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Quite a bit of media attention has been devoted recently to a working paper by two International Monetary Fund economists that re-examines the
“Chicago Plan”. First put forward by University of Chicago economists
in 1933, this proposal calls for the abolition of fractional
reserve banking and the
replacement of bank credit
with government money in order to do away with credit-induced business
cycles.
We can perhaps all agree that bank credit
created out of thin air shouldn’t exist. Unfortunately, there is never a
good time to deleverage bank
balance sheets, and to do so
now would result in a massive policy-induced
economic shock. The
Chicago Plan seeks to side
step this problem by replacing bank credit with
raw money; the approach favoured by the IMF working paper is for banks to match their lending by borrowing from the government. Customer deposits would be simply leant
to the government through
the Federal Reserve Banks.
The government therefore
not only becomes the sole
supplier of money through the banks,
but has tight control over its
use, a situation disliked by the banks because they become less
profitable. An important benefit for government is that interest-bearing government debt is monetised and borrowing constraints are lifted.
The attractions to economists in 1933 were obvious: the banking system was under pressure from contracting credit, and the New Dealers were
keen to ramp up government planning and spending.
The problems today are similar but perhaps more
urgent. The motivation for such a plan is for this reason
a gut-reaction by establishment economists
to extend state control over markets,
rather than eliminating the bank-credit-induced
business cycle per se.
However, the plan proposed
in the working paper is based on ivory-tower
fallacies and raises many questions, which cannot be fully
addressed in a short article. The paper’s bias is betrayed in a footnote on page 35, where the authors extol the benefits of the plan for social redistribution. No
mention is made in the working
paper of the external
position; but if international users of the dollar found themselves to be thinly-veiled counterparties of the US government,
they might be unhappy about the
implications. Furthermore, it
is assumed that the price-effects of bank credit are no different from that of money itself, a ludicrous proposition on many levels.
The IMF paper is
riddled with dangerous assumptions arising from a paucity of true economic knowledge. There is a naivety over the
intentions of governments and their
desire to fund escalating welfare payments: there can be no doubt
that any
“solution” to the problems of government finance coming from establishment economists invariably becomes a springboard for further monetary expansion. The writers’
analysis of how money works
is selectively empirical: in other words they select their historical evidence to support their
cause. Their use of mathematical
equations in a 71-page paper is obtuse and betrays minds that think in an accounting vacuum without relating to the real world.
As evidence of their
distant removal from
reality, they even conclude with respect to the German hyperinflation of 1920-1923 that, and I quote, “This episode can therefore
clearly not be blamed on excessive money printing by a government-run central bank…”
(page 16). They feebly contend that the Reichsbank was privately owned so not government run, but the reality is that like the Fed, it was a tool
of government.
What is worrying about this kite-flying exercise is that the IMF lends it credence.
We should be doubly worried
if the IMF is using it as a means to gauge reactions before imposing the ideas contained therein on an unfortunate
client state. Worried, but perhaps
not overly surprised.
Originally published
at Goldmoney here.
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