The purpose of this presentation is to understand the conditions in which money can be created and issued and to what extent it can be used to stimulate an economy.
There are many stories illustrating how money comes into being, and here is one of them.
Farmer A has a magnificent bull. Farmer B has ten healthy sheep. It suits them both to agree to exchange Bull for sheep. Farmer B brings his sheep to A’s farm. Farmer A is delighted to accept them, but says my bull is busy in the fields; can I bring him to you in a month’s time? B shows some hesitation, so A says “Look here, suppose I give you a token with my marks on it to show that I will perform my side of the bargain to anyone who brings me the token at the end of the month”. He finds a piece of leather, and scratches on it “one OX” with his mark. B is satisfied and departs, leaving the sheep.
A is well known, so B is able to use the piece of leather to exchange for a plough from Farmer C. Farmer C uses it to exchange for a large load of manure from Farmer D. Farmer D takes the token to Farmer A, who delivers the bull, takes back the token and puts it back on his shelf. (The origin of the Pound, from Pfund = ox)
As Henry George has it, “Money is not an invention, but rather a natural growth or development, arising in the progress of civilisation from common perceptions.
As we saw in the slides, the piece of leather came down off the shelf, did its duty, and went back on the shelf. This points to two different aspects of money. On the one hand there is government authorising it, printing it, coining it, and then the commercial banks giving a customer permission to use it. Up to that point it can be cancelled, with no consequences other than upset anticipations!
On the other hand once it has been used and put into circulation, the money has a life of its own. It will pass from hand to hand completing myriad transactions, until, well, until what? Does it go on for ever? In our example above it got back to the issuer, Farmer A, who put it back on his shelf.
If Farmer D had not taken it back to Farmer A, the bull would not have been passed over. Farmer D suffered a loss. The token was perhaps trampled underfoot!
This example shows us the essential nature of money. Farmer A made a promise, and by attaching it to a token, made the promise transferable. The token becomes a bearer instrument.
Let us look at another example.
OK, the king wants a pig. He goes to a farmer. Mostly the king just took it, but Alfred was a just king. He said “We must pay back the farmer for his pig. Give him a tally stick!” So the king gives the farmer a stick with a mark on it, to the value of one pig. He promises the farmer that he can use the stick to pay his rent/tax. But the farmer says, “I’ve already paid my rent!” “The next lot then” says the king. “OK” says the farmer, “but what you’re really doing is asking me to pay my rent in advance.” The king being a just king, sees that there is unfairness to be righted, so he answers “When it comes to Lady Day, we’ll let you off a bit more rent, and look, I’ve marked the stick at one pig and a bit.” The farmer, now satisfied takes the stick, which is split in two, and hands over the pig. He thinks “At least that’s better than I got from the last king. He just took my pig!”
Come Lady Day, he presents his tally stick to the king, it is matched with the other half, and his rent is reduced by one pig and a bit. Stick goes back to the king, and is no longer “money”.
If you think it through, all money is like that. It is issued by being spent in exchange for goods and services. Until it is spent, it is not counted as money, and when it is redeemed it is no longer money. There is no such thing as debt free money. The debt, while it exists is the due settlement or return of goods and services. The extra due to the farmer for the delay in settlement we call interest. If when he presented the tally stick it was not honoured, it would only be worth to him the heat he could get on his fire, and he would have suffered an injustice, and all the other tally sticks the king has issued would also be worthless.
In today’s terms, such defaults would lead to hyper-inflation of tally sticks!
What can we learn from this fable?
The immense benefits gained from a money system are grounded in justice. Hence “My word is my bond” With non-redemption, you get injustice and the price is hyper-inflation, – and riots!
Could it work today?
Yes, of course, for this is the way that money does work. It is accepted in exchange, and the debt has to be honoured. There is no credit without repayment.
Now, we should examine how money is issued, that is how it goes from the government side to the side where it is used and passed from hand to hand. Digital money is, of course, subject to the same rules.
So, apart from destroying it, what can you do with it?
You can give it, spend it, or lend it. Is there any other choice?
If it is lent, there is a good chance it will be redeemed by repayment. If it is not repaid, then the lender “writes it off” which means that it comes out of his own resources.
