The following text outlines the urgent need to address the issue of monetary control in a constitutional state, highlighting the misconception that central banks or governments are primarily responsible for money creation. Instead, it is revealed that commercial banks create and manage the bulk of a nation’s money supply through the process of extending and destroying credit. This system leads to significant problems such as economic instability, increased inequality, and high levels of debt. The proposed solution, often called Sovereign Monetary Reform (SMR), aims to reassign the power of money-creation to the people through a state-controlled monetary authority. This proposal, rooted in the 1930s Chicago Plan, advocates for treating the money supply as a public utility, which would stabilize the economy, reduce debt, and promote economic equity.
Author: Govert Schuller
Introduction
There are still many political economic issues outstanding which should be addressed with some urgency. One important issue is a somewhat hidden one and is about the question what legal entity in a constitutional state will have the power to create and destroy the currency of that state and thereby manage the money supply. A very powerful tool to shape society, as you can imagine [1].
Polls have indicated that in the west most people think it is the central bank or government which is in charge of creating the money supply, while the truth is–admitted now by leading central and commercial banks–that actually it is the commercial banks which create and destroy on an ongoing basis between 90 and 97 percent of a country’s means of exchange. Some countries from the Global South, like South Africa and India, scored significantly better on the poll, thereby displaying a superior level of monetary literacy [2].
The System
The mechanism is deceptively simple: When banks originate loans, they do not transfer to borrowers already accumulated capital from savers or investors, but instead, they credit the account of the borrower by a click of the mouse, or before that, at the stroke of a pen. Out of nothing an asset for the borrower is created, entered as a liability to the borrower for the bank, and at the same time the bank books the loan contract, i.e. the promise of the borrower to pay principal and interest, as an asset, thereby–some think surreptitiously–balancing their books. When principal and interest are paid, the principal gets booked away (destroyed) and the interest is the bank’s income, legitimately or not [3]. Such is the alchemical sleight of hand of banking.
Furthermore, because most economies grow, and therefore proportionally also their money supply, the commercial banks have the privilege to allocate this fraction of the money supply, that is, its very first use, also named seigniorage. In other words, if the GDP grows by 3% and inflation is stable, then the banks add the same percentage to the money supply. In the US this amount can get close to 1tr=1,000,000,000,000. Although commercial banks create this new money, they do not own it; their influence lies in determining which firms and individuals receive it, along with the terms of its allocation. They then earn interest on these loans, effectively profiting from the process without directly contributing to production or services—essentially functioning as a form of rentier income derived from controlling the flow of money [4].
To jump ahead, there are economists saying that this staggering amount of seigniorage belongs to the community and it is the state which should decide democratically about allocation. And here we can think of spending it on physical infrastructure, education, health care and tackling climate change, maybe even a citizens’ dividend or Universal Basic Income (UBI). Though such allocation might only be indirectly and over the long run profitable, it will immensely contribute to people’s well-being, which is to an extent priceless, but still can be quantified [5].
The Problems with the Current Debt-Money System
Macro-economic reasoning, computer modeling, and historical studies have made it clear that this system creates multiple and severe problems [6]. The most destructive is the sometimes violently swinging business cycle of irrationally exuberant booms and destructive busts, creating bankruptcies and unemployment. This cycle happens when initially commercial banks in their imprudent enthusiasm extend too much credit and, when the music first slows, then suddenly stops, after which they close the credit spigot, even call in outstanding loans, and thereby create financial crises and panics of different magnitudes. The crises do not all originate in some unfortunate event outside the economy, but usually have their direct cause in the reckless, self-serving behavior of the financial sector itself [7].
This system is also one of the major engines of inequality. The financial sector reaps huge profits when all is well, and then gets bailed out with tax-payers’ money when it faces insolvency. Meanwhile there is some trickle-down for the working people during the upswing, and then, during the downswing, they will experience unemployment, austerity, loss of savings, loss of equity, bankruptcy and in the end poverty for many.
Increased indebtedness is another problem. During both good and bad times governments, firms and individuals have a big appetite to borrow to make ends meet, either when they spend too much in good times, or do not earn enough in bad times. For governments this is a bit counter-intuitive, because why–as many would wonder–would a government borrow its own money? [8]
At a micro-economic level all parties can be blamed, but at a cultural level the combination of an unsatisfiable consumer mentality, the pursuit of creature comforts, the whipping up of capitalist desires by advertisers, and the promotion of a neoliberal ideology as a secular religion; all this resulted in a lucrative-exploitable society almost too neatly calibrated for commercial bankers to take advantage of. Did they know how to establish over time this profitable arrangement? Some people are positively and passionately convinced of some form of intentional planning [9]; others might regard it as the accumulation of many, smaller, improvised, different changes resulting over time in this highly complex, self-sustaining (but socially and ecologically unsustainable) system we have.
Possible Solution
So, what can be done? What are the regulations or bills which can tackle these problems short of an all-out nationalization of the financial sector, not to mention, of the whole economy? Is there a fine-tuning possible which will not interfere with the positive effects of entrepreneurship like job creation, better products, flexibility, innovation, and local knowledge?
