NGO Another Way
(Stichting Bakens Verzet), 1018 AM
SELF-FINANCING, ECOLOGICAL, SUSTAINABLE, LOCAL INTEGRATED DEVELOPMENT PROJECTS FOR THE WORLD’S POOR
Edition 01: 17 November, 2010.
Edition 02 : 08 August, 2011.
Edition 03 : Revised edition 07 September, 2011.
Edition 05 : 09 February, 2013.
Summaries of monetary reform papers by L.F. Manning published at http://www.integrateddevelopment.org
NEW Capital is debt.
General summary of all papers published.(Revised edition).
(The following items have not been revised. They show the historic development of the work. )
INTRODUCE AN E-MONEY FINANCED VIRTUAL MINIMUM WAGE SYSTEM IN
"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 author gratefully acknowledges the support of Raf Manji and the Sustento Institute for their encouragement and advice; and to Terry Manning and the NGO Stichting Bakens Verzet (“Another Way”) whose editing and constructive critique have been crucial as the paper has evolved over time.
01. EXECUTIVE SUMMARY.
02. THE ECONOMIC DILEMMA.
03. THE VIRTUAL MINIMUM WAGE PLAN A.
04. PLAN A DETAILS.
05. THE FOREIGN TRANSACTIONS SURCHARGE.
07. APPENDIX 1 :THEORETICAL BACKGROUND.
08. APPENDIX 2: THEORETICAL SUPPORT FOR THE PROPOSAL.
01 EXECUTIVE SUMMARY.
The main dilemma faced by today’s economic policy makers is that the price-based financial system they have been using has run out of room to manoeuvre. It is no longer possible either to substantially increase interest rates to combat inflation or to reduce them to stimulate “economic growth”.
This paper offers a
practical plan to resolve the world’s problem of exponential debt growth and to
inflation. The plan is based on a revision of the
well-known Fisher Equation of exchange enabling it to take account of
interest-bearing debt. It is designed to ensure that no substantial income
group in the community is worse off than it is now.
The plan focuses on a substantial virtual increase in the minimum wage to stimulate demand among low-income earners and enable them to repay credit card and other high-interest consumer debt. The plan does not directly increase the minimum wage.
The virtual wage increase is merely a delivery mechanism to distribute low-income support by the injection of E-notes or electronic currency into the banking system. The electronic currency will be created debt-free by the Central Bank. Firms will be granted a percentage of that low-income support for their participation in the plan and to provide them with additional capital for future investment. In this paper a figure of 20% has been used arbitrarily for the capital grant made available this way to firms.
increase in the minimum wage will continue step by step indefinitely. The
additional consumer demand created by the virtual minimum wage
increases will encourage economic growth in the usual way until full employment
has been reached. Once full employment has been reached
the economic stimulus might have to be slowed to avoid demand-pull inflation
unless it is sterilised through savings programs, such as, in
The modest debt-free injection of purchasing power using E-notes will increase the demand for labour, providing strong economic growth. The labour supply will be provided from existing spare economic capacity. Prices should not change because increases in production costs tend to be avoided. The plan is expansive because firms can increase their production in the normal way subject to human and physical resource limitations and consumption demand.
supplementary reserve ratio will need to be introduced to the banking system
over and above the existing Basel III risk-based capital adequacy requirements.
It will need to be large enough to sterilise the new e-note deposits in the
banking system, and also to support progressive lowering of the OCR (Official
Cash Rate). The banking system will
apply quantity controls on debt and money instead of using price controls through
interest rates as it does now. As the
OCR is reduced towards zero percent, the existing systemic inflation in the
economy caused by the payment of unearned income in the form of
the plan is, or can be made, practically inflation free it will not measurably
increase the cost of exports. The plan
does, however, propose to introduce a variable Foreign Transfer Surcharge or
FTS starting at 10%. This would allow the
basis of the preliminary debt model calculations for
Until now, prices P in the revised Fisher equation (Manning, 2009) have been maintained at the expense of output Q, as firms have sought to maintain or improve profits by cost cutting and shedding labour. Some firms may soon have to begin reducing prices P to maintain output Q at functional levels and still clear their market 02.
The plan offers a practical and stable route toward on-going debt reduction with a very low level of inflation in the economy.
The stabilisation and ongoing reduction in the nation’s total debt is a fundamental objective of the plan. The improved equity and better living standards from higher incomes are an integral part of the economic transformation the plan will produce.
02. THE ECONOMIC DILEMMA.
The body of work supporting this paper confirms that a revised Fisher Equation of Exchange 03 and the Fisher Theory of Interest (Fisher 1930) are sufficient to explain why debt is expanding exponentially throughout the world and why orthodox economics has failed to prevent unsustainable debt growth resulting in boom and bust economic cycles interspersed with downturns and recessions. The main difference between the revised Fisher Equation presented, which incorporates the impact of interest-bearing bank debt, and orthodox economics is that while the revised Fisher Equation is based on managing the quantity of debt, orthodox economics is focused on the price of debt.
