Jubilee Shares and the American Monetary Act

Oct04
by Steve Keen on October 4, 2010 at 3:32 pm

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Stephen Zarlenga of the American Monetary Institute invited me to speak at the 2010 conference in Chicago, which I did on the topic of "why a credit money system doesn't have to crash, and why it always does". My speech, the discussion, the speeches of Michael Hudson and Kaoru Yamaguchi, and a panel discussion, are linked at the end of this post. I recommend watching them all if you can spare the time.

I was pleased to be invited, since this indicated a very open-minded approach by the AMI: they are campaigning to have the American Monetary Act passed to establish a 100% reserve monetary system, which is a proposal that I have expressed ambivalence about in the past.

The proposal itself is functional: it would convert our current banks into institutions like building societies, which when they lend money to a borrower, have to decrement an account they hold at a bank--so that no new money is created by the loan. In the AMI's plan, banks would have accounts with the Federal Government (the Federal Reserve, which is currently privately owned, would be incorporated into the US Treasury), and could only lend what was in those accounts. Money creation would then be exclusively the province of the Government via deficit spending.

I don’t oppose this plan, but I think it directs atten­tion at the wrong prob­lem: the issue to me is not how money is cre­ated, but how it is used. If it’s used to finance pro­duc­tive invest­ment, then gen­er­ally speak­ing all will be well; but if it’s used to finance spec­u­la­tion on asset prices, then it will lead to finan­cial crises (though not nec­es­sar­ily as severe as the one we’re expe­ri­enc­ing now).

My reform pro­pos­als are there­fore directed, not at how money is cre­ated, but at how it can be used. Briefly, I argue that banks are always going to want to cre­ate as much debt as they can (under what­ever sys­tem of money cre­ation we have). So if we’re going to stop the use of money for spec­u­la­tive pur­poses, our reforms have to affect the will­ing­ness of bor­row­ers to bor­row, rather than expend­ing energy on ulti­mately futile attempts to limit bank lend­ing directly.

Bankers espe­cially might not like this anal­ogy, but it’s apt: banks are effec­tively debt push­ers, and try­ing to con­trol bank lend­ing at the source is like try­ing to con­trol the spread of ille­gal drugs by directly con­trol­ling the drug push­ers. While ever there are drug users who want the drugs, then there’ll be a profit to be made by sell­ing drugs, and drug push­ers will always find ways around direct controls.

So if you want to stop the spread of drugs, it’s far more effective–if it’s at all possible–to reduce the desir­abil­ity of the drugs to end-users. This was the basis of the very suc­cess­ful “Kiss a non-smoker: enjoy the dif­fer­ence” anti-smoking cam­paign run in my home state (New South Wales, Aus­tralia) in the 1980s.

We need some­thing like that in finance to counter the suc­cess­ful cam­paigns that bankers have run to give debt as “sexy” an image as tobacco com­pa­nies once gave cig­a­rettes, even though–in another apt analogy–it causes finan­cial can­cer: the uncon­trol­lable growth of debt is very much akin to the expo­nen­tial growth of a tumour that ulti­mately kills its host.

The metaphor is not per­fect of course, since a cer­tain min­i­mal level of debt is a good thing in a cap­i­tal­ist soci­ety. Pro­duc­tive debt both gives firms work­ing cap­i­tal, and finances the activ­i­ties of entre­pre­neurs who need pur­chas­ing power before they have goods to sell.

But debt that funds sim­ply spec­u­la­tion on asset prices is very much akin to a can­cer. And like the cig­a­rettes that cause lung can­cer, grow­ing unpro­duc­tive debt gives a “hit” that makes the bor­rower addicted to more debt: when debt is grow­ing,  the debtor and soci­ety in gen­eral feel bet­ter. It enables the bor­rower to make prof­its from spec­u­lat­ing on asset prices, since the ris­ing debt dri­ves up asset prices; and the spend­ing this cap­i­tal gain allows spreads into the wider econ­omy, cre­at­ing a gen­uine but ulti­mately ter­mi­nal boom. The boom can only con­tinue if debt con­tin­ues to grow faster than income, but at some point this guar­an­tees that the debt-servicing costs will exceed society’s capac­ity to pay, and the ces­sa­tion of debt growth causes a cri­sis like the one we are in now.

