by Felix Martin
A final principle relates to how to get to a system of money and banking reformed in line with these first two. The guiding rule must be that less is more. Conventional warfare will be an infinite regress: attempting to supervise the financial sector is a fool’s errand. The current regulatory proposals are correct that structural reform is the key. The trick is to set as few rules as possible and police them rigorously, while setting private initiative and innovation free for the rest. In the field of money—the greatest technology ever invented to liberate mankind’s entrepreneurial energies—this canonical rule of regulation is more necessary than ever.
Is there any realistic proposal for banking reform that answers to this daunting job description? Fortunately, there is—and it is not a new one. Eighty years ago, in the depths of the Great Depression, the great American economist Irving Fisher published a famous proposal with the inspiring title 100% Money.27 It was remarkably simple. Like the Scotsman’s strategy, it sought fundamentally to realign the balance of risks in the banking system. Like today’s regulatory response, it advocated doing this by restricting sovereign support to a limited range of activities. But it is simultaneously simpler and more radical. Fisher’s proposal was to require that any deposit that could be withdrawn or used to make a payment on demand be backed by sovereign money—and banks which offered such deposits be permitted to do no other business. “The checking deposit department of the bank,” Fisher wrote, “would become a mere storage warehouse for bearer money belonging to its depositors and would be given a separate corporate existence as a Check Bank.”28 As for the rest of what banks now do—whether client-facing or not, whether wholesale business or retail—these things would be treated like all other capital market activities, and the institutions that undertake them would neither enjoy special sovereign support, nor suffer special sovereign supervision. The market would decide what products would be offered, and what institutions would offer them. Outside the realm of “Check Banks,” even the dodgy promise of liquidity transformation would be permitted. If investors wanted to gamble on an intermediary’s ability to synchronise payments in and out of its balance sheet, they would be quite at liberty to do so—because there could no longer be any illusion on any side that such investors would be bailed out if the promise was not met.
Fisher’s proposal was taken up in the 1930s by economists at the University of Chicago, after which it became popularly known as “The Chicago Plan.” It was revived again in the 1960s by the subsequent Chicago luminary, Milton Friedman.29 Today, under the banner of “Narrow Banking,” it is being advocated once again by some of the world’s leading regulatory economists.30 It has even been the subject of a new study by the International Monetary Fund, which found that testing its consequences using a formal mathematical model strongly corroborates Fisher’s argument that it would lead to greater macroeconomic and financial stability.31
It is a reform consistent with the principles outlined above. The socialisation of financial risk would not be eliminated, but it would be far more strictly circumscribed. The utility activities of narrow banks would enjoy the support of the sovereign. No other financial institution would: and the clear distinction between narrow banks and everything else would eliminate the ambiguous no-man’s-land in which liquidity illusion and moral hazard have allowed the Monetary Maquis to thrive. Sovereign money would remain at the heart of the system, both as cash in the public’s pockets and as the only asset held by the narrow banks. Monetary policy, and with it money’s integration into the democratic organisation of society, would therefore be preserved. And finally, the necessary structural reforms are simple. The rules for narrow banks would be few but draconian, and anyone wanting a charter for a bank would have to abide by them. For anyone that does not want a bank charter, there would be no rules: just the ceaseless innovation which money itself unleashes, and which the financial sector has shown such a talent for exploiting.
John Maynard Keynes began the final chapter of the most important work of economics of the twentieth century with a realistic diagnosis of the situation seven years into the Great Depression. “The outstanding faults of the economic society in which we live,” he wrote, “are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.”32 Today, five years into another monumental economic calamity, it is the same outstanding faults of unemployment and an unjust distribution of economic risks that plague us. Money and banking, incorrectly understood, and so incorrectly configured, are what brought us here. Money and banking, correctly restructured, will be what bring us out again.
16 Taking Money Seriously
“So!” interrupted my friend the entrepreneur, “I always knew it!”
“Always knew what?” I answered.
“That you were a closet revolutionary. You don’t like capitalism or capitalists like me. And what your story about money boils down to is that you want to soak the rich and hang all the bankers from lamp posts.”
“Where did you get that idea?”
“Well, allow me to summarise your argument—or maybe I should call it your murder mystery. You said it would be an unauthorised biography. To me it sounded more like an Agatha Christie novel.”
“Oh yes? Who’s the victim?”
“Common sense—according to you. But let’s see if I’ve got it straight. You began by explaining that, contrary to first appearances, money is not a thing but a social technology—a set of ideas and practices for organising society. To be precise, you explained that in essence, money comprises three things: a concept of universally applicable economic value; a system of account-keeping whereby that value can be measured and recorded; and the principle of decentralised transfer, whereby that value can be transferred from one person to another. You used that story about Yap to show how absurd it is to think that coins, or any other tokens, are themselves money. And you used that story about the Irish bank closure to show that although money is usually issued by governments, it doesn’t always have to be. I bought all that—but then I asked you what difference it makes to take this view of things. You said a lot—which is why I’ve been sitting here listening to your so-called unauthorised biography.”
