Ann Pettifor has penned an effective rebuttal of the Chicago Plan, which has been taken up in the UK as “Positive Money”. Its advocates call for private banks to have their ability to create money taken from them, and put in the hands of a committee, independent of the state, that would decide on the level of money creation. Banks would be restricted to lending money that they already have on deposit.
Pettifor explains how the enthusiasm for the Chicago Plan rests on a fundamental misunderstanding of the nature of money and confusion about its relationship to credit. While readers may not like the notion that credit, and therefore money creation, is best left in the hands of banks, the problem is much like the one that Churchill articulated about democracy: it looks like the worst possible system until you consider the alternatives.
Pettifor points out that banks’ ability to create money out of thin air dates from 1694 in England. In addition to helping lower the cost of financing wars, an objective was to reduce interest rates to help facilitate commerce and end usury. If you read the works of early economists, one of their favorite topics was the need to end usurious lending, since businesses could not afford to borrow at those rates and survive, and so the money typically went to the most unproductive activities imaginable, namely, financing gambling by aristocrats.
Pettifor also stresses that she is no fan of banks and would support nationalizing them. But she points out that “…nationalising banks is a different proposition from nationalising (and centralising) money creation in the hands of a small ‘independent committee’.”
Here is the core of Pettifor’s article, which I strongly urge you to read in full:
In a recent paper, ‘Money creation in the modern economy’ Bank of England staff explained that: ‘[B]anks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits … Commercial banks create money, in the form of bank deposits, by making new loans.’ Because there is widespread confusion about the role of banks in creating money, it did not take long for the Bank of England’s report to ignite debate on the comment pages of the Financial Times. In his regular column, Martin Wolf called for private banks to be stripped of their power to create money….
Indeed, the notion to my mind is preposterous. It is an approach reminiscent of the misguided and failed monetarist policy prescriptions for controlling the money supply in the 1980s. Second, the proposal that only money already saved should be made available for lending assumes that money exists as a consequence of economic activity, and equals savings. But that is to get things the wrong way around. Rather, it is credit that functions as money, and it is credit that creates economic activity and employment. Deposits and/or savings are the consequence of the creation of credit and its role in stimulating investment and employment. Employment, as we all know from our own experience, generates income – wages, salaries, profits and tax revenues. A share of this income can then be set aside as savings. To restrict all economic activity to savings would be to contract economic activity to an ever-diminishing sum of existing savings. Furthermore, the restriction of all lending to existing savings would lead to higher rates of interest, because the level of savings is much lower than the level of potential economic activity and employment. Savers would be in a position to demand a higher return on the loan of their savings. This would return society to the dark ages, when investment and economic activity was subject to the whims of great feudal landowners, putting the financial elite in control of society’s surpluses or ‘savings’….
A return to a system based on existing savings would cause rates to rise, and once again harm both commercial activity and employment. And this is not to mention the role that high rates play in stratifying the imbalance of power between creditors and debtors, and with it poverty and inequality. Society’s long struggle to evolve away from dependence for economic life on the savings of the few (the ‘robber barons’) was precisely the point of the development of a sound monetary system. It called for a financial system that could provide the whole spectrum of society – individuals, farmers, entrepreneurs and the state – with affordable finance for the achievement of personal and public economic and social goals. If directed at productive activity, affordable finance can be used to meet society’s essential needs. In countries without sound monetary systems, there literally is no money. In these countries, only the savings of the fortunate are made available for lending at, invariably, usurious rates of interest. The result is that poverty is deeply entrenched, investment negligible and unemployment high.
Pettifor also stresses (without using this term) that the credit creation process results from demand for loans. We’ve seen in the US and in Japan how banks aren’t lending to small and medium-sized businesses, not due to miserly impulses, but lack of loan demand. Pettifor elaborates:
Without applications for loans, there would be no deposits. In other words, while the banker or bank clerk plays a critical risk assessment role in the ‘creation of money out of thin air’, and while the state plays an equally critical role in transforming that private loan into public fiat money, it is the myriad numbers of Britain’s borrowers who are the real spur for the creation of money. When entrepreneurs and other borrowers apply for loans, they help create money (deposits) ‘out of thin air’. If entrepreneurs and other borrowers do not apply for loans (because interest rates are too high, terms too tough, confidence low or business slack) the money supply shrinks, as now, and deflation may ensue. If the demand for and supply of loans exceeds the economy’s real potential then the money supply expands and inflation (of assets as well as wages and prices) is an inevitable consequence. In a well-managed monetary system, private bankers should be regulated by the central bank to ensure that applications for loans are carefully assessed as both affordable and repayable, and that loans are aimed at facilitating transactions between economic actors engaged in productive, income-generating activity. Lending or borrowing for gambling and speculation would be restrained or even prohibited. Speculation, after all, does not increase an economy’s productive capacity, but speculative fevers increase both the risk that borrowers will not make the capital gains needed to repay debts and wider systemic risk.
Readers may argue that there are no good regulators to be found these days. So pray tell why should we believe that we’ll be able to create what Lambert calls a “magic board,” a new body of wise men to whom we can safely entrust the power to create money? In a system with widespread corruption, a power node like that is an invitation to abuse. And that’s before you consider the much bigger issue that Pettifor raises, that relying on savings as the source for lending will inevitably send the economy down the path of greatly higher interest rates, more unemployment, and even greater inequality.
While banks have gotten such a bad name that it’s understandable that many want to reduce their role, the Chicago Plan would only give more power to the wealthy at the expense of ordinary citizens. Lending per se isn’t the problem, it’s letting banks not suffer the consequences of their recklessness and not being willing to restructure bad debts that should be the focus of reform efforts.