The Chicago Plan & Positive Money's proposals – What is the difference?

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This article was originally published on the Clint Ballinger’s website on 25th December 2012 as a reaction to the previous post on Post Keynesianism, MMT, & 100% Reserves Project, Post No. 2.

It gives an answer to the question:

Does full reserve banking actually stop banks being able to create money out of thin air?

Screen Shot 2013-02-15 at 17.23.36The Positive Money proposals are often mentioned alongside the Chicago plan/full reserve/100% reserve proposals. The Positive Money proposals do indeed have the same goal, that is: to stop banks creating money in the process of making loans (or buying assets). However, the method is different. In the case of Chicago plan they do it by forcing banks to hold reserves against their deposits. As some people have pointed out, this doesn’t necessarily stop banks creating money – that is it is quite possible for there to be money creation by the banking sector with 100% reserves (incidentally for exactly the same reasons a 10% reserve ratio doesn’t constrain deposit creation, although it does require the central bank to play along).

The Positive Money proposal, on the other hand, does not suffer from this problem. Instead of backing deposits with reserves, we give people access to the state created means of payment itself. Thus, unlike in the current system where two types of money circulate separately – central bank created reserves which are only used by the banking sector, and commercial bank created deposit money which is used by everyone else – in the Positive Money system there is no longer a split circulation of money, just one integrated quantity of money circulating among banks and non-banks alike.

This is achieved by removing the sight [or call] deposits from the banks’ balance sheets and placing them onto the central bank’s balance sheet (which will be called transaction accounts). The private banks then obtain a new liability of the same size to the central bank, and correspondingly the central bank an asset from the banks. This banks’ liability to the central bank is to be repaid as their assets mature, with the money repaid in this way to be recycled back into the economy by the central bank granting money to government to be spent into circulation.

In effect, the central bank has ‘extinguished’ the banks’ demand liabilities to their customers by creating new state-issued electronic currency and transferring ownership of that currency to the customers in question. In a sense everyone starts banking at the central bank (although we would hire the banks to administer our accounts for us).

Lending occurs in this system when people move their money from their transaction account (held at the central bank) to an ‘investment account’. This will be broadly similar to a time deposit today – there will be minimum notice periods, however, unlike today they will also carry some risk (i.e. if the underlying assets go bad they may lose some of their money). The money transferred to the banks will then be transferred to a borrower. So in this system lending by banks merely transfers money around the system, no new money or purchasing power is created when loans are made. Because in this system because all money is held on the central bank’s balance sheet any bank can be allowed to fail, without any effect on the money supply.

So with the PM system it is possible to achieve the aims of the Chicago plan, whilst retaining double entry bookkeeping.

Screen Shot 2013-02-12 at 18.21.59The Positive Money proposals are explained in detail in the brand new book “Modernising Money” (336 pages).

 

 

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Andrew Jackson

Andrew Jackson holds a BSc in Economics and a MSc in Development Economics from the University of Sussex, and is currently studying for a PhD at the University of Surrey. He is a co-author of the book “Where Does Money Come From? A guide to the UK monetary and banking system” with Josh Ryan-Collins and Tony Greenham from the New Economics Foundation, and Professor Richard Werner from the University of Southampton.
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  • parasitstopp

    What positive money is trying to achieve is kind of obvious but we have been conditioned to believe that the present system is the only way it can work. The electronic cash and the physical cash should have the same properties – belonging to the person holding it.

    To make an example that illustrates the total insanity of the present system:
    Lets assume that we use the physical cash in the same manner as the electronic cash. Lets say you want to buy a some food at your local store. But in order to buy it you first have to go the bank and hand over the 5£ note to the bank employe. The bank employe then follow you back to the store and the bank employe hand over the 5£ note to the cashier. The bank, of course, demand a fee for providing you this “service”.

    I think all can see the total insanity having a system handling physical cash in this manner. Adding a middle man (the bank employe) doesn’t add anything of value. But when it comes to the handling of electronic cash we been conditioned to believe that adding a middle man actually is something good. But it only add unnecessary complexity and costs – just as in the example above.

    So positive money is absolutely on the right track here! The payment system should be a public utility where all unnecessary middle men are removed. We ought to be able to pay each other directly with electronic cash just as we do with physical cash. Banks should primary handle money people can spare – the banks role as a middle man in the payment system should be minimized – not maximized as in the present system..

    • John Morrison

      Well said and nicely illustrated. We need more of this kind of perspective.

      • parasitstopp

        Thanks, John!