“Sounds fair so far.”
“Then you began to investigate these ideas that make up money—and especially the most important one: the concept of universal economic value. You explained that a dollar, or a pound, or a euro, or a yen is not a physical thing but a unit of measurement. You explained how some old Polish professor—”
“Witold Kula.”
“—that’s the one—had looked into the history of physical units of measurement and discovered that both the concepts they measure and the standards they embody have evolved over time. Like a good socialist, you even spoke admiringly of the great strides made by some international bureaucracy.”
“That’s right—the International Bureau of Weights and Measures.”
“But the useful part, if I understood you right, was old Professor Kula’s point that both concepts and the standards used to measure them are determined by the uses to which people put them. You made two points. The first was that the concept of universal economic value is just like a physical unit of measurement: the extent of its applicability, and what its standard should be, is properly determined by what it is used for. But the second was that universal economic value is also different from a physical unit of measurement. It is a property of the social rather than the physical world—it’s the central component of a technology for organising society, as you put it—so that its standard needs to be political as well.”
“Exactly. The right criteria for choosing its standard are not consistency and accuracy—as they are for a physical unit of measurement—but fairness, or political justice, or whatever you want to call the characteristic quality of a well-governed society.”
“Right. That was the philosophical part. Then you moved on to history.”
“Well: I did argue that there i
s evidence to support my claims about the nature of money. I claimed that it is because money’s central idea is that concept of universal economic value, and because the appropriate standard of value has to be a political one, that money as we know it today was first invented by the collision of the Mesopotamian inventions of literacy, numeracy, and accounting, with the notion of the equal social value of every member of the tribe that the primitive Dark Age Greeks had.”
“Ah yes. Well, you could be right about that—but it doesn’t seem to be that important if you aren’t. After all, money is still with us, so we can test your account of what it really is right here and now. How it was invented doesn’t really matter—and since we’ll never know, why worry?”
“That’s one way of looking at it—ever the philistine. But you’re right that the real test of my biography is how well it explains money today—and our problems with it, and how to start solving them. So carry on.”
“Well then, the history part. This is where the murder mystery began. You started out by praising the clarity of ancient Chinese monetary thought. You explained that their philosophers and emperors understood perfectly that money is a tool of government, and that the extent to which economic value is used to co-ordinate social activity, and the question of what the standard should be, are therefore to be determined solely by reference to how they contribute to the successful government of the country.”
“That’s right: to ‘peace and order in the sub-celestial realm’ as they more poetically put it.”
“Revolution, more like, if you ask me. But we’ll come to that in a moment. Anyway, then you told the story of Europe’s remonetisation in the Middle Ages. The real story here, you said, was a long-running battle between sovereigns and their subjects over the management of the standard. The Europeans, you seemed to be saying, were less concerned about the applicability of the concept of universal economic value—but they were very much concerned with what its standard was, because both sovereigns and subjects understood only too well that making the pound worth more or less in terms of real goods and services meant the redistribution of wealth and incomes.”
“Exactly. And especially, redistribution to the sovereign from his subjects.”
“Right. Seigniorage. The story you told was that as the monetary economy grew, so there were more and more subjects interested in the question of the standard—since they didn’t want to pay excessive seigniorage to their sovereign. They complained about it a lot. They invented all kinds of clever arguments against it. They hired that French bishop to show why it was wrong. But none of it did much good.”
“Because there was no realistic alternative—so they had no way of forcing the sovereign’s hand.”
“Until, that is, some bright spark rediscovered banking, and with it a viable means of issuing private money on a monster scale.”
“Exactly. Turned out to be quite a profitable invention for everybody—but especially for the bankers. The sort of thing I bet you wish you’d thought of.”
“Touché. Anyway: once bankers had rediscovered the trick of issuing private money, the boot was on the other foot. Now it was the sovereigns and their seigniorage that were under pressure. This was an unstable situation—monetary insurrection, to use your metaphor. But with the foundation of the Bank of England, a way to secure a permanent peace was found—at least until recently.”
“The Great Monetary Settlement. You’ve got it. But forgive me for interrupting. Only, where’s the murder?”
