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CONTENTS
Acknowledgements

A note for readers outside the UK

10

Foreword

11

Summary of Key Points

13

INTRODUCTION

21

The structure of this book

27

Part 1 - The Current Monetary System

29

1.

A SHORT HISTORY OF MONEY

31

1.1 The origins of money

A textbook history
The historical reality

31
31
33

1.2 The emergence of banking

36

THE CURRENT MONETARY SYSTEM

47

2.1 Commercial (high-street) banks

The Bank of England

47
50

2.2 The business model of banking

Understanding balance sheets
Staying in business

53
53
56

2.3 Money creation

Creating money by making loans to customers

59
60

2.4 Other functions of banking

Making electronic payments between customers

62
62

2.5 Money destruction

68

2.6 Liquidity and central bank reserves

How central bank reserves are created
How commercial banks acquire central bank reserves

70
70
71

2.7 Money creation across the whole

banking system
The money multiplier model
Endogenous money theory

75
75
78

WHAT DETERMINES THE MONEY SUPPLY?

81

2.

3.

4.

5.

3.1 The demand for credit

Borrowing due to insufficient wealth
Borrowing for speculative reasons
Borrowing due to legal incentives

82
82
84
85

3.2 The demand for money

Conclusion: the demand for money & credit

85
87

3.3 Factors affecting banks lending decisions

The drive to maximise profit
Government guarantees & too big to fail
Externalities and competition

88
89
90
94

3.4 Factors limiting the creation of money

Capital requirements (the Basel Accords)
Reserve ratios & limiting the supply of central bank reserves
Controlling money creation through interest rates
Unused regulations

95
95
97
100
108

3.5 So what determines the money supply?

Credit rationing
So how much money has been created by banks?

109
110
113

ECONOMIC CONSEQUENCES OF THE CURRENT

SYSTEM

115

4.1 Economic effects of credit creation

Werners Quantity Theory of Credit
How asset price inflation fuels consumer price inflation

116
117
127

4.2 Financial instability and boom & bust

Minskys Financial Instability Hypothesis
The bursting of the bubble

128
129
133

4.3 Evidence
Financial crises
Normal recessions

139
139
145

4.4 Other economic distortions due to the current banking system

Problems with deposit insurance & underwriting banks
Subsidising banks
Distortions caused by the Basel Capital Accords

147
149
151
152

SOCIAL AND ENVIRONMENTAL IMPACTS OF THE

CURRENT MONETARY SYSTEM

155

5.1 Inequality

155

5.2 Private debt

158

5.3 Public debt, higher taxes & fewer public services

159

5.4 Environmental impacts

Government responses to the boom bust cycle
Funding businesses
Forced growth

160
160
162
162

5.5 The monetary system and democracy

Use of our money
The misconceptions around banking
The power to shape the economy
Dependency
Confusing the benefits and costs of banking

165
165
166
167
169
170

Part 2 - The Reformed Monetary System

173

6.

PREVENTING BANKS FROM CREATING MONEY

175

6.1 An overview

176

6.2 Current/Transaction Accounts and the payments system

178

6.3 Investment Accounts

182

6.4 Accounts at the Bank of England

The relationship between Transaction Accounts and a banks
Customer Funds Account
Commercial banks
Central bank
Measuring the money supply

185
186
189
190
190

6.6 Making payments

1. Customers at the same bank
2. Customers at different banks
A note on settlement in the reformed system

191
192
192
193

6.7 Making loans

Loan repayments

194
197

6.8 How to realign risk in banking

Investment Account Guarantees
The regulator may forbid specific guarantees

199
199
200

6.9 Letting banks fail

201

THE NEW PROCESS FOR CREATING MONEY

203

7.1 Who should have the authority to create money?

203

7.2 Deciding how much money to create: The Money Creation

Committee (MCC)
How the Money Creation Committee would work

204
205

7.

Is it possible for the Money Creation Committee to determine

the correct money supply?

8.

7.3 Accounting for money creation

210

7.4 The mechanics of creating new money

211

7.5 Spending new money into circulation

Weighing up the options

211
213

7.6 Lending money into circulation to ensure adequate credit for

businesses

214

7.7 Reducing the money supply

216

MAKING THE TRANSITION

219

An overview of the process

8.1 The overnight switchover to the new system

Step 1: Updating the Bank of Englands balance sheet
Step 2: Converting the liabilities of banks into electronic stateissued money
Step 3: The creation of the Conversion Liability from banks to
the Bank of England

9.

208

219
220
220
227
230

8.2 Ensuring banks will be able to provide adequate credit

immediately after the switchover
Funds from customers
Lending the money created through quantitative easing
Providing funds to the banks via auctions

231
231
232
233

8.3 The longer-term transition

Repayment of the Conversion Liability
Allowing deleveraging by reducing household debt
Forcing a deleveraging of the household sector

233
233
234
235

UNDERSTANDING THE IMPACTS OF THE REFORMS

241

9.1 Differences between the current & reformed monetary systems

9.2 Effects of newly created money on inflation and output

241
242

9.3 Effects of lending pre-existing money via Investment Accounts

246
Lending pre-existing money for productive purposes
246
Lending pre-existing money for house purchases and unproductive
purposes
248
Lending pre-existing money for consumer spending
250
9.4 Limitations in predicting the effects on inflation and output

250

9.5 Possible financial instability in a reformed system

A reduced possibility of asset price bubbles
Central bank intervention in asset bubbles

251
252
255

When an asset bubble bursts

10.

11.

256

9.6 Debt

260

9.7 Inequality

260

9.8 Environment

261

9.9 Democracy

263

IMPACTS ON THE BANKING SECTOR

265

10.1 Impacts on commercial banks

Banks will need to acquire funds before lending
The impact on the availability of lending
Banks will be allowed to fail
The too big to fail subsidy is removed
The need for debt is reduced, shrinking the banking sectors
balance sheet
Basel Capital Adequacy Ratios could be simplified
Easier for banks to manage cashflow and liquidity
Reducing the liquidity gap

265
265
267
269
270

10.2 Impacts on the central bank

Direct control of money supply
No need to manipulate interest rates
A slimmed down operation at the Bank of England

274
274
274
274

10.3 Impacts on the UK in an international context

The UK as a safe haven for money
Pound sterling would hold its value better than other currencies
No implications for international currency exchange
Would speculators attack the currency before the changeover?

