Is It Time for Private Banks to Issue Currency?
Those of you with a penchant for 80's Indie music may remember a band called Pop Will Eat Itself. I remember thinking "what a great name!" and now, with X-Factor at its high water mark, that statement certainly turned out to be true. The same perhaps could be happening with fiat money.
This column has been fond of pointing out the circle of money that is quantitative easing and which has been responsible, ultimately, for the record highs observed this week of various equity indices. Central banks print money, which is used to buy government bonds. In other words the central bank funds the government's deficit. But the central bank and the government are the left and right hand of the same public sector entity. And the ocean of liquidity supports equity markets who think this largesse will never end.
What's wrong with this picture? If I funded my borrowing with my own printing press, no-one would have a problem understanding the obvious flaw. Don't get me wrong, QE did a vital job of preventing depression and even deflation during 2009 after the worst of the crash, but the longer it goes on the harder it will be to unwind without causing another recession.
But this week let's talk about something else. Why is it only central banks that have the right to print money? Why can't any bank print it? It's not as if it's difficult to think of examples of where a private sector bank has a better credit rating than its host sovereign authority.
This isn't a new idea. The 1974 Nobel laureate Friedrich Hayek suggested that "the government monopoly of the issue and control of money" was "the source and root of all monetary evil". Like the flat tax, this debate should be aired at the highest level, to determine if it would benefit an economy. And would it?
The U.S. Federal Reserve was created only at the start of the 20th century, after a string of failures amongst private banks. The rationale of the central bank money printer is that it protects the public, as a failing bank that had issued its own currency would cause immense damage to the taxpayer. That banks do fail is why we have the "lender of last resort" and public sector bailout mechanism, observed in action so memorably in 2008.
But customers already take a bank on trust when they deposit cash with it; this trust of credit quality would be no different if they held the bank's own notes, whose quality and reliability would reflect the reliability (read: balance sheet and liquidity strength) of the issuing banks.
The point of public money is meant to be that the central bank is a guarantor of value. That's why central banks have inflation targets. But inflation targeting is a recent phenomenon (except in Germany). Sterling has lost over 90 percent of its value since the 1970s: hardly a good advertisement for the stability value of public money. The U.S. dollar has fared no better in this respect. The rise of post-war inflation has been inexorable.
Another thing that has risen since the 1970s is the consensus that private sector production creates more (and better) value than its public sector equivalent, but more to the point more stability in value. This is true in just about all goods and services where there is genuine competition (thus allowing exceptions for health services, water utilities and railways). One wouldn't choose Aeroflot over Singapore Air Lines any more than one would, as Martin Durkin put it nicely, expect a Trabant to be more reliable than a Toyota.
It is logical to expect that private money would be more reliable than public money. An issuing institution that was deemed unreliable would not be able to find buyers for its notes. Banks or other firms that did issue currency would find it in their own interest to maintain the value of their liabilities as much as possible, just as they do the other goods and services they produce, otherwise taxpayers will not hold them.
Professor Hayek again: it is a nonsense to suggest:
"…that government, which only profits from excessive issues [of money], can be trusted more than a private issuer whose whole business depends on his not abusing that trust. Does anyone really believe that in the industrial countries in the West, after the experience of the last half century, anybody trusts the value of government sponsored money more than he would trust the money issued by a private agency whose business was understood to depend wholly on its issuing good money?"
To continue the private sector versus public sector analogy, competition preserves those goods and services that are reliable and reflect quality and value-for-money. This should not be different for currency. In other words, the private money market should be expected to thrive.
Who might be a natural issuer of private currency? Perhaps a global financial institution with a strong balance sheet, which includes banks but also companies such as Visa. Issuers may choose to link their notes to gold, to preserve the value, or may simply ask the customer to take their balance sheet strength on trust. How popular and liquid might a currency issued by such firms be? One might be surprised…
Professor Moorad Choudhry is at the Department of Mathematical Sciences, Brunel University and author of The Principles of Banking (John Wiley & Sons Ltd 2012).