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Edition 02: 18
November, 2010
Edition 03 : 23
February, 2011.
New, revised
edition 04 : 01 September, 2011.
Edition 06 : 09 February,
2013.
(VERSION EN FRANÇAIS PAS
DISPONIBLE)
HOW TO CREATE STABLE FINANCIAL
SYSTEMS IN FOUR COMPLEMENTARY STEPS.
By
Sustento Institute,
"The government should
create, issue and circulate all the currency and credit needed to satisfy the
spending power of the government and the buying power of consumers..... The
privilege of creating and issuing money is not only the supreme prerogative of
Government, but it is the Government's greatest creative opportunity. …….The
taxpayers will be saved immense sums of interest, discounts and exchanges. The
financing of all public enterprises, the maintenance of stable government and
ordered progress, and the conduct of the Treasury will become matters of
practical administration. …….. Money will cease to be the master and become the
servant of humanity."
[
“Financial markets
have worked hard to create a system that enforces their views: with free and
open capital markets, a small country can be flooded with funds one moment,
only to be charged high interest rates - or cut off completely - soon
thereafter. In such circumstances, small countries seemingly have no choice:
financial markets' diktat on austerity, lest they be punished by withdrawal of
financing”.
[Joseph E. Stiglitz “Taming
Finance in an Age of Austerity” Published by Project Syndicate, Monday July
12, 2010.]
Key Words: current
account deficit, debt, debt model, debt growth, deposit interest, domestic
debt, domestic credit, equity in society, exponential debt growth, Financial
Transactions Surcharge, Financial Transactions Tax, Fisher equation, foreign
debt, FTS, FTT, inflation, local currency systems, local economies, revised
Fisher Equation, savings, structural debt growth, systemic debt growth,
systemic inflation, unearned income,
THE PAPERS OF THIS SERIES PUBLISHED SO FAR ARE :
NEW Capital is debt.
NEW Comments on the IMF (Benes and Kumhof) paper “The
Chicago Plan Revisited”.
DNA of the debt-based economy.
General summary of all papers published.(Revised edition).
How to create stable financial systems in four
complementary steps. (Revised edition).
How to introduce an e-money financed virtual minimum wage
system in New Zealand. (Revised edition) .
How
to introduce a guaranteed minimum income in New Zealand. (Revised edition).
Interest-bearing debt system and its economic impacts.
(Revised edition).
Manifesto of 95 principles of the debt-based economy.
The Manning plan for permanent debt reduction in the national economy.
Missing links between growth, saving, deposits and
GDP.
Savings Myth. (Revised edition).
Unified text of the manifesto of the debt-based
economy.
Using a foreign transactions surcharge (FTS) to manage the
exchange rate.
(The
following items have not been revised. They show the historic development of
the work. )
Financial system mechanics explained for the first time. “The Ripple
Starts Here.”
Short summary of the paper The Ripple Starts Here.
Financial system mechanics: Power-point presentation.
ACKNOWLEDGEMENTS.
The author gratefully
acknowledges the support and advice of John Walley and Les Rudd and
the New Zealand Manufacturers and Exporters Association (MEA); to Raf
Manji and the Sustento Institute for their encouragement
and advice; and to Terry Manning and the NGO Bakens Verzet whose
editing and constructive critique have been crucial as the paper has evolved
over time.
This
work by Lowell Manning is licensed under a Creative Commons
Attribution-Non-commercial Share-Alike 3.0 Unported Licence
CONTENTS:
1. INTRODUCTION
AND
SUMMARY.
2.
MAJOR ISSUES IN REDUCING OR REMOVING DEPOSIT INTEREST.
3.
OPTIONS.
4.
EQUITY IN
SOCIETY.
5.
IMPACTS ON THE PUBLIC
SECTOR .
6.
INDICATIVE COMPARATIVE ECONOMIC
PERFORMANCE.
7.
CONCLUSIONS.
BIBLIOGRAPHY.
APPENDICES.
APPENDIX 1 : THE FOREIGN
TRANSACTIONS SURCHARGE (FTS): SOME INTERNATIONAL BACKGROUND AND CONSIDERATIONS.
APPENDIX 2 : GATS:
APPENDIX 3 : UNDERSTANDING ON
THE BALANCE OF PAYMENTS PROVISION OF THE GENERAL AGREEMENT ON TARIFFS AND TRADE
1994.
APPENDIX 4 : LIST OF DOCUMENTS
COMPRISING GATT 1994.
APPENDIX 5 : LEGAL TEXT OF
GATT ARTICLES XI AND XII.
APPENDIX 6 : IMF DEFINITION OF
CURRENT ACCOUNT AND RELATED CONCEPTS.
APPENDIX 7 : LEGAL TEXT OF
INTERNATIONAL MONETARY FUND (IMF) ARTICLES OF AGREEMENT ARTICLES 1 (PURPOSES)
AND VI (CAPITAL TRANSFERS).
1. INTRODUCTION AND
SUMMARY.
This paper is part of a series
of papers that examine the origin and consequences of unsustainable debt growth
and how to better manage debt levels, money supply and inflation in society at
large.
The paper “The interest-bearing debt system and its economic impacts”
looked at the fundamental cause of exponential debt growth and proposed several
key concepts:
(a) The fundamental debt
problem is that the economy has institutionalised the payment to deposit holders
of unearned income.
(b) That unearned income
takes the form of interest paid on bank deposits.
(c) Interest paid
on bank deposits creates systemic inflation and exponential debt growth.
(d) Orthodox economic
theory fails to provide an effective mechanism to manage either systemic
inflation or exponential debt growth.
(e) There has been a
financial incentive as well as a psychological incentive for deposit interest
to stay in the investment sector.
(f) Culture and
institutional “capture” of the debt debate has prevented rational discussion of
the debt problem.
(g) Sustainable debt
levels can only be achieved by removing most, if not all, new deposit interest.
(h) Quantitative
analysis can be provided using a new debt model of the economy based on a
revised form of the Fisher Equation of Exchange.
This paper is dedicated to
offering practical economic solutions that avoid most systemic inflation and
unsustainable exponential debt growth.
Section 2 sets out the major
issues that are involved when reducing or removing deposit interest from the
debt system to stabilise debt levels and avoid inflation.
Section 3 looks at four
options to reduce or remove deposit interest from the financial system. It also
examines solutions for managing foreign debt and exchange rates as well as the
potential role of local currencies.
Section 4 studies the equity
issues involved when deposit interest is reduced or removed.
Section 5 reviews the effect
on the public sector of reducing or removing deposit interest.
Section 6 compares economic
performance with and without deposit interest using Section 3 Option (B) for
comparison with the existing financial system.
The comparison
between Option (B) and the current financial system shows conclusively that Option
(B) will rapidly bring debt under control and change the SHAPE of the
productive economy. Option (A) in section 3 will produce the same result,
but more slowly, while Option (C) will do so more quickly. The proposals in
Options (A) to (D) in section 3 are not especially unusual. They have all been
used before in one form or another but they have never been linked within a
coherent economic framework until now. An instrument such as the Foreign
Transactions Surcharge (FTS) proposed in the Options is essential in debtor
countries to provide the interest-rate autonomy needed to reduce or remove
deposit interest from the banking system and bring debt growth under control.
2. MAJOR ISSUES IN REDUCING OR
REMOVING DEPOSIT INTEREST.
The paper “The
Interest-bearing Debt System and Its Economic Impacts” concluded that the
world’s debt problem and exponential debt growth arise from the payment of
interest on deposits. That interest represents unearned income. It is paid by
borrowers to deposit holders through the banking system even though the
borrowers get no legal consideration for the deposit interest they pay. Deposit
interest produces nothing, but it shifts consumption capacity from debtors to
the investment sector or paper economy as it is often called, increasing
inequality in society at large. This is discussed in Section 4.
Since the debt
problem arises from deposit interest, a logical solution to eliminating
excessive exponential debt growth is to reduce or remove deposit interest from the
banking system. While a range of options is available to reduce or remove
deposit interest, a number of issues associated with doing so need to be
considered.
Any decision to
substantially reduce deposit interest or remove it from the financial system
implies interest rates at or close to the average spread 01 of the licensed deposit
taking banks. Under the existing financial system the spread that represents
the banks’ costs and profit as well as occasional changes in their provision
for bad debts, is unstable 02. A typical average figure for
the bank spread in a stable financial environment in
1. In the
existing privately owned for-profit banking system low interest rates will
increase the demand for new consumer credit increasing the circulating debt and
unproductive “bubble” lending (part of the circulating debt My in the debt model 02 ). That would increase price
inflation once the capacity in the productive economy has been fully
utilised.
2. In
countries like
3. Lower
interest rates mean higher bond prices.
4. Some
sections of the community, particularly retired people on “fixed” incomes such
as national superannuation, depend upon deposit interest to augment the basic
lifestyle their fixed income allows.
01 The difference between a bank’s lending rate
and the funding rate of interest it pays.
02
The interest-bearing debt system and its economic
impacts.
The four groups are now
considered in turn.
1. Price
Inflation.
There are only two sources of
inflation in the debt model.
The first source is
inflation arising from deposit interest. That automatically reduces towards
zero as deposit interest rates reduce towards zero and so need not be further
considered at this point. Inflation in the price of existing assets in the
investment sector will also fall towards zero, stabilising house prices and
ensuring the investment sector expands in parallel with the productive economy.