275
275
276
277
277

10.4 Impacts on the payment system

National security
Opening the door to competition among Transaction Account
providers

277
277

CONCLUSION

Part 3 - Appendices

271
271
272
273

278

279

285

APPENDIX I - EXAMPLES OF MONEY CREATION BY THE

STATE: ZIMBABWE VS. PENNSYLVANIA
287
Zimbabwe
Other hyperinflations
Pennsylvania

288
295
297

Conclusions from historical examples

APPENDIX II - REDUCING THE NATIONAL DEBT

What is the national debt?

Who does the government borrow from?
Does government borrowing create new money?
Is it possible to reduce the national debt?
Is it desirable to reduce the national debt?
Paying down the national debt in a reformed monetary system
Is this monetising the national debt?

APPENDIX III - ACCOUNTING FOR THE MONEY

CREATION PROCESS
The current backing for bank notes
The process for issuing coins in the USA
The key differences between US coins and UK notes
The post-reform process for issuing electronic money
Ensuring that electronic money cannot be forged
Reclaiming seigniorage on notes & electronic money
Modernising the note issuance

An alternative accounting treatment

Balance sheets: alternative treatment (with money as a liablity
of the Bank of England)

301

303
303
303
304
305
306
309
310

311
311
313
314
315
315
316
316
317
321

BIBLIOGRAPHY

323

About the Authors

336

FOREWORD
Money ranks with fire and the wheel as an invention without which the
modern world would be unimaginable. Unfortunately, out-of-control money
now injures more people than both out-of-control fires and wheels. Loss of
control stems from the privilege enjoyed by the private banking sector of
creating money from nothing and lending it at interest in the form of demand
deposits. This power derives from the current design of the banking system,
and can be corrected by moving to a system where new money can only be
created by a public body, working in the public interest.
This is simple to state, but difficult to bring about. Andrew Jackson and Ben
Dyson do a fine job of explaining the malfunctioning present banking system,
and showing the clear institutional reforms necessary for a sound monetary
system. The main ideas go back to the leading economic thinkers of 50 to 75
years ago, including Irving Fisher, Frank Knight and Frederick Soddy. This
book revives and modernises these ideas, and shows with clarity and in detail
why they must be a key part of economic reform today.

Professor Herman Daly

Professor Emeritus
School of Public Policy
University of Maryland
Former Senior Economist
at the World Bank

SUMMARY OF KEY POINTS

Chapter 1: A Short History of Money
When early-day goldsmiths started to provide banking services to members
of the public, they would issue depositors with paper receipts. These receipts
started to circulate in the economy, being used in place of metal money
and becoming a form of paper money. In 1844 the government prohibited
the issuance of this paper money by any institution other than the Bank of
England, returning the power to create money to the state. However, the failure to include bank deposits in the 1844 legislation allowed banks to continue
to create a close substitute for money, in the form of accounting entries that
could be used to make payments to others via cheque. The rise of electronic
means of payment (debit cards and internet banking) has made these accounting entries more convenient to use as money than physical cash. As a result,
today bank deposits now make up the vast majority of the money in the
economy.

Chapter 2: The Current Monetary

System
The vast majority of money today is created not by the state, as most would
assume, but by the private, commercial (or high-street) banking sector. Over
97% of money exists in the form of bank deposits (the accounting liabilities of
banks), which are created when banks make loans or buy assets. We explain
how this process takes place and show the (simplified) accounting that enables
banks to create money. We also look at the crucial role of central bank reserves
(money created by the Bank of England) in the payments system, and explain
why it is that banks do not need deposits from savers or central bank reserves
in order to lend.

14 MODERNISING MONEY

Chapter 3: What Determines the Money

Supply?
With most money being created by banks making loans, the level of bank
lending determines the money supply. What determines how much banks can
lend? The demand for credit (lending) will always tend to be high due to:
insufficient wealth, the desire to speculate (including on house prices), and
various legal incentives.
The supply of credit depends on the extent to which banks are incentivised to
lend. During benign economic conditions banks are incentivised to lend as
much as possible creating money in the process by the drive to maximise
profit, and this process is exacerbated through the existence of securitisation,
deposit insurance, externalities and competition. The regulatory factors that
are meant to limit the creation of money such as capital requirements, reserve
ratios and the setting of interest rates by the Monetary Policy Committee are
for a variety of reasons ineffective.
Yet despite the high demand for credit, the strong incentives for banks to create
money through lending, and the limited constraints on their ability to do so,
banks do not simply lend to everyone who wants to borrow. Instead, they
ration their lending. For this reason, the level of bank lending, and therefore
the money supply, is determined mainly by their willingness to lend, which
depends on the confidence they have in the health of the economy.

Chapter 4: Economic Consequences of

the Current System
The economic effects of money creation depend on how that money is used. If
newly created money is used to increase the productive capacity of the economy, the effect is unlikely to be inflationary. However, banks currently direct
the vast majority of their lending towards non-productive investment, such as
mortgage lending and speculation in financial markets. This does not increase
the productive capacity of the economy, and instead simply causes prices in
these markets to rise, drawing in speculators, leading to more lending, higher
prices, and so on in a self-reinforcing process. This is known as an asset price
bubble.
While the increases in asset prices and the money supply may create the
impression of a healthy, growing economy, this boom is in fact fuelled by

SUMMARY OF KEY POINTS 15

an increasing build-up of debt (since all increases in the money supply are a
result of increases in borrowing). The current monetary system therefore sows
the seeds of its own destruction households and businesses cannot take on
ever-increasing levels of debt, and when either start to default on loans, it can
cause a chain reaction that leads to a banking crisis, a wider financial crisis,
and an economy-wide recession.
Financial crises therefore come about as a result of banks lending activities.
As Adair Turner, head of the UKs Financial Services Authority, puts it: The
financial crisis of 2007/08 occurred because we failed to constrain the private
financial systems creation of private credit and money. (2012) The boom-bust
cycle is also caused by banks credit creation activities.
Some measures implemented to dampen or mitigate against these effects have
the perverse effect of actually making a crisis more likely. Deposit insurance,
for example, is intended to make the banking system safer but in reality enables
banks to take higher risks without being scrutinised by their customers. The
Basel Capital Accords, again designed to make the system safer, gives banks
incentives to choose mortgage lending over lending to businesses, making
asset price bubbles and the resulting crises more rather than less likely.

