Economics - Full-Reserve Currency -
A Sound Currency for an Independent Scotland -
We are having discussions with friends in Common Weal about currency in the new Scotland. Some might see this issue as purely academic and not really of interest to the general public, but they would be quite wrong to think that. The problem of the national debt, high interest repayments, and the associated ‘austerity’ which comes with it, have a devastating effect on all the community, but most specifically on low income families. Since the currency is at the very centre of this, it is vital that we all take notice of it.
The Value of Money
Any discussion about money or currency has to start with the fundamental issues. What is money? What is its value? How is it used in the economy?
Adam Smith made it clear that money has no intrinsic value. Money is important for its use as a medium of exchange in the market. Its role, and its sole function, is to act as a medium of exchange in order to enable more flexible exchange in the market. It has an important role in a market based economy, but it has no intrinsic value. Money can be gold or silver coins, or paper notes, shells, or electronic bank accounts, but whatever it is, it has no intrinsic value. We have to be clear in our mind about that because it seems so counterintuitive. We see someone with a lot of money so we know he is rich, so we associate his wealth with his money, but his wealth comes from his access to goods and services, not to his money, which is merely a medium of exchange. With that clearly in our mind, a good currency is a good money system which can perform this exchange task effectively and reliably over time.
Now Scotland’s current currency and banking system is not doing that job very well. The British people have been forced to pay £billions of pounds of taxpayer’s money into saving the banks; but we know the ‘problem’ is not resolved. We also know that the system is only surviving because the national debt is growing at an alarming rate and we have to support this by paying huge interest towards ‘our’ debts each year.
The currency we are using now is sterling, an international currency and part of the fractional-reserve system. So what is a fractional-reserve system?
No-one ever sat down and designed a fractional-reserve banking system, and no rational person ever would. The system ‘emerged’ rather than being designed. It emerged as a result of fraud, and it is still based on fraud. The fraud is not complex it is quite simple. If you or I attempted to copy this fraud we would be arrested and would face a criminal court. If we had a printing machine in our garden shed and we managed to print off £5 notes and tried to exchange these in local shops we would be committing a criminal offence. Yet the big banks are creating £millions on a regular basis and mixing it in with real money into the economy and the law is not concerned.
This idea that there is one law for the elite, and another for the rest of us is not new. In our book ‘Moving On’, page 91, Ronnie Morrison draws our attention to a period in England during the ‘Enclosures’ in the 17th century when wealthy aristocrats realised that small patches of land could be sold as a commodity in the developing capitalist markets, so they started to steal the common land which had belonged to the people for centuries, so that they could sell it off for cash. This little poem from that period captures the people’s frustration about this:
“The law doth punish man or woman that steals the goose from off the common; but lets the greater felon loose, that steals the common from the goose”
The fractional-reserve system emerged when it was recognised that bankers had observed that in normal times people did not regularly withdraw money from their accounts, on average only about 10% was normally withdrawn. So they started to lend out the ‘unused’ money, with interest of course. This became common practice and it was a short step from that system to lending out money which did not exist, with interest of course.
That is the basis of the fractional-reserve system. The system uses money as a commodity to make ‘interest’ from the exchange system, it does not add to, or enhance the exchange system it merely uses it to attach its parasitical tentacles into and makes a return, not for the economy, but for the elite only.
This is a parasite which our new Scotland can’t afford and does not require. What we need is a clear and honest currency and banking system which meets the needs of savers, investors, of traders and of the economic system, but has no special facilities for parasites.
A fractional-reserve currency is clearly distinguished by its need to lend out more money than it takes in. This of course means that it requires an elaborate system of linked reserves and a lender of last resort, because it needs to win the trust of the community that it will not fail again.
A full-reserve system, on the other hand does not lend out more money than it takes in. It has no need to do that. The banking system is a function of the Government, it is not run for private profit, it is run to facilitate economic efficiency. The Government’s reward for running this system effectively is to have control over the main aspects of the economy, and to have access to interest free investment and control of the money supply.
Of course, the financial elite and their bought and paid for media, will tell you that this can’t be done. They will say it has never been done before so it won’t work.
Let’s start with the claim that it has never been done before. Exactly the same argument was presented to Aneurin, or ‘Nye’ Bevan when he tried to set up the NHS in post-war Britain. It had not been done before, in Britain, or anywhere else, but the logic of it was clear, it could be done, and it was done. The NHS was the greatest policy ever put into action by any Government in Britain, and remains so to this day.