The second source
of systemic inflation is the injection of new consumer bank debt or “savings”
(including non-tax based superannuation income) into the circulating debt (My in the debt model). Such
injections increase the amount of circulating debt My 03 without any corresponding
production of goods and services. The orthodox use of interest rates to manage
inflation is by definition excluded by the requirement to maintain low or zero
deposit interest. Other regulatory instruments will be needed to restrain
consumer debt growth. These are discussed later in the paper.
2.
Current Account.
Countries with a
current account deficit have to swap their debt for domestic assets 04. The exchange settlement
process gives the creditor part ownership of the debtor’s economy. Profits
arising from that ownership are also typically repatriated offshore creating a
continuous cycle of increasing their ownership of the domestic economy. Some of
that foreign ownership takes the form of
bank commercial paper whereby domestic banks in the debtor “borrow” foreign
currency to satisfy their exchange settlement requirements 05. In a world of profit-based debt financing,
the debtor is dependent on the willingness of the lender to lend. Foreigners lending to
03 From the revised Fisher
equation in the debt model 02, PQ(d) = My* Vy so that assuming the
structural component Vy remains constant and production Q(d) is also constant (because it has
reached its maximum), the price level P becomes a direct function of My.
04 For a detailed discussion
see The interest-bearing debt system and its economic impacts.
05 In
06 That would be
greatly advanced by limiting or removing inflation from the
07
3.
Bond and Securities Market.
Bonds and Treasury
Bills are usually sold on the basis of a coupon (interest) rate that applies to
the face value of the loan. When bonds and bills are traded, their yield (or
actual interest rate) goes up or down according to their price. When interest rates
fall, the yield falls and so the price must rise. Bond and Bill prices in most
small countries like
4.
Fixed Incomes.
Many household
deposits belong to elderly retired people who have little income other than
their government superannuation. As deposit interest falls, those people may
become more motivated to invest what deposits they have in productive
investments instead of leaving their money in the bank. Many see such
investment as risky, particularly in the light of recent international turmoil
and, in
Very low deposit
rates are far from unknown within the existing financial system.
The main difference
between
08 Though, as of March
2010, 1/3 of
09 In
10 Source : Bank of
11 As of March 2010,
Japan’s net international investment position (including reserve assets) was
plus Y269 trillion, and roughly 57% of its GDP compared with New Zealand’s
accumulated deficit of almost 90% of GDP. Japan’s GDP for the year
ending March 2010 was Y 476 trillion, its public debt was Y 883 Trillion and
private debt (May 2010) including “other surveyed domestically licensed banks”
was about Y 737 Trillion giving a total debt of Y 1620 Trillion or 3.4 x GDP
compared with 1.6 x GDP in New Zealand. [As at early June 2010, 60.5 Yen = NZ$
1, 91 Yen = US$ 1] Data source: Bank of
12 Defining
total debt this way is somewhat misleading. Perhaps a better way to express it
is that
13 House
prices in
14 In
effect, private sector debt has been replaced by public sector debt.
3. OPTIONS.
There are several workable
options available to reduce or eliminate deposit interest from the banking
system. They can be classified under four general headings, each of which
will be discussed in detail. They are discussed in relation to the debt model
shown below.
The first version of the debt
model was published in the paper Manning L., “The Ripple Starts Here : 1694-2009 : Finishing the Past” presented
at the 50th Conference of the New Zealand Association of Economists
(NZAE),
The premise in the
debt model is that the circulating deposits and cash My = Prices P x output q where q
is the quantum of domestic output produced by My over a single cycle. Taken over a whole year, the SNA definition
of Gross Domestic Product GDP is given in the debt model by mathematically
integrating the expression Pq* Vy, where Vy is the number of
times the circulating deposits and cash My are used during the year 16.
The SNA should
reflect an expression of the original Fisher Equation of Exchange 17. The only difference is that the money supply
M in the Fisher equation of exchange included hoarded cash, whereas in the debt
system for practical purposes there is now very little cash contributing to
measured GDP.
My cannot include hoarding of
debt beyond the term of the production cycle because all the productive bank
debt giving rise to My is conceptually repaid at the end of the cycle 18.
At
any point in time there are five broad blocks of deposits in the domestic
financial system.
They are:
Mt The transaction
deposits representing the productive debt My - M0y so:
My
= Mt + M0y (1)
Mca The accumulated
domestic deposits representing the sale of assets to pay for the accumulated
current account deficit. (see section 5 of this paper for details).
M0y The cash in circulation
included in My and used to contribute to productive output.
Ms The net after tax accumulated
deposits arising from unearned deposit income on the total domestic banking
system deposits M3 (excluding repos) 19.
(M0-M0y) Cash hoarded by the public and not used
to generate measured GDP.
In this paper the
total of these deposits, that is, Mt + Mca + M0y + Ms , is
provisionally assumed to be the M3 (excluding repos) monetary aggregate
published by most central banks monthly less the amount of cash in circulation
M0 except for the part M0v that is included in My. In this paper M0y is assumed to have the same speed of circulation as My. In industrialised countries, the contribution
of cash transactions to the measured output of goods and services (GDP) has
been declining in recent decades and their contribution to the GDP has been
provisionally calibrated for the purposes of this paper 20.
19 Repos refer to
inter-institutional lending.
20 More accurate
assessment of the cash contribution to GDP over time requires further detailed
study.
In this paper, the
total debt in the domestic financial system is assumed to be the Domestic
Credit, DC debt aggregate published by most central banks monthly.
At any point in
time there are four broad blocks of domestic debt in the domestic financial
system. Three of them together add up to DC such that:
DC = Dt + Dca 21 + Ds
(2)
Where :
Dt The productive
debt supporting the transaction deposits Mt. .
Dca The whole of
the debt created in the domestic banking system to satisfy the accumulated current
account deficit 22.
Ds The residual debt to balance equation (2)
21 Arguably the accumulated sum of capital
transfers could be included here, in which case the net international investment
position (NIIP) would be used instead of the accumulated current account. The
decision affects the size of the “residual” Db.
22 This is greater
than the monetary deposits Mca because the banking
system may have sold commercial paper to borrow foreign currency to satisfy the
foreign exchange settlement
The fourth block of debt is :
Db, the virtual “bubble” debt, the
excess credit expansion or contraction in the banking system such that Ds - Db = the debt supporting the accumulated deposit interest Ms defined
above. Db can be positive or negative.
There is also a
fifth block of debt Is that is, conceptually, not bank debt .
Is, the total debt
accumulated by investors arising from Saving Sy = S/Vy.
In the debt model, the
investor pays the investment Iy = I/Vy = Sy = S/Vy to the producer and the money is used to
retire the outstanding part of My relating to the investment in question. Conceptually the investor
borrows the purchase price from employee incomes and the business operating
surplus. Except for households buying new homes, the investor then becomes a
producer, and the interest on investment Iy is included as a production
cost in the subsequent production cycle loans My.
The predicament of
new homeowners is quite different. They cannot service their debt because they
cannot, conceptually earn more than they were before they bought their new
home, because the home itself is nearly always unproductive. There is no new
income stream from their housing investment. If economic demand is to be
maintained, homeowners must, in aggregate, rely upon increasing house prices
and refinancing of their properties, creating an aggregate “pass the baton”
systemic increase in debt.
When non-productive
investment assets are traded there is typically a capital gain because of asset
inflation on investment (Dca + Ms + the property
component of Is). The new purchaser pays more for the asset
because of asset inflation, allowing the seller to retire the outstanding
mortgage debt on the property.
By definition in this paper :
My x Vy = GDP
Ms = Ds
The cash contribution to GDP =
M0y * Vy. Therefore :
DC = (GDP)/Vy - M0y + Ms + Dca
+ Db (3)
Ms =Ds =
(DC – Dca ) – GDP/Vy + M0y - Db (4)
GDP = Vy *(DC - (Ms +Dca
+Db ) + M0y ) (5)
My = GDP/Vy
= DC - (Ms +Dca + Db) + M0y (6)
Where the terms are as defined
above.
Equations (3) to
(6) are all forms of the debt model developed in the earlier paper 23.
23 Links
are provided in the conclusion to this paper.
In the context of
the four Options (A) to (D) listed below, creation of new debt is to be
constrained to meet the needs of the productive economy but there will still be
“savings” so My may still increase.
Whatever option is chosen from among those given below the debt model offers a
solid platform for accurate calibration and management of the financial system.
The model relates to the quantity of GDP. It does not seek to say anything
about the quality of that output, which remains a matter of public debate and
government policy. Common sense would suggest that the more socially and
environmentally useful the productive output is, the better the wellbeing of
the nation is likely to be.
Typical options in
ascending order of effectiveness are:
(A) Maintaining the existing banking system as it
is but with the re-introduction of a supplementary reserve ratio on deposits
(and, should they ever be needed, interest rate caps) to manage the amount of
new lending. The supplementary deposit ratio will be applied over and above the
existing Basle III capital adequacy requirements. In debtor countries this must
be accompanied by some means to manage both the current account deficit and the
exchange rate, such as a universal, variable, temporary and tax-neutral foreign
transactions surcharge (FTS).
(B) As for Option (A) but using the central bank
instead of private banks to supply some new public debt to meet the needs of
the government, and/or to issue interest-free electronic cash (E-notes).
