Tuesday, July 10, 2012

564 Richard Werner and Ambrose Evans-Pritchard: get rid of debt and dethrone the bankers

Richard Werner and Ambrose Evans-Pritchard: get rid of debt and dethrone
the bankers

Richard Werner is Professor and Chair of International Banking at the
University of Southampton. Previously he was Assistant Professor of
Economics at Sophia University in Tokyo. He spent over a decade working
in Asia, including at the Bank of Japan, the Japanese Ministry of
Finance, Jardine Fleming Securities (Asia) Ltd, the Asian Development
Bank and as asset allocator of a major pension fund.

Werner is on "our" side. He's been taking on the bnanking establishment,
and is not much liked there.

The Foreword to Where Does Money Come From? (item 1) is by Charles A. E.
Goodhart, Professor Emeritus of Banking and Finance, London School of
Economics

(1) Richard Werner: Maatricht Treaty prohibits the direct financing of
government spending by the nation's central bank
(2) Richard Werner: Seigniorage and banks' 'special profits' ie interest
as a private tax
(3) Richard Werner asks: Could the government directly create money itself?
(4) Werner: governments can create money without debt, and use it to run
the economy, like Kublai Khan
(5) Werner: Banking in Ancient and Modern History; Chinese paper money
(6) Werner: The German and Japanese challenge
(7) US Treasury criticizes Germany’s chronic trade surplus
(8) WE in the Anglosphere are Greece; the Asia Model countries are Germany
(9) John Craig: demand deficits in East Asia cause excess consumption,
bubbles & debt in West
(10) John Craig: Asia Model current account surpluses recycled into
further expansion of production capacity
(11) What if we adopted a system where the Banks did not create our Money?
(12) Ambrose Evans-Pritchard: IMF's epic plan to conjure away debt and
dethrone bankers

(1) Richard Werner: Maatricht Treaty prohibits the direct financing of
government spending by the nation's central bank


Where Does Money Come From? A Guide to the UK Monetary and Banking System

by Josh Ryan-Collins, Tony Greenham, Richard Werner and Andrew Jackson

London: nef (new economics foundation), 2011

{p. 78} One of the most important rules of the Treaty in relation to
money creation is Article 101 EC (now known as Article 126 of the Treaty
on the Functioning of the European Union (TFEU)). This prohibits the
direct financing of government spending by the nation's central bank.
This includes any overdraft credit facility and the direct purchase of
any debt instrument (i.e. gilts, ) treasury bonds) by the central bank.
Article 101 EC does however allow the central bank to purchase debt
instruments on the secondary market, i.e. after have previously been
issued to private investors and started to be traded in money markets
(see Chapter 2, Box 4).

This is exactly what the UK central bank did during the financial crisis
of 2007/2008. During the period of what was called 'quantitative
easing', the Bank England did not create new money in the sense of new
purchasing power in the economy, as is often thought. Rather, it pumped
vast quantities of central reserves into the banking system via the
purchase of government bonds (gilts) on the secondary market. It did
not, and, is not permitted to under Article 101 EC, purchase newly
issued gilts directly from the UK government. Such action would, of
course, provide the government with newly created money which could be
spent directly into the economy via government departments or to reduce
national debt.

ECB has followed a similar course of action in the eurozone more
recently by buying €45 billion of Greek bonds and more recently Irish,
Portuguese, Irish, and Italian bonds from the secondary market in an
attempt to prevent a loss of confidence in the European sovereign debt
bond markets.

These EU rules ensure that when government spending exceeds taxes
governments are forced to borrow funds from the market and run up a
deficit, rather than finance the deficit or increase public spending
through new central money creation. This is why the interest rates on
government debt of different European countries, particularly since the
financial crisis, are the focus of so much media attention. If the
interest rates on government debt reach a certain level, the markets may
lose confidence in the government's capacity to repay its loans, or roll
over its debt, pushing interest rates even higher until eventually the
country faces the prospect of default. As political economist Geoffrey
Ingham argues, the Maastricht Treaty effectively removed the power of
money creation from individual states and subjected them to market
discipline: {continued on p. 79, after Box 9}

{p. 79} The latter constraint [article 10] is aimed at preventing
individual states ftom monetizing their debt, in the time-honoured
fashion, which would compromise the ECB's [European central bank's]
absolute control of the Production of money. Now that individual member
central banks cannot monetize their states' debts, budget deficits must
be financed directly in the money market - like those of any private
corporation.
{end quote}

These restrictions on credit creation do not apply to 'publicly owned
credit institutions', which have full credit creation powers and are
treated in exactly the same way as private banks by the central bank.
Furthermore, as the European sovereign debt crisis unfolded, the ECB has
interpreted some of the rules 'flexibly', so that its credibility and
enforceability in case of non-compliance by a member government are now
somewhat more doubtful. Finally, as will be discussed below, these rules
do not prevent the government borrowing from commercial banks which in
turn will create new money, to fund the public sector borrowing requirement.

How does the government then 'spend'? Like me and you, and unlike
commercial banks, in order to spend the government first needs to obtain
money from somewhere. Generally, this spending is either funded from

{p. 80} revenue, proceeds from profitable government-operated
enterprises or services, national insurance contributions and taxes, or
through borrowing.

4.2.1 The Consolidated Fund

Like any organisation that wishes both to receive and spend money, the
government has bank accounts. However, unlike most organisations, the
government's primary bank accounts are held at the Bank of England. The
oldest of the accounts is the Consolidated Fund (CF) (Figure 16), whA
was established in 1787 as 'one fund into which shall flow every stream
of public revenue and from which shall come the supply for every
service.' Administered by HM Treasury, the Consolidated Fund can
essentially be bought of as the government's current account. The taxes
collected by HM venue and Customs (HMRQ are the primary inflows into the
Consolidated Fund (Figure 16). However, if the government is running a
deficit, then pending outflows exceed tax inflows. To make the account
balance, the difference must be made up through government borrowing.

(2) Richard Werner: Seigniorage and banks' 'special profits' ie interest
as a private tax


{p. 68} Box 8: Seigniorage, cash and bank's 'special profits'

The Bank of England sells bank notes to commercial banks. They sell
these notes at face value (a E10 note sells for E10), yet the cost of
printing a E10 note is just a few pennies. The difference between the
face value and cost of production gives the Bank of England substantial
profit. This profit from the creation of money is known as
'seigniorage', and is paid over to the Treasury, where it can be used to
fund government spending or to reduce taxation. In the years 2000 and
2009 this seigniorage amounted to nearly E18 billion.

The growth of digital commercial bank money, vis-a-vis government issued
cash, can be een to have the effect of significantly reducing this
seigniorage profit to the government proportionate to the total money
supply. Commercial banks do not generate seigniorage themselves as they
issue credit which will, at some point, be repaid in full. However, as
we discussed in Section 2.4 on Fractional Reserve Banking, commercial
banks can be seen to generate 'special profits' from their power to
issue money in the form of credit through the interest charged upon
loans and used overdraft facilities.

