Alternative to the monetary system or “the fractional reserves lending banking system” or FRB

Dear All

the text is in 2 parts  1) diagnostic  and 2)  possible solution

Money is to the economy like blood to our body.  The purpose of this blog is to bring and discuss openly the nature of money since most of us do not seem really understand its creation and destruction.

I have been surprised about the lack of identification most economists and politician give to the origin of the biggest financial crisis.  I mean the essence of our monetary system called “Fractional  Reserve Banking” system.  Maybe, they have too many interests in keeping it this way and make sure we do not understand it?

I do recommend you to watch the documentary by Paul Grignon  called “Money as Debt” which explains well money

Anyway… money is just a medium of exchange which was invented by us and the following might surprise some of you but… solutions are available !!!

Fractional Reserve  Banking and central banking are the essence of the crisis today and… future crisis. The media carefully avoid to focus on the fact that the fractional reserve system promotes global growth through debt growth only. Money is debt and debt is money and….the banking system privately owned is… the main money creator. This leads to a world of excessive debt which simply… cannot be anymore be serviced by the overall disposable income. The last few years were very symptomatic since we had basically $5 of debt growth for $1 of GDP output!!!
This crisis is interesting since we never have seen such a convergence of negative factors on such a broad scale. What should not have been happening… is happening.
Could have been it avoided? I think so. Many advisors and analysts have been warning for years over the dangers of excess leverage. Since such crisis take a long time to occur it is hard to predict when they will indeed take place and therefore their warnings have been silently ignored. It is a little bit like knowing that a big earthquake will strike California but .. when and .. we keep building over it. All central bankers have a clear view about the overall disposable income available and the leverage accumulated. You do not need to be a rocket scientist to figure out that the more debt growth is accumulated… the more instable the system might become. Another fact is also simple. Some sources point out that early 2008, total financial assets value was around USD 160 Trillions and Global GDP… $50-60 Trillion. Hard to believe that such GDP size can…. provide decent returns on such broad asset market.

First.. to understand the basic of the system you need to understand how the basics works. Central Banks have delegated the power to create money at will to a cartel called… simply your usual bank at the corner of your street.

let’s say that tomorrow you can open a bank which will be the only bank in th country to make it easier. So before opening “Your Bank” , you go to your Central Bank (like the FED, ECB et..) and deposit 1000 in reserves!  The Fractional Reserve Banking stipulates a ratio. Let’s say 10/1.  This means that tomorrow, for your grand opening, you can lend 10’000.- to your first customers out of thin air!   So you lend 10’000 to Ms. A who is opening a beauty saloon.  Ms. A take the money and pays Mr. B 10’000.- who has installed all the equipments.  Mr. B takes the money and goes to “Your bank” to deposit the 10’000.- .   The ratio is 10/1 so now “Your bank” sets aside in reserves 1’000 and can go back on lending … out of thin air…  9’000.- to its next customer.  Etc…

At the end, you have 10’000 in reserves, 100’000.- in deposits and 100’000.- in loans!  If everyone decides to pay back their loan at the same time we do the inverse path and  end-up with no money but… the goods and services which have been consumed.   In fact, this means that money is debt and debt is money. All you deposits are counterparts of loans and overall the economy can only grow if some one is getting into debt. The other interesting part is that even creating money out of thin air… the interests due on the loans over time are not issued by the system so… it is not difficult to understand that… we might run into problems at some point in time (as it is today)

What are the problems of such system:

1. Globally, growth is achieved through debt growth which is inflationary. Debt growth tends te become more and more inefficient along with the leverage process. Just look at the evolution of M3 and you will see that the growth debt ratio to GDP output has been running to USD 5 to 1 the last few years. The process of asset price inflation feeds itself until growth and returns prospects falters. Then the created bubbles implode and result in such crisis as we have today.

2. The tax return or dividend to society will diminish since a greater share of you tax money will be used just to serve the interest on the public debt (rarely paid back)

3. Many argues that inflation is “under control”. Partially true since the income distribution is not even so…depending on the items, the inflation impact might be higher like… higher premium on your health insurance will be costlier if you earn 1’000 than if you earn 10’000. In addition, inflation calculation has several methods which.. usually presents quite large differences.

