What the Chicago Plan Revisited proposes

The Chicago Plan Revisited
Michael Kumhof









1. This is a proposal for the most profound monetary and banking reform in centuries. It is based on the work of a long line of distinguished economists, including Irving Fisher, Milton Friedman and the founders of the Chicago School of Economics, who advocated laissez-faire in industry but not in banking.
2. The work is motivated by Irving Fisher’s 1936 book “100% Money”, with actual quantitative results worked out for the US economy today.
3. The paper was written by two IMF economists, Jaromir Benes and Michael Kumhof. Kumhof was a Barclays Bank PLC manager for five years.
4. An extensive section on monetary history shows that government control over money creation has generally been superior to private control.
5. There is also an exhaustive explanation of the current money creation process, supported by many statements from eminent economists and central bankers.
6. The Chicago Plan ensures that the central bank, rather than private banks, creates the country’s money supply.
7. Deposits in banks would no longer be backed by loans, which are volatile because they depend on banks’ willingness to lend.
8. Deposits in banks would instead be backed by 100% of government-created money - indestructible money.
9. Credit creation would remain private, but could no longer be financed by private money creation.

How it is done
1. The government creates sufficient indestructible reserve money to provide 100% backing for all deposits. It lends this money to banks at a small interest rate. The government is left with a very large claim against banks.
2. The reserve money represents equity in the commonwealth, not debt.
3. The government repays part or all of outstanding government bonds, against the cancellation, or the transfer to households, of part of its claim against banks.
4. The government pays a one-off citizens dividend, through a transfer to households of part of its claim against banks. Households use this to repay a large portion of private debt.
5. The credit part of banks is separated from the deposit part. The bank becomes a true intermediary that has to attract reserve money before being able to lend it. This makes it much easier to prevent credit-driven business cycles.

Consequences
1. Money creation no longer requires private debt creation.
2. The quantity of money is directly controlled by the central bank, not by private banks.
3. Credit creation remains private, and on a much sounder long-term basis than before.
4. Banks become true intermediaries that can be run conservatively for the public benefit.
5. Financial crises do not affect the quantity of money or the safety of the payments system.
6. Dramatic reduction or even complete elimination of the public debt.
7. Dramatic reduction of private debt.
8. Credit-driven business cycles are not eliminated but significantly reduced if the Chicago Plan is combined with quantitative lending guidance, a policy that can be much more effective in a world where banks cannot create money.
9. No bank runs are possible because all money is 100% backed by public reserves.
10. There can be no liquidity traps, as central banks can always stimulate a severely recessionary economy through money injections or through below-zero interest rates.
11. Inflation can drop to zero without posing problems for monetary policy.
12. Real interest rates drop dramatically because equity, not debt, becomes the norm.
13. The government can use revenue from money creation to dramatically lower taxes.
14. Lower interest rates and taxes lead to potentially very large output gains.

If you look on youtube you will see some presentations by Michael Kumhof. The most recent of his slideshows is one he did in Stockholm on Sept 12, 2013 and it is here.

However, despite its good intentions and sound theory, I believe with others that it is politically unrealistic to think it could be implemented. There are three high level bank lobbyists for every elected member in Washington. Moreover, the New York Times article of 21 October 2011 said the banking industry had spent $2.3billion on campaign donations from 1990 to 2010.

Lietaer, Arnsperger, Groener and Brunnhuber in their Club of Rome book Money and Sustainability 2012, also point out that "although it would eliminate the risk of widespread banking crashes and of sovereign debt crises, there would still be monetary crises. ..The 2008 monetary crashes would not necessarily have been avoided." They also point out that nationalisation of money creation process can't be done on a small scale and any change involves risk. Large scale change involves greater risk. Moreover there could still be a risk of inflation if governments were the only ones in charge of creating money. The hyperinflation of the Zimbabwean dollar could happen if another Mugabe got into power.

What money is, why it’s important and why food is more important still

One of the delights I have had recently has been talking to a guy who has done a PhD in communication during financial crises. Naturally he had been reading Marx and Minsky and a thousand other authors over his ten years doing his PhD. He said that Marx talked about a M-C-M circuit. This means money to commodity to money. Money helps people buy and sell items of value. Then in 1971 Nixon delinked the dollar from gold and we had the rise of the financial industry.

As the financialisation of the economy has grown where money trades directly with money it is a M-M circuit. While in the M-C-M circuit has in it time lags, the M-M circuit is quicker. You make money out of money. The M-M circuit is more efficient and more profitable. The dotcom bubble was about money transactions, Enron got into finance. The M-M circuit has superceded the M-C-M market.

Hyman Minsky said that on a system level you go from a hedged position to a speculative position and eventually to a Ponzi state. The bubble has to keep growing. You have walked too far across a frozen pond and can't go back. The mood swings to irrational exuberance and greed. Eventually the bubble bursts, asset prices drop and down you go.

