This article examines the growing movement towards monetary reform as a result of the financial crisis in 2008.
Canada has remained in a precarious situation after the collapse of the financial system and this turmoil has placed greater scrutiny on the nature and inequities of the current banking system.
Many reformers have called for monetary reform and have proposed significant changes to the current monetary system.
These reformers come from different schools of thought, with different philosophies, and offer different alternatives to the current system.
Some of the more popular alternatives include:
The government control over the creation and issuance of money. Effectively democratizing the money system
The return to the gold standard or other commodity based currency, one that cannot be devalued nor inflated in value
The shift to Free/Full Reserve banking in order to prevent speculative behaviour, asset commodity bubbles, etc
Monetary reformists belong to different schools of thought, and it can be difficult to understand and differentiate between their proposals on monetary reform.
Due to this, we have undertaken an extensive in-depth analysis of each of these various reformers’ schools of thought.
The central theme that brings all monetary reformers together is on the elimination of the fractional reserve banking model.
The fractional reserve system is criticized by all reformers because, as covered in Article 2, the mechanisms of the current system create a cycle of perpetuating debt, excess speculation, and significant contractions in the money supply, all of which lead governments to undertake drastic measures in order to address it.
These measures, as covered in Article 1 of this series often tends to include the privatization of crown assets, a general rise in taxes, as well as fiscal austerity through cuts to social programs.
The solution to fractional reserve banking model is where the various reformers differ.
The differences between these reformers can be tied down to various ‘assumptions’ that are made on;
The nature of money
How money circulates in the economy
Nature of Money
All reformers acknowledge that money is a medium of exchange used to facilitate the transfer goods and services. However, reformers differ on the particular form that money should take.
Austrian economists believe that money should be in the form of a precious commodity such as gold and silver, since it cannot be manipulated through devaluation and inflation by excess money printing.
Chartalists and Modern Money Theorists view money as a creature of the state, and believe that money should be in the form of fiat currency, regulated and controlled by the government.
How Money Circulates in the Economy
Reformers are also split on how money circulates in the economy, and they differ across two competing theories;
- Endogenous Money
- Exogenous Money
Both of these theories are explained below.
The Exogenous theory asserts that the money supply is not a function of the interest rate. Proponents for this theory argue that the money supply is determined independently via the central bank.
The above graph depicts that in an exogenous model, the money supply is perfectly inelastic. This means that the money supply will not be affected by any change in the interest rate.
Notable reformers supporting the exogenous theory include economist Stephen Zarlenga, U.S. congressman Dennis Kucinich, and writer Ellen Brown.
These individuals are referred to as fiat debt-free reformers since they advocate for total complete government control of credit in order to abolish the fractional reserve system.
In contrast to the exogenous theory of money, the endogenous theory asserts that the demand for money does indeed affect the money supply.
Endogenous theory maintains that the money supply is a function of the demand for money.
The graph above illustrates that in an endogenous model, the money supply is determined by the demand for money.
As the demand for money increases, it will lead to a corresponding increase in the money supply in the economy.
Reformers supporting the endogenous theory argue that a change in the demand for money is caused by 2 factors;
1. Increase in the level of output
2. Decrease in the interest rate
1.) When economic output (production of goods and services) increases, it leads to the production of more goods and services, which in turn leads consumers to demand more money in order to purchase them.
2.) When the interest rate decreases, investors are more willing to invest, which leads them to demand more money for investment.
Under both of these circumstances, the demand for money causes an increase in the money supply.
This stands in contrast to the exogenous theory, since there is no independent money authority which can alter the money supply.
The endogenous theory has been adopted by Post Keynesians and the Post Keynesian branch of Keynesianism branches down further into a variety of other economic theories including Monetary Circuit Theory, Modern Monetary Theory, Horizontalism.
Notable individuals supporting the endogenous theory include economists Steve Keen and Bill Mitchell, and physicist William Hummel.
Also interesting to note, is that Islamic banks did not suffer the same fate as their western counterparts, and this has led to more academic study on the mechanics behind Islamic banks.
These banks have a completely different take on exogenous and endogenous money.
Since the charging of interest is strictly forbidden in Islam, the circulation of money through changes in interest rates does not occur. Instead, money is circulated through the loans provided by the Islamic banks.
These loans are endogenous, essentially coming from the state (central bank) because all loans made by Islamic banks should be approved by the central bank in order to ensure compliance with Sharia Law.
Thus as noted above, Islam societies not only view the nature of money differently, but the concept on how money circulates in the economy as well.
The next few articles provide an in-depth analysis into the various differences between monetary reformists and their own proposal for monetary reform.