Both approaches eventually require the quantity of debt to be regulated. The revised Fisher Equation shows that when the price of debt, expressed as the average interest rate paid on bank deposits, is used as a regulator, an exponentially growing pool of unearned income is created. That pool of unearned income has to be funded by inflation in the productive sector because unearned income, by definition, produces nothing itself. As long as that pool of unearned income was relatively small compared with economic output expressed as Gross Domestic Product GDP the interest cost could be funded from increased productivity and economic growth. The result was an ongoing shift in wealth from the productive sector to the investment sector, but as long as that shift was corrected through socially acceptable income redistribution, the system remained relatively stable. 04 As the world economy has become ever more reliant on interest-bearing debt instead of cash transactions the impact of unearned income on debt levels has increased exponentially.
Exponential “growth” curves are inexorable. What started as a relatively small effect has
rapidly become unsustainable throughout the world. In
Since the deposit interest on the pool of unearned income Ms is funded by inflation and all price in the productive economy is also inflation, the transaction deposits My funding the productive economy must increase at least in proportion to the debt funding the pool of unearned income Ms. If My is increasing more slowly than Ms the productive economy must be deflating provided the speed of circulation Vy of My is more or less constant .
In many countries the transaction deposits funding the productive economy grow a little faster than the debt funding the pool of unearned income Ms because the former includes new My deposits needed to fund endogenous growth. The relationship between the productive deposits My and the pool of unearned income Ms is a good indicator of a nation’s economic health. That relationship can become distorted when excess “debt bubbles” build up in the productive economy from time to time, producing the now familiar boom and bust cycles.
bubble debt is produced by failure by the banking sector to properly align
demand for credit with the productive capacity of the economy. It arises in
In the present debt-based financial system, the productive economy has to replace the deposits it loses to the unearned income investment sector My. While the unearned income deposits migrate to the investment sector, the corresponding debt backing Ms remains in the productive sector. To replace the deposits lost as unearned income the productive economy must borrow a new amount at least equal to what has been alienated from it as well as enough to fund the next tranche of deposit interest 05.
During booms there is excess debt in the productive system that affects both the rate of increase of the pool of unearned income Ms and the bubble dent Db shown in the debt model. By and large, Ms has followed My so closely in the debt model arising from the revised Fisher Equation because virtually all the nominal GDP growth in New Zealand over the past 30 years has been funded by offshore borrowing as demonstrated in “The Interest-Bearing Debt System and its Economic Impacts” (Manning, 2010).
March 2011 the total domestic debt in
From the March 2009 year through the March 2011
year there is little evidence of real expansion of
The dilemma faced by economic policy makers is
that the price-based financial system has run out of manoeuvring room. It is no
longer possible either to substantially increase interest rates to combat
inflation or for that matter to reduce them to stimulate “growth”. In
03. THE VIRTUAL MINIMUM WAGE PLAN.
This is an almost non-inflationary proposal to stimulate economic growth without the need for radical change to the existing financial architecture. The key to the proposal is to increase consumer purchasing power by increasing the circulating deposits (arising as an increase in electronic cash ME in the debt model shown in the Appendices) without significantly increasing prices and without causing any growth in the pool of unearned income Ms.
a). Increase the minimum wage to a VIRTUAL LEVEL of $20/hour, but leave youth rates for those below 18 years of age at a lower level but above $12.5/hour. The wage increase is virtual because the increase is paid through employers but funded by a central bank cash injection into the economy. Employers must pass the cash injection on to their employees. The higher virtual wage is an instrument to deliver the cash injection of purchasing power to those parts of the economy where it is most needed. The proposed increase would potentially add about NZ$ 5 billion annually to disposable purchasing power and 2.7% to GDP. The increase in GDP would be “real” growth stimulated by greater purchasing power at more or less constant prices.
b). Supply new electronic cash (not debt) to businesses to fund the virtual increase in the minimum wage, so there is no significant increase in price. The new electronic cash deposits would circulate at the same speed as deposits arising from debt. The first cash injection needed would be about NZ$ 5 billion/Vy = 5/18 or NZ$ 0,28 billion where Vy is the speed of circulation of the productive transaction deposits My in the debt model. Since this amount helps cover the deposit interest transferred to Ms , it must be repeated for very production cycle leaving residual incomes available for consumption and investment. It cannot be inflationary unless the total aggregate amount exceeds the aggregate increase in Ms.
c). Supply a corresponding injection to businesses to facilitate business growth, to be paid to businesses weekly together with the planned virtual wage increase. This supplementary support for businesses has been arbitrarily set at 20% of the virtual wage injection, that is 20% of NZ$ 5 billion, or NZ $ 1 billion/year.
