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Debt Jubilee for New Zealand – The Great Reset

A two part column/exposition on the concepts of a Debt Jubilee and Public Credit

Stephen Keys
April 13, 2012

Debt Jubilee for New Zealand – The Great Reset

Australian economist Steve Keen is amongst a growing group of economic renegades who believe things are so far gone with the global economy that a debt jubilee and a total reset of the financial system is required. He proposes nationalizing the banks and wiping the slate clean because he contends that it is now mathematically impossible for most countries to repay the combination of their sovereign and private debt. He also contends along with economic historian Michael Hudson that the mortgage and consumer credit that western banks have extended is verging on odious, lent recklessly for short term gain by banks more concerned about their profits from the resultant interest and fees than the effect it would have on not just individual consumers but also the nations they are citizens of. As Hudson says,

“This is why relinquishing policy control to a creditor class rarely has gone together with economic growth and rising living standards. The tendency for debts to grow faster than the population’s ability to pay has been a basic constant throughout all recorded history. Debts mount up exponentially, absorbing the surplus and reducing much of the population to the equivalent of debt peonage.”

Even Alan Bollard admitted in his book Crisis that banks may extend more credit than is good for individuals and nations. Have banks and the rest of the financial sector so grossly distorted capitalism that it is on the point of collapse?

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The concept of a debt jubilee is not new. It dates back to biblical times and the Book of Leviticus where the Hebrews would every 50 years free slaves, prisoners and forgive debts. In modern times the concept of jubilee has been applied to the debt of third world nations. If Keen and other proponents are correct the time has arrived for a general debt jubilee to be applied to western democracies including New Zealand.

But why should people be absolved from mistakes in their personal financial decisions? What about the prudent amongst us who have paid off their debt or refused to accumulate any of it at all? Surely you cannot reward the reckless, for what kind of message does this send to people and how does it distort future behaviour if everyone thinks they will be bailed out at some point down the track.

These are all valid points and not without irony given the biggest opponents to jubilee would probably be the big creditors like the banks who have had the same criticisms leveled against their own bailouts. What the jubilee does is give the money to the debtor to repay their debt rather than to the creditor to maintain the debt. One is consumer/citizen friendly, the other bank friendly.

The way Keen gets around the moral hazard problem is to give everyone a large chunk of cash whether they have debt or not. The proviso is that anyone with mortgage, student, consumer or personal debt would have to have the money applied towards that debt. They would remove or radically reduce their debt and thus free up more of their current earnings for consumption or savings. They could not use their money to leverage more debt or speculate. There would be no incentive to load up on debt before a jubilee. The people without debt would be able to use their unencumbered money to spend or invest in the economy immediately, unlike borrowed credit with no interest attached, jump starting economic activity again. Keen doesn’t mention a figure but consider how your own and the nation’s situation would change if say every adult over eighteen got $100-200 000.

This leads to the other major criticism of this jubilee concept, that it would be hyper inflationary. After all we are talking in New Zealand’s case about the government creating hundreds of billions of dollars out of thin air. This would not necessarily be inflationary if a number of other things were done concurrently. The idea isn’t just to pay off debts and restart the current credit system – it is to completely reform and re-regulate credit to prevent the same lunacy of the GFC happening again.

Keen talks about nationalizing the banks. The government would use its newly “printed” money to expunge debts it had assumed in the nationalization. Debts wiped out are deflationary rather than inflationary given that in the current system the vast majority of all “money” in the system comes into being from the banks as interest bearing credit. One would cancel out the other so in the case of the indebted the new money cannot increase the money supply.

Nationalisation might not be necessary. As debts were paid off the private banks would either shrink dramatically or withdraw from the market without needing to be taken over. They are not being forced to take a loss on their loans, only having their future income stream from interest radically reduced. Yes there would be large job losses in the banking sector but people would in theory be reabsorbed by a newly stimulated low debt economy.

Of course the people without debt would now have much greater spending capacity and this would be potentially inflationary without strict regulation. Keen’s suggestion is that the level of all types of credit available to the economy from the reset point be reduced by an amount equal to or greater than the new money created. There would be no getting your cake and eating it too.

For instance taking this idea further, Loan to Value Ratios on property might decrease dramatically, almost certainly below 80%. Commercial banks remaining could still lend but only at 100% reserve and depositors chasing interest with them would do so at their own risk. Customers would have government guaranteed current accounts held by the banks at the Reserve Bank. These would not be part of the banks balance sheet and non interest bearing. If a bank failure happened, current accounts and the payments system would be unaffected.

At the same time the tax system could change moving taxes away from income and towards financial assets. With high LVR, a high property tax, maybe a financial transaction tax or perhaps Gareth Morgan’s Comprehensive Capital Tax proposal, property prices would likely reset at a lower level, benefiting everyone apart from the most leveraged. This would be assisted by restrictions on absentee foreigners owning property and forcing longer term foreign investment rather than rewarding speculative hot money from abroad in property, the share market and the New Zealand dollar.

Welfare reform along the lines of Morgan’s Universal Basic Income could achieve similar simplicity and low cost of administration for welfare payments. Together with the tax reforms and the debt jubilee large numbers of beneficiaries and government department workers would be available and financially able to move into the private sector either as employees or as small business owners.

These ideas are radical but even financial heavy weights like Stephen Roach, retiring Chairman for Morgan Stanley Asia, are now proposing some form of jubilee. The banks and overseas interests with strong political connections would object and pressure a New Zealand government. New Zealand might even be threatened with overt or covert sanctions. There would be a period that was potentially disruptive and destabilizing. But a jubilee and public credit along with tax and welfare reform do offer an alternative to the current ideology of imposing austerity measures and keeping the banks awash with liquidity, hoping the day will come when we can start the mad cycle all over again. As Hudson points out, in our current situation, as long as any “surplus ends up being consumed by interest and financial charges, there is no revenue for new capital investment or basic social spending.”