Chapter 5: Social and Environmental

impacts of the Current System
Much of the money created by the banking system is directed into housing,
causing house prices to rise faster than the rise in salaries. As well as making
housing unaffordable for those who were not on the housing ladder before
prices started to rise, it also leads to a large number of people using property as an alternative to other forms of pension or retirement savings, without
them realising the rising prices are artificially fuelled by the rise in mortgage
lending and money supply.
The fact that our money is issued as debt means that the level of debt must
be higher than it otherwise would be. The interest that must be paid on this
debt results in a transfer of wealth from the bottom 90% of the population (by
income) to the top 10%, exacerbating inequality. In addition, any attempt by
the public to pay down its debts will result in a shrinking of the money supply,
usually leading to recession and making it difficult to continue reducing debt.

16 MODERNISING MONEY
The state currently earns a profit, known as seigniorage, from the creation of
bank notes. However, because it has left the creation of electronic money in
the hands of the banking sector, it is the banks that earn a form of seigniorage
on 97% of the money supply. This is a significant and hidden subsidy to the
banking sector, and the loss of this seigniorage requires that higher taxes are
levied on the population.
The instability caused by the monetary system harms the environment. The
burden of servicing an inflated level of debt creates a drive for constant
growth, even when that growth is harmful to the environment and has limited
social benefit. When the inevitable recessions occur, regulations protecting
the environment are often discarded, as is longer-term thinking with regards
to the changes that need to be made. In addition, there is little control over
what banks invest in, meaning that they often opt for environmentally harmful projects over longer-term beneficial investments.
Finally, the current monetary system places incredible power in the hands of
banks that have no responsibility or accountability to society. The amount of
money created by the banking sector give it more power to shape the economy
than the whole of our elected government, yet there is very little understanding of this power. This is a significant democratic deficit.

Chapter 6: Preventing Banks from

Creating Money
It is possible to remove the ability of banks to create money with a few relatively minor changes to the way they do business. This will ensure that bank
lending will actually transfer pre-existing money from savers to borrowers,
rather than creating new money.
From the perspective of bank customers, little will change, except for the fact
that they will have a clear choice between having their money kept safe, available on demand, but earning no interest, or having it placed at risk for a fixed
or minimum period of time in order to earn interest.
The specific changes made to the structure of banking make it possible for
banks to be allowed to fail, with no impact on the payments system or on
customers who opted to keep their money safe.

SUMMARY OF KEY POINTS 17

Chapter 7: The New Process for Creating New Money

With banks no longer creating money, an independent but accountable public
body, known as the Money Creation Committee (MCC), would instead create
money. The MCC would only be able to create money if inflation was low and
stable. Newly created money would be injected into the economy through one
of five methods, four of which are: a) government spending, b) cutting taxes,
c) direct payments to citizens or d) paying down the national debt. Which of
these methods is used to distribute new money into the economy is ultimately
a political decision.
Ensuring that businesses are provided with adequate credit is always a concern
whenever changes are made to the way that banks operate. However, rather
than resulting in a damaging fall in the credit provided to businesses, the
reforms ensure that the Bank of England has a mechanism to provide funds
to banks that can only be used for lending to productive businesses. This fifth
method of injecting money into the economy is likely to boost investment in
the real economy and business sector above its current level.

Chapter 8: Making the Transition

The transition from the current monetary system to the reformed system is
made in two distinct stages: 1) an overnight switchover, when the new rules
and processes governing money creation and bank lending take place, and 2)
a longer transition period, of around 10-20 years, as the economy recovers
from the hangover of debt from the current monetary system. Changes are
made to the balance sheets of the Bank of England and commercial banks,
and additional measures are taken to ensure that banks have adequate funds
to lend immediately after the switchover so that there is no risk of a temporary
credit crunch (however unlikely). The changes can be made without altering
the quantity of money in circulation.
The longer-term transition allows for a significant reduction in personal and
household debt, as new money is injected into the economy and existing loan
repayments to banks are recycled into the economy as debt-free money. The
potential de-leveraging of the banking sector could be in excess of 1 trillion.

18 MODERNISING MONEY

Chapter 9: Understanding the Impacts

of the Reforms
In the reformed system money enters circulation in one of five ways, with each
method having different economic effects. As in the current monetary system,
money that increases productivity will be non-inflationary, while new money
that does not increase productivity will be inflationary. Because banks will
no longer create new money when they make loans, lending for productive
purposes will be disinflationary, while lending for consumer purchases will
have no economic effect. As such the Bank of England will have to closely
monitor the lending activities of banks when deciding how much new money
to inject into the economy.
Lending for the purchase of property or financial assets would be self-correcting, in so much as the economy is less able to sustain asset price bubbles. As a
result financial instability would be reduced, while the effect of bank failures
or deflation is much milder than is currently the case, due to money no longer
being created with a corresponding debt.
As money is created without a corresponding debt, individuals are able to pay
down their debts without contracting the money supply. Likewise the government gains an additional source of revenue, reducing both the need for taxes
and the borrowing requirement. Many of the negative environmental impacts
of the current monetary system are lessened in line with the reduction of the
boom-bust cycle. In particular, the pressure to remove environmental regulation in downturns is reduced as is the constant need to grow in order to
service debt. Likewise, the directed nature of Investment Accounts means the
investment priorities of banks start to reflect the investment priorities of society. This also has positive effects on democracy by reducing the power of the
banks to shape society in their own interests. Finally, the reformed system
ensures that the creation of money is both transparent and accountable to
parliament.

