Monetary Reform


Monetary reform is not part of the party’s manifesto but we believe that many of our society’s problems are rooted in flaws in the way the monetary system operates.

The analysis below is taken from a proposal put forward by Malcolm Ramsay during the ConstitutionUK project run by the LSE in 2015 (to crowdsource a new constitution for the UK), and explains why the structure of the monetary system creates problems and outlines reforms which we believe would solve them.

Regulating the money supply has been regarded as a core function of government for many centuries but it is something which has developed haphazardly and, as we know from the experiences of recent years, it has never been done very satisfactorily. I believe some aspects of this should be entrenched in the constitution – but the exact nature of the responsibility needs to be analysed with some care.

My argument here is that the responsibility for the money supply is entwined with the state’s powers of taxation and that the way it works currently is a major cause of both inequality and instability. I apologise in advance for the length and complexity of this post but it is, unfortunately, an intrinsically complex subject.

When the state assumes a responsibility, directly or indirectly, it has an obligation to do so in a way which does not favour one section of society over another. With our current monetary system, that obligation is violated because the form in which the medium of exchange is created leads to a flow of wealth from the poor to the rich. The reason for this is that the medium of exchange can effectively be taken out of circulation by those who have a surplus; as a result, the rich are able to charge others for the opportunity to use it.

To understand this, it’s necessary to look briefly at a feature of the monetary system which we are all familiar with and take for granted but which is in fact fundamentally at odds with the natural economy: the payment of interest on savings. This is an essentially monetary phenomenon. In the natural world, if we wish to put something aside for the future there is a ‘carrying cost’ involved which effectively reduces its value to some extent. With money, however, not only does it not lose value, we actually expect its value to increase.

The reason it does increase – the reason people receive interest on money they put aside for the future – rests on the fact that money performs different functions which are not wholly compatible with each other. It acts as a medium of exchange, as a store of wealth and as an abstract standard of value. Those first two functions are in tension with each other – it performs its function as medium of exchange by circulating, but it performs its function as store of wealth by being taken out of circulation. That tension is behind much of the instability of the current monetary and banking system.

The quantity of medium of exchange cannot simply be increased (because that compromises money’s function as a standard of value), so a mechanism is needed to ensure that money stays in circulation. That mechanism is the payment of interest, and it constitutes a flow of wealth from those who don’t have much towards those who have a surplus. That flow of wealth has no natural cause; it rests entirely on the fact that the medium of exchange retains its (nominal) value indefinitely, and it would not happen in a society which separates those functions of money.

The fact that money in its basic form can be physically taken out of circulation means that the money supply is partly under private control. The authorities don’t have any direct means of adjusting the ratio between what is circulating and what is stored, and the indirect methods they do have are too crude to maintain a stable economy. They either rely on the very phenomenon – interest – which causes a flow of wealth from the poor to the rich, or they do it by increasing the money supply, causing inflation. In other words, instability is an inherent feature of the form of money we currently use.

Whether or not government should have an explicit obligation to actively provide a medium of exchange is debatable. My view is that what medium of exchange is used in private transactions is essentially a private arrangement which the law should oversee but not prescribe. What the state uses in the transactions it engages in itself, however, is not a private matter – and, in practice, what the state uses as medium of exchange will probably be what everybody else uses as well. The value of any currency rests on there being someone who is willing to accept it and the state can be regarded as a guarantor of whatever currency it accepts in payment of taxes.

In other words, the value of our existing money is underpinned by the fact that the state not only accepts it in payment of taxes but actually demands it. This locks us, as individuals and as a society, into an unfair and unstable financial system.

I’ve pointed out elsewhere (in Obligation to pay taxes  and Voting with your taxes) that the requirement that taxes be paid in money rather than labour reinforces the subservience of the poor to the rich. In this post I’ve argued that it also underpins a financial system which is inherently unstable. The reforms I’m proposing are aimed at remedying both aspects of this problem, but I’m concentrating here on the monetary reform which they would make possible.