    • DozyHole

      You are neglecting the fact that the banks create the money when they extend credit, banks are not simply middle men for transactions, they are middle men for money creation, it could be argued that this is their main role, although I bet many employees at the bank do not realise this.
      This is the argument that needs to be won, do we need banks to expand and contract credit(money) or is there a better way of doing it?
      I think the current credit system is flawed since it is based completely on trust, trust of private organisations which seem to have gone out of their way recently to show they are untrustworthy.
      So, I agree with you but feel you are missing the main argument.

      • parasitstopp

        No, I didn’t really miss it I just took it for granted and thought that it was implicitly given for readers of this blog. But you’re absolutely right: The fact is that banks can create their own debts and “lend” it to costumers accounts (since all that’s on a costumers account is the banks debt to the customer – hence: when a bank make a loan by putting some numbers on an account the bank actually lend out the banks own debt to the customer – how bizarre isn’t that? – Having a “monetary system” based on such a idiotic construction?)

        And you’re right! The fact that banks create and lends out it’s own debt has a number of pervasive consequences. The banks actually even acts like middle men in the so called market – making it hard to call, for instance the “Housing market”, a market. Let’s make an example out of that to:

        Lets say John is selling his house. Lets say Eric won the bid and “got” the house. John didn’t have the money during the bidding process (nor did the other bidders) John had to “borrow” from the bank. So here we got three participants in the selling process.

        1) The seller John
        2) The buyers who made the bids
        and
        3) The middle men: the banks who offered to “lend out” their own debt (that’s wrongly called credit) making the bidders overbid each other

        So the one actually deciding the price is the bank, the middle man. This is not a “market” – it’s a debt slave auction! The debt slave that wins the auction get’s to rent the house from the middle man, the bank. Can it get more idiotic?

  • parasitstopp

    What positive money is trying to achieve is kind of obvious but we have been conditioned to believe that the present system is the only way it can work. The electronic cash and the physical cash should have the same properties – belonging to the person holding it.

    To make an example that illustrates the total insanity of the present system:
    Lets assume that we use the physical cash in the same manner as the electronic cash. Lets say you want to buy a some food at your local store. But in order to buy it you first have to go the bank and hand over the 5£ note to the bank employe. The bank employe then follow you back to the store and the bank employe hand over the 5£ note to the cashier. The bank, of course, demand a fee for providing you this “service”.

    I think all can see the total insanity having a system handling physical cash in this manner. Adding a middle man (the bank employe) doesn’t add anything of value. But when it comes to the handling of electronic cash we been conditioned to believe that adding a middle man actually is something good. But it only add unnecessary complexity and costs – just as in the example above.

    So positive money is absolutely on the right track here! The payment system should be a public utility where all unnecessary middle men are removed. We ought to be able to pay each other directly with electronic cash just as we do with physical cash. Banks should primary handle money people can spare – the banks role as a middle man in the payment system should be minimized – not maximized as in the present system..

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  • http://www.facebook.com/people/Dan-Sullivan/1408883609 Dan Sullivan

    My understanding of the Chicago Plan is that it does not treat demand deposits (checking and demand savings accounts) as reserves. That is, one cannot make a long-term loan on deposits that have a shorter term than the loan. Therefore, while the borrower has access to the money, the depositor does not. Under these conditions, I do not see how banks can create deposits out of thin air with full reserve banking.

    One of the saddest things in reform circles is reformers being overly critical of one another in public and distracting themselves from the task at hand. Was this criticism sent to the advocates of the Chicago Plan for their response before it was posted here? I expect some of them do the same thing with regard to the Positive Money plan.

    I like both plans, and I pass on Voltaire’s concern that “the best can be enemy of the good.”

    • parasitstopp

      Your absolutely right, Dan! The Chicago plan was excellent and optimized for it’s time. But Fischer and the other Chicago boys didn’t have a clue about the computer “revolution”. The computer has changed everything and many of the things banks did in the 30ies are actually redundant to day. The banks had a very important role as a “middle men” back then. For instance:

      Let’s say Eric lived back then in Glasgow and wanted to send 2000£ to John living in London. Delivering them by post would be hazardously, going by train handing it over would also be hazardously and take a lot of time. The banks had an excellent service that helped Eric. The chain of event would have been something like this.

      Eric went to his local bank1 and gave the bank the 2000£ and ordered the bank1 to send it till Johns account at Bank2—-> Erics account went up 2000£ and Erics bank got a debt to Eric on the same amount—–> Erics bank1 contacted Johns bank2 and asked if the bank was willing to take over the debt making it bank2 debt to John instead——> Johns bank2 accepted taking over the debt provided that Erics bank1 compensated bank2 with 2000£ in central bank money——–> Bank2 put 2000£ on Johns account and received 2000£ in central bank money that bank1 transfer from it’s account at the central bank to bank2 account at the central bank –> John could withdraw 2000£ from his bank2 in London.