My two “kiss a non-debtor” pro­pos­als to make debt far less attrac­tive to bor­row­ers are:

  1. To rede­fine shares so that, if pur­chased from a com­pany directly, they last for­ever (as all shares do now), but once these shares are sold by the orig­i­nal owner, they last another 50 years before they expire; and
  2. To limit the debt that can be secured against a prop­erty to ten times the annual rental of that property.

The objec­tive in both cases is to make unpro­duc­tive debt  much less attrac­tive to borrowers.

99% of all trad­ing on the stock mar­ket involves spec­u­la­tors sell­ing pre-existing shares to other spec­u­la­tors. This trad­ing adds zip to the pro­duc­tive capac­ity of soci­ety, while pro­mot­ing bub­bles in stock prices because lever­age dri­ves up  prices, encour­ag­ing more lever­age, lead­ing to a crash when price to earn­ings ratios reach lev­els even the Greater Fool regards as ridicu­lous. Then shares crash, but the debt that drove them up remains.

If instead shares on the sec­ondary mar­ket lasted only 50 years, then even the Greater Fool couldn’t be enticed to buy them with bor­rowed money–since their ter­mi­nal value would be zero. Instead a buyer would only pur­chase a share in order to secure a flow of div­i­dends for 50 years (or less). One of the two great sources of ris­ing unpro­duc­tive debt would be eliminated.

I have to thank one of the par­tic­i­pants at the AMI con­fer­ence for inspir­ing a name for this pro­posal: Jubilee Shares, after the Bib­li­cal prac­tice of abol­ish­ing debt every 50 years. There’s a twist to my pro­posal of course: it wouldn’t be a lia­bil­ity that was abol­ished but an asset, but the intent is to stop the lia­bil­ity of debt ever ris­ing to the level where it would be a prob­lem. So I sug­gest call­ing shares that last for­ever Jubilee Shares, while those that are on the sec­ondary mar­ket are just ordi­nary shares that expire after 50 years.

Jubilee shares could be intro­duced very eas­ily, if the polit­i­cal will existed–something that is still years away in prac­tice. All exist­ing shares could be grand­fa­thered on one date, so that they were all Jubilee shares; but as soon as they were sold, they’d become ordi­nary shares with an expiry date of 50 years from the date of first sale.

The prop­erty pro­posal is some­what dif­fer­ent, and related to the “pro­duc­tive debt vs unpro­duc­tive debt” dis­tinc­tion I made ear­lier. Obvi­ously some debt is needed to pur­chase a house, since the cost of build­ing a new house far exceeds the aver­age wage. But debt past a cer­tain level dri­ves not house con­struc­tion, but house price bub­bles: as soon as house prices start to rise because banks offer more lever­age to home buy­ers, a pos­i­tive feed­back loop devel­ops between house prices and lever­age, and we end up where Aus­tralia is  now, and where Amer­ica was before the Sub­prime Bub­ble burst: with house prices out of reach of ordi­nary wage earn­ers, and lever­age at ridicu­lous lev­els so that 95 per­cent or more of the pur­chase price rep­re­sents debt rather than owner equity.

This hap­pens under our cur­rent sys­tem because the amount extended to a bor­rower is allegedly based on his/her income. Dur­ing a period of eco­nomic tran­quil­ity that occurs after a seri­ous eco­nomic cri­sis has occurred and is finally over–like the 1950s after the Great Depres­sion and the Sec­ond World War–banks set a respon­si­ble level for lever­age, like the require­ment that bor­row­ers pro­vide 30% of the pur­chase price, so that the loan to val­u­a­tion ratio was lim­ited to 70%. But as eco­nomic tran­quil­ity con­tin­ues, banks, which make money by extend­ing debt, find that an easy way to extend more debt is to relax their lend­ing stan­dards, and push the loan to val­u­a­tion ratio (LVR) to say 75%.

