The financial crisis has provided both the opportunity and an imperative to ‘remake’ market economies as proposed for the US by President Obama in his inaugural address.
Instead of bail-outs poisoning the financial system further with more debt, governments should be introducing an old type of natural-money that is self-financing and self-liquidating. Natural-money has a negative interest rate. Its introduction during the Great Depression was supported by John Maynard Keynes and Yale Professor Irving Fisher because it stabilizes prices and reverses the bias to invest in financial assets rather than real assets.
Natural-money creates an incentive to invest in the real economy. The real economy includes physical assets that increase productivity and counters inflation. It also includes technology that allows humans to live more lightly on the planet. By these means natural-money would ‘remake’ the economy with a more efficient, equitable and resilient financial system.
During the Great Depression thousands of communities in Europe and hundreds in the US were quickly invigorated with private, locally-issued natural-money. When banks stopped lending as they have today, natural-money was issued to fill the gap. Because natural-money competed so successfully with official money, governments banned it. Instead of banning it, governments today should be introducing it.
The remade New Economy created by natural-money would remove the ability of banks to expand the money supply by making loans. The cost of loans would only reflect the loan risk, not the cost of creating money. This would make a substantial reduction in the cost of the financial sector required to service the real economy. The reductions would include excessive payments to financial executives with more jobs going to those producing real goods and non-financial services.
Governments could quickly issue paper-based natural-money as proposed in a 1933 Bill introduced to the US Congress. The Bankhead-Pettengill Bill was overtaken by the New Deal introduced by President Roosevelt two weeks later. The Bill proposed that one trillion dollars of natural-money be issued as legal tender.
The natural-money was to be distributed to each state of the USA in proportion to its population. One half of the money was to be used to finance unemployment and welfare payments and the other half to finance infrastructure.
The natural-money currency notes created by Congress would only be valid for one year. To keep each $1.00 note valid during the year, note holders had to affix a two cent postage stamp each Thursday. After 52 weeks the Post Office would have received revenues from the sale of stamps equal to $1.04 for each $1.00 note. This would allow the Post Office to redeem the "Stamped Scrip" for ordinary money, and obtain a four cent gross profit to cover its costs.
Today, notes of up to $100 or more could be used. Natural-money could now be provided in an electronic form with payments made from cell phones that can also be "swiped" like a payment card.
Natural-money would increase the profit margin of merchants. Instead of losing over 2% of sales on every credit card transaction they would only pay 2% for the natural-money in their tills each Wednesday night. According to the analysis of Fisher, privately issued natural-money circulated twice as quickly as ordinary money.
One important advantage of natural-money is that it is spent quickly to avoid the holder having to buy stamps. This is why natural-money is much more effective in stimulating the economy than current money. Current money can earn interest and so provides a disincentive to be spent to generate economic activity.
If natural-money replaced the current biased money, real interest rates would approach zero. Money would no longer carry out its current role as being a store of value. The role of money would be simplified to only being a unit of account and a medium of exchange. Central banks would no longer be required to maintain the value of money. When innovators introduce electronic natural-money decentralized banking could finance the New Economy at a local level.
In the New Economy the incentive for savers and investors to buy real assets would be increased. Synthetic financial assets would be less able to poison the financial system.
Natural-money would make sustainable energy sources more competitive. Wind and solar generators require three or more times the investment per continuous unit of output than burning coal. Renewable energy could become cheaper than burning coal with natural-money in many locations.
Natural-money could be used to establish a global unit of account by making it redeemable into units of renewable electrical power. Its value would be determined by the endowment of renewable energy in each region. As the price of non-renewable energy increased due to scarcity, carbon taxing and/or trading, the purchasing power of natural-money would increase and counter inflation.
As shown above, natural-money can be both self-financing and self-liquidating. This would allow the government to gift natural-money to businesses that cannot obtain loans from banks. The gift could be tied, for example, to employee tenure, remuneration and their benefits so as to reduce unemployment and welfare payments.
Natural-money would allow governments to stimulate their economies without spending taxpayer’s money, going into deficit or debasing the currency system. Instead, governments would establish a basis for remaking both the real economy and the financial system.
This essay is based on a longer paper: "Options for Rebuilding the Economy and the Financial System" available here.