All power to the state! – Money madness at the IMF

IMF headquarters

Think Tank? - Think Again! - Headquarters of the IMF

You cannot escape an all-pervasive sense of crisis these days. Impending doom does not only announce itself in actual events but also via the proliferation of ever more hair-raising schemes that claim to solve our problems. Maybe it should not surprise us if, at a time when the world’s most powerful central banks keep interest rates at zero for years on end and keep printing quantities of money that are simply outside the facilities of human imagination (trillions? quadrillions?), bravely hoping it will end differently this time, people get the impression that economics holds no certainties, that it is merely an exercise in limitless creativity. In his excellent speech to the New York Fed, Jim Grant reminded us that when the Financial Times first explained to their readers what QE was, back in 2009, one of those readers wrote in a letter to the editor: “I can now understand the term ‘quantitative easing, but . . . realize I can no longer understand the meaning of the word ‘money’.” – This gentleman is not alone. The basics of monetary economics have been tossed out the window and a merry ‘anything goes’ of policy proposals has descended on us. Otherwise sane-looking men and women now propose that, although years of zero interest rates have not solved our problems, everything will change once interest rates are negative. We should all get checks from the central bank with free money to spend, and government bonds at the central bank should be cancelled. Grown men dream of money from helicopters and money buried in bottles in the ground. “Whom the gods would destroy, they first make mad.”

Just when you thought it could not get any madder there comes a policy proposal that sets a new low in monetary policy discussion. Of course, in the current climate it is being hailed as ‘epic’ and ‘revolutionary’. The easily excitable Ambrose Evans-Pritchard, a tireless campaigner for man’s exploration of the unknown in the field of money, could not believe his eyes: “So there is a magic wand after all,” he writes in the Daily Telegraph, “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.” It gets better all the time. No longer are we confined to debating arduous strategies for crawling slowly back to sustainable growth, no, we can now simply wipe out all our debt.

Harry Potter meets Irving Fisher

The proposal under discussion is the IMF’s Working Paper 12/202 by Jaromir Benes and Michael Kumhof (a link to a PDF version is provided in this article). It is titled “The Chicago Plan Revisited” and presents itself as a restatement of the ideas of Irving Fisher and Henry Simons of the University of Chicago from the 1930s and 40s, and an application of these ideas to the present crisis. It suggests the following:

‘Private money’ creation is the root of all economic evil. Most money today is created by ‘private’ banks through fractional-reserve banking. This means money-creation is linked to loan creation and debt accumulation. A hundred-percent reserve system is to be established by the state and the state will forthwith crack down on any attempt by the private sector to issue liquid financial instruments – near monies – that could be accepted by the public as cash equivalents. Money creation is put under the full control of the state. The new system is to be implemented right away in one big swoop: The banks are forced to borrow the needed reserves from the government (Treasury) to achieve the new 100 percent reserve ratios instantly. The government creates these reserves – as is usual in a fiat money system – out of thin air. In the US, this plan would amount to new reserves to the tune of 184 percent of GDP, according to Benes/Kumhof, which means $27.6 trillion or 15 times the combined size of QE1 and QE2. With the new 100% reserve requirement, this money will not circulate and not allow for further bank credit creation, which – it is expected by the authors – makes this intervention not inflationary. (A portion of the new reserves will also be cancelled in the next step.) The new reserves allow the government/central bank to ultimately transfer ownership of the bank assets to itself.

Importantly, these new reserves are issued in a process very different from how reserves are issued and placed with the banks today, for example through ‘quantitative easing’, and how it was suggested by Irving Fisher in 1935 (“100% Money”), or Milton Friedman in 1960 (“A Program for Monetary Stability”). These more ‘conventional’ procedures do not allow for any large-scale elimination of debt. Central banks acquire bank assets by exchanging them for newly created reserve money, which they issue as a claim against themselves (a liability), and under normal accounting principles, any write-down of the new assets (debt ‘forgiveness’) would necessarily cause the extinction of the bank reserves as well. Writing down debt shortens the balance sheet of the central bank and thus reduces the central bank’s liabilities, which are the banking system’s reserves.

Benes and Kumhof circumvent this by simply claiming that the new fiat reserves are not just a new liability of the central bank but that they are assets as well, Treasury Credit or ‘commonwealth equity’. Through this accounting gimmick, the state can issue new assets, simply as an administrative act. Thus, the new reserve money lengthens the balance sheets of BOTH central bank and ‘private’ banks in a first step, that is, the new reserve money is simultaneously an asset AND a liability for both. This novel approach then allows balance sheet reduction later on and debt forgiveness without elimination of the new reserves that now back bank deposits by 100%. (See model balance sheets on pages 64 to 66 of the Benes/Kumhof paper and compare them to the model balance sheet presented by Irving Fisher on page 57 of “100% Money”, 1935, which is much more conventional.)