Huber and Robertson suggest the interest charged on the issuance of
money by banks can be viewed as a 'money tax', since the government
could issue non-interest bearing money directly in to the economy. They
also argue that bank's {sic} enjoy a form-of additional 'special profit'
because they don't have to first borrow this money like other
organisations. This 'special profit' can be thought as equivalent to the
central bank's base rate over the course of the loan.

The total profits arising are then the rate of interest charged on the
loan (e.g. 8 per cent), added to the base rate (e.g. 2 per cent) = 10
per cent, minus any interest paid by the bank to the customer on any
portions of the loan that the customer has not yet spent. This is
opposed to an interest rate 'spread' profit of 8 per cent - 2 per cent =
6 per cent. Using this methodology, Huber and Robertson calculated that
in 2000 the 'special profits' generated through this were E21 billion.

(3) Richard Werner asks: Could the government directly create money itself?

{p. 79} Box 9: Could the government directly create money itself?

There are many historical examples of governments funding fiscal
shortfalls through the issuance of government money. This was done in
the UK during WWI, and prior to this via the elaborate system of tally
sticks deployed between the eleventh and nineteenth centuries (Section
2.3) Similarly, the governments of Germany, Japan, and the USA issued at
times significant amounts of government money, mainly during the
nineteenth century.

While the issuance of government money to fund fiscal expenditure is
often thought to be inflationary, this need not be the case, especially
if limited by the amount of money-supply expansion needed to reach the
growth potential of the economy. As has been argued by Huber and
Robertson and others, government-created money may represent an
efficient use of the monetary system to minimise the tax burden and
maximise value for tax-payers. No servicing costs in the form of
interest and interest on interest (compound interest) are incurred. This
could be a substantial benefit at a time when many a government spends
as much or even more on compounded interest on their debts than on their
core government expenditure programmes (see also Box 8 on 'seigniorage'
{see below}). Exploring alternative methods of creating new money is
beyond the scope of this book, but these historical examples are
important to illustrate that alternative systems are not just possible
but have been tested and been effective.
{end Box 9}

(4) Werner: governments can create money without debt, and use it to run
the economy, like Kublai Khan


New Paradigm in Macroeconomics: Solving the Riddle of Japanese
Macroeconomic Performance

by Richard A. Werner

Palgrave, London, 2005

{p. 258} The most efficient way to fund fiscal expenditure

There is a fourth option of funding government expenditure which has
also been ignored by most of the literature. The first three all share
one common drawback: they create debt, which needs to be serviced
through interest and interest on interest. In the case of most
industrialized nations, but especially in the case of the US and Japan,
these compound interest liabilities are substantial. They will have to
be serviced by generations of taxpayers, while public expenditures (such
as on public services, healthcare, education, and so on) will have to be
cut in order to save money to be able to service the accumulated debt
mountain. Economically, this is a highly inefficient, unproductive and
inequitable allocation of resources.

There is an option to fund government expenditure, which has the
advantage of no quantity crowding out, but also does not suffer from the
disadvantage of incurring debt. It is thus the most desirable, efficient
and equitable method: this is the option for governments to create money
directly and use it to fund their expenditure, just as Kublai Khan did
in thirteenth-century China, or as the US government did during several
stages of its history. In these cases, no debt is incurred, and no
interest liabilities weigh on future generations of taxpayers.

Indeed, the US Constitution, largely under the influence of Thomas
Jefferson (an opponent of privately-owned central banks), explicitly
reserved the right of money creation for the US government. Since the
creation of the privately-owned Federal Reserve banks in 1913, this
option was increasingly avoided, thus incurring significant government
debt and substantial interest liabilities. One of the few presidents to
challenge the de facto monopoly to create credit that the banking system
and the Federal Reserve banks enjoy was John F. Kennedy, who ordered the
issuance of 'United States Notes' in 1963 with one of his last executive
orders (No. 11,110).13 This government money had the same design as the
more common 'Federal Reserve Notes', but instead was entitled 'United
States Notes' (compare Figures 18.3 and 18.4). Further, it was only
graced by the seal of the US Treasury, and did not have any seal linked
to the Federal Reserve system. After Kennedy's death this practice has
not been repeated. Since then, interest liabilities of the US population
have mounted.

In line with this argument, Joseph Stiglitz has called for the Japanese
government to issue government paper money. 14 In Japan, this policy was
last implemented in the early Meiji era. To fund stimulatory fiscal
policy through the issuance of paper money is economically more
efficient than borrowing. In practice, the technique can still be
improved upon, however: paper note issuance is somewhat cumbersome,
carries (small) production costs and, most of all, is limited in
potential maximum scope by the fact that only about 5% of all
transactions make use of paper money. Therefore an improved version of
this funding policy, which allows the government to

{p. 259} {photos & captions}
Figure 18.3 The standard Federal Reserve Note

The standard five dollar 'Federal Reserve Note' is entitled as such and
carries the seal of the Federal Reserve system (on the left) and the
seal of the US Treasury (on the right)

Figure 18.4 The United States Note

In 1963, President Kennedy ordered the issuance of government paper
money, with the same design as the Federal Reserve Notes, but entitled
'United States Note' and bearing, only the seal of the US Treasury (on
the right)
{end photos & captions}

create larger volumes of credit, would be for the Finance Ministry (or,
in the case of the US, the Treasury) to institute credit creation on its
own accounts, the same way that currently the central banks and the
commercial banks create credit. This could be achieved if Milton
Friedman's (1982) advice was heeded, which constitutes the culmination
of his decades of research into the functioning and economic
implications of the Federal Reserve system, namely to fold the functions
of the central bank into the Treasury, by rendering 'the Federal Reserve
a bureau in the Treasury under the secretary of the Treasury' (Friedman,
1982, p. 118).15 ==

The Friedman reference is to p. 18 at
Friedman, Milton (1982), Monetary policy, theory and practice, Journal
of Money, Credit and Banking, vol. 14, no. 1, February, pp. 98-118.

Werner has a more detailed quote from Friedman (same source) in Princes
of the Yen at p. 247:

"The only two alternatives that do seem to me feasible over the longer
run are either to make the Federal Reserve a bureau in the Treasury
under the secretary of the Treasury, or to put the Federal Reserve under
direct congressional control. Either involves terminating the so-called
independence of the system. But either would establish a strong
incentive for the Fed to produce a stabler monetary environment than we
have had."

