The Case for Sovereign Money.
What it is, why it is overdue, and how it is feasible

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Sovereign money (central-bank money)

The term sovereign money stands for unrestricted legal tender, as issued in the form of cash and reserves by the central bank of a currency area. Reserves are balances of banks and state bodies in central-bank accounts. Sovereign money implies a central bank as the mone­ta­ry authority of a nation, or community of nations as in the case of the European Central Bank (ECB). The terms sovereign money, legal tender, central-bank money, base money or money base of the monetary system, denote much the same under different aspects.

The central bank as national monetary authority also applies to the U.S. Federal Reserve. Although it has private banks as shareholders, it is subject to public law in all essential matters of monetary policy and appointment to senior positions and committees. The U.S., furthermore, has had a tradition of Treasury-issued money, such as the colonial bills in the 18th and the Greenback dollar notes in the 19th and 20th centuries. Comparable forms of treasury-issued money also existed in Europe, but not as extensive as in America.   

Technically, like other modern money, sovereign money is pure token money, also called fiat money, referring to the biblical fiat lux, 'Let there be light', by analogy: 'Let this token be money'. Material money tokens made of metal (coins) and paper (notes) are likely to disappear. Account-based book money has long since taken its place, which in turn is bound to be replaced by digital tokens in the future. 

Sovereign money is safe, i.e. its existence is not threatened by crises and bankruptcies as is the case with money from private issuers such as banks and other financial institutions. Unlike a normal bank, a central bank, as the creator of base money deno­mi­nated in its own currency, cannot become illiquid and is not formally subject to insolvency.

Ideally, sovereign money is debt-free, that is, free of interest and repayment, spent into circulation independently of a credit agreement. A pre-modern example of debt-free sovereign money was precious metal coins. They came into circulation through sovereign spending. Under modern conditions, this would mean to transfer newly created sovereign money from the central bank to the national treasury as genuine seigniorage (the gain from money creation). However, within the framework of the current practice of creating and accounting for money, debt-free money creation is not possible. Today, bank­money as well as central-bank money is only created in connection with a credit-and-debt contract in the form of loans or asset purchases.

Deposit money (bankmoney)

While sovereign money from the central bank is first-tier base money, the second tier consists of bankmoney generated by the banks in the form of demand deposits, aka sight deposits or overnight deposits. Basically, bankmoney is a private money surrogate, a substitute for central-bank cash. In the course of the 20th century, however, bankmoney has increasingly acquired para-sovereign status, in that bankmoney is extensively supported by the central banks as 'bank of banks' and anytime 'lender of last resort' to banks, and warranted to a large extent by government as bankmoney guarantor of last instance.

Warranting and rescuing private bankmoney by the central banks and government resulted as a problematic constraint from the fact that over time bankmoney has become ever more important in relation to central-bank money, having become the dominant type of money today determining the entire monetary system. The share of bankmoney in the public money supply (M1) amounts to 90–97%, depending on the country and counting method.[1]

The bankmoney regime. Fractional reserve banking

Only a fraction of bankmoney is covered by a small base of operationally necessitated central-bank money (cash and reserves). Hence the expression 'fractional reserve banking'. Due to the low coverage of bankmoney, banks are vulnerable to crises and bankruns. In case of crisis, the banking sector needs be rescued to prevent worse for the entire economy. Beyond central-bank support and government bail-outs, also customer deposits can now be used for a bail-in, in, that is, temporarily converting customer deposits into bank equity – a formidable wild card for the banks.

Why does bankmoney need a degree of refinancing in central-bank money? The reason is that non-cash trans­actions between bank customers are settled by transferring reserves among the banks involved. Another reason is that private households and small businesses still use cash for smaller pay­ments, even though with a decreasing tendency. Systemically, cash does not play a defining role anymore because the source form of money today is non-cash, book money, that is, bankmoney for non-banks, and central-bank reserves for banks.

The money that first comes into circulation today is bankmoney. Banks create it as their own means of payment – in fact 'out of nothing' as is often said – when paying out loans to non-banks in the form of sight deposits, or when paying with such sight deposits for purchases of bonds, stocks and other securities from non-banks. The banks do this partly in proprietary transactions, partly on demand from their customers.

The bankmoney is paid out by way of crediting a customer's current account. Originally, a bank credit was not money, but re-presented money – on the one hand as the customer's claim on having paid out the amount in cash or having it transferred elsewhere, on the other hand as the bank's liability to pay out the account balance accordingly. In the course of the 19th and especially the 20th century, the account balance itself became non-cash money by being used directly as such. A credit entry into a bank account is therefore regarded as payment, according to common practice as well as according to prevailing legal interpretation. Crediting the amount of a loan to an account establishes the debt of the borrower to pay interest and repayment on the amount in question.

Cognitively, today's practice insinuates the identity of money and credit. Scientifically, this leads to the mistaken equation of money and credit. Hence the – rather metaphorical – terms 'credit money' or 'debt money'. In actual fact, this is about a fundamental economic fallacy and a construction fault in today's monetary and financial system, for there is only as much money as there are outstanding credit receivables and debt. If financing eco­no­mic activities by credit stagnates, or if debts are repaid net, money shortages arise with the consequence of decreasing investment and purchasing power, and thus decreasing eco­no­mic weakening.

Even though central-bank money functions as base money, while bankmoney is second-level money, the creation of bankmoney is the primary, pro-active step, while the issue of central-bank money to banks takes place re-actively afterwards. Therefore, under conditions of business as usual, it is the banks that determine whether and how much money is created or deleted, not the central bank. Today, reserves are in fact a kind of subset of bankmoney. the same applies to cash that is exchanged out of the stock of bankmoney and back in.

