And what about the money?

Date published: 10 October 2014

On September 15, 2008, six years ago, Lehman Brothers collapsed. Despite a “tsunami” of reforms, the financial system has not been transformed. To change finance, there might be a need to change our basic understanding of the financial system. This come-back to fundamentals has led reformers as well as central bankers to focus on money itself. Interestingly, new thinking comes with new methods of producing and spreading knowledge, and new ways of forcing ideas into the political agenda. This month, this blog introduces you to the most dynamic, entrepreneurial, and refreshing actors of the world of financial progressive thinking and to their latest success: an important recognition of their ideas by the Bank of England.

By Fabien Hassan, guest poster*

Since its creation in 2012, Finance Watch has been trying to have an impact on the regulatory agenda in Europe, and has achieved some remarkable results (see annual report for 2013). Just like other advocates of reform for the European financial system, Finance Watch believes that the financial turmoil of the 2000s is the result of a deliberate policy of deregulation in Europe and in the USA, which was initiated in the 1970s and accelerated in the 1990s. Their work has therefore focused on the legislation that came since the crisis, trying step by step to tighten and improve the new rules of finance.

But what of the reforms that have not made it onto the mainstream legislative agenda? A group of economists and alert citizens throughout the world believe that the present monetary system is fundamentally flawed and that more far reaching reforms than those on the ‘official’ agenda are needed. They have diverse opinions on the usefulness of regulatory measures such as enhanced capital requirements and some claim that a complete overhaul of the monetary system is inevitable if one wants to tame the excesses of modern finance. In the last two years, these debates have started to reach out to senior bankers, economists, and a broader public on the internet. This blog looks into a topic that a growing number of people think should be added to the ‘official’ reform agenda – reform of the monetary system.

The role of money in macroeconomics

Mainstream economics, a science which deals with prices, wealth, and production essentially claims that money doesn't matter. What looks like a puzzling paradox is best understood as a great scientific improvement if compared with the dominant theory between the 16th and 18th century: mercantilism. Mercantilists tended to assimilate money and wealth and recommended sovereigns to accumulate money. This led to policies which systemically aimed for a surplus trade balance, even at the expense of the development of national production.

As a reaction, the founders of modern economics (François Quesnay, Adam Smith, Jean-Baptiste Say, David Ricardo, John Stuart Mill) developed the theory of money as a “veil” which needed to be lifted. They claimed that the economy was best understood as a system of exchange of values, and presented money as a mere tool of exchange. Theoretically, barter is sufficient; and money is only necessary because of the practical impossibilities to conduct billions of in-kind transactions.

In the 1970s, opponents of Keynesianism built on this conception to develop the so-called “quantitative theory of money”. Basically, this theory claims that any policies that rely on an expansion of the money supply must be ineffective in the long run: mathematically, if you create twice as much money, prices and wages will double and in the end you won’t be richer than you were in the beginning. You might even be poorer, because of the destabilizing effects of inflation. Monetarists therefore take great care to control inflation, directing much effort to the analysis of interest rate decisions by central banks.

The distinction of money and wealth was a pivotal step for economic science. It revealed the reality of the exchanges that are taking place on the market. The problem with this distinction is that it led macroeconomists, including in central banks, to develop models that ignore money and disregard its effects on the economy (for an analysis of this problem, see for example this article by IMF Chief Economist Blanchard in 2010). But the financial crisis, with its leverage boom and credit crunch, is a reminder that money matters. Even if you believe the idea that, in the long run, changes in the quantity of money will be absorbed by price adjustments, the immediate effects of how and where money enters the economy are real and significant.

Who are the advocates of monetary reform?

Monetary reform is a fascinating theme because it involves international relationships, figures that start with “trillion”, and the possibility to reshape the world through simple reforms. It also challenges mainstream economic thinking, making it harder to gain attention in “serious” economic journals.

In the past, advocates of monetary reform have included a diverse set of people, from conspiracy theorists and gold-bugs to respectable academics. They include advocates for a return to the Gold Standard, such as Steve Forbes, the US Republican and editor-in-chief of Forbes Magazine, and Lewis Lehrman, who co-authored a book with leading Republican politician Ron Paul in the 1980s saying that money should not be disconnected from real physical goods. But they usually have a hard time explaining why gold is relevant as a universal standard, despite strong variations in its supply and price that proved devastating for monetary systems in the past.