The fact that financial interest, and its role in the ‘rentier’ economy, result from the susceptibility of money to being hoarded has been recognised for a long time, and proposals have been put forward for alternative currencies to get round the problem – most notably the system proposed by Silvio Gesell at the end of the nineteenth century, which required money to be stamped each month, for a small fee, in order for it to keep its value.

For the most part, however, this problem has been ignored by mainstream economists and bankers, though a number of prominent economists have considered it. In the 1930s, for example, Keynes referred to Gesell as a ‘neglected prophet’, and a few economists have also raised the issue in recent years, for example, Willem Buiter (currently chief economist at Citigroup). I believe most economists ignore it, however, because they consider the necessary solutions impractical for essentially political reasons.

There were in fact some communities which tried Gesell’s stamped money during the Depression in the 1930s in Austria and the United States. In both places, I believe, the currencies were successful in stimulating local economies but were banned because of fears they would undermine national currencies. (This was at a time when memories of hyper-inflation were still raw, and when floating currencies – currencies not linked to some commodity like gold which is fixed in quantity – were a comparatively recent innovation.)

The problem in getting away from the ill-effects of this feature of the monetary system is that it requires a fundamental change to the nature of money; basically, cash would have to lose its value when it ceased to circulate. As well as this circulation-dependent or time-limited currency, there would also have to be a separate, intangible form of money for savings. (I say more about this below.)

While a time-limited medium of exchange is technically feasible (and these days could be done more elegantly and unobtrusively than in Gesell’s system), such a major change to something which is so central to our lives is simply too much for most people to contemplate, especially when the need for it is not obvious – particularly since there are clear dangers in doing it carelessly. The benefits of the change are primarily societal, while its costs are individual; every individual who holds money naturally desires it to maintain its value, but if it does, society as a whole loses control of its medium of exchange.

The problem, therefore, is how to bring about a change which is both necessary and apparently inconceivable. The key to it, to my mind, is to create an environment in which a new time-limited currency can emerge as a competitor to the existing currency. In a contribution in the Local Government section I propose two reforms (designed to address other problems) which should enable this to happen:

  • Individuals should be able to choose between paying their taxes in money to higher-tier authorities or paying them, in labour (or money), to their lowest-tier authority.

  • Local authorities should be empowered to issue time-limited transferable tax receipts (up to a limit consistent with the taxes that individuals have opted to pay to them) in payment for goods and services; and required to accept such tax receipts, when tendered, as a substitute for labour owed them.

Those reforms would essentially allow local authorities limited powers to create local currencies, associated with their revenue-raising power. However, a proliferation of local currencies does have drawbacks since there are undoubtedly huge advantages to having a single currency.

Or, more precisely, there are huge advantages to having a single standard of value; there are major advantages to having a single medium of exchange (along with some disadvantages); but there are major disadvantages to having a common store of wealth.

The advantages come from the possibilities for increasing the overall volume of transactions and easier access to forms of wealth which aren’t available locally. The disadvantages come from the fact that money going out of a community can no longer stimulate trade within it, so there has to be some means of ensuring that outward flows are balanced by inward flows, which is very difficult with conventional, non-time-limited money.

With a time-limited medium of exchange, however, it would become much easier. I said above that, as well as the time-limited medium of exchange, there would also have to be a separate, intangible form of money for savings. This would be convertible on demand into the medium of exchange – but only at an exchange rate which would vary. The authorities would therefore have a variety of levers for managing the monetary system: the latency period of the medium of exchange (the time it keeps its full value for) and the speed at which it loses its value could both be varied in response to changing economic circumstances; exchange rates between the medium-of-exchange money and the intangible store-of-wealth money would also be variable; and those exchange rates could be different in different areas – making it relatively easy to attract investment funds into areas which were losing liquidity.

