Fixing Finance

We humans are a clever lot. We are curious about the world, and we are natural problem solvers within it. When we are free from ideologies and other delusions, we have a strong affinity for the natural world, and a genuine wish to live within its means and to protect it from harm.

But we humans are now chained to an economic system that is currently a planet destroying machine. So if we want to break free, and gain the power to save the planet and the human societies it nurtures, we need to understand the nature of the problems that make the economic system so destructive, and then decide on the best solutions to correct those underlying causes of dysfunction, and set some transition plans and put them into action.

As we start to look at what makes the economic system so destructive, we immediately come to realise that finance is at the heart of the problem. The system that creates the money on which the economy operates is driving the perpetual expansion of the volume of economic activities that deplete the planet’s finite resources and natural systems.

Already, armed just with the concept that finance is the problem, we gain enormous power. The way that finance works is subject to our political institutions, which are in turn subject to our collective political will. So finance is not some independent force of nature, it is something that we can control, should we be willing and able to gather the necessary political will to do so.

In this article we will come to see that fixing finance actually comes with enormous social and ecological benefits, along with dramatic improvements to the efficiency and stability of the economic system.

Ending the dysfunction.  As we begin the transition to the new model, these destructive processes in the current model will be switched off or greatly diminished:

  • Wealth extraction from the 99% to the 1%
  • The exacerbation of the boom and bust cycle
  • The inflation of housing bubbles
  • The inflation of overinvestment and speculation bubbles
  • Bailing out financial institutions
  • The destruction of savings when a bank becomes insolvent
  • Stability of the system depending on the accelerating growth of private debt
  • Destructive public policy serving the imperative for perpetual debt growth

The benefits of properly designed finance.  We will see that the benefits of operating under the new model include:

  • Money is created debt free
  • Money is controlled to serve the real economy
  • Savings are fully guaranteed and held safely at central banks
  • People can decide how much of their money to invest, and so to put at risk
  • The financial system becomes much more stable
  • The state receives all revenues from creating money
  • The state receives an enormous payment from banks during the transition
  • Banks lend prudently or risk failure when the economy contracts
  • Banks have to compete for funds, rather than creating their own money
  • Political systems are free to pursue qualitative growth and better societies
  • The economic system can be made sustainable

But before we can explore the solution that delivers these profound benefits, we need to be clear about how finance actually works, and what is actually wrong with it. When we have identified the design flaw at the heart of the financial system, the solution will become self evident, and fixing finance becomes the relatively simple matter of correcting that single design flaw.

This article is long for a blog post. If you don’t have the time to absorb it all in one go, you could bookmark one of these section headings, making it easy to come back later:  Finance for beginners,  Boom and bust,  The debt trading game,  Too much money,  Taking control,  The benefits of control,  Advocating for change

Finance for beginners

The good news here is that finance is not as complicated as people generally presume. Nicole Foss puts it like this:

There is no reason that people shouldn’t be able to understand how the financial system works, and we need to, because there are some very significant limits coming in the world of finance, sooner rather than later.”

Finance is about bank lending.  Basically, finance all boils down to the creation of loans by private banks. When a bank creates a loan, it summons two things into existence: money and debt.

Money and debt are created out of nothing.  Neither the money nor the debt exist the moment before the transaction is created in the bank’s computer system. Money and debt are both promises. Debt is the customer’s promise to repay the bank, with interest and over time. Money is the bank’s promise to make funds available, which it does by simply keying a number into an account. If the loan is for $1 million, the transaction creates $1 million of debt, and $1 million of money. The money does not come from anywhere else. It does not come from the savings of other customers stored in the bank. It does not come from some bank vault. It is just a figure in a computer.

This truth does not sit easily in some minds, because it seems so absurd that we would give private banks the freedom to literally create money out of thin air, and it is absurd, yet that is how the system actually works.

