IMF economist Michael Kumhof says the key function of banks is to create money

imfToday I made the mistake of going to a website where there was a sentence which made me mad. It said that in New Zealand, banks like finance companies can only lend out deposits made with them. Well I rarely get mad these days but I don't like untruths being perpetrated. So I thought the best way to recover would go and transcribe the first seven minutes of a talk Michael Kumhof, economist from the IMF made to a seminar in January 2013.  It is on youtube here and here is my transcript, give or take the odd aside I left out.

"Virtually all money is bank deposits.

The key function of banks is money creation not intermediation. The entire economics literature that you see out there today is that it is intermediation, taking the money from granny, storing it up and then when someone comes and needs it I can lend it out to them. That is complete nonsense. Intermediation of course exists, but it is incidental and secondary and it comes after the actual money creation. Banks do not have to attract deposits before they create money. I’m a former bank manager. I worked for Barclays for five years. I’ve created those book entries. That is how it works. And if a leading light economist like Paul Krugman tries to tell you otherwise, he does not know what he is talking about.

When you approve a loan, as a bank manager you enter on the asset side of your balance sheet the loan, which is your claim against this guy and at the exact same time you create a new deposit on the liability side. You have created new money because this gives this guy purchasing power to go out and buy something with it. Banks have created money at that point. No intermediation, because the asset and liability are in the same name at that moment. What happens afterwards is that that guy can spend it somewhere else later but it is still in the banking system. I care about the aggregate banking system. Looking at the microeconomy and transferring the logic to the macroeconomy is really wrong. Someone will accept that payment.

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What that means is that it becomes very, very easy for banks to start or lead a lending boom even though policy makers might not, because if they feel that the time is right, they simply expand the money supply. There is no third party involved, just the bank and the customer and I make the loan. The only thing that is required is that someone else will accept that deposit, say as payment for a machine, and he knows that is acceptable because it is legal fiat.

There is an important corollary to this story. A lot of loans are not for investment purposes, in physical capital. Loans that are for investment purposes are a small fraction. The story that is often told in development economics is that first you need to have savings, then once you have the savings, you can have investment. So a country needs to have sufficient savings in order to have enough investment. Nonsense too – at least for the part of investment that is financed through banks because when a bank makes a new loan it creates new purchasing power for the investment to go ahead. The investment goes ahead. Then the investor takes his new bank deposit and gives it to someone else In the end someone is going to leave that new deposit in the bank. That is saving.  The saving is created along with the investment. It’s not that saving has to come before investment. Saving comes after investment, not before. This is important for development economics.

The deposit multiplier that is taught in economics textbooks is a fairytale. I could use less polite terms. The story goes that central bank creates narrow money and there is a multiplier because banks can lend out a fraction. It is actually exactly the opposite. Broad monetary aggregates lead the cycle and narrow monetary aggregates lag the cycle."

Purchasing power, poverty and tax systems

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Who would have thought New Zealand children go hungry?

With child poverty a major political embarrassment it is time to examine causes and propose solutions. Not only are there 146,000 people out of work in New Zealand but the working poor are really feeling the pinch. Many part-time workers want full time work.

So it isn’t any surprise that even the National Government has realised that it is important to make some effort to feed hungry school children. Schools are the perfect indicator of the state of household wellbeing in this country. No measure proposed so far will get at the root cause.  Nurses in schools won't give families sufficient purchasing power to feed and clothe their children. Raising tax rates of those on high incomes won’t do it either. Nor will legislating for a minimum income.
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The problem is there is not enough money to buy essentials

So let's look at the family budget spelt out in the Dominion Post Sat 1 June. The family was a real Porirua family with three school aged children. The income was two benefits plus accommodation supplement plus family tax credit, which brought in a total of $685.29. The itemised expenditure tallied $752.69, leaving a weekly shortfall of $67.40.  There was no tobacco, alcohol or gambling listed in their expenses. Expenditure was $180 for food, $300 for rent. There was also a weekly payment of $80 for a car loan, and presumably this was for both capital and interest repayment.
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GST, income tax are reducing purchasing power.