Money really isn't supposed to be a commodity. It is something we use to trade with and we agree to accept from one another. Fundamentally, because it is a human invention, it is and always will be secondary to the real world it serves. It is the flows of resources that are important in a system, not the flows of money. It is in the resource flows that a thriving economy should have no waste.

weimarplayAnyway, then I was keen to find out about the Rentenmark, because my friend Adrian Wrigley had told me he believed there lay a key of how to get a currency backed by land. But since Adrian has now died and I was curious, I decided to find out as much as I could myself. I found quite a lot on the web, with authors Adam Fergusson writing When Money Dies and Gustavo Franco, The Rentenmark Miracle, Michael Kumhof and Jaromir Benes had obviously studied it while writing the Chicago Plan Revisited. Edward Norman Peterson had written Hjalmar Schacht: For and Against Hitler. All on the web, which is great these days.

Hjalmar-Horace-Greeley-SchachtThe Rentenmark was an emergency currency brought in by Germany in November 1923, when the hyperinflation of the 1913-1923 decade had brought the country to its knees. Reading about the social chaos during that post World War One period makes your hair stand on end.

Germany up till 1913 had used very stable goldmarks fully backed by gold. In 1913 only a third was backed by gold but by 1914 it was unbacked and called papermoney. Towards the end the First World War Germany set up private loan banks were set up to protect the country's gold reserves. These were to give credit to businesses, to the state, municipalities and to new war corporations. (It is often wrongly stated that the government created all this new money, but it was in fact private banks) Loan bank notes were made legal tender. The Reichsbank could include three month Treasury bills in its note coverage, so that unlimited amounts could be rediscounted against bank notes. (Have I lost you? I can't understand that either, but I gather the discounting was a disaster).

Then Germany proceeded to its descent into hell. Inflation picked up speed when the British demanded reparation in gold of 2 billion goldmarks a year, plus a quarter of their exports. Each year and with each crisis, more money was printed until by late 1923 $1US was worth 4.200,000,000,000 papermarks.

What happened during those years was a complete nightmare. Those who had precious items like gold, furniture, jewels, artworks exchanged it for food. A doctor's wife gave her piano for a sack of wheat, a gold watch was given for four sacks of potatoes. Artworks were exchanged for bread.

Those long on gold, land and other real assets were seen enjoying Germany's finest restaurants while wearing the most expensive of clothes.

Farmers refused to take any form of paper money for their crops. The harvest of 1923 sat in farmers' warehouses while supermarkets in the cities were empty. Urban people came to the country to demand food.

The Government had tried everything. In 1922 a private rye rentes bank (Roggenrentebank) had been founded; it issued its first bill of exchange denominated in pounds of rye in December of 1922. In the beginning of 1923 several public bodies - cities, states and public utilities' companies - started to issue loans denominated in commodities such as rye, coal, and others, but priced and serviced in marks according to the current commodity prices.

Reduced to a barter economy only, far right was pitted against far left, town against country, class against class, race against race, trade against trade and husband against wife. It brought out the worst in everybody, according to Fergusson.

Farmers accused of hoarding food were savagely attacked by urban hungry. Farmers sometimes bought up others crops and sold them for double the price. Jews were resented and blamed. Foreigners with overseas currency lived in luxury. Debtors were advantage over those with assets. There was a massive strike in the worst hit area, the Ruhr valley.

Anyway a very well educated economist and banker Hjalmar Schacht was appointed to fix it during that nightmare of November 1923 and given near dictatorial powers. One account from his secretary said he "sat in his room and smoked. Did he write letters? No he didn't. He telephoned and he smoked."

Hjalmar Schacht decided to do something new. He established a Rentenbank which was to create a new currency called the Rentenmark. It issued mortgages to farmers and those with industrial properties. Even though those with mortgages do well during hyperinflation and mortgages are easily paid off, from what I can gather they now badly needed to remortgage their properties to get cash. A huge quantity was printed very quickly and it didn't cause inflation. So why did it work? Some make no attempt to explain. Many authors simplisticly explain in terms of the restrictions on the amount printed, or, as Michael Kumhof and Jaromir Benes said, the fact that Schacht also stopped the converting of private monies to Reichsmark on demand, he stopped granting Reichsmark loans on demand, and furthermore he made the new Rentenmark non-convertible against foreign currencies. True. He also cut government spending. However remember that in one act the government bank created 2.4 million Rentenmarks, and 1 Rentenmark was equal to a trillion old papermarks. That should have produced inflation. But it didn't. Not a scrap of it. One writer basically said it was a coincidence, recalling that the Assignats of the French Revolution hadn’t worked, and then shrugging “Then the property backing seemed to give the currency value.”