For those who are yet to get their head around this absurd truth, there are many great videos to explain the process, and some of them cover the whole history that ended up with control of the financial system in the hands of private banks. Here are a few examples in a variety of styles:

Where does money come from?  This TED talk is a great place to start, and explains not just the creation of money in simple terms, but goes on to explain the financial dysfunction we are about to explore in this post, as well as the power the banking system gains over society when given the freedom to create money without constraint and the control to decide where it ends up:

How banks create money out of thin air.  This 47 minute video is highly recommended as well. It tells the whole story, complete with quotes from US Presidents, Central Bankers, economists and others:

Loans and mortgages are created out of thin air.  This is a fun little piece from NZ television, even if one of the presenters is a little complacent about the inherent risk:

One bank loan is no big deal.  Now, there is nothing especially threatening about $1 million of debt and $1 million of money being created out of thin air. As long as all promises to repay are credible, the process works, by and large.

A whole system of money out of thin air is unsustainable.  But when we zoom out and look at the level of the whole system, we can see exactly why this model of finance is inherently unstable and doomed to fail. In order to understand the dynamics and aggregate behaviour of a system as complex as the global economy, and the role that the enormous volume of money created out of thin air plays within it, we need to turn to a systems analyst, and the best in the business might well be Nicole Foss.

Boom and Bust

Finance and economics from a systems perspective. The companion article to this post is a transcript of a brilliant talk by Nicole Foss called Building Resilience in an Era of Limits to Growth. It explains how money has come to serve various functions in the economy and in societies, on ever expanding scales as the economy has become ever more global and interlinked. It demonstrates that as financial crises begin to interrupt business-as-usual, money stops properly performing these vital functions,  and this generates cascading failures in the wider economy.

Foss also goes to some length to explain the precarious situation Australia is in, with its loss of manufacturing, the enormous housing bubble, and our dependence on commodity exports to China in particular.  Foss goes on to suggest what we should be doing to prepare for the next crisis, given that it is almost certainly going to hit us particularly hard. No boom lasts forever, so bust is inevitable. Are we prepared?

Nicole Foss on Money and Financial Crises breaks both the audio and transcript of the 53 minute talk down into bite sized pieces, each a few minutes in length, which will make it a lot easier to absorb for most readers. The argument presented is a continuous stream of great points that are each worthy of a little extra thought, so it is very difficult to keep up, but here is the full audio for those interested:

Ultimately, the global financial system is based on a pile of promises upon promises upon promises. It is the failure to control the size and credibility of that pile of promises that drives the boom and bust cycle, and that repeatedly and inevitably leads to financial crises and potential collapse.

Musical chairs.  Foss summarises this scenario with an effective analogy (note that ‘credit’ is the term for the money that is summoned out of thin air along with debt when private banks create loans):

Credit is now of the order of 99% of the money supply, which means that 99% of the money supply is excess claims to underlying real wealth. We took a small amount of collateral, and we backed an enormous number of loans with it, so we now have a crisis of under-collateralisation. This means we are all playing a giant game of musical chairs, there is about one chair for every hundred people playing the game, and as long as we are all up and dancing to the music and enjoying ourselves, we don’t really notice how few chairs there actually are, and not all of us entirely understand the rules of the game we are playing either.

But, when the music stops, the people best positioned to understand the rules of the game are going to try to grab a chair as quick as they possibly can. The great collateral grab will be on, and everybody else’s excess claims to underlying real wealth will be rapidly and messily extinguished. This is deflation, by definition, and that is what we stand on the verge of today. So, the expansion phase lasts quite a long time, but the contraction phase can actually be quite rapid, and that is what we stand on the verge of, globally.

Credit is not actual wealth.  In order to help explain what Foss means by saying that credit represents excess claims to underlying real wealth, imagine that we represent the total volume of money as a number M, and the total volume of real world assets as the number R. When a bank creates a million dollar loan, nothing changes in the real world, no new real assets or goods are summoned out of thin air and added to the value of R. But a million dollars of money is added to the system, so M increases by $1 million.

Now, our money is our power to purchase, theoretically, but if our collective power to purchase increases, but the real world pool of assets available for purchase is unchanged, then it is impossible for everyone to fully convert their purchasing power into real world assets at the same time. And with every new loan created in the system, M grows but R does not, so the portion of purchasing power that can be converted into real assets gets increasingly smaller.

