IMF's epic plan to conjure away debt and dethrone bankers

In his Telegraph column, Ambrose Evans-Pritchard looks at the pros and cons of the IMF's proposal to have central banks turn over their holdings of government debt to the Treasury.

The benefits of doing this include reducing the sovereign debt outstanding, boosting growth and dethroning the bankers.

Regular readers know that prior to the IMF proposal your humble blogger suggested that the way to achieve all of these benefits was to require the banks to provide non-interest bearing excess reserves to the central banks to fund the central banks' government security portfolios.

With these interest free excess reserves, the sovereign debt outstanding is effectively reduced, growth is boosted and the bankers are dethroned.

So there is a magic wand after all. 

A revolutionary paper by the International Monetary Fund claims that one could eliminate the net public debt of the US at a stroke, and by implication do the same for Britain, Germany, Italy, or Japan. 

One could slash private debt by 100pc of GDP, boost growth, stabilize prices, and dethrone bankers all at the same time. It could be done cleanly and painlessly, by legislative command, far more quickly than anybody imagined. 

Yes, simply require the banks to hold the non-interest bearing excess reserves.  Something that the banks should be happy to do to maintain their access to the state deposit guarantee.  Something that is appropriate for banks to do considering how much of the sovereign debt had to be issued as a result of the financial crisis they created.

Instead, the IMF economists recommend

The conjuring trick is to replace our system of private bank-created money -- roughly 97pc of the money supply -- with state-created money. ...

Specifically, it means an assault on "fractional reserve banking". If lenders are forced to put up 100pc reserve backing for deposits, they lose the exorbitant privilege of creating money out of thin air. 

The nation regains sovereign control over the money supply. There are no more banks runs, and fewer boom-bust credit cycles. Accounting legerdemain will do the rest. That at least is the argument. 

Some readers may already have seen the IMF study, by Jaromir Benes and Michael Kumhof, which came out in August and has begun to acquire a cult following around the world. 

Entitled "The Chicago Plan Revisited", it revives the scheme first put forward by professors Henry Simons and Irving Fisher in 1936 during the ferment of creative thinking in the late Depression. 

Irving Fisher thought credit cycles led to an unhealthy concentration of wealth. He saw it with his own eyes in the early 1930s as creditors foreclosed on destitute farmers, seizing their land or buying it for a pittance at the bottom of the cycle. 

The farmers found a way of defending themselves in the end. They muscled together at "one dollar auctions", buying each other's property back for almost nothing. Any carpet-bagger who tried to bid higher was beaten to a pulp.... 

The original authors of the Chicago Plan were responding to the Great Depression. They believed it was possible to prevent the social havoc caused by wild swings from boom to bust, and to do so without crimping economic dynamism. 

The benign side-effect of their proposals would be a switch from national debt to national surplus, as if by magic. "Because under the Chicago Plan banks have to borrow reserves from the treasury to fully back liabilities, the government acquires a very large asset vis-à-vis banks. Our analysis finds that the government is left with a much lower, in fact negative, net debt burden." 

The IMF paper says total liabilities of the US financial system - including shadow banking - are about 200pc of GDP. The new reserve rule would create a windfall. This would be used for a "potentially a very large, buy-back of private debt", perhaps 100pc of GDP. 

While Washington would issue much more fiat money, this would not be redeemable. It would be an equity of the commonwealth, not debt. 

The key of the Chicago Plan was to separate the "monetary and credit functions" of the banking system. "The quantity of money and the quantity of credit would become completely independent of each other." 

Private lenders would no longer be able to create new deposits "ex nihilo". New bank credit would have to be financed by retained earnings. 

"The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business," says the IMF paper. 

"Rather, banks would become what many erroneously believe them to be today, pure intermediaries that depend on obtaining outside funding before being able to lend."

BU Professor Kotlikoff suggested something similar with his idea for limited purpose banks.

The US Federal Reserve would take real control over the money supply for the first time, making it easier to manage inflation. It was precisely for this reason that Milton Friedman called for 100pc reserve backing in 1967. Even the great free marketeer implicitly favoured a clamp-down on private money. 

The switch would engender a 10pc boost to long-arm economic output. "None of these benefits come at the expense of diminishing the core useful functions of a private financial system." 

Simons and Fisher were flying blind in the 1930s. They lacked the modern instruments needed to crunch the numbers, so the IMF team has now done it for them -- using the `DSGE' stochastic model now de rigueur in high economics, loved and hated in equal measure. 

The finding is startling. Simons and Fisher understated their claims. It is perhaps possible to confront the banking plutocracy head without endangering the economy....

Hello, Iceland showed the banking plutocracy can be confronted without endangering the economy when it adopted the Swedish Model for handling a bank solvency led financial crisis at the start of our current crisis.

The theory also has strong critics. Tim Congdon from International Monetary Research says banks are in a sense already being forced to increase reserves by EU rules, Basel III rules, and gold-plated variants in the UK. The effect has been to choke lending to the private sector. 

He argues that is the chief reason why the world economy remains stuck in near-slump, and why central banks are having to cushion the shock with QE. 

"If you enacted this plan, it would devastate bank profits and cause a massive deflationary disaster. There would have to do `QE squared' to offset it," he said.... 

One thing is sure. The City of London will have great trouble earning its keep if any variant of the Chicago Plan ever gains wide support.

Which is not a bad thing as the individuals who work for the City of London might instead of trying to make money from money take jobs that real goods and services.