So the argument that it has not been done before, is not a compelling one, in any event it is not quite true in this case, because, for many years, the UK Government made special regulations for Mutual Building Societies in Britain. These Building Societies were a form of full-reserve banking. This full-reserve banking system played a major role in British capital accumulation, indeed they financed virtually all the housing stock in the UK.
So full-reserve banking has indeed been tried in the UK and has been very successful. However in neo-liberal Britain, the big banks have increasingly forced the Mutual Building Societies out of business and are destroying the last full-reserve bank in Scotland right now.
The Airdrie Savings Bank (ASB) is a mutual and a full-reserve bank. It is being forced to close soon because it will be unable to continue in business. Now why should that be? In the banking crisis in 2007/8 Airdrie Savings Bank was perhaps the only bank in the UK not to require taxpayers help. It survived that war, without difficulty, but it can’t survive the ‘peace’ which followed. Why is that?
Like all full-reserve banks the ASB relied entirely on ‘real’ money lent to the bank by savers who got paid interest on the money they deposited, while the bank lent out this money and charged higher interest to lenders. That is how such a bank works. It had no problems of debt in the bank crisis, because it did not lend out more money than it took in so it was safe and stable as all such systems are.
However, what happens if you have to compete with banks who are happy with very low, or no interest to savers because they can create their own money and don’t need savers. What if all banks are asked to contribute funds to secure national bank reserves, even those banks who do not require such reserves? If you do this you cut off the means of earning a living for such banks, and you legally force them to fund the ‘overspend’ of fractional-reserve banks. This forces them out of business. And that is exactly what is happening to the Airdrie Savings Bank right now in Scotland, forcing its closure because it can’t operate in this neo-liberal banking environment. This tells us that a full-reserve banking system and a fractional-reserve system can’t operate in the same legislative environment.
In our new neo-liberal fractional-reserve banking system, interest rates no longer play their traditional role to encouraging savings and to discourage overspending. Getting interest on your savings is no longer thought important. Indeed there is even consideration of ‘negative’ interest rates, that is, the bank charging you for putting your savings in their bank. What is the logic behind that idea?
Well, the big banks no longer need savers. If you have the power to create money any time you need it (what has been described by one economist as ‘phony money’) why should you want to pay interest to savers for their ‘real’ money? So using interest rates to attract savers is no long the concern of the banks. Interest rates are being used as a tool of Macro Economic Government policy on the economy. The fact that interest rates are not of much value in this particular role, seems to have escaped the notice of most Western Governments.
An independent Scottish Government, which had control of its domestic currency, would find much more effective ways to influence macro economic activity through public investment and fiscal policies. Interest rates would return to their traditional role in a full-reserve banking system which would require a high rate of savings, which strangely enough, Scotland still has.
Finance in Economic Policy
I have previously set out the many advantages for the Scottish Government which a full-reserved currency and a banking system under their control would give them. What it would undoubtedly do is enable them to put the ‘real economy’ horse before the ‘currency’ cart.
The currency and the real economy are related and always will be related, because one acts as a reflection of the other. I underlined earlier that money has no intrinsic value, so where does any fiat currency in circulation get its domestic value? It gets that value as a reflexion of the value of the goods and services which it reflects in the economy.
If for example, using the classical definition of inflation as “too much money chasing too few goods”, we suggest that the money supply in the domestic economy doubled overnight, while the supply of goods and services remained static. This would suggest that inflation would double. This simple idea shows the relationship between goods and services on the one hand and money supply on the other. Now in this relationship, it is goods and services which are the real wealth; money is their reflected value in the market place. Any sound Government economic policy must put the goods and services ‘horse’ before the currency ‘cart’ if it intends to maximise the wealth of the economy.
If you doubt this, take a look at the economic situation in Greece. Instead of concentrating on the ‘horse’ which is the real economy, and adjusting the currency ‘cart’ to meet its needs, they are putting the currency ‘cart’ first and adjusting the real economy to meet the needs of the currency. The result is a disaster for the real economy and consequently for real wealth. The lesson is crystal clear.
Scotland must put the real economy’s needs first and use its control over the currency to shape it to meet the needs of the economy, not the other way round. It will then maximise the economic wealth of the economy and the domestic currency will reflect that greater wealth.
Therefore, if we in the independence campaign are serious when we oppose austerity, when we demand full employment, when we insist on higher incomes and better public services we can have all that, but only if we give the new Scottish Government the tools to do the job. If we give them political independence but no control over the currency we will leave a future Scottish Government in the same position as the present Greek Government, unable to make the economy work for the people and begging foreign bankers to help them.
That is not the independence I want, and I’m pretty sure it is not the independence which most Scots want either.