4. What I call “taxflation” takes place. I mean you need to spend more of your disposable income to maintain your living standard. Ex: you could drive freely on the highway, now you need to pay a vignette or a toll; the quality of the public school diminish and you need to spend your kids to private school but… still pay your taxes; you could park your car free in the street and now you need to pay; your insurance deductible was lower and now is higher, your airline ticket was all inclusive and now has some additional fees for fuel, security etc.. billed separately; the police response to an incident was quick and now is slower etc…the list is endless!

5. Let’s suppose that the interest rates is 5%. This means that for about every 14 years USD 1. becomes USD 2. This means that every 14 years the whole money stock has been siphoned by the banking system. If you look at M3 growth, you will see it clearly.

6. The system has structural instability built in. It means that even though this crisis might be the only true financial crisis you will go through in your life you need to realize that there is almost 100% chance for any individual with a life expectancy > 70 years to face such a crisis during his lifetime. This bears tremendous implications over the whole retirement and pensions system of any society without mentioning the destruction of wealth he could pass to his heirs.

7. The system over time promotes actively income inequality. Facts and data prove that. Wealth and capital will always follow a concentrating path over time due to the essence of the system. The middle class in rich countries has been under heavy pressure and savings capabilities have diminished a lot. The impoverishment of the middle class is a threat to true democracy and the tax share to the states paid form the riches becomes higher which becomes an incentive to tax evasion and/or “management”. At the end …. Government resources become under increasing stress due to growing social demand and programs.

8. The dependence on the financial system has proven to be extremely damaging. This has lead to the acceptance of absurd standards like “to big to fail” (AIG , Citibank…) which have incentivated the financial players in leveraging their balance sheet to extreme levels. No private citizen neither corporation has a blank check backing up. Only the financial institutions. (we do not need more regulation, we already have to much of it, we need a clear message that bank must go under when they do bad and I can assure you that they will make sure to keep their risk well appropriate. Have you seen any private bank in need of capital recently?)

9. The goals and interests of the “banking community” responsible of most of the money creation process collide with the interests of society . It is clear that greed is a powerful driver which lead individuals, corporations and ohers entities to take wrong investments decisions and this will not change. However, the “banking community” is forced by its controllers and shareholder seeking higher returns to constantly leverage their balance sheet and therefore take too much risks which… results in systematic crisis as we have today. You will understand that a financial system roughly doubling size every 14 years (5% int. Compounded) becomes harder to manage on the long run and “oversized” in comparison to other sectors (just compare total market capitalization).

10. Since government debts is one of the main factor o monetary growth due to its appetite for deficits …. it means that government share/size to GDP will only grow overtime reaching proportions which are just unbearable to the productive side of the economy. We can end-up having an oversized government and financial sector which can turn into a monster due to the multiplier effect of interests. The world is full of countries which face this problem like Argentina, Brasil etc…and… now developed countries are following the same path due the huge bailout plans.

Central bankers and other government entities take excuse now that they have been just fulfilling their mandate but… they had the tools to foresee such crisis. The leaders and individuals behind the public curtain have just ignored common sense. One very simple indicator easily available is the measure of debt and debt servicing over disposable income. The other one is savings rate. Constant decline in savings combined with accelerate debt growth is a sign of important changes to come. You do not need to be a genius to see that and this information is easy to obtain. I am sure that if you were a bank owner… your lending standards would be stricter since… your money and your wealth is at stake.
The interests of large financial institutions whose shareholders base are broad have been largely abused by the reckless conducts of many CEOs whose short term objectives for revenues and profits have proven to be creator of excessive leverage. They might argue that their decisions are based on risk models but risk models have proven to be wrong (se the Black Swan). Give me some data and I will create any model which will suits your needs. Just imagine…. creating a risk model against the costs of global warming… We could sell an insurance policy to all the cow farmers of the planet since their cows produce a few litters of methane (or just plain fart) every single day. What a “brilliant” idea… isn’t it? And the consumers pay the bill at the end (another example of taxflation)

What alternatives do we have?

Money is to the economy what blood is to the human body. We need money to keep the system working and history has shown that the world has already been through various severe crisis.

