As Gordon Brown struggles, on the eve of his Budget, to balance the unbalanceable – a job that was difficult enough even before we went to war with Iraq – a glimmer of an idea is emerging about how to pay for railways, postal services and all the other public service demands that crowd in upon him. It sounds like the search for Atlantis or for zero-point energy – and conventional economists say it’s even more mythical than that – but there is a flurry of interest among backbenchers about a proposal for a new source of public finance.
The proposal is very simple – and heretical. It is that the government – or rather the Bank of England – creates the money to pay for hospitals or the London Tube but charges no interest for it. The only requirement is that it be paid back. Having done its work, the money is withdrawn from circulation.
There is then no need either for the private finance initiative – the controversial PFI, with its vast payments to financial intermediaries – or for government borrowing, with its debt burdens to future generations.
An outlandish idea? “If the government can create a dollar bond, it can create a dollar bill,” said Henry Ford in 1921, proposing a scheme of this sort to finance dams in the Tennessee Valley. In 1914, David Lloyd George, then chancellor, issued Treasury notes to stave off a banking collapse. In 1933, the Yale University economist Irving Fisher – who invented inflation indices – proposed that money should no longer be based on debt.
The Labour MP David Chaytor – who has put down an early day motion on the subject – points out that as recently as 1964, 20 per cent of the money in circulation was interest-free, government-issued notes and coins. The equivalent figure today is 3 per cent.
Interest payments account for a third of the cost of some major projects, and they are the biggest single item of national spending after pensions. To create interest-free cash, therefore – today in electronic form, rather than as old-fashioned notes and coins – is a chancellor’s equivalent of alchemy. The traditional economist’s objection is that when governments create money in this way, inflation inevitably ensues.
But is this true? The answer goes to the heart of an issue that – strangely, given the vast sums we spend on economic research – almost nobody talks about. Where does money come from in the first place?
This hangs on obscure definitions – most of us dimly remember them from the early Thatcher era – that have become the 20th-century equivalent of angels on a pinhead.
Some money is created in the form of notes and coins (known as M0) issued without interest by the government via the Bank of England. This is dwindling fast because it is so inconvenient. One UK bank recently found itself saddled with six million 50p pieces it didn’t need, and seriously debated putting them in landfill. The rest depends on what you include; but most is created by banks in the form of mortgages and loans – including loans to the government – which eventually have to be paid back plus interest.
Banks can lend many times over the money that is deposited with them – as long as they observe the rules set by the Bank for International Settlements in Basle about how much they need to keep on deposit.
In other words, banks create money all the time. And the process by which they do so, as John Kenneth Galbraith ob- served in 1975, “is so simple that the mind is repelled”. Galbraith added: “Where something so important is involved, a deeper mystery seems only decent.”
But there is no deeper mystery. The banks just do it and make a handsome profit out of it – about £21bn a year, according to the former Inter-bank Research director James Robertson.
Issuing interest-free cash would only be inflationary if money were a finite resource. As it is not, replacing interest-bearing loans with free money might even cut inflation. “The share of interest-free money – cash and coin or M0 – has fallen dramatically compared with the total amount of money in circulation as a proportion of GDP,” says Austin Mitchell, the Grimsby MP who also tabled a Commons motion on the subject. “The power to issue credit,” he adds, “has effectively been privatised to the advantage of the banks, but to the detriment of the economy.”
These ideas come not just from rebel Labour backbenchers but also from campaign groups, websites and books on both sides of the Atlantic.
They are all driven partly by an awareness of the debt crisis but also by frustration with both private and public borrowing as a source of funds for public projects. More than 20 MPs – Labour, Liberal Democrat and Plaid Cymru – signed the Mitchell motion. In the US, Congress has before it a draft bill proposing that the Federal Reserve creates $72bn a year as interest-free loans for local infrastructure projects. The draft was tabled by a Republican congressman from Illinois, Ray LaHood, and was backed by more than 3,300 local authorities and four states, mostly from the Midwest – the region traditionally associated with money reform agitation a century ago.
The Forum for Stable Currencies has been meeting monthly in the House of Lords for two years now, attracting leading figures from the world of small business and across the political spectrum – and presided over by the pipe-smoking Lord Sudeley, chairman of the Monday Club.
Other reformers meet at an annual jamboree in the Midlands known as the Bromsgrove Group. The Green Party’s economic policy is based on similar ideas.
We have been here before. The issue of who creates money lay behind the rise of social credit, following the book Economic Democracy by Major C H Douglas, published in 1920. Despite the opposition of the Fabians at the New Statesman, Douglas by the 1930s was able to command stadiums full of supporters in Australia and Canada, as well as in the UK. An estimated 90 million tuned in to his radio broadcasts in the US, and two Canadian states elected social credit administrations. One stayed in power in Alberta until 1971, prevented only by the courts from pushing through its promise to give a monthly dividend of $25 to every citizen.
In the UK, a breakaway wing of the Boy Scouts formed itself in the 1930s into the Social Credit Party – much to Douglas’s horror – and marched, in those Blackshirt days, as the Greenshirts. The man behind the party, John Hargrave, became notorious just before the war when a green arrow was fired into the door of No 10 Downing Street. When he lost his deposit in Stoke Newington in the 1950 general election, he did a David Owen and wound the party up. Social credit petered out in anti-Semitism and paranoia: for some reason, those who believe there is a conspiracy of bankers seem to be only a hair’s breadth away from believing that it’s a Jewish one.
The conspiracies are still there on the internet: both Abraham Lincoln and John F Kennedy are supposed to have died because they were poised to take on the banks. But the Social Credit Secretariat, which still exists, based in West Yorkshire, has rejected anti-Semitism and is now undergoing a revival. Social credit proposes the complete centralisation of the money supply. It is hard to see how this would ever be enacted, even if it was desirable, but what’s the problem with putting more interest-free government money into circulation?
The conventional answer is that the requirement to borrow and to pay interest provides a discipline on governments and big public sector projects. Without this discipline, governments simply delude themselves about how much money it is wise to create.
But it’s an expensive discipline: investors in the London Underground expect to make about £2.7bn over the life of the public-private partnership, in return for investments of just £530m – and a third of that will go to financial intermediaries.
Nobody could possibly argue that that is financially efficient. It is quite easy to imagine something like the Bank of England’s independent monetary policy committee – which at present decides on interest rates – applying some kind of discipline on the government’s creation of money, at far lower cost.
“New money” may be an idea whose time has come. It could provide a rallying point for radicals desperate to come up with anything to prop up their struggling ideals of public infrastructure. At the very least, it is healthy that the fundamentals of the money system should be open to debate again.
“The world is full, on the one hand, of monetary cranks each with a patent panacea for setting all our ills to rights,” wrote the influential New Statesman economist G D H Cole. “And, on the other, of orthodox economists, so alarmed at the cranks’ proposals as to be wholly unwilling to make any new discoveries at all, for fear of appearing to sanction some of their notions.”
After half a century of silence, new discoveries are now rather badly needed.
David Boyle, editor of The Money Changers (Earthscan 2003), is a senior associate at the New Economics Foundation