Now let's analyse the family’s expenditure in terms of taxes and interest.  For decades we have lived with income tax and assumed it is fair and normal to tax income. Since Roger Douglas introduced it we have also taxed spending in the form of GST, now at 15%. I don’t know how long we have taxed enterprise but our company tax is projected to bring in $10 billion in the 2014 year. So income tax, GST and company tax now comprise over 79% of our Government revenue. Yet we completely fail to tax the use of the commons for private purposes – “the commons” being defined as that which is given to us by Nature.  Such resource rentals should include all private land and all commercial operations requiring the use of part of a natural resource e.g. aquifers, forests, fisheries. It includes minerals, oil, coal, gas, waveband spectrums and of course the 49% of Mighty River Power which is now in private hands and the proportion of any port or airport which has been sold off. The potential for gathering resource rent is significant. images-3This means taxing us for the use of residential land, valued by various reports at approximately $300 billion. Numerous tax reviews have recommended taxing land, but no government has adopted their recommendations, largely because the banks have sewn up all possible security on land. Since land will always be there (give or take an earthquake and a subsidence or two), banks want it as their security on their loans. And so government has to have the second best security – the labour of the people. Banks oppose any proposal to tax land. 98% of our money supply is created when banks issue loans. With most of the population blithely unaware, we allow private banks to create our money as interest bearing debt. When a farmer or a manufacturer has to borrow from a bank at interest, that interest is inevitably built into the cost of every item they sell. Secondly when a bank creates a loan, it creates the principal but not the interest. So everyone has to compete to earn enough interest to pay the bank. Because there is never enough money in the system to pay back all the loans with interest at the same time, someone has to go back for further loans. The Porirua family is a case in point. If their budget remains the same, they will have to borrow $67 every week to keep afloat, and pay interest on that. Unless WINZ issues them with another loan, the loans sharks with their exhorbitant interest rates will be circling. So where is this all coming through in prices? Well the landlord is paying interest on his or her mortgage and paying tax on income derived from rent, as well as GST on all landlord related expenses. If he or she buys a heat pump, carpet or curtains, GST is in the price. When the landlord employs a painter the wages have to be large enough to allow for income tax. imagesThe Porirua family’s meagre food bill includes 15% GST. The electricity, petrol, vehicle maintenance, vehicle registration and clothing bills all contain GST. Each of these items also contain a labour input. The mechanic had to pay income tax so calculates the charge-out rate to allow for this. Each of the items listed also contains an interest input. For example, the clothing factory may have borrowed from a bank for capital and the selling price of clothes allows for the interest the firm has to pay the bank. We are talking here about purchasing power. My granddaughter says she can easily live on $90 a week in Mexico because prices are low. It is wages relative to prices that is important for purchasing power. According to Matt McCarten (on Q&A 2 June), real wages in the last 20 years have gone down 30%.  It doesn’t matter how cheap an item is if you have only a few cents to use as payment. Purchasing power is a better indicator of wellbeing than inflation What this means is that until we change our tax system and return the money-creating privilege back to the people where it belongs we will continue to scratch our heads about hungry children and the growing number of people who can’t make ends meet no matter how hard they try. As you can see, both reforms will have to go together, because no government is going to tax land while the banks have this monopoly on land. While we live with the private creation of money, we won’t be able to tax land rather than labour, sales and enterprise. I am not suggesting the sum of resource rentals should raise all government revenue required. We would still need excise taxes and a Financial Transaction Tax. It’s just that once we face the money issue we can then face the tax issue and liberate purchasing power of the nation so that all may have enough to feed their children while labour is encouraged and enterprise is unleashed.  

How safe is your bank?

When you have your money in a bank, the money is legally no longer yours. It belongs to the bank and you become an “unsecured creditor”. This is the legal situation and it has been confirmed by the Reserve Bank in an email (27 March from Sonia Speedy) to Sue Hamill of Positive Money. When the bank has your money it can do what it likes with it, including take risks you don’t know about. So putting your money in a bank is a “customer beware” activity it seems. If you have your money in Bank of New Zealand, Westpac, ASB or ANZ, then you run the risk that you don't know too much about what your bank is up to. The latest thing is covered bonds, which is just one of these risks. They are packaging their ‘high quality residential mortgages’ up and selling them off as ‘Covered Bonds’ to investment funds. Then if the bank gets into trouble, the investment funds are ‘secured creditors’ and are ahead of you in line when the liquidator takes over. This means that Kiwi households will be forced to help bail out banks while overseas lenders have their money protected. If you think Kiwibank is an exception, then think again. They started selling off their mortgages as covered bonds in April 2013. But authorisation from Government doesn’t seem to matter to banks. When I rang Parliament on 9 May 2013, I found the Bill on covered bonds was still at committee stage, having passed its Second Reading on 22 February. Then there is the small matter of Interest Rate Swaps (IRS) which all these banks (and the Co-operative Bank too, not sure about TSB) engage in. If you can imagine taking out a variable-rate mortgage and then paying a bank to make your loan payments fixed, you've got the basic idea of an interest-rate swap. They comprise 80% of our derivatives market and are widely used by local authorities to hedge against the risk of interest rate changes. In April 2013 the US futures regulator was reported to be investigating allegations of manipulation of this popular derivatives benchmark and had issued subpoenas to market participants including the interdealer brokerage ICAP and several global banks. It seems the rates are set by 20 exhorbitantly paid brokers at a desk in Jersey City, New Jersey. A year earlier they had discovered that the LIBOR rates were being manipulated and this investigation has now been widened. LIBOR sets the actual interest rate that banks charge each other. Since mortgages, student loans, financial derivatives, and other financial products often rely on Libor as a reference rate, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide. At the time LIBOR was though to be the biggest financial scam ever. Two big banks have been fined for this including the Swiss bank UBS which was fined a record $1.5billion in Dec, 2012. Interest rates swaps are a gigantic market. Would you believe this figure, or even be able to imagine how big it is? It is $379 trillion in June 2012 (Bank of International Settlements website accessed May 1, 2103). The size of the global economy is $70 trillion, so it is more than five times this. The risk manager of the Co-operative Bank told me when I visited him in early 2012 that they were involved in interest rate swaps because it was safe and it saved them money. The Financial Manager of Kapiti Coast District Council told me they had made money from interest rate swaps and had no plans to drop the practice. So this leaves us with the possibility of putting your money with a credit union. Unfortunately all credit unions must use a bank for their overnight transfers, so that one is a dud too. There is one other possibility. When I rang the Reserve Bank some time ago about which banks were involved with Open Bank Resolution (where the customers bail out a distressed bank and which will be in place by July 1 this year) I was told there are two small Indian banks which were too small to be involved in the scheme. So there are the facts. The choice is now yours. I am sticking with the Co-operative Bank and TSB.