If you or I give money, we have to have it first! But a bank is not in that position. It could be asked by government to give all citizens a ration, sometimes called “helicopter money”. Similarly the government could just spend the new money on goods and services it needs. But if it just did that, what do we think would happen to money?
The government though, puts itself in the same position as you and me. It takes taxes from us so that it has the money to give or spend. And if it runs out, it borrows from us.
Nowadays, it is accepted that money is created by the action of banks lending it to the public. A loan is agreed by the bank, and the customer spends the money made available. The bank expects repayment so that redemption is complete. The total money lent at the end of June this year (M4) was £2174 billion, of which 52% was “secured on dwellings”, or mortgages.
Two dramatic failures
Wikipedia give causes;- “There are a number of theories on the causes of high and/or hyper inflation. But nearly all hyperinflations have been caused by government budget deficits financed by money creation. After an analysis of 29 hyperinflations (following Cagan’s definition) Bernholz concludes that at least 25 of them have been caused in this way”.
For now, we will look at two examples which were dramatic failures.
We have an excellent book written by Andrew Dickson White “Fiat Money Inflation in France”.(1) One effect of revolution was that the authorities had no tax revenue. Against strenuous warnings not to, they issued specially printed notes to pay for government expenditure. But they made no attempt to raise taxes to enable the new money to be redeemed. After initial success, further issues were made until 40,000 million Livres were in circulation. Then their value dropped, and went on doing so, until they were worth 3% of their issue value. Then they collected them up and burnt them!
Dickson White concludes “Thus was the history of France logically developed in obedience to natural laws; such has, to a greater or less degree, always been the result of irredeemable paper….”. When he arrived on the scene, Napoleon said “I will pay cash or nothing” and “While I live I will never resort to irredeemable paper!”
Stephen Zarlenga, of the American Monetary Institute maintains that the power to create money should not be given to the commercial banks but kept I government hands. He also says that the failure of the Assignats was because of massive forged notes being supplied by Britain. While the forgeries may have been true, it is a strange instance to use in defence of the issue of government money. After all, forged money must be the best example of “irredeemable paper” that exists! (2)
The German experience
After the First World War Germany was obliged to make reparations to France and other countries which were beyond the taxable capacity of the German people. Furthermore, the people were not able to subscribe for bonds.
Nial Ferguson in his book “The Ascent of Money”,(3) says, “the German and Austrian authorities had to turn to their central banks for short term funding. The growth of the volume of Treasury bills in the central bank’s hands was a harbinger of inflation because, unlike the sale of bonds to the public, exchanging these bills for banknotes increased the money supply”. How this inflation gathered momentum is shown on this chart.
It was finally solved by the issue of the “Rentenmark” supposedly secured by the value of land in Germany.
To sum up so far;
Natural law in relation to money includes;
- It is issued by being accepted in exchange for goods and services
- It is cancelled by the supply of goods and services to the issuer
- If not redeemed in this way inflation will follow.
But does it have to be created by a loan from a commercial bank?
This is a crucial question. For, in a sense, anything can be picked up and used as money. There were cowrie shells, and all sorts of rare or unusual things used. Also, in olden days we may suppose, the king minted coins and just spent them. But why would people accept the king’s shilling? It can only have been that they knew they could use the coins to pay their just dues to the king. The king had to be moderately careful to keep his spending and taxing in balance, or the value of his coinage would drop.
But why hand it over to the commercial banks? This is what the Positive Money people and The American Monetary Institute are complaining about. My conclusion is that governments do not wish to be responsible for the RISK of non-repayment.
Debts written off by banks have been huge. They were £10Bn in 2010, nearly £7Bn in 2011, and since then over £3Bn each year.(4)
The way things developed from the goldsmiths activities meant that the banks undertook the risk of bad debts. They became expert in assessing risk, and it was easier to allow those who lent bear the cost of default. Also, with intermittent wars, money had to be raised in excess of the amount taxation could be raised. So the government had to borrow too.
Here we come up against the conditions of the day, which was the concentration of wealth in the hands of a relatively small number of people. This on the one hand set a limit on what could be raised from the general population, and on the other hand produced those with surplus funds which could be used, but on their terms.
So, we come to the conclusion that banking today has grown step by step in accordance with natural law, but within a particular set of circumstances derived from not collecting the proper source of public revenue. It was this that concentrated wealth in few hands, and it still operates.