Others have focused on completing the international monetary system proposed by the greatest economist of the 20th century, John Maynard Keynes, after World War Two. The construction of the Bretton-Woods system was a task so exhausting that it took his life. But Keynes failed to convince the US to fully implement his program and parts of his ideas remain dead letter. For example, he wanted to build an international form of money that would be independent from States and a fortiori from politics. This became the SDR (Special Drawing Rights) of the IMF, based on a basket of the biggest moneys, but it failed to reach out to the rest of the economy.

Those groups have been around for quite a while. But a new wave of reformers is emerging. The financial crisis convinced them that our monetary system is flawed. However, instead of focusing on exchange rates and macroeconomic equilibriums, they focused on the way that credit was being created and reached the following conclusion: the reason why finance got out of control is because money got out of control. More precisely, the State lost control of money creation, which is now delegated to “the market”, i.e. the banks.

New plans and innovative methods for monetary reform

The key assumption here is that banks have the power to create money out of nothing. That realization has been around for a long time, and can be traced back to classic economists of the 19th century. But beyond a small circle of economists, bankers, and central bankers, most people still think that banks act as intermediaries that collect deposits and allocate capital by granting loans to the most efficient uses. A recent poll showed that 71% of British MPs believed that only the government has the power to create money. In reality, this is only true of coins and notes, which make up just 3% of all the money in the economy.


The other 97% is electronic money. Monetary reformers point to the fact that this electronic money is actually created by a bank when it grants a loan and destroyed when the loan is repaid: banks do not have the money in advance of making a loan, it is created by typing into a computer that there is now money in your account. The supply of money to the economy is therefore, for the most part, identical to the supply of credit to the economy.

In a brilliant 12-page article entitled “Money creation in the modern economy”, which should be a must-read for all economics students, three members of the Bank of England’s Monetary Analysis Directorate explain with simple words that “the majority of money in the modern economy is created by commercial banks making loans”. Symmetrically, customers destroy money by repaying those loans. Other ways for commercial banks to create money are the purchase of government bonds or other assets, and the issuance of long-term debt and equity instruments.

The important thing here is that: “Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits”. So the quantity of money is not determined by the quantity of central reserves created by the central bank. There is no direct way for institutions to control the evolution of the money supply. This may seem trivial, but it amounts to saying that the theory that students and future leaders throughout the world learn in their macroeconomics courses is completely false and misleading.

But then, why don’t banks just create unlimited amounts of money? According to the Bank of England (BoE), there are three factors that act as limits to how much banks can lend: market forces facing individual banks, constraints arising from the response of households and companies, and monetary policy, “the ultimate constraint on money creation”.

Monetary reformers question if this is the best way for society to organize its money supply. They have the feeling that universities are not interested in exploring the topic and academics are discouraged from publishing papers on it. To circumvent the obstacle and organize the production of ideas in a more horizontal pattern, a new method was used to study the topic. An interactive website,, collects comments from readers to make sure that all objections are covered: “Each Monday we will post a relatively short piece, gradually building toward a comprehensive theory of the way that money “works” in sovereign countries. We will then collect comments through Wednesday night, and will post a response to the comments on Thursday”. This resulted in a book entitled Modern Money Theory, by L. Randall Wray (Palgrave Macmillan, 2012).

The impact of the Bank of England’s revelations

The “revelations” of the BoE do not imply that money creation is out of control. But it enables the debate to move on to the next step: are instruments such as interest rates and capital requirements really effective in regulating the way that private banks create and allocate money? The BoE basically explains that it still has great means of control, using interest rates and macro-prudential tools like limits on mortgage lending to influence the credit supply. Central banks have also started to experiment with “credit easing”, in which they provide banks with liquidity to help them supply more credit to businesses in the real economy, such as the BoE’s Funding for Lending Scheme and the ECB’s programmes for targeted longer-term refinancing and ABS purchases. Some money reformers ask if that is enough.

