We need two, inter-related, big reforms – first to the official international monetary system and secondly to banking/financial markets.
The international monetary system
The first class of reforms needs to start at the beginning – with new reflection on the true nature of money. This is the most fundamental, and yet unavoidable, question raised by the global crisis.
Money cannot perform its functions in society as a toy of governments and private bankers – which is what, sadly, it has become in the age of crony capitalism. It has been used, outrageously, to sanction huge transfers of wealth to the already wealthy. Governments desperately throw money at every problem – “print more, print more!” they shout at shell-shocked central bankers, who anxiously try to appear calm and reassuring.
We need to get bck to basics, and build a reliable framework. Money should be tied to a universal standard of purchasing power; this would be simultaneously an agreed abstract measure of value (which is the key to conferring “moneyness” on a commodity) and also a claim on real resources. It must be readily understood by people everywhere. Money is created by debt, rests on promises and is damaged by loss of trust. That is why money has declined in volume and trustworthiness. Central banks try to fill the supply deficit but cannot fill the trust deficit. (See Geoffrey Ingham’s “The Nature of Money” for some profound reflections on this theme).
Various options for the “anchor” should be examined – there are several, as shown in survey in “The Money Trap”.
This can be re-established by linking the monetary unit to a global index of real assets – which are in my proposal best represented by holding the monetary unit constant against a diversified index of equity claims. I call this the Ikon standard – a word chosen to denote an abstract representation of an object of respect and rising long-term value. Money is not a “thing”, an “object” which “circulates” but a product of social bonds. Even gold derives its moneyness not from its inherent value alone but from society’s guarantee of convertibility now and in the future at a fixed price.
Holding claims on real resources through money would be the best way to create institutional arrangements for the modern world that embody the true nature of money.
It would empower every citizen of every country. As consumer prices declined with the rise in productivity and the real value of shares, the monetary unit would have a rising real value. It would give every holder of money balances the same proportional claim on the future of the world’s resources and its combined skills, capital and expertise. It would not readily be subject to manipulation by committees and governments as inflation targeting and similar standards are. The supply of money constrained by this constitution would be countercyclical, automatically increasing in a downturn and declining in business downturns. It would represent a natural evolution from a commodity standard such as gold. It is made possible – indeed, it is made necessary – for the first time by the globalization of money and capital markets.
As described in Chapter 15 of “The Money Trap”, the international system would work exactly as under the gold standard, except for the asset or standard at the centre of the system – the Ikon would replace gold. But tight market discipline would be imposed on all major actors.
Banking and finance – the private sector
Banking and private sector finance also need to find new models. The first step is to divide them wholly off from the constitutional rules governing money and official sector authorities, whose only role is to maintain observance of the constitutional rules. This separation would restore ethics to finance. And that is the only way to restore trust.
Seen from 2013, a positive development is that bankers are in fact developing new business models. These should go much further – and they will, once the full (and totally unacceptable) cost of traditional banking becomes clearer. Responsibility can be brought back to banking if the twin evils of banking – leverage and opacity – are driven out and replaced by equity-type contracts. Meanwhile, what governments must understand is that as long as the macro-economic and financial environment remains unstable, so will banking be.
There are signs of progress. Economists have proposed stabilising the economy by central bank intervention in stock markets – a step towards the concept behind the Ikon (see Farmer here). Markets turn down before recessions and appear quite a good leading indicator. Central banks’ QE goes some way towards this – with the equity markets seen as links in the transmission mechanism from policy to the real economy. But whereas QE is destabilising because of its arbitrary and discretionary nature, to fix money to a constant value of an equity index would constitute a monetary rule. Also, some central banks are investing directly in equities – to diversify their reserve assets. Thus central banks are already “getting their hands dirty” in stock markets. Meanwhile, commercial banks are changing their structures, activities and organisations drastically as a result of post-crisis market and regulatory pressures.
These developments are all part of the initial repercussions of the global financial crisis – which has led to the loss of many former so-called “risk-free” assets. Such assets have played a central role in banking and central banking since the development of modern banking systems. Yet even the US Treasury bond is no longer seen as risk free.
The longer-term repercussions of the crisis for money and banking are still greatly underestimated. Governmens and many sectional interests still want to get back to business as usual – or as near to it as possible. This won’t happen. The only question is whether the coming transformation of money and banking will be in a direction that benefits the public at large, or whether sectional interests, notably political and financial elites aroudn the world, keep control.
We are still only in the early stages of the progressive transformation of finance.