d). The planned increase in the virtual minimum wage income is largely expansive. It does not increase systemic inflation because the E-note injection is not interest-bearing debt. While it stimulates new productive activity by improving business confidence the net injection will not be large enough to produce significant demand-pull inflation. The circulating transaction deposits My in the debt model shown in the appendices does not change because the new funds are injected in the form of electronic cash. The proposed E-note injection will notionally support additional “real” GDP growth of up to 2.6%. However, some of the deposits arising from the cash injection will be used to reduce mortgage, credit card and other consumer debt. As set out the plan details, E-note injection at about the proposed level can be continued indefinitely.
Use taxation revenue (about NZ$ 2 billion) from the up to 2.6% increase in
GDP to index social welfare and
superannuation payments to the higher VIRTUAL average wage. The virtual average wage will rise by $2/hour
to $25/ hour. This is based on June 09 NZIS income survey figures, which have
not changed significantly over the past year and represents a virtual wage
increase of about 8%. In
g). Seek trade union agreement to keep real wage increases close to the inflation rate 12. Such inflation-led wage increases will apply to all workers in the usual manner, including those receiving the virtual wage increase. Under the agreement the E-note injections would be continued indefinitely as long as the rate of injection remains close to or within the permanent growth capacity of the economy.
h). Progressively extend the virtual wage increases. Many people will use some or all of their extra income to reduce debt. The program could therefore be continued until much, if not most, existing household debt is retired. Increasing the virtual minimum wage from $20/hour to $23/hour will add another $5 billion a year to lower incomes to enable the process to continue. Such extensions should be possible because normal wage increases will progressively reduce the size of the original injection as normal wages rise towards the virtual minimum wage of NZ$ 20/hour. A third similar tranche, raising the virtual minimum wage from $23/hour to $25/hour would follow the second, and so on.
i). The new cash deposits in the banking system could provide the base for increases in bank lending. Supplementary reserve ratios will need to be introduced into the banking system, over and above existing Basel III-based capital adequacy criteria, so that bank lending can be managed by quantitative means rather than by price. This will need to be done during the first year of execution of the plan. The banking system will progressively change the nature of its activities from credit creation toward savings and loan intermediation.
j). To reduce systemic inflation, progressively reduce the overnight cash rate (OCR) based on measured macroeconomic outcomes towards zero %. This may require the introduction of a Foreign Transactions Surcharge (FTS) to manage capital flows, as set out in the plan details below.
04. PLAN DETAILS.
a). Increasing the VIRTUAL minimum wage.
primary reason the New Zealand economy has not been growing very quickly is
that wages have not kept up with inflation in real terms and the benefits of
modest productivity increases have accumulated to the business gross operating
surplus instead of being passed on to employees.
The increased virtual wage will stimulate increased production and reduce unemployment. In the absence of full employment there will be little or no inflationary pressure. The plan can be continued over time by increasing workforce participation through greater innovation and productivity. It is also an axiom of capitalism that people tend to work harder if they know they are being rewarded for doing so.
Some workers will use their extra income to reduce debt, especially high-interest consumer and credit card debt, smoothing the initial positive impact of the programme. This is a composite part of the plan designed to reduce the country’s total debt over time.
regulatory provision may be needed to prevent employers seeking to reduce wages
, through the loss of jobs by workplace
attrition and subsequent replacement of workers at lower wages, or by failure
to negotiate or pass on the normal real wage increases agreed by wage
bargaining from time to time. Actions of
this type by employers would tend to keep their prices stable, but would lead
to higher injections of credit into the economy as discussed in point b) below,
eventually putting the plan at risk. As
discussed in point c) below, businesses will be well rewarded under the plan
and would be expected to support normal wage levels and normal wage increases
b). Injection of electronic cash.
The Central Bank does not need new legislative authority to make an injection of electronic cash into the economy. The money in the proposed plan will be used to increase virtual wages. It is not a subsidy to business, though business will be rewarded for its participation in the scheme and to stimulate business development. The plan is a non-inflationary way to increase wage-earners’ purchasing power. It is made possible through the greater understanding of the operating mechanisms of the existing interest-based debt system provided by the debt model discussed in detail in the appendices to this paper.
Each business will have to demonstrate the number of qualifying employees it has who earn below the proposed initial virtual wage threshold of $20/hour. That should be apparent from existing PAYE (Pay As You Earn) tax data. The amount needed to bring wage earners’ pay up to $20/hour will be deposited weekly into the firm’s business operating accounts in a manner similar to ordinary government transfer payments together with the corresponding incentive payment to be made available to businesses. Firms will have to provide records (as part of their normal PAYE returns) to show that all the money they receive has been used for its intended purpose. They will continue to pay workers at their usual (pre-existing) rates of pay together with any pay increases from time to time negotiated with the unions in the normal way as wage inflation increments arising from increases in the cost of living and increases in productivity.
