Chapter 1

1. Introduction

1.1 Introduction

On 10th June 2018 Switzerland held a people’s initiative in the form of a binding referendum on whether to instigate a Sovereign Money system. Its aim was to segregate the monetary and credit functions of the banking system by removing the power from commercial banks to create the medium of exchange through debt issuance, and place that power solely within the Swiss government via the Swiss National Bank (Dawnay, 2017). Although it received very little publicity externally, it was the most serious attempt towards monetary and banking reform since a group of Chicago school economists led by Frank Knight and Henry Simons, as well as Irving fisher from Yale put forward their plans for change to the nascent Roosevelt administration. In the early 1930s, in what has collectively come to be known as the Chicago Plan, these academics amongst many others also proposed the separation of banks’ money creating from money lending powers. The Chicago Plan wanted a 100% reserve requirement to be imposed on the banking system by requiring that bank deposits be totally backed by some sort of risk-free government-issued money (Phillips, 1995). These inquiries were motivated by a belief that an economic system with a media of exchange, appearing in the form of self-generated bank liabilities, is inherently unstable (Knight, 1927; Fisher, 1936; Simons 1948; Turner, 2010; Werner, 2014; Huber, 2017 (a)). The aim of this book is to critically review and compare the arguments put forward by these two inquiries. This thesis concludes that the consequences of a private banking industry having the power to influence the money supply, which is essentially a public good, are too socially important to render the process completely in the hands of commercial banks.

From the mid nineteenth century when the English Banking Act of 1844 was enacted, the debates between the currency and the banking schools focused on how the media of exchange should be created. Should it be a creation of the state, governed by a strict set of rules, as the currency school would argue? Or should it be left to private enterprise and allowed the flexibility to respond to the needs of entrepreneurs, as the banking school argued (Goodhart and Jensen, 2015)? This question is at the core of the Chicago Plan and Sovereign money inquiries into monetary reform. Frederick Soddy, the 1921 Nobel Laureate in Chemistry had already written in his 1926 bookWealth, Virtual Wealth and Debt that “[t]he only way banking today can be made safe both for the banker and the nation is for the nation to be the banker” (Soddy 1933:13). Soddy is credited with reviving the discussion around 100% reserve banking, although it was an argument already acknowledged by many academics of the 1930s. Prior to Soddy there had been previous attempts at full reserves banking, for example Laina (2015) points to the U.K. Bank Charter Act 1844 mentioned above, and the National Acts of 1863 and 1864 in the U.S. These acts were attempts by the proponents of the Currency school to place rules around money creation. These acts failed to understand and foresee the ability of banks to circumvent these rules by generating alternate means of settling transactions, for example in the form of chequing deposits. As Frank Vanderlip states insection 2.3 below, the median of exchange was already in 1908, 95% bank liabilities.

Money, as I will demonstrate, enters the economy through debt issuance by