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IMF's epic plan to conjure away debt and dethrone bankers


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http://www.telegraph.co.uk/finance/comment/9623863/IMFs-epic-plan-to-conjure-away-debt-and-dethrone-bankers.html

So there is a magic wand after all. A revolutionary paper by the International Monetary Fund claims that one could eliminate the net public debt of the US at a stroke, and by implication do the same for Britain, Germany, Italy, or Japan.

IMF_2175747b.jpg

One could slash private debt by 100pc of GDP, boost growth, stabilize prices, and dethrone bankers all at the same time. It could be done cleanly and painlessly, by legislative command, far more quickly than anybody imagined.

The conjuring trick is to replace our system of private bank-created money -- roughly 97pc of the money supply -- with state-created money. We return to the historical norm, before Charles II placed control of the money supply in private hands with the English Free Coinage Act of 1666.

Specifically, it means an assault on "fractional reserve banking". If lenders are forced to put up 100pc reserve backing for deposits, they lose the exorbitant privilege of creating money out of thin air.

The nation regains sovereign control over the money supply. There are no more banks runs, and fewer boom-bust credit cycles. Accounting legerdemain will do the rest. That at least is the argument.

Some readers may already have seen the IMF study, by Jaromir Benes and Michael Kumhof, which came out in August and has begun to acquire a cult following around the world.

Entitled "The Chicago Plan Revisited", it revives the scheme first put forward by professors Henry Simons and Irving Fisher in 1936 during the ferment of creative thinking in the late Depression.

Irving Fisher thought credit cycles led to an unhealthy concentration of wealth. He saw it with his own eyes in the early 1930s as creditors foreclosed on destitute farmers, seizing their land or buying it for a pittance at the bottom of the cycle.

The farmers found a way of defending themselves in the end. They muscled together at "one dollar auctions", buying each other's property back for almost nothing. Any carpet-bagger who tried to bid higher was beaten to a pulp.

Benes and Kumhof argue that credit-cycle trauma - caused by private money creation - dates deep into history and lies at the root of debt jubilees in the ancient religions of Mesopotian and the Middle East.

Harvest cycles led to systemic defaults thousands of years ago, with forfeiture of collateral, and concentration of wealth in the hands of lenders. These episodes were not just caused by weather, as long thought. They were amplified by the effects of credit.

The Athenian leader Solon implemented the first known Chicago Plan/New Deal in 599 BC to relieve farmers in hock to oligarchs enjoying private coinage. He cancelled debts, restituted lands seized by creditors, set floor-prices for commodities (much like Franklin Roosevelt), and consciously flooded the money supply with state-issued "debt-free" coinage.

The Romans sent a delegation to study Solon's reforms 150 years later and copied the ideas, setting up their own fiat money system under Lex Aternia in 454 BC.

It is a myth - innocently propagated by the great Adam Smith - that money developed as a commodity-based or gold-linked means of exchange. Gold was always highly valued, but that is another story. Metal-lovers often conflate the two issues.

Anthropological studies show that social fiat currencies began with the dawn of time. The Spartans banned gold coins, replacing them with iron disks of little intrinsic value. The early Romans used bronze tablets. Their worth was entirely determined by law - a doctrine made explicit by Aristotle in his Ethics - like the dollar, the euro, or sterling today.

Some argue that Rome began to lose its solidarity spirit when it allowed an oligarchy to develop a private silver-based coinage during the Punic Wars. Money slipped control of the Senate. You could call it Rome's shadow banking system. Evidence suggests that it became a machine for elite wealth accumulation.

Unchallenged sovereign or Papal control over currencies persisted through the Middle Ages until England broke the mould in 1666. Benes and Kumhof say this was the start of the boom-bust era.

One might equally say that this opened the way to England's agricultural revolution in the early 18th Century, the industrial revolution soon after, and the greatest economic and technological leap ever seen. But let us not quibble.

The original authors of the Chicago Plan were responding to the Great Depression. They believed it was possible to prevent the social havoc caused by wild swings from boom to bust, and to do so without crimping economic dynamism.

