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Renewing the Search for a Monetary Constitution

James Suzman

"Renewing the Search for a Monetary Constitution", White, Vanberg, Köhler

Financing of Basic Income


Working Paper number 1

The papers in this volume tend to converge towards an argument for competitive free banking, based on the main rule of the gold standard, which requires governments to run a balanced budget (Rolnick, p206).

More generally, the ‘monetary constitution’ the authors seek is ‘a set of enforced constraints on the creation of money by government’ (White, vii).

Their arguments are

  • ideological in favour of competition vs monopoly, free market vs state
  • objective in achieving low inflation and economic growth.

Their golden age of free banking, based on the gold standard as their claimed supreme version of a rules-based system, was breached by warfare, welfare, and Keynesian demand management.

Central banks were created by profligate governments and politicians, viz., ‘Inflationary default and simply creating money for politicians to spend are always serious threats’ (Woolsey, p129), and ‘All hyperinflations in history occurred after the breakdown of the gold standard’ (Bernholz, p120).

Currency issuers benefit from seigniorage, which is substantial. It is core to the argument as to whether seigniorage should benefit private competitive banks, or be the right of the state through its central bank (see Joseph Huber ‘Sovereign Money’).

Keynes, they claim, ‘rejected any return to a rules-based monetary regime after the collapse of the gold standard (Köhler and Vanberg, p74). Hence, ‘The consensus view on ‘rules versus discretion’ was that central banks needed a great deal of discretion for Keynesian policymaking’ (White, p201).

The policy consensus became for central banks to target inflation through the interest rate tool. This followed German Ordoliberal thinking, i.e., ‘The German notion that monetary policy should be solely committed to price stability to some extent prevailed’ (Schnabl, p174). The ‘Great Moderation’ of the ‘NICE’ (Non-inflationary constant expansion) period, was enabled by low wage Chinese production (Schnabl, p170), suggesting it is not endogenously coherent.

The authors are generally critical of this consensus. ‘Policymakers could not resist the temptation to raise expenditures instead of reducing already considerable public debt levels’ (Schnabl, p175). Lawrence White depicts ‘chronically excessive government budget deficits…high debt/GDP ratios…. continue to finance spending with additional borrowing… additional bond sales....resulting price inflation cannot be stopped’ (White, p206).

Various alternative rules and regimes are considered including

  • targeting nominal GDP (Scott Sumner).
  • constant money growth, optimal money growth (Friedman)
  • free banking + gold standard
  • fractional reserve banking
  • full reserve banking
  • quantitative money control (p6)
  • a commodity standard (p6)
  • index futures targeting (Woolsey)
  • private money, e.g., Liberty Dollar, Bitcoin

On Bitcoin, note ‘a key reason people demand Bitcoin is to do things they are not legally permitted to do’ (Dowd, p240), which is the ultimate libertarian view.

What is curiously missing in the book is

  • a definition of money
  • a description of the current real process of money creation
  • other sets of rules for a rules-based system
  • any consideration of the tenets of Modern Monetary Theory
  • consideration of a social context of banking and money
  • the macroeconomics of money in its feedthrough to income, consumption, investment, government capital and revenue expenditure, and production

There is an admission of the ‘fuzziness of just what now counts for money’ (Yeager, p2), and an acknowledgment that the homogeneity of digital money renders competitive branding meaningless (O’Driscoll, p270). However, whether money is quintessentially debt, whether its inherent value is derived from gold, government bonds, its acceptance in payment of tax, or its acceptance to transact goods, services, resources and assets, are not considered. Crucially, in the primacy of their concern with inflation, the authors regard money as a store of value between time periods, rather than as a means of exchange within time periods.

Even central banks now readily admit that it is not they who create money, but commercial banks when they extend loans to companies and individuals. Commercial banks, not the central bank, gain seigniorage. They cannot differentiate homogenous money, but they compete on differential service and pricing. They do apply rules to money creation, namely the ability of the borrower to repay with added value, and the constraints of loan-to-value and loan-to-income criteria. They have deployed resource and expertise. The lack of this expertise by central banks was the main objection raised by the Swiss National Bank in its opposition to the 2018 national referendum on sovereign money.

The current system is rules based, including

  • central banks are not allowed to buy government debt directly
  • deficit/GDP ceiling are applied in the EU Stability and Growth pact
  • a legally enforced interbank overnight rate setting process
  • central banks are statutorily tasked to target inflation using the interest rate tool

Modern Monetary Theory does make some worthy claims. A sovereign state can issue its own currency. Technically, through digital keystrokes, there is a ‘magic money tree’. MMT still generally insists that money is debt, but that government deficits create debt which is offset by surpluses in the private and overseas sectors of the economy, through a questionable application of their arithmetic identity. A leading variant of this theory claims that sovereign money can be issued debt-free.

Money is a social artefact and not simply a private product. Its value derives from public acceptance and public confidence. It is therefore a public good. It does enable macroeconomic variables of income, consumption, production, investment, et al, and must therefore be subject to macroeconomic management. There is no conceptual basis for money creation to be linked to gold holdings. Rather, it must relate to real full potential output GDP to which it philosophically refers.

We see as a result of crisis (2007) and Covid (2020), an empirical demonstration that

  • consumption can be justified by production, but if funded by household debt, is unsustainable
  • labour income is insufficient for consumption justified by production
  • necessary government welfare expenditure becomes unsustainable if funded by debt, leading to socially harmful austerity in the current paradigm
  • direct payment of income to consumers is feasible (Covid furlough schemes)
  • debt-free sovereign money creation is feasible (central bank purchase of government debt in secondary markets)

It is these phenomena that proposals for a monetary constitution should address, and which this volume fails to do.

The current suspension of the EU Stability and Growth pact creates space for a proposal for debt-free sovereign money to reverse austerity cuts, and to fund UBI.

Even within the current paradigm, a rule change to allow central banks to purchase government bonds directly should be examined, both because this has proved necessary and feasible, and because failure to allow direct purchase forces central banks to purchase government bonds from pension funds and insurance companies in the secondary market, thus attributing huge risk-free margins to those private intermediaries.

The book is available here.

Geoff Crocker
Editor ‘The Case for Universal Basic Income'
08 01 21

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