Sensible Money is promoting the system of sovereign money creation as a solution to not only our financial problems, but many of our societal issues too. It is a modern variation of the system of full reserve banking which was first proposed in the 1920s. The system was refined to better suit a digital economy by James Robertson and Joseph Huber in their 2000 book Creating New Money
Our solution involves running the economy the way most people imagine it runs. The central bank would create the entire money supply in all forms while the banks would just do banking. They'd facilitate any electronic payments between accounts within the economy and they'd act as financial intermediaries between investors and borrowers. The banks would only lend existing money and a loan repayment would not cancel money out of existence.
For a detailed discussion of our proposal please download our document A Guide to sovereign money creation in the euro zone or continue reading below.
If you have any issues with our proposal please let us know by email, check our FAQs page or if you'd like to help please sign up to our newsletter or go to the Get Involved page.
Why is fundamental reform of the banking system the only solution?
We've had banks creating/destroying money for over 500 years and we've regulated the system for over 300 years. To date we've tried many things to keep this system stable and 300 years later we have the biggest financial crisis to date.
We've tried linking money to commodities and removing such links. We've tried the same thing for international trade only. We've tried adjusting, abolishing and reinstating minimum reserve requirements. We actually had maximum reserve requirements at one stage.
We've tried private central banks creating the cash portion of the money supply and acting as the lender of last resort. We've tried nationalising central banks to focus on the public interest.
We've tried liquidity coverage ratios and capital adequacy ratios. We've placed strict limits on how much banks could create and then removed all limits. We've tried prohibiting banks from creating money for projects that don't involve an increase in GDP. We've tried public & private insurance on bank deposits. We've tried banking unions.
We've tried putting central banks, financial regulators and financial services authorities in charge of monitoring stability. We've tried providing banks with an abundance of central bank liquidity. We've tried capitol controls.
We've tried encouraging businesses to take on more debt, then governments, then households until all three have approached their limits and 300 years later we haven't been able to keep this system stable.
For the reasons outlined in What's different about this recession? we feel there's no better time to redesign the foundations of the economy.
Economists Promoting Full Reserve Banking
Many very well-known, important, respected and famous economists were or are calling for a full reserve banking system. Their proposals differ from each other slightly but full reserve banking is common to all of them.
Full reserve banking was proposed in the 1930s by a group of prominent economists. The proposal became known as the 'Chicago Plan' and it was supported by F. H. Knight, L. W. Mints, Henry Schultz, H. C. Simons, G. V. Cox, Aaron Director, Paul Douglas, and A. G. Hart. The proposal was discussed at length at the time but ultimately it wasn't implemented.
It enjoyed a revival when the US entered its second recession of the 1930s and this time it was championed by Irving Fisher. A Program for Monetary Reform was co-authored by Fisher and Paul H. Douglas., Frank D. Graham., Earl J. Hamilton., Willford I. King. and Charles R. Whittlesey. It was sent to the most complete list of academic economists available at the time which included 318 economists from 157 universities and colleges; 235 economists had general approval of the proposal, 40 economists approved of it with some reservations and only 43 economists expressed disapproval.
Milton Friedman described Fisher as "the greatest economist the United States has ever produced".
The 'Chicago School' promoted full reserve banking as a means of allowing the government's monetary policy to be implemented more directly. Another school of thought, known as the 'Austrian School' promoted minimal government involvement in the economy but interestingly they came to the same conclusion regarding the abolition of fractional reserve banking.
They saw full reserve banking as necessary for the correct functioning of a market economy.
Ludwig von Mises was the first twentieth-century economist to propose the establishment of a banking system with a 100-percent reserve requirement on demand deposits.
Nobel Laureate Friedrich A. Hayek also speaks of establishing a banking system based on a 100-percent reserve requirement.
French economist Maurice Allais, who received the Nobel Prize for Economics in 1988, has also championed full reserve banking.
Jesus Huerta de Soto is today's leading Austrian school economist, and has written that "a 100-percent reserve requirement would be established for private banks. This step would necessitate certain legislative modifications to the commercial and penal codes. These changes would allow us to eradicate most of the current administrative legislation."
Strong criticism of fractional reserve banking comes also from Nobel Prizewinner Frederick Soddy. Dedicated to Chemistry he eventually realised the world's underlying problem was faulty economics and for the second half of his career economics replaced chemistry as the centre of his intellectual life.
There is one more outstanding economist who has backed monetary reform. Milton Friedman, a Nobel Prize winner – known now as one of the most influential economists of the 20th century, wrote a book in 1960 called A Program For Monetary Stability. On page 65 he stated that he was in favour of what Henry Simons and Lloyd Mints were advocating, that is, 100% reserve. In other words, he advocated that a public institution, rather than private banks, should issue the money supply. Dr. Friedman also praised the American Monetary Reform Act which aimed to implement full reserve banking.
