This week May 26, 2018, we look at the upcoming national referendum in Switzerland to change the constitution so commercial banks can no longer create money. All money creation would reside with the Swiss National Bank. We analyze the potential consequences of this action if it is implemented.
Welcome to Money For the Rest of Us Plus. This is the premium edition of Money For the Rest of Us for Plus members, and this is Plus Episode 206, The Upcoming Swiss Vote To Radically Change Money. There is an initiative in Switzerland that I wasn’t aware of, until a member pointed it out to me. I wish I would have covered it in Episode 205, Is The Fed Really Printing Money? Or in Episode 199, What Kind Of Money Is It.
A Radical Proposal
This particular initiative and the way that Switzerland is set up, it’s a direct democracy. So, if 100000 people sign an official petition for a change to Switzerland’s written constitution,there has to be a binding national referendum on the proposed change, and there’s going to be a vote on June 10th for a radical change in terms of the monetary system.
Now, the member that wrote me about this, he, as I mentioned, is from Switzerland. He writes, “As much as I love our direct democracy, I feel in many cases the topics are far too complex to get a decision by vote. In this particular initiative, it sounds convincing, but the final outcome result is unpredictable and a possible damage to the economy seems to be irreversible.”
What is this change? Well, the proposed change is that commercial banks, as we talked about in Episode 205 and 199, they can create money out of thin air. They create money when they make a loan. Loans create deposits. They, on the asset side of the balance sheet when they make a loan, they record an loan receivable. And on the liability side, they create a deposit. This is private bank money.
In the referendum, they define it as electronic money. Here’s what it says, it’s the “numbers in bank accounts, also known as book money. Currently, the money in people’s bank accounts is not created by the Swiss National Bank, but by private banks when they make loans. This virtual money in our bank account isn’t legal tender. It’s just a promise made by the banks to pay us cash and settle payments on our behalf when requested. Legally, it belongs to the bank not to the holder of the bank account.”
We discussed that in Episode 199. This is private money. It’s a form of money. The only sovereign money issued by central banks, including the Federal Reserve, and the Swiss National Bank is currency. It’s coins and bills. They go on in describing this initiative, they asked the question, What is sovereign money?
It says, “The Swiss National Bank would be the sole organization authorized to create money, not only cash and coins, but also the electronic money in our bank accounts. The banks would provide all the services as they do now, including bank accounts, payment transactions and loans. They just won’t be able to create money anymore.”
So sovereign money is the coins and the bills and then bank reserves is the only form of electronic money that central banks now create. We talked about that in Episode 205. As part of quantitative easing or when any central bank buys treasury bonds or other securities in the public market, that money is created to buy those assets via central bank reserves. The central bank reserves sit as assets on the balance sheets of banks.
Checking Account Deposits Would Be Sovereign Money
Under this proposal, what would happen is, those deposits those private bank deposits (i.e. checking account deposit), which is part of what we described in Episode 205 as the monetary aggregate M1 held at commercial banks would be listed as liabilities of the Swiss National Bank. Essentially those deposits, would be swapped for sovereign money. They would be a liability that the commercial bank owed to the Swiss National Bank because those checking account deposits would be switched to Swiss National Bank money. So, it would be legal tender. So, there would be no such thing as private bank money in terms of checking deposits. It would actually all be Swiss National Bank money.
Here’s how the initiative puts it. It says, “before the sovereign money reform under the current system, there are two types of money in circulation; central bank reserves, which circulate between banks and the central bank, and bank money which circulates between people and banks. After sovereign money reform, there will only be one type of money; sovereign money in circulation. Immediately after the transition, the bank’s balance sheet is exactly the same size as before.”
“When a customer subsequently repays a loan, the bank has two choices, it may keep the money, so it is ready to make a new loan to another customer, or it may choose to repay this amount of its liability to the Swiss National Bank. In this second case, the balance sheet will contract.”
So, remember the deposits now on a bank’s balance sheet, those liabilities, their customer deposits are a liability of the bank. After this change, those deposits would be legal tender, be sovereign money. So, the commercial banks would essentially owe that money to the Swiss National Bank because it’s sovereign money. And that’s essentially what it is. That’s how the accounting would work.