Banks do not need central bank refinancing for 100% of the bankmoney they circulate. In the euro area, for example, banks only need a fraction of about 3% on average (prior to the 2008 crisis and the subsequent flood of reserves). The 3% are made up of 1.4% vault cash (ATM), approximately 0.1 ~ 0.6% liquid excess reserves for non-cash interbank payments, and 1% largely idle minimum reserve (which in some countries is formally or de facto 0%).

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How is it possible for the banking sector to operate on such a small reserve base? First of all, customer balances are not transferred directly from account to account like cash is trans­fer­red from hand to hand. Rather, non-cash customer transfers are mediated through inter­bank clearing or payment in reserves. Outgoing payments from one bank are incoming payments at other banks, and vice versa. Incoming reserves can be used immediately for all kinds of purposes, be it for customer payments next in line, or for a bank's proprietary transactions. In the existing system, a bank's customer balances and its proprietary funds cannot technically be kept separate. Instead, customer balances are held hostage, so to speak, on the bank's balance sheet, as customer claims on the bank, or bank liabilities to customers, respectively. As a result, outgoing and incoming reserve payments are largely netting out, the more so the larger a bank is, i.e. the more customers a bank has and the more payments it makes and receives. Unlike bank reserves used to the maximum, custo­mers' current account balances are only used in part and not all at the same time. In other words, the use frequency or velocity of circulation of the reserves is many times higher than that of the bank deposits. That is the whole 'secret' of fractional reserve banking.

It works as long as the banks expand their bankmoney creation more or less in line with the trend, so that no major payment imbalances or liquidity risks arise for the individual banks. In addition, it is assumed that each bank accepts incoming bankmoney liabilities (which were mainly created by other banks). With private banknotes, their lack of acceptance by other banks was often a problem. The problem was solved by the note monopoly of central banks. In the gradual transition to cashless payment and through the uniform valuation of bank­money by the central banks at par with central-bank currency, the same degree of acceptance was transferred to bankmoney.

New money surrogates (MMFs, e-money, stablecoins)

Beyond bankmoney, additional money surrogates have emerged in the course of financia­li­sation since around 1980. These currently include money market fund shares (MMFs), e-money and stablecoins.
At the local level, there are also not-for-profit com­ple­men­tary cur­ren­cies. These may pop up tempo­ra­rily as emer­gen­cy currencies, or for the joy of social experi­men­ta­tion. In the latter case, they have not ex­ceeded a limited use in com­­mu­­­­ni­­ta­­rian or alter­­native life­style milieus.

MMFs are mostly used by institutional players to pay for financial transactions. MMFs represent a monetary heavyweight in that they amount to more than twice the money supply M1 (bank money and cash combined) in the USA. In Europe they amount to as much as one third of the money supply M1.

E-money, on a much smaller scale, is for example currency units on card chips, smartphone apps or other electronic storage devices, obtained against payment in bankmoney. E-money has some pene­tration in a number of African, Latin American and Asian countries. As with MMFs, e-money doubles the money supply. The e-money exists in addition to the bank­money that continues to circulate. 

Stablecoins are cryptocurrencies firmly linked to a national cur­ren­cy unit, such as the US dollar, being backed by bankmoney or so-called cash-equivalents (near-money securities). Stable­coins are currently experiencing a strong upswing. In contrast, Bitcoins and other cryptocurrencies have no backing or con­nec­tion to existing money and currency systems at all. They seem to have appeal as casino tokens, but probably no future as commonly used money, as their exchange rate is much too volatile.

The new third-level money surrogates are mainly issued in exchange for bankmoney. So they are based on bankmoney. However, their coverage with bankmoney and securities is not as fractional as with bankmoney, but much higher, in some cases actually 1:1.

Dysfunctions of the bankmoney regime

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Compared to the existing regime dominated by bankmoney, a sovereign money system would be one in which sovereign money dominates – be it through a digital currency monopoly in continuation of the central banks' note monopoly and the treasuries' coin monopoly, or be it at least in the form of quantitative and systemic predominance of sovereign money.

Adherence to the existing bankmoney regime is quite irritating in view of the chronic problems that system has. Modern money is freely creatable fiat money. Its basic problem is no longer so much to gain general acceptance, neither that it is scarce, instead, that those who decide on money creation tend to create too much of it. This has been true for many a govern­ment at various times as much as recur­rently for the banking sector and central banks. Such being the case, there is no lack of insight into the necessity of con­trol­ling the adequacy of money creation (which does not include controlling the uses of money).

Central banks have developed approaches to corres­pon­ding monetary policies, partly based on the central-bank money supply, partly based on central-bank interest rates, more or less success­fully. For with necessitated operational reserve requirements averaging about 3% of the stock of bankmoney, the central-bank interest rate on reserves, no matter how high, is not weighty enough to decisively influence the banks' credit extension, or bank­money creation respectively, even if the banks frequently have to draw on interbank credit in reserves for financing exceptional payment volumes. The more dominant bankmoney became, the more this shortened the quantity lever of central-bank money.

As mentioned, the dominance of bankmoney at 90-97% of the public money supply has mar­gi­na­lised central-bank money (cash) at 10-3%. Without a substantial quantity of central-bank money in circulation, however, both quantity policy and interest-rate policy lack a strong quantity lever to achieve an effective trans­mission of interbank money market im­pul­s­es to the banks' creation of deposit money and the financial and real economy beyond. This led to an increasing loss of effectiveness of conventional monetary policy, since at least around 1980, irrespective of whether the reserve-position doctrine of monetarism or a neo­classical-Keynesian interest-rate doctrine was predominant. In the meantime, the only effective policy is massive open-market interventions in the form of Quantitative Easing (QE).