My proposal basically eliminates the central bank and fractional reserves system as we have today.
We would just keep an “independent treasury or T” which would issue money as needed for the good functioning of trade and the broad economy. Banks or so called new banks would be able to accept deposits on behalf of T. and would make some “treasury loans” to their customers instead. This Treasuries loans could be done based on excess “unused” deposits or by fresh new money issued by T.

No interest would be charged but… a tax rate. let’s say you borrow 100k for 20y and the tax rate would be higher due to the length. let’s say 120%. So as a borrower, you owe in fact 220k payable to the treasury in 20 years.

The so called new banks would receive a fee of let’s say 20%-30% of the tax rate imposed (not the principal).This would be used to cover their administrative costs, part of it would be kept as insurance or mandatory reserves in case they ‘ve done a bad job assessing the payment capacities of the borrower and a loss would be incurred and part of this 20% would be paid as “Tax credits” on the money of the depositors. The remaining would stay with the banks

Private debt issuance and private loans could be carried out as well without any problems. They would just obey the same rules as the treasury loans. The tax rates would apply the same way but the investors returns could be higher since they would be no need for reserves and administrative costs provisions. All private debt issuance and instruments would need to be registered at some clearing centrals or banks which would centralize the fund cash flow. It is basically already the case for most debt traded instruments today (euroclear).

The overall tax rates would be decided by a board (treasury board) in function of time and other policies like … a “tax curve” instead of a yield curve. The advantage is that it would avoid the compounded effect.
In case the government needs to embark on spending program or needs to stimulate the economy, it could ask the treasury to issue more currency to fund its programs, use unused deposits excesses in the system , lower the tax yield curve and or even tax the excess deposits balance in extreme case. Bad government spending could create inflation… as it is today which is anyway a hidden tax. On the opposite, if it needs to cool down the economy… the government could raise the tax yield curve etc..

Today’s tax structure, taxes income anyway. So you receive interests on your investments and pay taxes back. You receive dividends and pay taxes on them. Taxes are just an internal transfer between the private and public sector which has become more and more complex.

There would be no need for income and capital gain taxes in such a system. Government funding would come from private and public domestic and international treasury borrowing, currency issuance and eventually a kind of VAT or sales taxes if really required. In fact sound financial public policies will be judged on how carefully they balance tax loans revenues with currency issuance and eventual VAT revenues. If governments are managed by reckless public servants… we get what we can observe in Zimbawe today.

People might criticise the present proposal arguing that governments need to have a counterweight to such easiness as printing money when needed. True, but anyway… government do what they want anyway as we can see today. I would say that such proposal might shift positively the public attitude towards government. It could create a much stronger sense of collective awareness and participation to public affair in our daily life.

Basically almost all present financial transactions carried out today could be replicated including derivatives securitization etc… but there would always be the “tax curve” to price the length of the transaction. We could even imagine different “tax curve” in function of the importance of the amounts of this “treasury loans”. Consumer “tax rate curves” could be higher; tax curve on speculative or financial leveraged transaction leading to excessive asset price inflation could be different etc…tax curve on lower income families, on real estate investments etc…

It might seem too simple to be true but the fractional reserves system is simple in its essence. Such exposed proposal is much less inflationary on the long run since the compounded effect is not built in and IS SIMPLE. The issuance of currency or money would be done by the Treasury through the banks and banks would simply fail if they had done a bad job assessing the payment capabilities of their Treasury Loans customers.

In addition, the system offers the advantage of simplicity by diminishing tremendously all the fiscal red tape and administration. This represents a huge productivity gain for all economic agents.

International exchange would not suffer since the currency would remain fully convertible as it is today. Foreign debtors would just add to the tax base and excess reserves kept by foreign countries would be kept as deposits at the treasury or other financial institutions following the same treatment as any other depositor.

In such system the economy does not need to constantly borrow to grow. Excess deposits (savings) and currency issuance can be used in combination with tax curves policies to warm or cool down the economy

The above analysis of the present system demonstrates that the fractional reserve banking system is an un-necessary tax on the whole society.

In my proposal, investors relying on income would shift their habits. Capital is automatically put at work for productive incentives the best way it should. I deeply trust that such a proposal would give incentive to the capitalist and entrepreneur spirit which has brought many great achievements. Individuals and corporation will try to make the best of their money.
Imagine that the functioning costs of the present economic system would be lowered (no need for tax accountants etc..)Investors would be mainly rewarded by dividends and growth. Lower returns on bank deposit would be compensated by the lack of income and capital gain taxes.