This was certainly the question for American economists taken by surprise by the Great Depression of the 1930s. One group among them reasoned that the flaw was in the banking system, specifically its unbridled capacity to create and withhold credit, creating booms and busts necessitating eventual government intervention [10].
Their solution came down to nationalizing the money supply and treat it as a utility to be managed by an independent authority. Banks would not be able anymore to create and destroy credit money as they saw fit for their bottom line and would have to attract funds from savers and investors to obtain the money to become proper intermediaries between them and the prospective borrowers, exactly as most people think–and banks make us deceptively believe–the system actually works. The said economists reasoned, calculated and formalized such a financial system and concluded it would prevent bank runs, stabilize the economy with a less erratic business cycle, decrease overall debt and make society more economically equitable.
Though there were variants, the proposal became known as the 1930s Chicago Plan as there were many top economists involved from the University of Chicago. Later, economists with high-capacity computers and mathematical models at the IMF, duplicated the proposed, radical changes to the monetary system and concluded that it would even have more beneficial results than anticipated in the 1930s. Lesser debt, lesser inequality and more economic growth [11].
In discussions around Central Bank Digital Cash (CBDC) there are monetary reformers who perceive CBDC as the little cousin of the Chicago Plan, because cash is a form of sovereign money and in today’s high-tech payment environment it can competitively challenge the bank monopoly on payments and even replace large amounts of bank credit money, thereby making the financial system less crisis-prone. CBDC can also be used by the state for cash infusions when needed. The hope is that CBDC can incrementally become the preferred means of payment by the public and the best tool for the state to ensure a stable financial system at a far lesser cost than the current one which needs occasionally very costly bail-outs [12]. Beyond that, and all dependent on its design and implementation, CBDC might open the road to full monetary reform.
Seigniorage and Sovereignty
Another great advantage for the government and the people is that they would regain the seigniorage coming with the privilege of being the first spender of new money. For the US in the 2020s this amount could be approximately the $1tr per year mentioned before. But this amount would be more finely calculated, independently from the forces of party politics and corporate influence, and done by a newly empowered monetary commission surrounded by a strong fire-wall [13].
The proposal is now also named Sovereign Monetary Reform (SMR), because the money power is re-established with the ultimate sovereign of the state, the people themselves. The proposal has been studied, criticized, and defended by many experts and knowledgeable activists [14]. It was also discussed at multiple official government financial commissions, debated in quite a few parliaments, and even voted upon in a national referendum [15]. Meanwhile about 30 non-profits have been founded in different countries promoting the specific proposal and calibrating it to national, legal requirements. Most of them have associated themselves with an international umbrella organization [16].
Conclusion
Sovereign Monetary Reform seeks to reclaim monetary power for the people, ensuring that the process of creation and allocation of money will serve the public interest rather than commercial bank profits. By re-establishing the state’s control over the money supply through an independent monetary authority, the proposal aims to prevent economic crises, reduce inequality, and foster sustainable growth. This initiative, supported by historical precedent, modern economic analysis, and civic activism, represents a significant, maybe inevitable, step towards a more equitable and stable financial system.
References
[1]. Money as formative power: Huber (2017)
[2]. Poll on monetary literacy: Lampert & van Tilburg (2016)
[3]. Credit creation theory of money and banking: McLeay et al (2014a & b), Werner (2016).
[4]. On rentier capitalism: Hudson (2015), Pettifor (2017)
[5]. On seigniorage: Macfarlane et al (2017), Lainà (2017), Huber (2017)
[6]. Macro-economic: Robinson (1956), Rochon (2001), Rochon & Rossi (2015), Werner (2016), Pettifor (2014); Computer modeling: Kumhof & Benes (2012), van Egmond & de Vries (2020a & b), Yamaguchi (2010 & 2011); Historical studies: Del Mar (1969 & 1997), Kindleberger (2000), Rothbard (2002), Zarlenga (2002), Robertson (2007), Sklansky (2017)
[7]. Predatory class: Goldstein (2020)
[8]. Government’s own money: Patman (1941)
[9]. Examples are Griffin (1995) and Still & Carmack (1996), challenged by Flaherty (nd), then rejoinder by Griffin (2004)
[10]. On the 1930s Chicago Plan: Kumhof & Benes (2012), Phillips (2015), Zarlenga (2002)
[11]. On better-than-expected outcome: Kumhof & Benes (2012)
[12]. Kumhof & Noone (2021); Ordóñez (2018)
[13]. See endnote #5.
[14]. Fisher (1935), Zarlenga (2009), Mellor (2010), Jackson & Dyson (2012), McMillan (2015), Di Muzio & Robbins (2016), Huber (2017)
[15]. International efforts: AFP (2015), Lyons (2018), Positive Money (2011 & 2014), Lerven (2015), Svanbjörn et al (2016), Aaltonen (2016), Positive Money NZ (2024), WRR (2019), Stellinga (2021), Vollgeld Initiative (2014), Joób (2014), NEED Act (2012)
[16]. International umbrella organization: IMMR (2013)
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