The interesting thing is that advocates in this area are not purely academic. Of course, they use publications such as the above-mentioned BoE’s article, or a well-known 2012 paper from two leading IMF economists, entitled “The Chicago Plan Revisited”. However, activists throughout the world have now turned to mobilize the wider public to exert pressure on politicians. They have networked into a common organization called International Money Reform, which has branches in several countries.

One of most successful national movements is “Monnaie Pleine” (Full Money) in Switzerland, which has initiated a Peoples’ Initiative on monetary reform and is now in the process of actively collecting signatures. It needs to reach 100,000 to trigger a referendum.

In England, the group Positive Money has also been successful. In 2013, Andrew Jackson and Ben Dyson published a book called “Modernising Money: Why Our Monetary System is Broken and How it Can be Fixed”, which is used as a reference by other members of the network and by economics teachers in some more adventurous UK schools and universities.

In Germany, Klaus Karwat, the owner of a charming art gallery in Berlin, is the president of Monetative. He is convinced that the time had come for money reforms: “When we talk with politicians, we always get the same answer: ‘Your ideas are interesting but they are not on the agenda, we want to focus on achievable reforms’. So now, we need to lobby politicians and civil society to force monetary problems into the political agenda” (interview in Berlin).

For Ann Pettifor, an economist with her own views on money reform, this is certainly a political fight because it has a huge impact on the distribution of income: “As long as we remain ignorant of how monetary systems operate, for so long will the public good that is money be captured to serve only the interests of the tiny, greedy minority in possession of private wealth”. She also believes in new technology-based methods to reach out to a broader audience. In 2014, she published a short e-book, available for less than 4 euros, “aimed mainly at students – especially women students and green campaigners” (interview on ).

The next article will summarise some of the ideas that advocates of monetary reform have proposed. Readers interested in financial reform should definitely follow the issue, at least because of the refreshing perspective that it provides. Financial reform does not have to be only about accountancy standards and capital requirements. Credit is at the core of the functioning of the economy, and rethinking credit is nothing less than rethinking capitalism.

Image © Positive Money


#6 Dirk Ehnts 16 October 2014
[quote name="Fabien Hassan"]Europea n Commissioner-de signate Jonathan Hill: "We should acknowledge certain benefits that are contributed to the digital currencies such as financial inclusion, speed of transaction, certainty of payments received and potential lower transaction costs."

It makes one wonder if he understands that the pound as created by the BoE and the other banks is mostly a digital currency, too. It has the minor advantage of being subject to deposit insurance schemes (up to 85,000 GBP) and it can, mind you, be used to pay taxes. Apart from that, its value is not as volatile and its quantity can be expanded if needed.
#5 Fabien Hassan 15 October 2014
To follow-up on the Bitcoin topic, you may also read this statement by Finance Watch, which played the role of European Commissioner-de signate Jonathan Hill and answered the questions of the European Parliament: "We should acknowledge certain benefits that are contributed to the digital currencies such as financial inclusion, speed of transaction, certainty of payments received and potential lower transaction costs."
#4 Fabien Hassan 14 October 2014
@Peter Hool, Dirk Ehnts

Thanks for your comments. Indeed, Bitcoins are one big innovation that might in the long term push toward a reform of the money system.

However, in my view, Bitcoins and comparable projects rely on an "anti-State philosophy" where the control of money supply is purely independent and delegated to an algorithm, or determined in advance and forever. On the other hand, the Positive Money project tends to give back the power of money creation to public authorities.

It will be extremely interesting to see which project gains the most attention in the years to come.
#3 Peter Hool 13 October 2014
I only mentioned Bitcoin in the context of an existing system as an alternative to reliance on the present banking system.

The existing system is no longer fit for purpose. I am not suggesting that Bitcoin is an alternative to the Positive Money solution but Bitcoin does demonstrate to Government that there is already an alternative system attracting growing support if they need proof that alternatives can work in this day and age.
#2 Dirk Ehnts 13 October 2014
I don't believe that Bitcoin is progressive. Government would be dependent on rich people again if it wants to (deficit) finance anything. This would be a giant step backward.
#1 Peter Hool 13 October 2014
I have recently become more aware of Bitcoin and I wonder if it could help make the powers that be start to think more proactively about monetary reform.

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