(5) Werner: Banking in Ancient and Modern History; Chinese paper money

New Paradigm in Macroeconomics

{p. 164} In Ptolemaic Egypt 'payments were effected by transfer from one
account to another, without money passing' (Rostovtzeff, 1941, quoted by
Davies, 1994, pp. 52ff). Papyri served for bookkeeping and receipt
issuance. The bank books distinguished credit and debit entries." A
central bank was established in Alexandria. Next, 'Rome and
Constantinople became the main inheritors of the banking wisdom of the
ancient ~#orld' (Davies, 1994, p. 91). Banking has existed in Rome since
at least 310 BC. Wax-covered writing tablets served as deposit or loan
receipts and the collateralization of land to secure loans played an
important role. With bankers becoming influential senators and vice
versa, links to the political leadership were apparent and controversial
- Julius Caesar was involved in banking himself (Andreau, 1999).11
Between the third and sixth centuries AD banking houses are known to
have existed in Europe in the form of deposit-taking silversmiths
(Andreau, 1999). Meanwhile, bankers have been instrumental in the rapid
economic development of China since the Song Dynasty of the tenth
century. The Mongolian empire spread advanced banking practices across
much of Euroasia. Finally, over the past millennium, banking dynasties
have played a major and well-documented economic and political role in
the whole of Europe. To name a few, there were Italian bankers who at
one stage dominated European banking, influential banking houses in the
Low Countries, and even organizations such as the Knights Templar who
engaged in sophisticated, international banking activities, beginning in
the eleventh century. Bills of exchange were 'discounted' by banking
houses to circumvent the ban on charging interest (usury). In England,
an ancient form of issuing receipts were the wooden 'tallies', eight- or
nine-inch-long sticks carved from hazel, with notches to mark different
amounts. They acted as bills of exchange and stimulated banking
activities for centuries.12

Wars were often funded by banks, whether it was William of Orange's
invasion of Britain or Napoleon's international campaigns. Indeed, a
cursory survey of the history of banking appears to coincide with the
history of the rise (and fall) of advanced economies and empires. There
are few advanced civilizations that did not use credit systems. Sparta
appears to have been one such exception, which perhaps contributed to
the rivalry perceived by banking-dominated Athens. In almost all cases,
these banking systems led to the'development of economies dominated by
non-cash and non-money transactions. Petty transactions for day-to-day
expenses by the ordinary population were usually conducted with the use
of commodity money or cash, as they are today. But these amounted to a
small fraction of total trans-_ action values.

Banking, we thus find, has been at the heart of human economic activity
for thousands of years. It has also been an important aspect of the
political economy, and via its link to warfare contributed to reshaping
world history.' Given these facts, we should expect banking to either
constitute the crucial link between the monetary/financial side and the
'real economy' or at least

{p. 165} provide a major illumination of it. So why have banking
activities been neglected for so long by economists?13 When banks were
analysed, they were viewed merely as extensions of the 'money'-based
structures postulated by deductive theory. In Schumpeter's (1954) words:

The huge system of credits and debits, of claims and debts, by which
capitalist society carries on its daily business of production and
consumption is ... built up step by step by introducing claims to money
or credit instruments that act as substitutes for legal tender and are
allowed indeed to affect its functioning in many ways but not to oust it
from its fundamental role in the theoretical picture of the financial
structure ... The legal constructions, too ... were geared to a sharp
distinction between -money as the only genuine and ultimate means of
payment and the credit instrument that embodied a claim to money. But
logically, it is by no means clear that the most useful method is to
start from the coin ... in order to proceed to the credit transactions
of reality. It may be more useful to start from these in the first
place, to look upon capitalist finance as a clearing system that cancels
claims and debts and carries forward the differences - so that 'money'
payments come in only as a special case without any particfilarly
fundamental importance. (p. 717)

To identify the other special feature of banks, we need to research how
banks came about. While so far too few clay tablets have been found or
translated to answer this question in the case of the first banking
systems in Babylon, we can use the case study of more recent
introductions of banking systems, such as the development of the
goldsmith bankers in London. Since they were banks in every sense, the
key empirical features of their development should lend themselves to a
degree of abstraction and generalization.

Chinese paper money

However, first a brief look at an alternative financial system will be
useful, in order to put banks into sharper contrast. This is the
monetary system of the Mongol Empire, including China, as it is
described in the thirteenth 1~entury. Marco Polo was a trained merchant,
and his description of Kublai

Khan's financial system is highly Illuminating. The Khan's government
issued paper money, which was legal tender. It appears that the majority
of transactions were actually transacted through this paper money. In
this case, it is apparent that the definition for money in any quantity
equation would be the stock of paper money issued by the government's,
mint. Thus the government was directly in control of the money supply
and could stimulate demand by creating more paper money, or slow the
economy by taking paper Out of circulation. This was done through 'open
market operations', which

{p. 166} are also described by Polo. The description is well worth
citing at length:

{quote} It is in this city of Khan-balik that the Great Khan has his
mint; and it "' so organized that you might well say that he has
mastered the art o alchemy. I will demonstrate this to you here and now.
You must kn that he has money made for him ... out of the bark of troes
- to be precis from mulberry trees (the same whose leaves furnish food
for silkworms) . all these papers are sealed with the seal of the Great
Khan. The proce u of issue is as formal and as authoritative as if they
were made of pure gol or silver. On each piece of money several
specially appointed officia write their names, each setting his own
stamp. When it is completed due form, the chief of the officials deputed
by the Khan dips in cinnab the seal or bull assigned to him and stamps
it on the top of the piece money so that the shape of the seal in
vermilion remains impressed upo' it. And then the money is authentic.
And if anyone were to forge it, h would suffer the extreme penalty.

Of this money the Khan has such a quantity made that with it he coul buy
all the treasure in the world. With this currency he orders all payments
to be made throughout every province and kingdom and region his empire.
And no one dares refuse it on pain of losing his life. And assure you
that all the peoples and populations who are subject to his ruli are
perfectly willing to accept these papers in payment, since wherev they
go they pay in the same currency, whether for goods or for pearls o
precious stones or gold or silver. With these pieces of paper they can
bu anything and pay for anything ...

Several times a year parties of traders arrive with pearls and preciou
stones and gold and silver and other valuables, such as cloth of gold an
silk, and surrender them all to the Great Khan. The Khan then summon
twelve experts, who are chosen for the task and have special knowled of
it, and bids them examine the wares that the traders have brought and
pay for them what they judge to be their true value. The twelve experts
duly examine the wares and pay the value in the paper currency of which
I have spoken. The traders accept it willingly, because they can spend
it afterwards -on the various goods they buy throughout the Great Khan's
dorminions ...

Let me tell you further that several times a year a flat goes forth
through the towns that all those who have gems and pearls and gold and
silver must bring them to the Great Khan's mint. This they do, and in
such abundance that it is past all reckoning; and they are all paid in
paper money. By this means the Great Khan acquires all the gold and
silver and pearls and precious stones of all his territories ... And all
the Khan's armies are paid with this sort of money. I have now told you
how it comes about that the Great Khan must have, as indeed he has, more
treasure than anyone else in the world. I may go further and affirm that
all the

{p. 167} world's great potentates put together have not such riches as
belong to the Great Khan alone. (Polo, 1987, pp. 147ff.)

Marco Polo's description must have seemed exaggerated to his fellow
Europeans at the time, but we now know that he was giving what amounts
to a fairly precise description of the monetary system prevailing at
this time in the Mongolian Empire. Even his estimation of the Khan's
wealth as far exceeding that of his counterparts in the rest of the
world might well have been accurate. The government in the Mongolian
Empire could not only control nominal economic growth, but also allocate
resources at will. According to descriptions of the Chinese economy at
the time, it was flourishing.