Keen and Hudson implore us not to buy the neo-liberal mantra that there is no alternative. Change, particularly radical change is scary but as Greece, Ireland, Iceland, Portugal et al are demonstrating, perhaps the worst path is the one we are currently following.


Public Credit – Taking back money creation from the banks

If the idea of a debt jubilee is controversial, the mechanism by which it is funded, public credit, and its ongoing implications are equally so. Public credit involves removing the right to create “money” from private banks and giving it to the government or Reserve Bank. In order to fully understand the concept a brief description of the current process is necessary.

Most of the money in a modern economy comes into being as a loan from a commercial bank. If you need a mortgage or business loan it is simply a keyboard entry by your bank. They don’t have the money sitting in their vaults ready to lend. Banks create the amount as a double entry on their balance sheet, as an asset and a liability and book the ongoing income stream from interest as profit. At a later date they will go looking for deposits to cover their reserve/capital requirements, but these only need to be a fraction of the amount they have loaned out, hence the term fractional reserve lending. Under deregulation New Zealand banks are not required to keep any deposit reserves at all. They can do this because it is assumed, absent a financial crisis and/or bank run only a small proportion of their customers will be withdrawing money at any one time. They have to maintain enough money in their account with the Reserve Bank to cover normal day to day transactions although even here they can borrow short term from each other or the Reserve Bank itself to cover any shortfall.

So the upshot is as long as they can meet their capital requirements they can create as much credit in the form of interest bearing loans as they like. This money flows around the system from bank to bank generating even more credit creation as one customer’s loan is another’s payment and a means for that person’s bank to generate their own loans. This is very different from the common perception of banks as merely intermediaries between depositors and borrowers, lending only what they have as deposits and clipping the ticket. We do not have a Full Reserve system where every loan is backed by an equivalent deposit. A banking license is literally a license to print money, not just creating loans from thin air but also charging interest on it. This is how the vast majority of our “money” comes to be.

The concept of Public Credit works on the principle that this process should not be in the hands of corporations but the property of the commons – generally the government. This is perhaps where the biggest opposition to the concept arises. While many people would agree that it seems ridiculous to allow corporations, overseas owned ones at that, to generate electronic money and charge interest for it, giving this power to politicians would be just as bad, if not worse. At least banks, the argument goes, are more likely to restrain their lending and be more prudent in who they loan to because of their commercial acumen, risk management processes and the discipline of the market. The GFC has rather dented this argument. As Martin Wolf of the Financial Times notes:

"The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending. Why is such privatisation of a public function right and proper, but action by the central bank, to meet pressing public need, a road to catastrophe?"

Perhaps the most cogent exposition of the Public Credit concept is a paper by Joseph Huber and James Robertson for the UK think tank New Economics Foundation. They don’t propose either the legislative or executive arms of government have the right to create non-cash money but rather the increase or decrease of the money supply is controlled by a non partisan panel, in New Zealand’s case at the Reserve Bank. An inflation target would remain but at any given time they determine how much money the economy needs to maintain this target.

The government of the day gets to decide how the money is spent rather than loaned into circulation and would have to determine its spending priorities accordingly.

Thus the Reserve Bank rather than relying on the indirect and often slow acting process of interest rate setting to influence the level of credit demand in the economy would instead have a more direct lever via government spending. Governments could still determine taxes but this Reserve Bank panel would adjust the level of additional funding to keep inflation in check. Because the Reserve Bank is creating money for the government to spend directly and it is not an interest bearing loan, the theory is more money can be put into circulation and/or taxes lower as the government does not have to worry about interest repayments.

Banks would still be allowed to lend money but at 100% reserve of clearly designated interest earning savings/investment accounts (which would not be government guaranteed), as opposed to non interest earning current accounts (which would be government guaranteed and not part of a bank’s balance sheet). The payment system would be separated from the banks other services. If a bank failed, its customer’s current accounts and the payments system would be isolated from the liquidation of its other assets and remove the Armageddon threat bank executives use to get bailouts.

The reduction of the commercial banks credit creating ability has a couple of other potential effects. It could remove the ability of the big banks to “shape the way the economy develops” by favouring certain collateral, especially property over others, and favouring big business and the wealthy over small business and the disadvantaged. In a functioning democracy an elected government rather than the financial sector should be the ringmaster. At the moment our senior politicians often just shrug their shoulders and say there’s nothing they can do, it’s the market.

It should also reduce volatility. At the moment Huber and Robertson point out:
“commercial banks, as profit-seeking businesses, naturally behave pro-cyclically, not anti-cyclically. They expand credit creation in upswings, and reduce it in downswings. The result is that bank-created money positively contributes to overheating and overcooling business cycles, amplifying their peaks and troughs, causing recurrent over and undershooting of the optimum quantity of money in circulation, and systematically contributing to instability of prices in general and interest rates in particular.”

Public Credit and a debt jubilee deserve to be considered along with tax and welfare reform as alternatives to the current financial system. You don’t have to be a Marxist to see the current iteration of financial capitalism as unsustainable. As many commentators have pointed out, you can’t solve a problem of too much debt with more borrowing, desperately hoping that enough time will be bought for things to return to the way they were. Fear of change and powerful vested interests should not preclude considered examination of alternatives to the status quo.


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