Credit creates crisis when a growth cycle ends.  This is the money side of the picture, or more technically the credit side, because credit is only the promise of money, not money itself. In the musical chairs analogy, when the music stops, that is when it becomes clear that the expansionary phase is coming to an end, people try to convert their purchasing power into real world value. When our collective purchasing power is in the order of 100 times the value of real world assets, as it is now, there is simply no capacity to convert more than 1% of purchasing power into real world assets, and we have a crisis of under-collateralisation.

Debt is also a systemic risk.  Debt is the other side of the picture, and it is just as unstable. Debt is treated as an asset by banks, something of value on their balance sheets, and contributing to their value as perceived by the market. But not all debt is created equal, because one promise is not necessarily as credible as the next. And not all debt stays on the balance sheet of the bank that created it, because debt is traded in complex derivatives. So, above and beyond the reach of any one bank, there exists a system of debt, of varying credibility and with complex structures that obscure its true value and inherent risk.

The debt trading game

Foss explains the onset of financial crisis in necessarily broad terms, but it is also worth drilling a little deeper and considering the behaviour of individual market participants, because there is deliberate intent at play, and the result we get is not just the sum result of a bunch of stuff that happens.

Packaging and selling debt.  When market sentiment is high, the inherent instability in the system is exploited by the financial institutions that create and trade debt derivative assets. They structure the debt so that the parts with the highest risk also pay out the highest short term gains. This drives up the demand for the least credible debt, allowing the banks that created it to sell it into the market and so get it off their balance sheets. The financial game begins, and success in the debt trading market depends on holding the riskiest debt assets for as long as possible, in order to rake in the short term gains, but selling it off just before market sentiment turns against risk.

Toxic debt becomes junk.  The selling phase starts off as discreetly as possible, with those in on the game gradually offloading their toxic debt assets to an unsuspecting market, rather than dumping them all at once and allowing the market to understand what is going on. But, sooner or later, other players in the market start to catch on, and begin to understand how toxic the assets really are, so they begin to offload them too, and the selling phase accelerates. The more that other players catch on and sell their holdings, the faster the perceived value of the debt assets is extinguished. When the market as a whole finally comes to understand that one particular product or class of debt has no remaining real world value, trading comes to an end because there are no more willing buyers, and the debt is classified as junk, and those left holding it are the losers.

Debt triggers financial contagion.  So, that is the game. If the selling phase is limited to one product or one narrow class of debt, then the market will continue on as usual. with some players having to accept what is euphemistically described as a haircut. But if the market gets spooked, and starts to fear that other types of debt might be called into question, and have their value rapidly extinguished too, then market sentiment turns negative, and players start trying to offload their next riskiest debt, which loses value very quickly, so the process accelerates and repeats in an ever more frenzied cycle, and financial contagion has been unleashed.

Debt trading is out of control.   In order to demonstrate the sheer enormity of the debt trading game, these are the approximate volumes of the most important financial quantities in existence globally:

  • Bitcoin $10 billion
  • Silver $17 billion
  • Coins and Banknotes $5 trillion
  • Gold $8 trillion
  • Stock Markets $70 trillion
  • Debt $200 trillion
  • Debt Derivatives $1 quadrillion

Note:

  • 1 quadrillion = 10^15 = $1,000 trillion = $1,000,000 billion
  • Estimates in USD from this source

The debt trading game includes the amounts of actual debt being traded, and the derivatives which are effectively just bets on the price movements of that debt. So, even with many of the stock markets around the world experiencing large price bubbles, the debt trading game involves 14 times more money than the value of all of the stock markets of the world combined.

Failing derivatives cause global crisis.  It was a failure in the debt derivative market that triggered the global financial crisis in 2007/08, and it is very likely that the coming financial crisis will be triggered in the same way. Clearly, the debt trading game is something that needs to be taken very seriously, and it constitutes an enormous risk to the wider economy.