At the end of this process, not only has a lot of debt disappeared, the separation of the ‘credit’ and the ‘money’ sphere of the economy is now total, and so is the state’s control over the monetary economy. This, Benes and Kumhof, make perfectly clear, is the ultimately goal of the exercise, and they claim it is to our benefit. Why? Here they do not argue as economists (and very differently from Fisher and Friedman or, for that matter, any monetary theorist) but quote anthropologists and certain monetary historians who claim that 1) money originated not spontaneously from direct exchange but is a creation of the state, or rather the state’s early precursors, such as priests and religious masters of ceremony; this is deemed important because the origin of money determines the “nature of money” (quote Benes/Kumhof, page 12) and therefore determines who should best control its issuance. 2) They argue that thousands of years of monetary history confirm that the state can be trusted fully with the monetary privilege. (If you remember history somewhat differently, then, so Benes and Kumhof, you have to rethink. The paper follows a select group of maverick anthropologists and monetary activists that have simply rewritten monetary history. Needless to say, none of this was ever claimed by Irving Fisher or Milton Friedman, and to my knowledge, not even Henry Simons.)

Finally, the paper presents an elaborate econometric model that shows that all of this will work in reality.

In this essay I will do four things: I will put the proposed paper in the context of ‘Austrian ’ and Monetarist monetary theory, and show that it is not only outside these intellectual traditions but that its main argument is not even economic in nature. I will show that the core problem Benes and Kumhof claim to have identified is bogus, and that they do not understand money creation in our economy. I will then look at the paper’s peculiar historical, and non-economic, justification of complete state- control of money, and show that this argumentation is highly dubious but also irrelevant. I will then show that the proposal presented relies on unprecedented forms of state intervention and crucially advances the notion that the state can create vast new assets – commonwealth equity – by decree, which allows it to claim to have no net debt and thus engage in loan acquisition and ‘debt forgiveness’.

What this paper is not: it is neither ‘Austrian’ nor Monetarist

Benes and Kumhof, early in their paper, claim that fractional-reserve banking increases the risk of bank runs, causes boom-bust cycles, and that a 100 percent reserve system would ensure greater stability. These observations are, in principle, correct. But this is, sadly, where it stops. Benes and Kumhof do not build on these insights. In fact, for their further argument these insights are completely irrelevant. Their paper does not bother to investigate the full range of effects of bank credit expansion, and ask, for example, if the expansion of base money by the central bank under a 100%-reserve system could not have similar or even the same adverse effects that deposit-money expansion has in a fractional-reserve system.

The Austrian School has provided the most comprehensive analysis of the effects of bank credit expansion and has shown most conclusively why more inelastic (‘harder’) monetary systems offer greater stability. Expanding the money supply always has disruptive effects as the inflow of new money must distort interest rates, and interest rates are crucial for the coordination of investment activity with voluntary saving. The question the ‘Austrians’ ask is not, who should control money creation, but should anybody control money creation? Should anybody even create money on an ongoing basis? Once a commodity of reasonably inelastic supply, such as gold, is widely accepted as money, any quantity of this monetary asset – within reasonable limits – is sufficient, and indeed optimal, to satisfy any demand for money. Demand for money is demand for purchasing power in the form of money, and can always be met by allowing the market to adjust the price of the monetary asset relative to non-money goods. No money creation is needed, and any ongoing money creation is in fact disruptive.

‘Austrians’ tend to be critical of fractional-reserve banking but they are equally critical – in fact, even more critical – of fiat money and central banking. The problems they studied would also occur – and are even more likely to occur – if the fractional-reserve-banking system was replaced with one gigantic state central bank.

But Benes and Kumhof did not call their paper ‘The Austrian Plan Revisited’ but ‘The Chicago Plan Revisited’. The approach and the goals of the Chicago School were different. But it is still worth mentioning that in his 1935 book “100% Money” Irving Fisher suggested that his plan could be combined with the gold standard, something that is impossible with the Benes/Kumhof plan and that Benes and Kumhof show no interest in. Here is Fisher, page 16:

“Furthermore, a return to the kind of gold standard we had prior to 1933 (before the domestic gold standard was abolished by Roosevelt and private gold confiscated, DS.) could, if desired, be just as easily accomplished under the 100% system as now; in fact, under the 100% system, there would be a much better chance that the old-style gold standard, if restored, would operate as intended to operate.”

This would indeed be the 100% gold standard that many ‘Austrians’ propose, and a system immeasurably more stable than what we have today. However, it was certainly not Fisher’s primary objective to restore the gold standard. Fisher wanted to maintain the fiat money system and consolidate the control of the central bank over the banking system by eliminating any remaining discretion by ‘private’ banks. Fisher was a big proponent of price index numbers. He believed the purchasing power of money could be measured accurately through statistics – a fallacy that is still widely believed today and still causes confusion and harm – and he was an early advocate of inflation-targeting. (For an Austrian School response to Fisher’s original plan see Ludwig von Mises, Human Action, 1949, Chapter XVII, 12. The Limitation on the Issuance of Fiduciary Media.)

25 years later, Fisher’s fellow Chicagoan Milton Friedman also proposed a version of the 100% plan, this time with even less reference to boom-bust cycles or the potential for a gold standard. Friedman was an advocate of central banking because he believed that monetary and economic stability could be achieved by guaranteeing a stable, persistent and moderate expansion of the money supply, which is at the core of Friedman’s Monetarism. In a 100% system the state central bank – so he argued – can make sure that this would happen.

Importantly, both Fisher and Friedman had an asymmetrical view of monetary expansion. The ongoing expansion of the money supply – and therefore persistent injections of new money into the economy – were not considered harmful (quite to the contrary), as long as the money inflow remained moderate, but any contraction of the money supply (shrinking of bank balance sheets and destruction of money) was seen as a major problem and to be avoided at almost all cost. Their plans for full reserve banking was largely motivated by a desire to avoid the destruction of previously created deposit money. Of course, ‘Austrians’ see this very differently. The expansion of money – even if moderate and controlled – must already cause problems (capital misallocations), and when these problems come to the surface they cannot be suppressed with yet more money creation, at least not forever (although this is attempted under Friedman’s proposal for very easy monetary policy in crises).

