We need Money Reform, not Quantitative Easing

With the Bank of England base rate fallen now to 1%, the Bank and the Government are fast running out of ways of stimulating lending in order to get more money into the economy.

This has been recognised for some time, indeed, if base rate reductions were going to work at all, they would have worked when the rate was 2% or 1.5%. So it is that the frightful phrase 'quantitative easing' has entered the vocabulary of economic commentators.

This has been explained by some as 'printing money', but in fact it might not involve any increase on the Royal Mint's normal annual increase of one to two billion pounds-worth of extra legal tender. Instead, it might just involve the Bank of England issuing bonds in exchange for some of the commercial banks' rather more dubious assets – their toxic sludge.

With some nice AAA rated Bank of England bonds as assets on their books rather than the loans and mortgages of their more insolvent customers, so the theory goes, the commercial banks will be more willing to lend to each other and so facilitate their lending to their retail customers. There is a widespread belief that the commercial banks are currently unwilling to lend.

This is not quite the full picture. In truth, the commercial banks are more than willing to lend, but only to people and businesses with good-credit ratings and little risk of default. This is nothing more than we should expect of our banks. They should only lend to good risks. Indeed, the phrase 'to bank on it' rather implies that a total lack of risk should be the foundation of banking practices. The commercial banks have been roundly, and rightly, condemned for lending to risky borrowers over recent decades.

Unfortunately, both in this country and around the world, the supply of credit-worthy, low-risk borrowers has almost totally run dry. Never mind about an oil shortage crippling the economy at some point in the future, a world-wide shortage of solvent, prudent and obedient borrowers is crippling our economy now.

So quantitative easing in the form of Bank of England bonds is unlikely to get things going. It will doubtless be tried, as the powers-that-be run through their diminishing range of options, but it will fail. So the next step could indeed be the rolling of the printing presses.

This will get the economy functioning again, but the cost will be high. The cost will be high levels of inflation with all the insecurity and industrial action that we experienced during the 1970s and 80s.

The cause of this inflation will not be the extra bank notes themselves, but the fact that for every £1 of legal tender issued, the commercial banks will be able to conjure into existence £30 of bank credit. In other words, with the banking system unchecked, the commercial banks will be able to cause massive inflation through their current standard banking practices.

The current money supply serves to illustrate this. The total amount of sterling legal tender in circulation within the economy (including Scottish and Northern Irish notes) is about £50 billion pounds. However, the total UK money supply (M4), as reckoned by most economists and the Bank of England's own statistics, is in the region of £1,700 billion, over 30 times as much.

Without the capacity of the commercial banks to create credit, our money supply, along with prices, wages and savings deposits would be 3% of what they presently are. In other words, we would not have had the inflation of the past 40 years.

The Money Reform Party advocates that our money supply should be created solely by a public agency as legal tender and that commercial banks should be limited to lending only the legal tender in their possession. This is called 100% reserve banking to distinguish it from fractional reserve banking. (Although, for the 10 countries of the Basel Capital Accord, fractional reserve banking has been replaced by capital ratios.)

To cover all the existing debts, this would indeed involve creating a lot more legal tender, although it might only need be in the form of billion-pound bank notes, or it could probably be done electronically. This extra money would not flow into the wider economy, because only so much would be created as would have to be borrowed by the commercial banks to cover their existing loans. So it could not be used for further lending. Thus a cap and control would be placed on the money supply. There would be no risk of inflation.

Indeed, it is the view of the Money Reform Party that the public agency that is charged with creating and issuing the nation's money supply should be charged with maintaining inflation at 0%. Inflation is a necessary feature of a money supply consisting of bank credit, hence the current Government target of 2% and not 0%. It would not be necessary with a debt-free money supply, and only a 0% inflation rate is fair to both savers and borrowers.

The economy would be revived not through increasing the money supply, but through stripping out hundreds of billions of pounds worth of debt, both public and private, together with increasing Government spending, notably through investment in environmental protection measures, and reductions in taxation on low and medium incomes.

This is totally different to quantitative easing which is designed to keep the debt-based system largely in place and is deliberately intended to increase inflation. A low level of inflation is regarded as an essential aspect of a dynamic economy by conventional monetary theorists.

The current, debt-based money supply has been described as a form of slavery, debt-slavery. Quantitative easing is akin to a slave owner who, having flogged his slave nearly to death, decides to lay off the lash for a while to enable his property to recover sufficiently to be set to work again. Money reform is akin to abolishing slavery and giving each former slave a trade with which to support themselves in freedom and prosperity.

Both of these actions are intended to ease the lot of the slave, but their difference is quantitative.

Base rates are a broken lever

The Bank of England's reduction of its base lending rate to 1% is proof of the utter irrelevance of the economic theories under which it and the prevailing academic consensus is working. By reducing the base rate to 1%, it is announcing that a rate of 1.5% will not work.

