Are the Swiss Going To Revoke The Privileges of Private Banking? (Swiss Referendum 1/3)
A proposal to strip banks of their ability to create money goes to vote in Switzerland, economist Jo Michell discusses the issues at stake and their relevance to all modern capitalist economies
LYNN FRIES: It’s The Real News, coming to you from Geneva, Switzerland. I’m Lynn Fries. Should banks be stripped of their ability to create money? Under Switzerland’s system of direct democracy, that question will be brought to a yes-no vote. The vote will take place as a national referendum on the Swiss Sovereign Money Initiative. Under the Swiss system, if 100,000 people sign an official petition for a change in Switzerland’s written constitution, there has to be a national referendum on the proposed change. Advocates of the initiative claim the main advantage of the proposed reform would be a fairer and a more stable banking system. They say, for example, that, quote: “Sovereign money in a bank account is completely safe because it’s central bank money. It does not disappear when a bank goes bankrupt. Finance bubbles will be avoided because the banks won’t be able to create money anymore. The state will be freed from being a hostage, because the banks won’t need to be rescued with taxpayer’s money to keep the whole money transaction system afloat; i.e. the too big to fail problem disappears. The financial industry will go back to serving the real economy and society.”
Joining us to comment on this kind of reform of the monetary system and give us his take on it is Jo Michell, professor of economics at New W.E. Bristol, the University of the West of England. Welcome, Jo.
JO MICHELL: Hi. Thanks.
LYNN FRIES: Before we get to how this kind of proposed reform of the monetary system would change types of money that circulate throughout the economy, comment first on how things work now. The status quo.
JO MICHELL: OK. So, broadly speaking, there are two types of money which circulate in the monetary system. There’s the money which we all hold in our hands, bank notes, which are issued by the central bank, which is owned by the government. But then there’s the money which we hold in our bank accounts with private banks, our deposit accounts. And that money is created by the private banking system. It’s not created by a public body, by the government. So, broadly speaking, there are two places where money is created. One is the government-owned central bank, and the other is the private banking system which creates deposit money. Now, there’s one more slight complication here, which is that there’s a third kind of money which is created by the central bank, which is called reserves. And that is a money which is only held by the private banks. So when one private bank wants to pay another private bank, they can’t use the kind of money we use. They use something called reserves at the central bank. So I suppose there are three main types of money.
LYNN FRIES: And so in the monetary system today, the only sovereign money available to the public are coins and banknotes, physical money.
JO MICHELL: That’s right. By sovereign money, the people proposing the referendum mean money which is created by the government. And sort of the implication is money which is controlled by the government, which actually is not quite the same thing, but money which is created by the government has two forms, bank notes and coins, which are held by the public, and as you say are therefore the only type of sovereign money available to the public. And reserves, which are what the banks use to make payments between themselves.
LYNN FRIES: Proponents of the Swiss Sovereign Money Initiative have disclosed that their proposal is essentially based on the monetary system reform advocated by the UK-based Positive Money. Comment on this quote from the Positive Money website: “Most of the money in our economy is created by banks, in the form of bank deposits – the numbers that appear in your account. Banks create new money whenever they make loans. 97% of the money in the economy today is created by banks, while just 3 percent is created by the government.”
JO MICHELL: That point is broadly correct. The 97% number refers to the UK economy, where the Positive Money group are based. But I think it’s broadly comparable in many other economies. Probably the Swiss economy, too. So the point they start from, which is that every time a bank makes a loan it essentially out of nowhere creates new money, is correct. I mean, there are complications and limits and so on, but the basic point, I think, is broadly correct. And people do find this surprising, because it seems something so important and fundamental, and for most difficult to get hold of, i.e. money, could actually just be magic’d into thin air in this way by the banking system. But it is broadly correct, that view.
LYNN FRIES: Comment on the Chicago plan of the 1930s as the original blueprint for this kind of proposed reform of the monetary system.
JO MICHELL: Yes. So the original blueprint, or something very similar to the Positive Money and Swiss referendum proposals, came from a group of Chicago economists in the 1930s. And that’s why it’s called the Chicago plan. And the plan was to strip banks of this ability, to strip private banks of this ability, when they make a loan to issue new money. And the way that you do that is you prevent banks, money-issuing banks, from making loans. Instead of lending to the public, all they’re allowed to do is just hold on their balance sheet this special money created by the central bank called reserves.
So every customer account at a private bank is matched exactly by sovereign money, as they call it, by reserves at the central bank. And that means that central bank can choose exactly how how big, or how large, the amount of money in the economy is, because by changing the amount of the money it issues, it directly changes the amount of deposits that the public holds.
LYNN FRIES: When we hear terms like fractional reserve banking or fiat money, is that what this is about?
