Sovereign money: the answer to financial crises?

Bank notes and coins account for nearly 10% of the money supply in circulation. The rest is put out by commercial banks in so called "credit money" that exists only in transaction accounts. Keystone

Today money is mainly put into circulation by the private banks and not, as is often thought, by central banks. This is claimed to cause speculation and financial crises. The “sovereign money” initiative is intended to restore stability to Switzerland’s financial marketplace with a radical reform of the monetary system. For the government and parliament, however, this would be too risky an undertaking.

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Launched and supported by a number of economists, financial specialists and entrepreneurs, the people’s initiative “For crisis-proof money: only the National Bank to issue currency! (Sovereign money initiative)”,External link proposes to set up a more secure financial order in this country.

The text cites the world financial crisis that struck ten years ago, and which did not spare Switzerland: among other problems, the government and the Swiss National Bank (SNB)External link had to intervene to rescue the country’s biggest private bank, UBS.

The promoters of the initiativeExternal link base their argument on the fact that money is  created only partly by central banks, which issue banknotes and coins – in other words a ‘sovereign money’ means of payment with a legal basis.

In Switzerland, for example, the amount of cash in circulation amounts to CHF80 billion ($83 billion), which accounts for just 10% of the money supply in circulation. The rest is issued by commercial banks, generally by granting loans to to companies, individuals or other banks.

The term used for this is ‘credit money’ or ‘bank money’, a kind of money that exists only in transaction accounts. To grant a loan, a bank does not need to have the actual amount available; it is enough that the amounts being loaned are credited to the recipients as demand deposits.

Today, credit money is therefore not a means of legal payment, just a promise to credit a certain amount to an account.

The recent expansion of this kind of money has been facilitated by computerisation, which has made payment transactions and other banking operations much more rapid than they were before.

The use of credit money has clearly contributed to the growth of banking activity and indeed the whole economy, for example by channelling loans to companies. At the same time, however, it has favoured debt creation with nothing to back it up, speculative bubbles, insolvency of banks themselves, and finally, repeated financial crises.

What does the initiative call for?

The “sovereign money” initiative proposes a sweeping reform of the monetary system through a substantial amendment of the current Article 99 of the Swiss constitutionExternal link. In future the issuing of money – coinage and paper money, but also credit money – will be up to the government alone, through the SNB. Credit money would then become a true legal means of payment, issued and backed by the central bank.

Commercial banks would no longer be allowed to issue credit money, but just lend the money which had been put in circulation by the central bank. According to the proposal, on the day when the new rules come into force, credit money issued by the financial institutions is to be converted to sovereign money.

This conversion is to be made possible by the SNB granting equivalent loans to the banks – loans which are to be paid back within a “reasonable” transition period (say 15–20 years).

Billions more for government and cantons

The SNB is to remain an independent central bank, mandated to carry on monetary policy in the country’s general interests, to regulate the money supply, to guarantee the smooth functioning of the flow of transactions and the availability of money on loan to the private sector from the financial service providers. In this context, monetary policy would not be implemented primarily by means of interest rates, as it is now.

As previously, the net profits of the SNB would be paid back to government, one third at the federal level and two thirds to the cantons.

However, in future, the central bank is also to surrender to government all profits arising from the creation of new money, whether cash or electronic (the issue of a CHF1,000 banknote, for example, costs the SNB only a few centimes).

This money is to be distributed, unencumbered by debt or interest, to the federal government, the cantons, or directly to the citizens. Given the growth of the money supply in recent decades, this sum would likely amount to CHF5–10 billion annually.

Sovereign money advantages?

According to promoters of the initiative, under the new arrangements the franc would be the safest currency in the world and Switzerland would be protected against many financial crises.

The banks would no longer be able to create money “out of thin air”; there would thus be fewer risky investments and the financial marketplace would become more robust, reliable and, accordingly, more competitive.

If the problem is attacked at the root, the initiative’s advocates say, the banks will not need to be so heavily regulated and the government will not need to intervene in order to rescue them.

Customers too would benefit from a system that is more transparent and secure. 

Their accounts for transaction purposes will be covered 100% by SNB money. They would need to be managed by the banks apart from their own balance sheets and therefore not count as targetable assets in any bankruptcy. There would be less likelihood of  ‘runs’ on banks.

Banks would lose privileges

There will be benefits under the new monetary regime that will appeal to the government, cantons and ordinary citizens. The distribution of the considerable profits arising from the creation of money will help to bring down taxation and indebtedness, also to fund public infrastructure and social institutions.

According to the promoters of the initiative, the SNB could also transfer to the public coffers CHF300 billion arising from reimbursement of loans to the commercial banks to convert credit money into sovereign money.

The reform would be a shot in the arm for the real economy: money used to fund  infrastructure would mean business for many companies and would generate new jobs.

The banks would not be able to issue their own money and thus would not have unjustified competitive advantages over the other sectors of the economy.

Today, it is claimed, too much of credit money goes to feed financial speculation, instead of greasing the wheels of the real economy.

Government and the SNB against the initiative

The government says it recognises the importance of a stable financial marketplace, but thinks this goal can be achieved with the new international standards, beginning with the Basel Committee on Banking SupervisionExternal link, and the new national regulations regarding the assets of banks of ‘systemic relevance’ (too big to failExternal link).

According to the government, the sovereign money approach would mean a leap in the dark, since no other country has yet adopted such a system. 

Implementation of the initiative would mean an unprecedented radical reorganisation of the nation’s monetary system, which would expose Switzerland to high risks and potentially high costs.

Legal uncertainty about the consequences of this reform could undermine the credibility of Swiss financial policy, which up until now has stood out in international comparison due to the stability of its framework conditions. 

The Swiss financial marketplace would be put at a disadvantage compared to the competition, and the future of many banks and the jobs they provide would be set at risk.

Furthermore, the reform would in particular limit the commercial activity of banks. With a ban on putting out credit money there would be less resources for providing loans, from which the banks have a stable source of funding. To make up for losses in profitability, the banks would have to charge higher management fees and commissions to their customers.

The shrinking loan volume would have negative consequences for companies and thus for the real economy.

Independence of SNB at stake

Furthermore, according to the government, this initiative would hamper the independence of the SNB: as sole issuer of money it would be exposed to political pressure if it had to contribute on a regular basis to the funding of governments, paying them billions of francs a year.

The SNB might be forced to increase the money supply to get greater finances flowing to the government and the cantons. Under the new regime, the central bank would no longer have the freedom to follow an effective monetary policy – based on interest rates – to maintain price stability.

The SNB itself has come out against the initiative. Its president, Thomas Jordan, has said that in adopting such a reform, Switzerland would be taking a chance on a financial system that has never been tried and is radically different from anything done in other countries.

This would be likely to cause turbulence, even prior to its introduction, and the long-term consequences would be difficult to forecast.

What did parliament think?

The initiative has not convinced either of the chambers of parliament. A large majority of lawmakers are against it. 

The committeeExternal link campaigning for a “no” vote has representation from all the main political parties.

Translated from Italian by Terence MacNamee