Turning Point

Chris Waller - February 2013
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The Governor of the Bank of England Mervyn King appeared on the television news last night trying to find some straws in the wind of economic data which might suggest that Britain was heading for balmier economic waters but, despite all the political rhetoric, economic growth for the next twelve months is predicted not to rise above 1 percent. The governor also asserted that the current pattern of low growth looks set to remain for the foreseeable future.

The long term growth rate of the British economy has historically been around 2.5 percent per annum, this being the 'natural' trend, that reflecting a growing population and a rising standard of living. Britain needs to achieve a rate of economic growth of 2.5 percent even to stand still. A growth rate of 1 percent therefore is, in real terms, a contraction.

At this same time, across Europe, strikes brought national transport networks and public services to a standstill while protests flared up in 23 European cities. It must now be evident that not only are the austerity measures not working but that the end of a political and economic paradigm is approaching.

Thus far the argument has been that austerity is a necessary precursor to a resurgence of economic activity that will create employment and prosperity, that it is debt which is holding the economy back. It seems to me that that is absolutely the wrong approach to the problem: surely the way to pay off the debt is to employ people to generate the revenues with which to pay the debt. And even then, there are other schools of thought which propose a more radical plan to eliminate the debt - the 'Chicago Plan' as it is known. The Chicago Plan is not new, it was proposed in 1936 by Henry Simons and Irving Fisher in response to the 1929 Crash, but a new reading of it by Jaromir Benes and Michael Kumhof has been published under the aegis of the International Monetary Fund, thought the IMF has stated that the paper does not represent the IMF's thinking. ('The Chicago Plan Revisited', Benes and Kumhof, publ. IMF, August 2012.)

Benes and Kumhof state that: "The key feature of this plan was that it called for the separation of the monetary and credit functions of the banking system, first by requiring 100% backing of deposits by government-issued money, and second by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks." (Note - my emphasis.)

Friedrich von Hayek, one of the more recent champions of the Austrian school of economics, and the intellectual guiding-light to Milton Friedman, proposed that currency should be regarded as any other commodity, that is, that it should, in keeping with free-market ideology, be possible for anyone to issue currency. In light of the recent problems encountered by the Euro, Hayek's idea of private money, which he proposed in his 1977 publication, 'A Free-Market Monetary System' has resurfaced. This was the situation in America between the late 1830s and the early 1860s when anyone could issue currency; by 1860 there were around 8,000 different currencies in circulation. The period between 1837 and 1863 was known as the 'Free Banking Era'. The problem with these currencies was that if the issuer went bankrupt, or just simply got out of town, the notes and coins were worthless. The National Bank Act of 1863 put an end to the practice.

Any currency needs to be validated, that is, it needs institutions, structures and mechanisms to underpin its value. Historically in England, and later in Britain, it was the state that validated the currency. The bullion content of the money was determined by the state and the coinage was stamped with the head of the king - or queen - to assert its provenance. It was for this reason that people were confident to use the coinage for commercial transactions, knowing that its value was guaranteed. When this belief breaks down, as it has at various times and in various countries, then economic and political chaos ensues - Weimar Germany was the most egregious historical example of such a failure while Zimbabwe currently suffers similarly.

Private companies cannot validate their currency, therefore, if they wish to issue their own notes and coins then they should do so always providing that they do not denominate those notes and coins in sterling. In other words, if the Nat West bank, for example, wished to issue its own currency, then it would have to denominate it in 'Nat West Currency Units' and these would not be redeemable in sterling. If the bank wished for its currency to be redeemable in sterling, then it would either have to deposit sterling to the same value with the Bank of England, or the equivalent in gold, the universally accepted medium of exchange. Either of these two options would, of course, render the issuing of private currency completely pointless.

Even then, gold is only of value providing that everyone accepts that it has value. Historically gold has been universally accepted as a medium of commercial exchange because its supply is limited, controlled and, being a noble metal, it does not degrade with the passage of time. Nevertheless, even gold is only of use if the holder in part of a commercial community: gold is of no value if one were to be marooned on a desert island. The myth of King Midas reminds us of the folly of believing that gold - money - has intrinsic value.