JO MICHELL: It’s about ending fractional reserve banking. Now, what fractional reserve banking means is that private commercial banks have to hold a small amount of this central bank-issued money on their balance sheets. But most of what they have as assets is loans to the public. And that is something they can change, by and large, you know, at will. They can decide when they want to make more loans. And by making more loans they issue new deposits i.e. they create new money. Now, if they’re not allowed to make those loans anymore, all they’re allowed to do is hold these reserves at the central bank, to hold this sovereign money, then effectively it prevents them from making new loans, issuing new money. And the whole of their balance sheet, or all of their assets, 100% of their assets just become reserves at the central bank. So that’s why it’s sometimes called 100% reserve banking.
LYNN FRIES: Walk us through how this fits on a typical bank balance sheet.
JO MICHELL: OK. So on the asset side of the balance sheet we can see two types of financial assets. One is reserves. These are the money balances created by the central bank. And the other is loans. Loans to households, loans, ideally, to businesses, that help the productive economy function. On the liability side of the bank’s balance sheet, we see deposits. The things that, as customers, we hold. We think of-. To us, to individuals, a deposit is an asset. It’s something we can use. We can spend. But to a bank it’s a liability, meaning it’s something they have to make sure they fulfill certain obligations. And the obligation they have is actually that if I come to the bank, and I have a deposit, and I say, I don’t want this anymore, I want cash. I want real, physical, hard cash, the bank has to give me that money at the point I demand it.
So that’s, it’s a relationship between the customer and the bank. And it’s called a deposit. But we use it as money. We can almost everywhere use deposits directly to pay for goods, to buy a cup of coffee. I can just walk into the cafe very near this office. I can wave my card or my phone near the till, and it just automatically takes something from my deposit balance and moves it to somebody else’s deposit balance. So it functions as money.
LYNN FRIES: Again, using a typical bank balance sheet, show us the two ways deposits can grow.
JO MICHELL: OK. So, broadly speaking, there are two ways in which that simple bank balance sheet which we’re looking at, the deposit side of that balance sheet, can get bigger. The first one is the one probably which most people intuitively think of, which is when we make a deposit. That’s why the name deposit is there. And let me give you an example of this. Let’s say I’ve got 100 euros in cash in my hand, and I decide I don’t want to carry round with me for whatever reason. So I walk into a bank. I walk into a physical bank. I hand over 100 euros in cash, and in return they change the balance, the electronic balance, on my deposit account. And it increases by 100 euros. So I have 100 euros less cash, and I have a 100 euros more of a deposit balance. So effectively the quantity of money, to me and to the economy as a whole, hasn’t changed. So that’s the first way in which the deposits in the commercial banking system can change.
However, that’s actually a very small proportion of the kinds of transactions which do produce changes in deposit balances. The majority comes when a bank decides they want to make a new loan. And of course they need a customer to make a new loan, and a customer has to decide they want to take a loan now. But once the bank has decided the customer is creditworthy enough to make a loan, then they can simply increase the deposit balance for that customer at will. Then at the time it makes new loans, simply add numbers to customer deposit balances. And this is how the majority of new money [is put] into circulation in our economy.
LYNN FRIES: Essentially, then, what’s being talked about in comments, like banks have a license to print money, banks create money out of thin air, is that mechanism.
JO MICHELL: Exactly. This ability for banks to create new deposits pretty much at will, out of thin air, by making a loan to customers. Now, each individual bank does face limits to how much it can can do this. The banking system as a whole, i.e. all of the private banks in a particular country or in a particular currency area, faces much less tight restrictions on this. So the banking system as a whole is capable of expanding the money supply by making new loans. And we see in boom periods, we see credit booms where bank lending is very rapid, the money supply grows very rapidly. This, broadly speaking, this characterizes the 2001 to 2007 period in the United States, for example, where there was a lot of lending against real estate, and so on.
LYNN FRIES: Earlier in the conversation, you broadly agreed with the Positive Money description of how banks create money. Comment now on the next part of that quote, which goes on to say that: “The flipside to this creation of money is that with every new loan comes a new debt. This is the source of our mountain of personal debt. Not borrowing from someone else’s life savings, but money that was created out of nothing by banks. Eventually the debt burden became too high, resulting in the wave of defaults that triggered the financial crisis.”
JO MICHELL: I still broadly agree with the description of what happened. There was a boom in bank lending. The bank lending was against the customers who, in many cases, were not going to be able to repay, or was imposing debt burdens on people who would not be able to service them. That lending did create new money balances. And in a way, it is a result of the banks’ ability to issue money at will. I suppose where I disagree with Positive Money is their solution to this particular problem of excessive household debt, whether it’s mortgage debt or credit card debt, is to strip banks of the ability to make loans.
LYNN FRIES: Let’s talk about that next. We’re going to break and be back with our guest, Jo Michell, for Part 2 of this conversation. Jo Michell, thank you.
JO MICHELL: Thank you very much.
LYNN FRIES: And thank you for joining us on The Real News Network.
Link to Full Series here