It should now be clear why the Austrian School is enjoying a revival in the present crisis, not the Chicago School. Fisher and Friedman did not get their 100%- system with complete control over money creation for the central bank but whatever power central banks had in recent decades – and that power was formidable – was used in ways that were strongly influenced by the Chicago School. Fisher and Friedman have shaped modern central bank orthodoxy to this day. As long as inflation is moderate central bankers believe that no monetary problem exists, in line with Fisher. Even in the run-up to the present, spectacular financial crisis, inflation remained moderate in most major countries, at least in the common (and dangerously narrow) CPI definition. And for the past two decades, any crisis that, if left unchecked, could have caused bank balance sheet deleveraging and credit contractions was aggressively fought with low interest rates and base-money injections from the central bank, according to Friedman. In fact, the Bernanke-Fed has repeatedly referred to Friedman’s policy descriptions as a blueprint for its own actions. However, none of this has prevented major financial imbalances to build, and these policies have even helped create these imbalances, as Austrian theory would suggest.

But I digress. None of this makes any impression on Benes and Kumhof. In fact, Benes and Kumhof seem decidedly uninterested in monetary theory, business cycle theory, or the Austrian School. There is no mention of Mises or Hayek, and only Carl Menger is mentioned – in a footnote and disapprovingly.

Instead, the paper sets up an entirely new and I believe bogus problem based on the premise that in our monetary system money is supposedly provided ‘privately’, that is, by ‘private’ banks, and ‘state-issued’ money only plays a minor role. From this rather confused observation, the paper derives its key allegation that ‘state-issued money’ ensures stability, while ‘privately-issued money’ leads to instability. This claim is not supported by economic theory and certainly not by anything in the Austrian School or, for that matter in Friedman’s Monetarism or Irving Fisher’s original plan. Monetary theory does not distinguish between ‘state-controlled money’ and ‘privately produced’ money, it is a nonsensical distinction for any monetary theorist. An attempt to give credence to this distinction and its alleged importance is made in a later chapter in the Benes/Kumhof paper but, tellingly, this attempt is not based on monetary theory but on an ambitious, if not to say bizarre, re-writing of the historical record.

Benes and Kumhof create an artificial problem

For any analysis of the present financial system a distinction between state-created money and privately created money is entirely artificial and of no help whatsoever, because in our system money is created in a process in which ‘private’ banks are intimately connected with the state central bank. Any distinction between ‘private’ and ‘state’ is thus arbitrary and for an analysis of the economic consequences of such a system meaningless. Yes, most money in circulation today is deposit money and sits on the balance sheets of nominally ‘private’ banks, but the reserves are state fiat money, only to be created by the state central bank, which the nominally private banks have to have an account with in order to receive a banking license. Fractional-reserve-banks rely crucially on state-sponsored and state-controlled central banks that have a lender-of-last-resort function and that can – in a fiat money system – create bank reserves at will, no cost, and without limit, and are, under normal circumstances willing to do so to backstop the banks. Without this crucial backstop fractional-reserve banking on the scale on which it has been practiced in recent years and decades would be inconceivable. In their description of the present system, Benes and Kumhof take no account of any of this. Frankly, they do not appear to understand it.

Here are two statements from the IMF paper that may at first appear sensible but that on closer inspection reveal the grave misunderstanding of our present system by Benes and Kumhof:

“In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits.” (page 5)

 But what determines the willingness of the banks to supply deposits? Fractional-reserve banking (supplying deposits) is lucrative but also risky for the banks as the public can demand redemption of deposits in cash or in transfers to other banks, and banks cannot create cash or the reserve money required to facilitate transfers. These forms of money remain the prerogative of the state central bank. It is the certainty, or high probability, under present institutional arrangements that the central bank will support the banks and continue to supply whatever amount of cash and reserves is needed, that allows the banks to supply – very profitably, of course – vast amounts of deposit money on the basis of small reserve money. Should the public demand payment in cash, the central bank can reasonably be expected to stand by the banks and supply the needed cash.

In recent decades, the global banking system found itself on numerous occasions in a position in which it felt that it had taken on too much financial risk and that a deleveraging and a shrinking of its balance sheet was advisable. I would suggest that this was the case in 1987, 1992/3, 1998, 2001/2, and certainly 2007/8. Yet, on each of these occasions, the broader economic fallout from such a de-risking strategy was deemed unwanted or even unacceptable for political reasons, and the central banks offered ample new bank reserves at very low cost in order to discourage money contraction and encourage further money expansion, i.e. additional fractional-reserve banking. It is any wonder that banks continued to produce vast amounts of deposit money – profitably, of course? Can the result really be blamed on ‘private’ initiative?

Fractional-reserve banking on today’s scale requires two things: 1) a state-sponsored central bank that has the monopoly of bank reserve-provision and that has a lender-of-last resort function for the banking industry; 2) the central bank must have complete control over bank reserves and be able to create them at no cost and without limit. In short, the precondition for large-scale fractional-reserve banking is a complete, unrestricted fiat money system. By contrast, the ability of the central bank to create reserves is fundamentally restricted under a gold standard.

