MARTIN WOLF. Why the Swiss should vote for ‘Vollgeld’.

A radical rethink of the financial system was essential after a devastating crisis

There are many other ideas in this broad area that seem worth pursuing. One would be to allow every citizen to hold an account directly at the central bank. The technological reasons for branch banking are, after all, perishing quickly. Nicholas Gruen, an Australian economist, has argued that no private institution should have better access to the public’s central bank than the public itself does. Furthermore, he adds, the central bank could operate monetary policy by lending freely against safe mortgages. The central bank would not need to lend to banks per se at all. It would focus on assets.

A radical rethink of how the financial system works was, one might have thought, essential after the devastating crisis of a decade ago. Instead, the system was patched up. Now, predictably, the mood is shifting towards removing much of the regulation. That is why I hope, despite the polls, that the Swiss vote in favour of the Vollgeld proposal in the referendum on June 10. Finance needs change. For that, it needs experiments.

According to a database compiled at the IMF, 147 individual national banking crises occurred between 1970 and 2011. These crises afflicted small and poor countries like Guinea, and big and rich ones, like the US. They were colossally expensive, in terms of lost output, increased public debt and, not least, political credibility. Within just three years from 2007, cumulative output losses, relative to trend, were 31 per cent of gross domestic product in the US. In the UK, the recent crisis imposed a fiscal cost only exceeded by the Napoleonic war and the two world wars. (See charts.)

So how does this industry create mayhem on this scale? And why is it allowed to do so? It does so — and is allowed to do so — because, as the Bank of England has explained, banks create money, which is an essential public good, as a byproduct of their lending, which is an important economic good. We want banks to have risky assets and safe liabilities. Yet the liabilities of a highly leveraged, risk-taking institution cannot be safe and will unavoidably seem least safe during a crisis. Yet it is then that people want their money — their reserve of purchasing power in a frightening world — to be at its safest.

Worse, it is often easiest for banks to justify lending more just when they should lend less, because lending creates credit booms and asset-price bubbles, notably in property. The willingness of the public to treat bank liabilities as stores of safe purchasing power provides stable funding, until panic sets in. To reduce the likelihood of panic, governments insure bank deposits, liquidity and even solvency. That makes crises rarer, but bigger. The authorities are simultaneously supporting banks and reining in the excesses created by support. This is a system designed to fail.

Today, banks are less leveraged and better supervised than before the crisis. In the UK, retail banking is also ringfenced. Yet, the banks are leveraged at about 20 to 1: if the value of their assets falls by 5 per cent or more, such a bank becomes insolvent. One way to make banks safer then would be to increase their equity capital four or five times, as recommended by Anat Admati and Martin Hellwig in The Bankers’ New Clothes.

An alternative way to make the system safer is to strip banks of the power to create money, by turning their liquid deposits into “state” or “sovereign” money. That is the idea backed by the Vollgeld initiative. An alternative way of achieving the same outcome would be via 100 per cent backing of deposits by claims on the central bank — an idea proposed by free-market Chicago School economists in the 1930s. The rest of the financial system would then consist mainly of investment banking and mutual funds. The latter shift risk on to the investors automatically. The former might need to be regulated, but mainly on capital.

The shift to a system like this would, as Thomas Jordan of the Swiss National Bank argues, be a mini-earthquake. Moreover, the proposal raises questions about the purposes to which the new sovereign money might be used.

The obvious possibility is to use the money to finance the government. This idea is highly objectionable to some: it would surely create big challenges. Yet those challenges are nothing like as fundamental as was transferring responsibility for a core attribute of the state — the creation of sound money — to a favoured set of profit-seeking private businesses, co-ordinated by a price-setting government institution, the central bank. In no other economic area is public power so mixed with private interests. Familiarity with this arrangement cannot make it less undesirable. Nor can familiarity with its performance.

There are many other ideas in this broad area that seem worth pursuing. One would be to allow every citizen to hold an account directly at the central bank. The technological reasons for branch banking are, after all, perishing quickly. Nicholas Gruen, an Australian economist, has argued that no private institution should have better access to the public’s central bank than the public itself does. Furthermore, he adds, the central bank could operate monetary policy by lending freely against safe mortgages. The central bank would not need to lend to banks per se at all. It would focus on assets.

The fundamental point here is that the burden of proof should not be on those who favour change. After a long series of huge and destructive crises, it falls rather on those who support the status quo, even today’s modified status quo. The advantage of the Vollgeld proposal is that it is a credible experiment in the direction of separating the safety rightly demanded of money from the risk-bearing expected of private banks. With money unambiguously safe, it would be far easier to let risk-taking institutions bear the full consequences of their failures. To the extent that bankruptcy remained difficult, regulation would still be needed, especially of equity capital. At the limit, as some argue, risk-bearing financial intermediation might need to be ended.

The Vollgeld proposal is not as radical as this. Yet it could provide an illuminating test of a better possible future for what has long been the world’s most perilous industry. May the Swiss dare.

Ths article was published by The Financial Times on the 5th of June 2018. It was written by Martin Wolf. 


John Laurence Menadue is the publisher of Pearls & Irritations. He has had a distinguished career both in the private sector and in the Public Service.

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2 Responses to MARTIN WOLF. Why the Swiss should vote for ‘Vollgeld’.

  1. Peter M says:

    I have studied the Initiative, and whilst I have no objection to the theory of Martin Wolf’s conclusions, I have little doubt that the Swiss Sovereign (Swiss voters) will reject it. The creation of a financial monopoly is not in the interest of the Swiss system of Government.