Haircut anyone? Saver bailout is coming to New Zealand

images-1 On 1 February when I received a letter from the Minister of Finance on the matter of the Chicago Plan Revisited I learnt that New Zealand banks were working quietly behind the scenes with the Reserve Bank of New Zealand on a depositor bailout scheme probably unique in the world. ‘Open Bank Resolution’ was its bland and harmless name and it had apparently been discussed during 2011 when public submissions had been invited.  Registered banks with $1 billion or more in assets were required to work with the Reserve Bank to put their IT systems in place by 30 June, 2013. If a bank was in distress, accounts would be frozen overnight, while liquidators decided how much of a ‘haircut’ to give the accounts before releasing them the next day. Yet we had seen nothing in the news media. Nothing. Suddenly we woke up to the fact that as depositors we were to bail out a failing bank. At the height of the 2008 Global Financial Crisis, the New Zealand government guaranteed all bank deposits and this scheme stopped at the end of 2011. But during 2009 many South Canterbury Finance investors greatly benefitted from it. Their finance company, into which investors had poured money after the government guarantee, had gone belly up and the taxpayer coughed up to the tune of $1 billion. This experience turned the government against guaranteeing bank deposits. They didn’t want private deposit insurance either, arguing it was a cost to investors. So the Reserve Bank of New Zealand set about inventing a new scheme (or rather revisiting one they started formulating a few years earlier), but when they finally told the public about OBR in November 2012, their one media statement sank without trace. Perhaps they naïvely believed mum and dad bank customers would read their website, on which they now have plenty of information on Open Bank Resolution. Banks, naturally, didn’t tell their customers. On 8 February therefore the New Economics Party launched a petition.  We decided it was best to ask for a Parliamentary Enquiry into the best methods of making banks stable. We added that New Zealand could consider The Chicago Plan Revisited. We said we didn’t want either taxpayer bailout or customer bailout of a failing bank. We believe banks should be stable in the first place. Such radical monetary reform  has to be done internationally and simultaneously. Those who have collected petition signatures have found it relatively easy. In promoting this petition we cooperated with members of the Green Party, the Awareness Party, Positive Money NZ, the Democrats for Social Credit, The Maori Party and the Mana Party. We created a Facebook page at http://tinyurl.com/ab9qc7w and started an online petition. For five weeks it was an uphill battle to get any publicity. imagesBut on the weekend of March 16-17 the Cyprus news broke.  Suddenly depositor bailout of banks was in the news. Over the next two weeks I was completely obsessed with the daily dramas in Cyprus and Brussels, I tweeted relentlessly to inform my twitter friends that depositor bailout was also planned for New Zealand. Our Facebook page became very useful to share news. It is wonderful how networks work. When the newsletter editor of our local Transition Town group put our information about Open Bank Resolution in their publication, a friend rang me for more information. She then penned an excellent letter to the Dominion Post, which was published as the top letter on March 18.  The following day the Dominion Post published a comprehensive article on Open Bank Resolution, and more facts emerged. The New Zealand Herald and the Press followed, then radio and TV. On March 19, the Greens, who had a policy opposing Open Bank Resolution sitting quietly on their books, called for the Government to drop their Cyprus style solution. Saver bailout became the focus of a series of questions in Parliament from Russell Norman, leader of the Greens, where it emerged that the Government was fully behind the scheme and didn’t want a bar of taxpayer bailout or government guarantees. The Minister standing in for the Minister of Finance that day described OBR as “a brilliant policy.” He emphasised it would be a one off haircut overnight, enabling the bank to open the next day. The depositors in the troubled bank would then have the rest of their money Government guaranteed. The Minister couldn’t be pinned down on what percentage would be confiscated. The Greens also came out in favour of Government guarantees. The Labour Party, who often follow the lead of the Greens, said they would guarantee the first $30,000. They said if it was good enough for overseas lenders of covered bonds to be protected it was good enough for NZ households too. NZ First reiterated their long held interesting policy they would only guarantee deposits in New Zealand owned banks. In answer to my letters, I am told the TSB and the Co-operative Bank have no covered bonds or other protected assets. Kiwbank, however is getting in to both covered bonds and mortgage backed securities (RMBS). The letter said “In addition to the covered bond assets Kiwibank has transferred approximately $600m into a RMBS programme.“ The small credit union sector won’t be required to comply. Academics have not been inactive in this matter. Geoff Bertram and David Tripe wrote an article in the November 2012 edition of Policy Quarterly journal of Victoria University’s Institute for Governance and Policy studies (http://bit.ly.10c3750) shows how secured creditors are gaining more protection for themselves should a bank collapse. Among these are holders of Covered Bonds, now legal in New Zealand and used by the four major banks. These bonds are ring fenced high quality housing loans. New Zealand's big four banks have borrowed more than NZ$11 billion through covered bond issues, mainly to overseas institutional investors, since BNZ became the first to do so in 2010. Even the publicly owned bank Kiwibank is now getting into them, with the selling of their first covered bonds on March 25.  Interest.co.nz reports “Kiwibank has turned to Switzerland for its first covered bond issue, borrowing 150 million Swiss francs (about NZ$188 million). Covered bonds were made legal in 2012." Gareth Vaughan of the same website wrote an excellent article (Mar 25, 2012) on what it means for your mortgage. Tripe and Bertram list five other types of assets which would not be available to bank liquidators. These include loans sold back to the parent bank, residential mortgage backed securities sold to third parties, repos, assets pledged as collateral for derivatives, other derivatives and intangible assets not available to liquidators.  