The gold standard was abolished and replaced with a system of entirely unconstrained state fiat money through an act of politics. The state established monopolistic central banks that have a lender-of-last-resort function for the banking sector. The state did thus create the infrastructure that allows banks to supply vast amounts of deposits, and over the decades has repeatedly subsidized this activity and socialized its risks.

Here is the second statement by Benes and Kumhof:

“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.” (page 5)

 But what exactly constitutes the privilege? – In a free society, you are, of course, free to issue your own fiduciary media – just issue checks against yourself and have them circulate as money surrogates. You will probably have to convince the public that you will convert these checks into money proper on demand in order to persuade the public to use the checks as money equivalents, and even then you may not succeed. But if the public believes you and your endeavor is successful, you have indeed become a money-producer and can fund your own lending with your checks. In fact, this is pretty much how fractional-reserve-banking originated. So far no privilege. It only becomes a privileged business, and possible on the scale we see it today, once the state supports it. The ‘Austrian’ solution is straightforward: remove the privilege! Without fiat money, central banks and state-sponsored deposit insurance, let us see how much ‘private’ money creation there really is!

No theory but revisionist history

That the distinction between ‘privately produced’ money and ‘state-produced’ money is meaningful and important, Benes and Kumhof try to argue in a separate part of the paper. Here, they completely depart from any traditional analysis of money or even any that could still be called ‘economic’. An economic analysis of money understands money as a useful social institution and thus starts with an inquiry of what money is used for in general, including today by today’s money users (that includes you and me), and tries to explain, based on reasoning, what would therefore make for good money in a general context, including the present one. Benes and Kumhof, however, do not argue conceptually as economic theoreticians but as (re-)interpreters of history. History can tell us what is good money and how it comes about. The anthropologists and monetary historians Benes and Kumhof quote claim that because money originated – supposedly – with the state its issuance is best controlled by the state. Again, no economic – conceptual, logical, theoretical – explanation is given for why that should be the case and why this could be upheld as a general rule. Allegedly, history tells us that the state is a responsible issuer of money and the private sector an irresponsible one. And that’s that.

The interpretation of the historical record that is provided in support of this allegation ranges from the adventurous to the outright bizarre. Instances in which the redeemability of deposit money in gold and silver was abandoned by official decree and vast amounts of fiat money were created to fund wars, revolutions or other state expenditures, such as during the Revolutionary War in America, the Civil War in America, or 1920s Weimar Germany, are reinterpreted to show that the ensuing inflations and outright currency disasters cannot be blamed on the state but are entirely the result of the involvement of ‘private’ money issuers.

“Colonial paper monies issued by individual states were of the greatest economic advantage to the country…The Continental Currency issued during the revolutionary war was crucial for allowing the Continental Congress to finance the war effort. There was no over-issuance by the colonies,… The Greenbacks issued by Lincoln during the Civil War were again a crucial tool for financing the war effort, (Hooray! Another war courtesy of paper money! DS)… The one blemish on the record of government money issuance was deflationary rather than inflationary in nature.”

 Really? – The ‘colonials’ that were issued to fund the war with Britain ended up worthless, and to this day there is the idiom “worthless as a continental” in the American language. The period of the Civil War, too, was one of unusually high inflation, and in 1879 the USA decided to go back on a gold standard, at which point a period of considerable growth and rising prosperity set in.

While the enthusiasm for paper-money-funded wars on the part of Benes and Kumhof is already a bit disturbing, what is particularly striking is that Benes and Kumhof, and the ‘historians’ they quote (in particular the activists David Graeber, an anthropologist and leading figure of the Occupy Wall Street movement, and Stephen Zarlenga, founder and director of the American Monetary Institute), try nothing short of a complete re-writing of economic history and suggest conclusions – not only in one instance but throughout ALL of monetary history – that not only fly in the face of the generally accepted historical record but also common sense. The state as a monopoly-issuer of money with no restriction whatsoever becomes a trusted guardian of the common weal – simply qua being a state!

Their whole argument gets kooky in the extreme when they address more recent instances of fiat money currency disasters, for which we not only have ample documentation that supports the opposite interpretation but which some of the most distinguished monetary theorists actually lived through themselves and experienced first hand – and which they explained succinctly.

Ludwig von Mises wrote a seminal book on monetary theory in 1912 (Theories des Geldes und der Umlaufmittel), in which he laid the foundations for the Austrian Business Cycle Theory and in which he predicted (!) the European hyperinflations of the 1920s. He lived through the hyperinflation in Austria in 1923, and, as the chief economist of the Vienna Chamber of Commerce, was in direct contact with the key players in government and central bank. He later wrote his memoirs.

Benes and Kumhof now claim that all these accounts are simply wrong. The main culprit was not the state but the private sector. We only have to ask state officials (!) and they can tell us what really happened. Here is the IMF working paper, page 17:

“The Reichsbank president at the time, Hjalmar Schacht, put the record straight on the real causes of that episode in Schacht (1967).”