At the time, European kings and princes had far less control over the
economy. This is because the rulers did not understand the true nature
of money and therefore never realized that they could issue paper money.
instead, they believed that money had to be in the form 4 gold or other
precious metals. The problem was that in this case it is impossible for
the government to control the money supply at will and allocate
resources. Rulers spent significant resources on alchemy, in an attempt
to produce gold. While they failed, this delivered positive side effects
by advancing chemistry. It also demonstrates thaL rulers did seek to
exert power over the economy through the control of the money supply.
But they failed and thus European governments never gained nearly as
much control over the economy as Kublai Khan's government enjoyed.

The alchemy of banking

This was also largely the situation in England in the seventeenth
century. Precious metals and coins made thereof were considered the only
form of money. However, it was a time of war, lack of security, plague
and fire. In this time of insecurity, luxuries were less in demand. Thus
also 'the ordinary demand for goldsmiths to make objects of gold and
silver for the customers had ... practically ceased' (Davies, 1994, p.
250). However, there was demand for another activity the jewellers could
offer: dealing in precious metals and originally focusing on turning
them into handcrafted jewellery; they naturally had stocks of precious
metals, and the necessary safes and private security staff - if not
small private armies - to protect their property. Dealing in gold and
silver, they were already independently wealthy and thus considered
trustworthy. Therefore the general public began to use 'goldsmiths'
safes as a secure place for people's jewels, bullion and coins' (Davies,
1994, pp. 249ff.). This storage and safekeeping business generated small
fees. When gold was deposited with a goldsmith, he would write a receipt
to certify that it was in his custody, which would be presented in case
of withdrawals. As this practice became widespread, depositors

{p. 168} would soon begin to pay for purchases by handing over their
deposit receipts, and thus transferring the ownership of their gold to
the seller. To facilitate such cashless transactions, the use of unnamed
deposit receipts became more widespread. The diary of Samuel Pepys
mentions his sending of a deposit note to his father of over £600 in
1668. The deposit receipts had become paper money.

However, this European form of paper money was crucially different in
its function and implication from the paper money used in Polo's time in
China: it was issued not by the government but by a private group of
businessmen.

(6) Werner: The German and Japanese challenge

New Paradigm in Macroeconomics

{p. 333} The German and Japanese challenge

in many ways, all of these findings are not new. The new kind of
economics has an old predecessor. So has neoclassical economics: The
direct forerunner of modern mainstream economics, operating with simiiar
assumptions and coming to similar conclusions, was British classical
economics of the nineteenth century. It already operated according to
the deductivist paradigm. At the time Britain was the world's leading
economic and political power, running a world empire and mass-producing
advanced industrial output that required a market. Classical economics
appeared to serve a useful purpose for the empire: it recommended that
other countries did not need to develop competing industries, or use
government intervention, but instead should open their markets, without
charging any tariffs, to British exports. This would - said the British
classical economics - improve their welfare. Not surprisingly, classical
economics was used to advance British power worldwide.

Thus it came that German economists were also confronted with the
British classical school of thought. The German economists, like
scientists from other disciplines, at the time used the inductive
methodology. So they decided to empirically evaluate the British
classical theories and their claims. Friedrich List, one of the first
and most influential development economists, decided to investigate the
British claim that deregulation, liberalization and opening up to free
trade and free markets was the path to prosperity and economic
development (just like it has been the Washington claim for the past
decades). He developed the testable hypothesis that, if this claim was
true, the major episodes of successful national economic development
should be somehow linked to free trade and free market policies.

Studying the facts by meticulously researching the historical record of
economic development of the major economic powers over the centuries,
List concluded that there was not one major economic power that owed its
successful development to free trade and free market policies. His
conclusion still stands - although wehow have the benefit of 150 years
of further, and better, data on the world economy. List is particularly
insightful on British economic development. He found that although
British leaders were loudest in propagating the free market paradigm,
British economic development was due to trade restrictions,
protectionism, government intervention, industrial policy and other
'visible hands'. Until about the fifteenth and early sixteenth
centuries, Britain indeed followed the precepts of free market economics
by allowing laissez-faire trade and focusing on its comparative
advantage. As a result it remained primarily a nation of shepherds,
selling raw wool to foreign merchants. Economic prosperity did not grow
significantly. Britain remained poor and underdeveloped. Researchers on
Modern-day developing countries have identified the reason: focusing on
low-value-added primary commodities will not enhance welfare.
High-value-added items will be imported, but their relative prices rise
over time,

{p. 334} while that of commodities falls - thus resulting in a steady
deterioration of the terms of trade. Balance of payments crises and
indebtedness follow.

In Britain's case this took the form of the Crown jewels being pawned to
the dominating German traders. When the British leadership realized that
the invisible hand was not doing much for the country, free trade was
abandoned; protectionist trade and industrial policies were adopted. The
government intervened by importing foreign know-how in high-value-added
textile manufacturing - through importing experts from Flanders (as the
now common surname Fleming attests), banning the import of processed
wool products, stimulating domestic wool production through industrial
policy and building a fleet of ships to market its produce.

The British textile industry was established by government intervention.
Its mechanization triggered the industrial revolution, rendering Britain
the top economic and military power. To boost British mass exports,
convincing public relations activities had to persuade the rest of the
world to open their markets. Classical economics served this purpose.
Britain itself knew better: while British economists spoke of free trade
and the theory of comparative advantage, the far superior and cheaper
Indian textile produce was banned from Britain.

As List showed, the empirical facts are similar in the case of the US.
The North American colonies were explicitly forbidden to manufacture
anything for export and instead had to focus on their 'comparative
advantage' in agriculture. The policy of suppressing the creation of
indigenous industries in its American colonies while forcing them to
purchase the fruits of the 'free markets' from Britain was identified by
List as a factor in causing the War of Independence. The US started to
develop rapidly when it replaced the 'free trade' regime imposed by
Britain with protectionist trade barriers and government industrial
policy to create high-value-added industries. At the same time, the
British propaganda of free trade and free markets was copied in order to
force world markets open for US exports. The rest is history.

Thus when German economists considered the virtues of classical
economics over a hundred years ago, they rejected it as unrealistic and
inapplicable to reality. Instead, they developed a different kind of
economics that is based on realistic assumptions, such as that people
care about others; that market imperfections are pervasive and that
there is positive scope for fruitful government intervention - for
instance in the purposeful designing of incentive structures and the
allocation of resources to high-value-added industries, within a
framework that aimed at social justice and was guided by both realistic
and ethical considerations. These theories - dubbed variously the German
empiricist approach, the German Historical School or the German ethical
economics - had a profound impact on Japan and other East Asian
countries, which studied them, adopted them and followed their policy
advice.

{p. 335} The leaders, having read their German economists well, realized
that the laissez-faire policy suggested by Britain would relegate
developing countries to raw material exporter status and hence low
growth. To achieve high growth, comparative advantage had to be created,
through the visible intervention of government policy, primarily in the
form of clever institutional design, but also in the measured allocation
of resources. The Germans and East Asians used economic regulation to
foster technological development and the development and competitiveness
of targeted high-value-added industries. Furthermore, growth in itself
was not considered the main goal of an economy. For a stable society,
economic justice was also important - and again this would not come
about without a visible hand.

