Tag Archives: Modern monetary theory

The Federal Credit Bank

A few months ago we did a few post on monetary reforms. In the first two posts of those series, we argued in favour of debt-free money and full reserve banking. In short our argument can be summarized as follows: since the government can demand that taxation has to be paid in a certain currency, it is able to create a demand for that currency. Hence the government can spend money just by creating its own currency, and this without having to borrow anything. Because the government should be in charge of creating and allocating the money supply, private banks shouldn’t be involved in the creation of money. Instead banks should return to their role of intermediaries between savers and borrowers.

In order to prevent that politicians will manipulate the money supply for electoral gains, we have proposed the establishment of an independent body, the National Monetary Authority. This body will have to authority to determine the amount of money the government should spend, and also has the power to raise (or lower) the general level of the Land Value Tax.

In the third instalment of our series, we introduced another financial institution, the Federal Credit Bank (MFK). The primary objective of this institution is to provide zero-interest loans to the public. The National Monetary Authority would also in this case set a limit on how much money the MFK could lend. In this post we will expand on the function of the MFK.

During our discussion of full reserve banking, we made an implicit assumption that the amount of savings and the demand for loans would be equal. There is of course no reason to assume that this will indeed always be the case. Actually it’s reasonable to assume this will almost never be the case. We will discuss the role of the MFK on this matter, by discussing how banking would look like under full reserve banking.

If a bank wants to lend money to the public, it should attract funds from the public since it cannot create money through fractional reserve banking. The bank could attract funds either in the form of term deposits or by issuing bonds. For the sake of simplicity we will assume that banks will only issue zero coupon bonds.

A zero coupon bond is a bond which does not pay interest. Instead the bond is issued at a lower rate than its nominal value. Suppose that a bond has a nominal value of 1,000. This bond will then sold by the bank for a price less than 1,000, and the buyer of the bond will make a profit when the bank will repay the bond at maturity.

When people want to have a bank loan, the bank should attract funds to lend to them. In order to do this, the bank will sell bonds at the capital market. As long as there are sufficient buyers for these bonds, there will be no problem. If however, the demand for loans would be higher than the demand for bank bonds, problem can arise. Businesses can’t make investments, people can’t get a mortgage loan to buy a house. If this discrepancy becomes too large, the economy might be disrupted.

How can the MFK help in such situation? The MFK can use its lending power to buy bank bonds at the capital markets. By doing so banks receive the funds to lend to the public. But again, the MFK cannot buy more assets than the limit set by the National Monetary Authority.

By raising the MFK lending limit, the MFK can buy more bonds and hence their rates will increase, which equivalent to lowering interest rates by central banks. If on the other hand the National Monetary Authority would lower the MFK lending limit, the MFK will be forced to sell off some of its assets. This will result in a lower rate of bank bonds, and this is equivalent to raising interest rates.

Shifting the MFK lending limit gives the National Monetary Authority an additional tool to adjust the money supply of a space settlement.

Space colonies and monetary systems. Part 1

Introduction

A key aspect of any society is its monetary system, and Space settlements are no exception. Though money-less societies have existed in the past, and to some extent even to this day, all modern economic systems use money. However, there are different monetary systems possible, and the choice for a particular monetary system has fundamental consequences for how the economy operates. Therefore it is of great importance to choose a monetary system that fits into our commitment to create a secular, liberal and humanist society.

In this post and its sequels we will give a sketch of the monetary system we propose for a future space-based Republic. The basic features of this system are: 1. government issued debt-free money, 2. full reserve banking and 3. a federal credit bank for providing interest-free loans. We will deal with feature 1 in this post, feature 2 will be the subject of part 2, and part 3 will deal with the third feature. Though some people might argue that monetary and banking systems are separate issue, we believe that these two concepts are fundamentally connected with each other.

1 Debt-free money

First of all, we propose that space governments will have monetary sovereignty, e. g. they will issue their own currencies instead of using foreign currencies and also they won’t pledge the national currency to foreign currencies. If a space nation has no sovereign currency, it will not be able to implement its own monetary system.

Secondly, we propose a system of pure fiat money, which is money not backed by any commodity. Some readers might wonder how money with no intrinsic value would ever be accepted, this is an important question. The answer is given by what is known as modern monetary theory: taxation drives money. By mandating some payments in a specified currency, the government creates an effective demand for said currency. We will explain this by an appropriate example.

As the regular visitor of our site might know we support a land value tax as the primary method to fund government. It’s our opinion that all land in a space habitat should be the property of its respective government, but space governments will be able to lease their land to private parties. Since the government is the owner of the land, it is therefore capable of demanding that the lease has to be paid in the national currency. Subsequently the landholders will have a demand for some national currency, they have to earn this somehow. A landholder might, for instance, choose to become a farmer and to trade his crops for national currency. In their turn the buyers of these agricultural products will demand that their wages to be paid in national currency. And the end everyone will demand to be paid in national currency, and consequently the national currency will be generally accepted.

The requirement that the land value tax has to be paid in the national currency, also implies that so-called legal tender laws are superfluous. Legal tender laws are those laws which demand that a person must accept national currency as payment for debt. As we have seen, any sane person would accept the national currency because it is demanded by everyone else regardless of whether he is obliged to accept the national currency. Therefore legal tender laws could be abolished, or rather space colonies should not introduce such laws in the first place.

Now we know that taxation drives money, it follows that the government can create money, just by printing it. Once the government has imposed the obligation to pay land rents in national currency, it knows people will accept it in payments. And since the citizens has to get national currency somehow in the first place, they will be eager to sell goods and services to the government.

Since the government can print money at will, there is no need for the government to borrow any money, ever. This means that money issued by the government is debt-free, the government also pays no interest over it. The cautious reader should, however, be concerned about inflation. However, if the money supply grows proportionally with the economy, then inflation would be near zero. The problem of (hyper)inflation occurs when the government will print money at a faster rate than the growth of the economy.

It’s clear that even if the government can create money at will, it cannot afford to create an unlimited amount of money at a given time. According to modern monetary theory the growth of the money supply can be regulated by the government: by collecting tax, money is destroyed and by public spending, money is created. If more tax is collected than is spent, then the money supply will decrease. And if more money is spent than taxed, then the money supply will be increased.

Economists who support this theory, argues that in case of high inflation the government should raise taxes and to cut spending. Of course the problem will arise that if politicians control the money supply, they will use the tools of spending and taxing for political rather than economic reasons: decreasing taxes and increasing spending during the time just before an election. Therefore an independent agency should be created which decide whether taxes will be raised, and how much money the government is allowed to spend. Politician will be in charge of deciding how they spend the money, not how much.

Todd Altman has proposed an interesting idea: pegging the national currency to the consumer price index. If the general price level rises with, say, five percent, taxes will be raised also by five percent, whilst spending has to be cut down.

See also

External links

Richard Werner: Debt free & interest free money A YouTube video featuring economist Richard Werner, who explains how debt free money will work.

Modern Monetary Theory Primer An introduction to modern monetary theory on the “New economic perspectives” blog.

On “Republic of Lagrangia”

On the problem of taxation. Part One

On the problem of taxation. Part Two

On the economy of a Space colony

Space colonies and monetary systems. Part 2