1.5% was itself a record low. If reducing the base rate was going to work at all, then 1.5% should have been quite low enough. It was less than half the current level of inflation and meant that anyone with a tracker mortgage set at 1% above base would have been paid to borrow, in real terms.

The drop to 1% is akin to the tragi-comic situation whereby a character discovers that a particular control for a runaway machine no longer works but, instead of reassessing the situation in order to establish control by some other means, continues to pull on the broken lever in the vain hope that somehow it might spontaneously repair itself.

Thus it is that the Governor of the Bank of England, the members of the Monetary Policy Committee, the Prime Minister, the Government's Treasury team, most economic commentators and everyone else who takes base rate reductions as a serious solution to the present economic crisis can number themselves amongst a cast of notables that includes Dick Dastardly, Wile E. Coyote and the Keystone Cops.

To understand why this is, let us consider the theory behind the raising and lowering of interest rates.

Very simply, the theory is that when base rates are low, people borrow more and because people borrow to spend, so more spending takes place and the money moves around the economy faster. When saving rates are low, there is less incentive to save, because savings rates are low.
The implication of this is that there is only so much money within the economy, and people are either spending it or saving it. They cannot do both. What is not addressed is the question, if people are saving less and borrowing more, from whom are the borrowers borrowing?

The unspoken truth, of course, is that borrowers do not borrow from savers. Their borrowings are entirely new money created as debt by the clearing banks.

Even so, the lowering of interest rates at the retail level should stimulate economic activity, because through increased borrowing, more new money is created, enabling businesses to sell more, employees to earn more, people to spend more, and so on. It has always worked like this before.
The trouble is that we have never before had the levels of debt within the economy that we have now. People with tracker mortgages, who are finding themselves with hundreds of pounds extra money to spend each month are not spending it. They are using it to pay off even more of their mortgages, worried that in a few month's time, they might be unemployed.

Everyone with even the slightest amount of fiscal awareness, obviously excluding Dick Dastardly et al, listed above, is doing the supremely sensible thing for themselves and their families of paying off their mortgages and other debts, and building up their savings, no matter how low the interest rate they might earn, against the possibility of their own domestic financial difficulties.

This sensible course of action is disastrous for the economy. What is good for individuals is bad for the economy. What is good for the economy, indeed, what is essential for the economy is for individuals to borrow massively, even against their own long term best interests. This is a perversity within our current monetary system that rarely gets mentioned.

This peculiar and perturbing fact is due to our high dependence upon debt to provide the money supply. Without large numbers of solvent borrowers taking out mortgages for homes, loans to start businesses or credit cards to consume, our money supply would almost totally disappear.

This explains the Government's obsession with getting banks lending, 'to get credit flowing once again'. The trouble is that for the banks to lend, someone else has to borrow. The Government itself is doing its bit, but Government borrowing has fallen over recent decades as a proportion of overall national borrowing, and there is a political limit on future increases, especially if the Conservatives win the next election. They have so vilified Government borrowing, that whilst they might find it expedient to increase it slightly themselves should they come to power, they cannot do so by much without becoming a laughing stock.

So the burden of borrowing the increasing amounts necessary, a need that rises exponentially year-on-year, to fund both day-to-day economic activities and the high level of residual interest on past borrowing, will fall on the private sector, both households and businesses.

The question is how much increased borrowing are we, as a nation, collectively able and willing to undertake?

Even with base rates at 1%, with mortgages fallen to an all time low, the desire to borrow (and ability to repay) is modest. Even if people were not worried about possible unemployment or other insecurities, their borrowing might be expected to decline, for the very simple fact is that there is a limit to the amount that anyone can borrow.

Micro-economic factors feature rarely, if at all, in the macro theorising of most monetary economists, but real people, unlike lines on graphs have their limits.

With average unsecured debt for households that have such debt standing at £21,000 and average outstanding mortgages for the 11.7 million households who have mortgages standing at £104,000, there is a very real possibility that we have maxed out on debt. We have gorged ourselves and can borrow no more. There must be a limit somewhere.

If the limit has been reached, then cheap loans will not aid us. In that case, if we adhere to the economic orthodoxy that us got us into this mess, the only solution is to take the pain of our indigestion for the next decade or so as our level of indebtedness declines through house-repossessions, bankruptcies and high levels of unemployment.

With the current Bank of England base rate at the lowest point it has ever been in the Bank's 315 year history, firstly as a private company, then since 1946 as an agency of the state, we are clearly living in historic times. Few man-made processes last forever. We might well have reached the end of the Era of Debt.

There is, of course, an alternative to a money supply consisting of debt. We could quite easily switch to a debt-free money supply of the sort that currently exists in the minds of most ordinary people, who are baffled by the concept of money as debt. It does not make sense. Indeed, it does not, and we can expect to see the end of it during the next decade.