As a result, the Germans and Japanese consciously created a different
form of capitalism, which maintained market mechanisms, but ensured that
not shareholders but society at large would be its main beneficiaries.
Many aspects of the Japanese model were introduced in the successful
East Asian economies. Instead of serving the few, a form of capitalism
was born that succeeded in creating a decent quality of life for the
many. By focusing on mutually beneficial cooperation and coordination,
the designers of the German and Japanese systems managed to internalize
externalities (costs and benefits not reflected in markets), minimize
information costs, mobilize resources and motivate individuals. They
recognized that people compete in hierarchical fashion and have a common
desire for justice and fairness of organizational arrangements. They
then succeeded in devising organizational forms that can reap benefits
from cooperation in ways that all participants can consider fair. One
such organizational form was the system of industry associations, which
were a modern incarnation of the medieval guild structure. Due to their
public goods character, resulting cartels often were welfare-enhancing.
The cooperative orientation did not mean that there was no competition.
That was encouraged in the form of competing for moving up ranks in
hierarchies. Much more needs to be said on their approach, but this
remains beyond the scope of the present book (see Werner, 2003c,
2003d,2004c).

Reality-based economics, following the inductivist approach, was
pioneered by German economists in the nineteenth century. Their writings
emphasized credit and institutional design. This provides a final test
of the validity of our approach: if their work was right, then those
countries that followed their prescriptions, including the direction and
allocation of credit and the shaping of overall institutions, should
have performed well. These countries were Germany in the twentieth
century, Japan, Korea and Taiwan since the late 1930s, and China since
the 1980s, to name the most important examples. For many decades, their
economic performance has been superior to that of most other countries.
This, then, solves the final enigma, discussed in Chapter 5, namely that
of the puzzlingly high economic growth of these countries.

(7) US Treasury criticizes Germany’s chronic trade surplus

http://www.telegraph.co.uk/finance/currency/9709882/Germany-displaces-China-as-US-Treasurys-currency-villain.html

Germany displaces China as US Treasury's currency villain

The US Treasury has issued a damning criticism of Germany’s chronic
trade surplus in its annual report on worldwide exchange rate abuse,
although it stopped short of labelling the country a currency manipulator.

By Ambrose Evans-Pritchard

6:53PM GMT 28 Nov 2012

Treasury officials told Congress that internal balances within the
eurozone are disrupting the global trade structure, with almost nothing
being done by north Europeans states to curb their huge surpluses.

The report said Germany’s current account surplus is running at 6.3pc of
GDP, and Holland is even worse at 9.5pc. Yet the countries still cleave
to fiscal austerity policies that constrict internal demand.

The EU’s new tool for cracking down on intra-EMU imbalances is
"asymmetric" and does not give "sufficient attention to countries with
large and sustained external surpluses like Germany".

While the eurozone as a whole is roughly in trade balance, the EMU
regime of austerity in the South without offsetting stimulus in the
North is creating a contractinary bias, holding back global recovery.

The US Treasury said eurozone surplus states have "available room" for
fiscal stimulus but refuse to act, despite repeated pledges by EU
leaders that more must be done to foster growth. "They have not yet made
any concrete proposals capable of yielding meaningful near-term results."

Germany's permanent surplus is in stark contrast to the shift under way
in Asia. China has "partially succeeded in shifting away from a reliance
on exports for growth", and has slashed its surplus to 2.6pc from 10.1pc
in 2007.

While the yuan remains "significantly overvalued", China’s has stopped
building reserves to hold down its currency and has seen a 40pc
appreciation against the dollar since 2005 in real terms. Double-digit
wage growth is closing thecurrency gap by oither means.

A chart published in the report shows that Germany has overtaken China
to become the biggest single source of global trade imbalance, alone
accounting for a large chunk of the US deficit.

Switzerland is top sinner with a surplus of 13pc GDP, though the report
says the country faces unique circumstances as a safe-haven battling
deflation.

The Swiss National Bank has bought $230bn in foreign bonds since mid
2011 to hold the franc, more than China, Russia, Saudia Arabia, Brazil
and India combined.

The US Treasury’s shift in focus away from China - and towards Germany’s
disguised mercantilism - reflects mounting irritation in Washington over
North Europe’s "free-rider" strategy, which relies on exploiting global
demand rather than generating it at home.

The US Treasury said China still needs to do more to wean itself off
investment - almost 50pc of GDP - and boost consumption instead. It
called for a change in the tax structure, reform of the big state
enterprises, and an end to financial controls that force up the savings
rate. There is concern that China’s surplus will rise again over coming
years unless Beijing pushes through radical reforms.

The tone of the report is conciliatory, a far cry from the hot rhetoric
of the US election campaign. Republican candidate Mitt Romney had vowed
to label China a currency manipulator from "day one", a move that would
have entailed trade sanctions and an ugly turn in superpower relations.

A separate report from the International Monetary Fund said China’s
excess credit growth and investment have moved into "dangerous
territory" and has begun to impose major costs on China itself.

The country spending 10pc of GDP more on investment than the Asian
tigers at the peak of the investment bubble before onset of the East
Asian meltdown in the late 1990s.

The Fund said the excesses are unlikely to lead to the sort of
sudden-stop crisis seen in Thailand, Indonesia and Korea during that
episode, since those countries relied on dollar funding whereas China’s
credit comes from internal savings, but there is disguised damage
nevertheless. Rampant over-investment acts through complex channels as a
transfer of income from families and small businesses to big state
firms, distorting the whole economic system over time.

The IMF said there is little doubt that investment in plant and
infrastructure has driven China’s great boom over the last thirty years
but the law of diminishing returns is setting in.

"The marginal contribution of an extra unit of investment to growth has
been falling, necessitating ever larger increases to generate an equal
amount of growth. Now with investment to GDP already close to 50
percent, the current growth model may have run its course," it said.

(8) WE in the Anglosphere are Greece; the Asia Model countries are Germany
- Peter Myers, December 16, 2012


Collectively, Anglosphere countries have pursued the "Post-Industrial"
paradigm, believing that we don't need manufacturing. Germany and the
Asia Model countries have gone the opposite way, with the result that
the rest of the world is now in debt to them.

We may not notice that debt, because our Current Account Deficits are
handled quietly. We Deficit countries pay for our excess imports and
borrowings by handing over ownership of our assets, little by little.

Our reliance on American military power has shielded us from the worry
that we might ever have to repay our debt.

But the crisis in Southern Europe gives warning of a reckoning one day.