(C) Vesting all credit and money creation in the
government operating through its central bank as in the quote from President
Lincoln at the beginning of this paper, together with a universal, variable,
temporary and tax-neutral foreign transactions surcharge (FTS) as in Options
(A) and (B)
(D) Any of Options (A) to (C) in conjunction with
formally constituted and taxed local currencies.
While the
progression from (A) to (D) may offer a viable route for progressive financial
transformation, the combination of (C) and (D) would ultimately offer the most
powerful benefit and greatest stability to the domestic economy.
Legislation for
each of these proposals can readily be drafted but is outside the scope of this
paper.
The four graded
options are now considered in turn.
OPTION (A): EXISTING SYSTEM
WITH NEW SUPPLEMENTARY DEPOSIT RATIO AND MANAGED CURRENT ACCOUNT AND EXCHANGE
RATE.
Retaining the
existing system is the least flexible of Options (A) to (D) because economic
resource allocation remains, in the first instance, at the discretion of the
private banking system, moderated, as now, by a wide range of tax incentives
and grants administered through the budget according to the government policy
of the day.
The underlying
concept of Option (A) is that the Reserve Bank would set an Official Cash Rate
(OCR), on a regular basis, as it does now, but with a specific supplementary
cash reserve requirement over and above the existing prudential capital
adequacy requirements specified by the international financial institutions,
particularly the Basel III Accord 24.
The mechanism used
to provide the supplementary reserve requirement is of secondary importance as
long as it restricts new bank lending to prevent bubble formation. The
reserve could be a percentage of its net capital assets or net worth.
The cash rate might
be, for example, 0.5%. Interest rate caps would only be contemplated if
the claims interest rate (the lending rate) charged by the registered banks exceeds
a target maximum interest rate specified by the Central Bank from time to time 25. The Official Cash Rate
reduction from present levels could be phased in over time, but quite a few
developed countries already have lower official cash rates than
24 The Basel III accord revised the risk based capital requirements for
the international banking system.
25 Rather like present
inflation targets-for example, with a cash rate of 0.5% and an acceptable
spread of about 2%, an interest rate cap might be specified if average claims
(lending) rates exceed, say, 2.75% .
26
As discussed later in this section, time may be needed for the various
structural adjustments to “bed in” and it may turn out to be prudent to reduce
interest rates and increase the FTS in parallel. The implementation of Options
(A) to (D) will need to be integrated to avoid capital flight.
To give a
practical example, suppose Option (A) is in place and that the rate of change
in Dca , (dDca/dt) and in Ds , which is the debt
corresponding to the unearned income deposits Ms, (dDs/dt) in equation (5) are zero, that domestic
credit is NZ$ 310.8 billion (New Zealand, March 2011) and that the bank debt
multiplier under the Basel III accord is 12 (so the banking system risk-based
capital base is, say, roughly NZ$ 26 billion 27). An increase in the reserve
ratio of just 0.01% of domestic credit would require extra capital reserves of
NZ$ 26 million to be deposited by the registered banks with the Reserve Bank.
Compared with the status quo, that would restrain lending by NZ$ 31.2 million
or 0.15% of the NZ March 2011 gross domestic product of NZ$ 197.4 billion. That
makes banks’ capacity to lend sensitive to the proposed supplementary reserve
asset ratio.
The supplementary
reserve ratio would be operated in conjunction with the banking system to
ensure the creation of new debt increases at the (almost) inflation-free productive
growth capacity of the economy, say, 5% or NZ$ 9 billion a year. In
equation (3) above, five percent growth would require a very small change in
domestic credit Dc of about NZ$ 0.5 billion (NZ$ 9 b growth divided by an
assumed value of Vy of 18) 28. In the example, using
equation 3, assuming the change in Dca and Db remain constant, the increase
in Domestic Credit would be reduced by about
(2.5% -0.5% , the change in OCR and the interest rate paid on deposits)
x the existing figure for M3-repos, (say NZ$ 230 billion) or
about NZ$ 4.6 billion. This is a small
portion of recent historical total debt growth in
Five percent real economic
growth, representing NZ$ 4.6 billion of new debt, with 0.25% inflation in the
productive economy and about 0.5% inflation in the investment sector sounds a
lot better than in New Zealand in recent years where the total debt growth has
been more than NZ$ 30 billion, real GDP growth around 2.5%, investment sector
inflation up to 10% and CPI inflation 2% or more 30 .
Eliminating the so-called
fractional reserve banking system is now getting mainstream attention. Mervyn
King, the Governor of the Bank of England is reported to be raising the
possibility of eliminating the fractional reserve system altogether 31. "If [
27 For illustration –
detailed figures are at Reserve Bank of New Zealand Statistical Series G3
28 Neither Vy nor My has been accurately estimated
for New Zealand yet because the indicative debt model application provided in
the papers does yet accurately reflect the effect of taxation on gross deposit
interest.
29 Except for the
March year 2010 when it was still more than NZ$ 14 billion despite nominal GDP
growth of just NZ$ 1.3 billion (which included 2% of GDP, or NZ$ 3.7 billion,
inflation).
30 The profound economic impact
of these proposals is shown visually in Section 6 of this paper.
31
BBC News 25/10/10 “Mervyn ponders abolition of
banking as we know it.”
The second “leg” of
Option (A) involves at least one new instrument to manage the current account
deficit and the exchange rate. One possibility is to use an automatically
collected foreign transactions surcharge or FTS, which would also be simple to
administer 32. It has only very
rarely been used in the past 33. Introducing a financial instrument such as the FTS is essential if
offshore borrowing and interest costs are to be reduced. Orthodox monetary
policy efforts to manage the exchange rate and current account using the Official
Cash Rate (OCR), insofar as it has sought to manage them at all, have failed,
in part because financial deregulation has facilitated unrestricted speculative
capital flows 34. Some
economists may object that a unilateral FTS will not work because banks and
traders can evade the surcharge by “bundling” transactions and reporting, say,
only a single daily settlement sum, or else trading in
32 The “beauty” of FTS
is that it applies to outward capital flows, not inward capital flows. Moreover,
FTS is not a “restriction” on capital flows, it is a temporary universal tax on
all outward transactions.
33 It was used
successfully in
34 Note deleted.
35 Setting the
parameters for that regulatory framework falls beyond the scope of this paper.
A broader issue is
whether a foreign transactions surcharge would contravene international
financial agreements. There are provisions in the relevant international World
Trade Organisation (WTO) protocols for countries to protect their balance of
payments. Relevant material is contained in the Appendices to this paper.
The GATT legal text, Article XI clause 1 (Appendix 5) appears to specifically
permit taxes to be applied. Provision of funding is a service that falls under
the GATS protocols (Appendix 2).
The so-called policy
“trilemma” referred to in the paper “The interest-bearing debt
system and its economic impacts” is important to any debate on the
FTS. Obstfeld (1998) put it this way: “In most of the world's
economies, the exchange rate is a key instrument, target, or indicator for
monetary policy. An open capital market, however, deprives a country's
government of the ability simultaneously to target its exchange rate and to use
monetary policy in pursuit of other economic objectives”.
If the current
account is to be managed, some form of exchange management will be required. To
restructure the financial architecture as proposed in this paper, a tool such
as the FTS will have to be inserted at the currency exchange interface. Failure
to do so would condemn the world to economic ruin. It is now widely, if not yet
universally, acknowledged the current economic system is deeply flawed as
suggested or implied in recent articles from the Bank for International
Settlements, the World Bank, and leading economists like Joesph Stiglitz and
Paul Krugman.
The exchange
management instrument(s) would apply to all outward exchange transactions, not
just outward capital flows.
The proposed FTS is
not a tariff or trade barrier of any kind. Nor is it a restriction on capital
flows as such. It is a temporary because it will apply only until the net
foreign debt has been repaid and it is a fiscally neutral tax on all
outgoing exchange transactions. Moreover the FTS would be variable. It goes no
further than the specified objective of balancing the current account and
progressively repaying the accumulated net foreign debt. This proposal mirrors
the historical position that existed prior to the removal of the
Financial receipts
from the surcharge would be used to offset a corresponding amount of domestic
taxation (for example by reducing GST), to make the surcharge tax-neutral apart
from any receipts put towards foreign debt reduction. Its intent is to correct
the current account, part of the balance of payments as defined in the legal
WTO, GATT, GATS texts, by removing the existing subsidy enjoyed by those
engaging in foreign currency transactions at the expense of those who do not
engage in such transactions or engage less in them. Those using foreign
currency in
The overall saving
to the wider New Zealand economy from the introduction of an FTS is likely to
be more than the annual current account deficit itself 38. In addition to the
obvious reduction in interest costs and the amount of foreign debt there are
consequential downstream benefits to the economy of a country like
A foreign
transactions surcharge would cause the exchange rate to fall towards a stable
base level allowing exports to increase and imports to decrease, providing a
more even playing field for local manufacturers and producers 39 .
36 Under the gold
standard, capital flows do not appear to have been directly restricted, but
they were influenced by the exchange rates fixed from time to time.
37 The famous Bretton
Woods meeting was where the basis for the post World War II financial
architecture was agreed among the allied powers. The British position was
effectively vetoed by the
38 Each 1% in interest rate alone
represents nearly NZ$ 3.1 billion per year on a domestic credit of around NZ$
310 billion, including net foreign debt, as at March 2011. Estimating the
actual economic effect of FTS is outside the scope of this paper, but,
according to the System of National Accounts, every dollar off the current
account deficit is a national “saving” before taking into account other
downstream benefits.