Debt trading is deceptive.  The important message here is that financial crises are not just something that happen now and then. There is deliberate deception at the heart of the products being traded, and deliberate manipulation of the market outcomes by powerful players with insider knowledge. The whole game is corrupt, there are essentially no rules, and there is certainly no person or organisation in control. Why do we put up with this? How have we come to have such an absurd situation? What is the driving force behind it all?

Debt trading in media.  The absurd and corrupt nature of the debt trading game has been depicted in popular culture, like the US film The Big Short, and the excellent German television series Bad Banks, which may still be available at SBS on Demand.

Money must flow

It might be useful to simply leave the question about the driving force behind the absurdities of financial trading hanging for a moment, and return to the excellent analysis by Foss. While we might not particularly care about who wins and who loses in the financial markets, and might be inclined to just dismiss it all as a giant Ponzi scheme, telling ourselves that there is nothing we can do about it anyway, we cannot afford to be that complacent.

Financial dysfunction causes real suffering.  If financial markets freeze up, money stops flowing, and the economy stops working. Financial markets freeze when trust in the system of debt breaks down, and banks are unwilling to lend in an environment where it is not clear how, where, and when financial value is going to be extinguished. Foss explains the resulting processes of deflation, deleveraging and the frantic race to secure collateral as the system of virtual wealth collapses. These processes are accompanied by many real and painful social consequences, including rising unemployment, falling wages, mortgage defaults, increasingly unaffordable basic goods and services, and potentially this time the seizing of the funds of depositors in order to bail out banks.

Operating system crash.  Foss adds:

We are looking at an operating system crash, so this is something that happens quite quickly. It is something that pulls the rug out from under people’s feet, and it’s a crash of a virtual system, so you wouldn’t expect that to play out over a long period of time. We can’t say exactly when something like this might happen in any specific place, but it is already happening in a number of places, and the places where it hasn’t happened yet look a lot like the places where it was happening a few years ago. So if you look at say Iceland, and Ireland, and Spain at the peak of their bubble, they look a lot like places like Australia, New Zealand, Canada and Brazil, places where we haven’t seen the bubble burst yet, but all the risk factors are in place for it to do so.

Now when you crash the operating system, you are not going to be doing much of anything until you have rebooted it. So it is our job today to start to think about how we might: a) prepare for an operating system crash, b) get through the crunch period that will come as a result, and c) how do we reboot the system into something that looks a lot less like a planet killing Ponzi scheme than our current economy does, because our current economy is thoroughly pathological.

We don’t want to reboot the system into the same form, so we need to start thinking about how we might have a system reboot into something that’s a lot more sustainable, that is based on a lot more solid foundation. So we need to start thinking about that up front, and we have a lot more capacity to do that now, before we are in the thick of a period of crisis.

Prepare for disaster?  Now we come to the crux of the argument about fixing the financial system. There are two paths that we can take. Foss has us preparing for the coming crash, by focusing on what we can do from the bottom up to make our local systems more resilient, and better able to function without the global flows of money. She then goes on to describe what we can and should build up from the wreckage. Her arguments constitute a very sound plan for that scenario, and the more we follow that plan and the sooner we begin, the much better off we will be.

Or try to avoid it?  The second path is to focus on what we can do from the top down, by making a transition to a new model of finance that is no longer driven by the same destructive and unsustainable force:  the banking system’s power to expand the money supply without real world constraint.  This is the fatal design flaw driving the dysfunction of finance, and it is what must be fixed before we can even dream of having a global economic and political system that is even remotely sustainable.

Too much money

In what might seem a contradiction to the fact that if money stops flowing the economy stops working, the simple reality is that financial dysfunction is wholly driven by having too much money in the system. Foss distinguishes between two types of inflation with this:

Inflation is an increase in the supply of money plus credit, relative to available goods and services. The implication is that there are two ways you have inflation: either by increasing the money fraction, or the credit fraction. If you increase the money fraction, you’re taking your real wealth pie, and cutting It into many, many more pieces, each of which will be very small. That’s currency hyperinflation, like modern day Zimbabwe, like Weimar Germany in 1923. So that’s what happened if you’re getting out a printing press and generating real physical currency. But that’s not what we did.