Chapter 10: Impacts on the Banking

Sector
With money no longer issued when banks make loans or buy assets, deleveraging of the economy becomes possible. As the level of debt falls, the banking
sectors balance sheet will shrink. Because banks can now be allowed to fail,

SUMMARY OF KEY POINTS 19

the too big to fail subsidies for large banks disappear. However, at the same
time it becomes much easier for banks to manage their cashflow (because
all investments are made for fixed time periods or have notice periods),
and regulations such as the Basel Capital Accords could be simplified when
applied to the reformed banking system. An effect of the accounting changes
made during the transition period is that the liquidity gap that is endemic to
modern banking would be significantly reduced, making banks much safer in
liquidity terms.
The reforms mean that the central bank would have direct control over the
money supply, rather than having to indirectly control it through interest
rates. As interest rates would be set by the markets, the central bank would no
longer need to play this role.
From an international perspective, there are no practical implications with
regards to how the monetary system connects to those of other countries,
and international trade and finance can continue as normal. With regards to
exchange rates between sterling and other currencies, the common fear that
sterling would be attacked and devalued is misguided; the greater risk is that
the currency would appreciate. However, the design of the reformed monetary
system ensures that large changes in exchange rates are self-balancing. Finally,
the reforms have advantages for national security, by making the payments
system more robust.

Conclusion
There are very real challenges facing the world over the next few decades,
including likely crises in food production, climate, energy, and natural
resources (including water). To focus on dealing with these extreme challenges, it is essential that we have a stable monetary system and are not
distracted by crises that are inevitable in the current monetary system. The
monetary system, being man-made and little more than a collection of rules
and computer systems, is easy to fix, once the political will is there and opposition from vested interests is overcome. The real challenges of how to provide
for a growing global population, a changing climate, and increasingly scarce
natural resources, require a monetary system that works for society and the
economy as a whole. For that reason, our current monetary system is no
longer fit for purpose and must be reformed.

INTRODUCTION
Of all the many ways of organising banking, the worst
is the one we have today.
Sir Mervyn King
Governor of the Bank of England, 2003 - 2013
October 25th 2010
After the experience of the last few years, few people would disagree with
Mervyn Kings claim above. The 2007-08 financial crisis led to massive
increases in unemployment and cuts to public services as governments around
the world were forced to bail out failing banks. While the complete collapse of
the financial system may have been averted, six years later the countries at the
centre of the crisis have still not recovered. In economic terms the permanent
loss to the world economy has been estimated at a staggering $60 - $200 trillion, between one and three years of global production. For the UK the figures
are between 1.8 and 7.4 trillion (Haldane, 2010).
Yet while the 2007/08 crisis was undoubtedly a surprise to many, it would be
wrong to think that banking crises are somehow rare events. In the UK there
has been a banking crisis on average once every 15 years since 1945 (Reinhart and Rogoff, 2009), whilst worldwide there have been 147 banking crises
between 1970 and 2011 (Laeven and Valencia, 2012).
It seems clear that our banking system is fundamentally dysfunctional, yet
for all the millions of words of analysis in the press and financial papers, very
little has been written about the real reasons for why this is the case. Although
there are many problems with banking, the underlying issue is that successive
governments have ceded the responsibility of creating new money to banks.
Today, almost all of the money used by people and businesses across the world
is created not by the state or central banks (such as the Bank of England),
but by the private banking sector. Banks create new money, in the form of

22 MODERNISING MONEY
the numbers (deposits) that appear in bank accounts, through the accounting process used when they make loans. In the words of Sir Mervyn King,
Governor of the Bank of England from 2003-2013, When banks extend loans
to their customers, they create money by crediting their customers accounts.
(2012) Conversely, when people use those deposits to repay loans, the process
is reversed and money effectively disappears from the economy.
Allowing money to be created in this way affects us all. The current monetary
system is the reason we have such a pronounced and destructive cycle of boom
and bust, and it is the reason that individuals, businesses and governments are
overburdened with debt.
When banks feel confident and are willing to lend, new money is created.
Banks profit from the interest they charge on loans, and therefore incentivise
their staff to make loans (and create money) through bonuses, commissions
and other incentive schemes. These loans tend to be disproportionately allocated towards the financial and property markets as a result of banks preference for lending against collateral. As a result our economy has become
skewed towards property bubbles and speculation, while the public has
become buried under a mountain of debt. When the burden of debt becomes
too much for some borrowers, they default on their loans, putting the solvency
of their banks at risk. Worried about the state of the economy and the ability of
individuals and businesses to repay their loans, all banks reduce their lending,
harming businesses across the economy.
When banks make new loans at a slower rate than the rate at which their
old loans are repaid, the money supply starts to shrink. This restriction in
the money supply causes the economy to slow down, leading to job losses,
bankruptcies and defaults on debt, which lead to further losses for the banks,
which react by restricting their lending even further. This downward spiral
continues until the banks eventually regain their confidence and start creating new money again by increasing their lending.
We have no hope of living in a stable economy while the money supply - the
foundation of our economy - depends entirely on the lending activities of
banks that are chasing short-term profits. While the Bank of England maintains that it has the process of money creation under control, a quick glance
at the growth of the bank-issued money supply over the last 40 years (shown
opposite) calls this claim into question.

INTRODUCTION 23
Cash vs bank-issued money, 1964-2012
Cash vs Bank-Issued Money, 1964 - 2012

2500

2000

BANK-ISSUED MONEY
CASH

BILLIONS

1500

1000

500

2012

2008

2004

2000

1996

1992

1988

1984

1980

1976

1972

1968

1964

By ceding the power to create money to banks private sector corporations

the state has built instability into the economy, since the incentives facing
banks guarantee that they will create too much money (and debt) until the
financial system becomes unstable. This is a view recently vindicated by the
chairman of the UKs Financial Services Authority, Lord (Adair) Turner, who
stated that: The financial crisis of 2007/08 occurred because we failed to
constrain the private financial systems creation of private credit and money
(2012).
Yet if this instability in the money supply werent enough of a problem, newly
created money is accompanied by an equivalent amount of debt. It is therefore extremely difficult to reduce the overall burden of personal and household debt when any attempt to pay it down leads to a reduction in the money
supply, which may in turn lead to a recession.
The years following the recent financial crisis have clearly shown that we have
a dysfunctional banking system. However, the problem runs deeper than bad
banking practice. It is not just the structures, governance, culture or the size
of banks that are the problem; it is that banks are responsible for creating the
nations money supply. It is this process of creating and allocating new money
that needs fundamental and urgent reform.
This book explores how the monetary system could be changed to work better
for businesses, households, society and the environment, and lays out a workable, detailed and effective plan for such a reform.