(9) John Craig: demand deficits in East Asia cause excess consumption,
bubbles & debt in West


Progress Towards Ending the Global Financial Crisis?

by John Craig

http://cpds.apana.org.au/Teams/Articles/globalization.htm#EndingGFC

[...] excess savings / demand deficits by Japan, China, and major oil
exporters) and this gave rise to international financial imbalances.
Large demand deficits ... would have stifled global economic growth if
they had not been counter-balanced by their trading partners' (mainly
the US's) willingness and ability to absorb excess savings and provide
excess demand. That excess demand was sustained by domestic easy money
policies and capital inflow that stimulated property inflation (which in
turn encouraged very high levels of consumer spending as the web-cast
noted) until the bubble burst and gave rise to the GFC (eg see
Structural Incompatibility Puts Global Growth at Risk, 2003 and
Impacting the Global Economy, 2009);

there are cultural factors which have encouraged major East Asian
economies (eg Japan and China) to accumulate high levels of foreign
exchange reserves (and thus run current account surpluses) in order to
protect against financial crises. ...

the resulting financial imbalances reflect not only a 'clash' of
financial systems, but also a broader 'clash of civilizations', that has
arguably affected recent history though it has been almost invisible to
Asia-illiterate Western economists and defence analysts (see An
unrecognised clash of financial systems, 2001+; Babes in the Asia Woods,
2009+; and Comments on Australia's Strategic Edge in 2030, 2011);

Alternately the fiscal problem might be resolved, as far as government
is concerned, by increasing taxes and / or reducing spending, so as to
stabilize government debts. However, if the US is to maintain current
account deficits (to accommodate excess savings elsewhere), it must
maintain a capital account surplus (ie import capital / increase debt
levels). ...

Without rapidly rising asset values, households and businesses in the
North America, Europe, Australia etc can't provide the excess demand
that is needed to sustain structural demand deficits in East Asia,
emerging economies elsewhere and major oil exporters. And, if rising
asset values were again to provide the basis for spending well in excess
of income, this would recreate conditions like those prior to the GFC
and presumably lead to another crisis ...

(10) John Craig: Asia Model current account surpluses recycled into
further expansion of production capacity


http://cpds.apana.org.au/Teams/Articles/competing_civilizations.htm#financial_systems

... Japan's post WWII economic system involved a mercantilist policy
goal of creating production capacity far in excess of domestic demand
and without regard to profitability through the creation of credit by a
tightly regulated financial system - which resulted in large current
account surpluses that have been recycled into further expansion of
production capacity and, in recent decades, into investments in $US
assets (see Why Japan cannot deregulate its financial system).

(11) What if we adopted a system where the Banks did not create our Money?

From: Tim OSullivan <timos2003z@hotmail.com>
Subject: Monetary Reforms
Date: Tue, 6 Nov 2012 15:15:37 +0000

What If We Adopted A System Where The Banks Did Not Create Our Money?

By Michael, on October 22nd, 2012

http://theeconomiccollapseblog.com/archives/what-if-we-adopted-a-system-where-the-banks-did-not-create-our-money

What if there was a financial system that would eliminate the need for
the federal government to go into debt, that would eliminate the need
for the Federal Reserve, that would end the practice of fractional
reserve banking and that would dethrone the big banks? Would you be in
favor of such a system?

A surprising new IMF research paper entitled "The Chicago Plan
Revisited" by Jaromir Benes and Michael Kumhof is making waves in
economic circles all over the globe. The paper suggests that the world
would be much better off if we adopted a system where the banks did not
create our money.<http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf>

So instead of a system where more money is only created when more debt
is created, we would have a system of debt-free money that is created
directly by national governments
<http://theeconomiccollapseblog.com/archives/where-does-money-come-from-the-giant-federal-reserve-scam-that-most-americans-do-not-understand>.


There have been others that have suggested such a system before, but to
have an IMF research paper actually recommend that such a system be
adopted is a very big deal.
<http://theeconomiccollapseblog.com/archives/debt-free-united-states-notes-were-once-issued-under-jfk-and-the-u-s-government-still-has-the-power-to-issue-debt-free-money>


At the moment, the world is experiencing the biggest debt crisis in
human history, and this proposal is being described as a "radical
solution" that could potentially remedy some of our largest financial
problems. Unfortunately, apologists for the current system are already
viciously attacking this new IMF paper, and of course the big banks
would throw a major fit if such a system was ever to be seriously
contemplated. That is why it is imperative that we educate people about
how money really works. Our current system is in the process of
collapsing and we desperately need to transition to a new one.

One of the fundamental problems with our current financial system is
that it is based on debt. Just take a look at the United States. The way
our system works today, the vast majority of all money is "created"
either when we borrow money or the government borrows money. Therefore,
the creation of more money creates more debt.
<http://theeconomiccollapseblog.com/archives/where-does-money-come-from-the-giant-federal-reserve-scam-that-most-americans-do-not-understand>

Under such a system, it should not be surprising that the total amount
of debt in the United States is more than 30 times larger than it was
just 40 years ago.<http://research.stlouisfed.org/fred2/data/TCMDO.txt>

We don't have to do things this way. There is a better alternative.
National governments can directly issue debt-free currency into
circulation. The following is a brief excerpt
<http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf> from the IMF
report...

At the height of the Great Depression a number of leading U.S.
economists advanced a proposal for monetary reform that became known as
the Chicago Plan. It envisaged the separation of the monetary and credit
functions of the banking system, by requiring 100% reserve backing for
deposits. Irving Fisher (1936) claimed the following advantages for this
plan: (1) Much better control of a major source of business cycle
fluctuations, sudden increases and contractions of bank credit and of
the supply of bank-created money. (2) Complete elimination of bank runs.
(3) Dramatic reduction of the (net) public debt. (4) Dramatic reduction
of private debt, as money creation no longer requires simultaneous debt
creation. We study these claims by embedding a comprehensive and
carefully calibrated model of the banking system in a DSGE model of the
U.S. economy. We find support for all four of Fisher's claims.

Why should banks be allowed to create money?

That is a very good question.

Why should sovereign governments ever have to borrow money from anyone?

That is another very good question.

Our current system is designed to enrich the bankers and get everyone
else into debt.

And is that not exactly what has happened?

Taking the creation of money away from the bankers would have some
tremendous advantages. A recent article
<http://www.telegraph.co.uk/finance/comment/9623863/IMFs-epic-plan-to-conjure-away-debt-and-dethrone-bankers.html>
by renowned financial journalist Ambrose Evans-Pritchard described some
of these benefits...

{quote}
One could slash private debt by 100pc of GDP, boost growth, stabilize
prices, and dethrone bankers all at the same time. It could be done
cleanly and painlessly, by legislative command, far more quickly than
anybody imagined.

The conjuring trick is to replace our system of private bank-created
money -- roughly 97pc of the money supply -- with state-created money.
We return to the historical norm, before Charles II placed control of
the money supply in private hands with the English Free Coinage Act of 1666.

Specifically, it means an assault on "fractional reserve banking". If
lenders are forced to put up 100pc reserve backing for deposits, they
lose the exorbitant privilege of creating money out of thin air.

The nation regains sovereign control over the money supply. There are no
more banks runs, and fewer boom-bust credit cycles.
{end}
http://www.telegraph.co.uk/finance/comment/9623863/IMFs-epic-plan-to-conjure-away-debt-and-dethrone-bankers.html

So why don't we go to such a system immediately?

Well, the transition to such a system would undoubtedly be a major shock
to the global financial system, and most people try to avoid significant
short-term pain even if there are tremendous long-term benefits.

More importantly, however, is that the bankers have a tremendous amount
of power in our society today, and they would move heaven and earth to
keep a debt-free monetary system from ever being implemented.

