Thursday, 20 May 2010

Could this actually work?

I found this article through Daniel Hannan's blog.

It is very interesting to read and it looks like it has some good ideas, but I don't have the economic knowledge to know if this could actually work.

Have a read and see what you think.

The Emperor’s New Clothes: How to Pay off the National Debt & Give a 28.5% Tax Cut
By Toby Baxendale.

I offer a £1,000 reward for anyone who can tell me why this logically won’t work, practical politics, for now, being another matter.

What follows is an attempt to show you that this can be done.

Remember the story about the Emperor whose only concern was not the welfare of his people but the state of his clothes? Lacking a new outfit for his procession, he instructs the finest clothe-makers to propose designs. Step forward Slimus and Slick, promising that only clever people will be able to see their splendiferous garments; they will be invisible to anyone stupid. In exchange for gold coin – real money – they make something special for the King. The King, seeing nothing when presented with these designs made out of thin air, worries that he must be stupid because he pretended to the fraudsters that they were wonderful. Word goes round that only clever people can see the garments, so everyone cheers the naked King during his procession. It takes a small child, on top of his father’s shoulders, to exclaim: “the Emperor has got nothing on!” Everyone falls silent. Then, one by one, they start muttering, “the Emperor is naked!”

I am going to tell you that our Emperor – the government – has no clothes and is indeed naked with respect to our money. The sooner we realise this the better. Then we can make real progress and prevent the imminent misery. Indeed, the realisation of its nakedness should reveal that we have a unique moment in history to do something very special: to make banking secure, pay off the national debt, and even enable a 28.5% income-tax cut.

We all know what notes and coins are: money, or cash. It allows us to exchange the fruits of our work for the goods of others. When we deposit cash in Bank A – say £100 – we lend this money to the bank. This may come as a surprise to most, as we think what we deposit in a bank actually remains “ours” beyond this point. But as soon as you make a deposit it becomes the bank’s i.e. “theirs.” They then lend what is called credit of £100 to an entrepreneur, who banks it in bank B. Like magic, we now have you, who have a claim to “your” £100, and the entrepreneur, who also has an equally valid claim to “his” £100. This happens 33 times for every £100 deposited in the UK economy on average, meaning that for every £100 deposited, it is lent out to 33 people. Some of the banks did this up to 60 times. This cash cannot exist in two places at the same time, let alone 60 places at once. So what bank A does, is write you an IOU. Yes, your bank-statement is a mere IOU, the bank saying “ bank A owes you £100 on demand.” This is called a demand-deposit. We now see that demand-deposits are created out of thin air! Indeed, these are just ledger-entries from one bank customer to another.

Tesco groceries can be paid by electronic transfer. All we are doing is moving our bank’s IOU to Tesco’s bank in exchange for their groceries. This is how the world works. Do we care that we are buying goods and services out of thin air? Like the Emperor, does he care – as long as all believe he is clothed? Well, the customers of Northern Rock did. So when more than a small percentage of them asked for their IOUs from Northern Rock to be repaid – or, as they thought, for “their” money back – it could not be, as the bank had already lent it many times, making it impossible to reimburse all they owed. Indeed, if the government had not pledged to underwrite all deposits, then there would be a very good chance that the whole system would have collapsed.

If we accept that the Emperor is naked then the path to solving all our current financial problems becomes clearer.

Consider this following programme of reform:

Print cash and replace all the demand-deposits/IOUs that exist in the system with that cash. This means the government printing approx £850 billion in cash and injecting it directly into the vaults of the banks and into the accounts of individuals. Thus, if you deposited £100 once thinking it was “yours,” it now really exists in cash, with the bank acting as custodian of your money.

Mandate all banks to hold your cash (100% reserved) on demand at all times.

Wipe from the bank ledgers all the demand-deposits/IOUs as banks would not owe you money anymore. This means the “thin air” money disappears, to be replaced exactly with cash money. Note: this is not inflationary, as the cash replaces the demand-deposit which acted as money. As we have established, it is only thin-air that the banking system has created to facilitate the multiplicity of lending of the same bit of money, so its total replacement with cash would mean the money supply stays exactly the same.

Require all banks to lend real savings that people knowingly place with banks to lend to businesses to get a return of interest and capital back when the business repays that loan. This is nice, simple and safe utility banking. This is what Mervyn King advocates.

As you are not a creditor of the bank anymore, the banking system will only have its assets and its capital, i.e. no liabilities. This means that there never again could be a bank run.

As for the banks, not having you the depositor as a liability anymore, they will suddenly be £850 billion better off, with no current liabilities and only assets (loans to business etc), post reform. The government can now put those assets into Mutuals, which would then immediately pay off the national debt, and leave the banks in exactly the same position net worth wise as they were prior to the reform, owned by their existing shareholders. As the national debt is still just under the £850 billion, which would be available as surplus assets of the banks, this could still be achieved.

No national debt means no interest costs (currently £40 billion p.a) associated with paying for our borrowing. Therefore, give an immediate 28.5% income-tax cut. Total income-tax raised is £142 billion.

The boy in the story stood on his father’s shoulders. I stand on the shoulders of great men who have advocated part of this reform: Irving Fisher, the greatest American economist, the Nobel Prize winners Soddy, Hayek, Buchanan, Tobin, and Allais. Recently, Kotlikoff of Boston University has published an excellent book, “Jimmy Stewart is Dead” advocating a similar reform. It is endorsed by more Nobel Winners: Akerlof, Lucas, Fogel, Prescott, and Phelps. I count 36 endorsements from the great and the good for the book. All endorse Kotlikoff’s move to what he calls Limited Purpose Banking which is another way to get 100% reserved (i.e. secure) deposits backed by cash rather than thin-air.

The Economist Huerta De Soto, in “Money, Bank Credit & Economic Cycles,” has seen the opportunity that presents itself to reform for 100% money while also paying off the National Debt. Following on from this, I suggest a substantial wealth-creating tax cut for the people. Just like the boy in the story, I do hope that people start to realise that the emperor really has no clothes, and that an enlightened approach can address this.

If this could work, will the politicians use it, or at least consider it?

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