Their calculation for a typical bank is that after allowing for secured depositors, approximately only  58% of deposits could still be available to liquidators. Such an alarming figure indicates the study needs repeating. Whatever the figure for the actual bank in distress, it means unsecured creditors bear a large share of the losses. There is something else the Reserve Bank appears to have overlooked. Business commentator Rod Oram has pointed out that, after a bank had been liquidated and deposits government guaranteed, bank customers from other banks would transfer to the bank where their deposit was safe. The Reserve Bank tells us there is no need for legislation to authorise Open Bank Resolution. But is it legal? Apparently when you deposit money in a bank you forfeit ownership of money and gain ownership of a claim against the bank – a claim for instant repayment of money but a claim nonetheless. Here is a quote from a House of Lords decision Foley v Hill (1848). The money paid into the banker's, is money known by the principal to be placed there for the purpose of being under the control of the banker; it is then the banker's money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal, according to the custom of bankers in some places, or the principal and a small rate of interest, according to the custom of bankers in other places. The money placed in the custody of a banker is, to all *1006 intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal, but he is of course answerable for the amount, because he has contracted, having received that money, to repay to the [37] principal, when demanded, a sum equivalent to that paid into his hands. Sue Hamill of Positive Money NZ asked the Reserve Bank if this decision is the common law in New Zealand who confirmed that the common law she had quoted was still standing. The email (27/3/2013) from Sonia Speedy of RBNZ said "Our legal advice is that the case you mention is part of the common law in New Zealand. In essence it confirms that a bank/customer relationship, in respect of a deposit, is a contractual one of debtor/creditor. In that sense the bank is liable to repay the customer the sum of the deposit. The case confirms there is no fiduciary relationship between the two parties. It also confirms the customer/creditor has no right to challenge the use put by the bank to the money deposited with it." UnknownBecause New Zealanders are dependent on the four big Australian owned banks, ASB, ANZ, Westpac and BNZ, I thought it interesting to investigate their ownership and their directors. (The ASB is owned by Commonwealth Bank and the BNZ is owned by NAB). It seems in each case four of their major shareholders are HSBC, JP Morgan, NAB Holdings and Citigroup. Their directors come from banking, real estate, infrastructure, contractors, building, aluminium, communication, computing, investment, asset management, gambling, alcohol, aviation, food and beverages, fossil fuels, mills, clothing and mining. Their lawyer directors are in the field of tax, litigation or mergers and acquisition.  And they have their fair share of academics and former government regulators and Central Bankers. One can’t help but get the feeling that the interconnectedness of all this is overwhelming.  If banks go down, the pension funds of the world go down and so does the economy. But how likely is it that a bank will fail in New Zealand? Financial adviser Chris Lee has told a friend who asked, “In my opinion a major bank wipeout would rank in likelihood with global nuclear war – possible but hopefully unlikely. The chance of one lesser bank failing is more realistic.” (3 April private email) But according to an IMF working paper[1] on the vulnerability of NZ banks (Jan 2013), the big four banks have 90% of the bank assets in New Zealand and together their assets amount to 160% of our GDP.  “The banks’ large exposure to highly indebted household and sizeable short term offshore borrowing are key vulnerabilities.” The big four account for 95% of the residential mortgage market. A rise in mortgage rates together with an increase in unemployment could lead to an increase in nonperforming loans. A large fall in commodity prices would impair the quality of agricultural loans. It says our house prices are 10-20% too high. Since that paper the Auckland house prices have risen again. The big four are all making healthy profits. In November it was announced that the BNZ, ANZ/National, Westpac and ASB had made a combined $3.4 billion profit after tax in New Zealand, up an average of 20 percent on 2011. This is an average of $772 profit for every person in New Zealand, with a large chunk of it heading across the Tasman. So New Zealand is an interesting case. As at the end of 2012 there were total deposits of $115.2 billion in our banks.  Will a crisis in one of our banks test out the political viability of our Open Bank Resolution proposal as did the first Cyprus/Brussels solution? Will our small depositors have their savings confiscated? We watch of course the unfolding drama in Europe and see whether the Cyprus solution is going to be a blueprint for other countries in crisis. Those who have the stomach for it might be at this moment monitoring Slovenia. Or Greece, or Spain, or France or Lichtenstein.  Obviously each country is different. The banks operating in New Zealand are part of a larger global system. While their capital adequacy is high at 13 percent in 2012 and the big four have proved resilient in the past, speeches and articles from our Reserve Bank indicate there is no certainty. They even point out that few foresaw the Global Financial Crisis  either and we are in new territory nowadays. According to IMF data, there were 145 banking crises, 208 monetary crashes and 72 sovereign debt crises between 1970 and 2010. This represents a total of 425 systemic crises, an average of more than 10 countries getting into trouble every year. This was even before the Global Financial Crisis and illustrates the fragility and structural flaws of the banking system. Time for 100% backing for deposits, as the Chicago Plan Revisited explains. We will have to watch our house prices, and dairy and meat prices. The IMF paper says, “A hard landing in China, and thus Australia, would consequently reduce demand for New Zealand exports, worsen terms of trade and could trigger a sudden decline in house prices.” So my concerns about Open Bank Resolution are:
  1. While it is fine to argue that it is preferable to a bank closing after failure and preferable to taxpayer bailout, it frightens bank depositors and is a political lemon. The idea of confiscating the money of small bank depositors has been tested in Cyprus and found wanting.
  2.  The Reserve Bank doesn’t appear to have thought through the situation that would arise when the failed bank becomes the only one to have Government deposit guarantees. More homework boys and girls!
  3. In the case of Westpac, ASB, ANZ and BNZ, depositors will bear the main brunt of the loss, as there are many types of bank assets unavailable to liquidators. This whole field needs more discussion and clarification and bank customers should write to the CEO of their bank to find out who is ahead of them in the event of liquidation.
  4. It could become an election issue in 2014.
  5. The common law on this topic needs to be known and the law needs to be obeyed.
Deirdre Kent, author of Healthy Money Healthy Planet –Developing Sustainability through New Money Systems  

