Sovereign Money System

Definition

Andrea Leadsom:

"“Under a sovereign monetary system it would be the state not banks creating new money. The central bank via a committee would decide how much money is created and this money would mostly be transferred to the government. Lending would then come from the pool of customer’s investment account deposits held by commercial banks." (http://www.positivemoney.org/2014/11/sovereign-money-response-andrea-leadsom-economic-secretary-treasury/)

Discussion

Positive Money responds to seven questions:

(from by Andrea Leadsom MP, the Economic Secretary to the Treasury in the UK)

"1) “How would that committee assess how much money would be created to meet the inflation targets and support the economy?”

Today the Bank of England’s Monetary Policy Committee is responsible for setting interest rates as a very indirect way of influencing how much money banks create. The 9-person committee has a team of researchers, access to a wealth of data about the health of the economy, and spend up to 2 days deliberating before casting their vote to raise or lower interest rates.

In a sovereign money system, the process would be much the same, but instead of raising or lowering interest rates, the Monetary Policy Committee (or a new Money Creation Committee) would directly increase or decrease the rate at which new money is created by the Bank of England. (The banks by this point would no longer be able to create money.) Show More...

2) “If the central bank had the power to finance government’s policies what would the implications be for the credibility of the fiscal framework and the governments ability to borrow from the market if it needed to?”

This relates to the fear that if the government is allowed to create money directly, it will get carried away and print money to pay for every white elephant or vote-winning project they can think of. It is thought that even the fear that this might happen is enough to scare investors in financial markets to the extent that they’ll stop buying the government’s bonds. This is normally put fowards as the reason for prohibiting governments from creating money, and placing that power in the hands of commercial banks, who we know would never use it recklessly or excessively(!).

It doesn’t take much thought to find an answer to this. Show More...

3) “What would the impact of the availability of credit for businesses and households?”

This is certainly a topic that requires greater study, and we will be releasing a paper on this in the near future. But a few points are important here:

Banks would still be able to lend; they’d just need to get money from savers before they could do so. The amount of credit provided by banks to households to date has been totally excessive. Because most of it went into property (through mortgages) it has resulted in a huge increase in the cost of housing relative to salaries. There is an appropriate amount of credit: enough to allow people to buy houses, but not enough to push the price of those houses up at 20% or more in the space of a year. With regards to credit provides to businesses: o Only around a tenth of UK banks’ loans are to businesses. Lending to business is a sideshow compared to their main business (i.e. lending secured on property).

o Around 66% of SMEs (small and medium enterprises) said they never used bank loans anyway. Instead, they finance their investment through retained profits and other sources of funding.

o In a survey of UK businesses, the majority said that the primary barrier to their growth was not their access to finance from banks, but whether they could increase their sales. In other words, to boost the economy, we need more money in consumers’ pockets. Sovereign money makes it possible to get money in consumers’ pockets without relying on them to take on ever greater amounts of debt.

4) “Wouldn’t credit become very pro-cyclical?”

Leadsom doesn’t elaborate here, meaning that we have to guess what her thinking was on this point.

Clearly, the level of credit is already hugely pro-cyclical. Banks provide too much credit (and therefore create too much money) when the economy is growing, leading to the kind of debt-fuelled boom we had before the financial crisis. Then, in the recession, they restrict their lending (therefore restricting their money creation), which makes the recession worse. You can read more about this process here, but it’s clear that credit is already procyclical, and it’s hard to imagine that it would become even more so. Show More...

5) “Wouldn’t we incentivise financing households over businesses, because in the case of businesses presumably expect the state to step in?”

It’s hard to make sense of this point, and Leadsom doesn’t elaborate, so we’ll have to guess at what she means.

Leadsom suggests we would incentive financing households over businesses because “presumably the state would step in” [to lend to businesses?]. But this point makes no sense. Firstly, in a sovereign money system, the Bank of England would be able to create money to lend to banks so that those banks could lend more to businesses. But this money goes through the banks, not around them. The banks would therefore have a role to play in lending to businesses. Why would this incentivise banks to not lend to business? Show More...

6) “Wouldn’t we be encouraging the emergence of an unregulated set of new shadow banks?”

The argument here is that by prohibiting banks from creating money, a whole collection of companies that are not banks but act like them will spring up and start creating equivalent substitutes for money, in effect creating the same situation we have today.

Most shadow banks are simply entities that behave like banks but avoid registering as banks in order to escape regulation. So the government approach to shadow banks should really be, “If it looks like a bank and behaves like a bank, then regulate it as a bank.” And who has responsibility for making sure that the regulators do their job properly? Funnily enough, Andrea Leadsom, the City Minister. Show More...

7) “And wouldn’t the introduction of totally new system untested across modern advanced economies create unnecessary risk at a time when what people need is stability?”

This final point rests on the assumption that the current system can provide ’stability’, and that the government’s reforms since the crisis have been adequate. But even her own Prime Minister has recently been warning about danger signs in the global economy, and the former head of the Financial Services Authority, Adair Turner, has been warning about the dangers of rising household debt for financial stability.

Right now, what Leadsom thinks is ‘stability’ may in fact be the calm before the storm. The point of a sovereign money system is that it should provide greater stability.

8) Concerns about the makeup of the committee that would create money.

Leadsom makes a rather silly point, parrotting points made earlier by Ann Pettifor. Leadsom says:

“And of course bearing in mind our current set of regulators we would presumably then be looking at a committee of middle aged white men making the decision on what the economy needs and that’s also would be a significant concern to me were that to happen. “

Yes, the Monetary Policy Committee, which makes decisions on interest rates, is made up of white, middle class, middle aged men with similar backgrounds. Until now, I have not heard Leadsom campaigning for the Monetary Policy Committee to be made more representative or diverse, so it’s interesting that she has suddenly taken an interest. Presumably if she objects to the Monetary Policy Committee having the power to directly manage money creation, she would also object to them having the power to set interest rates (which indirectly influences money creation).

However, the makeup of the committee in a sovereign money system is up for grabs. The committee could be completely white and middle class in either system, or it could be hugely diverse in either system. We are designing a new system that works in the public interest, so if the key decision makers need to be more diverse, then make them more diverse. If we want that committee to be more diverse and more representative of society, then it shouldn’t be beyond a government minister to figure out how to achieve that.

This point rests on a logical error. When choosing between two systems, something that is a disadvantage of both is not an argument in favour of one. Part of the debate that would have to be had around a sovereign money system is about who we want to have the power to create money. But for anyone who can think about it logically, it should be clear that the fact that we currently give the power to set interest rates to a undiverse committee of men is an argument for reforming that committee, but it is not an argument against reforming the monetary system more fundamentally." (http://www.positivemoney.org/2014/11/sovereign-money-response-andrea-leadsom-economic-secretary-treasury/)