Sovereign Money: piggy bank economics or the answer to financial crisis?

The Centre for Economic Empowerment is run by NICVA and seeks both to promote better understanding of economic issues and therefore help the voluntary and community sector engage more effectively in economic debates.

Ideas do not get bigger or bolder than the one presented by the London-based group Positive Money which is currently being put to a referendum in Switzerland: Sovereign Money.

To understand what is being proposed it is first important to understand the problem.

There are two sources of money in the economy. The first is that which is created by the government, the notes and coinage in circulation.

The second, which accounts for the vast majority is created by the banks in the form of credit. So, when you are given a mortgage, for example, the bank will credit the sum you need to your account. It’s not giving you money per se, it is granting you credit. It will expect you to pay that money back either when you sell the house or pay off the mortgage.

Banks will always prefer to issue loans on property because those loans are secured against the property and therefore recoverable, whereas there is greater risk attached to business loans, for example. The problem is that the money used to buy property does not find its way into the real economy, it becomes locked up in the property itself and also causes housing inflation.

Ultimately it can lead to a situation where property prices are so inflated that people cannot afford to pay them back. In the 10 years running up to the financial crash of 2007 40% of bank lending went to property.

Proponents of sovereign money believe that the government is making the same mistake again by adopting what Lord Adair Turner former chair of the Financial Services Authority calls the “hair of the dog” strategy – trying to stimulate economic recovery by encouraging banks to issue more and more credit. Household debt is now approaching the highest it has been in history, and many observers believe that there is a serious risk of another financial collapse.

So what is the big idea?

The sovereign money movement argues that what is required is for government to create money and put it into the real economy. This is not the same solution as Quantitative Easing (QE). QE involves flooding the financial markets with more cash in the hope that some of this trickles down into the real economy.

Instead what is proposed is that money is put directly into the real economy through increased government spending, tax cuts and rebates.

Positive money has specific initial proposals. It wants the Bank of England to create an additional £10 billion and transfer that money to the government’s bank account and for the government then to use that money to invest in projects, such as building more homes improving the infrastructure etc. This will create jobs, and by doing so both increase the tax take and also lead to employees spending more money and therefore boost other parts of the economy and also reduce indebtedness as people pay off borrowings to the banks.

Ultimately the plan would be to “democratise money” by removing the banks’ ability to create money altogether, effectively nationalising credit. In the future therefore banks would no longer be permitted to lend money that they do not have, instead they would be obliged to borrow “real money” from the central bank and then loan that on to their customers.

The Vollgeld-Initiative campaigners in Switzerland now have the required 100,000 supporters to secure a referendum on introducing such a system and so the first attempt to introduce the system will be in that country.

It is a bold and simple proposal but one which is not without its critics both from the right and left.

Ultimately what campaigners want is to establish a public authority with total control over the money supply, both cash and electronic money on current account holdings. This authority would have enormous power making it just as important as the legislature, the executive and the judiciary. The monetary authority would be bound by law to expand the money supply according to the growth potential of the real economy. The money created by the monetary authority would be transferred to the Treasury and would come into circulation by public spending; thus, it would benefit the public purse and contribute to the reduction of national debt.

Banks on the other hand would no longer create money – they would only be allowed to lend from money they have already collected.

Given the enormous amount of power this monetary authority would have a key issue would be how to ensure its independence.

The Sovereign money movement has provoked a huge, and not always polite debate, amongst economists. Martin Wolf, the economic commentator at the Financial Times is in favour. Ann Pettifor who is best known for having predicted the 2007 financial crisis and has recently advised the Labour Party is against.

She argues that the creation of credit is vital to a modern economy, stating: “Before the establishment of a banking system, society could only embark on ventures that could be financed by “savings” – inevitably the surpluses built up, stolen or appropriated by the already wealthy. Because savings were scarce, they would be lent out at high rates of interest – inhibiting investment, and above all employment.”

She claims that its introduction would return us to the Middle Ages, reducing us to funding everything from piggy banks, and is especially scathing about the concept of an “independent” authority running the new system: “the idea that society can set up a single “independent” committee of men to make far-reaching decisions about the quantity of money needed by a nation of sixty four million people, all engaged in varied and complex activities, is bordering on authoritarian.”

It is a fascinating debate which will rumble on for many years. Positive Money is gaining traction and there is a support group in Belfast which can be located here . Right or wrong Positive money is helping many thousands of people understand more about how money actually works, and is provoking an absorbing conversation about radical alternative ways of running the economy.

The Centre for Economic Empowerment has produced a whole range of important reports on a range of key economic issues which can be accessed here