Since it is likely that a substantial part of the E-Notes injection will be used to reduce existing consumer and credit card debt it is probable that the initial programme can be continued over time and expanded beyond the virtual wage of $20/hour.
Normal wage increases will progressively erode the amount of the initial E-Note injection providing an automatic “sunset” clause to the plan should a political decision be made to discontinue it. To maintain the effects of the initial E-Note injection, the virtual minimum wage will need to be increased in tranches as set out below under point h) of the plan or simply increased incrementally each year.
c). Business participation.
In many countries, the business gross operating surplus is 50% or more of the purchase price of goods and services. It is therefore usually beneficial for firms to expand production capacity as demand rises. There will be a reward for business participation in the plan. The reward will take the form of a capital grant. Businesses will be required to show how they use the capital grant provided to them to increase productive capacity. All businesses employing wage and salary workers will be eligible, not just those employing workers below the proposed virtual minimum wage. The proposed level of 20% of the planned initial E-Note injection of NZ$ 5 billion/year would provide an annual capital injection to business of about NZ$ 700 for each FTE (Full Time Equivalent) worker, or in round terms, about NZ$ 14 per worker per week. This would, in principle, continue as long as the plan is operative and for as long as individual firms continue to invest in increased production capacity.
Since the E-Note injection is not part of production costs firms can continue to produce the same output as they do now for the same price. The E-Note injection will increase wage-earners’ consumption capacity, stimulating further new production at nominally constant prices. It does this by reducing the drain of incomes to the unproductive investment sector leaving more of the earned incomes (both compensation of employees and gross operating surplus) for consumption and investment. The need to increase consumption capacity in the short term arises from the exponentially growing transfer of deposits from the productive sector My to the investment sector Ms. Increase in unearned income Ms will continue as long as interest continues to be paid on deposits. Increasing debt levels require an ever-higher proportion of incomes to cover interest payments for debt servicing. The debt model presented in Appendix 2 shows there will be a deficit in effective consumer demand in the economy whenever wage-earners’ net incomes fail to fully compensate for increased debt servicing costs and inflation. This is especially the case when the OCR is used to increase interest rates in an effort to manage inflation, producing unemployment and a contraction in consumption and, over time, a contraction of economic output.
power is increased modestly, the miracle happens as employees spend at least
some of their new income on consumption. Since prices remain very nearly the
same, the increased purchasing power induces added production using existing
unused resources available within the economy. The initial stimulus provided
does not need to be large. In practice it is a lot less than what has been used
in countries such as the
wage increases and new growth would initially continue producing systemic
e). Indexation of transfer payments including Superannuation.
Indexation of transfer payments on a tax-neutral basis does not change the figures referred to under points a) to c) above. The higher virtual minimum wage level results in higher employee incomes. A substantial portion of that wage increase is transferred back to the government through taxation. The government then redistributes that tax, leaving the global increase in purchasing power intact, but further improving its spread amongst the population. Some existing transfer payments should fall as the rate of employment increases with economic expansion. People on other benefits should become more motivated to seek work because the higher minimum virtual wage allows them to escape the poverty trap 13. This plan assumes such budget “savings” would be used to increase the transfer payments to the people still needing them. Whether the government of the day chooses to increase the present level of social welfare transfers and, if not, what it does with the resulting ‘savings” becomes a matter for public policy debate.
f). Other forms of income support.
lower income levels rise, the need for supplementary income support through
programs such as the
g). Wage restraint.
The trade union movement is expected to be strongly attracted to the plan because it will improve the purchasing power of many of its members. A unique feature of the plan is that it provides a systemic bottom up approach to reducing income disparity rather than a top down approach. The plan is neutral on taxation rates, which are considered to be a political matter.
The plan does not remove systemic inflation from
the economy though it will reduce it over time through the reduction in the
OCR. As in the past, wages may increase to reflect price changes induced by
inflation as well as to allow employees to enjoy a share of increased
productivity. Such wage increases will
also apply to those benefiting from increases in the virtual minimum wage. They
are included in systemic inflation. The
whole economy will continue to inflate by an amount equal to the systemic
inflation, which is expected to be about 1.8% in
It would be advisable to keep annual wage increases to less than 2.5%, that is, up to 1.8% for inflation (reducing as inflation falls) and 0.7% for productivity gains.
