by Ambrose Evans-Pritchard
21 October 2012
So there is a magic wand after all.
A revolutionary paper by the International
Monetary Fund claims
that one could eliminate the net public debt of
the US at a stroke,
and by implication do the same for Britain,
Germany, Italy, or Japan.
The IMF reports says
the conjuring trick is
to replace our system of
private bank-created money.
One could slash private debt by 100% of GDP, boost growth, stabilize prices,
and dethrone bankers all at the same time. It could be done cleanly and
painlessly, by legislative command, far more quickly than anybody imagined.
The conjuring trick is to replace our system of private bank-created money -
roughly 97% of the money supply - with state-created money. We return to the
historical norm, before Charles II placed control of the money supply in
private hands with the English Free Coinage Act of 1666.
Specifically, it means an assault on "fractional reserve banking". If
lenders are forced to put up 100% reserve backing for deposits, they lose
the exorbitant privilege of creating money out of thin air.
The nation regains sovereign control over the money supply. There are no
more banks runs, and fewer boom-bust credit cycles. Accounting legerdemain
will do the rest. That at least is the argument.
Some readers may already have seen the IMF study, by Jaromir Benes
and Michael Kumhof, which came out in August and has begun to acquire
a cult following around the world.
Chicago Plan Revisited", it revives the scheme first put forward
by professors Henry Simons and Irving Fisher in 1936 during
the ferment of creative thinking in the late Depression.
Irving Fisher thought credit cycles led to an unhealthy concentration of
wealth. He saw it with his own eyes in the early 1930s as creditors
foreclosed on destitute farmers, seizing their land or buying it for a
pittance at the bottom of the cycle.
The farmers found a way of defending themselves in the end. They muscled
together at "one dollar auctions", buying each other's property back for
almost nothing. Any carpet-bagger who tried to bid higher was beaten to a
Benes and Kumhof argue that credit-cycle trauma - caused by private money
creation - dates deep into history and lies at the root of debt jubilees in
the ancient religions of Mesopotamia and the Middle East.
Harvest cycles led to systemic defaults thousands of years ago, with
forfeiture of collateral, and concentration of wealth in the hands of
lenders. These episodes were not just caused by weather, as long thought.
They were amplified by the effects of credit.
The Athenian leader Solon implemented the first known Chicago
Plan/New Deal in 599 BC to relieve farmers in hock to oligarchs enjoying
private coinage. He cancelled debts, restituted lands seized by creditors,
set floor-prices for commodities (much like Franklin Roosevelt), and
consciously flooded the money supply with state-issued "debt-free" coinage.
The Romans sent a delegation to study Solon's reforms 150 years later and
copied the ideas, setting up their own fiat money system under Lex Aternia
in 454 BC.
It is a myth - innocently propagated by the great Adam Smith - that money
developed as a commodity-based or gold-linked means of exchange. Gold was
always highly valued, but that is another story. Metal-lovers often conflate
the two issues.
Anthropological studies show that social fiat currencies began with the dawn
of time. The Spartans banned gold coins, replacing them with iron disks of
little intrinsic value. The early Romans used bronze tablets. Their worth
was entirely determined by law - a doctrine made explicit by Aristotle
his Ethics - like the dollar, the euro, or
Some argue that Rome began to lose its solidarity spirit when it allowed an
oligarchy to develop a private silver-based coinage during the Punic Wars.
Money slipped control of the Senate. You could call it Rome's shadow banking
system. Evidence suggests that it became a machine for elite wealth
Unchallenged sovereign or Papal control over currencies persisted through
the Middle Ages until England broke the mould in 1666. Benes and Kumhof say
this was the start of the boom-bust era.
One might equally say that this opened the way to England's agricultural
revolution in the early 18th Century, the industrial revolution
soon after, and the greatest economic and technological leap ever seen. But
let us not quibble.
The original authors of
the Chicago Plan were responding to the
Great Depression. They believed it was possible to prevent the social havoc
caused by wild swings from boom to bust, and to do so without crimping
The benign side-effect of their proposals would be a switch from national
debt to national surplus, as if by magic.
"Because under the Chicago Plan banks have
to borrow reserves from the treasury to fully back liabilities, the
government acquires a very large asset vis-à-vis banks. Our analysis
finds that the government is left with a much lower, in fact negative,
net debt burden."
The IMF paper says total liabilities of the US
financial system - including shadow banking - are about 200% of GDP.
The new reserve rule would create a windfall.
This would be used for a "potentially a very large, buy-back of private
debt", perhaps 100% of GDP. While Washington would issue much more fiat
money, this would not be redeemable.
It would be an equity of the commonwealth, not
The key of the Chicago Plan was to separate the "monetary and credit
functions" of the banking system.
"The quantity of money and the quantity of
credit would become completely independent of each other."
Private lenders would no longer be able to
create new deposits "ex nihilo".
New bank credit would have to be financed by
"The control of credit growth would become
much more straightforward because banks would no longer be able, as they
are today, to generate their own funding, deposits, in the act of
lending, an extraordinary privilege that is not enjoyed by any other
type of business," says the IMF paper.
"Rather, banks would become what many erroneously believe them to be
today, pure intermediaries that depend on obtaining outside funding
before being able to lend."
Federal Reserve would take real control over the money supply for
the first time, making it easier to manage inflation.
It was precisely for this reason that Milton
Friedman called for 100% reserve backing in 1967. Even the great free
marketer implicitly favored a clamp-down on private money.
The switch would engender a 10% boost to long-arm economic output.
"None of these benefits come at the expense
of diminishing the core useful functions of a private financial system."
Simons and Fisher were flying blind in the
They lacked the modern instruments needed to
crunch the numbers, so the IMF team has now done it for them - using the
stochastic model now de rigueur in high economics, loved and
hated in equal measure.
The finding is startling. Simons and Fisher understated their claims. It is
perhaps possible to confront the banking plutocracy head without endangering
Benes and Kumhof make large claims. They leave me baffled, to be honest.
Readers who want the technical details can make their own judgment by
studying the text here.
The IMF duo have supporters.
Professor Richard Werner from Southampton
University - who coined the term quantitative easing (QE) in the 1990s -
testified to Britain's Vickers Commission that a switch to state-money would
have major welfare gains. He was backed by the campaign group Positive Money
and the New Economics Foundation.
The theory also has strong critics.
Tim Congdon from International Monetary
Research says banks are in a sense already being forced to increase reserves
by EU rules, Basel III rules, and gold-plated variants in the UK. The effect
has been to choke lending to the private sector.
He argues that is the chief reason why the world economy remains stuck in
near-slump, and why central banks are having to cushion the shock with QE.
"If you enacted this plan, it would
devastate bank profits and cause a massive deflationary disaster. There
would have to do `QE squared' to offset it," he said.
The result would be a huge shift in bank balance
sheets from private lending to government securities. This happened during
World War Two, but that was the anomalous cost of defeating Fascism.
To do this on a permanent basis in peace-time would be to change in the
nature of western capitalism.
"People wouldn't be able to get money from
banks. There would be huge damage to the efficiency of the economy," he
Arguably, it would smother freedom and enthrone
a Leviathan state.
It might be even more irksome in the long run
than rule by bankers. Personally, I am a long way from reaching an
conclusion in this extraordinary debate. Let it run, and let us all fight
until we flush out the arguments.
One thing is sure. The City of London will have great trouble earning its
keep if any variant of the Chicago Plan ever gains wide support.