One might doubt this state of affairs in view of the fact that, as a result of QE, the banks' reserves now amount to over 40% of bankmoney. However, these excess reserves are not needed by the banks as operational liquidity, but rather as a balance-sheet solvency prop-up. Most of these reserves lie fallow. What the banks might spend in the interbank circuit will return to them. The reserves flowed to the banks unintentionally, as the central banks pay for their massive bond purchases with reserves – and these have nowhere else to go but into the reserve accounts of the banks at the central bank. The shadow banks (i.e. non-monetary financial institutions, thus non-banks) from whose holdings the bonds are mainly bought, cannot receive any reserves. Instead, they obtain credit entries into their current bank accounts.

Overall, bankmoney creation, and reactively also central-bank reserves creation, has been strongly in excess of nominal GDP since around 1980. The increasing oversupply of money as debt capital (for loans, or bond issuance) caused interest rates and consumer prices to fall. In three decades, the then problem of high inflation and high interest rates gradually turned into the current problem of entrenched disinflation or even deflation and an interest-rate level close to zero, or even below in some European countries.  

Low interest rates are usually a sign of a poorly performing economy. The extent to which low interest may help the economy to recover is disputable. What is undisputed, however, is that low interest rates boost trade in assets, more precisely speaking, non-GDP finance, which does not contribute to financing real economic output, such as for example asset manage­ment, secondary trading in shares and bonds, the lion's share of foreign exchange and derivatives trading, not least real-estate transactions as a way to build financial capital.

The term 'savings glut' downplays what is involved, namely financial asset and debt accu­mu­lation in GDP-dispro­­por­tio­nate excess. Since this money does not go as mass purchasing power into real-economic demand, but pre­domi­nantly into non-GDP finances, consumer price inflation (CPI) has been largely absent. (Low-wage pressure from former developing countries, now newly industrialised countries such as China, and weakened bargaining power of trade unions, also contri­bu­ted to low CPI). Instead, there have been recurrent bouts of asset inflation, i.e. inflation of asset prices combined with a strong expansion of financial assets by numbers and volumes.     

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For example, from 1992 to 2008, real GDP in Germany grew by 23%, nominal GDP by 51%, while the active money supply M1 grew by 189%. In the U.S., there has not been such a pro­noun­ced rise in bankmoney. Instead, there was the fulminant takeoff of MMFs. From 1980–2008, MMFs rose from near 0 to 2.5 times M1. In the euro area, MMFs are about one third of M1.

The GDP-disproportionate increases in the money supply definitely did not go into the real economy, GDP finance and CPI, because these increases are already represented in nominal GDP. The excess growth of bankmoney thus served to expand non-GDP finances and asset inflation. The volume of financial market transactions increased from 15 times GDP in 1990 to 70 times in 2007. US financial assets (stocks, bonds, other debt securities, but excluding real estate) had oscillated around 4.5 times GDP until around 1980. From 1980-2007, they rose to over 10 times. Financial assets held by US asset managers were 50% of GDP in 1946, while they reached 240% in 2014.

In the short period from 2014 to 2019, real-economic CPI in Europe rose by a total of 5%, while the increase in asset prices was 20%, four times as high. Most recently, asset inflation was especially virulent in real estate and housing. Real property prices in the U.S. had risen by only 7% in the hundred years between 1890 and 1997, but rose by 85% in the ten years from 1997 to 2007. In all industrialised countries, house prices have risen by an average of 14 times since the late 1970s until today.

These figures prove chronic financial market failure. Instead of showing self-limiting negative feed­back, as claimed by neoclassical price-equilibrium economics and the efficient market hypo­thesis, financial markets tend to follow the positive feedback and the self-propelling dyna­mics of asset prices, upwards as well as down­wards. Both the financial instabi­lity hypo­thesis according to Minsky and the feedback theory of financial crises according to Shiller have explained the relevant mechanisms. Negative feedback of restraint does exist. But it is over­run by the positive feedback force of dazzling profit expectations. Anyone who objects criti­cally is excommunicated as a spoilsport.

Such dynamics comes with instability and proneness to crisis. Above certain thresholds of the monetary absorbency and financial carrying capacity of the economy, expectations of returns are no longer fulfilled, claims are no longer serviced. Investments then become over-investment, debts become over-indebtedness, and the financial cycles concerned collapse partially or entirely. With the historical predominance of bankmoney, the frequency and severity of banking and financial crises has increased. Between 1970 and 2007, according to a much-cited study by the IMF, there were 425 national and international financial crises worldwide; 145 of them systemic banking crises, 72 sovereign debt crises, and 208 currency crises. The lack of knowledge about an economy's monetary absorbency and financial carrying capacity is a momentous void, not least for the monetary policy of central banks.

Another aberration that follows from the dominance of bankmoney and, increasingly, from QE, is a bias in favour of non-GDP financialisation and thus a bias in favour of financial income at the expense of earned income. The continued growth of financial assets and debt in excess of GDP expands the relative share of financial claims in national income and reduces the relative share of earned income. Although non-GDP financial assets do not contribute to financing GDP, the profits realised from them allow direct access to the economic product.

In every banking crisis, it turns out that bankmoney based on a small base of central-bank reserves is unsafe. Since around 1930 ever more support measures have been developed by central banks and governments to save threatened big banks and their bankmoney, crisis after crisis – deposit insurance, state guarantees for account balances, recapitalisation of banks by the govern­ment (bail-out), legally enforceable bail-in by custo­mers, anytime refinancing of banks by the central bank at favourable conditions, and QE on an ever larger scale. The para-state status that the private, system-defining and crisis-prone bank­money has acquired through its warranty by the central bank and the govern­ment is of dubious legiti­macy.

