Tuesday, July 16, 2024

Draining the Swamp : Permanent Money & 100% Reserve Banking


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By Kitdor H. Blah

In the article “Draining the Swamp” dated 2nd July, 2024, I had defined the swamp as the rising public debt, rising fiscal deficit, bloated government budget, rising taxation, rising inflation, recessionary cycles, and a currency that is collapsing. I had pinpointed the root of this problem as the two ways in which money is created – government borrowing from the Central Bank, and minimum reserve lending by commercial banks. I had shown how this system of money creation makes it necessary to perpetually increase the flow of debt, which means that public debt and fiscal deficit must perpetually rise, which also means that taxation must also rise to keep the fiscal deficit in check to an extent. Since the perpetual increase in the flow of debt means more money in the economy, therefore inflation must also continue to rise.
All these factors mean that government budgets are already bloated. Furthermore, because money is created as debt, the increase in the flow of debt causes economic boom, and when the flow of debt is constricted, the decrease in the flow of money causes recession or bust. Thus, this system creates the business cycles of booms and busts, and also allows for this cycle to be manufactured. Lastly, I had shown how the minimum reserve system of banking puts the citizens’ deposits at risk of being wiped out under the burden of huge loans or NPA’s. If the banking system fails to contain NPA’s, it would eventually fail to make good on paying the depositors’ money. And if the big corporations fail to make good on paying their big loans, they would burden the whole banking system with huge NPA’s. If they were to fail, a huge chunk of the citizens’ deposits would be wiped out.
The only way to prevent this is to refinance this debt burden perpetually. So this minimum reserve system creates an ever increasing burden of debt on our deposits. The longer it takes to crash, the bigger the crash will be. So we can imagine the burden on resources, the consumerism culture, the toll on the environment, the waste generated, the need to buy and produce far beyond necessity, just to keep the system from crashing.
Many people, including some economists, scoff at the idea of a financial collapse. But to get into that debate, we must first properly define this term. What does a financial collapse really mean? Does it mean nationwide or worldwide poverty? Does it mean an economic tragedy for each and every citizen of the country or the world? I think the best way to define a financial collapse is as the greatest transfer of wealth from the poor and middle class and upper class to the super wealthy. When the currency collapses, the daily wage earner becomes non-existent; the middle class person with savings and no assets becomes extremely poor; the upper class person with a few assets will have some buffer against the loss of value of his money, since assets serve as a sponge that absorbs the value that is lost from the currency. But it is the big business corporations whose wealth is mostly measured in assets, infrastructure, commodities, or industries, and less in currency or money that will have absorbed most of the value that is lost from the currency. In other words, the ones with real assets, commodities and industries will profit and the ones with only currency or savings will be impoverished. But this is already a reality today with inflation. People buy gold or property as a hedge against inflation. The very poor and daily wage earners do not have this luxury. So, inflation affects the daily wage earners more than the gold investors. Inflation which is caused by our debt based monetary system, has slowly transferred wealth from the citizens of all classes to the big corporations and industrialists. Inflation should be seen as the silent, gradual and hidden version of the eventual collapse of the currency.
Therefore, a financial collapse is nothing but the logical conclusion of inflation. It is the ones who build their wealth on debt, and continue to have access to huge debt, who will benefit from the system, but at the cost of the value and the security of the citizens’ savings. A financial collapse is simply that which will cause the greatest and most drastic wealth inequality ever.
So, what is the solution? How do we drain this swamp? First of all, we must recognize that the issue is not that some people built their wealth on debt. The issue is not even that some people have a more privileged access to debt. The problem is that they do so at the cost of the value and security of the citizens’ savings. There are some radical solutions that people have proposed. The one at the forefront is crypto currency. Bitcoin is already legal tender in the country of El Salvador. Sure, Bitcoin is not created as debt, nor is it created out of the minimum reserve banking system.
What citizens deserve is a stable currency that will act as a stable storage of value for every hour of work they put in. What citizens deserve is that the work they do will be reflected in a stable currency in which they can save all their hard earned money, and not get robbed by inflation, financial collapse or taxation. Bitcoin is not a stable form of money to this end. Of all forms of money, it is the one that is most drastically influenced by the environment, just like the stock market. Crypto-currency, like stock trading, is not a serious form of money. Like stocks, it is a speculative investment.
Some have proposed digital currency. The idea of a digital currency is to eliminate cash. In fact, the Bank of England and the Reserve Bank of India have started the Central Bank Digital Currency. This eliminates the cash crisis that banks must face in case their loans go bad. It also means that the banking system is constantly recapitalized. Since deposits serve as banks’ capital, every time money is withdrawn from the system in the form of hard cash, the system loses capital. By eliminating cash, a digital currency allows for banks to constantly be recapitalized every time money is created from the minimum reserve banking system. This will help the banking system meet its capital requirements as recommended by Basel from time to time. In fact, this is exactly what Demonetization did. Demonetization ensured that all the cash came back into the banking system, and withdrawal limits were also imposed to ensure the deposits stayed in the system, and no frills or zero balance accounts were also quickly made into Rs. 200 or Rs. 500 minimum balance accounts, all to recapitalize the banking system.
A digital currency will achieve to the maximum what Demonetization was intended to do. In fact, if we look at our country, we would see that the cashless payment systems really got a momentum from both Demonetization and COVID-19. But a digital currency is only a cosmetic solution, to prevent a banking cash crisis, to ensure deposits remain in the system, and to help with the deposit-credit ratio of the banking system. It will not drain the swamp in any way.
Some, like the author Harvey Francis Barnard, who wrote the book, “Draining the Swamp: Monetary and Fiscal Policy Reform,” which is the inspiration for the name of this article, have proposed a bi-metallic system of money, that is, a return to gold and silver as legal tender. But this is not a viable solution. Under a bi-metallic system of money, he who has no gold or silver suddenly has no money. Those who have saved in currency will have to convert their currency into silver or gold, which are already rare commodities. Gold and silver cannot absorb all the bloated amount of money in the economy.
What about a bi-metallic standard of money? Under this system, every unit of currency is based on a unit of gold or silver. For example, every Rs. 5000/- worth of currency may be backed by 10 grams of gold. This would stabilize the value of currency according to the amount of gold, so governments cannot inflate the current at will. This would definitely protect our savings against inflation, but since it is so rigid, the government may be forced to borrow from the market and raise taxation in order to meet its spending. Moreover, such a transition is no longer possible because of the bloated amount of currency and money already created in the economy. If this system is adopted, the price of gold would sky rocket because the inflated amount of money has to be absorbed by this limited commodity. This would create drastic wealth inequality between those who have gold and those who do not. There are other novel proposals by innovative people like a land backed currency, or a credit barter system.
The solution does not need to be too radical. Since the problem is rooted in the simple fact that money is created as debt, we can simply eliminate the two ways in which money is created as debt – that is, government borrowing from the Reserve Bank of India and the minimum reserve banking. In the first part of this article, I mentioned that coins are permanent money created by the government. We can expand this means of money creation and create debt free permanent money in the form of currency notes under this same legal power.
This one small change will eliminate the perpetual increase of public debt and fiscal deficit. It will therefore check inflation as well as reduce taxation. And in order to secure the citizens’ savings, the government can simply eliminate the minimum reserve system, and bring in a 100% Reserve Banking system, so that the citizens’ deposits are always secured, regardless of the huge loans of big corporations or the big NPA’s of the commercial banks. With these two simple steps, we can keep much of the current system and do justice to all citizens. How this transition can be done requires an ingenious and common sense approach, which may be the subject of another article.


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