John Tomlinson

A Challenge to Banking

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SECTION TWO - Honest Money

Sound Money

Once the production of new units of money by the banking system had ceased, and once sufficient notes and coins to repay government debt have been printed, and once forgery is adequately controlled, and once governments and Central Banks are prohibited from producing new notes and coins - even for foreign exchange transactions - except to replace damaged or worn ones, there will be no means of expanding the paper money supply. Money will then seek its own realistic level of exchange value.

The new notes and coins minted by the government will cause an increase in the money available for exchanges, so there will be one further decrease in the exchange value of money. This means one further round of inflation. After that, there will be no more debasement of the currency - and thus no inflation to follow in its wake.

To what extent will this minting of new notes increase the money supply? Perhaps an exercise I did some years ago can shed some light.

In America, as of June 1985, total government debt stood at approximately $6,525 billions. The money supply, including both cash in circulation and bank deposits, stood at $3,136 billions; less than half the government debt. There, if none of the government debt were owed to banks and the newly minted notes and coins went directly into circulation, the money supply would increase about three times to $9,661 billions. The United Kingdom presents a similar picture. As of the same date, the money supply stood at £138.5 billions, while total government debt was £170.7 billions: the money supply in the United Kingdom would increase at most 2.25 times.

To the extent that the government owed money to the banks, the newly minted notes and coins used to repay the banks would be placed in the banks' vaults and would be available to be claimed by depositors. They would become part of the previously measured money supply and so the size of the increase would be less. The repayment of government debt has another important benefit. Once new coins have been minted to clear the debt, governments will no longer need to service their debts. No interest payments will be required. Their budgets can be significantly reduced. This will benefit all taxpayers.

Having by these processes established a stable, limited, money supply, it is important to remind ourselves of how the boundaries of exchange value are set. Natural human self-interest might well, at a time of concern about the value of money, discourage people from holding it. The resulting lack of demand could push the value of money below its realistic level. Many might then not want to hold money. Demand for it could fall further. But demand for exchanges cannot go below the level required for the survival of the population. Therefore the demand for the medium of exchange will also have a minimum level. With a fixed money supply the minimum level of demand for money would, in due course, be discovered.

Of course, there is also a concern about how high the value of money can go. To avoid hoarding as the value of money increases, thereby reducing the amount available for exchanges and forcing the value of money even higher, substitution can be encouraged. If substitutes are legally acceptable as currency, the demand for money will be reduced by the amount of the substitutes accepted in exchanges and the upward pressure on the exchange value of money will be accordingly reduced.

Under normal conditions, as time progresses, both population and the expectations of that population will increase. This will lead to both an increase in the demand for money, and an increase in the norm around which the exchange value of a fixed money supply will fluctuate. The introduction of substitutes will help to avoid an increase in the level of this norm and thereby will help to promote price stability.

Control forgery and limit the minting of new money to the replacement of worn or damaged stock, and the total paper money supply will not be able to increase. Any increase in total bank deposits will be limited to that coming from private storage, or returning from foreign countries. These figures are accurately measurable and predictable within reasonable tolerances. By keeping a watchful eye on the total of all bank deposits, both domestic and foreign, those responsible for any currency should soon detect any leakage and its source.

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The processes of re-assessment

Once this non-money-lending fixed paper money supply system is established, two processes of re-assessment will occur: the value of money will be measured and reassessed in terms of goods and services and the value of goods and services will similarly be measured and reassessed in terms of money. Both processes will be part of each exchange transaction. Thus, the processes of reassessment will occur continually, every minute of the day, hour by hour, day by day, transaction by transaction.

Until the value of money begins to stabilise, there will no doubt be much more negotiation and haggling over prices in restaurants, shops and other retail outlets than there is now. Prices will not be fixed. The precise value of money will be uncertain. So, too, will the strength or weakness of the position of both buyer and seller be uncertain. In due course, however, the value of money will begin to settle and buyers and sellers will begin to recognise their respective strengths and weaknesses.

As people come to recognise that the value of money has begun to reach its bottom, some will begin to set units aside in the hope that their value might rise. Inevitably the value of money will begin to rise and prices will begin to fall. We will then be presented with a new problem: there are mechanisms in place for altering the prices of goods and services both upwards and downwards but there are no mechanisms for adjusting wages and salaries downwards when the value of money increases. This is an area which will need attention.

If your salary begins to buy more than it did, you will be delighted. The difficulty will arise if you are an employer. As prices decline, so too will the number of units of money received by the business. The exchange value received may be the same but the amount of money will be less. If the amount of money paid in wages and salaries remains fixed, employees will receive a greater portion of the wealth produced, profitability will be squeezed and the survival of the business will be threatened. In the processes of negotiation which will naturally follow, the interdependence of manager, employee and shareholder will become more obvious. Out of this recognition can grow mutual respect and co-operation.

From the perspective of those of us who might wish to put something aside for the proverbial "rainy day", we will no longer be able to avoid real decisions by using debt as a method of storage or investment. We will have either to store our money, or exchange it permanently for something else. Storage and distribution will become a more expensive option than currently.

Banks would no longer have the benefit of interest income to carry most of their operating costs. They might gain some income from brokerage fees on share exchanges and for other financial services which they might choose to offer, but these will not fully replace interest income. So, in addition to having to become more efficient, full storage and distribution charges will have to be introduced. Leaving money in a bank will become an expensive choice.