 According to Benes/Kumhof, Schacht blames the inflation on aggressive money creation by the private sector but his account also suggests that this was only possible because the Reichsbank generously redeemed deposit money in Reichsmark, that is, the central bank provided essential support for money expansion. With a generous backstop from the state the private sector will, of course, create money. But does that mean the state had nothing to do with the whole debacle? Kumhof, Benes and their prime source, Zarlenga, seem to not understand the role of central banks and the essential ingredient of state-backing for large-scale fractional-reserve banking. Furthermore, Schacht is a source of a somewhat dubious reliability in this debate. Schacht became a Hitler supporter later on, introduced socialist New-Deal-type policies in Germany, and helped the Nazis with re-armament and plans for German autarky. I am not saying this to discredit Schacht as an economic observer, only to highlight that he had – and this is probably an understatement – a considerable pro-state bias in all his economic views and is just hardly an objective observer on the question if the state can be trusted with money. (As an aside, all totalitarian ideologies are anti-gold and pro-paper money and central banks. The Socialists, the Communists, the National-Socialists, the Fascists – they all hated to see the state restrained in its maneuverability by a gold standard.)

Benes and Kumhof’s case simply ignores the numerous historical accounts that paint a very different picture, such as the work by English historian Adam Ferguson whose seminal book “When Money Dies” has recently found a wide new readership. It ignores the eye-witness reports of one of the most distinguished economists of the 20th century, Ludwig von Mises, or the work of Swiss monetary historian Peter Bernholz.

I am not a historian and I want to be careful in dismissing challenges to the established historical record out of hand, but the account presented here strikes me as simply ridiculous, as unscientific, mystical pro-state propaganda. As a scientific argument it is without merit.

But almost the worst aspect of it is this: where are the economics, where is conceptual analysis and reasoning? Even if we accepted – simply for argument’s sake and contrary to the overwhelming evidence to the contrary – that the state has more often than not been a good guardian of the money privilege, what are the explanations for this, what are the theoretical and conceptual arguments that underpin this historical pattern? Could we rely on this always being the case? If it is in the “nature of money” (Benes/Kumhof) to be provided by the state, is it therefore in the “nature of the state” to always provide good money, or would we need specific institutional arrangements, legal frameworks, or some ‘good-money’-culture or tradition for this to be the case? Of course, Benes and Kumhof provide no answers.

This part of the paper is simply unscientific because the argument is essentially mystical. The whole idea that a socially useful institution such as money can only be understood if we understand its “nature”, which does not derive from how people use it (including you and me today) but from how it came into being thousands of years ago, is nothing if not rooted in mysticism.

Money is a tool, and so are hammers. If I asked you to tell me what a hammer is for, what makes for a good hammer and a bad hammer, and what type of hammer I need for a specific purpose, would you tell me that I first have to understand the “nature” of the hammer, and to do so I would have to ask anthropologists how the first hammers came into being and what the first hammers or hammer-like tools were used for?

Mystical assets

Remember what I said above about circulating your own checks as fiduciary media? That is a pretty good description of paper money issuance. The newly circulated paper money is accounted for as a liability on the balance sheet of the paper money creator, and the things he acquires through issuing/spending this new paper money become the corresponding assets. By issuing paper money the money creator lengthens his balance sheet, while those who transact with the money-creator neither lengthen nor shorten their balance sheets but exchange positions on the asset side of their balance sheets, they replace other, previously held assets with new money.

This can also be observed in the creation of base money (extra bank reserves) by central banks today. When the Federal Reserve creates an extra $1 trillion as part of ‘quantitative easing’ and decides to buy mortgage-backed securities from its member-banks, then the Fed’s balance sheet expands by $1 trillion dollars. The new bank reserves are on the liability-side of its balance sheet, while the mortgage-backed securities are on the asset-side. The balance sheets of the banks do not expand as a result of the Fed operation. The banks simply replace mortgages with new reserves. Both are on the asset side of their balance sheets. Their asset-mix has changed. They now have more reserves.

This process could be extended until almost all bank assets have moved to the central bank and the banks are fully reserved and thus cease to be fractional-reserve banks. This was precisely the process that Irving Fisher had in mind when he wrote “100% Money” in 1935 (see page 57), and Milton Friedman when he wrote “A Program For Monetary Stability” in 1960.

At no point did any of these economists suggest, nor does any central bank today suggest, that the creation of new paper money enhances the overall wealth of society, that there is now more property in this society. It is also clear from this process that ‘debt forgiveness’ by the central bank is difficult. The central bank can issue enough reserve money to acquire all bank assets but whenever it writes down the book value of any of these assets it also has to shrink the liability side of its balance sheet, it has to destroy reserve money.

Benes and Kumhof now come up with an entirely novel approach. The state simply declares that its new reserve money is also an asset in its own right. Per decree the state creates wealth: Treasury Credit or commonwealth equity. The central bank books the new reserves on its liability side, just as in a conventional money creation process but now does not book existing assets against it that it acquires from whoever books the new reserves as assets (the banks). The corresponding asset is now ‘Treasury Credit’, which did not exist before but now comes into being per government decree. At this stage, the central bank’s balance sheet lengthens without any acquisition of new assets – the offsetting asset is created simultaneously with the reserve money liability!

The balance sheets of the banks now also lengthen: the banks book the new reserves on their asset side without (at this stage) transferring other assets to the money-issuer. The asset-side of their balance sheets lengthens. The corresponding lengthening of the liability side is achieved by booking ‘Treasury Credit’ as a liability.

It is this slight-of-hand that allows, in the following steps, various bank assets to get written off without a corresponding shrinking of reserve money. Only via the accounting gimmick of creating central bank assets out of thin air (and not just new central bank liabilities) and thus claiming that overall wealth – new assets – have been created administratively by the government can the large-scale debt write-off that is the paper’s allegedly strongest selling point, proceed.