An agreement with the unions would be helpful because there will be some pressure to increase incomes above the median wage to restore skill differentials in the labour market. Skilled employees should not be worse off under this plan than they would have been without it. Upward pressure among middle incomes could be dealt with by making the tax system more progressive by adjust adjusting tax thresholds to maintain income differentiation. 15
h). Plan extension.
is enough spare capacity in
Most New Zealanders on low incomes struggle to make ends meet now. The bulk of the first cash injections will probably go into new consumption as they are intended to do rather than into debt reduction. This will change as further cash injections make debt reduction more feasible.
Economists and political leaders throughout the world are calling for an end to exponential debt growth. This plan does that by progressive credit monetisation of the existing debt as well as by permanently reducing the OCR (Official Cash Rate) towards zero, at which point systemic inflation would be removed from the financial system.
i). The banking system.
This plan will progressively and significantly increase cash deposits in the banking system. The difference between cash deposits and deposits arising from debt is that cash deposits reduce the banks’ risk-based capital requirements thereby increasing their lending capacity. Nobody can default on a cash deposit because it can’t be liquidated. Cash deposits remain somewhere in the banking system unless they are used to repay debt. That makes a credit (electronic cash) based financial system inherently more stable than the existing debt-based system.
Bank deposits will continue to increase, but at a slower rate than during recent decades. The increased deposits will result from population expansion and from residual systemic inflation. They will tend to be offset by increased productivity derived from increases in employees’ purchasing power. The growth of debt in the economy will reduce towards zero as the OCR is progressively reduced towards zero, eventually eliminating most, if not all, exponential debt growth.
One main element of past exponential debt growth has been the use of the price mechanism to “manage” it. This has turned out to be a perverse system. The debt model set out in the appendices shows how raising interest rates increases systemic inflation instead of reducing it. During downturns and recessions the systemic inflation is still there. Higher systemic inflation is, however, masked by falling purchasing power caused by higher debt financing costs, and falling production with aggregate discounting of goods and services by producers leading to a reduction of their gross operating surpluses. The systemic inflation is not visible in consumer prices and therefore tends to go unnoticed and unmeasured.
Since cash deposits increase banks’ nominal lending capacity this paper proposes using variable supplementary bank reserve ratios to limit bank lending. This is to avoid risk of added inflation caused by increases in circulating productive transactions deposits My over and above what is needed to maintain real GDP growth within the resource constraints of the economy.
There is nothing new about reserve ratios for bank lending. Most countries still have them in some form even though they have usually played a minor role in economic management in recent years. How the supplementary deposit ratio to be incorporated in the plan is framed is outside the scope of this paper. Its purpose is to slow down the exponential growth of bank lending as new debt is replaced by electronic cash injections so that systemic inflation can be reduced and eliminated altogether over time.
Over the longer term, household debt can be first stabilized and then gradually reduced. The banks will be gradually transformed into savings and loan institutions. This process will reduce systemic banking risk while at the same time maintaining banks’ profit margins.
The main change under the plan will be the elimination of unsustainable exponential debt growth. This is what the world wants to happen. Unlike this plan, orthodox economics offers no mechanism to achieve it.
j). Reducing the OCR.
The introduction into the financial system of electronic cash credit injections and supplementary reserve ratios allows the OCR (Official Cash rate) to be gradually reduced, and systemic inflation to be removed from the financial system. The financial system becomes based on the quantity of debt (and E-notes) rather than its price. The persistent problem of exponential debt growth will be solved. Over time, interest-bearing debt can be removed entirely from the financial system.
systemic point of view, the decline in the OCR can be carefully managed to allow
The plan does not, of itself, resolve either the current account deficits of debtor nations or the current account surpluses of creditor nations. It does, however, provide a platform from which the exchange rate and current account can be effectively dealt with using other options such as the Foreign Transactions Surcharge (FTS) discussed briefly in Section 5 below.
plan has been conceived to avoid significant additional costs for exporters.
Except for tourism, most producers of
From the structural macroeconomic point of view debtor countries clearly need to get their current account deficits under control. One mechanism to do this is by applying a variable Foreign Transactions Surcharge (FTS) whereby a currency exchange surcharge is automatically collected whenever domestic currency is converted into foreign currency. It would have no effect on export prices, but it would increase effective import prices. The proposal would be made tax neutral by reducing domestic taxation by the amount of the surcharge collected.
05. THE FOREIGN TRANSACTIONS SURCHARGE (FTS).
It is advisable to introduce a Foreign Transaction Surcharge (FTS) as soon as possible to protect against the export of assets (financial leakage) offshore and progressively repay the nation’s foreign debt.
An FTS would be
simple to administer 16. It has very rarely been used in the past 17.
Introducing a financial instrument such as the FTS is essential in the medium term
if offshore borrowing and related interest costs, which are among the main
causes of exponential inflation in
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. The GATT legal text, Article XI clause 1 appears to specifically permit non-discriminatory taxes to be applied. Provision of funding is a service that falls under the GATS protocols.