In this scenario, creation of the medium of exchange would be shared between local communities and central government, with local authorities deciding how much to issue, and central authorities regulating how soon it would start to lose value and also setting exchange rates. Creation of the store-of-wealth money would be largely controlled at a higher level.

I’m not entirely sure how this should be written into a constitution but the monetary system is so central to the operation of a mature society that I do feel it deserves to be included.

(Malcolm Ramsay, Spring 2015)

The following was added as a comment to the initial proposal in the LSE project:

I think the specific constraints and obligations which will be entailed in maintaining a stable monetary system are going to centre on limits to government borrowing. I always like to root my arguments in principle if I can so I’m intending to come at this from the angle of inter-generational sovereignty. (This is an area where my thoughts are only just beginning to crystallise so bear in mind, with the next few paragraphs, that I’m making it up as I go along.)

Currently, the principle that no parliament can bind its successors simply means that every generation is entitled to make its own laws. But, in practice, the past entangles us, both in inadequate laws which are a nightmare to change and in financial obligations which we can’t repudiate without jeopardising the operation of the broader economy. I would like to see a constitutional obligation to respect the autonomy of future generations as far as is practical.

That would probably be little more than a guideline in most areas, but in fiscal policy it would constrain government borrowing to an amount that the current generation could be deemed willing to repay. That’s obviously not something which anyone could pin a hard and fast figure to but, in the long run, I think it would be based on the average ratio between tax revenues and demand for savings. (Bear in mind, there, that the store-of-wealth money might well never offer positive rates of interest, so demand for savings might not operate in quite the same way that it does today.) That would manifest eventually, I believe, in some fairly firm rules, setting a maximum interest rate on the store-of-wealth money, and also linking the levers I mentioned in the initial post to the level of government debt.

Discussion on monetary matters always descends quite quickly into detail and I find the will to live starts to slip away so I’ll leave it there for now. Basically, I think all that would be needed in the constitution (other than the rights I’ve discussed in the other sections) is a general requirement that legislation and policy respect the autonomy of future generations. The details should follow from that.

In the refining stage of the LSE project, after the initial proposal had been accepted, we moved on to drafting proposed clauses for the constitution. At that stage I realised that a tax-related medium of exchange can’t easily be divorced from the unit of account the government uses, so the draft clauses I proposed started with that:

  • Government fiscal accounting shall be based on an ‘official unit of account’ whose value may not be either a) arbitrary or b) controlled, wholly or in part, directly or indirectly, by private interests or by agencies outside Britain. Minutes or hours of passive labour shall be regarded as an acceptable official unit of account. This provision shall not constrain the continued use of an established non-qualifying unit of account during a reasonable transition period.
  • Government shall not issue any transferable debt unless a) its full value be limited in time to no later than the end of the following fiscal period and b) it loses all value at a steady rate through the subsequent fiscal period.
  • Government may issue transferable debt instruments (‘official currency’) in payment for goods or services and shall accept it in settlement of taxes. The quantity of official currency in circulation at any time shall not exceed anticipated total tax revenues for the next eighteen months. Parliament shall legislate to require that official currency be regarded as legal tender for private debts denominated in the official unit of account.
  • The time at which official currency starts and finishes losing value shall be variable according to a formula deemed by an appropriate independent body to encourage a velocity of circulation consistent with public demand for a stable medium of exchange.
  • Government may issue non-transferable debt (‘government securities’) up to a limit recognised by the appropriate independent body as the maximum that the current generation might reasonably be deemed willing to repay. Such government securities shall only be issued to regulated financial institutions; shall be purchasable only in the official currency at a price which shall vary according to a formula deemed by the appropriate independent body to be consistent with maintaining a stable medium of exchange; and shall be redeemable only in the official currency.
  • Holders of government securities shall be regulated to ensure that any loans they make are consistent with maintaining a stable medium of exchange and with maintaining their own solvency. Government shall not guarantee any private debt which is not fully backed by government securities.

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