All of this is state intervention in private contracts and property rights on a gigantic scale. The state may have the power to rewrite accounting rules and simply claim the existence of mysterious ‘government wealth’. Stranger things were claimed by governments in the 20th century. But what are the consequences? How will the public react? What confidence will it have in the new 100% state controlled monetary system?

Simply writing off all household debt is a mixed blessing. How would you feel if you worked hard and saved and did pay down your debt to give your family financial security, only to find out that your irresponsible and reckless neighbors, living high on the hog on credit cards, just saw all their debt wiped out by the Benes/Kumhof plan?

All power to the state!

This whole plan is nonsense on the greatest scale. Benes and Kumhof have thoroughly embarrassed themselves. Maybe we should simply look the other way and ignore this ill-conceived rubbish, maybe excuse it as the confused musings of two state-worshipping econometricians who fell under the spell of the New Age historicism of Graeber and Zarlenga, which they saw as a great opportunity for some fancy econometric modeling. But this comes with endorsement from the IMF, a major state-organization. Could it be that those who benefit from the accumulation of more state power feel that all the widespread banker-bashing and the erroneous but skillfully planted notion of the failure of capitalism can be turned even more to their advantage? Even the otherwise intervention-happy Ambrose Evans-Pritchard has his doubts:

“Arguably, it would smother freedom and enthrone a Leviathan state. It might be even more irksome in the long run than rule by bankers.”

Ambrose, for once I agree.

In the meantime, the debasement of paper money continues.


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Detlev interviewed by The Daily Bell and Germany's FINANCE-TV
“But there is no inflation!” – Misconceptions about the debasement of money


  1. Martin Hazeleger says

    You know, said an accounting gimmick might not be as bad as it seems at first sight. If used properly it could solve the problem we have now that we constantly have to create more debt to service our current debt. However, I do strongly feel that the government can’t be trusted to do such a thing properly as long as they are main beneficiaries. In other words, as long as the can create money to use themselves. The same thing holds true for the bankers as well as any private entity. The solution is obvious isn’t it? Separate the creators of the fiat from the beneficiaries.

    I would bet that government would suddenly be perfectly capable of managing the money supply if the only way said money could be created is by depositing it directly on the bank account of every single citizen of the country. If this is done slowly over time, while also slowly raising reserve requirements over time, it will have the same effect. Eliminate the debt problem without being inflationary. Citizens will spend this new money, creating taxable revenue which will indirectly raise the governments income as well. What do you think?

  2. Myno says

    I recall having read Ambrose’s florid article with rising blood pressure. With distaste I noted how he slyly avoided taking a stand on Benes and Kumhof, by appearing at the start to support them, then retracting his support at the end. I am most grateful to see you tear Benes and Kumhof to itsy bitsy pieces, start to finish. And Ambrose too. They all deserved the Detlev Treatment.

  3. Single Acts of Tyranny says

    To a very limited extent, it is possible to issue fiduciary paper today as a non-banking institution. If you were given gift vouchers by a major supermarket, you would probably have reasonable confidence that they would be honoured.

    But I accept that legal tender laws, (just coercive monopoly enforcement really) largely prevent this.

  4. Dr James Thompson says

    A good article. Strange to find the IMF associating itself with make believe economics. It plays to the gullibility of the public that they think that debts can be magicked away, without savers being defrauded. Even readers of your blog like Martin Hazeleger seem to want to believe in accounting gimmicks.

    • Stephan Larose says

      “It plays to the gullibility of the public that they think that debts can be magicked away, without savers being defrauded.”

      The debts are themselves “magick” they are for the most part simply moneys printed out of thin air by other central banks, and money printed out of thin air via fractional reserve lending by commercial banks. Only the most minute fraction of those debts represent investments of money made honestly by human beings. The debts themselves are massive frauds perpetuated on the public by the private owners of the global monetary system.

      It’s not gullibility that should see the public want to “magick” away these debts which were themselves “magicked” into existence, it’s a matter of necessity. We either write these fraudulent debts off or our economic system is paralyzed. Were we to write off all national debts, the fraction of humanity that would lose any savings would be so negligible as to be dismissible out of hand, meanwhile, every resource and talent on earth would remain, only the crushing weight of debt and taxes would be removed. Perhaps at that point people would wake up and realize the value of money is based on their own productive potential and that citizens should be the owners of central banks, not tiny cabals of evil men who print money out of thin air and charge the rest of us debt + interest on it. We should own that money, loan it to commercial banks and collect interest.

      “Give me control of a nation’s money and I care not who makes its laws” Mayer Amschel Rothschild

  5. says

    Hi!, Patrons Of The Schlichter Files Et Al:

    To me everything mentioned in this article has nothing to do with anything except mumbo jumbo, because there’s no absolute definition as to what constitutes real money? The word money can be used for the words paper money; how so can that ever be but dumb? The American Institute For Economic Research in Great Barrington, Mass. defines paper not as money but instead “purchasing media” which is much more sophisticated and uncomplicated a term. To settle any argument, first the terms used should be clearly defined and thoroughly understood shouldn’t they? Ludwig Von Mises, in his book, Human Action, defines gold as money which it is all by itself without issuance by a state or Banking system, due to the fact that it has its origination in limited quantities/form from Mother Nature’s Store House, the Earth. If you started a nation wthout any money, its’ barter system would naturally collapse all its’ efforts effortlessly wouldn’t it for a lack of capital known as money? However, if that same economy was to use real money or gold as its’ capital, the only place its’ capital could be obtained would be from the bowels of the Earth like they do today in AFrica and elsewhere huh? This would mean that ONLY the gold miners & not gold ETFs would be the providers of real money/capital right? No government nor bank or ETF EVER produced even one troy oz. of real money/capital utilizing its’ false, counterfeit gimmicks center in paper have they? If the forlorn citizens of the United States want any real money from its’ Federal Government, let the US mint mint the gold reserved in Fort Knox, Kentucky etc. and thereby circulate the peoples’ gold as their exclusive capital which is ordered in Article 1; Section 10 of the US Constitution. Only then will they possess real money/capital which can NEVER be expanded upon by such an entity as the STATE nor BANKS etc. Then they can stop chasing debt repayments with additional, expanded monetized State or Bank created inflationary purchasing media money substitutes which can NEVER serve as money. Look around you Americans & you will see plenty of purchasing media circulating which increases prices constantly; while finding absolutely no specie gold and/or silver “money” will you? Your economic FREEDOM has been handed over to the State & to the Banks hasn’t it? For how mucyh longer America?

    RUSS SMITH, CALIFORNIA (One Of OUR Broke States)

    • Stephan Larose says

      The Fed is private, it’s not part of the government and is owned by private interests. The U.S. used to issue money debt free, but the European private bankers would not allow it, they wanted to impose a private central bank that created money out of thin and loaned it as debt to governments. These “legally” counterfeited moneys, backed by nothing, would have to be paid back with real value plus interest. See Moneymasters.

      “The refusal of King George III to allow the colonies to operate an honest money system, which freed the ordinary man from the clutches of the money manipulators was probably the prime cause of the revolution.”
      -Benjamin Franklin

  6. says

    The underlying problem is interest on money. If you do not fix that, the economic system will remain destructive, with booms and busts, overheating and depressions. It is possible to have a better monetary system that does not require government intervention and central banks.

    The economic problems we face now revive the controversy of Capitalism versus Socialism. Both economic systems have their limitations. Supporters of Capitalism will argue that the problems are caused by government intervention in the markets. Proponents of Socialism will argue that the problems are caused by too little regulation of the markets. Both arguments seem reasonable but they conflict.

    The real cause of the problems lies in the nature of our money system in which interest on money is charged. Interest causes wealth to concentrate as the poor pay interest to the rich. Interest can therefore be seen as a tax on poverty to the benefit of the rich. Money in the bank is backed by debt, so interest is a fraud that forces the poor into debt if the rich do not take the money out of their accounts and spend it. The following example demonstrates this and also that interest on money is unsustainable and leads to crisis:

    “If someone brought a 1/10 oz gold coin to the bank in the year 1 AD, and the money remained there until the year 2000 AD, collecting a yearly interest of 4%, the amount of gold in the account would have been 3.6 * 10^31 kilogramme of gold weighing 6,000,000 times the complete mass of the Earth.”

    When interest is charged on a limited scale or over a short timeframe then those problems do not surface. Interest is an insidious process. Over time it is inescapable that it reduces large numbers of people to a state of servitude to the money lenders. This is a long term development that transcends the life span of a human. Interest is the main reason why a number of civilisations have failed and why Western civilisation is about to fail. Therefore all interest is usury and the current financial system is a usury financial system. Interest is also the cause of inflation as more and more money has to be created to keep the economy going. To get an understanding of the issue, you can view the documentary “Money as Debt” on our current money system.


  7. KevinR says

    When socialist policies that meddle, interfere and manipulate the economy fail, as they always do — and as we have seen over the past years — socialism’s true believers always call for ever more socialism, because it is this which gives them ever more power and control. At no time do they allow reality to rear its ugly head as that would usually mean them stepping back and allowing proper economics to take control, which is anathema to socialists. That is how modern day government operates.

    As a result, we are now living in two parallel worlds: on the one hand we all know that our economies are well and truly stuffed by the elites printing, printing and printing and running an unsustainable credit bubble for years, and there is an endless supply of statistics and charts which clearly demonstrate this. This is the reality.
    But on the other hand, we are bombarded daily by the political elites with a stream of phony statistics which amount to misinformation, disinformation and outright lies which attempt to reassure us that our economies are on the mend, albeit with some fragility. Their message is “more of the same will solve it”.

    I cannot say where all this will end …probably war or civil war preceded by economic collapse. In fact, exactly as you have long predicted, Detlev.

  8. therooster says

    Gold is money, debt free money ! Now that it trades in real-time (floats) , the rising value gives incentive to “de-hoard” it. Gresham’s Law is less applicable with each passing month. Add this reality to the new found ability to digitize the gold weight and use fully backed digital currency ( again, by weight) and you have the perfect combination of debt-free store of value married to instant global liquidity. Gold currency’s past liquidity challenges were not about bullion. They were about the FIXED peg placed on the trade value. The FIXED peg had to be abolished to set gold free as a user friendly, highly liquid and honest form of money.

