What is positive money?

I’m going to the 3rd Positive Money conference in London on Saturday, “Modernising Money.” It’s a subject I know very little about but since economics affects us all, since I took on A-Level Economics as a teenager and since someone else offered to pay for my entry ticket and rail fare to London, I’m going along to find out what the fuss is all about. Rooting around inside Positive Money’s website reveals much we all already know about the flawed monetary system the entire world uses. Here’s a short video explaining what we all already know. It also proposes a solution. I’ll come onto that later.

I’m not sure that it is quite as simple as that. From my own education, I had understood that banks were obliged, either by law or by sheer practicalities, to maintain a certain liquidity ratio. A liquidity ratio is the percentage of a bank’s total assets which must be held in liquid form. Liquid money is usually taken to mean cash or assets which can be instantly converted into cash. I’ve no idea what the rule is now but I think the received wisdom always used to be that between 8% and 12.5% of a bank’s assets should be liquid. The reason why this ration is required is that if it is allowed to fall below whatever the appropriate figure is, there is a real risk that people and institutions will try to withdraw cash from the bank when it doesn’t have it. Inevitably, that causes panic and a run on the bank, whereby everyone tries to withdraw money the bank does not have.

History teaches us that very often a run on one bank leads to a run on lots of banks. Banks go bust in the process. Governments don’t want a run on their banks, so they generally regulate for an appropriate liquidity ratio, which is determined by the monetary behaviour of the investors at the time. Even if they don’t regulate for it, the banks impose a similar rule on themselves, unless they are criminals engaging in fraud. Otherwise they find themselves in trouble that they did not seek.

It’s a small but important quibble with the video above. Being factually accurate is critical, if we want analyse a system. It’s simply not true to say that money is created out of nothing when someone borrows it from the bank. It is true to say that it is created out of mostly nothing. Thus, if I borrow £1,000 and the bank is operating a liquidity ratio of 10%, £900 has been created out of nothing. Not to mention the interest charged.

Nonetheless, it is very well established that the capitalist monetary system operates on a foundation of debt and credit. Money didn’t always function like this. In fact, it has been used for thousands of years without any trace of this foundation being established. Modern banking began with the issue of fiat money, which is money which has no instrinsic value (like gold coins do) and is not completely backed by real money or real wealth held elsewhere. Although wikipedia will tell you that fiat money was first used in China in the 11th century and that it became widespread after the United States of America removed its currency from the gold standard (which determined how much gold each paper note or metal coin was worth) in 1971, both these points mislead those historians seeking a proper grasp of how modern capitalism began and how fiat money was crucial to its ‘success’. Curiously, wikipedia reveals its American bent most obviously on its page on fiat money. History aside, much though it has to teach us, it does not help us work out whether there is a solution to the problems caused by our monetary system. That much is self-evident: debt creates inequality and inequality causes no end of social problems. If you doubt the first point, there’s probably no point trying to explain anything to you. If you doubt the second point, please read Richard Wilkinson’s The Spirit Level. Is there actually anyone left who hasn’t read that seminal text?

Presumably, the video above is an over-simplification. It proposes to hand over the control of lending to a central bank. This is pretty much what the Soviet Union did. No money could be spent without its say so. Obviously that tied in with the communist regime’s political command of the economy. The Positive Money people do not seem to be proposing a centralised command economy. Therefore, the proposal is simply that the Bank of England, which manages its affairs independently of the UK government but is obliged to meet various targets, particularly with regard to inflation. In purely practical terms, that means that the central bank would have to employ many more people to manage its own lending. In itself, that might not be such a bad thing. However, if I’m trying to start a business and I want an overdraft facility from a bank to get it going and the central bank doesn’t like the sound of me or my business plan, that’s it, I’m stuffed. One advantage of the present system is that the banks compete for my business. There’s a reasonable chance that if one bank is wary, another might step in with the credit. If no bank wants to lend the money in a competitive environment, it is unlikely that a central bank would.

The other fundamental problem is that whilst the proposed system might be a much better way of organising our economic affairs, there’s no proposal for how to get from here to there. In any radical change, transitional arrangements are crucial for its success. Until we hear a proposal for how to manage the transitional arrangements, this is just pie in the sky. We might want that pie but we can’t reach for it. Clearly, this system could not be brought in overnight. Perhaps there will be transitional plans to be kicked about on Saturday in London? If so, I’ll report back.