The so-called policy “trilemma” referred to in paper 1(cited in Appendix 2) 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” 20.
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 could 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 21 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 can be adjusted
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, which is 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.
Those using foreign currency in
The proposal for an
FTS also deserves mention in the context of ongoing negotiations for a TPPA
(Trans-Pacific Partnership (Free Trade) Agreement) presently being negotiated
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
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 28. At the moment they face a severe economic disadvantage through the hidden costs represented in the status quo.
Introduction of the
FTS 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
That would be enough to reduce
GST to 10% from 15% and begin foreign debt repayment
There would be a substantial
reduction in interest payments as the current account is brought under control,
the reduction of foreign ownership begun and inflation 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
That would produce a sharp fall in the exchange rate. The FTS is a very powerful economic tool because of its indirect redistributive impact within the domestic economy 34. Its introduction would also prevent a reversal of the so-called “carry trade” 35 once domestic interest rates have been reduced to low levels.
The share of the
That those annual servicing
requirements should be more or less equal to
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 favour the replacement of foreign funding with domestic funding.
literature supports the need for some form of foreign exchange management to
correct the balance of payments and the current account. “Pegged” exchange rates
have been widely used by major countries, including
argues that the levels of the
The FTS outlined
above is much broader in scope than
The paper sets out the underlying economic problems relating to the exponential growth of debt and offers a detailed plan to deal with them. The private interest-bearing debt-based financial system generates systemic exponentially increasing transfers of wealth from the productive sector of the economy to the investment sector. The transfers take the form of net interest paid on bank deposits. The deposit interest has to be funded from the productive economy. This causes an inflationary expansion in the debt levels the productive economy has to service. Over the past few decades, the orthodox economic approach to that inflationary expansion has been to increase the price of debt by raising interest rates. Not only is that approach shown to be counterproductive but debt levels in developed economies are now so high that small increases in interest rates are enough to force them into recession. The consequence it that interest rates now have to be reduced close to zero to stimulate the economy.
The proposed plan resolves the exponential debt problem. It is limited in its scope to reducing debt in the economy and stimulating sustainable growth.
plan introduces the concept of a virtual minimum wage. In
Debt reduction occurs as people receiving the stimulatory payments use some of them to repay existing consumer debt and mortgages 36. Debt is progressively replaced by electronic cash circulating in the economy at the same speed as existing bank debt. The paper shows the debt reduction process can probably continue indefinitely. The proposed cash injections become self-limiting as normal wage increases reduce the difference between ordinary wages and the virtual minimum wage. The plan can then be extended by increasing the virtual minimum wage first from NZ$ 20/hour to NZ$ 23/hour and then to NZ$ 25/hour. Each of those extra increases has approximately the same effect as the original increase to NZ$ 20/hour; being about 2.6% of GDP. The program can be continued in stages, and progressively broadened until most debt in the economy has been retired and the economy is permanently working at full capacity.
The plan is accompanied by at least two monetary instruments. The first is the introduction of a supplementary deposit ratio into the banking system and the second is the introduction of a foreign transactions surcharge to manage the current account and retire foreign debt.
The supplementary deposit ratio is applied in addition to the Basel III risk based capital requirements under which the banking system operates at present. The supplementary deposit ratio enables the effect of the E-note injection to be sterilised (offset) so that new bank lending is correspondingly reduced. This eliminates the possibility of inflation being caused by an oversupply of new interest-bearing bank debt as the Official Cash Rate (OCR) is reduced towards zero. Lowering the OCR will progressively remove systemic inflation from the economy.
The Foreign Transactions Surcharge (FTS) serves two main purposes. The first is to limit any capital flight as the OCR is reduced. The second is to provide a powerful ongoing instrument to regulate the exchange rate and progressively repay the nation’s foreign debt. The FTS is a variable tax on all outward transfers of NZ currency. It would start at about 10% and be automatically collected through the banking system. The income received would be used to reduce domestic taxes, such as GST, and to begin reducing foreign ownership. The proposed 10% initial level for the FTS is much lower than the recent percentage variations in the NZ$ exchange rate. The proposed FTS rate would apply to ALL exchange transactions including speculative financial transactions. It appears to come within the context of existing international protocols such as GATT and the WTO that allow for protecting a nation’s balance of payments. It is important that this position be reserved in any TPPA (Trans-Pacific Partnership Agreement) the country decides to enter into.
07. APPENDIX 1 : THEORETICAL BACKGROUND.
The first paper of this series “The Interest-Bearing Debt System and its Economic Impacts” 37 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 increase of the debt burden.
(d) Culture and institutional “capture” of the debt debate has made rational discussion of the debt problem difficult.
(e) Sustainable debt levels cannot be achieved without removing most if not all new deposit interest.