The effect was dramatic. Farmers released food to warehouses for sale in the cities. The riots stopped. Skilled unemployment, which had risen to 28% by Dec 1923 dropped to 8.6% by May 1924. Real wages grew.

No it worked because if you back a currency with land, you back it with something that doesn’t go away, something solid and permanent. But not just that. If you remortgage the land, the occupier has to pay fees to the bank (in this case a government owned development bank) So the money goes round in a full circle at a steady pace. The mortgage payment, because it is to a government agency goes to the Government and it acts like a land tax in its early years. Sure since there was no way by which property could be foreclosed or distributed, it seems rather a strange way of backing money. But so is gold. You back a currency with gold but owners of gold don't come for the gold and use that as money. But it works. I am not sure of the relationship between the Rentenbank and the treasury but I guess sometime I will find out.

I think this scheme is the nearest there has been in history to a land backed currency. It is as though the government bought the land (though they did buy the improvements too in this case) and then rented it to the farmer. "We will pay for your land as long as you pay us a fee of 5% per annum."

So here I am, having realised how utterly critical it is to avoid inflation. I am extremely grateful that during my lifetime there has never been hyperinflation where I live. Thank you central bankers for that. And I realise how critical food is.

But I also believe that the Rentenmark miracle has not yet properly been explained in terms of the theory of money going round an economy. In this case it was created by a public bank and went back to a public bank. Those in the complementary currency movement have always been looking for commodities to back their currency with. Metals are probably better than food products. But what better than having a national currency backed by land? Then those who have the privilege of living on a bit of land can pay their rent to government and the money will go round and there will be no inflation.

Hyperinflation is the hell on earth, food is critical and all food comes from the land. Money is important but food is more important. If money is designed correctly and backed by land, we all benefit.

Incidentally, the rentenmark was never a legal currency, just an emergency one. Another gold backed reichsmark was established in August 1924. The rentenmark continued to be used until 1948.

Slideshow on the Post Fossil Fuel Economy – Jobs, leisure and innovation

The new slideshow is at http://www.slideshare.net/deirdrekent/steady-state-economy-jobs-for-a-postgrowth-economy. It addresses many of the questions our members have been asking and hopefully makes it easier to understand. There are presenter notes with most slides.

A thriving, vibrant economy is possible after fossil fuels – tax reform, currency reform and welfare reform

http://www.slideshare.net/deirdrekent/sustainable-economics-without-fossil-fuels-21 This slideshare show is now updated and made clearer. It is the first time it has been published on this site and represents a lot of feedback from our members. If others have a method of reforming the tax and money system in a way that is politically possible and in a way that doesn't shock the economy, we would love to know. Meanwhile this is a serious proposal. Feedback is welcomed.

Why not do monetary reform then land tax reform?

challenge_ident2007b

What is your solution?

One of the questions we often get asked is why not do monetary reform first and then do other things later.

Positive Money NZ and its parent in UK have done wonderful work in teaching about the dysfunctional money system. There is no doubting that. They are reaching a wide range of people and describing what is wrong with the money system, how it leads to growing debt, wealth disparity and the growth imperative. We really recommend going to their website and seeing all the wonderful youtube videos and articles and links there. It is a great website.

But when we are in a political party we need to aim to get a thriving economy and that means jobs.

clear_river_and_sky_Wallpaper_b3wcw

Untaxing labour and sales is like unblocking a currency river

And when we think of where the money flows and why it doesn't flow into job creation if you fix the money system, we also need to think about the tax system.  Our party says it is time to untax labour and sales and to tax land and its resources. When we do this, all sorts of miracles occur.

Imagine having a currency where completely new rules apply. When using this new currency there is no tax on labour, sales or enterprise. No income tax, no GST and no company tax when using this money. Wow! What happens? Well employers realise that workers get 100% of their salary so they have a happy workforce. But that is not the end. When the workers spend their money they won't have to pay GST. This is that they have more purchasing power. Their wages are higher now in relation to the prices of goods. And that is what unions have been crying out for for ages.

So it is like having the river bed carved out for a new currency. The new money flows in the riverbed unimpeded by taxes. So it flows into productive investment and creates jobs.

We have proposed the slow introduction of a parallel national currency created by a new agency (the Treasury) which adheres to these rules. The slideshow for this is now at http://www.slideshare.net/deirdrekent/sustainable-economics-without-fossil-fuels-21

Of course having argued that it is important to treat the global economic system as a living system and that we need to intervene where the effect is greatest, and having argued that the global economy is what Cantabrians would call 'mega-munted' and that you need to start again, people still come back saying Couldn't we just have monetary reform for a start.