Money only has value if it can be converted into real wealth and therefore any viable economic system must create the institutions, structure and mechanisms whereby the value of money is rooted in real wealth. The word 'wealth' is of Anglo-Saxon origin and meant 'the state of being well'. Later, its meaning expanded to mean 'those things that contribute to one's being well', that is, food, water, shelter, warmth and so forth.

Another argument against private money can be found in the abuses that were finally ended by the Truck Act of 1877. Many companies in the 19th century paid wages in tokens - a form of money - which could only be used at shops owned by the company. These shops typically sold goods at inflated prices and in so doing effectively retained a large proportion of the wages paid out to workers. Not only was this immoral, it also prevented the development of free enterprise in the local community. Private shopkeepers would not accept the tokens because they could not redeem them in sterling.

More recently, with the demise of the Comet electrical retail chain, the administrators suspended the use of gift vouchers and people found themselves holding vouchers which they feared would be useless. In the event, the use of gift vouchers was reinstated two days later. A gift voucher is a form of private money, that is, it can only be spent with the issuer. If the issuer goes bankrupt then the voucher is useless. In light of the recent experience of Comet, a scheme should be introduced whereby the money taken by companies issuing vouchers should be paid into an escrow account where it would sit until the voucher was redeemed, at which point the issuing company would receive the money.

Hayek's objection to the state's having a monopoly in the issuing of currency is that it conflicted with his free-market ideology. One can, to a certain extent, understand his apprehension. Given our experience of the economic and financial management of this country over the last 35 years, it would not be unreasonable to doubt the ability of politicians to validate and regulate the currency.

One measure which will begin to address the current problems is the implementation of full reserve banking. This is, indeed, one pillar of the Chicago Plan: "... by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks ...".

However, this does not address another, greater problem, that is, that governments can issue money which is not founded upon the prior production of real wealth, i.e. goods. The government is currently putting money into circulation by way of Quantitative Easing (QE) and already there is evidence that inflation is starting once again to rear its ugly head. Notwithstanding the spectre of inflation, the Bank of England has suggested that a further round of QE may be necessary - that is on top of the 3375 billion already pumped into the economy as of September 2012. ("Bank of England hints at quantitative easing as growth falters again" - Larry Elliott, Guardian, Wednesday, 14/11/12)

We are not alone in this. The US Federal Reserve is seemingly unabashed about the wholesale printing of money:-

"From December 2008 to the end of last year (2011), total US debt increased from $10.7 trillion to $15.2" trillion, an increase of $4.5 trillion. However, only $2.9 trillion of this amount was borrowed from investors; the $2.9 trillion came from US investors, insurance companies and more than half from foreign countries and international investors. The remaining $1.6 trillion came mostly from the Federal Reserve." - Forbes (My emphasis).

In all of this there is a fundamental error. It is the belief that the economy is the product of money - whereas in reality it is money that is the product of the economy. It is perfectly possible to have an economy without money - this is the barter economy. It was superseded by the cash economy because the latter is vastly more efficient. However, the power of money is such that it needs careful regulation, and it is in this that governments have been remiss.

The economic paradigm to which the government clings, and which it offers as the best, indeed the only course, is confronted by the fact of 2.5 million unemployed, 4 million children living in poverty, 7.4 million homes failing to meet the government's own Decent Homes Standards while 930,000 residential properties stand empty.

We are told repeatedly that we live in, and should embrace, the free-market economy. Nothing is further from the truth. A truly free-market economy would not permit the ludicrous situation described in the previous paragraph. Change is needed now before the situation deteriorates further and becomes irretrievable.

Sources and References

www.forbes.com/sites/matthewcampione/2012/04/20/quantitative-easing-only-in-america/ http://england.shelter.org.uk/campaigns/why_we_campaign/the_housing_crisis

Chris Waller - Permission granted to freely distribute this article for non-commercial purposes if attributed to Chris Waller, unedited and copied in full, including this notice.

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