We had a credit hyper-expansion, in which case you don’t cut your real wealth pie into smaller and smaller pieces, you create – for the same number of pieces of pie – more and more claims to each and every one of them. So you create excess claims to underlying real wealth. It is still inflation, because you are still increasing the effective money supply, but it doesn’t look like having to use a trillion dollar note to buy a cup of coffee – it doesn’t end up working in the same way, and it doesn’t resolve itself in the same way either.

The search for yield.  All this credit – this bank created money – has to find a place to earn. It has to be invested somewhere, and one euphemism for this is ‘search for yield’. The share of new money that finds its way into the real sector of the economy is limited, in that there is only so much incentive to invest in a real world system that grows at an average rate of only about 2 to 3% per year, while there are better growth rates to be found in the virtual financial sector. There are even limits to private businesses soaking up the excess money via public offerings, which come with the implicit promise of delivering future capital gains in share prices and increasing dividends to shareholders, but at the cost of diluting earnings per share in the shorter term..

So, the lion’s share of all that unneeded money sloshing around the system and searching for yield necessarily ends up in the financial sector, the virtual part of the economy that does nothing that is constructive in the real world. For an example of how the effects of having too much money play out in reality, we can turn to the next great resource to be explored here, this article by Joseph Huber: What is Sovereign Money

In the run-up to the present crisis, from 1992 to 2008 the money supply M1, for example, in Germany, grew by 189%, nominal GDP (which includes consumer price inflation) by 51% and real GDP by 23%.[2] Hence one can argue that only one eighth of the money supply increase went into real productivity and real income. Another eighth went into consumer price inflation. What happened to the remaining three quarters? They went into financial investment, ever more of it of a purely speculative nature (‘global casino’) without making a contribution to financing real output, while drawing on the up-market items of that output nonetheless.

In that case, over a decade and a half, the banking system created eight times as much money as the real economy needed, and so nearly 90% of the new money ended up as pure inflation, mostly of the unproductive virtual sector. This flow of unneeded money into destructive financial speculation is not limited to Germany or Europe; it is happening in every country where there is no control over how much private banks increase the money supply.

Money is simply wasted.  Inflation benefits no one and nothing in the real world. Inflation destroys real wealth, real jobs, and real prosperity. A system that continually expands inflation and destroys real wealth is evidently dysfunctional, yet that is what the current model of finance does.

Financial dysfunctions.  So, the list of serious dysfunctions with the current model of finance is growing and making the case for change more compelling.  The problems caused by the banks having control over money creation, some of which have already been covered here, and some are covered by resources in the next section, include:

  • Banks create too much money in the good times, causing financial crisis
  • Banks create too little money in the bad times, causing recession and unemployment
  • Governments are denied the profits from creating money, which goes to the banks instead
  • Nearly all money in the economy is effectively on loan from banks, and interest must be paid on it
  • Debt must always grow, and grow at an ever increasing rate
  • There is an ever rising risk of a potentially catastrophic ‘operating system crash’

To these we can add the consequences of too much money in the system:

  • Large bubbles in housing prices
  • High levels of personal debt
  • High levels of volatile financial speculation and associated economic instability
  • Exacerbation of the boom and bust cycle
  • Only a small portion of new money flows to real businesses outside the financial sector
  • Financial income accumulates faster than earned income, further widening inequality
  • Real world resources are consumed in the production of wealth that is only virtual

Clearly, having the banks in control of the system and able to expand the money supply at will amounts to a very destructive force, which pushes the economic system into dangerous territory, and at the same time denies us the opportunity to have an economy that works a lot better, and that actually serves people and allows us to build better societies.

Taking Control

The good news here is that restoring control over the money supply so that it serves the needs of the real sector is a relatively straightforward task, and there are excellent and well-developed proposals for making the required transition. The same model of fixing finance is advocated by a global network of organisations, with those under the banners of Sovereign Money and Positive Money being the most visible advocates of change.