The benign side-effect of their proposals would be a switch from national debt to national surplus, as if by magic. "Because under the Chicago Plan banks have to borrow reserves from the treasury to fully back liabilities, the government acquires a very large asset vis-à-vis banks. Our analysis finds that the government is left with a much lower, in fact negative, net debt burden."

The IMF paper says total liabilities of the US financial system - including shadow banking - are about 200pc of GDP. The new reserve rule would create a windfall. This would be used for a "potentially a very large, buy-back of private debt", perhaps 100pc of GDP.

While Washington would issue much more fiat money, this would not be redeemable. It would be an equity of the commonwealth, not debt.

The key of the Chicago Plan was to separate the "monetary and credit functions" of the banking system. "The quantity of money and the quantity of credit would become completely independent of each other."

Private lenders would no longer be able to create new deposits "ex nihilo". New bank credit would have to be financed by retained earnings.

"The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business," says the IMF paper.

"Rather, banks would become what many erroneously believe them to be today, pure intermediaries that depend on obtaining outside funding before being able to lend."

The US Federal Reserve would take real control over the money supply for the first time, making it easier to manage inflation. It was precisely for this reason that Milton Friedman called for 100pc reserve backing in 1967. Even the great free marketeer implicitly favoured a clamp-down on private money.

The switch would engender a 10pc boost to long-arm economic output. "None of these benefits come at the expense of diminishing the core useful functions of a private financial system."

Simons and Fisher were flying blind in the 1930s. They lacked the modern instruments needed to crunch the numbers, so the IMF team has now done it for them -- using the `DSGE' stochastic model now de rigueur in high economics, loved and hated in equal measure.

The finding is startling. Simons and Fisher understated their claims. It is perhaps possible to confront the banking plutocracy head without endangering the economy.

Benes and Kumhof make large claims. They leave me baffled, to be honest. Readers who want the technical details can make their own judgement by studying the text here.

The IMF duo have supporters. Professor Richard Werner from Southampton University - who coined the term quantitative easing (QE) in the 1990s -- testified to Britain's Vickers Commission that a switch to state-money would have major welfare gains. He was backed by the campaign group Positive Money and the New Economics Foundation.

The theory also has strong critics. Tim Congdon from International Monetary Research says banks are in a sense already being forced to increase reserves by EU rules, Basel III rules, and gold-plated variants in the UK. The effect has been to choke lending to the private sector.

He argues that is the chief reason why the world economy remains stuck in near-slump, and why central banks are having to cushion the shock with QE.

"If you enacted this plan, it would devastate bank profits and cause a massive deflationary disaster. There would have to do `QE squared' to offset it," he said.

The result would be a huge shift in bank balance sheets from private lending to government securities. This happened during World War Two, but that was the anomalous cost of defeating Fascism.

To do this on a permanent basis in peace-time would be to change in the nature of western capitalism. "People wouldn't be able to get money from banks. There would be huge damage to the efficiency of the economy," he said.

Arguably, it would smother freedom and enthrone a Leviathan state. It might be even more irksome in the long run than rule by bankers.

Personally, I am a long way from reaching an conclusion in this extraordinary debate. Let it run, and let us all fight until we flush out the arguments.

One thing is sure. The City of London will have great trouble earning its keep if any variant of the Chicago Plan ever gains wide support.

Pretty sure if this were to happen Iraqi currency would increase in value. Iraq has a GDP similar to Greece but a currency way way way worse than it.

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THX SS!! They were talking about this back in August, here's an article from then and the IMF working paper on it's benefits:

http://www.positivemoney.org.uk/2012/08/imf-working-paper-offers-supports-full-reserve-banking/

IMF Working Paper Offers support for Full Reserve Banking

Mon, 13th Aug 2012by Mira Tekelova (Positive Money)31 CommentsWe’ve been in a state of mild shock since Saturday, after discovering strong support for full reserve banking from a working paper by economists at the International Monetary Fund (IMF), an institution that many have come to see as preserving the status quo and protecting the banking sector against the interests of ordinary people.

The discussion paper “The Chicago Plan Revisited” supports the proposals of Irving Fisher – those which are the basis for Positive Money’s proposals - using state of the art economic modelling.