24 MODERNISING MONEY

Our proposed reforms

We have little hope of living in a stable and prosperous economy while the
money supply depends entirely on the lending activities of banks chasing
short-term profits. Attempt to regulate the current monetary system are
unlikely to be successful as economist Hyman Minsky argued, stability
itself is destabilising. Indeed, financial crises are a common feature of financial history, regardless of the country, government, or economic policies in
place: Crises have occurred in rich and poor countries, under fixed and flexible exchange rate regimes, gold standards and pure fiat money systems, as
well as a huge variety of regulatory regimes. Pretty much the only common
denominator in all these systems is that the banks have been the creators of
the money supply. As Reinhart and Rogoff (2009) put it:
Throughout history, rich and poor countries alike have been lending,
borrowing, crashing -- and recovering -- their way through an extraordinary range of financial crises. Each time, the experts have chimed, 'this
time is different', claiming that the old rules of valuation no longer apply
and that the new situation bears little similarity to past disasters.
Rather than attempt to regulate the current monetary system, instead it is the
fundamental method of issuing and allocating money that needs to change.
These proposals are based on plans initially put forward by Frederick Soddy
in the 1920s, and then subsequently by Irving Fisher and Henry Simons in
the aftermath of the Great Depression. Different variations of these ideas
have since been proposed by Nobel Prize winners including Milton Friedman (1960), and James Tobin (1987), as well as eminent economists Laurence
Kotlikoff (2010) and John Kay (2009). Most recently, a working paper by economists at the International Monetary Fund modelled Irving Fishers original
proposal and found strong support for all of its claimed benefits (Benes &
Kumhof, 2012).
While inspired by Irving Fishers original work and variants on it, the proposals in this book have some significant differences. Our starting point has
been the work of Joseph Huber and James Robertson in their book Creating
New Money (2000), which updated and modified Fishers proposals to take
account of the fact that money, the payments system and banking in general
is now electronic, rather than paper-based. This book develops these ideas
even further, strengthening the proposal in response to feedback and criticism
from a wide range of people.

INTRODUCTION 25

There are four main objectives of the reforms outlined in this book:
1.

To create a stable money supply based on the needs of the economy.

Currently money is created by banks when they make loans, driven by the
drive to maximise their profit. Under our proposals, the money supply
would be increased or decreased by an independent public body, accountable to Parliament, in response to the levels of inflation, unemployment
and growth in the economy. This would protect the economy from credit
bubbles and crunches, and limit monetary sources of inflation.

2.

To reduce the burden of personal, household and government debt.

New money would be created free of any corresponding debt, and spent
into the economy to replace the outstanding stock of debt-based money
that has been issued by banks. By directing new money towards the roots
of the economy - the high street and the real (non-financial) economy we can allow ordinary people to pay down the debts that have been built
up under the current monetary system.

3.

To re-align risk and reward. Currently the government (and therefore

the UK taxpayer) promises to repay customers up to 85,000 of any
deposits they hold at a bank that fails. This means that banks can make
risky investments and reap the rewards if they go well, but be confident
of a bail out if their investments go badly. Our proposals will ensure that
those individuals that want to keep their money safe can do so, at no
risk, while those that wish to make a return will take both the upside and
downside of any risk taking. This should encourage more responsible risk
taking.

4.

To provide a structure of banking that allows banks to fail, no matter

their size. With the current structure of banking no large bank can be
permitted to fail, as to do so would create economic chaos. Simple changes
outlined in this book would ensure that banks could be liquidated while
ensuring that customers would keep access to their current account
money at all times. The changes outlined actually reduce the likelihood of
bank failure, providing additional protection for savers.

In order to achieve these aims, the key element of the reforms is to remove
the ability of banks to create new money (in the form of bank deposits) when
they issue loans. The simplest way to do this is to require banks to make a clear
distinction between bank accounts where they promise to repay the customer

26 MODERNISING MONEY
on demand or with instant access, and other accounts where the customer
consciously requests their funds to be placed at risk and invested. Current
accounts are then converted into state-issued electronic currency, rather than
being promises to pay from a bank, and the payments system is functionally separated from the lending side of a banks business. The act of lending
would then involve transferring state-issued electronic currency from savers
to borrowers. Banks would become money brokers, rather than money creators, and the money supply would be stable regardless of whether banks are
currently expanding or contracting their lending.
Taken together, the reforms end the practice of fractional reserve banking, a
slightly inaccurate term used to describe a banking system where banks promise to repay all customers on demand despite being unable to do so. In late
2010 Mervyn King discussed such ideas in a speech:
A more fundamental, example [of reform] would be to divorce the payment
system from risky lending activity that is to prevent fractional reserve
banking In essence these proposals recognise that if banks undertake
risky activities then it is highly dangerous to allow such gambling to take
place on the same balance sheet as is used to support the payments system,
and other crucial parts of the financial infrastructure. And eliminating
fractional reserve banking explicitly recognises that the pretence that riskfree deposits can be supported by risky assets is alchemy. If there is a need
for genuinely safe deposits the only way they can be provided, while ensuring costs and benefits are fully aligned, is to insist such deposits do not
coexist with risky assets. (King, 2010)
After describing the current system as requiring a belief in financial alchemy,
King went on to say that, For a society to base its financial system on alchemy
is a poor advertisement for its rationality. Indeed, over the next few chapters
we expect readers to find themselves questioning the sanity of our existing
monetary system.

CHAPTER 1
A SHORT HISTORY OF MONEY
In this chapter we outline a brief history of money and banking. We start by
looking at the textbook history of the origins of money, before examining the
alternative accounts of historians and anthropologists, which contradict the
textbook history. We then discuss the development of banking in the United
Kingdom and its evolution up to the present day.