      (I know, the banks lumped lots of transactions and made the clearing but we ignore that in order to keep it simple)

      It was a very good service that helped people.even though the process above seems tedious

      But the computer has changed everything. We hardly use physical cash anymore (people ought to since the centralized banking system is extremely vulnerable). People move their holdings of bank debt between each others banks accounts instead. So the chain of chain above can be reduced to:

      Erics bank1 contact Johns bank2 and ask if the bank is willing to take over the debt making it bank2:s debt to John instead——> Johns bank2 accept taking over the debt provided that Erics bank1 compensate bank2 with 2000£ in central bank money——-> Bank2 put 2000£ on Johns account and receive 2000£ in central bank money (electronic cash) that bank1 transfer from it’s account at the central bank to bank2 account at the central bank

      This is in a sense better since it’s less complex. It’s also obvious that this what the large banks are striving for since less usage of physical cash means that the bank don’t need to pay their debts to costumers as often (since the only way banks can pay their debts to costumers is through costumers withdrawals). The large banks have made large efforts to get to this stage. But ironically it also make the banks role as a “middle man” redundant. With the present technology there wouldn’t be any need of having a bank as a “middle man” at all since we all should be able to have accounts with electronic cash at the central bank (the large banks will be screaming if their monopoly on the electronic cash at the central bank is removed – that is understandable). So the chain of events could be reduced to:

      Eric move 2000£ of electronic cash from his central bank account to—>Johns central banks account

      Thats it, The “middle men” chain in the form of banks can be removed all together thanks to the computer technology that the Chicago boys never could have expected.

      So even though I have full respect for the Chicago plan I do think the new technology has to be considered and it actually make it possible to make the money system even more democratic and fair.

      Sorry for any misspelling and grammar errors – I’m from Sweden I don’t have the time to double check.

      • http://www.facebook.com/people/Dan-Sullivan/1408883609 Dan Sullivan

        I agree that a central bank or peer-to-peer system can transfer balances without depending on banks as middle-men. However, the problem of bank charges on debit transfers is trivial compared to the problem of banks lending money (or credit that is treated as money) that they created out of thin air.

        Yes, anyone can do the transferring, but there must be something (such as sovereignty) behind the transfer. Super-encrypted transfer systems such as e-cash can even allow anonymous transfers without a record of how the credits went from one person to another, but there must still be something one can either redeem or use as legal tender for debts and taxes.

        My focus is always to get privilege out of the way and let technology take care of itself. Also, I see bank transfers becoming more costly if not buttressed by money lending, at which point people will go back to cash for face-to-face transactions. At that point, such devices as e-cash will come to the fore.

    • Simon

      Rather than looking at which plan is “best”, we need to concentrate on what is wrong with the present system. The mechanics of a replacement can be worked on later, but it has to be better than what exists now. I loathe the accounting approach (apologies to those with an accounting background, I did some myself, and am familiar with double entry bookkeeping. I used to work on IT systems in an accounting environment – stock, sales order processing, nominal ledger et al and I used to think in terms of increases and decreases rather than double entry which is as old as the original Venetian bankers), and much prefer an engineering/systems approach to how money and banking works. The economy would work much better if an engineering approach was used. Parasitstopp, I know you are from Sweden, and my father describes something called “The Swedish Solution” on his web site http://www.legalforgery.com which is a close relative to the Positive Money proposals. The Swedish Solution was used when some of their banks got into trouble in the 1990s.

      • John Morrison

        Simon. Maybe we should not obsess with what is best but we should insist on something that is good and fair. I agree that an engineering approach would be better but engineers need a clear specification to work to. To give engineers the freedom to design what is best, the specification should be expressed in terms of scope and fundamental requirements. It is a matter for all us to prepare this specification and we definitely have to look away from the current system to do it.

        The only defence that the current system has is the argument that there is no other way. We have to clear that there most definitely is another way.

        Personally I think that no more is required than that the government provide us all with electronic cash accounts and start issuing new legal tender directly into the economy through the public wage bill. If this is done we will become accustomed to using real money and banks will not be able to inflate the economy with their IOUs. It is a red herring to become consumed by the tricks banks play with their spendable IOUs. They are only able to do any of this because of the monetary vacuum left by government not doing its job properly.