    In the final analysis, when you reverse engineer real-time gold-as-money, it’s easy to see the FED’s footprints all over it, especially Bretton Woods. The USD’s ultimate role is NOT that of a currency, ironically. It’s a currency within the debt-currency paradigm, yes … but within the new real-time gold-as-money paradigm , it has a very useful role as a real-time measure. The big picture is larger than going from debt based currency to asset based currency, as many think. It’s actually a process that goes from FIXED gold-as-money to real-time gold-as-money with the pure fiat paradigm stuck in-between as part of the transition and “necessary evil” on our road back to providence.

  9. Stephan Larose says

    All money is the result of an “accounting gimmick” and all money is fiat. the value of money is based on the productive potential of the citizenry, but for some reason citizens do not own the bank that prints that money, private interests do. The idea that small cabals of sociopathically greedy men will manage the monetary system better than a government that actually has some accountability to its voters is patently ridiculous and morally bankrupt. We have had, for the last century, a privately controlled monetary system, and the result has been nothing short of disastrous. An yawning wealth gap, nations in constant states of war, the earth on the brink of eco-disaster, democracy and human rights being rolled back, the list goes on. The Fed was created to ensure monetary stability, its track record speaks for itself, one of the least stable systems in history and it’s private.

    Private “national” banks like the Fed do nothing but counterfeit money “legally,” this is something the public treasury could do just as easily without the burden of debt to the public. There is absolutely no defensible argument for letting private interests create money out of thin air, loan it to a nation, and then demand that citizens pay back their funny monies with real value plus interest, period.

    There are countless ways to set up debt-free monetary systems that control inflation through means such as mandated retirement of bills upon printing, curtailing or ending outright fractional reserve lending, managing monetary supply growth judiciously, but the main point is, it’s best that the public own and supervise the institution to prevent the power of such an institution being corrupted for the benefit of a few individuals–the situation we have now.

    Citizens are the source of money’s value, we ought to own the central bank and commercial banks ought to pay us interest on the moneys we lend them for them to conduct their business. With a debt-free publicly owned monetary system their would be no national debt and no need for income taxes (you’ll remember income tax came in expressly to finance the debts the Fed would create).

    As the vast majority of “national” debts are the result of money printing by private central banks and fractional reserve lending, these debts are virtual and can be written off. Crisis solved. Don’t let these idiots try to fool you into thinking it’s any more complicated than that.

  10. KingTut says

    I think Gaeber has made an enormous contribution to the history of money. I found his theories extremely enlightening. But rather than repudiate FRB, his account of primitive societies and early civilizations relying on complex webs of debt and obligation actually supports it. In fact, after reading Gaeber Fractional Reserve Banking seems like a natural extension of the way people have operated for millennia.
    Where FRB goes wrong is in scale, the “fraction” must be kept within reason, or the system collapses. In the old days it was impossible to keep track of all the debits and credits, so periodic Jubilees were required.
    Today computers can keep track of our transactions and obligations effortlessly, and so a sustainable system should be achievable. It all boils down to trusting someone (anyone) with the task of creating credit (money).
    Today its hard to trust anyone, the whole thing is so screwed up. The scale is too large, the regulation has been captured, and the architecture is full of ways to get around having any reserves at all. What we have is best described as negative reserve banking.
    Unfortunately, Gaeber brings a leftist agenda to his work, which almost ruins it as a serious treatise. But, his facts repudiate his own biases, which he doesn’t seem to see. In the end he provides a much needed perspective on human behavior.

  11. says

    I must differ somewhat with niphtrique.

    Too much interest is not the problem, yet. Interest is basically the cost of using someone else’s money. Our problem is when the interest rates are pegged artificially low, inducing a false sense of cheap money. This produces speculation and excessive debt creation at almost no cost which creates wild swings in a normal economic cycle because gamblers, like investment bankers, are abundant. The resulting excessive fluctuations reward the lucky, the politically astute, or those in control, not ordinary citizens. As a result, the lower half of society is generally screwed because they are not in the know, happily going about their business, assuming that the government is monitoring the situation in a somewhat fair manner. They are wrong. The lower economical half of citizens don’t follow the stock market or the price of gold. They become interested only when prices go up or they get laid off, then they wonder how someone messed up their life.

    Since the experts continue to think that lowering interest rates to near zero will create prosperity, the financial industry will continue to prosper and the poor will get the short end, like a foreclosed home. I don’t see any end to this as long as Bernanke is in charge.

    On the other hand, Fed policies and the low rates would not be necessary if the Fed did not have to create so damn much money out of thin air to provide cash to fund the deficit spending of a Congress without self discipline. Any attempt to limit the deficit, like a debt ceiling, is treated as a politically criminal offense, and has not been seriously mentioned by either candidate for president because they both know it is a black hole.

    Continuing deficit spending will inherently screw the lower half of American citizens, and the financial gulf between the top and bottom segments of our society will continue to grow.

    Sometime in December we will reach the debt ceiling again and we will see who has the guts to vote against continued deficit financing of our massive overspending. Those with courage will be outnumbered by those with limited vision who don’t understand the magnitude of the economic disaster awaiting us.

    All other topics discussed in the political theater will be irrelevant when the economy collapses due to the cost of paying interest on the national debt. In the end, I agree with niphtrique. Higher interest will bury us. Buy gold.

  12. david says

    This paper by Benes and Kumhof appears to my inexpert eyes as just another scheme to keep the production of money out of the market and in the public sector, i.e., the government. Like the production and distribution of any other commodity, the government cannot know by central planning how much and at what price to produce. But they keep trying anyway, because to give up the money power is to largely give up power. And that will never do, will it?


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