We saw in the story of the Tally Sticks that an adjustment of price to reflect timing differences might well have been a natural way that interest came to be recognised. There has been huge debate over the years on the morality of paying interest, but in a family or small community it might be regarded as pointless. In the Guernsey experiment they built the new market hall and other improvements without paying interest. Where does the dividing line lie?
Maybe, where there is a common interest, interest is not thought of! But an investor will seek for some share in the project for which his money is to be used, especially if he is not involved in management himself. Any bank which takes on the risk of non-repayment will seek some recompense. The level of interest may be controlled by religious doctrine or state priorities, but this may interfere with the investment process. The variation would seem to be limitless.
And now we know that 90% of us pay interest, but only 10% receive it. (5) Does this not point to the same inequality that governed the development of our money system?
While banks provide loans for mortgages and overdrafts, if you need a loan for capital improvements you have to find investors. Who are they? Surely, none other than those who over a thousand years have accumulated in the form of rents. These investors have the power to refuse, and have not a common interest with the borrowers, and will exact a price for their co-operation. As they generally do not want to be bothered with running the project, they will favour a limited company set up, limiting their risk to the amount lent.
So the interest rate expresses the power that lenders have over borrowers, balance by the lenders desire to have a return on their investment.
What money has to do.
The money supply, measured by M4 is now enormous. Some large percentage of it is the result of lending to those who wish to buy a house. Unfortunately these houses sit on land, the price of which has ballooned due to the same cause, not collecting the proper source of public revenue. Not only is the price high, but also it takes a long time to repay the loans. The increase in money supply closely mirrors the increase in land prices.
What follows is a set of slides to illustrate the enormous task that money has to fulfil. Enormous because of the conditions at the point of interaction, conditions that we, the people, have set!
The value of work has been enhanced by all the factors names above, so that now it is many, many time what would have been produced in a simple agricultural community.
The producy of work is distributed among three claimants.
And further re-arranged as the three claimants spend the money.
The final slide shows the relationship between money in circulation and the functions of the banking system.
The situation we face is daunting. We have a wholly dysfunctional tax system. As it largely attaches tax to wages, the cost of wages has become twice value of the reward for work, taking into account both direct and indirect taxes and National Insurance contributions. This means that an employee has to be able to add value by his work at twice the amount he gets for his work. Not all can do this and some are unemployed as a result. A further result is that our exports become uncompetitive.(6)
The state then has to step in to provide housing and food etc for the unemployed, so that taxes have to rise, creating more unemployment. The limit of taxation by this means has been reached, so that government has a deficit. This is finance by loans, which incur interest, thus increasing the deficit.
Meanwhile the nation is further burdened by the demands for rent by those who control the land. This is nothing more than a transfer from those who work to those that do not. But this rent is produced by the nation through its activities and the provision of infrastructure, and is seen by us as the natural source of public revenue. But as it is diverted to those who control the land, it acts as a stream of revenue outside the reward for work, and accumulates. The collection of rent in private hands is the source of the finance that government needs to cover its deficit. Thus a system of DEBT is built up, aided and abetted by the debt that those who work must undertake to obtain a house to live in.
The pressure on house prices ensures that they will continue to rise, reflecting underlying rents. This then brings a speculative boom, as those with funds buy more land, putting yet more pressure on wage earners.
We see the solution as being the collection of the rent of land as public revenue, and the removal of all taxes on work and enterprise.
There is a relationship between the rent of land and taxes. Looking at it from a historic perspective, first wages were forced down by rents until the horrors of Dickensian times. When these were exposed, taxation became necessary to relieve the poor, and this taxation had to come out of rents, as wages could not bear it. Thus if we reduce taxation rents will increase, thus increasing the flow of funds to the state as rent is collected. We need not fear that a “location value refund” would not be sufficient for all needs, but the incidence would change.
The incidence of current taxation is such as to do maximum damage to the nation by not recognising that different locations have different advantages.
This situation is also the cause of the way that our monetary system has evolved. Without curing this fundamental problem we are unlikely to improve the money system.
Bills of Exchange.
In order to better appreciate the Guernsey Experiment which follows, we should take a look at Bills of Exchange. Here is a standard definition;-
“An unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to or to the order of a specified person or to bearer.”