1.1 The origins of money

A textbook history
The standard theory of the origins of money, commonly found in economics textbooks, was perhaps first put forward by Aristotle (in Politics) and
restated by Adam Smith in his book The Wealth of Nations (1776). According to Smiths story, money emerged naturally with the division of labour, as
individuals found themselves without many of the necessities they required but
at the same time an excess of their own produce. Without a means of exchange
individuals had to resort to barter in order to trade, which was problematic
as both sides of the deal had to have something the other person wanted (the
double coincidence of wants). To avoid this inconvenience people began
to accept certain types of commodities for their goods and services. These
commodities tended to have two specific characteristics. First, the majority of people had to find them valuable, so that they would accept them in
exchange for their goods or services. Secondly, these goods had to be easily
divisible into smaller units in order to make payments of varying amounts.
It is suggested that as metal satisfied both requirements, it naturally emerged
as currency. However, metal had to be weighed and checked for purity every

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CHAPTER 2
THE CURRENT MONETARY SYSTEM
In this chapter we build up an understanding of the monetary system. We start
by looking at the modern banking system, focussing on the role of the two key
players: commercial (high street) banks, and the central bank (the Bank of
England). We explain the fundamental business model of a modern bank and
then look at the mechanics by which commercial banks create (and destroy)
money and central banks create (and destroy) central bank reserves and cash.
This chapter provides enough knowledge of the existing banking system to
understand the analysis that follows in the rest of the book. However, for
those who would like a much more in-depth understanding of the modern
monetary system, the book Where Does Money Come From? published by the
New Economics Foundation is very highly recommended.

2.1 Commercial (high-street) banks

The banks that most of us use today are referred to as commercial banks or
high-street banks . They perform a number of practical functions:
They make loans. This could be seen as the raison dtre of modern banking.
It is by making loans that they expand and generate the bulk of their profits.
They allow customers to make electronic payments between each other
through electronic funds transfers (accessed by internet or telephone banking) or via the use of debit cards.
They provide physical cash to customers either through bank branches or via
ATM cash machines.
They accept deposits. This is the role most of us associate banks with, from
our first childhood experiences of putting money in the bank.

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CHAPTER 3
WHAT DETERMINES THE MONEY
SUPPLY?
In the previous chapter we saw that banks create money, in the form of bank
deposits, when they make loans and buy assets. In this chapter we discuss the
incentives banks have for creating money in this way, as well as looking at the
restrictions and regulations that prevent them from doing so.
We begin by looking at what determines the demand for bank loans, concluding that as a result of the distribution of wealth, the desire to speculate, and the
effect of various laws, the demand for credit will almost always be very high.
The demand for money is also discussed, as is the effect on the economy of any
attempt to pay down debts in aggregate.
Second, we will look at the incentives facing banks: given the high demand
for credit, why do banks not simply lend to every individual or business that
applies for a loan? We will see that due to the profit motive, financial innovations and some other institutional quirks, banks will attempt to lend as much
as they can as long as it is profitable for them to do so.
Third, we will look at the reaction of the regulators. Faced with a banking
sector that has a huge number of willing borrowers and an incentive to lend
to them, in the current institutional structure, is it possible to temper banks
natural desire to create credit? We will conclude that despite the wide variety
of tools available, none are particularly effective, and thus banks are relatively
unconstrained in their ability to create credit. The main determinant of bank
lending, and therefore the money supply, will be found to be the desire and
willingness of banks to lend, which in turn will rest on their confidence in the
wider economy, the profitability of lending and the likelihood that loans will
be repaid.

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CHAPTER 4
ECONOMIC CONSEQUENCES OF THE
CURRENT SYSTEM
Chapter 2 discussed the mechanics of bank lending, showing that when a bank
makes a loan it increases both the broad money supply and the level of debt in
the economy. Chapter 3 showed that banks profit from making loans, that the
demand for credit tends to be very high, and that banks face little constraint
on their ability to lend. Consequently, in the current monetary system it is the
commercial banks, rather than the central bank, which determine both the
quantity of money and debt in the economy, as well as the first use of newly
created money.
In this chapter we analyse the economic effects of such a monetary system. For
non-economists this chapter may be the most challenging, although we have
attempted to convey the theories as simply and with as little jargon as possible.
Some readers may wish to skip to Chapter 5 and return to this chapter after
reading the rest of the book.
We begin by looking at the short-run impact of bank lending, distinguishing
between lending to the productive and non-productive sectors of the economy. Particular attention is paid to the effect of money created (via bank lending) to fund purchases of financial assets, in contrast to the effect of money
created to invest in businesses that contribute to GDP. We also consider the
links between asset and consumer price inflation.
The longer-run dynamic effects of bank lending on the economy are then
discussed with reference to Hyman Minskys Financial Instability Hypothesis. Minskys theory explores the role of the financial sector in driving the
boom-bust cycle, financial crises and debt deflation, showing that in the long
term stability is itself destabilising. Evidence for Minsky's theories will also be
examined.

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CHAPTER 5
SOCIAL AND ENVIRONMENTAL
IMPACTS OF THE CURRENT
MONETARY SYSTEM
The previous chapter discussed the economic effects of the current monetary
system, showing how through its normal functioning it could lead to booms,
busts, and occasionally financial crises and depressions. In this chapter we will
address some of the other impacts of the monetary system. In particular, we
will look at the effect of the monetary system on inequality, public and private
debt, the environment and the level of democracy.

