Why the “Vollgelders” are right.

The Swiss vote today on whether to ban private banks from printing / creating money. A system where that ban in place is referred to in the German speaking world as “Vollgeld”, though such a system has several other names. I’ll stick to “Vollgeld” in the paragraphs below. I’ve explained a dozen times before why such a ban is desirable, but in celebration of this vote I’ll explain again.

First, it is often said that “money is a creature of the state”: that is (as is pretty obvious) there has to be general agreement in a country as to what the country’s basic form of money is – at least it’s much better if that agreement is in place. For example in the US, the basic form of money is Fed issued dollars. But of course any number of other items have performed the function of money throughout history: gold, cowrie shells (used in several countries), cattle, sticks, stones, you name it.

So let’s assume a hypothetical country wants to abandon barter and switch to a money based economy. An important question then arises, namely: what’s the best amount of money to issue? Well that’s easy: the more money people have, the more they will tend to spend, thus the optimum amount to issue is whatever results in enough spending to bring full employment, but no so much as to result in excess inflation.

Some readers will spot that I’ve assumed money can be created at will so as to issue that above optimum quantity. That’s the case with Bank of England pounds, Fed dollars, etc, but things are more difficult in that regard in a cowrie shell or gold based system. But never mind: so as to keep things relevant for the 21st century, let’s assume there is a central bank like the Fed which can issue whatever it thinks is the optimum amount of money.

Having done that, people will borrow from and lend to each other. And they’ll do that direct person to person. Plus organisations that specialise in intermediating between borrowers and lenders will be set up, i.e. commercial banks. People will deposit money at commercial banks among other reasons for safe keeping, and second with a view to the bank lending on that money at interest.

Now is there any reason why the rate of interest that results from that system would not be some sort of genuine free market rate? Not that I can see.


Commercial banks start to create money.

Next, let’s assume that commercial banks make the amazing discovery (which London “goldsmith bankers” actually made in the 1600s) namely that they do not actually need to acquire $X worth of deposits before lending out $X: they can simply issue or lend out “promises to pay” central bank money (or “promises to pay gold” in the case of those goldsmith bankers). Indeed that’s what commercial banks actually do nowadays: lend out promises to pay.

But notice that prior to that discovery, commercial banks had to pay interest to depositors in respect of every dollar loaned out, whereas under the “lend out promises” system there is no need to pay interest to anyone! Magic! Obviously banks are better off lending out home made money rather than money which they can only acquire by paying interest to someone. In fact banks will be able to cut interest rates and lend more.

Now is that an example of “if it sounds too good to be true, it probably is”? Well the answer is “yes” and for the following reasons.

The fact of commercial banks making extra loans increases demand: it’s stimulatory. But it was assumed above that enough central bank money had been issued to keep the economy at capacity / full employment. Thus government will have to impose some sort of deflationary measure to counter that excess demand: like raising taxes and confiscating central bank money from the population.

In short, banks, when they initiate to the above “lend out promises” do not create wealth out of thin air: the riches they have created for themselves and those they lend to have effectively been stolen from the general population. Plus the rate of interest is not at the above mentioned free market rate: it’s an artificially low rate. And as is widely agreed in economics, GDP is maximised where the price of everything is at its free market rate (including the price of borrowed money) except where there are good social reasons for thinking the price should be above or below the free market rate.

The above “stolen from the general population” explains why the Nobel laureate economist Maurice Allais claimed that what banks do is essentially counterfeiting: that is, for every fake $100 bill turned out by a traditional backstreet counterfeiter, government has to confiscate $100 from the general population so as to keep demand under control. I.e. the production of “promises to pay” has the same effect as creating fake $100 bills.

A possible objection to the above claim that the extra lending caused by “promises to pay” is inflationary is that while the initial effect of the extra lending will clearly be inflationary, that effect will die down once the “initially loaned” money has been spent. However, there is unfortunately another effect: the recipients of that new money will find themselves in possession of more money than they want (or the amount that brought about the above mentioned “full employment without excess inflation” scenario). They will therefor try to spend away that excess, which amounts to a permanent increase in demand.

As for the new borrowers / debtors, if they borrow $Y, spending that money obviously has an inflationary effect (as mentioned above), but then they gradually repay that $Y and they’ll have to cut their purchases of goods and services to do that, which amounts to an anti-inflationary effect. Over the long term the amount of new loans made per year roughly equals the amount of loan repayment (ignoring interest), the borrowers do not on balance add to or subtract from aggregate demand. Net effect: an increase in demand, which (as mentioned above) has to be negated, e.g. by extra taxes.