39 Rose (2009) notes
that, historically, exchange rates have relatively little influence on imports,
but it is likely that the FTS would act more directly on the import sector
because it is visible, being drawn directly from bank accounts.
Introduction of the
FTS policy could allow the removal of all remaining tariffs and subsidies in
the
The FTS can also be
seen as a correction designed to offset the unmanaged volatility in
There would be a
substantial reduction in interest rate premiums as the current account is
brought under control, foreign debt repayment begins and inflation is reduced
to very low levels. Rose (2009) notes: “Effectively the market is pricing
country and/or currency risk into national interest rates”. On the other
hand, the
40 It might be
possible to have a separate FTS rate for speculative capital flows. This paper
arbitrarily assumes a single rate and that speculative flows will cease.
41 Source: Reserve
Bank of
42 New Zealand National Accounts
year ended March 2009.
43 The outward
payments would fall from their present level and inward receipts would
increase.
44 This could be done
through some form of tender process. The worked indicative example for
Option (B) at Table
45 The Keynesian
transfer problem implies the current account should go far enough into surplus
to meet all transitional foreign investment claims, though that might be
optimistic in the short term.
46 Rather like the
47 On the other hand,
debtor countries could be better off “biting the bullet” and getting their
financial restructuring out of the way. Since the volume of exports cannot be
rapidly increased, the FTS must rely on changing the relationship between the
NZ$ value of exports and imports.
48 The carry trade is the practice
of transferring deposits from countries where deposit interest is low to
countries where deposit interest is high(er).
The share of the
Banks would quickly
unwind their dependency on foreign debt when the funding rate falls below what
they are paying offshore. Transitional arrangements may be needed to
promote the replacement of foreign funding with domestic funding.
The comparative
example given in Section 6 offers the possibility of foreign debt monetisation
but does not incorporate it as a major feature. Domestic currency
monetisation could change
Some academic
literature supports the need for some form of foreign exchange management to
correct the balance of payments and the current account. Similar policies, such
as “pegged” exchange rates, have been widely used by major countries around the
world, including
Preston (2009)
argues that the levels of the
Option (A) as it is
outlined above is much broader in scope than
OPTION (B): AS OPTION (A) BUT
WITH SOME NEW GOVERNMENT FUNDING REQUIREMENTS PROVIDED BY THE RESERVE BANK.
Under existing policy,
government borrowing is raised at interest through the private banking
system. In New Zealand, government and local authority debt, while less
than that of many other developed countries as a proportion of gross domestic
product, is now rising quite steeply after having been stable in recent years.
Central government debt servicing costs are projected to be about NZ$ 2.4
billion in the fiscal year ending June 30, 2011 49 and as much as NZ$ 4.5
billion by 2014. Because of the recent recession in
The New Zealand
Reserve Bank Act specifically provides the power to the Reserve Bank to issue
currency and to act as Banker to the Government 50 so there is no reason existing
policy cannot be amended to instruct the Reserve Bank to responsibly issue
electronic cash currency credits (to be called E-notes in this paper) 51 and low interest or even
interest free debt to replace debt presently borrowed from commercial banks;
and for the government of the day to spend that new money and debt into
circulation 52. Brash
(1996) noted (page 5) that:
“(T)he Reserve
Bank Act does not prevent the government from choosing to override the price
stability objective chosen for monetary policy by Parliament, but it does require
any government choosing some other objective to tell everybody that that is
what their new instruction to the central bank is.”
This proposal does
NOT seek to change the inflation objective, but rather strengthen it and add
additional viable objectives to manage debt expansion and the exchange rate to
permanently stabilise the nation’s financial system. The present Governor
of the Reserve Bank of
“ (T)he extent of the
recent financial crisis showed that inflation targeting monetary policy was not
sufficient to guarantee comprehensive macroeconomic stability” 53.
49
50 See especially
sections 5,8,9,25,34,39.
51 Since E-notes
become part of the circulating deposits in bank accounts just like deposits
arising from debt, their speed of circulation will, unlike notes and coin in
circulation, have the same aggregate speed of circulation Vy in equation (3) as debt that
can only be used once because once used it must be repaid. Vy might be expected to undergo a gradual
structural increase as the proportion of E-notes to debt increases.
52 Some low cost debt
might be used as well as E-notes to facilitate repayment (amortisation) of
capital goods. If debt is not used for capital expenditure, capital
repayments would have to be taxed out of circulation, otherwise there would be
an inflationary build up of deposits in the banking system. To cope with that,
tax rates would need to change whenever there are substantial changes in the
rate of capital investment.
53 Allan Bollard, speech to Canterbury Employers’ Chamber of Commerce Friday 29/1/2010.
Such views suggest
that despite the historical reluctance of central banks to test new policy
concepts, additional instruments could enhance a country’s growth prospects and
macroeconomic stability if they are properly designed, while still maintaining
tight fiscal responsibility and inflation targets.
The proposed
government-issued debt does not have to be interest-free. It could even
be issued at the same interest rate as private debt. In that case any profit from
the bank spread would accrue to the government through the Reserve Bank rather
than to private banks. Once the government has spent the new funding into
circulation it would become deposits in the banking system just like all other
deposits and would be available for lending intermediation by the private
banks.
Some experts
believed in the past that Reserve Bank funding would be inflationary because it
would increase the available excess reserves in the private banking system the
way government bond issues do (or did) in fractional reserve credit expansion.
Those new excess reserves from creation of new debt funding by the Reserve Bank
would then encourage (further) expansionary growth of private bank debt. When
direct Reserve Bank funding was used in the past, particularly during the
1930’s world depression, there was a vast reservoir of unused capacity in the
economy, which meant the additional reserves did not create inflation. The
situation in Option (B) is quite different.
In Option (B), any
surplus excess bank reserves resulting from new bank deposits arising from the
issue of central bank E-notes or credit would be sterilised by adjusting the
supplementary reserve ratio established for the banks under Option (A),
removing any possibility of inflation arising within the domestic banking
system.
The debt model
derived from the modified Fisher Equation of Exchange referred to above
requires an extra term to be added to account for E-note injection because
E-notes are not subject to repayment and, unlike debt, can be used repeatedly
as long as they remain in circulation 54.
Some advantages of central
bank funding of new government expenditure include:
-
It is cheaper than private funding and can be costless, saving billions of
dollars each year in interest costs compared with the present system, and
savings compared with Option (A), too 55.
-
Existing privately issued interest-bearing government debt can be progressively
retired as it matures and replaced with publicly issued interest-free debt or
E-notes.
-
It is easier for governments to prioritise productive resource allocation in
the public sector.
-
Direct public taxation can be gradually reduced as the economy grows.
54 E-notes and
existing cash are provided for in the general expression of equations (4) and
(5) (Manning 2009, referenced footnote 2, page 25) which includes a term E0*Ve0 where E0 is the
electronic cash in the system and Ve0 is its speed of circulation.
Ve0 is thought to
be the same as Vy.
55 The saving is less
under Option (A), because in Option (B) the effective net costs of government
debt is almost zero. In Option (A), at 2.5% bank spread plus 0.5% deposit
interest the cost of $40 billion of government debt would still be NZ$ 1.2
billion.
The first two
points are self-evident. The third is more political. It concerns the role of
government in the economy and is outside the scope of this paper. However, the
government could choose to use unutilised resources in the economy for
infrastructure projects, investment in health and education or other productive
investment.
If the New Zealand government
were to inject, say, a net NZ$ 0.5 billion/year of direct Reserve Bank funding
into the economy transaction accounts My, total government debt would,
in the long term, still never exceed 6% of GDP, still lower than most other
developed countries 56. There
is no particular reason to keep government debt to any arbitrary figure,
because its use is almost costless.
One of the major
concerns among economists about the vast government debt growth in the United
States 2008-2010 is that it has been borrowed through the private banking
system without any means other than the Basle III capital adequacy requirements
to constrain debt expansion. Some of that borrowing has served to cover bank
losses against loan defaults. There has been little new lending to the
productive economy so there is no inflation (yet). “
56 In Option (A), the
assumed growth was $ 9 billion/year. If the government injected NZ$ 5
billion/year out of that $9 billion increase in GDP, the total government
injection in the long run could not be more than 5/9 of the total debt, or less
than 56%.
57 The worked
comparison in Section 6 shows public debt could, under Option (B), potentially
be fully repaid quite quickly.
58 NZ$ 0.5 billion (My) * 18 (Vy ) * say, NZ$ 0.4 billion tax /total gross government
revenue (budget 2010) of NZ$ 70 billion= 5%
59 NZ$ 0.5 billion * Vy * 18 /GDP NZ$ 186
billion = 4.8%.
OPTION (C) VESTING ALL CREDIT
AND MONETARY ISSUE IN A PUBLIC RESERVE BANK OR CREDIT AUTHORITY AS RECOMMENDED BY
UNITED STATES PRESIDENT LINCOLN TOGETHER WITH THE FOREIGN TRANSACTIONS
SURCHARGE OF OPTION (A).
As recently as
World War II, a large part of war expenditure was funded from government debt
rather than from taxation 60. Domestic consumption was reduced through the issue of War Bonds,
price controls and rationing. In many cases the total public debt was far
higher in countries like
Key underlying
issues when deciding what levels of public debt are acceptable are the price of
that debt, and the ideological concept that private debt is “good” and public
debt is “bad”. As long as interest rates are used as the primary, if not
the only instrument to manage inflation in modern economies, the cost of public
debt purchased from the private banking system is likely to be high and
volatile. That in turn creates uncertainty in bond markets and leads to
recurrent financial crises.