5.1 Inequality
The current economic system depends on an adequate supply of money being
available for transactions between households, businesses and government.
However, as section 3.2 showed, for there to be a supply of money, some people
must be in debt. Even the small amount of cash money which is not created
by the commercial banking sector can only enter the economy in exchange
for bank deposits. Consequently, in effect the non-bank sector must rent the
entire money supply from commercial banks, resulting in a constant transfer
of wealth from the rest of the economy to the banking sector (through interest
payments).
In the UK the money supply currently stands at approximately 2 trillion.
Assuming an average interest rate of 8% on bank loans, in order to keep the
money supply at a constant level requires the non-bank sector to transfer 160

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CHAPTER 6
PREVENTING BANKS FROM
CREATING MONEY
Part One of this book critically examined the current monetary system. Chapters 1-2 began with a brief history of money and banking, before moving on to
discuss the mechanics of the current system. In particular we saw that banks
create money when they make loans. Chapter 3 looked at what determines
the demand and supply of credit, concluding that the high demand for credit
combined with ineffective regulations leaves the determination of the money
supply in the hands of the banks. Chapters 4 and 5 asked, given the structure
of the current monetary system, what is the likely result? The normal functioning of such a system was shown to result in periodic booms, busts, and
occasionally financial crises, depressions and even debt deflations, as well as
serious consequences for growth, unemployment, investment, house prices,
public and private debts, inequality, the environment, and democracy. With
such a wide array of negative consequences, we feel obliged to ask the question
first put forward by Mervyn King - of all the ways of organising money and
banking, is the best really the one we have today?
In the second part of this book we describe an alternative monetary system
that we believe addresses many of the weaknesses of the system we have today.
Chapters 6-8 outline how the reformed banking and monetary system would
work, contrasting this against the existing system, while Chapters 9-10 explain
the impacts of the reformed system. In this sense the second part of this book
parallels the first part: Chapters 6-8 correspond to Chapters 1-3, with Chapters 9-10 corresponding to Chapters 4-5.
In this chapter the new monetary system is introduced, beginning with the
different types of account available to customers and the new accounts at the
central bank. A description of the mechanics of how banks will make loans

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CHAPTER 7
THE NEW PROCESS FOR
CREATING MONEY
After the reform, banks would no longer be able to create money in the
form of bank deposits when they made loans or bought financial assets. As
a result, an alternative method for injecting money into the economy will be
required. However, before we address the question of how new money is to be
created, we first must address the questions:
1.

Who should decide how much new money is to be created?

2.

Who should decide how that money is to be used?

We will now look at both of these questions in detail.

7.1 Who should have the authority to

create money?
The overriding principle when we are deciding who should have the authority
to create money is whether or not the creator can benefit personally from
creating money. If the answer is yes, then we have a conflict of interest.
Banks profit from making loans, and as such they incentivise their staff to
maximise lending through sales targets, bonuses, commissions, the opportunity of promotion, etc. During periods where economic conditions are
relatively benign banks and bankers profit by increasing their lending and by
implication increasing the money supply as fast as possible. In theory the riskmanagement side of banks should place some kind of limitation upon this
increase in lending and consequent increase in the money supply, but history
has shown that risk management and prudence is often forgotten in the chase
for profits. Besides, while the percentage increase in the money supply was

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CHAPTER 8
MAKING THE TRANSITION
This chapter explains how we make the transition between the current system
and the reformed system. It is necessarily quite technical. Readers who wish
to avoid the balance sheets may skip this chapter, as the following chapters
assume that this process has already been completed.

An overview of the process

There are two elements of the transition to the new banking system:
1.

The overnight switchover on a specified date when the demand deposits of banks will be converted into state-issued currency and customers
accounts will be converted into Transaction Accounts and Investment
Accounts.

2.

A longer period, potentially 10-30 years after the reforms, as the consequences of the conversion of demand deposits into state-issued currency
allows a significant reduction in household debt and a gradual reduction
in the size of the aggregated balance sheet of the banking sector.

The economy will be operating on the basis of the reformed monetary system
immediately following the switchover. However, it will take a longer period of
transition to recover from the hangover of debt created by the current debtbased monetary system. The monetary system cannot be considered fully
reformed until this process is complete.
The balance sheets for the Bank of England, the commercial banking sector
and the household sector (i.e. the non-bank sector) before, just after, and
around 20 years after the reforms take place are shown at the end of this chapter. An alternative accounting treatment of the reforms and these balance
sheets, in which money remains on the liabilities side of the central banks
balance sheet, can be found in Appendix III.

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CHAPTER 9
UNDERSTANDING THE IMPACTS OF
THE REFORMS
This chapter looks at the economic impacts of a monetary system where
money is issued solely by the state and injected into the economy through the
various mechanisms outlined in Chapter 7.
We begin by briefly summarising a few key differences between the current
monetary system and the reformed system. We then look at the likely impact
of banks lending and central bank money creation in a reformed system,
before addressing the reform's impact on financial stability and asset price
bubbles. Finally, we address the environmental and social impacts of a
reformed monetary system.

9.1 Differences between the current &

reformed monetary systems
There are a few key differences between the current monetary system and
the reformed system outlined in Chapters 7 and 8. In essence the rules of
the monetary system have changed and this will change the dynamics of the
economic system. The key differences are shown in the table overleaf.

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CHAPTER 10
IMPACTS ON THE BANKING SECTOR
10.1 Impacts on commercial banks
The reforms outlined in Chapter 6 and 7 have both advantages and disadvantages for the banking and financial sector. These effects are discussed below.

Banks will need to acquire funds before lending

As we saw in Chapter 2, currently when a bank makes a loan it creates new
deposits for those who have borrowed the money. After the reform, this will
no longer be the case, although banks will still be able to make loans using
funds that customers have provided specifically for this purpose. Banks will
no longer be able to make loans first (by making an accounting entry) and go
looking for the reserves later, as they do in the current system. Instead, they
will have to find the money they need to make loans before they make them.
Banks will thus become true intermediaries, merely transferring pre-existing
purchasing power from savers to borrowers.
It is difficult to predict how individuals will allocate their funds between
Investment and Transaction Accounts after the reform. However, the current
ratio of money in sight deposits (which are similar to Transaction Accounts)
to time deposits (which are similar to Investment Accounts) may give us a
clue. Currently the balance of time deposits to sight deposits is 1.5 trillion to
1.1 trillion (58% in time deposits vs. 42% in sight deposits).1

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1. These figures were arrived at by adding together all sight deposit categories
(MFIs, public sector, private sector and non-residents Bank of England codes:
RPMB3GL, RPMB3MM, RPMB3NM, RPMB3OM) and all time deposit categories

