An Analysis of Debt-free Money System

for a Steady State Economy

Koay Chia Chia

(201091162)

University of Leeds
School of Earth and Environment

May 2017
1 Introduction

This paper discusses the analysis of the debt-free money system for a steady-state
economy. Within this paper, I explain the details of debt-free money system,
discuss the relationship between debt-free money and steady-state economy,
discuss the obstacles to implementing this proposal, and look at the examples of
implementing debt-free money system.

In the UK, 97% of money in circulation is created by private banks in the form
of loans, while 3% of debt-free money is created by the Bank of England and the
Royal Mint in the form of notes and coins (Robertson and Bunzl, 2003). To make
changes to current situation, private bank must not issue money from depositors
as loans. In other words, full-reserve banking system (100% reserve requirement)
has to be implemented to prevent private banks create new money and make the
money debt-free (Dietz and O'Neill, 2013).

Full-reserve banking is an alternative to fractional reserve banking, which means

banks are required to keep 100 percent of the funds deposited in cash by
customers and have full coverage of money they lend. Funds deposited would be
ready for withdrawal and would not be loaned out by the bank to create new
money (Wikipedia, 2017). There are other proposals of full-reserve banking. For
example, the Chicago plan (Benes and Kumhof, 2012), Narrow Banking plan
(Kay, 2009), and Limited Purpose Banking plan (Kotlikoff, 2010) etc. These
proposals have the same point that banks will not be able to create money through
debt. The differences are the ways banks are allowed to operate to control money
supply level (Dow, Johnsen and Montagnoli, 2015).

2.1 Details of debt-free money system

The debt-free money system has three features.

Firstly, central bank controls the issue of money. The right to create money is
limited to central bank (Zarlenga, 2002; Zarlenga, 2009). The central bank
decides the amount of money to be issued (Dietz and O'Neill, 2013). There are
several ways to control money supply and hence inflation. For example, taxes
applied when prices rise and government spending applied when prices fall (Dietz
and O'Neill, 2013). Moreover, the quantity of money produced can be limited by
the production of gold or commodity money (Yamaguchi, 2017).

Secondly, Prohibition of credit created by private banks. The current fractional-

reserve banking system is that banks are required to hold a small portion of
deposits and the remaining is loaned out (Zarlenga, 2002; Zarlenga, 2009). Under
debt-free money system, fractional-reserve banking is revoked. Reserve is raised
to 100 percent (Yamaguchi, 2017). Banks do not need to pay interests for the
deposits but get paid a fee for saving service, unless customer chooses to invest
their money to earn interest (Dietz and O'Neill, 2013). The American Monetary
Act suggests to the private banks to act as intermediaries between depositors and
borrowers but they are no longer able to create any money supply (Zarlenga,
2009).

Thirdly, constant inflow of money to stabilize economy (Zarlenga, 2002;

Zarlenga, 2009). Central bank can issue and distribute money into circulation in
priority to infrastructures, education, and environment. Moreover, the central
bank can make loans to private banks for the interest and welfare of public
(Yamaguchi, 2017). This concept does not cause the money created out of thin
air as central bank is the only authorized institution to issue money (Dietz and
O'Neill, 2013).

2.2 Relationship between debt-free money system and steady-state economy

(SSE)

SSE is defined by Herman Daly as an economy with constant population and

constant stock of capital, maintained by a low rate of throughput that is within
the regenerative and assimilative capacities of the ecosystem (Victor, 2009).

Debt-free money system can help to achieve steady-state economy in several

ways. Firstly, the debt-free money system can control inflation more effectively
by applying taxes and government spending (Pilote, 2016). Moreover, the central
bank would not have to fall into debt and even pay interest on the debt (Fontana
and Sawyer, 2015). In turn, the money created as loans by private banks causes
inflation, especially when the money created is not parallel to the country
production causes prices of goods increase (Pilote, 2016).