[1] New Zealand Banks’ Vulnerabilities and Capital Adequacy by Byung Kyoon Jang and Mashiko Kataoka. IMF Working paper/13/7. January 2013

You could always change to a Credit Union

Unknown-1Today I phoned the CEO of the NZ Association for Credit Unions, Henry Lynch. I told him that feedback we had had from our members about our petition on Open Bank Resolution had included people who said they banked with a credit union anyway so didn’t have to worry about Open Bank Resolution. It seems there are three big credit unions in New Zealand. Baywide Credit Union based in Hawkes Bay has 15 branches. First Credit Union in Hamilton has 50,000 members and NZCU South covers the South Island. No limit on deposit size. And there are other smaller ones. They are owned by their members and you can go to their AGM etc. They do have mortgages, but only at floating rates. They don’t have credit cards but their debit cards, where you preload your money, uses your own money and is fine for all online payments like Amazon etc. That is a relief for those wanting to change. I also learnt by listening to a Radio Live interview with the CEO of the Co-operative Bank that people don’t have so many problems changing banks these days. The only situation in which they have problems is if they have a fixed rate mortgage and it costs them to break it. Credit Unions in New Zealand are champing under controls which don’t exist in Canada, where almost one in three people bank with a credit union.  Last Sunday the Sunday Star-Times had an article which outlined the various laws and regulations which constrain credit unions or impose unnecessary costs on them. Obviously the New Economics Party would develop policies which address these concerns.  

NZ borrowing to lend to IMF, the latest absurdity

It’s a strange world this world of money. In the melee of the Greek elections and the frantic ramming through of the asset sales legislation came a strange announcement, but it was lost. It wasn’t even reported in the Dominion Post. The Government would be lending $1.26 billion to the IMF’s new bailout fund for the debt-wrecked Eurozone, but it would have to borrow this first. In addition to earlier billions for the stabiility fund, the total cost to NZ would now be over $4 billion, according to Bill English. Ponder on that one! We borrow in order to lend in order to save Europe. Whew. The child in us will ask how money is created in the first place. Can only banks create money? Of course not. We the people can create our own money without the burden of interest. But we stupidly use banks. These days we don’t even use our own banks. So to add insult to injury, when we want to borrow, we go to overseas banks for loans because their rates are cheaper. So let’s get this again. We borrow $1.26 billion at interest and then lend it to the IMF. What? At interest? They don’t say. And they will give it back, the part they don't use apparently. The Minister of Finance says it is our insurance policy. And it is the banks who are in trouble.  So we pay interest to the overseas banks so we can protect them from future bad debts. This is Alice in Blunderland stuff.  Where is the cartoonist? Reuters has just reported “Ireland's High Court began hearing a challenge to the European Union's new bailout fund on Tuesday, launched by a politician who said the European Stability Mechanism (ESM) was not compatible with the Irish constitution.” The Guardian reports: “This, for certain, is a high stakes game. Part of Europe's fighting fund has already been spent on bailing out Greece, Portugal and Ireland. Spain has also pledged funds to the EFSF and ESM, and these clearly cannot be spent buying up the country's own debt…. If the gamble fails, Spain will still need a bailout and Europe will have nothing left in the kitty for Italy.” So let's go back to the Pre-election Fiscal Update and see what it assumed about Europe. I seem to remember ...yes here it is: The PREFU's main forecasts critically assume the reasonably orderly resolution of sovereign debt problems in the euro area. Wow they were so wrong. And these our best economists and financial experts? An ordinary person listening to the news can do better. They could see that if you are solving debt by lending ever more money to a country, the problem won't be solved. And here is another thought. If Greece is too big to fail, and Spain is too big to fail and Europe is too big to fail, then it is going to apply to UK, US and China too.  Who knows where it will stop? The size of the global economy is about $63 trillion. According to Bernard Lietaer et al in Money and Sustainability, the Missing Link, "one day's currency speculation represents more than the annual economic output of Germany or China changing hands. The notional amount of currency derivatives are now more than $700 trillion today. Currency derivatives by themselves represent therefore almost nine times the entire global annual GDP". And that is only one type of derivative. No, the IMF's bailout fund is going to fail and it must fail because it can never match the power of the investment banks.    

Land and Money, the Conjoined Twins

Land and Money, the Conjoined Twins

When there are two separate movements each claiming that they have the solutions to the world’s economic problems, we have an intellectual challenge. Rational beings might conclude each group of reformers has a key part of the truth. The two groups I refer to are the monetary reform movement and the Georgist movement.

The monetary reformers come in several varieties, but in common they believe the creation of money should be without interest and should be a public function. Privatising the right to create and control our means of exchange is the ultimate privatisation. The list of evils resulting from creating money as a monoculture with interest is long: it forces compulsory growth, concentrates wealth, causes rising debt and instability, and is generally incompatible with life on a finite planet.