Monetary sovereignty

The importance of the monetary system and money creation by banks and shadow banks has long been misjudged. The massive financia­li­sa­tion of the last decades could not have occurred through circulation of existing money alone, and there is no huge credit multiplier as a result of acce­le­ra­tion of the non-GDP financial circu­la­tion of money, despite new IT and securitisation vehicles that have brought such acce­leration to some extent. Ultimately, however, the development was only possible because of the largely unrestrained expansion of the money supply by the banking sector. 

At the root of the overshooting dynamics of financial markets through positive feedback is an analogous process of unrestrained money creation by the banking sector, partly also by shadow banks. Central banks accommodate the banks' demand for reser­ves any time, in times of crisis even more unreservedly than in business-as-usual mode. This is where approaches to strengthening the role of sovereign money come into play. Stabi­lising banking and finance requires a stable monetary system, and for stabilising the monetary system, fiat money creation must be under control – which is one of the genuine tasks of modern central banks in the overall institutional and functional structure of markets and the state.

Sovereign money is in the tradition of the Currency School of the 1830–40s and the state theory of money (Chartalism) since around 1900, in contrast to the teachings of the Banking School.  The latter asserts the false identity of money and credit, and regards money as a purely market-based matter of private law. This is allegedly unproblematic, because money is seen as a neutral medium of exchange, which can shift price and income levels, but without structurally changing the economy, especially price relations, investment structure and income distribution. The markets would by themselves lead to an optimal supply of credit-and-debt money.

However, there were other liberal schools of thought that did not follow the banking doctrine, including most classical economists of the 19th century, partly the historical-insti­tu­tio­nal school around 1900, as well as ordo­liberalism from around 1930 until the 1960s. They consi­de­red it dys­functio­nal to apply the mechanisms of market competition to currency competition. For them, as well as for Keynes, there was no question that money, particularly modern fiat money, must be a creature of state law, thus chartal money (G.Fr. Knapp), in the hands of a monetary authority.  

Currency theories in this tradition demand the separation of money creation from banking and finance. For the monetary system is part of the state's legal system, monetary sove­reign­ty a state prerogative of constitutional importance, comparable in its significance to the tax monopoly or the monopoly on the legal use of force. However, control of money crea­tion does not normally include control over the uses of money, which basically ought to remain a private matter for the market economy.

A sovereign money system aims thus at establishing a state's or community of states' monetary sovereignty. This includes an enhanced task profile of the central bank. Instead of acting unilaterally as anytime refinancer of the banking sector, a central bank will have to develop a more comprehensive understanding as basic money provider for the entire economy, for public and private finances as much as for GDP finance and non-GDP finance. Fulfilling this task requires the ability to pursue effective monetary policies, which in turn requires the highest possible degree of monetary sovereignty. This includes
-    the determination of the national currency (as unit of account)
-    the creation of money as legal tender denominated in that currency
-    the prerogative of the first use of newly created sovereign money, left to the public purse   as genuine seigniorage.

In today's bankmoney regime, only the first part (defining the currency unit) is still intact. The other two – money creation and seigniorage – have largely been left to the banking sector in the form of bankmoney and related seigniorage-like refinancing privileges. Under the impression of rapid digitisation of the monetary and financial system, and the emer­gen­ce of new private currencies (MMFs, e-monies, crypto­curren­cies), accom­pa­nied by a massive decline in the active use of cash, politicians are now fortu­na­tely recalling the impor­­tan­ce of mone­tary sove­reign­ty. However, the fact that monetary sovereignty includes money crea­tion and seigniorage seems to be a point not yet really gotten.

Sovereign money reform.
Conversion overnight or over time

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Sovereign money reform is basically conceivable in two ways:
- ideally, as a full substitution of central-bank money for bankmoney overnight, or
- as a gradual transition over time.

The first option, a complete overnight conversion, can be done, in that
- the bankmoney in current bank accounts is re-declared to be sovereign money,
- the current bank accounts are taken off the banks' balance sheets as sovereign money accounts, possibly still managed by the banks, analogous to bank-managed customer asset accounts, while
- on the banks' balance sheets, the previous overnight liabilities to their customers are reclassified as sovereign-money con­ver­sion liabilities of the banks to the central bank, as if it had been the central bank that created these funds in the first place.

In the 2010s, congressman Kucinich introduced such a reform bill developed by the American Monetary Institute in the U.S. House of Representatives (NEED Act). Around the same time, there were strong sovereign money efforts in the Icelandic parliament and also some debate in the English and Dutch parliaments. From 2011 onwards, a Swiss initiative brought about a referendum on a comprehensive sovereign money reform in June 2018. The Swiss initiative in particular attracted a great deal of international attention, and, like other such national initiatives, contributed effectively to create awareness of the problematic bankmoney regime and the case for sovereign money. Legislatively, however, these attempts have come to a standstill.

The focus of monetary reform has since shifted to partial approaches or a gradual long-term transition to sovereign money. Partial approaches aim, for example, at making non-cash central-bank money (reserves) available to non-banks through 'safe accounts' in one way or another. In parallel, since 2015/16, the central banks themselves have begun a process of supplementing the public supply of central-bank money in the form of dwindling solid cash by introducing sovereign digital money, in international parlance called Central Bank Digital Currency (CBDC), in the euro area called the digital euro.

Such sovereign digital currency would be gradually circulated in parallel to and, for the time being, in coexistence with bankmoney. The share of bankmoney would decrease over time. To the extent this is realised, the banks' creation of deposit money would ultimately come to an end. In view of previous tidal changes in the composition of the money supply, a gradual long-term transition appears to be the more realistic approach. The introduction of CBDC and the corresponding pilot tests have already set the course for this.