In their summary the authors write [our emphasis]:

At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve backing for deposits.

Irving Fisher (1936) claimed the following advantages for this plan:

(1) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money.

(2) Complete elimination of bank runs.

(3) Dramatic reduction of the (net) public debt.

(4) Dramatic reduction of private debt, as money creation no longer requires simultaneous debt creation.

We study these claims by embedding a comprehensive and carefully calibrated model of the banking system in a DSGE model of the U.S. economy. We find support for all four of Fisher’s claims.

Here are few extracts from the paper:

We therefore conclude that Fisher’s (1936) claims regarding the Chicago Plan, as listed in the abstract of this paper, are validated by our model.

The effectiveness of countercyclical policy would be further enhanced under the Chicago Plan relative to present monetary arrangements. ank runs can obviously be completely eliminated… It would lead to an instantaneous and large reduction in the levels of both government and private debt, because money creation no longer requires simultaneous debt creation…

By validating these claims in a rigorous, microfounded model, we were able to establish that the advantages of the Chicago Plan go even beyond those identified by Fisher (1936)…

One additional advantage is large steady state output gains due to the removal or reduction of multiple distortions, including interest rate risk spreads, distortionary taxes, and costly monitoring of macroeconomically unnecessary credit risks.

Another advantage is the ability to drive steady state inflation to zero in an environment where liquidity traps do not exist… This ability to generate and live with zero steady state inflation is an important result, because it answers the somewhat confused claim of opponents of an exclusive government monopoly on money issuance, namely that such a monetary system would be highly inflationary. There is nothing in our theoretical framework to support this claim. And as discussed in Section II, there is very little in the monetary history of ancient societies and Western nations to support it either.

The History of Monetary Thought in Section II is very interesting and certainly worth reading is the analysis of Government versus Private Control over Money Issuance (p 12).

On the other hand, the historically and anthropologically correct state/institutional story for the origins of money is one of the arguments supporting the government issuance and control of money under the rule of law. In practice this has mainly taken the form of interest-free issuance of notes or coins, although it could equally take the form of electronic deposits.

The historical debate concerning the nature and control of money is the subject of Zarlenga (2002), a masterful work that traces this debate back to ancient Mesopotamia, Greece and Rome. Like Graeber (2011), he shows that private issuance of money has repeatedly led to major societal problems throughout recorded history, due to usury associated with private debts. Zarlenga does not adopt the common but simplistic definition of usury as the charging of “excessive interest”, but rather as “taking something for nothing” through the calculated misuse of a nation’s money system for private gain.

To summarize, the Great Depression was just the latest historical episode to suggest that privately controlled money creation has much more problematic consequences than government money creation. Many leading economists of the time were aware of this historical fact. They also clearly understood the specific problems of bank-based money creation, including the fact that high and potentially destabilizing debt levels become necessary just to create a sufficient money supply, and the fact that banks and their fickle optimism about business conditions effectively control broad monetary aggregates. The formulation of the Chicago Plan was the logical consequence of these insights.

Here is the link to the actual working paper on the benefits of this plan:

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

#1.

The first advantage of the Chicago Plan is that it permits much better control of what Fisher and many of his contemporaries perceived to be the major source of business cycle fluctuations, sudden increases and contractions of bank credit that are not necessarily driven by the fundamentals of the real economy, but that themselves change those

fundamentals. In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of

a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits. Because additional bank deposits can only be created through additional

bank loans, sudden changes in the willingness of banks to extend credit must therefore not only lead to credit booms or busts, but also to an instant excess or shortage of money, and

therefore of nominal aggregate demand. By contrast, under the Chicago Plan the quantity of money and the quantity of credit would become completely independent of each other.

This would enable policy to control these two aggregates independently and therefore more effectively. Money growth could be controlled directly via a money growth rule. The

control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business.

Rather, banks would become what many erroneously believe them to be today, pure intermediaries that depend on obtaining outside funding before being able to lend. Having to obtain outside funding rather than being able to create it themselves would much reduce the ability of banks to cause business cycles due to potentially capricious changes

in their attitude towards credit risk.