So what do Georgists want? Named after Henry George, Georgists want to ensure we all have an equal right to the fruits of the earth. They seek economic justice. Since we can't all occupy the one spot, land value taxation is the means by which those with exclusive use of the best sites or resources compensate the rest of us (who are excluded). The method of doing that is to tax land. They want to untax labour and enterprise and tax the monopoly use of land. This reduces paperwork and stimulates productivity. Business will boom. A land tax would prevent housing bubbles, arrest suburban sprawl, stop the transfer of wealth from the landless to the landowners, increase everyone’s purchasing power as incomes rise relative to prices, share the bounties of the earth and our accumulated wealth more equitably.

Both arguments seem reasonable. Neither movement is popular with any current political party. Very few have ever heard of Henry George or read John Stuart Mill on land. Politicians have fought the banks since 1694 when the Bank of England was formed and banks were given the right to create the nation’s money supply and charge interest.  While indigenous people have owned land communally and can understand why land should not be monetised and treated like other assets, they are wary because of historical injustices, and are very suspicious of local government when it comes to rating.

Some, like me, find themselves in both camps. And there are some in each movement who vaguely understand the other. Some monetary reformers realise that if interest rates fall, there will be another housing boom and those who own houses will reap an unearned windfall when they eventually sell.  They understand there must be some built-in disincentive against land speculation but when it comes to solutions they only get as far as capital gains tax.  Capital gains tax is limited because its effect is just to prevent property from coming on the market while owners wait for a law change to avoid paying it. To be effective it has to be imposed on all property at 100%. Unfortunately, current proposals by New Zealand political parties appear not to aspire to this ideal. Those in the Georgist movement have seen housing booms and watched banks charge interest on mortgages. They claim the banks are reaping what they call the ‘economic rent,’ an in-house term for the phenomenon where landowners reap the rise in land values over the years. Since these have actually been caused by the efforts of the community around them with the arrival of new businesses, government services and organisations, the windfalls should all be going to people in the form of the government, local and central.

Within the monetary reform movement there are two main camps. There are those (Type A) who believe fervently in central government action to control the banks and create the money supply for the country. These include the American Monetary Institute, Social Credit, and the more recent Positive Money movement.  The second type arises from the complementary currency movement (Type B) who argue that centrally issued national money is still a monoculture, can still cause monetary crises, can still cause inflation, is very disruptive to the economy and is politically impossible to achieve anyway because there are so many bank lobbyists for every legislator.

Let's reflect for a moment on the historical connections between land and money and go back to the Italian goldsmiths. A decree of the year 1423 forbade all Jews of Venice to hold real estate ("pro Dei reverentia et pro utilitate et commodo loco rum"). So they became goldsmiths. People brought in their gold and the goldsmiths issued a receipt for that gold. Soon they found people using the notes for trading weren't coming back for their gold very often. They discovered  a trick: they could issue more receipts than there was gold to back it with. They lent out the notes and charged interest. And we have had that banking system ever since.

Now Jews couldn't lend to Jews at interest, Gentiles were forbidden from lending out money at interest. Christians couldn't lend to anyone with interest because the Christian church banned usury. But Jews could lend to Gentiles at interest. That was essentially their retaliation for not being able to own land. The Rothschild family of course comes from a line of goldsmiths. Leymann Bros, Goldman Sachs and many others join them.

In Fiji Indians can't own land. Indians have now been in Fiji for many generations so they have become the traders. A Fijian dominated military government has been in power for many years. The moral of the story is that unless the earth is shared fairly we cannot hope to have peace or justice. Repeating an earlier sentence, since we can't all occupy the one spot, land value taxation is the means by which those with exclusive use of the best sites or resources compensate the rest of us (who are excluded).

Now let us go back to the type of monetary reform Type B. Unfortunately so far in New Zealand complementary currencies we have known e.g. LETS (Local Exchange and Trading Systems, for trading goods without dollars) and Timebanks (for trading time without dollars) make scarcely a scratch on the national economy. Perhaps Bartercard and other trade exchanges do. If we want to reduce unemployment it is time to upscale complementary currencies by creating a currency at local authority level, together with a range of currencies operating at national level. The argument is that monetary reform of this type will create a permaculture of currencies and the consequence will be a more stable and resilient national economy. Leave the national currency alone meanwhile and introduce a range of complementary currencies until we get enough liquidity to create jobs and restore hope.


If we undertake monetary reform alone with interest rates dropping to zero or below and money being publicly issued, then the extra money in the economy goes towards land speculation and landowners grow rich at the expense of the many. Low interest rates cause excess money to go into property rather than the productive sector. To prevent this happening there needs to be a price on the holding of land. In the tsunami of dollars that hit America during 2001-2006, 40% of homes were either investment homes or second properties. Most of any country’s land is owned by corporates in central cities. But if we carry out the land tax reform alone, the money goes towards banks and the banking industry gets rich.

So both reforms must be undertaken together. Money and land are conjoined twins that can’t be separated. We need a solution which reforms money and puts a price on the ownership and holding of land while simultaneously taking it off income tax, sales and company tax. This is a tall order.

 

A word about the current world situation

Financial analysts like Nicole Foss and economists like Steve Keen now claim we have entered into a long depression where purchasing power will keep declining. Even as prices decline, wages decline further and faster.

 

We have witnessed the largest asset bubble the world has ever seen and the bubble is bursting. House prices have fallen in Ireland and the US and this trend is coming, though unevenly, to Australia and New Zealand. Our house prices are rising in Auckland, Christchurch and Queenstown but dropping elsewhere.