Private banks
oppose public funding of public debt because they want debt levels to expand as
quickly as possible to increase their profit. Their profit comes from the
spread on their loans, which is the difference between the interest they charge
on their loans and the interest they pay to their deposit holders. As a general
rule, the more debt there is the more profit the banks make. In the recent
deregulated lending environment the large (mainly US banks) went beyond their
existing physical debt base to create a vast pool of virtual debt in the form
of complex derivatives from which they also sought to profit. The system
collapsed because the productive economy could no longer fund the profit
expectations of the bloated investment sector 61.
60 War expenditure has
been a common cause of sharp increases in public debt for centuries.
61 These matters will
be discussed fully in a later paper.
Public credit and
money creation will tend to reduce the capacity of the private banking system to
increase total debt in the financial system. That is essential because
the present financial system has failed to adequately manage the exponential
growth of debt. Slower debt growth could reduce the banks’ future profit
growth, but it will not affect their profit margin because the proposals in
this paper address the interest rate on deposits, not the bank spread.
Under Option (A)
the growth of bank profits is subject to the relatively minor restraint that
less new debt will be needed. Under Option (B) the growth of bank profits might
be reduced further depending on the amount of public E-note and debt issued. In
both Options (A) and (B) the nominal reduction in debt creation is offset by
much higher economic growth as well as minimal inflation and, possibly, lower
taxes. The economy will grow faster, so there will still be some growth in bank
deposits and some growth of bank profits.
Option (C) is
different from Options (A) and (B) in that the private banks would operate as
intermediaries in the financial system rather than issuing new debt themselves.
Under Option (C) the government would issue all the new E-notes and debt needed
to achieve optimal economic activity by spending them into circulation. The
money would then be deposited into the banking system in the normal way and the
private banking system would operate like a savings bank, redistributing
deposits to borrowers using existing lending criteria but with lending rates
limited as set out in Options (A) and (B).
The debt model
(equation (3) above) supporting this paper shows that to achieve 5% growth in
New Zealand the new debt issue (based on March 2010 figures) might be about NZ$
4.6 billion. Debt growth would be a lot less than recent increases in domestic
credit reducing the growth of the total debt base by about one sixth after
taking into account the annual current account deficit. The required reserve
ratio of the private banks will gradually increase as more public debt is
introduced to the system, until it ultimately reaches 100%.
Public credit and
money issue will enable the domestic banking system to operate in a high
growth, low risk, low interest, low inflation economy while retaining its
existing profit and growth path except that the debt growth exponential will be
lower because growth is tied to the productive economy instead of being
inflated by deposit interest.
A consistent growth
rate of 5% could be possible in
The management of
outward financial flows proposed in Option (A) could dramatically change
domestic manufacturing opportunities.
Under the present
economic and financial structures, without retraining, people displaced by
"cuts" in the service sector have nowhere to go except the
unemployment queue. Adjustments being imposed by restrictions on public
spending around the world today are brutal, to say the least. They are
also misplaced. Without changes of the kind set out in this paper, the United
Sates and other developed economies are not just eating their own economic
tails. Most of their people are also being asset stripped through the rapid
transfer of wealth to the holders of bank deposits by way of unearned income
from deposit interest. Unless exponential debt growth is contained, the
future must be one of worsening economic crisis.
62 The figures are for 2009 taken
from the CIA “World Factbook”. Other organizations also provide sectoral
breakdowns and the numbers do vary from one to the other.
OPTION (D) : INTRODUCING
FORMAL LOCAL CURRENCY SYSTEMS.
There are many
local currency systems in use around the world and quite a few have been
proposed to assist development in areas where there is little or no national
currency available and few current options to initiate local development
programs 63. Such
proposals are not intended to replace national currency or national development
but to supplement the growth of useful local economic activity where it would
otherwise be unlikely to take place.
63 A highly developed
regional development model with a raft of fully detailed applications can be
found at the website of the Dutch NGO Stichting
Bakens Verzet (Another Way). Details of the nature and organisation of local money
systems in integrated development projects can be found in sections 3 and 4 of
the financial structures section of the course for the Diploma
in Integrated Development there.
Almost all local
currencies have the single outstanding characteristic that they fall broadly
within Option (C) of this paper; that is, they are mostly co-operatively owned
interest free, self-cancelling monetary systems. Typically, from a modelling
perspective, they conform to a simple dynamic production cycle 64 where participants operate as
entrepreneurs. Any debt incurred during the production phase is sterilised when
the product is sold leaving the supplier with an operating credit and the
purchaser with a corresponding operating debit. There is then a reciprocal
imperative for those with an operating deficit to contribute to economic
activity within the system. There is no net systemic debt. Where
participants default on any residual debit balance they may have when they
leave the local currency group, the debit is effectively offset by the goodwill
of those holding the corresponding credit balances, and vice versa.
Local currency systems are
designed to work in parallel with the national economy, and to supplement it,
not supplant it.
The dominant
advantages of local currencies are that they avoid financial leakage whereby
national currency incomes are drawn away from local communities, they stimulate
community cohesion and local development, they strongly encourage personal
independence, responsibility and participation, and they induce useful economic
activity that would otherwise not take place, especially among those presently
active in unpaid work.
The overwhelming
disadvantages of most local currency systems are that they are usually too
small to operate as a “market” in any normal sense because they lack the range
of skills and number of participants to provide economic efficiency and choice,
and they cannot be properly taxed without destroying the integrity of the local
accounting systems.
The twin keys to
future success of local currencies in developed countries are that they are
acceptable for the payment of taxes, thereby greatly encouraging participation,
and that the local currency activity can in turn be taxed on a broadly similar
basis to national economic activity. In most cases neither of these crucial
elements is presently satisfied.
Option (D) provides
for formal recognition of the positive role local currencies can play in
economic and community development by encouraging the participation of
government agencies, particularly local and regional government, whereby local
currency is accepted for (at least some of) that part of taxation that
territorial authorities expend on local productive output. Territorial
authorities could even be encouraged to become the driving force of local
currency initiatives. While the local currency initiatives would remain
local, a nationwide “EFTPOS” style accounting system would need to be
introduced so that local currency trading can be measured and taxed. To
accomplish this, each local currency member could be issued a “local currency”
debit card that could be accessed through an EFTPOS terminal or similar system 65. The card
would carry two separate balances: the local currency balance and a separate
national currency balance. When a credit transaction is entered (that is, an
income), a national currency tax, essentially similar in nature to GST, but set
by parliament from time to time at a level it decides is appropriate 66, would be deducted from the
seller’s national currency balance and the full local currency credit would
then be credited to the seller’s local currency balance. If there is
insufficient national currency balance on the seller’s card, or if the
purchaser is operating outside the authorised local currency debit range, the
transaction would be declined, just as EFTPOS transactions are declined now
where there are insufficient funds to meet the payment 67.
The process
described above also theoretically allows centralised entry of transactions at
a local level by authorised personnel. In that variation, the transactions
would be recorded by notes or by cheques68. The transaction accounts would still be the same but
it might not be necessary for every participant to have a separate card.
Some method would still be needed to enable individual accounts to be
downloaded with national currency so the tax payments can be made. There
appears to be no particular technical reason why the “local-currency” card
couldn’t also function as a normal EFTPOS debit card, and likewise no obvious
reason why existing debit cards couldn’t be modified to incorporate the local
currency features. This paper keeps the two systems separate on grounds of
public perception: most of those participating in local currency
transactions will be keen for others to see they are using local
currency.
It is likely that
local currencies used as outlined above significantly increase measured gross
domestic product and economic growth. As long as the local currency tax rate is
set to encourage local activity without measurably inhibiting growth in
national currency activity 69 the local currency option must benefit all parties,
including the government of the day. Used in the manner set out above, local
currencies could become an extension of Options (A) to (C).
64 Manning L., “The interest-bearing debt system and its economic impacts”,
Section 3, Figures 1 and 2.
65 Eftpos facilities
are already becoming quite common at local markets in New Zealand, and can be
held on a group basis – the proposal is not suggesting that every member
necessarily have an Eftpos terminal – but it is technologically possible for
the EFTPOS programs to be amended to enable local currency payments to be
processed from any existing terminal (for example 1 swipe and entry
“from”, another swipe and entry “to”) There are also already several mobile
phone platforms in use (Kenya, India, US) for making small payments.
66 The national
currency debit would also include any formal money EFTPOS processing costs.
67 Should, in the
future, any Universal Basic Income (sometimes called Guaranteed Minimum Income
or GMI) be introduced, the proposal provides a ready-made payment route since
everyone would have such a local currency debit card, and the formal
money UBI could be paid automatically onto the card. A full plan for the
introduction of a GMI into
68 This paper does not
consider Option (D) from the point of view of system security, that is, for example
the risk of a lengthy electricity failure or viral or other corruption of
network electronic processors. Such systemic risks are very low and common to
most modern economic activity.
69 If the tax rate is
too low it will draw activity away from the national economy into the local
economy reducing gross tax revenue, whereas the intent of Option (D) is to
enhance both economic activity and total gross tax revenue.
4.
EQUITY IN SOCIETY.
Figure 1 shows compensation
of employees plotted against the operating surplus for
Click here to see :
FIGURE 1 COMPENSATION OF EMPLOYEES v GROSS OPERATING
SURPLUS NEW ZEALAND 1978-2009.