The bill of exchange is used to enable the seller of goods to receive his money before the buyer is in a position to pay. For example the delay in payment may be due to the goods being in transit, or the buyer may have to process the goods before he can re-sell them.
The process is that the seller types out the bill and signs it. Then he sends it to the buyer who “Accepts” it by signing across the face of the bill, indicating where it will be paid, ie at which bank. It is then returned to the seller who endorses it making it payable to a “Discount House”. He sends it to the discount house which will pay him the proceeds less a discount representing the delay in receiving the money from the buyer. If the buyer is not well known a further step is inserted by the bill being presented to an “Acceptance House” which will add a “great” name for a small extra fee.
Here is an example.
Before the advent of modern banking bills were the main way of obtaining credit, and they were extremely flexible. An understanding of how they work explains how the Guernsey Experiment was so successful.
The Guernsey Experiment.
Background “At the beginning of the 19th Century, after the Napoleonic Wars, the Island of Guernsey was in dire straits. Apart from the natural beauty and pleasant climate, there was precious little else to attract visitors to the island, or indeed, to keep her inhabitants from removing to the mainland. The deep roads were mere cart-tracks, only 4ft. 6ins. wide, which in wet weather became muddy rivers between steep banks. The town was ill-paved and unattractive, and there was not a vehicle for hire of any kind on the island. There was no trade, nor hope of employment for the poor. Worst of all, the sea was fast encroaching on the land, and washing away large tracts of it, thanks to the sorry state of the dykes. The States Debt of £19,137 bore an annual interest charge of £2,390; the annual revenue was only £3000.This meant that while vast sums of money were required to save the land from the sea, and make the island fit to live in, the net revenue from all sources was only £600 per annum. The dyke project alone was estimated at over £10,000.In 1815 the need for improving the Public Market, which then provided neither cover nor shelter, became pressing, and a Committee was duly appointed to examine the matter. It was found that further taxation on the impoverished island was impossible. The alternative, that of borrowing money from the banks, would incur debt charges at a high interest rate, which they could not afford. It was abundantly clear that whatever they might borrow, although they paid interest charges for years, would never be repaid.
(from Olive and Jan Grubiak “The Guernsey Experiment” 1960)(7)
The island had an autonomous government, “the States of Guernsey.” So it had the rights inherent in all sovereign government, among other rights, that of regulating the volume of money in circulation in the country. But, no more than any other country, the States of Guernsey had thought of exercising this sovereign prerogative.
The island was especially in need of a new market house, and a committee was set up to take care of it. The committee went to see the governor to explain the situation to him:
“We need a new market, but we have no money to build it.”
“With what material are you going to build a market?” asked the governor.
“With stone and wood.”
“Do you have it in the island?”
“Certainly, and in plenty.”
“Do you have workers?”
“Yes again. But it is money that is lacking.”
“Could not your parliament issue money?” asked the governor.
A new idea! (from Louis Even “Guernsey’s Monetary Experiment” P2P) (8)
Finally, after grave deliberation, the Committee reported in 1816 with this historic recommendation – that property should be acquired and a covered market erected; the expenses to be met by the Issue of States Notes to the value of £6000.
The fullest account of what happened that we have is by J Theodore Harris BA, with forward by Sidney Webb, 1911.(9)
It appears that the man behind the whole operation was Daniel de Lisle Brock. Born in 1762 to an established Guernsey family, educated at primary school, then to learn French from a Swiss pastor in Alderney, then at a school in Richmond, Surrey. At age 14 he was called away to travel with his father in France, and when his father died in 1778, he travelled, eventually returned to the island, and was elected “jurat” in 1798. Between 1804 and 1810 he was deputed by the royal court of Guernsey to represent them in London four times. In 1821 he was elected bailiff, or chief magistrate, and continued representing the island with conspicuous success. He continued as bailiff until 1842 when he died, with a public funeral.
We can assume that he knew all about bills of exchange, and may have been aware of Napoleon’s famous dictum, “While I live I will never resort to irredeemable paper!”