Secondly, the bookkeeping would be simplified. The money can be brought back
to its proper function under debt-free money system as only the central bank
creates money. The money would reflect the exact value of products, making a
simple bookkeeping (Pilote, 2016). New money is issued when new products are
made, money would be withdrawn when products are consumed (Even, 2016).
The value of money would not exceed the value of products to prohibit inflation
and hence achieve steady-state economy (Pilote, 2016).

Thirdly, there would be no more financial problems. Since the government issues
money according to the society’s needs, the money would be able to pay all
products in the country. In other words, all that is physically feasible would be
financially possible (Pilote, 2016). In turn, under the present system, money
would be eliminated when debts were paid off which will cause depression (Pilote,
2016).

2.3 Obstacles to implementing debt-free money system

There are a number of concerns when implementing debt-free money system.

Firstly, the debt-free money may be a misnomer (Dixhoorn, 2013). The central
bank is authorized to issue money but it accepts back these money as exchange
of bonds and bills or taxes payment (Fontana and Sawyer, 2015). Bonds and bills
are like debts in the market. It would be complicated if bonds and bills are to be
distinguished in the market. Hence, with the existence of bonds and bills, the
central bank is accepting money in the form of its own debt. The bookkeeping
would be complicated to record these transactions (Fontana and Sawyer, 2015).

Second, the availability of credit will be limited. Since the private banks are not
allowed to create loans, when the loan’s demand exceeds supply in market, the
central bank would extend loans directly to the public or through banks (Dixhoorn,
2013). In other words, when the money supply exceeds country’s production, it
would become additional money and central bank is forced to provide reserves
for public or banks to avoid credit crunch (Dixhoorn, 2013). Additionally,
unregulated high-yield debt issuers may take over the bank’s role as debt issuers
in the market (Wikipedia, 2017), hence destabilizing economy and causing
financial crises.

Thirdly, with 100 percent reserve requirement, the money is not invested, hence
no return can be obtained by depositors. If there is inflation, depositors are
exposing risk of losing money. However, there would not be a problem if there
is no inflation (Dixhoorn, 2013).

2.4 Examples

The debt-free money system can be found in the Positive Money and the New
Economics Foundation (NEF) Reform Proposal (Jackson and Dyson, 2012). In
reality, the closest example of the implementation of debt-free money system is
by Guernsey, an island in the English Channel off the coast of Normandy. In
Guernsey, the government issues their own currency for nearly 200 years. The
government issues money when it needs to pay for a work. It is not simply created
by loans. The government calculate the money supply transparently and watch
inflation closely. The calculation is open to public on their website (Guernsey,
2017).

Other close examples like Switzerland is holding a referendum to consider full-

reserve banking system. The Federal Chancellery of Switzerland had received
110.955 valid signatures on a petition to end fractional reserve banking on 24
December 2015. The effort is named as the Vollgeld, or Full Money Initiative
(Voss, 2016). This example is more close to the Chicago Plan Revisited as this
proposal is mainly discussing full-reserve banking. However, it contains element
of debt-free money system which credit created by bank is prohibited. It is a good
start for Switzerland steps forward to achieve steady-state economy.

3 Conclusion

The starting point of this study is that the idea of continuing economic growth
would no longer sustainable and desirable as it fails to improve people’s quality
of life. Hence, the idea of steady-state economy emerged (mostly in wealthy
countries) which proposes three features: constant stocks, constant flows and
sustainable scale (O’Neill, 2012). There are different ways to achieve a steady-
state economy. For example, limit resource use, reduce inequality, full-reserve
banking, and new progress indicators etc. This paper aims to analyze the debt-
free money system, which is one of the proposals of full-reserve banking, discuss
how this system helps to achieve a steady-state economy, state the obstacles or
concerns when implementing this system and show real-life examples.

The debt-free money system has three main features: money issued only by
central bank, prohibition of loans created by banks (which means 100% reserve
requirement) and constant inflow of money (section 2.1). This system is proposed
as it would help to achieve a steady-state economy which mainly controls
inflation and financial problems section 2.2). However, we have to concern about
what is meant by debt-free money when money itself is a debt which I have stated
in section 2.3. Lastly, the closest example to the debt-free money system I found
is the Guernsey banking system (section 2.4).
(1499 words)
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