You see, the influence of the bankers is not just limited to the big
banks. Our largest financial institutions (and the people who own them)
also have large ownership stakes in the vast majority of the big Fortune
500 corporations. In essence, the big banks are at the very pinnacle of
"the establishment" in the United States and in almost every other major
country in the western world.

And the vast majority of all political campaigns are funded by "the
establishment". It takes an enormous amount of money to win campaigns
these days, and most politicians are extremely hesitant to bite the
hands of those that feed them.

So don't expect any changes to happen overnight.

One proposal that has actually been put forward in Congress is to cancel
all of the government debt that the Federal Reserve is currently
holding. Right now, the Fed is holding more than 1.6 trillion dollars of
U.S. government debt...

That would seem to make a lot of sense. That would immediately wipe more
than 1.6 trillion dollars from the U.S. national debt without any real
harm being done.

But "the establishment" would be horrified if such a thing happened, so
I wouldn't anticipate it happening any time soon.

Hopefully we can get the American people (along with people all over the
globe) educated about these things so that we can start to get millions
of people pushing for change.

A debt-free monetary system is superior to a debt-based monetary system
in so many ways.

For example, if the U.S. government directly spent debt-free money into
circulation, it could conceivably never need to borrow a single dollar
ever again. If the government wanted to spend more money than it brought
in, it would simply print it up and spend it.

Of course the big danger with that would be inflation. That is why it
would be imperative for there to be a hard cap on what the government
could spend. For example, you could set the cap on spending by the
federal government at 20 percent of GDP. That way we would never end up
looking like the
<http://theeconomiccollapseblog.com/archives/quantitative-easing-did-not-work-for-the-weimar-republic-either>
Weimar Republic.

And the current federal debt could be paid down a little at a time using
newly created debt-free dollars. This would have to be done slowly to
keep inflation under control, but it could be done.

That way we would not hand a
<http://theeconomiccollapseblog.com/archives/55-facts-about-the-debt-and-u-s-government-finances-that-every-american-voter-should-know>
16 trillion dollar debt to our children and our grandchildren. We
created this mess so we should clean it up.

Theoretically you could also do away with the federal income tax if you
wanted to. Personally, I would like to see the federal government be
funded to a large degree
<http://theeconomiccollapseblog.com/archives/obama-and-romney-both-favor-a-one-world-economic-system-that-kills-american-jobs>
by tariffs on foreign goods. That would also have the side benefit of
bringing millions of jobs back into the United States.

Our system of income tax collection is just so incredibly inefficient.
It costs us mind boggling amounts of time and money. Just consider the
following stats
<http://theeconomiccollapseblog.com/archives/24-outrageous-facts-about-taxes-in-the-united-states-that-will-blow-your-mind>
from one of my previous articles...

1 - The U.S. tax code is now
<http://www.taxfoundation.org/press/show/28121.html> 3.8 million words
long. If you took all of William Shakespeare's works and collected them
together, the entire collection would only be about 900,000 words long.

2 - According to the National Taxpayers Union, U.S. taxpayers spend
<http://www.ntu.org/news-and-issues/taxes/tax-reform/complexity.html>
more than 7.6 billion hours complying with federal tax requirements.
Imagine what our society would look like if all that time was spent on
more economically profitable activities.

3 - 75 years ago, the instructions for Form 1040 were two pages long.
Today, they are
<http://www.smartmoney.com/taxes/income/10-things-i-hate-about-tax-day-1334094821191/#printMode>
189 pages long.

4 - There have been <http://www.taxfoundation.org/press/show/28121.html>
4,428 changes to the tax code over the last decade. It is incredibly
costly to change tax software, tax manuals and tax instruction booklets
for all of those changes.

5 - According to the National Taxpayers Union, the IRS currently has
<http://www.ntu.org/news-and-issues/taxes/tax-reform/complexity.html>
1,999 different publications, forms, and instruction sheets that you can
download from the IRS website.

6 - Our tax system has become so complicated that it is almost
impossible to file your taxes correctly. For example, back in 1998 Money
Magazine had
<http://www.ntu.org/news-and-issues/taxes/tax-reform/complexity.html> 46
different tax professionals complete a tax return for a hypothetical
household. All 46 of them came up with a different result.

7 - In 2009, PC World had five of the most popular tax preparation
software websites prepare a tax return for a hypothetical household. All
five of them came up
<http://www.ntu.org/news-and-issues/taxes/tax-reform/complexity.html>
with a different result.

8 - The IRS spends
<http://www.9news.com/money/taxes/29093/301/Random-facts-about-taxes-to-ease-what-may-be-a-painful-day>
$2.45 for every $100 that it collects in taxes.

For long stretches of our history the United States did not have any
income tax, and during those times we thrived. It is entirely
conceivable that we could return to such a system.

At this point, the wealthy have become absolute masters at hiding their
wealth from taxation. According to the IMF, a total of 18 trillion
dollars is currently being hidden in offshore banks. What we are doing
right now produces very inequitable results and it is not working.
<http://theeconomiccollapseblog.com/archives/the-global-elite-are-hiding-18-trillion-dollars-in-offshore-banks>

In many ways, inflation would be a much fairer "tax" than the income tax
because inflation taxes each dollar equally. Nobody would be able to
cheat the system.

But if people really love the IRS and the federal income tax, we could
keep them under a debt-free money system. I just happen to think that
the IRS and the federal income tax are both really bad ideas that have
never served the interests of the American people.

In any event, hopefully you can see that there is a much broader range
of solutions to our problems than the two major political parties have
been presenting to us.

We do not have to allow the banks to create our money.

The federal government does not have to go into more debt.

We don't actually need the Federal Reserve.

There are alternatives to the federal income tax and the IRS.

Yes, it is very true that no system would be perfect. But clearly the
path that we are on is only going to lead
<http://theeconomiccollapseblog.com/archives/unsustainable> to disaster.
U.S. government finances are
<http://theeconomiccollapseblog.com/archives/55-facts-about-the-debt-and-u-s-government-finances-that-every-american-voter-should-know>
a complete and total nightmare, and this mountain of debt that we have
accumulated is going to absolutely destroy us if we allow it to.

So somebody out there should be proposing a fundamental change in
direction for our financial system.

Unfortunately, our politicians are just proposing more of the same, and
we all know where that is going to lead.

(12) Ambrose Evans-Pritchard: IMF's epic plan to conjure away debt and
dethrone bankers


http://www.telegraph.co.uk/finance/comment/9623863/IMFs-epic-plan-to-conjure-away-debt-and-dethrone-bankers.html

IMF's epic plan to conjure away debt and dethrone bankers

So there is a magic wand after all. A revolutionary paper by the
International Monetary Fund claims that one could eliminate the net
public debt of the US at a stroke, and by implication do the same for
Britain, Germany, Italy, or Japan.

By Ambrose Evans-Pritchard

2:31PM BST 21 Oct 2012

One could slash private debt by 100pc of GDP, boost growth, stabilize
prices, and dethrone bankers all at the same time. It could be done
cleanly and painlessly, by legislative command, far more quickly than
anybody imagined.