Bor­row­ers are happy to let this hap­pen, for two rea­sons: bor­row­ers with lower income who take on higher debt can trump other buy­ers with higher incomes but lower debt in bid­ding on a house they desire; and the increase in debt dri­ves up the price of houses on sale, mak­ing the sell­ers richer and lead­ing all cur­rent buy­ers to believe that their notional wealth has also risen.

Ulti­mately, you get the run­away process that we saw in the USA, where lever­age rises to 95%, 99%, and even beyond–to the ridicu­lous level of 120% as it did with Liar Loans at the peak of the Sub­prime frenzy. Then it all ends in tears when prices have been dri­ven so high that new bor­row­ers can no longer be enticed into the market–since the cost of ser­vic­ing that debt can’t be met out of their incomes–and as exist­ing bor­row­ers are sent bank­rupt by impos­si­ble repay­ment sched­ules. The hous­ing mar­ket is then flooded by dis­tressed sales, and the bub­ble bursts. The high house prices col­lapse, but as with shares, the debt used to pur­chase them remains.

If we instead based the level of debt on the income-generating capac­ity of the prop­erty being pur­chased, rather than on the income of the buyer, then we would forge a link between asset prices and incomes that is cur­rently eas­ily punc­tured by ris­ing debt. It would still be possible–indeed necessary–to buy a prop­erty for more than ten times its annual rental. But then the excess of the price over the loan would be gen­uinely the sav­ings of the buyer, and an increase in the price of a house would mean a fall in lever­age, rather than an increase in lever­age as now. There would be a neg­a­tive feed­back loop between house prices and lever­age. That hope­fully would stop house price bub­bles devel­op­ing in the first place, and take dwellings out of the realm of spec­u­la­tion back into the realm of hous­ing, where they belong.

The AMI Conference

I was impressed that AMI wanted me to be a keynote speaker at its con­fer­ence, know­ing that I (while not a critic) was not an enthu­si­as­tic sup­porter of their plan. Their inter­est was in my analy­sis of how pri­vate money is actu­ally cre­ated, since they have been crit­ics of “frac­tional reserve bank­ing” (FRB), which I have argued doesn’t actu­ally exist. As an expla­na­tion of how debt-based money is cre­ated, FRB asserts that “deposits cre­ate loans”, whereas the empir­i­cal data estab­lishes that “loans cre­ate deposits”.

My talk is linked below, as are the talks by Michael Hudson–who was one of the hand­ful of econ­o­mists who saw the cri­sis com­ing and warned of it publicly–and Pro­fes­sor Kaoru Yam­aguchi, who heads the Sys­tem Dynam­ics Group of the Doshisha Busi­ness School at Doshisha Uni­ver­sity in Kyoto Japan.

I recorded my pre­sen­ta­tion using the screen cap­ture pro­gram BB Flash­back, while I videod Kaoru’s and Michael’s pre­sen­ta­tions. I’ll let the pre­sen­ta­tions speak for them­selves, but I will make a few quick com­ments about QED (the pro­gram I used to demon­strate my mod­els) and the sys­tems dynam­ics model pre­sented by Pro­fes­sor Yam­aguchi (for some rea­son, my pod­cast plu­gin isn’t work­ing, so the videos are shown as links that will open and run in another win­dow. My apolo­gies for that; if I get the time–and some tec­ni­cal advice!–I’ll fix this up later).

