed to prevent Legal Forgery by accurately measuring the amount of "money" in the form of existing bank deposits in the same way as currency is measured.  Problems with banks subsequent to Registration could still happen but would be far less likely than they are at present.  Any problems that do occur could be settled by using the measures proposed in paragraph 10 below. 

9.         All deposits registered at the BoE would be “Legal Tender” by definition. Access to these deposits could only be through a financial intermediary, normally a bank who is a member of APACS. 
 
10.       Under these proposals a run on a bank or other financial intermediary such as a building society would be highly unlikely If it got into trouble through unwise lending. In serious cases where a bank was unable to meet requests for withdrawals it would be nationalised.Its loans would be sold to help pay off its creditors and its Depositors would be guaranteed by the BoE.  The mere fact that such a guarantee existed would prevent a "run". Under no circumstances would Directors or Senior Managers be entitled to compensation, regardless of employment contracts. This would help to concentrate the minds of bank managements and virtually eliminate “moral hazard”[3]
           
11.       Taking the case of Northern Rock as an example: In the first place it would have been far more difficult to use their particular method of financing by short term inter-bank loans because other banks could not have created money to lend and it would have to have been Registered Money. In the second place they could have been allowed to become bankrupt just like any ordinary non bank company, their share holders would have lost their money but their depositors’ funds (private or commercial) would be guaranteed by the new owner, the BoE.  See chapter 7, The Swediish Solution. Very little new money would be require as very few depositors would wish to move their money. The loan book and other assets would be sold at whatever price they would fetch on the open market. Directors would not have received any compensation.  The bank would be sold on the open market when it became profitable again, almost certainly at a profit to the taxpayer.
 
12.       Registered deposits would be indestructible. They would have a life of their own, held by banks acting as intermediaries on behalf of their depositors. They would be lent by banks in exactly the same way as they are now but they would not be increasing at anything like the speed M4 now increases and as a result banks would not be under pressure to find ever more risky loans “off balance sheet.”  
 
13.       New deposits flow into a bank in the normal course of business from the activities of its customers and in so far as deposits come in faster than payments a bank would have money available to increase the amount it lends. Deposits from individuals and businesses of Registered Money would be steadily increasing as a result of unfunded Government expenditure (Seigniorage).   A bank could supplement its receipts by attracting savings at the going rate of interest,  or by borrowing money from the BoE.
 
13B.    Additions to Registered Money could not be used as a base for “The Multiplier Effect” by banks as this process would no longer be possible so could not cause added inflation. Inflation could only result from the known increase in Registered Money and for the first time the cause and effect would be obvious and we would know who to blame. Inflation caused by creating more money than surplus capacity can absorb it should not be confused with price increases caused by world shortages or currency devaluation.
 
14.       At this point the total amount of Registered Money could only be permanently increased by Government expenditure (unfunded by tax receipts or borrowing by the Government) made by the BoE on behalf of the Government. This would be new money adding to the Registered Money supply. There would be no other way of increasing Registered Money. This would allow the Government to bail out or support our ailing banks at a profit to the taxpayer instead of a loss. 
 
 
Seigniorage.      
 
15.       New money created by unfunded government expenditure could be used as a substitute for general taxation or government borrowing. This new money would flow into the clearing bank system as it was spent by the private sector (after receiving it from the government) and increase the bank deposits available for making loans by banks to the private sector.  The essential ingredient would be that registered money could not be used as base money by private banks for lending more than their deposits.
 
Controlling the creation of Registered Money.
 
16.       The amount of new money created each year by the Bank of England would be decided by a body independent of the government somewhat similar to the present Monetary Policy Committee but with greater independence from political control. The quantity of new money created would be limited primarily to control the rate of wage and asset inflation (Both the RPI and CPI indexes of inflation are much too dependent on external influences, see Chapter 5). The amount of new money created would be less than the rate at which M4 is now increasing because so much of the new lending by the private banks now goes into purely speculative activities and the creation of asset bubbles. It would however allow a significant reduction in taxation and make it much more difficult to use money borrowed from banks for purely speculative leveraged activities by Hedge Funds and Private Equity “buy outs”.
 
Effect on external money flows and exchange rates.
 
17.       Britain is an island geographically but very far from being an island economically. We have an adverse trade balance, as we buy far more abroad than we sell. Our balance of trade for the year to March 2008 was minus $177 billion (rising to $186 billion for the year to June). We have been spending more than we earn for a very long time and as a result the value of the pound is bound to fall.  A recent large fall in the pound was caused by speculators closing “Carry Trade” positions following reductions in UK interest rates; a clear example of the unwanted side effects when interest rates are used to either stimulate or inhibit money supply. The introduction of Registered Money would give a second, more powerful and much more immediate control lever.
 
18.       After all deposits have been registered at the BoE we will have an accurate figure for the total amount of Sterling for the first time. As a currency limited in quantity, Sterling would be very attractive to foreign investors even at very low interest levels. This would make it easier for us to prevent the value of Sterling falling against other currencies but may result in Sterling being valued too highly for what is left of our manufacturing industries to compete in world markets.
 
19.       There are measures that could be taken to limit the adverse effects of having too strong a currency although many of them fall foul of EU regulations and World trade agreements. If, however, we continue to run a trade deficit at present levels and if it is no longer so easy for our banks to convert money borrowed in foreign currency into Sterling, we may be glad that our currency will be more attractive to hold as an investment in its own right.
 
20.       When other countries, particularly the EU and USA, see the advantages of Registered Money they will copy us. It is not possible to predict the effect this will have, but we will all have more control over exchange rates and hopefully the world will follow us into a more stable monetary future. The situation now is near to anarchy and it is obvious that the monetary authorities have no idea what to do about it. If interest rates are cut to the bone we can expect a re-run of the ”burnt fool’s bandaged finger going wobbling back to the fire”, or perhaps a copy of Japan’s inability to prevent deflation in spite of zero interest rates.
 
21.       By moving immediately to the registration of clearing bank deposits most of the present problems would simply disappear and banks that have been very rash could be safely allowed to fail, be nationalised, or simply supported, at no cost to the tax payer. At the same time we would get a bonus in the form of seigniorage allowing a reduction in taxation and lower interest rates to take the strain off over- borrowed mortgage holders.
 
22. If Registered Money was adopted by the Euro Zone the seigniorage would remove the need for contributions by member States. It would make the need for political integration in order to control the money supply unnecessary. It may well be the only hope of a stable future for the Euro.  
 
T W R Davies, Scottish Borders, (December 2008)


[1] Milton Friedman: Essays in Positive Economics, 1953 pp 135-6
[2] Irving Fisher: “100% Money” first published in 1936
[3] “Moral Hazard” is used to define the tendency for banks to become too relaxed about financial failure because they believe they will always be rescued by the central bank to avoid contagious bank failures.