The conjuring trick is to replace our system of private bank-created
money -- roughly 97pc of the money supply -- with state-created money.
We return to the historical norm, before Charles II placed control of
the money supply in private hands with the English Free Coinage Act of
1666.

Specifically, it means an assault on "fractional reserve banking". If
lenders are forced to put up 100pc reserve backing for deposits, they
lose the exorbitant privilege of creating money out of thin air.

The nation regains sovereign control over the money supply. There are no
more banks runs, and fewer boom-bust credit cycles. Accounting
legerdemain will do the rest. That at least is the argument.

Some readers may already have seen the IMF study, by Jaromir Benes and
Michael Kumhof, which came out in August and has begun to acquire a cult
following around the world.

Entitled "The Chicago Plan Revisited", it revives the scheme first put
forward by professors Henry Simons and Irving Fisher in 1936 during the
ferment of creative thinking in the late Depression.

Irving Fisher thought credit cycles led to an unhealthy concentration of
wealth. He saw it with his own eyes in the early 1930s as creditors
foreclosed on destitute farmers, seizing their land or buying it for a
pittance at the bottom of the cycle.

The farmers found a way of defending themselves in the end. They muscled
together at "one dollar auctions", buying each other's property back for
almost nothing. Any carpet-bagger who tried to bid higher was beaten to
a pulp.

Benes and Kumhof argue that credit-cycle trauma - caused by private
money creation - dates deep into history and lies at the root of debt
jubilees in the ancient religions of Mesopotian and the Middle East.

Harvest cycles led to systemic defaults thousands of years ago, with
forfeiture of collateral, and concentration of wealth in the hands of
lenders. These episodes were not just caused by weather, as long
thought. They were amplified by the effects of credit.

The Athenian leader Solon implemented the first known Chicago Plan/New
Deal in 599 BC to relieve farmers in hock to oligarchs enjoying private
coinage. He cancelled debts, restituted lands seized by creditors, set
floor-prices for commodities (much like Franklin Roosevelt), and
consciously flooded the money supply with state-issued "debt-free" coinage.

The Romans sent a delegation to study Solon's reforms 150 years later
and copied the ideas, setting up their own fiat money system under Lex
Aternia in 454 BC.

It is a myth - innocently propagated by the great Adam Smith - that
money developed as a commodity-based or gold-linked means of exchange.
Gold was always highly valued, but that is another story. Metal-lovers
often conflate the two issues.

Anthropological studies show that social fiat currencies began with the
dawn of time. The Spartans banned gold coins, replacing them with iron
disks of little intrinsic value. The early Romans used bronze tablets.
Their worth was entirely determined by law - a doctrine made explicit by
Aristotle in his Ethics - like the dollar, the euro, or sterling today.

Some argue that Rome began to lose its solidarity spirit when it allowed
an oligarchy to develop a private silver-based coinage during the Punic
Wars. Money slipped control of the Senate. You could call it Rome's
shadow banking system. Evidence suggests that it became a machine for
elite wealth accumulation.

Unchallenged sovereign or Papal control over currencies persisted
through the Middle Ages until England broke the mould in 1666. Benes and
Kumhof say this was the start of the boom-bust era.

One might equally say that this opened the way to England's agricultural
revolution in the early 18th Century, the industrial revolution soon
after, and the greatest economic and technological leap ever seen. But
let us not quibble.

The original authors of the Chicago Plan were responding to the Great
Depression. They believed it was possible to prevent the social havoc
caused by wild swings from boom to bust, and to do so without crimping
economic dynamism.

The benign side-effect of their proposals would be a switch from
national debt to national surplus, as if by magic. "Because under the
Chicago Plan banks have to borrow reserves from the treasury to fully
back liabilities, the government acquires a very large asset vis-à-vis
banks. Our analysis finds that the government is left with a much lower,
in fact negative, net debt burden."

The IMF paper says total liabilities of the US financial system -
including shadow banking - are about 200pc of GDP. The new reserve rule
would create a windfall. This would be used for a "potentially a very
large, buy-back of private debt", perhaps 100pc of GDP.

While Washington would issue much more fiat money, this would not be
redeemable. It would be an equity of the commonwealth, not debt.

The key of the Chicago Plan was to separate the "monetary and credit
functions" of the banking system. "The quantity of money and the
quantity of credit would become completely independent of each other."

Private lenders would no longer be able to create new deposits "ex
nihilo". New bank credit would have to be financed by retained earnings.

"The control of credit growth would become much more straightforward
because banks would no longer be able, as they are today, to generate
their own funding, deposits, in the act of lending, an extraordinary
privilege that is not enjoyed by any other type of business," says the
IMF paper.

"Rather, banks would become what many erroneously believe them to be
today, pure intermediaries that depend on obtaining outside funding
before being able to lend."

The US Federal Reserve would take real control over the money supply for
the first time, making it easier to manage inflation. It was precisely
for this reason that Milton Friedman called for 100pc reserve backing in
1967. Even the great free marketeer implicitly favoured a clamp-down on
private money.

The switch would engender a 10pc boost to long-arm economic output.
"None of these benefits come at the expense of diminishing the core
useful functions of a private financial system."

Simons and Fisher were flying blind in the 1930s. They lacked the modern
instruments needed to crunch the numbers, so the IMF team has now done
it for them -- using the `DSGE' stochastic model now de rigueur in high
economics, loved and hated in equal measure.

The finding is startling. Simons and Fisher understated their claims. It
is perhaps possible to confront the banking plutocracy head without
endangering the economy.

Benes and Kumhof make large claims. They leave me baffled, to be honest.
Readers who want the technical details can make their own judgement by
studying the text here.

The IMF duo have supporters. Professor Richard Werner from Southampton
University - who coined the term quantitative easing (QE) in the 1990s
-- testified to Britain's Vickers Commission that a switch to
state-money would have major welfare gains. He was backed by the
campaign group Positive Money and the New Economics Foundation.

The theory also has strong critics. Tim Congdon from International
Monetary Research says banks are in a sense already being forced to
increase reserves by EU rules, Basel III rules, and gold-plated variants
in the UK. The effect has been to choke lending to the private sector.

He argues that is the chief reason why the world economy remains stuck
in near-slump, and why central banks are having to cushion the shock
with QE.

"If you enacted this plan, it would devastate bank profits and cause a
massive deflationary disaster. There would have to do `QE squared' to
offset it," he said.

The result would be a huge shift in bank balance sheets from private
lending to government securities. This happened during World War Two,
but that was the anomalous cost of defeating Fascism.

To do this on a permanent basis in peace-time would be to change in the
nature of western capitalism. "People wouldn't be able to get money from
banks. There would be huge damage to the efficiency of the economy," he
said.

Arguably, it would smother freedom and enthrone a Leviathan state. It
might be even more irksome in the long run than rule by bankers.

Personally, I am a long way from reaching an conclusion in this
extraordinary debate. Let it run, and let us all fight until we flush
out the arguments.

One thing is sure. The City of London will have great trouble earning
its keep if any variant of the Chicago Plan ever gains wide support.

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