In more recent years more and more economists have been advocating a sound and stable monetary system based on 100% reserves. They include Laurence Kotlikoff, Josef Huber, James Robertson and Nobel Prize winner James Tobin.
Herman Daly, former Senior Economist at the World Bank, strongly endorses full reserve banking, saying "I think we can really do a whole lot for our economy if we would just move away from fractional reserve banking and go back in the direction of 100% reserve requirement."
The Governor of the Bank of England Sir Mervyn King has also hinted that full reserve banking is not such a bad idea after all:
"Another avenue of reform is some form of functional separation. The Volcker Rule is one example. Another, more fundamental, example would be to divorce the payment system from risky lending activity – that is to prevent fractional reserve banking".
Where to begin?
First of all we'd have to change the rules regarding money slightly and
acknowledge that bank balances are legal tender. Technically bank
balances are a record of how much cash a bank owes and so they are defined as liabilities of the bank. However this is no longer a realisitic description of bank accounts because, for all intents and purposes, your bank balance is the money itself.
From then on only the central bank would have the power to create, or destroy, any electronic money.
Rarely would money be destroyed under this system, unlike today, and so after a transition period the economy may not need much new money to function well. If the central bank felt that new money was needed they'd create it by typing it into the government's bank account.
The government would not have the power to create money because of their poor history in managing the economy anytime they've been in charge of directly creating the money supply. However they would decide how best to spend any newly created money.
The decisions on how much to create, and how best to spend are thus separated.
How it would affect you?
No action would be required by the general public. To the average person the system would look very similar to the one we have today. Entrepreneurs would borrow from banks, stock markets would fluctuate, governments would borrow occasionally, we'd have credit cards & overdrafts, taxes & charges, rich & poor.
Even the daily workings of most bank employees wouldn't
But, we'd have a more stable economy.
The major change you'd notice would be that banks would separate your daily transactions and any money you wish to invest with them into two separate accounts, namely current and savings accounts.
If you have money in a current account only you can use it. And if you have money in a savings account only the bank can use it.
"Only you can use it"
"Only the bank can use it"
Low risk: might be used for mortgage loans, credit card , etc.
High risk: might be in a new development; off shore oil drilling, etc.
Note that if you wanted to save money 100% risk free, you would keep it in your current account.
If you want it seperated from your day-to-day current account banking; open a second current account, just for savings. Of course no interest will be earned in a current account (a charge for the service may in fact apply) but your money will be absolutely 100% safe and yours alone to access.
More on Current Accounts:
There would be no risk to current accounts whatsoever. In the unlikely
event of a bank failure all current accounts would be transferred to other
banks without burden to the taxpayer. There would never be a bank run or
bank bailout again. There would be no need for banks to have deposit insurance either.
Current account balances would no longer be considered a liability of the bank. They would finally be considered legal tender and would be held 'off the balance sheet'.
More on Savings accounts:
Savings accounts would be slightly more complicated. They would really be
investment accounts and could be renamed as such. The banks would have to
attract the funds that they want to use for lending. These funds would be
subject to risk and reward like any other investment and there would be no
Upon transferring money to a savings account customers would lose access to their money for a pre-agreed period of time or a minimum notice period. The savings account would never actually hold any money since any money 'saved' will immediately be transferred to a central investment 'pool' held by the bank.
At the point of opening a savings account the bank would be required to inform the customer of the intended uses for the money that will be invested along with the expected risk level.
The risk of the investment now stays between the bank and the investor rather than the taxpayer. In some accounts the risk will fall entirely upon the bank, while on others a large proportion of the risk will fall on the investor. Any investor opening a savings account should be fully aware of the risks at the time of the investment.
Savings accounts would operate as follows;
Banks would have the option of offering savings account holders a
guarantee that they will be repaid a minimum percentage of their original
investment, in some cases 100%, others 80%, 60% etc. or they may offer a
guarantee on the rate of interest that will be paid on the savings account
product, for example, guaranteeing to pay interest at 2%, 4% or 5% etc.
For more detail on how savings accounts would function in practise click here for a worked example.
Savings accounts – A worked example
Suppose a bank wants to attract funds to invest in housing market loans to middle-income families. It charges an interest rate of 6% on the mortgages to borrowers and it knows that only a tiny amount of the loans that it makes to these families will default. Consequently, allowing for some defaults, the normal case rate-of-return will be around 5.8% overall and in the very worst case scenario, with a high rate of defaults, the rate of return might drop to 2%.