In order to assist with finances a duty on spirituous liquors was imposed in 1814 and renewed in 1819 for ten years with the proviso that £1000 be used each year to reduce the States debt. It was then renewed for 15 years in 1829. This formed the security for the issue of States notes. In 1816 they issued £4000 in States notes, repayable as to £1500 on 15.4.1817, and £1250 on 15.10.17, and also on 15.4.18.
What this means is that they could be used by the States to pay wages and for materials, but the notes would be retired on the above dates. So the notes would circulate and as the retirement date came nearer they would only be acceptable to those who owed money to the States, which would then cancel them. “In this manner” they said, “without increasing the debt of the States, we can easily succeed in finishing the works undertaken, leaving moreover in the coffers sufficient money for the other needs of the States”.
They kept meticulous records of how many notes were retired, calling them “Notes to bearer of £1”. With this success behind them they made further issues of notes, but they were not dated, they now identified which States receipts were to be used to cancel the notes.
In 1817 they bought the site of the proposed covered market for £5000 with a loan at 4.5%. The plan for improving the market were agreed at £5500, to be financed as to £1000 already coming from the duty on spirituous liquor, and £4500 in twenty shilling notes. The provision for repayment was
“The 36 shops , built for butchers according to the plan recommended would produce at £5pa, £180 From this must be deducted £20 for hiring the house at the corner and £10 for repairs, £30 , leaving £150, The States should grant for 10 years after the first year £300, this would give an income of £450. This sum would be spent each year in paying off and cancelling as many Notes.”
And it was noted that at the end of ten years all the notes would be cancelled but the income of £150 would continue to accrue to the States. The result is the picture below, showing the date of 1822.
The next issue of £4000 was to pay off the loan, saving interest of £225pa, taking into account the aforesaid £1000 from liquor duty. Further issues followed, to improve Rue de la Fontaine, build a College, and more, until by 1837 £80,000 had been issued and £55,000 were still in circulation. At each stage the means of repayment were identified and put aside for the redemption process.
Thus the equivalent of some £3.5 million in today’s money was financed entirely interest free. Needless to say, Mr Brock had to deliver a speech at the House of Lords to justify his policies, and succeeded! Part of his speech dealt with the attractiveness of St Peter Port brought about by the scheme. Some £220,000 came into the town by the building of houses, and the increase in trade. Population increased from 20,302 in 1821 to 26,649 in 1824.
In 1837 the scheme was brought to an end. Two private banks had been set up, and had threatened to flood the town with extra cash. The history simply records the agreement that £15,000 of the notes would be withdrawn, leaving £41,318 in circulation. The banks agreed to honour and use these notes and to pay the States £10,000pa to complete the redemption. Brock’s letter of agreement follows;-
What can we learn from it?
From our earlier discussions we arrived at the conclusion;-
Natural law in relation to money includes;
It is issued by being accepted in exchange for goods and services
It is cancelled by the supply of goods and services to the issuer
If not redeemed in this way inflation will follow.
In the Guernsey case they took great care to identify and actually redeem each issue. The States spent, not lent the money, so they had to deal with redemption. They were familiar with the result of non-redemption of Assignats, and they knew how Bills of Exchange are used to enable the seller of goods to receive his money before the buyer is in a position to pay.
Could we do this today?
Yes, but there is a snag. Infrastructure improvements give benefits but most of it lands up in the hands of those who control the land. So, we pay for them twice, once by taxation, and secondly in rent increases. The story of the extension to the Jubilee Line in London makes the situation quite clear.(10)
We saw in the Guernsey Experiment that they relied on the rent of butchers’ shops to assist with redemption. But the States owned the site.
So let us consider, suppose we did find a way to recover to the community that which the community creates, by some sort of “location value refund”. And we had removed all taxes on production. The price of land would be removed thereby, and the money supply could revert to a more natural base, probably one quarter of the present total. The accumulation of debt would cease. Banks would kick the habit of lending on security, and assess risk instead. And a house could be bought for the price of a house!
But financing infrastructure would be so easy, as it would be self-redeeming! Providing it was wisely spent, it would work just like the bill of exchange. Pay in advance for work and materials, and an increase in the location value would follow as night follows day. That would really be Peoples Quantitive Easing!
St Peter Port, Guernsey
The Necessity of Debt
I would like to attempt a summary of how we come to be in so much debt, both personal and nationally.