The transition to a controlled money supply comes with some great short term social and economic benefits, as well as profound longer term benefits, which include savings accounts held safely at central banks, eliminating the very idea that some financial institutions are too big to let fail, considerably more stable finance, and opening the way for far more sustainable economics.

A simple introduction to sovereign money.  This is the video introduction used on the UK based Positive Money.  It should be easy to understand as a starting point, and might help to motivate more reluctant readers to pursue a deeper understanding of the money system, and of the best way to repair it:

A comprehensive case for a sovereign money system.  This article by Joseph Huber makes a very compelling argument for a transition to a financial system with a controlled money supply, and presents a broad description of the steps required to get there, along with an outline of the benefits of doing so.

Some excerpts on the problem:

Analyses of the financial crisis and measures taken have so far considered a wide range of factors, but failed to take into consideration the monetary root cause of all those banking and financial-market problems: banks’ basically unrestrained credit and deposit creation. Money governs finance, as finance governs the economy. Regaining control of the money supply is a basic prerequisite for coming to grips with the banking and financial system.

A sovereign nation or community of nations ought to have monetary sovereignty, as a prerogative of constitutional importance such as the exclusive powers of legislation, executive government and administration, jurisdiction, the monopoly of taxation and the monopoly of force.

Under today’s bankmoney regime, only the control of the currency unit is still intact. Money creation and seigniorage-like privileges, however, have largely been ceded to the banking industry.

In contrast to what textbooks say, money and capital markets do not bring about a self-limiting state of equilibrium. The reason is that modern money is not ‘scarce’, but is fiat money which can easily be created at the stroke of a key. Banks’ credit creation almost always tends to be overshooting in the course of business and financial cycles, i.e. the banking sector creates volumes of credit, deposits and debt vastly out of proportion to economic growth as indicated by GDP. This causes inflation and, particularly since the 1980s, asset inflation and financial bubbles. Economic cycles are thus pushed to extremes they otherwise would not reach. Ensuing banking and financial crises cause damage to the entire economy, including financial fortunes, real income, employment, and state coffers.

And the solution:

The dysfunctions and illegitimate privileges of the present bankmoney regime require a monetary reform which phases out bankmoney in favour of a money supply that exclusively consists of sovereign money.

Banks’ deposit creation would be brought to an end – either immediately on a set date or gradually over a certain transition period. Banks could no longer pour large amounts of additional bankmoney into the ‘irrational exuberance’ of financial-market bonanzas. Business and financial cycles would still exist, but remain on a moderate path.

Sovereign money is safe money. It cannot disappear anymore. In a banking crisis there would be no threat of payment services breaking down. Insolvent banks, no matter how big, would no longer have to be rescued in order to prevent a standstill of economic transactions.

The central bank’s task is to provide the money and keep control of the stock of money, to make sure that there is neither too much nor too little money, thus ensuring that the banks and the economy can work at optimal capacity utilisation.

Banks will no longer be able to lend or spend money without having taken it in or up before—from their customers, from other banks, on the open money and capital market, and ultimately, if need be, from the central bank.

A comprehensive proposal and transition plan.  This proposal for Monetary Reform for Iceland was commissioned by the Prime Minister in the wake of that nation’s dramatic financial crisis. It might be a little easier to read than Huber’s article, and it also has sections with more detail should the broad explanations of the concepts and benefits not be enough to persuade readers.  Note that Iceland is still the only country that has actually jailed bankers for their role in the Global Financial Crisis, so even though it is a small nation, its government should not be taken lightly.

The benefits of control

Control over the money supply would not only change the financial system, but also greatly improve our societies and our future prosperity. With all that excess money no longing driving asset price inflation, especially in real estate, the population would not be losing such a large part of its income in servicing household debt and feeding the profits of the banks.

Ending income distortion.  Just as importantly, the distorting effects to income distribution between the rate that people earn money and the rate that money earns money would be removed. Controlling the money supply means that the money you earn is no longer continuously diluted by the expansion of the financial sector bubble, and so solves these problems as described by Huber:

There are further problems with the banks’ overshooting primary credit creation, thus bankmoney creation, in particular an inbuilt bias in income distribution to the benefit of financial income at the expense of earned income. Growth of financial assets in continual disproportion to GDP expands the relative share of financial claims on the national income and thus reduces the relative share of earned income.