Yes I know a lot of people just want us to do the monetary reform and do the rest later. But what happens? Yes money is spent into existence rather than lent into existence so it doesn't bear a debt and it has no interest due either. All good. But where does it go? With GST and income tax and company tax, it will of course go into buying up yet more property and naturally occurring assets, putting pressure on the limited resource of land and raising its price. And as before, the wealth concentrates with land owners.

Q. I thought you wanted to close the gap between rich and poor?

A. Oh yes we will do that now, we will impose a land tax.

Q. Well how are you going to do that?

A. Well we will start at 0.5% land tax and lower income tax a little across the board at the same time. That way we won't shock the economy.

Q. But I am still paying my rates and my mortgage. Why should I pay a third land tax?

A. Oh I don't know.

And there is stops. If there is another way, please would someone tell us about it! In all the time we have had this initiative up and running, nobody has come out with an alternative solution other than by starting again with a second national currency differently designed.

If you can come up with a suggestion which is better than the dual currency, we would be pleased to hear from you.

How To Build A Life-Supporting Economic System

How To Build A Life-Supporting Economic System

Unknown

Earth is a Living System

Earth is a living ecosystem and necessarily the model for the human economic system. The words ecology and economy have the same Greek root ‘ekos’, meaning ‘home’ or ‘earth’, so our economy is a subset of our ecology. All life-based systems are unique home economies – Earth, nations, states, cities, towns, communities, families, and each living being. Each economy can only survive in balance within natural limits.

Every global crisis derives from an unbalanced economy:

  • Financial collapse is caused by an interest-bearing debt-based money system and a grossly overinflated ‘shadow economy’. These cause rising debt as “promises to pay” that cannot be met by the real economy.
  • Energy collapse is caused by our economic dependence on fossil fuels and the new reality of relentlessly declining energy returns, leaving less energy to drive the economy.
  • Biosphere collapse is caused by the real world demands of the growth-based economy, required to service exponentially expanding interest-bearing debt.
  • Societal collapse is the descent into social unrest, the police state and militarism, driven by the above.

We have a Deadly Economy

In an interest-bearing debt system of money creation:

  • Private banks create money as a commodity for private profit, causing cycles of boom and bust as the money supply expands and shrinks. The lack of balance is destabilizing. Scarcity of money during recessions/depressions causes unemployment and turmoil.
  • The interest mechanism automatically transfers wealth upward from those with the least to those with the most, increasing income inequality. This undemocratic money system leads to social polarization and social collapse.
  • Interest-bearing debt expands exponentially, demanding perpetual growth of GDP despite our finite Earth, which exhausts all human and natural ‘capital’.
  • The need for growth is inflationary, promoting unproductive speculation in financial markets and real estate, inflating house prices, and eroding the productive economy.

A tax system which taxes labour, sales or enterprise discourages work discourages trade and discourages enterprise. It also greatly reduces people’s purchasing power (though there are cases for reducing this e.g. tobacco, alcohol, fossil fuel etc.). A tax system like this encourages property speculation, reduces productivity and concentrates wealth with landowners.

When we tax these three but fail to tax land, we invite taxpayers to use tax havens and do under-the-counter trades, resulting in lost government revenue. Land cannot be hidden offshore.

However, though it has been recommended for centuries, a land tax in the 21st century is a politician’s nightmare. Successive tax review by Inland Revenue, Treasury and universities have recommended land tax, but no government has implemented them. In fact there is actually a law prohibiting land tax in New Zealand, probably enacted to please the banks.

People already pay on their property two payments – rates and mortgage – so the possibility of government imposing a third burden is zero. In fact it is political suicide for any politician to recommend land tax, no matter how small. Yes, the banks have claimed land for themselves, as it is their best security on their loans. They vehemently oppose land tax and so governments have to be content with taxing a less secure asset – income taxes.  Banks love lending on property because as the price of land rises, so does the size of their loan portfolio.

A means tested welfare system with an intrusive state and a ‘benefit trap’ is trapping our unemployed and dampening enthusiasm for working. It is also complicated and expensive to run and requires billions being spent on IT systems. The benefit system with its various income support schemes which favour the children of employed over the children of the unemployed like Working for Families is basically unfair. A Universal Basic Income has been recommended for centuries, starting when someone saw thieves hanging in the street and said it would be better to pay them a living wage. However there has been no progress.

All of the above – monetary reform, a Georgist tax reform and a Citizens Dividend – would if introduced suddenly shock the economy. All of the above have attracted loyal movements that have made virtually no progress over the centuries. It is important to reflect on the reasons for inaction. Each major reform would shock the economy.

