Nationalising money is an odd way to fix markets

Switzerland is voting on whether to rip up the rules of banking, but is it ready for the consequences?

One of Switzerland’s defining characteristics is its love of referendums – direct democracy in action. Many of these votes are on relatively obscure – or seemingly trivial – matters, a description which might seem to apply in spades to one of the two national plebiscites scheduled for this weekend. Yet the apparently arcane nature of the subject matter is in this case deceptive, for it speaks to a mass of seething, antiestablishment discontents and yearnings which are very much of our time and not at all uniquely Swiss; it’s called Vollgeld, or the sovereign money initiative.

There is no simple way of explaining the issue, so it is perhaps best to start by setting it in the context of the Global Financial Crisis, the start of which is coming up for its tenth anniversary. Only now are the wider consequences of this calamity becoming clear. It was not just an economic disaster which destroyed trust in bankers and finance. It also undermined faith in liberal political and economic elites more generally, catalysing a process of alienation that has swept all advanced economies.

At the heart of this crisis was money, and more particularly the freedom that bankers enjoy in creating it. “It is well enough,” Henry Ford, arguably the most transformational businessman of the 20th century, is reputed to have said, “that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

Indeed so, because although you might think that governments and central banks are the ultimate arbiters of the money system, that’s not quite how it works. Private bankers are in fact the prime movers in the creation and destruction of money.

It’s amazing how many of us, up to and including some of the most senior bankers in the land, don’t properly understand this dynamic.

Here’s how it works. Every time a banker makes a loan, he must fund it with deposits and capital. Yet the loan itself is essentially new money which will end up in some shape or form getting deposited back in the banking system, thereby allowing the creation of further loans. Some might call it a Ponzi scheme. The only limits on this process of credit expansion are the banker’s instinctive fear of making a bad loan, and the fraction of deposits he is obliged to hold as reserves against the possibility that depositors want their money back – hence the term “fractional reserve banking”.

During the bonus-fuelled credit bubble of the 2000s, liquidity buffers were allowed to fall to dangerously low levels. When confidence collapsed, many banks had insufficient reserves to meet demand from depositors for their money back. Bankers went violently into reverse, contracting credit and therefore destroying money with the same disregard as they had created it. The economy cratered accordingly.

Thus far, policymakers have responded to these events by bailing out the old system, patching it up, and supposedly making it safer. Already the power of the banking lobby is beginning to erode the reform agenda.

What promoters of Vollgeld propose is an entirely new system, which by forcing bankers to back all deposits with central bank reserves, couldn’t be subject to runs, panics and solvency concerns.

It would therefore go some way to answering popular demand for radical change, at a stroke stripping the elites of their privileges and taxpayerfunded backstops, and tearing down what Michael Gove, no less, has this week called a rigged system that concentrates economic power in the hands of a few crony capitalists.

The Swiss, on the other hand, are much too sensible and cautious to vote for such an upheaval. There are two obvious drawbacks. The first is one of principle. Do we really want a system in which governments, rather than markets, are entirely in control of money creation? That politicians would do it better than bankers strikes me as deeply unlikely. The second is one of practice. The disruption in getting from here to there would be monumental, and as Franklin D Roosevelt concluded during the last great banking crisis in the 1930s when considering a similar proposal, scarcely worth the risk.

This might be hard to credit given recent events, but warts and all, fractional reserve banking has on any long-term perspective actually served us well; its rule has coincided with the most remarkable period of growth in living standards and output in history.

Nor, given advances in technology, does this any longer need to be a one or the other choice. The craze for alternative currencies such as Bitcoin has galvanised central banks into thinking about their own digital currencies, which like Vollgeld, would for the first time give ordinary depositors access to risk free central bank reserves. Bring it on.

Rarely do revolutions work out well. Much better the evolutionary approach, allowing the best of the old to be mixed with the shock of the new.

We can tear down the gates of mammon if we like, but what, pray tell, lies beyond?