QED

QED is a new pro­gram for build­ing dynamic sim­u­la­tions that has been tailor-made to model finan­cial dynam­ics, using the tab­u­lar method I have devel­oped, where each col­umn in the “God­ley Table” is a sys­tem state (nor­mally a bank account), and each row spec­i­fies flows between sys­tem states. The dynam­ics of each state are derived sim­ply by “adding up” the columns.  My tab­u­lar approach has been aug­mented by the program’s devel­oper with two addi­tional fea­tures: a “For­rester Dia­gram” that is sim­i­lar to other sys­tems dynam­ics tools derived from the work of Jay For­rester (Ven­sim,  Simulink, Vis­sim, Stella, Ithink, Sci­cos and the like), and a “Phillips Dia­gram” that ren­ders a sys­tems dynam­ics model using the “hydraulic” metaphor that Bill Phillips devel­oped back in the 1950s.

As a brand new pro­gram, QED can’t as yet com­pete with the range of fea­tures offered by Ven­sim, Simulink and Vis­sim. But it has some advan­tages over these estab­lished pro­grams too:

  • The tab­u­lar inter­face makes it much eas­ier to model finan­cial flows, which nec­es­sar­ily appear in mul­ti­ple loca­tions: a debit from one account appears as a credit to another, and as I note in my pre­sen­ta­tion, the trans­fer if often also recorded in a third loca­tion. These trans­fers can be mod­elled using the flow­chart metaphor of stan­dard sys­tems engi­neer­ing pro­grams, but doing so is a very tedious process;
  • QED auto­mat­i­cally gen­er­ates the flow­chart ren­di­tions of a model from the tab­u­lar rep­re­sen­ta­tion, and vice versa;
  • QED sim­u­lates the dynam­ics on the flow­chart ren­di­tions them­selves, as well as in graphs. Espe­cially with the Phillips Dia­gram ver­sion, this makes it an excel­lent expo­si­tional tool; and
  • It’s free–or rather by arrange­ment with the program’s devel­oper, I have the right to dis­trib­ute the cur­rent ver­sion for free. The files I used in the talk are linked below the fol­low­ing videos. You can down­load the pro­gram itself from the QED tab on this site.

Pro­fes­sor Kaoru Yam­aguchi & Sys­tem Dynamics

As reg­u­lar read­ers would appre­ci­ate, I regard sys­tem dynam­ics as the core approach that should be used to develop an empir­i­cally based eco­nom­ics. There are a hand­ful of econ­o­mists work­ing in sys­tem dynam­ics–Mike Radz­icki in Worces­ter Poly­tech­nic, Dave Wheat at the Uni­ver­sity of Bergen, Trond Andresen at the Nor­we­gian Uni­ver­sity of Sci­ence and Tech­nol­ogy, to men­tion the ones I know best.  Until this con­fer­ence I wasn’t aware of Pro­fes­sor Kaoru Yamaguchi’s work, so I was pleas­antly stunned to see that he has devel­oped the most com­pre­hen­sive sys­tem dynam­ics mod­els of the econ­omy I’ve yet seen, and the only one that I am aware of–apart from my own–that is explic­itly monetary.

His model, which he explains in the pre­sen­ta­tion below, is far more com­plex and thor­ough than mine, but uses a “money mul­ti­plier” as the basis of its money cre­ation mech­a­nism. We are now exchang­ing research, and Kaoru is very inter­ested in pro­duc­ing a ver­sion of his model in which the money sup­ply is endogenous.

Why Credit Money Fails

Video (opens in a sep­a­rate window)

Audio record­ing

Audio record­ing of the discussion

Pow­er­point presentation

QED and model sim­u­la­tion files (right-click and choose “Save As”)

QED (expand zip file and click on QED.EXE to run the program)

Free Bank­ing with only inter­est pay­ments (this and the other sim­u­la­tion files below are also included in the zip file above–their file names begin with the num­bers 1 to 4 respectively)

Free Bank­ing with con­stant num­ber of notes

Free Bank­ing with loan repayment

Min­sky model of debt deflation

Panel Dis­cus­sion

Michael Hud­son

Talk (opens in a sep­a­rate window)

Dis­cus­sion

Kaoru Yamaguchi: A sys­tems dynam­ics model of the economy

Kaoru’s files includ­ing Ven­sim sim­u­la­tion viewer (right-click and choose “Save As”