We might come at this by a consideration of the distribution of Added Value.
Why do people work?
We work to satisfy our needs and desires. That is the need for food, clothing and shelter, and also the means to make our work more efficient. And on top there is a whole host of desires, and we may balance the willingness to work against the strength of our wants.
So the population works, or most of them. A result is achieved which is sometimes called Added Value. The claimants for the Added Value have come to be Wages, Taxation, Rents and Interest.
Wages are largely spent on living, and some saving. Taxes are spent by our government, and they usually do not have enough taxes to meet the spending needs.
However Rents are in different category. Here we mean the rent of land, as the rent of buildings and equipment has already been deducted in arriving at Added Value.
The rents of land are a direct transfer from those who work to those who do not. So it transfers wealth steadily from the poorer to the richer. This is the prime cause of “bad” inequality, distinguishing it from inequality arising from the amount of work a person is prepared to do, and his/her talents.
But it results in accumulations of wealth with no object for it to be spent on. But we still have a desire to make our work more efficient. So we are prepared to borrow.
Coupled with this, the power to charge rents for land arises because we have allowed ownership of land. The land becomes valuable. So to find a place to live, it is necessary either to rent or to buy land. As we need shelter, again we must borrow.
The debt accumulates just as fast as the wealth accumulates. Neither is real!
A look into the future?
Let us suppose that we have come to realise the force of natural law, and decided to collect location value and eliminate the disastrous tax system we had in its place. The transition has been tricky, as we have had to unwind so many unnatural results of the old system. So here we are thirty years on. Why thirty? It has taken a generation to deal with the disastrous effects of a wholly dysfunctional tax system. By now, we no longer attach the vast bulk of our taxes to wages. We have devised a suitable mechanism to collect location value, that is, that part of production attributable to the efforts of the whole community. The result of the efforts of individuals are retained in full – no tax deductions. The cost of living has come down by the cancellation of most indirect taxes – VAT, customs duty and all the rest. A great rebalancing has taken place. The general level of wages has risen to the maximum available from the best site still available for use. The accumulation of wealth in the hands of those who thought “this land is mine” has been stopped in its track.
As public revenue was gradually collected, the value of land has fallen, and now has no private value. Landowners still have their land, so long as they pay the appropriate annual charge, but land is no longer counted as wealth. A house can now be bought for the price of a house. Mortgages have fallen to a small proportion compared with the old basis. The level of debt has plummeted, and the money supply likewise. Those who took out mortgages when they had to purchase the land as well as the house have been encouraged to honour the debt they took on, and many find that the increase in wages makes this possible. But also a debt forgiveness scheme has been set up, whereby those whose accumulated assets arose partly or wholly from land appreciation before the changes can voluntarily hand this to the scheme, which is used to reduce all old mortgages pro-rata. This has become possible following the realisation that land is a free gift, without which the changes noted above would not have been possible.
After about twenty years, government expenditure began to fall as some parts of the welfare state became unclaimed. It was found that location value was buoyant as the cancellation of taxation added to it but impacted on city centres instead of marginal areas. For some years is has been possible to reduce government debt, and there is speculation about what might be done with a surplus in future. But much infrastructure improvement has been funded, and the fact that this is speedily paid for by an increase in location values has created a wholly different attitude.
The ownership of assets is now much more even, so that partnerships replace limited companies. Interest payments become irrelevant as common interests prevail.
The suggestion is that society has made just one simple mistake, the consequences of doing so have magnified enormously as the years passed.
Is it really true that so much reform can follow one simple return to natural law?
- (1) Fiat Money Inflation in France, Foundation for Economic Education Inc 1959
- (3)The Ascent of Money by Nial Ferguson Allen Lane ISBN 978-1-846-14192-8
- (4)Write-offs of loans by banks and building societies Table C2.1 NSO
- (5)http://www.outersite.org/interest-and-inflation-free-money-extracts/ Comparison of interest paid & gained
- (6) http://landisfree.co.uk/-16.pdf
- (7) The Guernsey Experiment, leaflet Omni Publications USA 1999.
- (9) An example of communal currency, the facts about the Guernsey Market House A 1911 book on the Guernsey experiment
- (10) https://books.google.com/books/about/Taken_for_a_ride.html?id=VfW3..