An intriguing proposal about how to rethink the global financial system is the notion of debt free money. This idea is typically raised in relation to the fact that the US Federal Reserve is not a central bank, it is a privately owned institution. The documentary “Secrets of Oz” details a long history of battles between American bankers and US presidents, with the bankers winning in 1913. The greenbacks issued by Abraham Lincoln were debt free money, for example. The documentary is worth watching, not necessarily for what it proposes as a solution, but for its history of wars between bankers and politicians, the latest of which we have just witnessed in the GFC.
The idea of debt free money is a questionable proposal for change. It is not going to happen any time soon and in America the contest was resolved in favour of bankers almost exactly a century ago. Moreover, this argument looks at the monetary system as a national phenomenon, when it has clearly become a global phenomenon with a life of its own. Still, it is worth considering for what it reveals about the situation in which we are now enmeshed and perhaps how the next crisis will be resolved when governments no longer have the financial fire power to produce another bailout. It also sheds light on the question of governance of the financial system. As previously suggested, governments have in this era of “financial de-regulation” handed over governance to the banks and traders, with predictable results.
First, I will list what I see as the flaws in the argument put forward by Bill Still in the “Secrets of Oz”:
- He blames the Depression and recessions on the use of bank issued money with debt. At best, this is a confusion of causation and correlation. The correlations are nowhere near as simple. There have been periods in which debt based money has been economically beneficial, there have been periods when it has been disastrous.
- He confuses ownership and control. Private banks may own the Fed, but that does not necessarily equate with private bank control. The Fed acts like a central bank for the most part, even though it is not government owned. Ownership did not confer influence for Lehmann Brothers in 2009. (Lehman was thought to have been one of the owners, although which banks own the Fed seems to be a point of considerable dispute). Equally, many central banks that are owned by their government do a perfectly good job of making a mess of their economies. That is not just a job for privately owned banks, it is a job for all bankers.
Let’s look at the current situation:
- We do have debt free money in most of the developed world. Central banks are running zero or near zero interest rates pretty much everywhere in developed economies, Australia being an exception. That is debt free money, although by the time it gets into the hands of actual business borrowers it has a very health interest rate on it. Someone is making a fortune on the spreads .. oh, banks of course.
- The idea that bankers can control the supply of money to get what they want partially applies. They are certainly more reluctant to lend to the “real” economy. But there is a whole level of meta money above that ($700 trillion of derivatives) which is money, so part of the money supply, sort of, which can be confected at will. The conceptualisation of money as a means of exchange, whose “supply” can be restricted has really become a thing of the past. It has become a disappearing point in which traders just make up their own rules.
Here, I think, is where the argument relates to what is happening.
- There is a ceaseless battle between bankers and governments, usually won by bankers in the first round. The second round is where we now are — governments having to fix up a mess and trying to take back the role of setting rules in order for the crisis not to happen again. Money defines the rules for a society and economy, and as the perennial wickedness of bankers becomes obvious, political leaders try to reassume control to restore the society. Obama, for the most part, ducked the issue, perhaps because, being overly generous, he had little choice. But the trend is slowly reasserting itself with an increased regulatory load being applied to the banks.
- Debt based money inevitably causes problems because the interest payments compound, bringing on crises as servicing the debt puts too much pressure on cash flows. That is especially a problem for governments. Whether or not governments can legitimately issue debt free money as proposed by Robert Zerliga is arguable. A number of Asian governments have done it for decades, especially Japan, without great results. But it is undoubtedly a bad idea for governments to rack up debt with an interest rate on it. Because the interest payments have to be serviced from increased taxation revenue it becomes a big problem in ageing economies. The only country that gets off the hook is America. Because it has the world’s reserve currency, there is always demand for whatever debt it issues. Europe, as we are seeing, does not escape. A considerable part of Australia’s strong position is due to Peter Costello in the Howard government refusing to run large deficits, unlike, for example, the Blair-Brown government. Government debt is vulnerable.
The argument about debt free money is a debate about whether to see money as a means of exchange, for utility only, or whether money should apply a cost-of-capital discipline to what happens in an economy. If money is debt free, there is no cost of capital, which, oddly, is pretty much exactly the situation in which we find ourselves. The crises in much of Asia, especially Japan’s implosion, show us what happens when there is no cost of capital. But one can point to many other crises, such as the Latin American debt crisis of the 1980s, when the compounding of interest eventually made a situation unsustainable. The answer to this dialectic is by no means clear cut.
What is clear is that bankers should be viewed with absolute and perpetual suspicion. Their behaviour goes in predictable patterns, and the patterns are routinely destructive. The GFC is just the latest iteration. Banking may be a necessary evil, but an evil it all too often is. It should be heavily monitored. Here is a description of how the bankers undid the greenback, Lincoln’s debt free money:
“Even after (Lincoln’s) death, the idea that America might print its own debt free money set off warning bells throughout the entire European banking community. On April 12th in 1866, the American congress passed the Contraction Act, allowing the treasury to call in and retire some of Lincoln’s greenbacks, With only the banks standing to gain from this, it’s not hard to work out the source of this action. To give the American public the false impression that they would be better off under the gold standard, the money changers used the control they had to cause economic instability and panic the people. This was fairly easy to do by calling in existing loans and refusing to issue new ones, a tried and proven method of causing depression. They would then spread the word through the media they largely controlled that the lack of a single gold standard was the cause of the hardship which ensued, while all this time using the Contraction Act to lower the amount of money in circulation.”
Little has changed about the behaviour of bankers. Only the complexity of the financial markets, and the bankers’ tricks, have changed.