Money (38 page)

Surprisingly, this fundamental principle is far from alien to the current regulatory response to the crisis. The structural reform proposals of Volcker and Vickers make a nod to Law’s fundamental idea of realigning the distribution of risks implicit in the current structure of the banking system. There are more aggressive contemporary reform proposals under debate as well. The prominent U.S. economist and public intellectual Laurence Kotlikoff has put forward one of the more important ones: “Limited Purpose Banking.”
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Under Kotlikoff’s radical proposal, banks as we now know them would cease to exist. All economic risk would simply pass unimpeded through an infinitely expandable spectrum of mutual funds from borrowers to savers. The phoney claims of financial intermediaries to practise “liquidity transformation,” and the intrinsic mismatches that lie at the root of what is wrong with the current system, would be exorcised once and for all. Only manual gearboxes would be allowed on the roads.

Kotlikoff’s vision is a bold one—but even it stops short of taking the Scotsman’s strategy all the way to the revolutionary conclusion which John Law himself attempted. Under Limited Purpose Banking, although private banks are henceforth forbidden to issue short-term liabilities of certain nominal value whilst holding long-term assets of uncertain nominal value, the sovereign itself is not. Sovereign money remains just as we know it today at the heart of the system: a safe and liquid promise to pay under all circumstances. Law’s idea was to rid money-users of even this last resort of risk aversion. At the heart of his new financial world was to be not sovereign debt,
but sovereign equity. Once again, it is an idea that sounds incredible to modern ears—but it is one that has its influential advocates today. The U.S. economist Robert Shiller—a modern Projector, as well as one of the world’s most distinguished academic economists—has for many years urged sovereigns to share with investors the risk to the public finances inherent in uncertain economic growth by issuing bonds that pay interest linked to GDP.
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Shiller’s proposals urge a gradual shift towards such innovative financial instruments. In the midst of the greatest economic and fiscal crisis France had ever seen, Law lacked the luxury of time.

Law’s strategy of creating a monetary system which privatises all risk represents one extreme option. At the opposite end of the spectrum is a reformed monetary system structured to socialise all risk. This alternative extreme would see the banks replaced not by mutual funds, but by the sovereign. Money’s seductive promise would not be abolished. Instead, the one issuer actually capable of making good on it—the sovereign—would be the only issuer permitted to do so. Both capital markets and the banking sector would continue to coexist; and money would remain the special preserve of the latter. But under this extreme option, it would be entirely owned and operated by the state. Once again, it is a reform that sounds dramatic, but is not as far-fetched as it first appears. Indeed it is towards this extreme that the crisis, with governments’ nationalisation of banks and central banks’ unprecedented interventions in the money markets, has thrust us by default. When the U.S. Federal Reserve has taken over more than U.S.$1 trillion of mortgages, and the balance sheet of the European Central Bank has absorbed everything from car loans to credit card receivables, why not finish the job?
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As counter-insurgency strategies designed to disable the Monetary Maquis and secure a new Great Monetary Settlement, these extreme strategies have the merit that they would eliminate once and for all the problematic distribution of risks inherent in the current structure of the banking system. Unfortunately, they would do so only at the cost of destroying monetary society itself. The Scotsman’s solution would represent the apotheosis of the vision of modern
academic finance: the abolition of banks and money in favour of capital market securities, the value of which would vary in perfect sympathy with the underlying risks present in the real world.
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The sovereign’s ability to redistribute these risks by adjusting the monetary standard would cease, because there would be no sovereign liabilites the value of which was fixed in terms of it. Money would no longer be a tool of government. Instead of a rule for anarchy there would be just anarchy—until some other system for organising society took its place. Rather than reimposing legitimate government, this is defeating the insurrection by permitting a free-for-all.

Meanwhile, the alternative extreme of a return to sovereign money alone—a society in which all money is issued by the state because all banking is operated by it too—presents an equally nightmarish prospect. Money would no longer be a tool of government, it would have become government. All the benefits of decentralised decision-making in finance would be gone, replaced by a monetary system that replaced the injustice of taxpayers’ enforced insurance of the bankers by the alternative injustice of their insuring absolutely everybody all the time instead. Like encouraging a descent into anarchy, this is a counsel of despair: defeating the insurgency by becoming a totalitarian state.

If we are to turn the locusts into bees, we do need a radical reform of the banking system. The unconventional view of money suggests three useful principles to begin from: two regarding where we want to go, and one regarding how we get there. First, the solution to the problem of moral hazard at the heart of the modern banking system lies neither in redesigning the system to privatise all financial risk, nor in redesigning it to socialise it. What is required is a closer match—not a perfect one—between the costs and benefits that taxpayers, bankers, and their investors are at risk of bearing. The current regulatory response is on the right track. U.S., U.K., and EU proposals all argue that more risk must be borne privately, and less socialised and borne by the taxpayer. But the reforms they propose do not go far enough.

Second, since money is a tool for organising society, and since the
only authority with the political legitimacy to command how society should be arranged is by definition the sovereign, any redesign must maximise the room for monetary policy. Money’s fantastic promise to deliver both stability and freedom has become a boondoggle in the hands of the banks: the specious claim of “liquidity transformation” has become camouflage for a one-way bet, and should be forbidden. Yet that same promise is nothing other than the essence of money, one of the most powerful and important tools of democratic government the world has ever known. So long as democratic politics commands the escape valve of a flexible monetary standard, it should therefore be preserved.