      • parasitstopp

        Well, actually the state only took over the bank for a while and then made them private again. Since then the banks in Sweden been doing the same thing as in for instance the UK and Spain – building a large Ponzi scheme by jacking up the housing prices. People in Sweden are among the most indebted people in the western world and our property bubble is beginning to burst. We are just some step behind for instance Spain (Spain had state surplus before their property bubble burst)

        So I wouldn’t recommend doing what they did here in Sweden. We basically just let the bank patch the balloon so they could pump it up again – making a new bubble even larger.then the previous it’s just a matter of time before it pops here to.

    • Simon

      Rather than looking at which plan is “best”, we need to concentrate on what is wrong with the present system. The mechanics of a replacement can be worked on later, but it has to be better than what exists now. I loathe the accounting approach (apologies to those with an accounting background, I did some myself, and am familiar with double entry bookkeeping. I used to work on IT systems in an accounting environment – stock, sales order processing, nominal ledger et al and I used to think in terms of increases and decreases rather than double entry which is as old as the original Venetian bankers), and much prefer an engineering/systems approach to how money and banking works. The economy would work much better if an engineering approach was used. Parasitstopp, I know you are from Sweden, and my father describes something called “The Swedish Solution” on his web site http://www.legalforgery.com which is a close relative to the Positive Money proposals. The Swedish Solution was used when some of their banks got into trouble in the 1990s.

  • http://www.facebook.com/stamatis.kavvadias Stamatis Kavvadias

    “… The private banks then obtain a new liability of the same size to the central bank, and correspondingly the central bank an asset from the banks. This banks’ liability to the central bank is to be repaid as their assets mature, with the money repaid in this way recycled back into the economy by the central bank granting money to government to be spent into circulation.”

    Sorry but, this is not an explanation of what happens with deposits. Deposits are evetully withdrawn from an account, and according to your “explanation” the banks are left with a liability to the central bank. How does this work?

    I would understand if you said that the deposit to a private bank become directly centrl bank “reserves” and the private bank writes a liability to its accounting books, which disappears when the deposit is withdrawn. Is that what you mean, and if it is more complicated, can you tell us how and why??

  • http://www.facebook.com/stamatis.kavvadias Stamatis Kavvadias

    “… The private banks then obtain a new liability of the same size to the central bank, and correspondingly the central bank an asset from the banks. This banks’ liability to the central bank is to be repaid as their assets mature, with the money repaid in this way recycled back into the economy by the central bank granting money to government to be spent into circulation.”

    Sorry but, this is not an explanation of what happens with deposits. Deposits are evetully withdrawn from an account, and according to your “explanation” the banks are left with a liability to the central bank. How does this work?

    I would understand if you said that the deposit to a private bank become directly centrl bank “reserves” and the private bank writes a liability to its accounting books, which disappears when the deposit is withdrawn. Is that what you mean, and if it is more complicated, can you tell us how and why??

  • http://www.facebook.com/stamatis.kavvadias Stamatis Kavvadias

    Is it your point that central bank always keeps *all* money in circulation in its books, and can locate part of them, as long as they are in a private bank’s books as a liability? But, when the deposit is withdrawn and the libility disappears from the private bank’s books, what happens to the asset of the cantral bank?
    Could you explain more??

  • RJ

    I would still like to see the full journal entries for what positive money propose. Because until this is done it is quite meaningless. Money is created and destroyed by journal entries. Money is also a financial asset ALWAYS backed by a financial liability (debt). Without exception. If PM think otherwise prove it with double entry book keeping. The journal entries are essential and can not be avoided.

    • parasitstopp

      Nope it’s not ALWAYS backed by debt. The only thing you get if you hand over a 5£ note to Bank of England is possibly another newer 5£ note i exchange – but you are welcome to prove me wrong. What are you going to claim from BoE in exchange other then possibly replacing the 5£ note with another?

      Actually even Michael Kumhof (the IMF economist that propose the Chicago plan) make this very clear in this new video (17:55)
      http://www.youtube.com/watch?v=YnAtHbDptj8&feature=share&list=UUegQs-U_vRxxhe_4tuXJICQ

      • Bob Welham

        That is one terrific video, thanks for the link. It is extremely encouraging to see a senior banking insider supporting monetary reform so enthusiastically and precisely.

  • http://www.zitmaxx.eu/banken/loungebanken/p_1_50/banken-bankstel Loungebanken

    This is achieved by removing the sight [or call] deposits from the banks’ balance sheets and placing them onto the central bank’s balance sheet . The private banks then obtain a new liability of the same size to the central bank, and correspondingly the central bank an asset from the banks.

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