System Cure: Monetary Dialysis

Slowly but surely mainstream commentators, economists and policy analysts are all starting to realise that exponential debt is the core of our current economic malaise. This is great news to those of us who have been banging on about this for many years.

But still there is confusion around what to do about it. “Saving” has become the new buzzword, sitting squarely alongside “austerity”, as private individuals are urged to save more and governments are urged to spend less. That sounds like a sensible way forward. But watch the economy tank when that happens. Why?

Simply because when debt is paid down (and no corresponding new loans made) the money supply contracts as the debt is destroyed. The debt never existed as “money” in the sense of notes and coin but as an asset and liability for the bank. The interest is collected and the debt destroyed, leaving the profit for the bank. A monetary system based on debt will always lead to booms and busts as the interest charged overwhelms the ability of the productive sector to pay it. Ironically the system always needs infusions of new debt to stay afloat as the amount of money in the system declines.

Of course, when companies start to lay off workers (their first cost saving option) this creates uncertainty and an unwillingness for new borrowing to take place. This creates a self-reinforcing cycle which in some cases leads to recessions and occasionally to depressions. So what’s the best way out of this?

Austerity? No. Austerity will keep some investors happy but generally this will simply lead to slower growth and higher unemployment. But austerity is also a fact of life. When you have borrowed money and spent it, you know one day you have to pay it back. If you haven’t saved for that day then you will have to forego consumption for repayment. If you are in that position, which many governments are, you have, in fact, over consumed your income and eaten into your future. That’s not a pleasant space to be.

Is there an alternative?

Yes there is. I’d like to propose what i term “Monetary Dialysis”. This process seeks to replace debt money with real money (let’s assume for the moment that fiat money is real). The difference between debt money and real money is two fold: firstly, real money is permanent and once it enters the banking system it remains there; secondly, real money enters the banking system without interest, with no charge for its creation.

This two key differences will lead to new outcomes: a more stable money base and a less inflationary one.

How will this process take place?

The government, instead of issuing new bonds to raise money (primarily from overseas investors), will directly spend the money into the economy. In other words public spending will be funded by new money, not new debt. Immediately there will be a saving in interest costs, with current funding costing 5-6% per annum. The current annual bill (previous to the recent enlarged debt issuance) has been running at close to $4billion a year which is a hefty sum (I am only talking government borrowing here).

I use the term dialysis as a representation of a monetary system that is malfunctioning, not just here but globally. I propose a slow transfusion with the goal to end government borrowing completely by 2017.

Where’s the catch? Ok clearly there needs to be some balancing on the other side of the equation. As well as issuing new money instead of new debt, another part of the monetary dialysis approach is to create stronger limits on the abilities of banks to increase the money supply through the issuance of new debt. This can be done in many ways, using a variety of macro prudential tools, whether it’s increasing capital requirements or other similar actions.

Monetary Dialysis is the first step to cleaning up our monetary system. It will lead to a more stable money supply, lower inflation and clear savings in interest costs. The reduction in public debt will be highly beneficial for the economy and the country as a whole. The cost savings from this clean up will be in the order of $20billion over 6 years.

Now that’s something to really think about.