However, the
relationship between employee incomes and gross operating surplus can mask
dramatic changes in equity among income groups. One common way of measuring
income equality is by using the Gini coefficient 72 . A high score means relative
income inequality and a low score income equality. Over recent decades,
70 The figures have
been amended several times. The discontinuity in the series is due to the
change in the SNA accounting system from SNA68 to SNA93.
71 It remains possible the relationship between the numbers of entrepreneurs and the numbers of wage and salary earners has altered, for example if firms became bigger on average. Such changes would not be disclosed in Figure 1.
72 The Gini
coefficient is developed from the Lorenz curve, which is a plot of incomes
against population starting from the poorest groups in the population.
Wkikpedia provides a good introduction to the Gini coefficient. The Gini
coefficient does NOT typically include investment income.
73 The Gini curve used for these figures was taken from the
NZ Green Party website 19/6/10 because it is reasonably current Various
organizations like the UN and the CIA calculate Gini coefficients which can
vary depending on the way the basic data is compiled.
Poor income
distribution suppresses demand for domestically produced goods and services. People
with low incomes have relatively little to spend on domestic consumption,
especially on services, which make up the bulk of monetised economic activity.
Income concentration encourages relatively high demand for imported “luxury”
products adding to
There are just two
ways to avoid large earned income imbalances. The first is by increasing lower end
wages and salaries, especially minimum incomes. The second way is by
reconsidering taxation policy, not for political reasons but because the
existing income distribution structure has not been working well. Both the debt
model referred to Section 3 of this paper and the analysis in the paper “The Interest
Bearing Debt System and its Economic Impacts” Section 375 show that inflation and growth must be reflected in
incomes for the production cycle to clear. Heavily skewed income
distributions make the process of clearing the market from each production
cycle more difficult. Some people have “too much” (and growing) income in
relation to domestic consumption and many others “too little” (and falling)
income. “Ordinary” employment gets squeezed.
Every economy can
be thought of as having its own physical shape. That shape reflects the degree
of “reasonable self-sufficiency” the economy possesses. Reasonable
self-sufficiency describes how well domestic production matches the consumption
patterns of the population as a whole taking into account its income structure.
The less of its own domestic product an economy can afford to consume and the
more reliant that economy becomes on importing what it needs but does not
produce the more skewed the economy becomes. The more skewed the economy the
more dependent it is likely to be on foreign trade, globalisation, and in some
cases, on foreign debt.
Income distortions
have become structural, especially in industrialised economies. According to
the debt model, increased incomes are inflationary unless they are accompanied
by corresponding increases in productive output. Since the employed workforce
is already producing goods and services, the SHAPE of the economy, the basket
of goods and services produced in relation to incomes and consumption patterns,
will have to change if it is to improve the lot of the people as a whole so
that everyone gets a “fair” share 76. Increasing incomes
without increasing production would just increase prices.
74 This does not
suggest
75 Manning L. “The Interest
Bearing Debt System and its Economic Impacts” Section 3
76 What that “fair”
share is should be a defining political debate in a democracy.
Changing the shape
of the economy means eliminating excessive debt, especially foreign debt, as
discussed in Section 3. It also suggests changing the tax structure to optimise
the options as also set out in Section 3.
Tax structures in
most parts of the world are confusing, antiquated and expensive to run.
They are layered like an onion. New taxes have been added over the centuries as
the means to collect them have become available. They are full of loopholes and
exceptions granted to vested interests of one kind or the other. Governments of
all hues have tended to weight tax law with an eye towards their own perceived
constituencies and re-election. This implies adoption of short-term goals
instead of policies for the long-term benefit of the nation as a whole.
Governments claim to know the importance of goals such as economic efficiency,
research and development, the “knowledge” economy, investment and the reduction
of welfare dependency but they are unable to “walk the talk”. Systemic
constraints have made effective political action to adapt the existing
financial architecture to the needs of modern economies all but impossible. The
basic issues to be addressed are covered in the debt model referred to in Section
3 of this paper and in the paper “The Interest Bearing Debt System and its Economic
Impacts”. The current financial system has become a straightjacket on the
world’s economies as the recent debt “crises” have demonstrated.
In
A flat tax to
achieve tax universality is available to governments that choose to use
it. It is called a Financial Transactions Tax (FTT) 78. FTT is very cheap to
administer. It could easily replace all other forms of taxation except social
excise and environmental taxes such as those on tobacco, alcohol, fuel,
pollutants, and perhaps source deductions on sugars and saturated fats that
contribute heavily to obesity, diabetes and heart disease. Most of the nations’
Revenue Departments could be dismantled. One version of FTT is to deduct the
tax automatically every time money is transferred out of any deposit account
unless the transfer is to another account held by the same account holder.
Savings in downstream compliance costs (government, accountants, lawyers,
business administration), would be substantial 79. The quality of
economic output could be improved. The quantity of output would
play a smaller role in the economy. FTT would considerably increase economic
efficiency, releasing a pool of educated and experienced people for more productive
and useful output 80.
77 GST refers to Goods
and Services Tax. In
78 This is a general
tax, not to be confused with the so-called Tobin, or “Robin Hood” tax
79 Estimation of the
savings is outside the scope of this paper, but could easily exceed 5% of GDP
80 No reflection on
the people concerned is intended – in the present context they are productive
and useful–but in the broadest economic sense their skills could well be better
utilised.
As described above,
the quality of output refers to the real benefit the economic
activity contributes to national and environmental well-being. Reducing
compliance costs and the demand for legal, taxation and policy advice, for
example, would, over time, free more people to do more work that is more useful
to society. The more complicated and controlled society becomes the less
beneficial its economic output will be.
The level of the
FTT is easy to calculate. In New Zealand, for example, the 2010 budget
proposes total revenue of NZ$ 70 billion out of a GDP of, say, NZ$ 190 billion.
Suppose NZ$ 65 billion is to be raised from FTT. This is based on total
transactions in the New Zealand economy of about 1.8 times the GDP or, say, NZ$
340 billion 81. The
required FTT rate is then about 19% (65/340)82. All income is kept until it
leaves the bank account into which it has been placed.
Unlike GST, which
is a “pass-the-parcel” tax on value added, FTT is a layered tax because it is
charged every time money is transferred from a bank account. The more complex a
product is, and the more packaging, transport and storage it needs the more
expensive it will be because there are more payments made before the final
product is consumed. FTT therefore favours local production and local
consumption of local products. Local development will be stimulated. Typically,
exports are sold exclusive of such domestic taxes 83. FTT would be added to
imported goods and services when they are sold just as GST is at present.
The proposed overall
FTT tax level clearly illustrates the hefty tax skew masked by the existing
taxation system that substantially exempts the investment sector from paying
its “fair share” of tax.
Most ordinary
people spend most of their income on basic needs. While those buying a house
will pay FTT 84 on both the house
and on loan repayments, the interest rate under the four options in Section 3
may be less than 3%. 19% tax on the interest and repayments is still probably
less than 1% of their outstanding loan. Their total household financing cost is
still less than 3% interest plus another 1% FTT tax on their interest and
repayments, or 4%. That 4% is much less than the interest most people pay now.
A universal “flat tax” of about 20% considered so desirable by some political
parties in
81 The additional
transactions include such things as intermediate transactions in production,
property and equity transactions, financial transactions, interest, and loan
repayments.
82 The 19% figure
could be reduced to 17.5% with government injection into My of NZ$ 0.5b/year (Option B
above).
83 Consumption taxes are
usually levied under the tax system of the country where they are consumed, not
in the country where they are produced. In any case they are levied on sales
rather than purchases. The exporter is selling and not buying. It might be
practical to strip out some of the FTT costs layered into the export sale price
of the exported goods. That is not recommended because it would add complexity
to an otherwise extremely simple tax system and could make it subject to abuse.
Two of the beauties of FTT are its universality and its simplicity.
84
The tax would presumably be added to the loan
just like GST is added to prices now.
Social transfer
payments from tax revenue to beneficiaries and super-annuitants will still be needed.
They may need to be extended a little because the reduction or removal of bank
deposit interest as proposed in Section 3 will affect people, especially
retirees, who currently depend on interest income to supplement their pensions.
Options to deal with these issues are outside the scope of this paper. One
option is to provide insurance or guarantees for investments in new businesses
and deposits with qualifying non-bank deposit taking institutions. If the
existing tax system is, for the time being, retained, retiree depositors could
be compensated for loss of interest income by exempting some of their pension
from income tax.
Case management for
beneficiaries other than pensioners has always been fraught with difficulty,
and that will, unfortunately, not change unless a universal basic income (UBI) 85 (Manning, 2010) is introduced to replace the plethora
of individual entitlements that characterise “modern” social transfer systems.
In the meantime, earned incomes will still have to be linked to social
transfers with the on-going intrusion of eligibility qualifications.
85 A UBI would
nominally increase the FTT closer to 26% unless it is accompanied by a wealth
tax. Assuming the UBI is made very close to “social-transfer neutral”, the 7.5%
difference in FTT would, in aggregate, be “refunded” as UBI to those who have
paid most of it. The net income redistribution would then be roughly similar to
what it is now, but without any of the present barriers, stigmas, or government
intrusion in peoples’ lives and without the massive compliance costs involved
in the application of social legislation. Manning, 2010
provides a fully worked plan for a Guaranteed Minimum Income for New Zealand , incorporating a
wealth tax of 1% and a small E-note injection.