Because the bank knows that in the worst case scenario it is still likely to make a return of 2% it might guarantee a rate of return of perhaps 1.5% to investors. This provides a good investment vehicle for savers/investors who don't want to take much risk.
In this scenario the bank holds all the risk of the investment. If the investments were made badly and the bank somehow lost a huge percentage of everything it invested it would still need to repay 101.5% of the entire original amount invested with it and it would cover its losses with its own profits.
Bear in mind that today it's impossible for all loans to be repaid since there is more debt to banks than there is money. However under the proposed system banks would be lending existing money. A large portion of the money supply would be guaranteed safe in current accounts there would be far less reason to expect mass defaults.
Let's look at another scenario. Imagine that the bank wants to raise funds for investing in an emerging market that may be risky. The bank wants to limit its own risk by sharing some of the risk with its customers. The potential interest rate that it will offer if its investments are successful is 8%. However, if it is unsuccessful, and the market turns out to be a bubble about to burst it could end up losing up to 50% of the funds invested.
In this case, the bank may opt to offer no guarantee on the rate of return but to offer a guarantee of perhaps 60% of the principal invested. This would attract funds but would force the investors to share the risk with the bank. If the investments failed badly the investors would lose 40% of the principal and the bank would need to make up the other 10% of the losses from its own profits.
Competition between the banks will lead them to offer a full range of products for every type of investor.
Savings would not be guaranteed absolutely safe by the taxpayer but there's no justifiable reason economically or ethically why bad investments by banks or otherwise should be redeemable by the taxpayer.
The Financial RegulatorTo safeguard savings as best we can the financial regulator may get involved to stop banks making unrealistic guarantees, perhaps based on their best case scenario only.
If the bank tries to offer a savings account product with a guaranteed rate of return of 8% in what could easily turn out to be a bubble the financial regulator may not allow this. They'd insist on seeing the reasoning behind such a guarantee and act accordingly. The financial regulator would not accept any responsibility for bad investments regardless of its actions.
The transition would be very gradual and most of it would happen over the course of around 25 years.
We'd announce a changeover date, perhaps 12 months into the future, by which time the banks would secure existing money from investors for the purposes of lending.
From that date on bank accounts would not appear as liabilities on the balance sheets of the banks, in a similar manner to which cash in wallets isn't recorded on the banks' balance sheets. Similarly, outstanding loans would be removed from the assets side of the banks' balances sheets. Instead they would be recorded at the central bank.
As the commercial banks take in loan repayments for loans processed before the changeover date, the money would be transferred to the central bank whereupon the debt would be settled. Ultimately the money would be deleted in a similar manner to today's loan repayments. This would only occur for loans organised before the changeover date.
No more money would be created through the bank loan process and so the central bank will have to type the deleted money into the Government's bank account and have them spend it into circulation. Eventually the money supply, as a whole, would be debt-free, although of course there would be some creditors of existing money and hence debtors within the system.
The National Debt
We'd also repay the national debt towards zero very slowly rolling over many 10 year bonds for decades. A portion of the
national debt is owed to the central bank, essentially as an accounting
procedure, and it would make sense to simply cancel this debt. The rest would be gradually
repaid as the Government of the day sees fit.
Some of the repayments may be funded with newly created money although this would not be the same as 'printing' money to repay the national debt, which loses a country international credibility. The reason for this is that the amount of new money created will be small and there will still be debate about how best to spend it.
How this would suit the banks
It might appear that our current banking system is
the one which suits banks the best since ultimately ever euro is owed to a
bank. They also have the power to create money although only for other
people. Bear in mind also that banks delete most of the money they receive as repayments of loans.
Full reserve banking could be better for all, including the financial sector.
It would be easier for banks to earn money from circulation through
full reserve banking than the stagnant fractional reserve banking we'll
experience for the foreseeable future.
Banks could manage their cash flows much better too.
The amounts that the bank
would need to repay to investors on any one day would be far more predictable also. With
regards to minimum notice periods, they will know the statistical
likelihood of an account being redeemed within the next 'x' days, and so
they would be able to plan the payments that will come due on any
particular day for many months into the future.
Because they have a collection of debtors with specified repayment dates and amounts they could predict almost exactly how much money they will receive on any particular date for many months into the future.
Consequently the banks' computer systems will easily be able to forecast cash flow with a much greater degree of certainty and prepare for any shortfall.
Also, since every euro has a matching debt today it's impossible for everyone to repay their loans. Under full reserve banking it would be very possible for everyone to repay their loans and banks would not have to deal with the problems of defaults and repossessions.