(f) Quantitative analysis can be provided using a new debt model of the economy based on a revised form of the Fisher Equation of Exchange.
The paper “The Interest-Bearing Debt System and its Economic
Impacts” showed that the debt system in
economy is progressively becoming paralysed. The exponentially growing pool of
unearned deposit income is funded by inflation of the productive economy. The
unearned income investment sector is becoming so large that servicing the
nation’s total debt requires inflation close to the deposit interest rate 38.
The present situation has probably never arisen before, not even during the
depression of the 1930’s.
Orthodox economic instruments such as the use of interest rates to manage inflation mask systemic inflation at the cost of economic growth as shown in Figures 2 and 4 of Appendix 2. The inflation cost is still there and it is still being paid, but it is being paid in the form of lost production and unemployment instead of showing up in prices.
Appendix 2 provides
detailed evidence of the current position for
The world’s financial system is approaching a state of collapse and cannot be repaired using orthodox economic theory. Orthodox economics has failed to reveal the fundamental mechanisms at the root of the debt problem or to offer any practical long-term solution to address it.
08. APPENDIX 2 : THE THEORETICAL SUPPORT FOR THE PROPOSAL.
The theoretical basis for this paper is the debt model shown below which is the same as the one described in “The Ripple Starts here….”39 and the first paper of this series “The Interest-Bearing Debt System and its Economic Impacts” cited above. The debt model is based on the Fisher Equation of Exchange amended as follows:
While the debt model is based on the volume of debt, it is unrelated to earlier volume-based reform proposals like those of Social Credit that failed to offer a viable theoretical basis to support them.
The premise in the debt model is that the circulating deposits and cash My = Prices P * 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 40.
The SNA should reflect an expression of the original Fisher Equation of Exchange as shown in Figure 2 41. The only difference is that the money supply M in the Fisher equation of exchange included hoarded cash, whereas in the debt system shown in Figure 2 for practical purposes there is now very little cash contributing to measured GDP.
In circulating cash and deposits 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 42.
At any point in time there are five broad blocks of deposits in the domestic financial system.
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.
M0y The cash in circulation included in Mv 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) 43.
(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 M0y 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 44.
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 45 + Ds (2)
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 46.
Ds The residual debt to balance equation (2)
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 as discussed further below in relation to Figure 5.
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.
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 * 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 previous papers 47.
Ms is the same format as Ms in the earlier forms of the model. It has been freshly calibrated. Unlike the previous forms of the model equations (3) to (6) are general and include the contribution made to the economy by cash transactions.
In equation (4), all the terms except GDP/Vy = My and Db are known or can be estimated with reasonable accuracy. For the purposes of equations (1) and (6) My can be approximated using trend-lines because it is small compared with Ms. Db is unknown but can be approximated through the calibration as in Figure 5. The calculations in equations (5) and (6) involve the subtraction of large numbers to get relatively small numbers, which leaves them sensitive to modelling and data error.
If Ms , calculated as “the
accumulated deposits arising from unearned deposit income on the total domestic
banking system deposits M3(excluding repos) ”agrees more or less
with that calculated in equation (4), bearing in mind the value of Mb , the proposition that debt
growth is determined by deposit interest will be proven. The model will require
further calibration as further data becomes available. Despite that, it is self-evident Db will be positive during periods of rapid expansion,
particularly as bubbles form, and will become negative during periods of rapid
contraction, particularly as bubbles collapse. The classic case of this in
The dependence of the gross domestic product (GDP) on the Domestic Credit DC and the interest rate on bank deposits in the modern cash-free economy from which Ms is calculated has profound implications for economics.
In the light of the worldwide financial chaos of 2007-2009 the indicative debt model shown in Figure 1 provides a powerful argument in support of public control of a nation’s financial system.
Click here to view FIGURE 1 : THE SCHEMATIC DEBT MODEL OF A DEBT-BASED ECONOMY.
The vertical axis
in Figure 1 applies to the Domestic Credit for
It isn’t possible to have a simpler model of the economy than equation (5):
My =Nominal GDP/Vy equals domestic credit DC less (unearned net deposit income Ms + the accumulated current account Dca + the cash contribution to GDP M0y plus a correction for bubble activity Db (+/-))
Click here to view FIGURE 2 : EXPONENTIAL DEBT AND GDP NEW ZEALAND, 1993-2011.
It is theoretically impossible to maintain exponential debt expansion faster than GDP expansion over an extended period because the added debt servicing costs will always leave the productive sector insolvent.
To avoid national bankruptcy, each nation must maintain, in aggregate, a zero accumulated current account deficit.
approximation for the speed of circulation Vy of productive debt plus cash
transactions My is given in Figure
3. Vy varies with the
change in the payments systems. Minor secondary shorter-term cyclical variability
also occurs through changes in the average time taken to pay bills. When times
are tough people take longer to pay their bills, and each change of a day in
the time taken to pay them can alter Vy by perhaps 0.25%.