The benefits of reform.  These are the benefits of moving to a Sovereign Money system as listed in the Iceland proposal :

In a Sovereign Money System the amount of money in the economy is controlled directly by the Central Bank, preventing private banks from expanding it.

The pro-cyclical expansion of the money supply by private banks will be made impossible. Instead, the Central Bank will increase the money supply in proportion with the overall growth of the economy and to meet inflation targets.

Crucially, the power to create money is kept separate from the power to decide how that new money is used, thereby ensuring that conflicts of interest do not lead to too much (or too little) money being created, or money being created for private, rather than public, benefit.

The risk of sudden bank runs is greatly reduced. Deposits on Investment Accounts have maturities that are distributed over a longer period, allowing banks time to liquidate assets if needed. Deposits in Transaction Accounts are protected in a bank failure as they are kept at the Central Bank, on behalf of the customers, and are separate from the failing bank’s own assets. A deposit guarantee scheme is therefore not necessary for Transaction Accounts.

Income from creating the money supply accrues to the state owned Central Bank, resulting in larger dividend to the state, and can be used for democratically decided purposes. Based on annual GDP growth of 2%, an inflation target of 2%, and an initial money stock of ISK 500 bn the annual income from sovereign money creation could be close to ISK 20 bn. In addition, the state will get a one-time income of 300-400 bn ISK over a number of years during the transition to a Sovereign Money system. This happens as the Central Bank creates sovereign money to replace the old bank created money. The new sovereign money can be put into circulation by the state via: the purchase of government bonds, increase in government expenditure or reduction of taxes, by lending to banks, or a blend of those methods.

By using a state created money supply, instead of effectively ‘renting’ the money supply from private banks, the overall level of debt in the economy will be reduced. Demand for loans will be reduced which puts downward pressure on interest rates.

A Sovereign Money system dramatically reduces the risk involved in commercial banking. This could open the way to some reduction in regulatory burden in banking and reduction of overhead costs. It could also reduce the need for separation of investment and commercial banks thereby allowing for better economies of scale.

To that we can add not having to bail out failing banks with public money, nor to allow banks to effectively steal money from their depositors’ accounts to bail themselves out. Not having to protect private banks from failure would also bring genuine competition to the financial sector, where firms would be free to compete fiercely based on the risks they are willing to take, and free to fail should they get it wrong. That is exactly how capitalism is supposed to work.

Finance made sustainable.  What we would also get is a financial model that no longer depends on the perpetual and exponential growth of private debt, and so no longer depends on the perpetual quantitative growth of economic activities. This means that the political system could finally direct the economic system to pursue more qualitative growth instead, where it is the growth of activities that benefit society that becomes the focus and dictates the agenda. That would deliver the outcomes that social and environmental advocates have been pursuing all along.

Clearly, a transition to a controlled money supply serves the interests of everyone and everything in the real and productive sector. It comes at no cost and delivers enormous benefits, both short term and long term. To summarise the list of benefits again:

Ending the dysfunction.  These destructive processes in the current system will be switched off or greatly diminished:

  • Wealth extraction from the 99% to the 1%
  • The exacerbation of the boom and bust cycle
  • The inflation of housing bubbles
  • The inflation of overinvestment and speculation bubbles
  • Bailing out financial institutions
  • The destruction of savings when a bank becomes insolvent
  • Stability of the system depending on the accelerating growth of private debt
  • Destructive public policy serving the imperative for perpetual debt growth

The benefits of properly designed finance.  We will see that the benefits of operating under the new model include:

  • Money is created debt free
  • Money is controlled to serve the real economy
  • Savings are fully guaranteed and held safely at central banks
  • People can decide how much of their money to invest, and so to put at risk
  • The financial system becomes much more stable
  • The state receives all revenues from creating money
  • The state receives an enormous payment from banks during the transition
  • Banks lend prudently or risk failure when the economy contracts
  • Banks have to compete for funds, rather than creating their own money
  • Political systems are free to pursue qualitative growth and better societies
  • The economic system can be made sustainable

Promise of Fixing Finance delivered?  If readers feel that some of these benefits are not fully demonstrated in the argument and resources here, then please raise objections via a comment. The goal here is to build an evolving argument that is increasingly persuasive, and as comprehensive as it takes to persuade a significant majority of the audience. This means that all valid objections and their responses will be incorporated into the argument, and so all reasonable critique is welcome and constructive.