CONCLUSION
When you start printing money, you create some value
for yourself. If you can issue a thousand pounds-worth
of IOUs to everybody, youve got a thousand pounds for
nothing. And so we do restrict the ability of people to
create their own [bank] notes Were protecting you
from charlatans.
Paul Fisher1
Executive Director, Bank of England
There is a curious contradiction at the heart of the contemporary monetary
system. While one agency of the state the police spend considerable
time and resources trying to prevent the private creation of paper money
(commonly referred to as counterfeiting), another agency of state the Bank
of England spends significantly more time enabling and facilitating the
private creation of money by the corporations that we know as banks. Banks
are able to create money because their IOUs (liabilities) can be used, via a
sophisticated electronic payment system, as a substitute for the paper money
issued by the state. These privately-issued IOUs now make up 97% of all the
money in the UK economy.
Yet as Paul Fishers quote attests, the Bank of England is clearly aware that the
ability to issue a thousand pounds-worth of IOUs gives the issuer something for nothing. In the last decade alone, UK banks have issued more than
a trillion pounds of additional IOUs. The value that they got for nothing was
a trillion pounds-worth of interest bearing assets in the form of debt contracts

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1.

Speaking to BBC Radio 4 Analysis What Is Money?, 1st April 2012.

APPENDIX I
EXAMPLES OF MONEY
CREATION BY THE STATE:
ZIMBABWE VS. PENNSYLVANIA
The common response to the idea of allowing the state to issue money and
spend it into the economy is that such an approach would be highly inflationary. The examples of the hyperinflation in Zimbabwe or Weimar Republic
Germany are often mentioned as a reason why states cannot be trusted to
issue currency. However, those making these claims rarely have any in-depth
understanding of what happened in Zimbabwe, Germany or any of the other
hyperinflationary periods. In reality, each period of hyperinflation happens
due to a unique set of circumstances that are completely inapplicable to the
UK or any of the countries where these reforms are likely to be implemented.
In this appendix we look first at the Zimbabwean experience between 2007
and 2008, as this is the most recent example of a hyperinflation. We also briefly
look at the period of hyperinflation in Weimar Republic Germany.
We then look at a Pennsylvanian money system in the 1720s, to show that if
managed properly, money creation can lead to a prosperous and low inflation
economy. Unfortunately there are few contemporary examples of responsible
state-issued currency; every country world-wide runs on some variant of the
banking system outlined in Chapter 2, and as a result has suffered significant
inflation and indebtedness (whether at a household or government level, or
both). In many cases, countries under the current system can only attempt to
keep inflation low by raising interest rates, which can stifle beneficial investment (Chang, 2007). Under the proposals outlined in this book, it would be
much more straightforward to maintain inflation at a reasonable level without
the need to use high investment-stifling interest rates.

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APPENDIX II
REDUCING THE NATIONAL DEBT
As discussed in Chapter 7, one potential use of newly created money could
be to pay down the existing national (government) debt. In this appendix
we explain the basic concepts necessary to understand the national debt. We
then discuss the reasons why in the context of these reforms, paying down the
national debt is not the top priority.

What is the national debt?

The government has three main sources of revenue:
1.

Taxes & fees - such as Income Tax, National Insurance, Value Added Tax
(VAT), taxes on alcohol, fuel, air tickets and so on.

2.

Borrowing - this is mainly achieved through the issuing of bonds.

3.

Creation of money - the revenue from this source is miniscule under the
current monetary system.

If government spends more than it collects in taxes the difference is called

the deficit. If it collects more in taxes than it spends, this difference is called a
surplus. Surpluses have been relatively rare in the UK in recent decades, with
the government typically running deficits, spending more than they collect in
taxes and borrowing to make up the difference. These deficits have increased
the nominal value of the national debt (whereas surpluses would have reduced
it).

Who does the government borrow from?

Rather than borrowing from banks, the government typically borrows from
the market - primarily pension funds and insurance companies. These
companies lend money to the government by buying the bonds that the
government issues for this purpose. Many companies favour investing money

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APPENDIX III
ACCOUNTING FOR THE MONEY
CREATION PROCESS
The reforms outlined in this book modernise the process by which money
creation is accounted for at the Bank of England and the Treasury.
Instead of treating money as a liability of the issuer (as is the current setup
for bank notes), we treat money as a token, issued by the state. This money is
accepted and used by people and businesses because they are confident they
can exchange these tokens with other people for goods or services of equivalent value. In general, if too many of these tokens are issued, their value will
fall, in terms of the amount of goods or services they can buy. This is inflation. Conversely, if insufficient tokens are issued, their value will rise this is
deflation.

The current backing for bank notes

The concept of backing the currency is a hangover from the days when pound
sterling bank notes were in effect receipts for gold held at the Bank of England.
Bank notes have not been backed by or redeemable for gold since 1931, and
despite the phrase I promise to pay the bearer on demand the sum of 10 on
a ten pound sterling bank note, if you return this note to the Bank of England,
you will be given not gold, but an identical note of equal value. The Bank of
Englands own website is quite clear about this:
The words I promise to pay the bearer on demand the sum of five [ten/
twenty/fifty] pounds date from long ago when our notes represented
deposits of gold. At that time, a member of the public could exchange one
of our banknotes for gold to the same value. For example, a 5 note could
be exchanged for five gold coins, called sovereigns. But the value of the
pound has not been linked to gold for many years, so the meaning of the

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ABOUT THE AUTHORS

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
in Management (specialising in finance and banking) at the University of
Southampton. He co-authored 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. He is currently Head of
Research at Positive Money.
Andrew can be contacted at [email protected]

Ben Dyson has spent the last 5 years researching the current monetary system
and understanding the impacts it has on the economy and society as a whole.
He is the founder and director of Positive Money, a not-for-profit dedicated to
raising awareness of problems with our monetary system amongst the general
public, policy makers, think tanks, charities, academics and unions. He has
spoken at events around the UK, in Chicago, and for the BBC.
Ben can be contacted at [email protected]

You can keep in touch with Positive Money by signing up to its regular email
update at www.positivemoney.org