 

In depressions thinkers seek solutions. Henry George, a San Francisco printer, did his thinking during the 1870s depression.  Silvio Gesell, a German businessman in Argentina, did his in the 1880s depression and wrote The Natural Economy. The great economist John Maynard Keynes wrote during the Great Depression of the 1930s. While a long depression will cause unending pain and disruption and may buy us time to mitigate climate change, we do need a lasting solution. This century there is a lot more at stake because global warming is proceeding at an alarming rate and our current political leaders are mindlessly locked into a monetary system requiring growth. Because of peak oil and climate change the so-called ‘developed world’ is challenged to transform in a short time period to a very low carbon economy.  This time we can’t wait and must work together (fortunately with the help of the internet) for solutions.

Three Golden Ages
So let’s have a look at history. To my knowledge there have been at least three periods when there has been both great prosperity and great egalitarianism. In their book New Money for a New Society Bernard Lietaer and Stephen Belgin describe a golden age in Dynastic Egypt for sixteen centuries up to about 30BC. Food was plentiful, there were many holidays and education was common among ordinary housekeepers and servants.  They had a dual currency system with gold and silver being used for long distance trades, as well as a currency linked to the storage of food. Farmers brought ten bags of corn to the warehouse and were given a pottery receipt (an ostraka) with a date on it. When they came in a year’s time to get their corn, they were only given nine bags back. This accounted for the storage and protection against vermin. The longer the food was in storage the higher the cost. So people would not hoard the currency but spend it. Taxes were payable in ostraka and some in kind like wheat. One researcher said, “A landlord would request to have the renter of a farm pay for him the taxes in wheat owed by the landlord to that location, and that amount would be deducted from the renter’s dues.” So there was a dual currency system and a tax system based on a full land rent.

A second economy they described which was both prosperous and stable was in the Central Middle Ages in Europe from 1040 to 1290, “the Age of Cathedrals” when there was a building phenomenon. The general populace ate well, grew tall and only worked six hours a day. Some regions had 170 holidays a year.

 

There were two different types of currencies operating. One was a centralised royal coinage for long distance trading. The second consisted of an extensive network of different local currencies. There was a rather subtle hoarding charge for keeping the currency for too long without spending it. They changed the coins every time a lord died in a process called “renovatio monetae” As a rule four old coins were handed in when a lord died and exchanged for three new ones. As each coin had the same value of the coins they replaced and no one knew when the lord was going to die, it acted as a 25% tax and an incentive to spend or invest the currency quickly. The result was a great deal of building, land improvements, high quality maintenance of water wheels and windmills and enduring investments such as cathedral building. During this period the land would have been owned by a local lord and rented out to families. In other words probably the only tax they paid was on land and it was a full rental.

The third period was very much shorter – in Austria during the Great Depression in Austria from 1932-1933 for fourteen months. While the national taxation system of Austria at that time needs to be researched, the local taxes would probably have only been on the value of land. Faced with 25% unemployment and declining funds, the Mayor of the small town of Wørgl thought he would put Silvio Gesell’s ideas into practice. So he put 20,000 Austrian schillings aside and spent a new currency into existence. They paid their workers in Work Certificates rather than Austrian schillings and on the back were 12 spaces. Every month the holder would need to stick a one penny Austrian stamp on the back to validate the note. This monthly stamp requirement was sufficient to act as an incentive to spend the note or invest it. Back taxes were paid and there was growing council spending on infrastructure like bridges. People came from miles around to witness what they called the “Miracle of Wörgl”. However, soon the banks put enough pressure on the Austrian government to make the whole scheme illegal, and Wörgl went back to unemployment.

Although caution would have to be exercised in describing these three scenarios as idyllic and there undoubtedly have been other periods in history where a measure of prosperity and happiness has been achieved, these three periods all have the following features:

  1. There are two currencies in operation and the local currency has a built–in penalty for hoarding money. It is a spending currency.
  2.  A full rental is paid on land occupied and there are probably very few or no other taxes applied.

The first two eras were before the extraction of fossil fuels, while the second was in a period where there was growing oil and gas use.

Land tax, a political landmine

To invent a similar system these days provides a bigger challenge. When land taxes were an accepted feature of societies with local ‘lords of the land’ there was no income tax, company tax or sales tax. Now we are dependent on those taxes and, apart from a tiny fraction at local level, have no land tax. There may have been excise taxes imposed in Austria but it wouldn’t have significantly affected the outcome. Thus there may have been effectively only one tax operating during the Egyptian period or the Age of Cathedrals. Since all unique economies need an appropriate currency for trading, these societies each designed theirs to be a currency with an incentive to spend or invest rather than hoard.

When the idea of land tax is raised these days, there is often an immediate reaction. “I pay my mortgage on my property, I pay rates and now you want me to pay a third one? No way! The mortgage is paid to the bank, the rates to the council and now you want a tax to central government?” This is a political landmine.

These days in New Zealand we have a situation where land taxes have historically been imposed in some form at local authority level through the rating system. Local authorities used to gather in 12% of the country’s tax revenue, but now this has dropped to around 6%. At national level land taxes reached a peak of 9% of tax revenue in 1919 but these stopped in 1962. A law prohibiting land tax came into force in 1992.

The two world wars, together with a worldwide trend towards income tax, saw a great change in the tax systems. Income tax comprised 9% of tax revenue in 1909 but by 1944 it had risen to 54%. The change is probably due to the increasing power of the banks. Banks prefer income tax and hate land taxes. Income tax means banks can lend against the full value and security of land. Land tax means banks would have to lend against the security of people's earnings power - less reliable, especially with the abolition of slavery. 2500 years ago, when borrowers defaulted, they could simply be enslaved. Now we have strong land tenure and weak "person tenure", the land is the security to lend against. (You can get full rights over the tenure of land but you can’t get full rights over the tenure of people). Banks are higher up the "food chain" than governments. So banks get mortgage payments, governments get income tax. Our modern slavery is to the banks.

