The monetary system and sovereign money

Table of Contents

1 INTRODUCTION

2 THE MONETARY SYSTEM
2.1 HOW THE MONETARY SYSTEM DOES NOT WORK
2.2 HISTORY OF MONETARY SYSTEM
2.2.1 THE MONEY CREATING PROCESS
2.2.2 CENTRAL BANKS
2.3 FINANCIAL SYSTEM TODAY

3 MONEY AND GROWTH
3.1 MONEY CREATION AND GROWTH
3.2 IS THERE A GROWTH IMPERATIVE ?

4 SOVEREIGN MONEY
4.1 THE BASIC IDEA OF SOVEREIGN MONEY
4.2 CONCLUSION : CAN SOVEREIGN MONEY DECREASE THE GROWTH IMPERATIVE ?

5 QUOTES

Abstract

According to the rising demand of sustainable economic models, based on the increasing awareness that our planet cannot withhold the current pressure of the continuous economic growth, this essay raises the question whether our current monetary system creates a growth imperative and if sovereign money is an alternative to overcome this growth imperative. The essay gives an introduction into the function of the two-tier, fractional reserve banking system and reflects the consequences of the “money creation privilege” of modern private banks. Moreover, it is discussed if and how this system creates a growth imperative in our economic system. Therefore, the neutrality theory of money is criticized as well as the common idea that interest creates growth. Furthermore, the pro-cyclical behavior of private banks and the lack of control of central banks is discussed as a possible reason for growth imperative. Still as a result there is no systemic necessity to growth based on the monetary system. The monetary system is not a driving condition of the economic growth, but it lays the necessary basis for growth. The essay concludes that it is questionable that the growth imperative can be avoided with sovereign money, especially because the causality goes from economic growth to money creation and not vice versa.

1 Introduction

In 2009, Rockström et. Al. defined a safe operating space for humanity translated into nine planetary boundaries. Transgressing these boundaries would cause abrupt, irreversible and unacceptable environmental changes to our planet, which would have huge influence on human existence on earth (Rockström et. Al. 2009: p. 472f.).

Still our current economic system depends on continuous growth, which leads to a state of overshoot, where our resource use is faster than the regeneration of the resources. The “earth overshoot day” foundation illustrates human resource exploitation by calculating the day of a year, when humanity’s resource exploitation exceeds the earth’s capacity to regenerate those resources in the given year. During the last decades this date has been continuously reached earlier (October 23 in 1987 vs August 1 in 2018) (Umweltbundesamt 2018).

There are several drivers of the predominant growth imperative in our economic system. Regarding the Uited Nation Sustainable Development Goals, growth is still a political goal with the aim to increase the Gross Domestic Product (GDP) as a common indicator for the well-being of humanity and to guarantee the stability of the society (United Nations 2018). Neoclassical economists see economic growth as the basis for increasing wealth in all societal layers (“a rising tide lifts all boats”).

Even though these paradigms might have been effective with regards to the overall growth of GDP we face new challenges which make a paradigm shift necessary. Continuous GDP growth does not necessarily lead to an increasing social well-being. We face an increasing gap between rich and poor people of the world and the limits of our planet are almost exhausted on various levels (Costanza, Robert 2009: p. 3f.). To prevent further transgression of the planetary boundaries the idea of post-growth or degrowth of our economic system is rising in societal as well as scientific circles (Kallis, Demaria, D’Alisa 2014: p.1f.). Even though a lot of underlying mechanism of our current system have been criticized for creating a growth imperative, the most underlying system – the monetary system – is often just a side note of this critique. Henry Ford was possibly not wrong by saying: "It is regrettable that people think about our monetary system, and of our economic structure, only in times of depression" (Ford News 1922: p.2).

The following essay will focus on the question if a post-growth society is possible within the structures of the current monetary system. It is therefore structured into three main parts. First of all, an insight into the function of the monetary system is given to make clear how the monetary system builds the basis for the continuous growth of our economy. In the second part the problems regarding the “money creation privilege” of the private banks should be discussed, especially with regards to its contribution to the growth imperative of our economy. Finally, “Sovereign money” is presented as an alternative approach and is evaluated for its effectiveness regarding the aim to overcome a systemic growth imperative.

2 The monetary System

2.1 How the monetary system does not work

Critics of the present monetary system already see a fundamental problem in the absence of a profound understanding of the monetary system in society as well as in science. Therefore, the starting point of this essay is to explain the commonly used multiplier model in order to analyze its problems and to transfer them into the larger context of today’s monetary system. The role of banks in the monetary system is often explained as follows (Huber 2010: S.44f).