5.
IMPACTS ON THE PUBLIC SECTOR.
This paper does not
argue for or against more or less public sector involvement in the
economy. The proposals are “public sector neutral”. The debt model shows
that the debate about the public sector should not be about its size, but about
the quality of its economic output compared with that of the
private sector for the same amount of economic input. When the public sector is
more efficient it should be used. It is easy to be ideological about the role
of government with one side wanting to reduce government and open more of the
economy to private profit and the other wanting to improve “people power” or
social equity.
Whichever side of the
ideological fence is chosen the impact on government from the proposals
contained in this paper is profound. They should enable government to function
more effectively. There will still be a tax system and there will still be
income redistribution, public welfare and (in
The only effect of
the proposed changes to the banking sector will be that the exponential growth
of debt will fall (in
Looking at the
options (A) to (D) in relation to the Pubic Sector:
Option (A) merely
reinserts a supplementary reserve requirement on the banking system that
enables the central bank to manage the quantity of new debt by a means other
than the domestic OCR (official cash rate). The reserve requirement allows the
price of domestic debt to remain cheap so deposit interest can be reduced or
removed in much the same way debt expansion used to be managed before the oil
shocks of the 1970’s. If Option (A) is to be successful, the foreign exchange
interface has to be carefully managed as set out earlier in this paper. Capital
flows will be managed to bring the current account into balance and, over time,
enable net foreign debt to be repaid. The reduced demand for foreign debt
should permanently reduce the Trade Weighted Index (TWI) to a stable lower
level consistent with a balanced current account and much lower interest rate
structure. Permanently lower exchange rates will increase profits in the export
sector. The government may have to find ways to sterilise some of those profits
to avoid inflation in the domestic economy. One way to do this would be to offer
attractive national development bonds to stimulate increases in productivity
through investment in new industry and research, and similar schemes designed
to direct the additional income into national productive use. The foreign
transactions surcharge (FTS) will stop the “carry” trade and prevent it
from being reversed when domestic interest rates fall to very low levels.
Option (B) provides
the public sector with more leverage over its own activity to the extent there
are unused or under-utilised resources available to increase productive
economic output. In addition to making use of available resources, public
credit can be extended to provide funding for economic growth and to refinance
existing government bonds as they mature. Transitional provisions will need to
be introduced to allow for the supplementary reserve ratios to steadily rise as
traditional new bank lending through debt expansion is reduced and lending of
deposits through bank intermediation increases.
From the government
and public sector point of view, Option (C) is conceptually different from
Option (B) only in that it leads more quickly toward 100% reserves in the
private banking system. That 100% reserves status is reached not by calling in
loans but by increasing the system reserves as the public issue of money and
credit increases gradually as indicated in this paper. It does not
substantially change the total supply of money and debt from Options (A) and
(B). Nor does it change the banking system lending criteria or the banks’ spread
or profit margin. The main impact of Option (C) on the public sector is that it
introduces government authority over the issue of money and credit expressed in
the quote at the beginning of this paper. Several legislative proposals for
implementation are already available or under development 87.
Seen from the
public sector point of view Option (D) increases productive economic output at
very little public cost by encouraging economic participation among those who
are unable to do so within the formal economy 88. Some monetisation of
presently unpaid work would help improve the self-esteem and status of those in
society who presently feel alienated. Depending upon how the government of the
day decides to manage the relationship between social transfers and local
currency activity, there could be a significant reduction in government
transfer payments and other intangible benefits such as a fall in crime rates
and domestic violence.
86 10% is from the paper “The Interest
Bearing Debt System and its Economic Impacts”, Figure
9. The 1% is from growth (up to 5% of My.) and inflation (say, 0.25% *
GDP) plus Ms NZ$ 250 billion * 0.5% (1 – 0,24% tax rate on deposit interest))
assuming the change in Dca is reduced to zero, less any monetisation effect from E-notes in Options
(B) and (C).
87 For example “The
American Monetary and Financial Security Act “ promoted by Congressmen Denis
Kucinich and the American Monetary Institute in the US; and The Bank of
England Act 2010 currently under preparation.
88 For example, when
availability for paid work in the formal economy is irregular or sporadic, as
with parents with young children, beneficiaries, or those subject to periodic
illness or disability.
6.
INDICATIVE COMPARATIVE ECONOMIC PERFORMANCE.
Any detailed comparison of
economic performance is outside the scope of this paper. Some idea of what will
happen as a result of the application of the proposals in this paper can be
seen in Tables 1 and 2 and in Figures 2 to 7.
While the data in Figures 2 to
7 is indicative only, Option (B) dramatically changes the SHAPE of the economy from
one that is debt and inflation ridden with poor growth to one where both
foreign ownership and domestic debt, as well as government debt are
demonstrably under control and the economy is transformed towards high growth
and low inflation.
No graph is provided for
changes in the exchange rate (trade
weighted index, TWI). In addition to the positive effects from Options (A) to
(D), what happens with the TWI in
After just five years, the
89 On 23/6/2010 the TWI stood at about 68 – having fluctuated widely in
recent months.
Click
here to view : TABLE 1 : INDICATIVE NEW ZEALAND OPTION (B).
2011-2017 90.
While the data in
Figures 2 to 7 is indicative only, Option (B) dramatically changes the SHAPE
of the economy from one that is debt and inflation ridden with poor growth to one
where both foreign and domestic debt, as well as government debt are
demonstrably under control and the economy is transformed towards high growth
and low inflation.
No graph is
provided for changes in the exchange rate (trade weighted index, TWI). In
addition to the positive effects from Options (A) to (D), what happens with the
TWI in
Click here to view
: TABLE 2 : INDICATIVE NEW ZEALAND CURRENT SYSTEM,
2011 -2017 91.
At Table 1 Line 21 the
government of the day has a choice. It can reduce government debt, reduce
taxation or spend more if there are sufficient resources available to do so. Or
it can increase the E-note injection. In Table 1 the E-note money is
arbitrarily used to reduce government debt.
De-facto tax cuts are already built into the calculations in Table 1
because the domestic interest rate structure will be much lower, with average
interest rates permanently below 3% at the end of the period compared with an
average of 7% or more under the existing system.
90 Note deleted.
91 Prof. Michael
Hudson, “The Coming European Debt
Wars” 9/4/10
The comparisons
between the results from tables 1 and 2 are shown graphically in Figures 2 to 7
below.
Click here to see FIGURE 2
OPTION (B) DOMESTIC CREDIT OPTION B v. CURRENT SYSTEM.
Click here to see FIGURE 3
OPTION (B) NOMINAL GDP OPTION B v. CURRENT SYSTEM.
Click here to see FIGURE 4
OPTION(B) FOREIGN OWNERSHIP OPTION B v. CURRENT SYSTEM.
Click here to see FIGURE 5
OPTION(B) CUMULATIVE GROWTH OPTION B v. CURRENT SYSTEM.
Click here to see FIGURE 6
OPTION (B) CUMULATIVE INFLATION OPTION B v. CURRENT SYSTEM.
Click here to see FIGURE 7
OPTION (B) GOVERNMENT DEBT OPTION B v. CURRENT SYSTEM.
88 A parabolic trend line actually gives a better fit R2=0.975, but that is because the slope of
the Vcd curve is structurally changed by changing interest rates.
After just five
years, the
At Table 1 Line 24
the government of the day has a 3-way choice. It can reduce government debt,
reduce taxation or spend more if there are sufficient resources available to do
so. In Table 1 the money is arbitrarily
used to reduce government debt. De-facto
tax cuts are already built into the calculations in Table 1 because the
domestic interest rate structure will be much lower, with average interest
rates permanently below 3% at the end of the period compared with an average of
7% or more under the existing system.
89 Prof. Michael Hudson, The Coming
European Debt Wars , 09 April, 2010.
7. CONCLUSIONS.
This paper
discusses the causes of the rapid exponential growth of interest-bearing debt
in the world’s developed economies, and what pathways might be available to
reduce debt growth to sustainable levels.
The paper builds on
the theory and debt model presented in the paper “The Interest
Bearing Debt System and its Economic Impacts”, of this series.
That theory is based on a revised form of the Fisher Equation of Exchange that
takes the presence and cost of interest paid as unearned income on bank
deposits into account.
Section 3 of the
paper offers four options, labelled Option (A) through Option (D). The options
are in ascending order of the degree of transformation of the existing financial
architecture they provide.
Option (A) leaves
the existing banking system as it is, but maintains a very low Official Cash
Rate (OCR) and introduces a supplementary reserve ratio over and above the
normal risk weighted capital adequacy ratios to manage debt expansion in the
domestic economy. Since
Option (B) is similar
to option (A) but allows the Central Bank to provide funding to retire
government debt as it matures and to pay for some government expenditure that
would otherwise be supplied at interest by the private banking system. The
funding foreseen is a mixture of debt and electronic cash (E-notes). The Central Bank funding is
sterilised using the supplementary reserve ratio from Option (A) so funding
injections by the Central Bank have no inflationary impact. The Central Bank
funding for government expenditure, once spent, increases the deposits in the
banking system as is the case with existing private bank funding, broadly
maintaining the banks’ lending capacity and margins. The debt growth
exponential is reduced, but that reduction is partly offset from the banks’
point of view, by a very low rate of inflation.