We Need a Living Economy

A living economy will feature:

  • Publicly created permanent debt-free money as a medium of exchange for public benefit, circulating permanently, its volume regulated by a publicly accountable body. A sufficient, balanced supply of money is stabilizing, promoting business and employment.
  • Reliable public revenue without debt or interest is spent directly into the economy. It is critical to take the power from the banks to create the country's money and return this to the people.
  • Tax will be removed from ‘good’ activity like work and enterprise and trade, and will be imposed where people take more than their share of the commons or impose a burden on the commons.
  • A Citizen’s Basic Income removes the need for Social Welfare and numerous income support programmes. It avoids the ‘benefit trap’ and allows voluntary work and new businesses to thrive.
  • A stable money supply that is neither inflationary nor deflationary, and flows freely into productive investment in the real economy.

Transition To A Healthy Public Money System and to a Reformed Tax and Welfare system

First we need to explain why we are applying a broad-brush approach to reform, not doing it piece by piece.

When family therapists are presented with the problem of a difficult adolescent, it is important to treat the family as a whole system, rather than just look at the presenting problem, the adolescent. Tweak just one part of the system and the whole becomes healthier. You seem to solve all sorts of problems. But if you just try and fix one problem at a time, it won’t work. The original problem tends to persist. That is because the issues don’t exist in isolation and the relationships continue. You can’t divide up a system because you break the links and destroy the patterns. It is the same for any living system. The challenge is to intervene at the points where it is going to effect the greatest change. This is in the areas of goals of an economy and the fundamental paradigms which are taken as gospel. Those paradigms are the basic beliefs and ‘givens’ of a system.

In our case, we have an economic system showing a range of Big Problems. First we have the property bubbles in Auckland and Christchurch while the economy in the regions stagnates.  Second we need to sort out the welfare mess by introducing a universal payment, the UBI. Third we need to get a tax system that taxes what we hold or take, not what we do or make. (Taxing labour and enterprise is counterproductive, while it is quite fair to tax those who take or use more than their share of the commons.) Fourthly we need to move from privately created interest-bearing money to publicly created interest-free money.

These big issues are all connected through banks, land and taxes. If there is quite a simple solution where, if you tweak one or two parts of the system and the other problems solve themselves naturally, then we should use it. This is the systems approach. You don’t tackle the intractable problems issue by issue; you look at the whole integrated system and choose your point of intervention that gives the greatest leverage. In that way the fundamental relationship between the elements of an economic system will remain intact.

You will notice we are suggesting the point of intervention that has the most leverage – the currency, tax and land. We have paid attention to what is important. Changing the paradigm from a currency monoculture to a currency ecosystem is going to bring big change. Changing the tax and welfare systems will also have a major effect.

Second we set up a small new system parallel to but very different from the old system.

This proposal will put in place the small beginnings of a new and healthier system to coexist with the earlier deadly system as the old system dies away.

So we are going to start a new currency with new rules. This will be the beginning of the new healthy economy. The old economy will die and a new one will be born. It’s a transformational change. In order to transform the tax system from taxing labour, sale and enterprise to only taxing land and the use of the commons, you need to link that new tax system to a completely new currency.

It can’t be done effectively otherwise. New life is full of health and vitality. Just as new growth in a forest after a fire appears slowly, so will this process be gradual.

Note that by setting up a fledgling parallel system we have not just fiddled round the edges. We have changed the whole paradigm. So we would expect major change.

Step one

Government issues a new currency called Tradeable Tax Credits. These are acceptable by Treasury for tax on a certain date. (The Reserve Bank is left out)

Step Two

Using Tradeable Tax Credits, Treasury gradually buys up the land of homeowners who opt into the system voluntarily. Government doesn’t want to use New Zealand dollars – first because it hasn’t got enough of it and second because Government wants to link the vouchers to a new tax regime. The dated Tax Credits are to ensure that Treasury issues just the right amount so as not to cause inflation. The date by which it must be redeemed also serves as a circulation incentive.

Step Three

Then Government makes the rules for these tradeable tax credits. They say trades in Tax Credits will not incur income tax, GST or company tax. IRD is not involved with them except insofar as it imposes "land rates" and resource taxes.

Step Four

Full land rates would be set if possible by tender or auction and the lessee will pay it in perpetuity to Government, the revenue to be shared in some proportion between central and Local Government.

Step Five

A Land Rates Index would be established for each general area and rates adjusted annually or biennially according to the rates index. Note the rates are not indexed to inflation. Rates vary very little unless there is an earthquake, subsidence or new infrastructure or a significant business arrives in the area or departs from it.

Step Six

There would be no impediment preventing the Tradeable Tax Credits from being freely traded with NZ Dollars. Employers will want the Tax Credits and importers will want the New Zealand Dollars. The Tax Credits would be issued at par and redeemed at par. What happens in between will depend on the sentiment of the market.

Step Seven

From time to time Government will issue all men, women and children with a small Citizens Dividend in Tradeable Tax Credits to share some of the revenue with its citizens. This dividend would gradually grow as the area of land in the scheme grew.