A final principle relates to how to get to a system of money and banking reformed in line with these first two. The guiding rule must be that less is more. Conventional warfare will be an infinite regress: attempting to supervise the financial sector is a fool’s errand. The current regulatory proposals are correct that structural reform is the key. The trick is to set as few rules as possible and police them rigorously, while setting private initiative and innovation free for the rest. In the field of money—the greatest technology ever invented to liberate mankind’s entrepreneurial energies—this canonical rule of regulation is more necessary than ever.

Is there any realistic proposal for banking reform that answers to this daunting job description? Fortunately, there is—and it is not a new one. Eighty years ago, in the depths of the Great Depression, the great American economist Irving Fisher published a famous proposal with the inspiring title
100% Money
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It was remarkably simple. Like the Scotsman’s strategy, it sought fundamentally to realign the balance of risks in the banking system. Like today’s regulatory response, it advocated doing this by restricting sovereign support to a limited range of activities. But it is simultaneously simpler and more radical. Fisher’s proposal was to require that any deposit that could be withdrawn or used to make a payment on demand be backed by sovereign money—and banks which offered such deposits be permitted to do no other business. “The checking deposit department of the bank,” Fisher wrote, “would become a mere storage warehouse for bearer
money belonging to its depositors and would be given a separate corporate existence as a Check Bank.”
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As for the rest of what banks now do—whether client-facing or not, whether wholesale business or retail—these things would be treated like all other capital market activities, and the institutions that undertake them would neither enjoy special sovereign support, nor suffer special sovereign supervision. The market would decide what products would be offered, and what institutions would offer them. Outside the realm of “Check Banks,” even the dodgy promise of liquidity transformation would be permitted. If investors wanted to gamble on an intermediary’s ability to synchronise payments in and out of its balance sheet, they would be quite at liberty to do so—because there could no longer be any illusion on any side that such investors would be bailed out if the promise was not met.

Fisher’s proposal was taken up in the 1930s by economists at the University of Chicago, after which it became popularly known as “The Chicago Plan.” It was revived again in the 1960s by the subsequent Chicago luminary, Milton Friedman.
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Today, under the banner of “Narrow Banking,” it is being advocated once again by some of the world’s leading regulatory economists.
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It has even been the subject of a new study by the International Monetary Fund, which found that testing its consequences using a formal mathematical model strongly corroborates Fisher’s argument that it would lead to greater macroeconomic and financial stability.
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It is a reform consistent with the principles outlined above. The socialisation of financial risk would not be eliminated, but it would be far more strictly circumscribed. The utility activities of narrow banks would enjoy the support of the sovereign. No other financial institution would: and the clear distinction between narrow banks and everything else would eliminate the ambiguous no-man’s-land in which liquidity illusion and moral hazard have allowed the Monetary Maquis to thrive. Sovereign money would remain at the heart of the system, both as cash in the public’s pockets and as the only asset held by the narrow banks. Monetary policy, and with it money’s integration into the democratic organisation of society, would
therefore be preserved. And finally, the necessary structural reforms are simple. The rules for narrow banks would be few but draconian, and anyone wanting a charter for a bank would have to abide by them. For anyone that does not want a bank charter, there would be no rules: just the ceaseless innovation which money itself unleashes, and which the financial sector has shown such a talent for exploiting.

John Maynard Keynes began the final chapter of the most important work of economics of the twentieth century with a realistic diagnosis of the situation seven years into the Great Depression. “The outstanding faults of the economic society in which we live,” he wrote, “are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.”
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Today, five years into another monumental economic calamity, it is the same outstanding faults of unemployment and an unjust distribution of economic risks that plague us. Money and banking, incorrectly understood, and so incorrectly configured, are what brought us here. Money and banking, correctly restructured, will be what bring us out again.

“So!” interrupted my friend the entrepreneur, “I always knew it!”

“Always knew what?” I answered.

“That you were a closet revolutionary. You don’t like capitalism or capitalists like me. And what your story about money boils down to is that you want to soak the rich and hang all the bankers from lamp posts.”

“Where did you get that idea?”

“Well, allow me to summarise your argument—or maybe I should call it your murder mystery. You said it would be an unauthorised biography. To me it sounded more like an Agatha Christie novel.”

“Oh yes? Who’s the victim?”

“Common sense—according to you. But let’s see if I’ve got it straight. You began by explaining that, contrary to first appearances, money is not a thing but a social technology—a set of ideas and practices for organising society. To be precise, you explained that in essence, money comprises three things: a concept of universally applicable economic value; a system of account-keeping whereby that value can be measured and recorded; and the principle of decentralised transfer, whereby that value can be transferred from one person to another. You used that story about Yap to show how absurd it is to think that coins, or any other tokens, are themselves money.
And you used that story about the Irish bank closure to show that although money is usually issued by governments, it doesn’t always have to be. I bought all that—but then I asked you what difference it makes to take this view of things. You said a lot—which is why I’ve been sitting here listening to your so-called unauthorised biography.”