Positive Money goes wrong on seigniorage.

This article by Positive Money claims that if government created all money, we’d have billions more to spend on health, education (and/or tax cuts). It sounds too good to be true, and it is.

I support Positive Money mainly because they advocate full reserve banking. But no two economists, amateur or professional, agree on everything, and I don’t agree with PM’ ideas on seigniorage. The first 2/3rds of the PM article is reproduced below (in green italics) interspersed with my comments.

The Bank of England still prints paper money (e.g. £10 notes). Because it only costs a few pence to print a £10 note, the government makes a profit on every single bank note that it prints. Between 2000 and 2009, this profit on newly-created money added up to £18 billion – enough to pay the salaries of around 90,000 nurses over that time.

More or less correct so far. That is, government can print extra money and spend it on whatever (and/or cut taxes) assuming the economy has spare capacity.

But the Bank of England only creates the paper money, and leaves it to banks to create the electronic money that we also use every day. When banks create money, they – not the government or the taxpayer – get the benefits of creating that money.

Now hang on: a commercial bank (“commbank”) when it monetises an asset cannot simply spend the money on wild parties for bank staff. In fact private banks just don’t spend the money they create: of course they charge interest and charge for the administration costs involved in that process and something to pay bank shareholders a dividend, but that’s it. That might typically come to roughly 5% of the total amount of money created per annum.

From 2002 to 2009, banks increased the amount of money in the UK by £1 trillion through lending (with every new loan creating new money). Because this money was created by banks, it’s the banks that get the benefit from it (in this case, the interest received on £1 trillion of additional loans).

Approximately correct. Thought strictly speaking, commbanks only charge borrowers interest because those banks have to pay interest to those who fund banks: depositors, bond-holders, shareholders, etc. In addition, commbanks obviously charge for administration costs as mentioned above. But that distinction between what might be called “genuine interest” and administration costs is perhaps a minor technical point.

If the government had created this money instead of the banks, taxpayers would have been able to pay up to £1 trillion less taxes: approximately £33,000 for every person who pays income tax over just 7 years.

Nope. Serious and major blunder there. As I pointed out above, commbanks do NOT SPEND the money they create. Thus if taxes are reduced by £1 trillion, then total or aggregate spending for the economy as a whole would rise by £1 trillion. Inflation would go thru the roof!!!! (Incidentally, I’m assuming for the sake of simplicity that when a household’s taxes are cut by £X, it’s spending rises by £X. Obviously households SAVE a proportion of any increased after tax income. Thus the rise in spending might be, at a wild guess, 75% of £1 trillion rather than £1 trillion. But still, inflation would go thru the roof.)

Put another way, if private money production had been banned at any of the periods since WWII when the economy was at capacity, where exactly is the capacity supposed to come from to meet the extra demand stemming from that extra trillion being spent? I’m mystified.

Because the profits from creating money currently go to the banks instead of to the government, the government has to borrow much larger amounts of money to make up for this lost income.

Nope. To repeat, private banks do not spend the money they create. Thus if private money creation is banned, there is no magic pot of extra money for government to spend. And as to the fact that those who borrow from commbanks spend what they borrow, that spending must be matched, all else equal (or assuming constant GDP) by others who spend less. In fact those “others” are the people who deposit money in banks for extended periods (i.e. who save or abstain from spending). (Rather than the latter constant GDP assumption, another more realistic assumption would be that the economy is at capacity and GDP is expanding at it’s average 2%pa or so and that it cannot expand faster as a result of extra demand coming from the above borrowing.)

The real flaw in private money creation is thus.

Commbank created money is a liability of such banks: a liability consisting of a SPECIFIC NUMBER of pounds / dollars. In contrast, commbanks’ ASSETS can decline in value dramatically (when they make silly loans). And when they do decline far enough, the bank is bust.

Indeed, assuming the 3% or so capital ratio that has been common in recent years, a commbank’s assets only have to decline by 4% in value, and the bank is technically insolvent: an absurd arrangement.

So to deal with that weakness or absurdity in our existing banking system, governments pile one absurdity on another: that is, to deal with the above inherent weakness in the current system (i.e. private money creation) governments stand behind or subsidise banks.

So . . . . dispose of private money creation (i.e. implement full reserve banking) and the tendency of banks to suddenly collapse disappears, second credit crunches stemming from those collapses disappear and third  the need for bank subsidies disappears.

QED.