Also created by commercial lending

Capitalism and sovereign money

Financial crises cannot be avoided simply through bypassing the commercial banks, argues Michael Roberts

On June 10, the Swiss voted down in a referendum a proposal known as ‘sovereign money’ (Vollgeld or Monnaie Pleine). This proposed to do away with ‘fractional banking’ and make the central bank the sole authority for creating money.

In the modern banking system, notes and coins - currency - (along with some special reserves) are created by the central bank. But this ‘monetary base’ only represents a small part of the total money supply in any economy. Instead, the majority of money is created by commercial banks, when they lend to consumers and businesses. When banks make loans to households, companies and other financial institutions, they create money deposits (because these loans then appear as deposits for the borrowers in the bank).

But the amount that banks have to keep as reserves to meet these depositors’ demands for cash - and as a buffer against any collapse in the value of the assets offered by the borrowers against their loans asset write-downs - is very small in comparison to their assets: just a fraction. That is because the risk of failure or non-repayment is low, as is the regular demand for cash. In practice, banks keep about 5% of liabilities as ‘fractional reserves’.

The Swiss sovereign money initiative proposed that all deposits have to be kept as reserves with the central bank. So the commercial banks’ ability to ‘create’ money through loans would disappear and, effectively, the central bank would be in sole charge of money supply.

Why do this? The argument is that commercial banks are inefficient in lending and cause regular financial crises. They tend to lend more for financial speculation rather than for productive investment and this leads to financial crashes. If the central bank holds all the country’s cash, it can control the lending and make sure it is for productive purposes. And the central bank could directly boost demand in the economy by expanding the money supply without the inefficient intermediary of the commercial banking system.

The sovereign money idea is not new, but has been revived because of the global financial crash and the long depression that has followed. It was previously mooted in the great depression of the 1930s - Chicago University ‘debt depression’ economist Irving Fisher put it forward then. More recently, some economists at the International Monetary Fund resurrected the idea in a working paper, ‘The Chicago plan revisited’ (IMF working paper WP/12/202).1 Several top Keynesian economists have also vigorously supported the idea - including Martin Wolf at the Financial Times2 and Steve Keen,3 the post-Keynesian economist.

Naturally, the monetary authorities are opposed to the idea because of the fear that governments could remove the ‘independence’ of the central bank and start to use the country’s cash deposits, which would be at the central bank, for their own purposes. They could also expand the money supply without any productive assets backing - thus leading to runaway inflation.

The other question is whether putting all the money supply in the hands of the central bank would stop future financial crashes. In fact the credit crunch and global financial crash of 2007-08 did not originate in commercial banking, but in investment banks like Bear Stearns and Lehman Brothers. These banks held no customer deposits and made no loans to households, but were engaged in speculative capital, like ‘exotic derivatives’. With ‘sovereign’ banking, such speculation would continue and could even increase in the commercial banking system.

I have dealt with this banking scheme in a previous article.4 As I argued then, sovereign money would only work if the banks were brought into public ownership and made part of an overall funding and investment plan. But if that happened there would be no need for it.

Behind these schemes is a belief that all that is wrong with capitalism is a bad monetary system and reckless bankers. Also there is the Keynesian belief that government-controlled money expansion can avoid crises and slumps by boosting ‘effective demand’. It is ironic that Keynes himself, with the experience of the great depression in the 1930s, came to the conclusion that monetary stimulus was inadequate to get economies out of slumps and eventually opted for fiscal stimulus.

The reality of the capitalist system is that only if profitability is sufficient will investment increase and lead to more jobs and then greater consumption. Artificial money creation by fiat from the government does not get round this - as the experience of ‘quantitative easing’ has already shown.

The outcome of a sovereign money scheme to bypass the banking system will not be a sustained economic recovery, but either a new bout of financial asset speculation or inflation - or both. It is not the banking system that has to be bypassed, but the capitalist system of production for profit that has to be replaced by planned investment under common ownership. Indeed, if the banking system is circumvented, the capitalist system of production will be thrown into greater confusion.

Michael Roberts blogs at https://thenextrecession.wordpress.com.


1. www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf.

2. www.ft.com/content/d27b000e-6810-11e8-8cf3-0c230fa67aec.

3. https://rwer.wordpress.com/2012/11/12/the-imf-gets-radical.

4. https://thenextrecession.wordpress.com/2013/02/21/helicopter-money-and-the-chicago-plan.