Option (C) takes
Option (B) a step further by issuing all debt and money through the Central
Bank. Option (C) is the one recommended by United States President Lincoln in
the quote at the beginning of the paper. The end-point of the process is that
the banking system reserves gradually increase to 100%, and the private banking
system becomes a savings and loan institution without the right to issue debt.
The banks’ lending margins, policies and lending criteria remain essentially
unchanged.
Option (D) provides
for an integrated, measured and taxed local currency system that can be used in
conjunction with any of Options (A) through (C) to further promote measured
local economic participation that would otherwise be unlikely to take place,
and also to further widen the equitable tax base,
Section 4 of the
paper discusses equity in society. It shows how the existing financial and
taxation systems have skewed the income structure of industrialised economies.
It argues the only way to correct the skew is to change the SHAPE
of the economy. A single universal financial transactions tax (FTT) is proposed
as an option to do that. The FTT would be deducted on all transfers out of bank
accounts, and in
Section 5 reviews
the impacts of the various proposals on the public sector. While Options (B)
and (C) potentially offer more leverage for greater economic participation of
the public sector, the proposals can also be presented in “a public sector neutral” form. The degree of
influence of the proposals on the public sector is subject to political
evaluation and is beyond the scope of the paper. Despite that, even the modest
application offered in Section 6 produces dramatic downstream benefits for
governments’ accounts, especially in relation to public debt levels and the
sharply reduced cost of funding that debt.
Section 6 uses the
economic debt model to produce a comparison between Option (B) and the present
economic system. Just one of a
theoretically infinite number of combinations is tested. The underlying test assumptions are modest in
the context of the wider possibilities, but Figures 2 to 7 show an impressive
economic transformation over a seven-year period. Within the context of a similar nominal GDP
there is a vast increase in largely inflation-free growth while at the same the
foreign and domestic debt levels are brought under tight control, allowing
public debt to be eliminated over the medium term.
The proposals in
this paper provide a clear pathway to sustainable debt, very low inflation and
high real productive economic growth. The economy can be safely reshaped to
offer more equity in society and to function much more efficiently than it does
under the current financial system.
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Unknown authors, (ca. 2000) Alternative monetary policy instruments.
PRIMARY WORLD
TRADE ORGANISATION (WTO) DOCUMENTS.
TRIM (TRADE RELATED INVESTMENT MEASURES).
Inconsistent TRIMS
are those inconsistent with:
(a) National treatment under Article III: 4 of
the GATT 1994 and
(b) The general
elimination of quantitative restrictions under Article XV: 1 of the GATT: 1994
INTERNATIONAL
MONETARY FUND (IMF).
Appendix 7 gives the legal text of IMF Articles I (Purpose) and VI (Capital Transfers) .
APPENDIX 2 :GATS -
URUGUAY ROUND MARRAKESH
AGREEMENT.
Article XII:
Restrictions to Safeguard the Balance of Payments back to top
2. The
restrictions referred to in paragraph 1:
(a) shall not discriminate among Members;
(b) shall be consistent with the Articles of
Agreement of the International Monetary Fund;
(d) shall not exceed those necessary to deal with
the circumstances described in paragraph 1;
(i) the nature and extent of the
balance-of-payments and the external financial difficulties;
(ii) the external economic and trading environment
of the consulting Member;
(iii) alternative
corrective measures which may be available.
Procedures for
Balance-of-Payments Consultations
Notification and
Documentation
Conclusions of
Balance-of-Payments Consultations
APPENDIX 4 :
DOCUMENTS COMPRISING GATT 1994.
GENERAL AGREEMENT
ON TARIFFS AND TRADE 1994
1. The General
Agreement on Tariffs and Trade 1994 ("GATT 1994") shall consist of:
(i) protocols and
certifications relating to tariff concessions;
(iv) other
decisions of the CONTRACTING PARTIES to GATT 1947;
(c) the Understandings
set forth below:
(d) the Marrakesh
Protocol to GATT 1994.
(c) (i) The text
of GATT 1994 shall be authentic in English, French and Spanish.
APPENDIX 5 : GATT AGREEMENT TEXTS
Article XI*: General Elimination of
Quantitative Restrictions back to top
2. The provisions of paragraph 1 of this
Article shall not extend to the following:
Article XII*:
Restrictions to Safeguard the Balance of Payments back to top
2. (a) Import
restrictions instituted, maintained or intensified by a contracting party under
this Article shall not exceed those necessary:
(i) to forestall the imminent threat of, or to
stop, a serious decline in its monetary reserves; or
3. (a)
Contracting parties undertake, in carrying out their domestic policies, to pay
due regard to the need for maintaining or restoring equilibrium in their
balance of payments on a sound and lasting basis and to the desirability of
avoiding an uneconomic employment of productive resources. They recognize that,
in order to achieve these ends, it is desirable so far as possible to adopt
measures which expand rather than contract international trade.
(c) Contracting parties applying restrictions
under this Article undertake:
4. (a)
Any contracting party applying new restrictions or raising the general level of
its existing restrictions by a substantial intensification of the measures
applied under this Article shall immediately after instituting or intensifying
such restrictions (or, in circumstances in which prior consultation is
practicable, before doing so) consult with the CONTRACTING PARTIES as to the
nature of its balance of payments difficulties, alternative corrective measures
which may be available, and the possible effect of the restrictions on the
economies of other contracting parties.
(c)
(i) If, in the
course of consultations with a contracting party under subparagraph (a)
or (b) above, the CONTRACTING PARTIES find that the restrictions are not
consistent with provisions of this Article or with those of Article XIII (subject
to the provisions of Article XIV), they shall indicate the nature of the
inconsistency and may advise that the restrictions be suitably modified.
5. If there is a
persistent and widespread application of import restrictions under this
Article, indicating the existence of a general disequilibrium which is
restricting international trade, the CONTRACTING PARTIES shall initiate
discussions to consider whether other measures might be taken, either by those
contracting parties the balance of payments of which are under pressure or by
those the balance of payments of which are tending to be exceptionally
favourable, or by any appropriate intergovernmental organization, to remove the
underlying causes of the disequilibrium. On the invitation of the CONTRACTING
PARTIES, contracting parties shall participate in such discussions.
Current account
balance 2006[3].
Main article: Current
account.
India has the world's
largest surplus of remittances.[4]
Capital account (IMF/economics).
Financial account
(IMF) / Capital account (economics).
Main article: Capital
account.
The United States
persistently has the largest capital (and financial) surplus in the world.[5]
Official international reserves.
The balance of
payments identity states that:
Current Account = Capital
Account + Financial Account + Net Errors and Omissions
…..[This produces a accounting balance of payments identity]….
International
investment position
IMF
Balance of Payments Manual
List
of countries by current account balance (different from balance of payments)
a b IMF
Balance of Payments Manual, Chapter 2 "Overview of the Framework",
Paragraph 2.15 [1]
Current
account balance, U.S. dollars, Billions from IMF World Economic Outlook Database,
April 2008
Remittance
Trends in 2007 - World Bank
Chapter
6 - The US Capital Account Surplus
Coyle
on the Soulful Science - EconTalk
http://www-personal.umich.edu/~alandear/glossary/b.html Glossery of International Economics
"Bank
of Canada - Intervention in the Exchange Market - Fact Sheet - The Bank in
Brief".
Economics 8th
Edition by David Begg, Stanley Fischer and Rudiger Dornbusch, McGraw-Hill
Economics Third
Edition by Alain Anderton, Causeway Press AS and A Level Economics
APPENDIX 7 IMF
ARTICLES OF AGREEMENT PART 1 PURPOSES AND PART VI CAPITAL TRANSFERS.
The purposes of the
International Monetary Fund are:
Article VI -
Capital Transfers.
Section 1. Use of the Fund's general resources for
capital transfers.
(b) Nothing
in this Section shall be deemed:
Section 2. Special provisions for capital transfers.
A member shall
be entitled to make reserve tranche purchases to meet capital transfers.
Section 3. Controls of capital transfers
More information
on monetary reform :
Summaries of monetary reform
papers by L.F. Manning published at http://www.integrateddevelopment.org
NEW Capital is debt.
NEW Comments on the IMF (Benes and
Kumhof) paper “The Chicago Plan Revisited”.
DNA of the debt-based economy.
General summary of all papers
published.(Revised
edition).
How to create stable financial systems in four
complementary steps. (Revised edition).
How to introduce an e-money financed virtual minimum wage
system in New Zealand. (Revised edition) .
How
to introduce a guaranteed minimum income in New Zealand. (Revised edition).
Interest-bearing debt system and its economic impacts.
(Revised edition).
Manifesto of 95 principles of the debt-based economy.
The Manning plan for permanent debt reduction in the national economy.
Missing links between growth, saving, deposits and
GDP.
Savings Myth. (Revised edition).
Unified text of the manifesto of the debt-based
economy.
Using a foreign transactions surcharge (FTS) to manage the
exchange rate.
(The
following items have not been revised. They show the historic development of
the work. )
Financial system mechanics explained for the first time. “The Ripple
Starts Here.”
Short summary of the paper The Ripple Starts Here.
Financial system mechanics: Power-point presentation.
Return to : Bakens Verzet homepage.
"Money is not the key that opens the gates of the market but the
bolt that bars them."
Gesell, Silvio, The Natural Economic Order, revised English edition,
Peter Owen,
This work is
licensed under a Creative Commons
Attribution-Non-commercial Share-Alike 3.0 Licence.