Step Eight

Resource taxes are imposed on anyone with a monopoly on any part of the commons e.g. Oil, Coal, minerals, water, fisheries etc.

Step Nine

The homeowner who has opted into the scheme receives Tradeable Tax Credits to the value of their land and either puts it in the bank or uses it to pay labour for home improvements or for productive investment and always to pay taxes.

Step Ten

The bank lends out the new Tradeable Tax Credits to businesses to pay a portion of their labour and New Zealand materials. New jobs are created. As there will be no need to move to Auckland, labour intensive industries will attract young people back to regions, back to New Zealand. Organic farming and manufacturing will want them. At first some workers are paid only a small proportion of their wages in the new credits.

Step Eleven

No rates will be payable on any property where the land is Government owned and full land rates are paid.

 

The land to be changed to publicly owned leasehold land would include: -

  1. All land owned by those who do not pay income tax in New Zealand. This would have to be done in steps. It also includes trusts and companies who don't pay tax in New Zealand.
  2. All land owned by government or local government and intended to be sold off to private buyers would stay with the Government e.g. The “green frame” in central Christchurch.
  3. Any other freehold land through an-opt in scheme. This would not alarm those who are capital rich and income poor like the elderly and would not alarm farmers. It would also take the worry from our would-be subsistence farmers on small holdings.
  4. All land under infrastructure like roads, hydroelectric power stations, airports, sewerage or stormwater or water servicing will be required to be converted to leasehold land. Once again to avoid inflation, this must be only done in stages.

The circulation incentive

Dated Tradeable Tax Credits will circulate relatively fast. They will not pool for long in anyone's bank account. People don’t want to find themselves in possession of them when the date arrives, so they trade with it, put it in the bank for the bank to lend out or else pay their land rates early. When a tax credit circulates smoothly without pooling anywhere, it nourishes everything in its path. A trade mutually benefits the buyer and the seller. Even if the Tax Credit goes out of the country there is an incentive for the holder to get it back to New Zealand before its maturity date.

The NZ Dollar and the Tradeable Tax Credit

These can be exchanged. A market will develop naturally. There are two opposite forces acting. The NZ dollar will be used for importing goods and for those who are travelling overseas. The Tax Credits will be particularly attractive to those who plan to use it to pay for labour because this currency is completely delinked from all disincentives to show initiative. The labour they buy will not be taxed, their employers business will not be taxed and the goods and services produced will not be taxed. The Tax Credits will always be worth one NZ Dollar when it is paid for taxes before the expiry date. It is rather like the NZ Postage stamps they sold us when the 70c stamp replaced the 40c stamp. One stamp will take the letter anywhere in the country.

The Tradeable Tax Credits would be digital only

Kiwibank has a “Loaded” card. It is a debit card with embedded chips for each currency. It is issued when a customer travels overseas. Perhaps the Tax Credit could be issued this way, with EFTPOS machines dealing with both types of currency. It is possible each new voucher could have a unique identity so that their circulation speed could be tracked.

Results

Transformational reform when carefully and gradually introduced has an exciting range of effects. This policy gives us low cost housing while gradually but fundamentally changing the tax structure. According to the Productivity Commission, the value of land is on average half of the total value of an urban property, but for Auckland it is 60%. Secondly it makes an important but gradual change in the money creation process. Thirdly it starts on an overdue reform of the welfare mess. Fourthly it gradually changes the way we fund local authorities.

While it releases much needed liquidity for new businesses it has to be implemented along with adequate controls on resource use through resource taxes e.g. carbon tax.

Wouldn’t people cheat the system?

History tells us that wherever money is involved people will try and find a way to cheat the system. Some suggest that people will exchange their Tax Credits for NZ dollars and go and buy another property and do it again. But these people haven’t planned to pay their ground rent and this is a large ongoing obligation. In fact wise people will not opt in unless they have a plan to use the new credits productively to create sufficient revenue flow to pay the rent. Most will pay their land rates in advance. Remember the Tax Credits are issued at par and redeemed at par. The sorts of things that happen in between will soon settle down as people learn the rules. The new law will have meaningful penalties for those who default on their obligations to pay land rates.

How much land rates?

A full ground rent  or land rates for an urban or suburban property is ideally set by auction. However, rule of thumb indicates it is around five percent per annum or more depending on the zoning and other restrictions on the land. Location is important. The further away the property is from government services, the lower the rate. Certain land is however, already overvalued e.g. Auckland land and dairy land, so allowances for that would then have to be made. Other restrictions would include land with a  QE2 covenant or land under historic buildings or land otherwise used for the public purpose.