  2. Vincent Cheok says:

    Martin Wolf, what a brilliant article. Thank you.
    Tbhe Swiss idea of Vollgeld, or “sovereign money” or the ‘creation’ of fiat money being the sole (Sovereign or Crown or State) prerogative vested on the country’s Central Bank is so fundamentally and inherently true that it is amazing that it has escaped the notice of Economists for so long!
    In fact all sovereign states have this inherent power to create ‘fiat’ money. Not just the United States. The U.S. is unique in that its ‘fiat’ $ or Greenback has acquired the status of a ‘global’ fiat currency.
    The U.S. has been able to enhance its sovereign fiat as an individual sovereign to a global fiat because of its assumed status as the global hegemon both financially and militarily. This started off innocuously enough as a global consensus through the Bretton Woods Agreement predicated on all trading nations (including the U.S.) having their currencies backed by their respective gold reserves.
    This Arrangement became a farce when the U.S. under President Nixon withdrew from the gold standard in 15/8/71 and promulgated an artifice whereby the US$ fiat has as its basis that the U.S. is the global economic powerhouse. But when analysed in factual terms it is no different from a ‘matter of faith and trust and goodwill’ sales pitch based on the presumed confidence or guarantee of the integrity of the US$ being as ‘good as gold’. This has led to the ingenious ability that some might rather describe as gross and insidious in allowing the U.S. to tap on this advantage to its economy and dominating the global economy based on its ability to printing its global ‘fiat’US$, generating economic activity through ‘deficits’ of US$ debts.
    It has in the recent decade been bolstering the ‘fiat’US$ by enforcing directly or indirectly the prerequisite that all global oil trade be transacted in ‘petrodollar’, which is the ‘fiat’US$ in another guise.
    And because the U.S. at the same time controls the global banking system and international banking settlements and in fact the IMF and the World Bank, the other major global trade nations can only come up with a half-way solution in the creation of a new poor alternative – of a global fiat currency through the SDR or Special Drawing Rights arrangement in the IMF.
    Simply put these IMF SDRs are like a common currency viz-a-viz the different nations. The SDR is however in theory based on free floating market convertibility in arriving at the ‘basket of currencies’ that the nations use to establish or formulate the value of the SDRs.
    In fact China was not allowed to be part of the SDR scheme until 1/10/16 because it did not have a free floating yuan and still does not. This mandatory requirement of a free float is a deception because the mechanism relies on other currencies being valued by reference to the ‘fiat’US$ first.
    The concept of ‘free float’ is not quite the case because it is subject to currency speculation by people like Soros and kind. It is never ever solely based on trade statistics. And even then statistics can lie, whether it be trade or economic statistics. In a world of relativity and subjectivity where nothing can be absolute, the practical answer lies in a properly arbitraged, ‘basket of currencies’ relevant to a particular trading nation, conversion rate that is neither fixed nor free float but a ‘trading band or range’ in the middle.
    I will not discuss it here but merely point out the irony that the U.S. Federal Reserve is not a true Central Bank as well but a private cartel of some of the world’s top private banks.
    Allow me to explain why our government does not have to issue treasury notes to private sector banks or financial institutions or investment funds or even borrow money from other sovereign states or even international monetary funds like IMF, World Bank or AIIB (Asian Infrastructure Investment Bank).
    I submit as a factual historical example the case when President Lincoln was unable borrow adequate money from banks and private parties through the issue of war bonds (sort of like Treasury Bonds) to fund the Union Army in the American Civil War. There was no Government Central Bank then. Then a smart young treasury official came to the conclusion as to querying what is so different from issuing a treasury note to issuing a U.S. legal tender (now commonly called ‘Greenback’) at zero coupon rate. If this Sovereign legal tender is being circulated around sort of ‘daily’ it is as good as not requiring the payment of interest, as a continuing ‘daily loan’ for in due of interest, you are at least totally assured that you will get the face value in kind in exchange when you use it to buy things.
    And thus President Lincoln’s Legal Tender Act 1962 won the war and saved the nation from being divided! There was no need for public borrowing! The trick or constraint in economics terms is that the ‘fiat’US$ used to fund government spending must exactly equal the value added marked to market to National Assets or GNP – so that there is no inflation – supply equals demand!
    Now allowing private banks to lend money without compensating the Sovereign in some way for this devolvement of the Sovereign sole prerogative to create money is making private banks ‘rich’ at the taxpayers or the citizens’ expense. For every $1000 that the private bank lends out it only has $100 capital, possibly only $10 capital in relation to that loan! What it was ‘lending out’ that was not its own shareholders capital is the Vollgeld!
    To sum up:
    Only the Sovereign can ‘create’ money and so leaving aside the Central Bank, any private bank must be licensed or be franchised by the Central Bank to lend out more than their own capital, with the Central Bank licensing out Special Drawing Rights for a ‘fee’ (share of interest income) based on the value of the Special Drawing Rights and tied to an appropriate security deposited with the Central Bank by way of gold bullion or similar high value security at a prescribed formula to be worked. In other words, every private bank lending out in excess of its own capital is doing so as a licensee or franchisee of the Central Bank
    And thus because the integrity and proprietorship of the Sovereign in the Vollgeld – the prerogative to create fiat money – always remains with the Sovereign, no private Bank can make money without making money for the Sovereign as well, in partnership in equity. The private bank shareholders will make their own money (interest income) from their own capital, but above and separate from that the Sovereign in mutual partnership with the private bank is also making money (interest income) from the loans arising from funds that are based or predicated on the Special Drawing Rights arrangement with the Central Bank.
    Further to this the Sovereign through the Central Bank can license different and keep separate categories of banks so that housing banks are separate from agricultural banks and industrial banks and commercial banks so as to fit in ‘hand and glove’ with the National Economic Policy, as regards the different sectors of the economy.
    Vincent Cheok

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