There is probably not a single legitimate reason to oppose a transition to a sovereign money system. With the list of benefits so compelling, and the costs so high if we allow business-as-usual to continue into the next financial crisis, and potentially into a catastrophic collapse of global systems, it would be hard to justify not supporting the transition advocated here.

Advocating for change

Of course the political resistance to such a model of change would be enormous, given the unprecedented power the global banking system has to dictate terms to sovereign nations. The credit ratings issued by the ratings agencies directly impact the profitability and competitiveness of a sovereign nation’s businesses, so downgrades come at great political cost. If there is one thing that those in finance understand only too well, it is that leverage is everything.

So while the technical challenge of moving to a sovereign money system is quite straightforward, as promised, the only way to make this transition politically viable is a successful advocacy campaign, which builds understanding and political will for this model of change to levels that government can no longer ignore.

Your contribution to the necessary advocacy campaign depends on what you do next. Armed with the argument and knowledge you have now, you can make a contribution in a wide variety of ways:

  • share links to this article or other resources on the sovereign money model
  • ask questions if you need clarification of the argument presented here
  • make rational arguments that challenge the proposed model of change
  • talk with others about financial reform and the dysfunctions of the current system
  • leave a comment. whether critical or supportive of the argument
  • even just thinking more about the argument has to be a positive thing.

Anyone who is already advocating for effective climate policy or some other aspect of sustainability better try to get behind the sovereign money movement, because without fixing finance, fixing economics is impossible, and without fixing economics, sustainability is impossible.

Thanks for reading and stay tuned. Coming soon: Fixing Economics and Fixing Climate Change.

Review article by section: Finance for beginners, Boom and bust, The debt trading game, Too much money, Taking control, The benefits of control, Advocating for change

 

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Sue James
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Loved the article – a very clear explanation, with a number of new ideas for me to ponder. I’d not come across any of the resources or articles you draw on, and will definitely read those as well more closely when time permits. For now, I’m intrigued by the concept of a state-run Central Bank. The case for this, as you (and the resources you’ve used) have explained it, makes a great deal of sense. But I do have one question … probably more of a ‘what next’. If this system is established, what checks and balances would be advisable… Read more »

Anita Spinks
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Anita Spinks

A thorough lesson in finance for the financially illiterate. Well presented. I didn’t click on the links or play the videos though I would have done well to do so. I’ve had the concept of sovereign wealth and money creation explained to me in the past and I think I understand but certainly not at the level you’ve achieved here.

Bravo. Hope my comment goes through.

Ben
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Ben

Hi Brandon. Very interesting resource, and argument, you present here. Pros: lots of well-written, well-articulated material. Well-edited with a good flow, ending in positives – having outlined issues and problems, you provide outlines for solutions. Blog and page layout are clean and scan pretty well. Good fonts. Cons: Huge page – massive info dump, and massive expectation of the readers. Suggestion: breaking it up more via pictures / cartoons / artwork, also breaking it up into, say, three sections – global finance 101, how and why global finance sucks, solutions. That said, wow – you’ve provided a tonne of work… Read more »

John Roles
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John Roles

Hi Brandon
I have been aware of this concept and the work of Nicole Foss for many years. If people need a more detailed explaination of the real nature of money and how it is created, you may want to also reference Chris Martensen.

There is no real explanation of the possible transition actions that governments could take to (re)establish soverign money. I assume the transition path would be through increasing the proportional reserve rate from the current 10% progressively up to 100%. This is not mentioned.