The Citizens Dividend

Although this starts out being small, the first payout will attract a great deal of attention. When people realise these Tax Credits will pay for food and other essentials, they will begin to trust them. Their value relative to the standard currency will rise. As time goes by this dividend will be repeated and will increase, perhaps allowing, say working couples to opt to care for their own children rather than drive to jobs they don’t like. It might also enable inventors to spend more time inventing. Because the dividend of a dependent will go to the nominated carer, it will redress the economic balance of power between those who care for dependents and those who don’t. This raises the status of carers – usually women, raises the standard of care for children and reduces the social service burden on the state. Many carers will opt to spend their dividends on further education. There is also a long known fact that as the education of women rises so does the control over fertility.

Shouldn’t relief of mortgages be a first priority?

Yes. However in practicality those who opt in at the start will probably be those who are mortgage free because those with mortgages don’t want the hassle of going to their banks and having the bank refuse the Tax Credits. It would be easier in the case of New Zealand owned banks like Kiwibank, the Cooperative Bank, TSB and the SBS. However over 90% of New Zealanders’ mortgages are with the Australian owned banks and the banks might take the case to the World Trade Organisation or other authority to challenge it. So it is better to do the easy things first until the public is onside.

Is there a precedent for Step One?

Yes. These Tradeable Tax Credits are the same as the Treasury Notes that have been used before in history e.g. China 1912 when there was an uprising.  Abraham Lincoln used the US Treasury to issue Greenbacks in 1865 and The UK Chancellor of the Exchequer Lloyd George, on the advice of John Maynard Keynes, issued Emergency Bradbury Treasury Notes in 1914 to pay for World War I. Lord Bradbury was the Secretary of the Treasury.

Bernard Lietaer and Stephen Belgin in their book New Money for a New World describe three periods of history in which there were dual currencies. First, Dynastic Egypt, where there was gold for long distance trade and also pottery chards that were receipts for corn taken to a store. The built-in circulation incentive was that when, after a year, farmers came back with ten chards, they were only given nine bags of corn. These pottery pieces circulated for sixteen centuries in a period of relative prosperity.

Secondly in the Central Middle Ages in Europe people used gold for long distance trade but silver coins for local trade. The local Lord or Duke, who owned the land and issued the coins, reminted the silver coins at irregular and unpredictable intervals. Though the periods between reminting varied from area to area, a lord might give out, for example, four coins for every five that were brought in. Reminting happened when the Lord died. This practice coincided with a massive period of cathedral building and the authors say the enthusiasm cannot only be explained in terms of religious devotion but in the currency system. Maintenance of water wheels, mills and wine presses was excellent. Ordinary people wore silver buckles. Nutrition was so good that the average height of a woman in London at that time was 1 cm higher than today.

Thirdly in Wørgl Austria in 1933 during the depth of the Depression, ‘work certificates’ were paid to council workers who could in turn have them accepted by the butcher, baker, etc because they were redeemable for tax. But each month the bearer of the note had to place a stamp on the note to validate it. During the 18 month period these work certificates circulated, unemployment declined dramatically, bridges were built, people paid their local tax early and visitors came from far and wide to witness the ‘Miracle of Worgl’.

Lietaer and Belgin claim that in each period there was prosperity across all classes and a huge building programme. They attribute this favourable economic outcome to the dual currency, and in each case the domestic currency had a built-in circulation incentive. The authors did not describe the tax system of each society, but to my knowledge there was no income tax, sales tax or company tax during this period. In the central Middle Ages tax was more likely to be a regular tithe to the lord or duke, possibly paid in produce. This is basically a land tax.

There is also a precedent in New Zealand history for Step Six, a Citizens Dividend. In 1951, after a particularly high wool cheque, the government gave out a five pounds dividend to all families.

Why can we see so many bad symptoms start to reverse?

If we observe the results of these small actions being set in place, it is truly astonishing. It is almost as though a fallen domino set has begun to rise, piece by piece. Some are totally disbelieving, because we are so used to thinking that only one result is possible.