Nothing is taken away from the banks in the process, because bankmoney flowing back to a bank from non-banks in repayment of a loan or bond principal is deleted anyway (in that the bankmoney as a banking liability is removed from the payer's account, while the respective claim of the bank is fulfilled and thus also closed out). Sovereign money, by contrast, in the form of cash or future CBDC, continues to exist when it is handed over from debtor to creditor. The replace­ment of a bankmoney position by a sovereign-money position thus means that a largely 'empty' (only fractionally covered) promise-to-pay by the banks is replaced with fully existing central-bank money in the immediate possession of the customers.

Forms of sovereign money would initially continue to be traditional cash, as long as cash remains in use, as well as the banks' current reserves at the central bank, to the degree there is still bankmoney. It would also be conceivable for non-banks to have direct access to reserves via special transaction accounts (like governments have), or indirect access via a central-bank omnibus account that is administered in trust by a bank or a payment service. However, most central banks have so far objected to some such option. 

In contrast to conventional account-based approaches, there are now digital token-based approaches. In fact, the trend is now to introduce CBDC in the form of digital tokens later in the 2020s. They will be handled by means of digital wallets. These work like a wallet, but digitally and via electronic and telecom devices. Just as cash moves 'from hand to hand', CBDC circulates directly from the payer's digital wallet to the payee's wallet without intermediate reserve transfers from banks or other payment services.

How sovereign digital currency is circulated

In a gradual reform, central bank digital currency (CBDC) comes into circulation in the same way as cash has done up to now. Cash is withdrawn from a current account. In the same way, CBDC is exchanged out of a current account, or exchanged back into one. The present situation is particularly favourable for a conversion of bankmoney into CBDC. As a result of recent QE policies, banks in the euro area have obtained reserves amounting to over 40% of bankmoney. Such high reserve holdings are not needed for day-to-day ope­ra­tions, which make do with a small fractional base of reserves. It would thus be possible to convert almost half of the bankmoney into digital euros without the banks incurring refinan­cing costs. This means that reserves and future CBDC are opened up to dual use by the banks. This would answer worried questions about how to finance CBDC for a longer period of time.

Independently of the reserve option, banks can take up CBDC – partly on the interbank market, partly from other financial institutions as well as from own and external customers (which is not possible with bankmoney), and finally also from the central bank. Financing digital euros borrowed in this way costs the banks as much as funding vault cash. And similar to cash, there will not be too much new financing to be done in each case, since bank revenues, if they are in CBDC, for example fees, commissions, interest and above all repayment of principal, already make up the lion's share of the funds needed for new loans and investments. Moreover, the handling costs of CBDC will be significantly lower than those of physical cash.

A decrease in the share of bankmoney in the total stock of money and a corresponding increase in sovereign digital currency certainly means the loss of the banks' bankmoney privilege to a degree, but not a loss in business volume. Bank financing remains in demand. (That an increasing share of lending and investment business is offered by non-bank financial institutions rather than conventional banks concerns another thing).

Whether the banks pay out their loans in bankmoney or central-bank money, they earn the same interest. A bank cannot finance its proprietary business with the bankmoney of its customers anyway, nor have the banks been able to do so with savings and time deposits for a long time, because these funds are not deposited cash, but deactivated bankmoney that cannot be used by the banks as loanable funds either. CBDC, on the other hand, which is let to a bank by its customers until further notice or fixed maturity, in fact represents loanable funds a bank can make use of.

Ultimately, additions to the stock of sovereign money come into circulation either through central-bank credit as hitherto or through genuine seignio­rage as mentioned above. Overall, the issuance of sovereign money by means of central-bank credit should account for a smaller part of the money put into circulation. The long-term bigger part of the sovereign money issue is to take place through genuine seigniorage, spent into circu­lation by way of govern­ment expenditure. However, debt-free issuance of sovereign money in a formally proper way requires a certain modi­fi­cation of how central-bank money is created and accoun­ted for.

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Advantages of sovereign money   

The more sovereign money spreads, becoming dominant in the long run, the more apparent associated advantages will be. Thus, as explained, the gain from increased creation of sove­reign money can benefit the state coffers as genuine seigniorage – as the one-off gain from converting bankmoney into central-bank money, as well as current seigniorage resul­ting from additions to the official money supply. With both sources of sovereign money creation a large part of the national debt could gradually be reduced without much ado – without 'haircut', i.e. without capital losses of creditors, and without unsocial and counter­productive austerity, that is, losses of jobs and mass purchasing power, low capital invest­ment and eco­no­mic weakness, and restricting public services.

Assuming a pure sovereign money system without bankmoney, and assuming money crea­tion to expand roughly in proportion to GDP (which is not meant to be a mechanical rule), current seigniorage alone, according to today's standards, would represent 1–6 per cent of total public budgets, depending on the economic situation and government spending. In addition, the conversion gain alone would correspond to more than half of total public debt in the euro area.   

Another advantage of sovereign money, perhaps the most important one, is the safety of its stock. Sovereign money is not vulnerable to banking and financial crises. Banks and other systemically sensitive financial institutions threatened with bank­rupt­cy would no longer have to be rescued at the expense of the general public. Even if sovereign money is issued by central-bank credit to banks, it is still safe money, because a central bank, unlike a normal bank, cannot default in its own cur­ren­cy and does not have to declare insolvency if it were to run on negative equity (which, how­ever, if prolonged, would ruin the exchange rate of the currency in question and trigger high inflation).

Money needs to be safe, but banks and their bankmoney, including nationalised banks, will never be truly safe, no matter how much bureaucratic reporting, equity and liquidity require­ments are imposed. In the 19th century, European banks operated at an equity level of about 30%, American banks at 50%. Nevertheless, in times of crisis, banks have gone bankrupt time and again. Bankruptcy comes from bank. As free enterprises they should not have to be deprived of that possibility.

