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Are the chances of real reform improving?


In The Money Trap, I argue that our problems result from the way in which we have applied a particular concept of money – the state theory of money. This dominated government policy in the 20th century. As Keynes said, all modern money is state money – it is seen as a creature of the state, which gives it value. It can thus change that value at will. An extreme version of this doctrine is that the state should determine not only how much money is good for us but also how much we shall spend and how much we should  save.  That is what lies behind proposals for helicopter money, reducing use of cash and issuing time-limited spending vouchers.

Currently the state is very irritated that we are collectively not spending enough. We need to be punished for such impertinence. Indeed modern electronics allows the state to identity the individual culprits who are letting the side down: they deserve to be hounded, shamed, outed and pilloried…

But one thing the state has been careful to ensure – that it can borrow cheaply.  Official sponsorship of academics ensures there is always a chorus ready to sing the praises of state spending, to ensure adequate “demand”. Thus the state has looked after its own interests very well, thanks to its dominance of the state theory of money. The downside it that in the process all the mechanisms for putting private money to good use have got clogged up.

The working out of the doctrine has led the public to distrust money. Can I put my savings into cash? What is cash anyway? Is it safe? Not for a bail-inable creditor of a bank, surely.  How should I invest my money? Clearly I should avoid productive enterprise: for even though real interest rates might be zero, I have no means of knowing what the returns on a longer-term investment will be; over and above the real risks of the investment are the further monetary risks. The State might suddenly decide to halve the value of my returns. That is its prerogative. It might forbid me to hold some kinds of asset that have always been seen as money, such as gold coins; or make cash compulsory. It might suddenly decide to increase the value of money. All these have happened in the 20th century.

Now some economists, such as Kenneth Rogoff, propose banning all large bank notes.

We are all aware that our precious investments might collapse, given that asset prices are so distorted by monetary manipulation. Do we need to save even more. In other words, in calculating the returns from an investment, we are fog-bound. That is why real investment is so low.

Hyperinflation was the old fashioned way in which the state made money socially useless. But the state has devised other ways. It creates uncertainty. This makes people increase savings because in this fog of uncertainty. We say  “all I can do is try to look after the needs I anticipate for myself, my children, grandchildren, my old age, pushing income into the future” . Please leave me enough to do that! “I am scared, frightened to death. And I expect my children to earn less that I do,. Thus all I can do is hold a diversified portfolio of assets, as recommended by my (state approved) investment advisor. I shall try not to chase after the latest investment craze. I shall batten down the hatches. I promise to invest as much as I can in short-dated government bonds – as you want! If I am a company CEO, I hope to extract the maximum cash from my company that I possibly can, before you notice, line my pockets and announce I am enhancing shareholder value. Thank you for protecting offshore havens for me!

In The Money Trap, I are that what is needed is a radical reform both of banking and of money. Governments are ducking both. That is why people are so angry.

The state is an interested party

The state is not in a position to create good money, as it is an interested party. Good money is and always has been a joint venture between the state and the private sector (see Geoffrey Ingham’s book, “The Nature of Money”). The State defines the monetary unit; but then commits itself constitutionally to maintain the value of the money unit in terms of that definition. If it has a long-term horizon, like the monarchs in secure kingdoms and empires of old, it will aim to preserve purchase power. However, experience has shown that this can be maintained in the long run only if money is defined in terms of something real.

The huge economies of scale available mean that the ideal money must also be the global standard – to which individual countries will voluntarily join.

The best anchor for money

My view is that the best numeraire would be a basket of world equities. Everybody with any money at all would then have a personal stake in the future prosperity of the world and be induced, as if by an invisible hand, to work towards it.

In all other respects, money tied to global equities would behave exactly as in the gold standard. Imbalances in international payments would be adjusted without the need for a bureaucracy.

People have complained to me this would amount to a massive centralization of power. On the contrary, as experience under the gold standard shows, such a world monetary standard is quite compatible with political decentralization and autonomous nation states.

Such a numeraire would immediately bring a sharp reduction in the role of bank lending and banking. Loans would become expensive to service. Companies and banks would be financed mainly by equity. The State would have to finance itself by taxation and residual borrowing in a transparent way. In fact, fixed-interest obligations of all kinds would be extremely expensive to service, causing states to reduce debt-gdp ratios. Indeed, this could be one way in which Meltzer’s assumption about market expectations actually works out.

Some encouraging straws in the wind

The United States may become interested if Bernanke’s view  that the dollar’s international role could be more of a burden than an “exorbitant privilege” becomes widespread(see Bernanke here).

Worries about about competitive currency manipulation will not go away.

G20 leaders meeting now in China are more conscious than ever before of the need to sell “globalisation” to their electorates. Disenchantment with the status quo could spark renewed interest in reforms.  China’s agenda for the G20 meeting focuses on reforms to global governance. Its  pursuit of what it calls “win-win cooperation and common development” is evident in projects such as the Belt and Road Initiative, and the Asian Infrastructure Investment Bank. China’s efforts highlight a new perspective: “A new model of economic governance featuring innovation, interconnectivity and inclusiveness” to help the global economy to recover from sluggish growth.

Even the madness of Brexit might have a silver lining if it alerts world leaders to the need to repair the structures supporting international trade and monetary cooperation.


Please see also my pevious post the money trap revisited