Equity investment will prove a more attractive option to most of us, whether it be in shares, a partnership, our own business or simply buying a commodity, a product or a property which we believe will increase in value. Those of us who receive dividends from our investments will also be more likely to invest it in equity investments rather than to store it. Thus, the portion of the money supply which seeks investment will be constantly being renewed and measured against the investment opportunities on offer.

There will be a continuous flow of capital seeking equity investment. Either it will go into new ventures, commodities, products or properties or it will be used to buy existing ones from previous equity investors. In the latter case, the previous equity investor who sold will then have the money and will face the same choices. The net result will be a continuous flow of new capital available for new equity investments. Sustainable economic growth is a natural result of an equity-based economic and monetary system.

Nevertheless, some will wish to store money itself for future use. They will either pay the rate for storing it in someone else's facilities or they will provide their own. This private hoarding would cause a decrease in the amount of money available to service the existing level of exchanges. Demand for money will then increase. As a result the exchange value of the money will increase and prices will fall.

The decreasing prices will produce two separate effects. The first is that it will draw units of money back from savings. Some who have stored cash will want to take advantage of the increased purchasing power gained during the period of storage. As they bring money from storage and use it in exchanges, the amount of money available for exchanges will increase. The value of money will then fall and prices will increase.

The second effect is, as we noted earlier, that it would draw money substitutes into the market-place. When the exchange value of notes and coins increases and individuals are tempted to store or hoard their money, each will need to find something else to use for exchanges. Substitution will occur. No doubt some will use gold in exchanges. Others will simply barter their own products or services. Perhaps barter will become a more common practice once again. In any event, in due course, some other products will become commonly acceptable as media of exchange. Each of these practices will allow the money supply to expand at whatever rate is required.

The net result of all of these processes will be the establishment of a norm around which the value of units of money will fluctuate. As greater experience is gained by all involved in these new market activities, a tendency to narrow the range of the fluctuations will grow. In time this will promote genuine and sustainable price stability.

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New function for banks

The changes in the law which are proposed will not themselves lead to the closure of any banks or the system as a whole. There are still valid and important functions to be performed. The need to store money safely and to distribute it efficiently with minimum risk will continue. Depositors wishing to exchange their money for shares will need to be brought together with those seeking capital. The existing staff in most branches of most banks are in the best position to assist in each regard in each local market as well as to provide both information and connections through their national networks.

At the same time, through the conversion of debt to equity, banks will have themselves become large holders of shares. Much of the loans which they had previously issued will have been converted to shares whose value will need to be determined. This valuation will, in turn, help to determine the value of shares in each bank which will now be owned by many previous depositors. In each respect, existing banks are a logical place to begin to develop the new market for shares which will emerge as a result of those who suddenly find themselves with shares when they need cash and those who intend to invest rather than to store money.

The natural activity of the market-place will also begin the process of measuring the exchange value of goods and services more precisely and more accurately. The alternative to exchange is storage: those choosing to put their money to work rather than pay the cost of storage will exchange it for a share in a business venture, a property, a commodity, a product or a service. Each carries risk. So each potential investor will need critically to examine the merit of each potential investment.

The permanency of exchange requires careful judgements about present and future value. Products of poor quality with built-in obsolescence are unlikely to maintain their value in terms of either investment or consumer acceptability. Quality and durability will need to be more accurately assessed.

The arrangements which the proposed system would require to finance housing illustrate the need for critical judgement. Debt investment, or mortgages, would no longer be an option. Those wishing to purchase a home would have to seek co-owners on an agreeable shared-ownership basis. Each of the co-owners in a particular house, whether they be an individual or a company, would own an exact portion of that house. The resident owner would pay the appropriate rental to each other owner. There could, if required, also be an agreed programme between the resident owner and his co-owners by which he could purchase from them additional equity, eventually owning his own house completely.

Whatever the arrangement, the value of each co-owner's investment would depend on the value of the house. If its condition deteriorated, each investor would lose. Investors might well be very chary of many of today's construction practices. The use of green soft wood which warps and deteriorates over time may not be acceptable to the critical investor. Construction materials which have proven the test of time will be sought after. Their use will assure the investor that his investment has less risk of deteriorating and thus less risk of losing value. Similarly, owner-occupiers who have a reputation for caring for their properties will be sought after. Those who do not care for their properties and have a reputation for neglect will find it hard to raise equity-based finance.

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New perspectives

Every product, every service, every commodity, every bit of land, will be viewed from this new and critical perspective. Each and every individual will also continually have to re-assess the size of the unit of measurement of exchange value from his or her own perspective. That measurement will then need to be applied to the products of his or her own energy.

Each different measurement will have an effect on another. The resulting changes will work their way through the market-place. The dynamic of change will be considerable: continual re-assessment in the light of changing conditions and priorities.

The extent of the interdependence of owner, shareholder, manager, employee, supplier and customer will be more readily apparent. Each business will be a joint venture. The individuals in its component parts will act with self-interest. Continuing co-operation at all levels of business will be vital to continued prosperity.


World-Wide Changes
Applied on a world-wide basis, the conversion of debt to equity can also resolve the international debt problems.

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