What If Banks Didn't Create Money?
A Swiss initiative to ban private banks from creating money has gathered enough signatures to put the matter to a referendum. This looks like another cranky economic idea that Swiss voters will throw out, as they did last year's proposal to require the country's central bank to keep at least a fifth of its balance sheet in gold. Yet perhaps such an experiment needs to be held somewhere to put to rest all the theoretical arguments about 100 percent reserve banking.
In the current financial system, private lenders create most of the money in circulation: Every time they issue a loan, they set up a matching deposit in the borrower's name, and since banks are only required to hold some 10 percent reserves against such claims, 90 percent of the deposits constitute new money. Central banks only influence the process through regulation. What the authors of the Swiss initiative want is a situation in which the Swiss National Bank becomes the sole creator of money.
Under such a system, private banks would only serve as intermediaries for citizens and businesses, in effect keeping current accounts with the central bank.
It's a variation on the so-called Chicago Plan developed by Henry Simons and supported by Irving Fisher in the 1930s. That plan amounted to making banks hold 100 percent reserves against all demand deposits, from which customers can withdraw money. That should make it impossible for bankers to inflate bubbles with risky lending, while making bailouts and other nasty consequences of financial crises obsolete. Banks would survive on the commissions they made for basic payment services -- the way PayPal does.
Under various versions of the scheme, commercial banks would also be allowed to accept time deposits, which are considered investments and would not be covered by the 100 percent reserves, and to borrow from the central bank to make loans. That wouldn't represent a return to the current system: The central bank would still be in full control of the amount of money created.
The 2008 financial crisis has brought the 1930s proposal back to life. Martin Wolf entertained it in a Financial Times column last year, and a 2012 International Monetary Fund working paper -- cited on the Swiss campaign's site as a supporting document -- found it workable, after testing it on a modern model of the U.S. economy. That paper also provided a detailed description of how the banking system would be reformed under a modern-day Chicago Plan. Greatly simplified, the idea is that the central bank would provide private banks with 100 percent reserves against their deposits, in return taking over most of the banks' loans, such as mortgages and consumer debt. This would result in a separation of the banks' basic payment and deposit keeping functions on one side, from risky lending on the other.
Here's the transfer scheme as presented in the paper (assets on the left, liabilities on the right; the numbers are in percent of gross domestic product):
This, of course, would mean cataclysmic change. In June 2015, Swiss banks had 1.58 trillion Swiss francs (about the same in U.S. dollars) worth of loans on their balance sheets -- about 230 percent GDP. Of that amount, 942 billion francs represented mortgage loans. The asset transfer, as described in the IMF paper, or even a process whereby banks would gradually repay the central bank for the 100 percent reserves, would be immensely complicated. Then, if banks are only allowed to lend money they have made from commissions and interest, borrowed from the central bank or from depositors, they will probably provide less funding to the economy than they are providing now.
One could argue that much less is needed if we are to avoid bubbles. In his FT column, Wolf said only 10 percent of U.K. bank lending was going to business sectors other than commercial property (it's a much bigger share in other countries, such as Germany, although property developers are big borrowers there, too). Yet small business owners and people planning to buy a first home would probably disagree with that logic. Proponents of a government monopoly on money creation say the central bank would take care to provide resources so the economy didn't choke, but relying on that is just a tiny step removed from central planning.
"The idea that the National Bank or any other government authority could determine the optimal quantity of money fully objectively and without any political influence is unrealistic," the pro-business think tank Avenir Suisse pointed out in response to the initiative.
The fall of Communism completely discredited the idea of a planned economy; even in the Soviet Union for about two decades before its collapse, few believed state planning could work. Somehow, the idea that governments are less evil and better at making financial decisions than private banks has survived that disaster. It's mainly the banks' fault: They have been flagrantly irresponsible. A state monopoly on money could test the theory, and Switzerland, where the central bank is disinclined to do crazy things and democratic institutions are more powerful than in most other places, could be an ideal proving ground.
It's conceivable that the Swiss National Bank wouldn't cause hyperinflation by printing tons of new money. It's possible, too, that non-bank companies would pick up the slack in mortgage and small business financing. Mutual lending -- a fashionable business now that technological platforms such as Lending Club have proven their viability -- could get a boost. There's no need to kill off entire financial markets to keep demand deposits and the payment system safe: It might be enough to move them outside the banking sector.
For the rest of the world, at least, it's a shame that the Swiss, reasonable and conservative as they are, will probably vote down the proposal. No other country is likely even to contemplate such a momentous reform and the debates raging among economists will keep going, without much real-world evidence to support the theories.
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