Another important advantage of an expanding base of sovereign money is increasing effectiveness of monetary policy instruments enabled by the expanded quantity lever of the sovereign money supply. The central bank would have correspondingly more control over money creation and the flexible re-adjustment of the money stock. Banks and shadow banks would no longer be able to create monetary overshoot at will, particularly regarding non-GDP finances. Accordingly, financial and economic cycles would be more moderate.

Credit-and-debt money (liability) versus debt-free money (asset only)

Today, money creation at banks and central banks inevitably generates a pair of claim and debt, i.e. so-called credit money or debt money (and the hasty conclusion that money = credit = debt). For the respective holders of cash or deposits, this is about a monetary asset, 'asset money' according to Th. Mayer. On the balance sheet of a bank or central bank that puts these means of payment into circulation, however, these means are liabilities, 'liability money' according to Th. Mayer.

Historically, this is due to the fact that banknotes, including central-bank notes, were once promissory notes, that is, a promise by the banks concerned to redeem the notes in silver coins or gold at the request of the note-holders. Tempi passati. Today that no longer makes any sense at all. Central-bank money became fiat money in its own right, the monetary system's base money without reference to other types of money or monetary assets. Even cash has become a form of change from preceding account balances. Bankmoney, too, is used as if it were money proper rather than being the money surrogate which it still is.

Accounting and bookkeeping rules, however, continue to apply in this respect as if nothing had changed in the last one and a half century. So, within the current framework, even the central banks' sovereign money – in the forms of cash, reserves and soon also digital tokens – is bound to exist as credit-and-debt money for the time being. This does not diminish its stability as crisis-proof base money. Nevertheless, it's a kind of birth defect. By its very nature, as unrestricted legal tender, fully valid, 'pure' base money, sovereign money should exist as a monetary asset only. Liability money should no longer exist, neither on the balance sheet of banks, nor at the central bank. But the outdated practices and accounting rules in this regard stand in the way.

Starting from this, the initial idea about debt-free issuance of sovereign money was for the central bank to make newly created sovereign money available to the treasury as genuine seigniorage, accounting for it as an interest-free perpetual loan. Technically, this is conceivable.  But would it be factually sustainable in the long run? Modern money theory (MMT) still thinks so. Sovereign money advocates, however, soon corrected themselves. Howsoever you spin it, an interest-free perpetual loan remains a loan, a paired claim and liability, a debtor-creditor relationship. To re-interpret this as a non-debt position is to distort the concept of credit and debt. 

As an alternative, the idea came up to book newly created sovereign money as equity capital of a central bank, sort of national monetary endowment. This, however, is an improper overstretching of the category of a company's or other institution's equity. Under Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), every credit entry must be based on a business transaction. In other words, an asset must come from somewhere or have a corresponding counter entry. A bank or central bank can issue deposits or banknotes or digital tokens, but according to the applicable rules it is not allowed to conjure them up as its own net assets.

A solution to the problem lies in separating the act of money creation from the operational business of a central bank as reflected in its balance sheet. Money creation would take place in a separate 'book', say, a currency register. That register is not a bank and no balance sheet either. It is just a registry, a 'book' that records how much money of which type the monetary authority has issued or received back. From the register, one part of the money can flow to the treasury as genuine seigniorage, free of interest and redemption, while the other part is left to the operational central-bank balance sheet as a callable loan. In terms of monetary policy, money creation of the currency register and the (re-)financing business and open market dealings of the central bank can be decided by the same governing body or policy committee. In the Eurosystem, this would be the ECB Governing Council.

It was Ricardo who developed the plan of separating money creation from banking for the Bank of England 200 years ago. He conceived of the separation of a note issue department from the banking department as it still exists today. However, that separation is no longer relevant and never really was, because the note monopoly was only partially and slowly implemented and bankmoney began to outstrip central-bank money as early as in the 1880/90s.

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The evolving role of central banks

A sovereign money system will specify the division of labour between the central bank and the banking sector. The central bank acts as monetary authority, responsible for supplying the economy with money, while the banks and other financial institutions are responsible for financing activities on the basis of central-bank money. In a sovereign money system, central banks should limit themselves to their monetary tasks and intervene as little as possible in foreign exchange and bond markets. Today, such interventions are necessary as an almost regular constraint to stabilise the unstable banking and financial system.

In a sovereign money system, the task of money creation increasingly, or even exclusively, falls to the independent central bank. In the Eurosystem, this would be the European Central Bank and the national central banks. The central banks thus become more than hitherto an independent fourth state power, an organ of a state's monetary sovereignty, the monetary power in addition to the legislative, executive and judicial powers. The associated functional division is between monetary responsibility (central bank) and fiscal and budgetary respon­si­bility (government), as well as between these two and the more extensive creditary and other functions of financial markets.  

Independence of a central bank means that it is not subject to government directives and takes its own monetary policy decisions on the basis of a legal mandate which regulates its tasks and competences. Currently, the legal mandate of central banks is not yet sufficiently detailed. Irrespectively, a central bank must be accountable to the parliament, the Cabinet, and the public in general. Even if central banks must be independent in their monetary policy decisions, comparable to the independence of the judiciary, they are not outside the res publica.

Functional independence of central banks vis-à-vis the banking and financial sector is another story. The present bankmoney regime involves a very close linkage between the banking sector and the central bank. The monetary initiative lies predominantly with the banks. They create the monetary facts. The central bank has little choice but to accommodate resulting necessities, even more so in crisis mode than in normal operation. In a system dominated by sovereign money, on the other hand, there would be an unbundling of banks and the central bank.

Today, central banks in Europe act as bank of the banks, quite one-sidedly. Yet central banks were once founded as bank of the state. In the EU, however, they are even forbidden to be the latter. Article 123 (1) TFEU (Lisbon Treaty) prohibits any contribution by the central bank to financing government expenditure. Not even the otherwise customary ways and means advances for bridging revenues and expenses are allowed. 