  1. A better, fairer tax system with reliable revenue.
    You can see it works towards a much simplified tax system where tax evasion becomes impossible, because you can’t hide land offshore. Many tax-based subsidies will cease to exist as GST, income and company taxes are gradually phased out. For example, tax exemptions on aviation, fuel, interest on mortgages simply disappear. The black and criminal economies no longer gain an unfair advantage. When you use the new money to employ a tradesman, you won’t have to hand it under the table.
  2. New life in industry, and a sea change in horticulture and agriculture. The new Tax Credits,  with a built-in circulation incentive, give opportunities for labour intensive industries to return. The post fossil fuel age will require a whole new set of businesses and these Tax Credits will provide the lubrication. It will be great for organic farming and pest destruction, both of which require a large labour input. Clean green technology will finally blossom and green jobs will no longer need to be subsidised.
  3. Lower prices and higher wages. The increased purchasing power, which results when Tax Credits are free of all other taxes, cannot be underestimated. The affordability of labour and of New Zealand produced goods increases dramatically. Holders of the credits find they can access the basics of food and clothing. Import substitution starts to happen and clothing factories may re-open. When the Tax Credits circulate unburdened by taxes on labour or trade, prices inevitably drop. When employers pay their employees in Tax Credits, which have no income tax, you get a contented workforce. And when workers discover their Tax Credits can buy necessities without GST they are doubly happy.
  4. Issuing of Tax Credits starts a process of gradual but inexorable reduction of private debt. This can only be good for our population and our businesses as all debt under the current system incurs interest.
  5. Because there will no longer be the necessity to move to Auckland for employment, it will be great for regional development, which will take some pressure off Auckland housing. The new Tradeable Tax Credits will flow to the regions without impediment. The attraction of Auckland where a growing portion of the economy is in the FIRE section – finance, insurance and real estate – will no longer apply. The two speed economy, where Auckland  and Christchurch are going ahead yet the regions are withering and suffering unemployment, will even out.
  6.  It is the origin of a new method of funding local authorities. No longer will all of their revenue come from the regressive policies of universal fixed charges or from rating on capital values that discourages investment.
  7. Maori and Pacific Islanders and low income people will benefit from this policy, as they will all be recipients of the jobs created, and from time to time of a Citizens Dividend.

This is quite a list of achievements.

 

Summary

The policy is powerful, elegant and simple. It creates jobs, provides cheaper housing and transforms interest-bearing money to government interest free money all simultaneously. And it does the whole thing gradually without shock to the economy.

 

More discussion needed

Among the issues to be fleshed out are: -

  1. Policy as it affects Maori. Because this is a policy dealing with land and its ownership, it is important to take the proposal round the country from iwi to iwi, preferably by group including Te Reo speakers, because in each rohe and iwi there would be a different situation with respect to the various types of Maori land, incorporations and trusts. However, because the system is an opt-in arrangement, nobody is immediately penalised.
  2. A programme to be devised for gradual rollout without causing inflation. There will have to be robust research on the value of foreign owned land, the tax take and the value of land in each category.
  3. We need a plan to handle the possible fear engendered in those who want their land to be made leasehold but have their mortgage with one of the big four Australian banks, which comprise over 90% of all mortgages.
  4. What is the role of Government in encouraging retail business to accept Tradeable Tax Credits, especially in the early days of implementation?
  5. Since the cost of the house and improvements are not included in the proposed mortgage relief, there needs to be other interest-free arrangements similar to the JAK Bank of Sweden6.   The role of banks in making loans to businesses wanting Tradeable Tax Credits to finance wages and materials.  Does this mean the banks finally get to be an intermediary between saver and borrower?

 

Deirdre Kent deirdre.kent@gmail.com 06 364 7779

021 728 852

New Economics Party

http://neweconomics.net.nz

With acknowledgement to the late Dr Adrian Wrigley of Cambridge UK

 

Banks are not intermediaries, the loan comes before the deposit

20130323_LDP001_0A key thing missing in last week’s coverage of the Cyprus crisis is that banks create a loan before they create a deposit.  Almost all journalists and commentators all fall into the trap, believing that banks are true intermediaries between saver and borrower. Michael Kumhof, a former bank manager at Barclays, disposes of this myth in his article with Jaromir Benes called the Chicago Plan Revisited, and in subsequent lectures and papers. Kumhof, an IMF economist, says clearly; "The loan precedes the deposit. I know because I did it and if anyone like Paul Krugman tells you otherwise he doesn’t know what he is talking about.” I was explaining to a friend the other day that if banks have 100% backing for their deposits there is no risk of a run on the bank. Her reply was “But then they would have nothing left to lend out.” This friend was believing, as is fed to her in the daily media, that banks lend out their deposits. Kumhof goes further than this by saying “The chief function of banks is to create the nation’s money supply. They are solely in charge of it.” So when rich Russians deposit their money in the Laiki Bank in Cyprus the deposits are not lent out at all. The bank itself decides who will have loans, issues the loan and at the same time writes an equivalent deposit on the other side of the ledger. How do you think the size of the banking sector in Cyprus reached eight times the size of the economy in 2011?  The banks made loans and were solely in charge of the credit blowout. And it is the same with the rapid expansion of the Iceland banking system. Banks made loans for houses, cars, aeroplanes, condominiums and seldom asked questions. In fact as Hordur Torfason the Iceland activist explained, he was called into the manager’s office and offered a big loan when he didn’t even want one. We know that the bank staff have incentives for issuing more loans. They are paid more if they do. The tragedy of all this is that the universities are not teaching it honestly to each generation of students of economics. The economists tell the journalists and so the myth continues. Hopefully Cyprus will help the public understand the whole horrible faults of the way we rely on banks to create and decide on the country's supply of credit. A transcript of the first seven minutes of Michael Kumhof's talk is here.