“I can see you don’t read many detective stories. It’s just about to happen, of course—just when everyone is least expecting it. You see, up until now, everyone might have been arguing over whether the sovereign should manipulate the standard to raise seigniorage, and whether the bankers should be allowed to issue private money, and so on—but at least they all understood what money was. In terms of your ‘unconventional’ account of money, in other words, common sense still reigned. But just as your Great Monetary Settlement was being struck, somebody murdered monetary common sense. What’s worse, having done away with the correct understanding of money, the wicked criminal buried the evidence and put in its place a seductive imposter—a view of money and economic value that looks and sounds awfully persuasive to ignoramuses like me, but one which according to you actually blinds our moral faculties, blunts our economic policies, and—much the most terrible of all—even gave us the banksters currently lording it over Wall Street and the City of London. And in true Hercule Poirot style, you revealed that the culprit was the very last person one would have suspected: none other than the most respected thinker in the land, John Locke.”
“Ah, I see.”
“And to cap it all, it was what aficionados of the genre call a perfect crime. Nobody noticed that the correct view of money had been swapped for the wrong one—so nobody accused Locke of murder. Quite the opposite, in fact—he seems to have gone down in history as a bit of a hero.”
“Absolutely. He did provide the intellectual basis of modern Liberal democracy, after all.”
“Right. But it’s at this point, I’m afraid to say, that your plot has a hole in it. You see, I’ll grant that John Locke might have been able to murder monetary common sense in the course of that particular debate about the recoinage—and even that the imposter he substituted was quite persuasive as a replacement. But given the rule of common sense up to that point—all those thinkers that you mentioned—how on earth did Locke manage to change everyone’s mind? I mean, I don’t care how influential John Locke was, how can he possibly have managed to fool everyone? Why didn’t people notice that his view of money was just wrong? No, I’m afraid your theory just doesn’t add up, Mr. Holmes.”
“Hang on a minute—you’re the detective here. I never said that this was a murder mystery—and I don’t think it is.
“John Locke was no murderer—he was the greatest philosopher of his age, one of the greatest of any age, and there can hardly be any doubt that he was motivated by his sincere belief in the rightness of political Liberalism and constitutional government. But in trying to achieve this, he made a mistake. He was a doctor and a don—not a banker or a businessman—he wasn’t familiar with the world of finance. He thought the only way to guarantee that the Great Monetary Settlement didn’t turn into a giant boondoggle for bankers was to put the standard beyond their—or the sovereign’s—control. And that was what his political theory told him must be the case anyway.
“So Locke ended up with the right idea about politics—that it should be Liberal and democratic—but the wrong idea about the monetary standard—that it had to be fixed. John Law was the opposite. He had the right idea about the standard—that it needs to be flexible—but the wrong idea about politics—that absolute monarchy is the right system to determine its adjustment. Now Law really was a murderer—or at least a duellist—but in the world of ideas he was no more a criminal than Locke was. Both of them were trying to solve the political and economic problems presented by the growth of monetary society—and each of them got halfway to the right solution.”
“All right. But why was it Locke’s view of money that became the conventional one, then? Like I said: if it is so obviously mistaken, why didn’t anyone stand up and say, ‘all this that Locke’s saying isn’t true: money isn’t silver, it’s transferable credit!’? Or rather, why didn’t everyone believe Lowndes when he said that?”
“Ah! That is a good question. Part of the answer is because of Locke’s prestige, of course. To most people, Locke was a great authority, even if the financial experts didn’t think him one on money. Law was a maverick. But the main reason—and this is what explains your ‘perfect crime’—is more fundamental. It is that Locke felt that in order to arrive at the conclusion which he felt was necessary to protect the Great Monetary Settlement from itself—that the standard needed to be fixed—one had to understand money as silver and value as a property of the natural world. I explained what the practical consequences of that kind of reas
oning have been for economic and financial sector policy, as well as for the ethical disabilities of economics. But naturalistic reasoning of this sort has another effect as well.
“It’s well known to sociologists and anthropologists. Once people accept the idea of a particular set of social arrangements as a necessary fact of the natural world, rather than just a social contrivance, it becomes well nigh impossible for them to think critically about it—no matter how progressive they are, and no matter how morally wrong those social arrangements might be. History is full of examples. In the nineteenth century, there was a great fashion for ‘positive criminology,’ which claimed that felons could be identified by their physical attributes. It sounds bizarre to us today that anyone could believe that you could tell an anarchist by his ears, or a thief by the shape of his nose. But the point is that the people who believed all this had no vested interest in locking up people with unusual faces—they simply believed in the naturalistic explanation of criminality as a product of physiological factors. Likewise, ‘scientific racism’ was widely accepted as the truth in nineteenth-century America. The inferiority of non-white peoples could be ‘proved,’ it was believed, by physical differences. And again, it was the hallmark of a liberal outlook—not a reactionary one—to believe this kind of thing. The point is that naturalistic reasoning in the social sciences—claiming to explain social phenomena as objective truths of nature—is self-reinforcing. It spins social and political prejudices into a web of fake facts—and once the web has been spun, it is virtually impossible to escape. Or in terms of our Chinese proverb, naturalistic reasoning like Locke’s understanding of money is what fills the fishbowl with water.