In a sovereign money system, there is direct genuine seigniorage from money creation, not only indirect interest-borne 'seigniorage' from central-bank loans to banks and gains from foreign exchange management. It has not yet been clarified what genuine seigniorage means with regard to Art. 123 (1) TFEU. The transfer of central-bank profits to the treasury does not fall within the scope of Art. 123 (1). Genuine seigniorage is a special type of central-bank profit. Irrespectively, one should understand that Art. 123 (1) is an absurdity against the background of a state's monetary sovereignty. If it makes any sense at all, then it is to give a massive structural advantage to the creation of bankmoney and general financialisation, in the event of a crisis also at the expense of the treasury and sovereign indebtedness to banks and bond markets.

In the wake of the banking and debt crisis after 2008 and the 2020/21 corona pandemic, central banks have in actual fact begun to contribute to government financing indirectly through the monetary policies of QE. They do this by buying government bonds held by banks and other financial institutions on the open market on a large scale. According to Art. 123 (2) Lisbon Treaty, this is explicitly allowed. Attempts to portray QE as an inad­missible trans­gression of Art. 123 (2) have failed at the European Court of Justice.

In a sovereign money perspective, the practice of ECB bond purchases on the open market should be main­tained to some extent, as is common elsewhere, for example in the US and Japan. Moreover, direct contri­bu­tions to govern­ment financing should also be made possible, for example by re-introducing ways and means advances as well as by enabling the direct absorp­tion of a limited percen­tage of sovereign bond issues on the central-bank balance sheet – as is the case with the Bank of Canada that absorbs 20–13% of each sovereign bond issue.

Effectiveness of monetary policy

One of the great advantages of a larger and growing sovereign money supply is much higher effectiveness of monetary policy. The transmission lever of monetary policy is stronger the more dominant the supply of sovereign money becomes compared to other means of payment. A central bank can control events in a conventional way both via the money supply (thus influencing interest rates) and via its interest rates (thus influencing quantities). In a sovereign money system, both approaches are effective thanks to the strong transmission lever. This indeed enables a flexibly re-adjustable, non-excessive and steady supply of money in a demand-oriented as much as macro-economically appropriate manner. Financial and economic cycles will certainly continue to occur, which is basically desirable to promote structural change, but in a more moderate and steady way.

Monetary policy should not target the quantity of money. This may sound counterintuitive. The money supply, however, is not a target, but an instru­ment of monetary policy, not an end in itself, but a means to achieve the best possible balance of refe­rence variables as listed below. Wanting to prescribe the money supply is a basic error of mone­ta­rism as well as of the calls for a new gold standard. The economic situation keeps changing all the time. Mone­tary policy must be able to flexibly take into account ever-changing supply and demand dyna­mics, be it pro-­cycli­cally or counter-­cycli­cally, with changing focuses of concern.

Accordingly, the stock of money should not be predetermined, but should emerge as a result of the ongoing analysis and assess­ment of a number of key variables to be weighed against each other for main­taining the best possible overall stability. The relevant refe­rence variables include

- as hitherto, the development of real economic prices, interest rates and the external value of the currency

- the development of real-economic activity and employment, in support of the economic policy of the day. As key variables these should be on an equal footing with the other refe­rence variables, not sub­ordi­nate to them as is the case in the EU today.
As a special aspect of economic policy, climate and environmental aspects should be included in the (re-)financing conditions of the central banks.

- Furthermore, asset price developments can no longer be ignored. Asset inflation and bubble formation must be taken into account as key indicators. This includes an extended macro-economic analysis of the dynamics between GDP-contributing finances and non-GDP finances, as well as private and public finances.

Central banks do not need to fixate on operative targets regarding the reference variables relevant for monetary policy. This is true simply because the central banks are able to a degree to influence the development of inflation, interest rates etc., but they cannot effectively control the relevant variables and bring them about as desired.

On the basis of the ongoing analyses of the reference variables and their interactive dynamics, the monetary policy body of a central bank will decide on a regular basis whether and to what extent it will tighten or loosen its interest rate and quantity policy. This cannot be calculated. Monetary policy is about politics, and thus an art of the possible; certainly something for experts, but by no means an office to be exercised 'technocratically', as is often thought in misjudgement of the matter. However, it is important that a central bank explains its deliberations and decisions publicly. The public would presumably understand sense and purpose of weighing-up considerations better than a seemingly concrete, but in reality abstract target fetish such as 'inflation at or near 2%'.

In a sovereign money system, too, credit guidance should not normally be part of the toolbox of a central bank. This is because capital market policy basically exceeds the limits of focused monetary responsibilities. However, credit guidance should not be forbidden either. Exceptional circumstances will continue to occur from time to time, in which credit guidance can be an effective means of choice.

A measure that should nevertheless be available to a central bank is to grant credit to banks and financial institutions at tiered conditions, depending on whether credit feeds GDP finances or non-GDP finances. Credit for real-economic purposes should generally be better off than credit for non-GDP investments. The ECB's TLTRO programmes already do this to some extent. Such tiered conditions in favour of real-economic purposes can also take into account whether or not activities to be financed serve climate and environmental policy goals.

Beyond such tiered credit conditions, monetary policy should not want to interfere in the uses of money, that is, finance and the economy. This applies in particular to the popular question of what genuine seignior­age from sovereign money creation should be used for – current public spending, or debt reduction, or tax cuts, a citizens dividend or basic income, special investment in public infra­struc­ture and eco­lo­gical moder­ni­sation, etc. All this is part of the tasks of govern­ment and parlia­­ment and is basically none of a central bank's business.

Monetary policy is capable of many things, but less than one tends to attribute to central banks these days. Just as courts should not be there to make up for inadequate legislation, a central bank should not be there to make up for inadequate government. In a sovereign money system, monetary policy can and should support both markets and the state, but cannot take their place and will not prevent future market and state failures in one way or another. A sovereign money system offers a realistic prospect of improved financial stability and a better balanced economy. But it's not a secularised promise of salvation.  

