Libertarian Party (UK) Monetary Reform Policy

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With the house of cards that is the world's banking system falling apart all around us, and mainstream politicians apparently completely unable to come up with any solutions that don't involve propping up the system with even more dodgy credit and regulations, here's an interesting article from the British Libertarian Party's official blog (http://lpuk.blogspot.com/) that explains what's been going on and what a Libertarian government would do to stabilise the financial system in the future. Tuesday, 30 September 2008 LPUK Policy: Monetary Reform Why Do We Need Monetary Reform? The monetary reform proposals of the Libertarian Party consist of three central planks. However, and before we can talk about what we'd like to change, we need to take a brief look at how the current banking system works, and expose the flaws that our policies seek to address. Where Does Money Come From? Most people think that the government creates all of our money by printing banknotes, and minting coins. But that is not the case. Let's start by looking at where the government gets its income from. Government Income Banknotes are printed by the Bank of England (BoE) on behalf of the government. The BoE then sell those notes at face value to commercial banks, who use them to fill their cash machines and to hand over to us when we withdraw money from our bank accounts. The profits from the sale of these notes by the BoE (known technically as seigniorage) is passed straight back to the government, and netted the Treasury the sum of £2.3 billion in the tax year 2007/081. The second source of government income is well known and hated by us all—taxes. Finally, the government gains income through borrowing. If insufficient funds have been brought in through seigniorage and taxation to meet the government's spending commitments, it sells bonds. Bonds are the equivalent of a government IOU, and promise the holder that the government will buy them back at a future date for the value of the bond plus some predetermined interest. Raising money through selling bonds has a huge downside, though. It means that the government incurs debt. And, like the rest of us with debts (on a credit card, for example), the government ends up paying a sum of money each year simply to service those debts. Government estimates for 2007/08 put the figure that it will have spent on servicing its own debts last year at a staggering £30 billion2—over 20% of the total amount of income tax that we all paid!3 Money From Thin Air Currently, around 97% of the 'money' in our economy isn't in the form of notes that you can fold, or change that weighs down your pockets—it's in the form of credit (or debt, depending upon which side of the transaction you are standing). So the real question to be asking if we want to understand where our money comes from is how all of this debt appears? Our commercial banks create money as debt, effectively from 'thin air'. Imagine a person paying, to keep the example straightforward, £100 in notes or coins into their bank account. Now, bankers know that most of the time, most people leave their money in their bank accounts; we tend to pay for goods with our debit cards, or by writing cheques to one another. Consequently, if a bank has just received £100 in cash it knows that there is little chance that the depositor is going to come along and ask for it back at any moment. Knowing this, banks only keep on hand a certain proportion of deposited funds; the amount that they reasonably expect they will need to cover any requests for withdrawals. The amount is termed the reserve ratio, and for any funds deposited, a bank will solely keep the amount of the reserve ratio on hand, and lend out the remainder. The whole process is known as fractional reserve banking (FRB). So, to carry on our example, if the bank that person paid his £100 into maintained a reserve ratio of 10%, the bank would accept the £100 deposit, keep £10 on hand, and lend out the remaining £90. But what happens to that £90 loan? The individual or business who takes it from the bank will probably not just spend it straight away, but deposit it into their bank account. If they do so in cash, the whole process can start again. Assuming that their bank also maintains a 10% reserve ratio, the bank will accept the £90 deposit, keep £9 on hand, and lend out the remaining £81. And so the process continues. In fact, if fully worked through the system, that original £100 deposit will end up having 'created' a total of £1,000 that can be spent in the real economy. In accounting terms, no money is actually created. If each borrower were to pay back their loan in sequence, the debts would unwind until we were left with our original £100 deposit at the first bank. This is why those who defend the existing system will tell you that no new money is really created. What these folks conveniently overlook, however, is that in real terms, as opposed to accounting niceties, new money has appeared—it's in your hands, and you can spend it. And as long as new bank deposits are being made, the process above can continue. Keeping The Merry-go-round Turning And what allows the entire process to continue is our central bank—the Bank of England. Remember the bonds that the government sells to raise additional funds, the Treasury IOUs? Well the BoE will, from time to time, buy bonds in the market. To pay for its purchases, the BoE genuinely does create money from thin air, and credits the seller's account with money that it has just decreed should exist. This process injects new money into the economy, which spreads about and ensures that the fractional reserve system described above never grinds to a halt. If it wishes to, the BoE can use the same process in reverse; selling Treasury securities and destroying the money the purchaser pays. In this manner, the BoE has a crude control mechanism available for determining how much money exists in our economy at any one time. The BoE also sells money to the commercial banks. These banks buy money at one rate, then loan it out to their customers at a higher rate, pocketing the difference. The above is, of necessity, a simplified explanation of how FRB operates, and the role played by the central bank. The Bank of England do not appear to have ever produced a layman's guide to these processes, but the US Federal Reserve has. Although several years old now, this document is still a good guide to the operation of a fractional reserve system, and largely applicable to the regime in the UK as well as the US. If you wish to look at the technical detail for the UK system, the Bank of England's Handbooks In Central Banking series of publications, and in particular Handbook #24 (Monetary Operations), is a good place to start. And whilst the above is a simplistic version of the processes at work, remember that much of the complex language and obscure practice of the banking industry is designed to mask its operations from public scrutiny. At its heart, it is a simple fraud: central banks genuinely creating money from thin air, and commercial banks lending money that's not rightfully theirs to loan. As the famous economist JK Galbraith once noted: "The process by which banks create money is so simple that the mind is repelled." Why Have We Got This System? The short answer is because bankers profit from it! Remember the seigniorage that the government receives from the printing of banknotes by the Bank of England? That brought £2.3 billion into the Treasury last year. Estimates by Huber and Robertson back in 2000 suggested that the loss in seigniorage to the government by allowing commercial banks to create money was in the order of £49 billion per annum4. And, of course, the more money there exists within the economy, the greater this loss is to the government. The big driver for commercial banks is the interest that they charge on loans. Obviously, the more loans that they have on their books, the greater the potential amount of interest that they can earn. Simply by being able to loan (effectively) the same money over and over again, they are able to develop multiple interest income streams from a single deposit. Banks also profit from the business of actually arranging loans. Most will charge a small percentage of a loan's value simply for allowing you to enter into the loan contract with them. We've enjoyed this system—largely unchanged—since the Bank of England was first established in 1694. Seeing the obvious benefits to themselves, bankers around the world have, over the centuries, embraced a model first imposed upon the people of our nation. But it's a flawed model. It's one built to serve the interests of the few, not the many. It's one that results in the scourge of inflation. It's one whose time has long passed. Libertarian Monetary Reform: Three Necessary Planks To build a strong bridge from our unfair and failed banking system to an honest and prosperous future one requires some sturdy materials. The Libertarian Party's monetary reform proposals consist of three central planks. Plank One: Sterling — A National Currency That Belongs To The Nation Our first key proposal is to wrest the privilege of creating money from the private banking industry, and to return it to where it rightfully belongs: the Crown. Where an increase in the money supply is required to maintain monetary value—because of a growth in the underlying economy—government will spend the newly created debt-free money into the economy in the form of financing capital works, paying the salaries of public sector workers and so on. This money will be the money that we are all familiar with: pounds Sterling. Our national currency, it will once again become the property of the nation. Out of control inflation caused by feckless bank lending will become a thing of the past, as we will demand