To impose a land tax and at the same time dramatically lower income tax, company tax and sales tax, would require significant cooperation between local and national government. To seriously propose this sudden change over could be political suicide, and it would cause a huge shock for the economy. A history of the New Zealand tax system certainly doesn’t include such big jumps.

So we are faced with the challenge of not shocking the economy while moving away from taxing labour and enterprise and towards taxing what we hold or take. This includes land, including the land of the family home.

There is another reason why land tax is important. It stops the monetising of the commons (the land) and so halts the expanding of the money supply. It is this expansion of the money supply without expanding the supply of goods and services which causes inflation. Inflation robs from everyone.

We now need to reform a system where local authorities have power to tax the unimproved value of land, but increasingly opt for regressive fixed annual charges and to rate on capital value rather than unimproved value. Fixed annual charges are really regressive according to a study done by Internal Affairs in 2007. While all councils have a different mix, in the case of the Auckland supercity they are forced by statute to tax on capital value.

Various people have advocated a land tax including the commentator Bernard Hickey of interest.co.nz, while in an article by economists Andrew Coleman and Arthur Grimes in October 2011 they explore and evaluate land tax as an option. They say a central government tax could be added as an adjunct to the current system with little additional administrative cost. The authors conclude a land tax has favourable efficiency properties relative to other taxes and that a 1% land tax on all non-government land could raise approximately $4.6 billion.

The authors of The Big Kahuna, Gareth Morgan and Susan Guthrie, propose a Comprehensive Capital Tax (CCT). Capital is defined as land, buildings, structure, plant, equipment and intellectual property. There is no exemption for homeowners. Capital that consistently earns less than the required minimum rate (6% in the proposal) would face an increased tax burden. They also tax income at a flat tax on the remainder of earnings (the total earnings less required amount of earnings). The lender (the bank), having an interest in the property, also pays CCT. The authors make an excellent case for a Universal Basic Income. They argue their changes will ensure incentives to use capital productively, to use our housing stock efficiently and redistribute wealth fairly. They spread a wider net. They say they would tax anyone who owns capital in New Zealand, anyone who earns an income in New Zealand and anyone who lives here, thus encompassing any person or any corporate who owns land here or who operates a company here.

A different type of economic growth will result

For forty years since the Values Party started, green politicians have been railing against economic growth. All Budgets have been full of the phrase and many listeners have been  flinching with pain for forty years. That is because what is being advocated by politicians economic growth of the type you get when you use only one currency, the national currency, a monoculture. This sort of economic growth stuffs our houses, shopping malls and landfills with electronic junk, plastic, polystyrene and nylon, clothing made using exploited labour, etc etc.  When we have a land tax together with a scaled up local currency based only on what we can produce locally from the land, the type of economic growth we are going to get is quite different. It is the type we all want – growth in affordability of the basics. This includes labour to produce food from the land, revival of the local textile industry (factories in Levin lie idle as all these jobs were exported to Asia). The house maintenance industry will thrive, the biopaint industry will expand, the insulation industry using natural materials will develop and expand. With an abundant local currency designed to circulate faster than the national currency our house building will move towards using local materials. The prospects become quite exciting as we start to see a future for our semi employed friends and family and all the teenagers and young people without hope. This is a qualitatively different type of economic growth from the one we have known. The type of land tax system I am proposing is one which creates this new type of growth but not the old sick type.

And you say wouldn't we cut down all our trees, burn all our wood for fuel or take all the fish from our waters? Wouldn't we dam all the rivers, mine all our metal or cover our whole area with wind turbines and change our climate? The answer that in some communities this could happen if there isn't enough awareness. Maori eliminated moa, Easter Islanders deforested their land and couldn't build boats and Indian communities burn the dung nutrients that should be returned to the soil. Turning all your trees into charcoal (as in parts of Africa) is a disaster on many fronts.

But on the whole most communities would observe and monitor their environment and wise heads will prevent this happening. When we rely on trade for goods made with exploited labour and exploited forests we don't notice the environmental effects because it is too far away. It is someone else's problem. The closer a problem is to home, the more responsibility you will take.

How big should a land tax be?

It is generally understood from Georgists’ knowledge that a full rental on land is around 5% of the value of the land. In 1924 a Royal Commission named this figure as the correct percentage to impose on idle land for speculation. Only a land tax at this level can in anyway hope to replace income and company tax, let alone GST. Only a land tax at this level will discourage property speculation.

Earlier it was mentioned that we already pay mortgages and rates on land and that a third payment would be totally unacceptable. It would be politically impossible to persuade the public. The proposal that follows collapses all the payments into one. The ideas outlined in the next section address three challenges. We need to introduce a land tax without shocking the economy, to introduce a full land rental not a token one ­– and all the while be mindful it must be politically achievable. Land tax is not about adding another tax. It is about paying to the government rather than the bank while keeping the fruits of your own labour. The land levy proposed is payable to the local authority, it keeps banks out of the loop and uses the council income to distribute a local citizens’ dividend, thereby immediately making the system relevant to the wider public and winning their support. It designs a local currency with a built-in circulation incentive. Moreover, it provides considerable hope for a transition to a very low carbon economy in a short time period.