A private bank receives a certain amount of reserves R from a central bank. Customers can lend money from the bank or save it on their accounts. In order to stay liquid and be able to pay out their customers if they want to get money, the private banks always need to hold a minimum reserve MR of their issued loans L in the amount of x percent of R. The Banks don’t need to hold all the money due to nearly equal inflows and outflows but relatively stable stocks. So, the amount of money a bank can lend is: L=R(1-MR) ^{R=Reserve ; MR=Minimum Reserves; L=Loans}

This continues iteratively, until the credit multiplier gradually reduced by L is zero. Finally, the sum of all credits is:

L=R/MR

Let’s assume R is 1000 and x=10 %. So, the bank can hand out loans in the amount of

10000:

10000/0.1 = 10000

If x would be only 0,02 the amount would be 50000.

Even though this model is consistent and partially accurate, it does not do justice to the complexity of the monetary system. It is not true that deposits of bank customers are lent by the bank (Huber 2010: p.45). To gain a deeper understanding of the mechanisms of the monetary system it is worth to have a look into the history of the money.

2.2 History of monetary system

2.2.1 The Money Creating Process

In the 17th century in England, the emerging trade lead to an increasing amount of gold in the hands of tradesman. For those it was a big risk to store all the gold at home. Therefore, a lot of tradesman started to store their gold at goldsmiths and payed a fee for their services (Binswanger 2015: p.53). In order to clarify which person had stored how much gold, the goldsmiths began to issue so called goldsmith notes, which could be exchanged for the corresponding gold value (Binswanger 2015: p.53f.). Instead of going back to the goldsmith again and again to exchange the goldsmith note for real gold, people just started to use the goldsmith notes as means of payment. Earlier or later the gold would have been brought back to the goldsmiths anyway. Sooner, goldsmiths enabled their customers to exchange a goldsmith note, regardless on which name it was issued, also they started to subdivide the goldsmith notes into smaller units. Furthermore, the goldsmiths united and made it possible to redeem a goldsmith note no matter where it was issued. Large goldsmiths accumulated a big amount of gold that was not reclaimed any more. To increase their profits, they handed out loans to earn interest. Due to the high profitability of this business, goldsmiths no longer claimed a fee from their customers but even started to pay interest on the deposited gold in order to gain new customers. Because of these activities, the goldsmith notes were only particularly covered with gold (Binswanger 2015: p.55). This system already faced problems that are still characteristic for our monetary system today. If the customers lost trust into the system (for example as a reaction on war) a lot of people wanted to exchange their goldsmith notes into gold. This rush of customers couldn’t be met by the goldsmiths (Bank runs).

But instead of turning back to a system where the deposited gold covers 100% of the goldsmith notes, the goldsmiths began to give loans in form of goldsmith notes instead of real gold (Binswanger 2015: p.59). With this step the money created by the goldsmiths was now on the liability side of the balance sheet – the process of “creating money” was born. This is illustrated by the following table:

Abbildung in dieser Leseprobe nicht enthalten

This possibility of - casually said - creating money out of nothing was the basis for the industrial revolution and continuous growth, which will be discussed later in more detail.

2.2.2 Central Banks

The two-tier banking system as we know it today was a result of the establishment of central banks which also has its root in England. In order to prevent inflation, the government-backed Bank of England had to maintain a high gold coverage of its banknotes (Herger 2016: p.17). In return they received the monopoly of creating banknotes from the governance. This was also a good business for the governance because they could finance wars with the help of the Bank of England. Due to the governmental support, the Bank of England became the largest player in the English financial system. Other banks therefore had to focus on new business regions, for example on the issue of checks. Small banks also started to exchange their gold for banknotes from the Bank of England. As a consequence of this centralization and an increased interconnectedness of the financial system, the Bank of England also started to serve as the “lender of last resort” for smaller banks to stabilize the financial system (Herger 2016: p.19).

This laid the foundation of the creation of modern central banks as we know them today.

2.3 Financial System today

Today’s financial system basically consists of three actors: central banks, private banks and non-banks (private households, private companies, etc.). The interactions between these actors are divided into two isolated stages (Illustration 1). This leads to three circuits of money: the interbank circulation between banks and central banks, the public circulation between banks and non-banks and the cash circle, which connects all three actors but is relatively unimportant due to the small amount of cash money circulation in the monetary system (Huber 2017: p.58). The interbank circle consists of the circulation of so-called reserves that a private bank can lend from a central bank.

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