Now, the initiative I talked about eventually, they want to cut the link between most money and debt. 90% of money in Switzerland is created by commercial banks about the same in the US and I suspect in most countries. So, any money created is tied to debt. The idea is this is to cut that linkage between debt and money creation.
How Money Would Be Created
How would money be created then? If it’s no longer created by banks through lending, in other words, banks would only be able to make a loan if they had money to do so. Either savings account deposits that they attracted through CDs, or they had central bank reserves on their balance sheet. That would be the only way. They can no longer make this accounting entry to create money. Because there would be no private bank money. It would all be sovereign money.
The ways that money would be created by the Central Bank is by buying assets such as securities or foreign exchange reserves. That’s how central banks create money now through what we know as quantitative easing. They buy securities, they create money, that puts reserves as an asset on the bank’s balance sheet oftentimes. In which case, then, that sovereign money is what the bank could lend out.
The other way money could be created is by lending money directly to banks. It is the other way it could be done. Now, here’s a third way that’s pretty interesting. It says, by handing debt free money directly to the government to be spent back into circulation. If the banks are no longer creating money, that means the Central Bank needs to really step up the amount of money creation. One way to do that would be give the money to the government, and then the government would spend that money and it would be debt free money.
The other thing it could do is the money could be given directly to citizens, or they say, reduce taxes. This is sort of mind blowing when you think about it. Because it is still fiat currency. It’s still backed by nothing.
The constitution in Switzerland says part of the Central Bank lending needs to be backed by gold reserves. But, not all of it. I believe one of these initiatives, these direct initiatives that were voted on. I think it was in 2014 that all central bank money needed to be backed by reserves. That failed. But this one, essentially, all the responsibility for money creation would fall on the central bank and they could create it and just give it away. Which seems as ludicrous as our current system. That’s why I find the monetary system so fascinating because … And it astounds me that this initiative made it this far because, at least in the U.S, most citizens don’t even realize that banks create money. I would say most politicians don’t realize that. Yet here is the Swiss voting on it, recognizing, yes, banks do create money and we do not want to let them do that anymore.
Now, that certainly gives more power to the Swiss Central Bank to control the money supply. That would be the concern. Now, their job is to make sure that the inflation stays in check, and that the Swiss franc is stable. The proponents of this initiative suggests that by … Those are already mandates of central banks. So, by taking away this money creation from commercial banks and giving it to the central bank, that will allow it to better fulfill its mandate because it has a better understanding according them of how much money needs to be created.
Now, if this happens, this potentially could put … upward pressure on the Swiss franc. It could make the Swiss franc much stronger because now, all money in Switzerland would be sovereign money. Even checking accounts held at banks.
Top Down Versus Bottom Up Money Creation
One of my concerns though, and in fact, my main concern regarding this, is the money creation that occurs right now, is banks create money, but only if households and businesses want to borrow. So, it’s a bottom up process. A localized process of money creation. It’s demand driven in terms of households and businesses wanting to borrow.
To me, that just seems to make more sense as opposed to a top down, the Central Bank will decide how much money needs to be created. And if need be, will give the money away to the government and citizens so there’s enough money flowing through the economy in terms of that velocity of money. To me, that’s the critical element.
So, I’d have to think about it more to decide if I would vote for this or not. There could be some unintended consequences. In other words, if banks can’t lend unless they have the money, how restrictive could that be in terms of the economy, the ability of households and businesses to borrow? Would they still have as easy access to credit? And will that potentially slow the economy?
But at the end of the day, that that puts way more power into the Central Bank’s hands. Obviously, citizens are worried about how much power banks have, but now you have the Central Bank with even more power, creating all the money, and deciding on a top down basis whether to do that or not. As opposed to it being spread around many different banks around the country, and that money is created by the fact that households and businesses want the loan.
It’s a fascinating vote. So we’ll see, we’ll monitor it, and see how it turns out. That is Plus Episode 206.