What to do with third-tier money surrogates?

by Zignaly

by Zignaly

Whether it is about introducing sovereign money step by step or a full changeover overnight, either way the question arises as to what should happen with new third-level money surrogates (MMFs, e-money, stablecoins). From a sovereign money perspective, such private means of payment are fundamentally undesirable and functionally unnecessary, unless they offer an advantage in terms of technical efficiency and costs.

The historical justification for money surrogates – whether issued by treasuries or merchants or private banks – was the permanent shortage of money due to a lack of gold and silver. Today, however, after the abolition of any gold link of freely creatable fiat money, money surrogates no longer have any functional justification, especially since digital currency from central banks can be expected to have the same efficiency and cost advantages as e-monies and stablecoins. Whether the banks' money-on-account can keep up with this is not yet certain. Therefore, private money today has its origins solely in the fact that someone wants to achieve special private advantages with monetary transactions or circumvent onerous regulations (as in the case of the American MMFs, which were created in the 1970s to circumvent an interest-rate cap imposed by the Federal Reserve).

Whether it is about introducing sovereign money step by step or a full changeover overnight, either way the question arises as to what should happen with new third-level money surrogates (MMFs, e-money, stablecoins). From a sovereign money perspective, such private means of payment are fundamentally undesirable and functionally unnecessary, unless they offer an advantage in terms of technical efficiency and costs.

If one does not want to prevent another spread of private means of payment, one would have to insist on the observance of four criteria, as already partly laid down in existing regulation:
- Third-tier surrogates must be backed 1:1 by sovereign money or, to a small extent, by government bonds.
- The issuers must pursue a passive monetary regime. An active policy, such as the purchase of securities with their own third-level money surrogate, must not be permitted.
- Money deposited and assets acquired with it must be denominated in domestic currency.
- The private currencies concerned, on the other hand, must be denominated in their own private currency unit, not the official currency unit.

If, however, one deems unnecessary to worry about today's third-level surrogates, digital private money could set the stage for sovereign digital currency (CBDC) to suffer a fate comparable to that which bankmoney caused central-bank notes in the 20th century.

Further questions about the introduction of sovereign digital currency

There are further questions about the dissemination of sovereign digital currency (CBDC), especially with regard to a gradual transition. For example, the question is often raised as to whether CBDC should be interest-bearing. This stems from the doctrine of the identity of money and credit, as well as a misleadingly constructed oppo­sition of endogenous versus exogenous fiat money. If there is anything to pay interest on, it is certainly credit, not however the money used to pay out credit. As far as bankmoney is concerned, it is in fact based on an implicit cash loan from customers to the bank. This is why early private banknotes, and also current accounts in some countries in the 20th century, were indeed interest-bearing. Currently, however, the matter is being discussed in the context of steering the demand for CBDC versus bankmoney. The extent to which demand for digital currency depends on interest or on the safety of digital currency can be left to the emerging realities and pragmatically reacted to. 

There are two monetary design issues wrongly at the forefront of the CBDC debate – financial inter­media­tion and bank run. The finan­cial inter­media­tion issue concerns the fear for banks of running out of loanable funds by losing the deposits that are converted into sovereign digital currency. This problem is fictitious. Deposits are loanable funds for customers, not for a bank. Today's banks are not financial intermediaries who would broker deposit money from non-bank customers upstream to non-bank borrowers downstream. (That's what investment trusts do, but such trusts are not banks, even if they act under the umbrella of a banking corporation). In monetary terms, banks manage customer payment transactions in bankmoney by carrying out interbank payments in reserves. Financially, however, banks are not lenders of customer bankmoney, banks are its creators. To make payments, those of customers as well as their own, banks need cash and reserves. Moreover, banks can only transfer reserves to each other, but not to customers. This will only be possible with sovereign digital currency (CBDC).

The real financial intermediaries today are the shadow banks, that is, non-banks, non-monetary financial institutions, such as investment funds, private equity investors, insurance companies, or building societies. They operate just as well with sovereign digital money as they do with bankmoney. And the more sovereign digital money flows at the banks, the more they will use it to disburse credit according to customer demand – and then the banks will indeed be financial intermediaries of sovereign digital money which they borrow from their own customers or on the open market or from other banks or from the central bank.

As to the bank run problem, one has to be aware that bank runs are the problem of bankmoney, not of central-bank money. Bank runs are the system-inherent 'writing on the wall' of fractional reserve banking. In a sovereign money system, a run on safe sovereign money is out of question. You don't storm the bank if you have your money in your pocket as solid cash, just as little if you have it in your e-wallet as sovereign digital currency. Under conditions of business as usual there is no bank run anyway and no reason for a landslide conversion of bankmoney into CBDC.  

In a banking and financial crisis, however, bank runs are the order of the day, held in check only by central-bank support and government guarantees – guarantees that become gradually dispensable with the spread of sovereign digital currency and should accordingly be pared back. Even without state guarantees, a sudden change from bank­money to sove­reign digital currency would be monetarily feasible, provided the payment infra­structure is available. A central bank cannot become illiquid in its own currency, so that a shortage of central-bank digital currency necessitated for the conversion can be ruled out.

Despite predictable frictions in the coexistence of sovereign digital currency, bankmoney and new third-tier surrogates, the introduction of sovereign digital currency is overdue. By comparison, the inherent dysfunctions and governability problems of the bankmoney regime remain by far the bigger problems.

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[1] Statistical data as well as references to authors and economic schools are taken from the author's book Sovereign Money (palgrave macmillan 2018) and can be traced there using the index of subjects and persons.