#2.

The second advantage of the Chicago Plan is that having fully reserve-backed bank deposits would completely eliminate bank runs, thereby increasing financial stability, and

allowing banks to concentrate on their core lending function without worrying about instabilities originating on the liabilities side of their balance sheet.

The elimination of bank runs will be accomplished if two conditions hold. First, the banking system’s monetary liabilities must be fully backed by reserves of government-issued money, which is of course true under the Chicago Plan. Second, the banking system’s credit assets must be funded by non-monetary liabilities that are not subject to runs. This means that policy needs to ensure that such liabilities cannot become near-monies.

The literature of the 1930s and 1940s discussed three institutional arrangements under which this can be

accomplished. The easiest is to require that banks fund all of their credit assets with a combination of equity and loans from the government treasury, and completely without

private debt instruments. This is the core element of the version of the Chicago Plan considered in this paper, because it has a number of advantages that go beyond decisively

preventing the emergence of near-monies. By itself this would mean that there is no lending at all between private agents. However, this can be insufficient when private agents

exhibit highly heterogeneous initial debt levels. In that case the treasury loans solution an be accompanied by either one or both of the other two institutional arrangements.

One is debt-based investment trusts that are true intermediaries, in that the trust can only lend government-issued money to net borrowers after net savers have first deposited these funds in exchange for debt instruments issued by the trust. But there is a risk that these debt instruments could themselves become near-monies unless there are strict and

effective regulations. This risk would be eliminated under the remaining alternative, investment trusts that are funded exclusively by net savers’ equity investments, with the

funds either lent to net borrowers, or invested as equity if this is feasible (it may not be feasible for household debtors).

We will briefly return to the investment trust alternatives

below, but they are not part of our formal analysis because our model does not feature heterogeneous debt levels within the four main groups of bank borrowers.

#3.

The third advantage of the Chicago Plan is a dramatic reduction of (net) government debt. The overall outstanding liabilities of today’s U.S. financial system, including the

shadow banking system, are far larger than currently outstanding U.S. Treasury liabilities. Because under the Chicago Plan banks have to borrow reserves from the treasury to fully back these large liabilities, the government acquires a very large asset vis-à-vis banks, and government debt net of this asset becomes highly negative.

Governments could leave the separate gross positions outstanding, or they could buy back government bonds from

banks against the cancellation of treasury credit. Fisher had the second option in mind, based on the situation of the 1930s, when banks held the major portion of outstanding government debt. But today most U.S. government debt is held outside U.S. banks, so that the first option is the more relevant one. The effect on net debt is of course the same,

it drops dramatically.

In this context it is critical to realize that the stock of reserves, or money, newly issued by the government is not a debt of the government. The reason is that fiat money is not

redeemable, in that holders of money cannot claim repayment in something other than money. Money is therefore properly treated as government equity rather than government debt, which is exactly how treasury coin is currently treated under U.S. accounting conventions (Federal Accounting Standards Advisory Board (2012)).

#4.

The fourth advantage of the Chicago Plan is the potential for a dramatic reduction of private debts. As mentioned above, full reserve backing by itself would generate a highly

negative net government debt position. Instead of leaving this in place and becoming a large net lender to the private sector, the government has the option of spending part of the windfall by buying back large amounts of private debt from banks against the cancellation of treasury credit.

Because this would have the advantage of establishing

low-debt sustainable balance sheets in both the private sector and the government, it is plausible to assume that a real-world implementation of the Chicago Plan would involve

at least some, and potentially a very large, buy-back of private debt. In the simulation of the Chicago Plan presented in this paper we will assume that the buy-back covers all

private bank debt except loans that finance investment in physical capital.

We study Fisher’s four claims by embedding a comprehensive and carefully calibrated model of the U.S. financial system in a state-of-the-art monetary DSGE model of the U.S.

economy.

We find strong support for all four of Fisher’s claims, with the potential for

much smoother business cycles, no possibility of bank runs, a large reduction of debt levels

across the economy, and a replacement of that debt by debt-free government-issued money.

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