The process is usually reversed in better times. Otherwise Vy reached a constant value of
Click here to view FIGURE 3 : SPEED OF CIRCULATION Vy NEW ZEALAND 1978-2011.
Note that in Figure 3, no correction has been applied to Vy for secondary increases in payment time during recessions or decreases in payment time during economic boom periods. The maximum correction in Vy appears to be in the order of +/- 0.3 or up to 1.5%. The series shown is less stable from 1978 to 1989. This is possibly due to distinctly different growth exponentials 1978-1989 arising from the very high interest rates that were typical during those years.
As shown in Figure 4, My in
Click here to view FIGURE 4 : ESTIMATED TRANSACTION FUNDING My NEW ZEALAND 1990-2011.
used to calculate Vy in Figure 4 is as
follows. The GDP in
Businesses pay suppliers monthly, and indirect payments are usually made on a monthly basis too, so their speed of circulation is about 12 on average. Most workers get paid fortnightly (though some get paid weekly and some monthly) so an average speed of circulation of 26 has been assumed for that.
When the above figures are weighted the weighted average speed of circulation is (12 * (42.7+12.3)+45 x 26)/100 = 18.3.
A similar estimate of payment trends and a separate Vy calculation was made for each of the other years, and a polynomial best fit curve was drawn as in Figure 4.
My was then obtained by dividing the official GDP figure by the speed of circulation taken off the best fit trend curve. This gives the data series shown in Figure 5 and used when applying the debt model.
The methodology is easily replicable using better information about payment trends and is applicable to any country.
Figure 4 shows the
preliminary estimate for estimated production debt and cash My in
Figure 5 shows an
indicative comparison between the residual debt Ds for New Zealand calculated
from equation (2) and plotted against the model Ms calculated as the accumulated
after tax deposit interest on M3 (excluding repos). The curve for Ms is a first approximation
because assumptions have been made on the average tax deducted from the gross
payments of unearned income (M3 (excluding repos x the average interest paid on
deposits). The tax is the average tax
paid by each income-earner on his or her total income. It is not the marginal
tax rate 49. The losses from the 1987 share market crash
Once the tax rates on Ms have been accurately calibrated, the size of any debt bubble Db can be immediately calculated. Measures can then be taken to eliminate the bubble without risking any economic downturn.
Click here to view FIGURE 5 : BUBBLE DEBT Db AND Ms NEW ZEALAND 1978-2011.
Allsopp C & Vines D, (2008) “Fiscal policy, intercountry adjustment
and the real exchange rate in
Bertram G (2009), “The Banks, the Current Account, the Financial Crisis and the Outlook”, Policy Quarterly, Vol. 5 Issue 1, February 2009.
Brash D (1996), . New Zealand and international financial markets: have we lost control of our own destiny?” Address by Donald T Brash, Governor of the Reserve Bank of New Zealand to the 31st Foreign Policy School, University of Otago, Dunedin, 29th June 1996.
Fisher I (1930) “The Theory of
George H (1879) “An inquiry into the cause of
industrial depressions and of increase of want with increase of wealth... The
Remedy” Self published in
Kelsey J (Ed) “No Ordinary Deal: Unmasking the Trans-Pacific Partnership Free Trade Agreement” Bridget William Books, 2010. ISBN 978-1-877242-45-0
Manning L (2009), “The Ripple Starts Here: Finishing the Past 1694-2009”, New Zealand Association of Economists 50th Anniversary Conference July 1-3 2009, as published under a creative commons licence at www.integrateddevelopment.org.
Manning L, (2010) “The Interest-Bearing Debt System and its Economic Impacts” Version 3, 18 August, 2010, Sustento Institute, Christchurch NZ with the assistance of MEA (Manufacturers and Exporters Association of New Zealand) as published under a creative commons licence at www.integrateddevelopment.org.
Obstfeld M (1998), “The Global Capital market: Benefactor or Menace?” Draft April 27 1998.
Preston D (2009), “Putting Credit back into Monetary Policy: Reconstructing the New Zealand Monetary Policy Framework”, Paper for NZ Association of Economists 50th Anniversary Conference, July 1-3 2009.
Rose D (2009), “Overseas Indebtedness, Country Risk and Interest Rates”, Policy Quarterly, Vol. 5 Issue 1, February 2009.
Unknown authors, (ca. 2000) “Alternative monetary policy instruments”.
More information on monetary reform :
NEW Capital is debt.
General summary of all papers published.(Revised edition).
(The following items have not been revised. They show the historic development of the work. )
Return to : 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,
This work is licensed under a Creative Commons Attribution-Non-commercial Share-Alike 3.0 Licence.