People and corporations would welcome such a system which simplify and rewards their life without having constantly the obligation to leverage exponentially the overall economy to grow. Lower income people could improve their living standard at much more affordable costs too and higher income people would feel comfortable knowing that their wealth building process is being protected. In fact all economic agents would feel comfortable about their wealth accumulation process.

The present system could be quite easily adapted. . Existing central bankers would turn into monetary growth and “tax curve” administrators with the responsibility to hold the true purchase power of the currency over time.  Voters could votes every year about the main bugdets allocations of the federal, states and local government since they bear too responsabilities about the overall well being of the economy.

It’s kind of provocative….(would need a few details to be worked out due to the globalization of finance) but seems sound, simple and fair. Savers and investors would be rewarded anyway and bad GVT policies would be sanctioned anyway (as it is today… at the end)


11 thoughts on “Alternative to the monetary system or “the fractional reserves lending banking system” or FRB

  1. I like very much the explanation about the monetary system on the first part. Every one is able to understand what´s is going on, how things works, throught a simple s and smart words, very educative, for everyone, economist, students, house works, etc etc…
    About the second part, the soluition, or a better system, I have some doubts, becoause is a new aproach for me, and I will thing about and came back later.

  2. A very good analysis. Lets hope web surfers can find their way here.

    There is only a small part of your posting that makes me hesitant. This:

    “No interest would be charged but… a tax rate. let’s say you borrow 100k for 20y and the tax rate would be higher due to the length. let’s say 120%. So as a borrower, you owe in fact 220k payable to the treasury in 20 years”

    So, you propose a tax of 120% on top of the created fiat money. Where would this extra money be taken from? I mean is there not a discrepancy or an impossibility here – as all money available is created as fiat credit, never mind the treaseury would be doing it in your proposition…?

    This extra 120%, or as in your example 120.000 would have to be extracted from previously created money, right. This means the borrowers has to fight against all other borrowers for the “capital” needed to pay off their debt + 120%…

    As I see it this does not sound like a sustainable solution. But maybe I am wrong. I am sure you have an explanation that settles this apparent problem.

  3. well you are right about your comment and I thought about it. I’ll resume as follows:
    1)the tax rate proposed of 120% is just an example so… in reality it can be less or more
    2)the system proposed is less inflationary
    3)the borrower has to find the money in the money pool available as you point out and as it is today but… who will create this money? My answer is that the “Treasury” will do it for the government since it can issue money debt free to meets its financial needs.
    4)Now… it is clear that government can do a good job or not implementing budget policies so it has different options available. If money is created for productive investment for the society like … highways, public transport etc… it probably will have a much better impact on the overall society and be les inflationary.
    5)people could vote every year on the broad line of the government spending budget as…a way to “avoid” stupid governement policies but.. anyway it can happen and create inflation.

    so… the tax money created on top of the “private” fiat money… has to come from the Treasury as debt free money for the government for budget spending. This doe not mean that goverment size to GDP shall increase.

    The money system has to be expandable/ flexible and i think this proposal is a good compromise

  4. There is a cooperative bank that has been working for 40 years in Sweden and it doesn’t use interests. It is not the solution of all problems but definitively of some of them. The bank is called JAK:

  5. well, we need a revolution here. The system is broke and our politicien do not have the courage to challenge such a system. I… an many other want our money.. our own money… is gold the right alternative? might be a start again

  6. first i found a bit confusing your text but if i understand correctly
    1)monetary growth (part of it) is fresh money issue by the treasury and people vote for the budget which sets the broad guidelines for monetary growth
    2)no more capital gain taxes, dividend taxes , income tax but just.. borrowing taxes

    makes some sense to me…. and it will definitively change the balance of power too.

  7. Pingback: Fractional Reserve Banking: Is there a better alternative to fractional reserve banking? - Quora

  8. Pingback: Sustainability: Is Fractional Reserve Banking sustainable? - Quora

  9. Pingback: Join the move…..Knowing the truth about money is not that difficult | Relativemoney's Blog

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