The Great Transformation: Addendum
Karl Polanyi began his famous 1944 treatise, “The Great Transformation”, with the following words:
“Nineteenth-century civilization has collapsed. This book is concerned with the political and economic origins of this event, as well as with the great transformation which it ushered in”. His thesis was “the idea of a self-adjusting market implied a stark utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society”. As we continue to make our way forward in the 21st Century, Polanyi’s words are worth reconsidering. He noted that the success of the Industrial Age was based on four key pillars: a balanced international system, a stable financial system, the self-regulating market and the liberal state. The end of the balanced power system towards the end of the 1800s was the signal that the almost 100 years of near peace, was coming to an end. When the gold standard failed, it was the end. Polanyi notes,
“The true nature of the international system under which we were living was not realized until it failed. Hardly anyone understood the political function of the international monetary system….to liberal economists the gold standard was purely an economic institution; they refused to consider it as part of the social mechanism.”
When we look at the implosion of the current debt based monetary system, it is worth pausing to re-consider Polanyi’s thesis. As Europe considers the all or nothing integration and the US climbs slowly off its knees, the social importance of a stable and high functioning monetary system is slowly being recognised. This has been seen in the amazing efforts of global policymakers to try and fix the banking system, mainly by flooding it with new liquidity. Whilst this policy shift has seen a stabilisation of the system, serious structural problems remain. Many of those problems have been noted but little, so far, has been done to deal with them. At the same time, austerity, the normal medicine, is no longer regarded as a economic panacea, with both the social and economic impacts hitting hard.
But out of the chaos has come a shift in focus. Initially the response to the GFC was to protect the banks, to bail them out and, in repairing their balance sheets, to use them as a conduit for recovery in the general economy. Unfortunately, that plan didn’t work, for the simple reason that trying to get people to borrow, when they are trying to pay down debt at the same time, is simply unworkable. Still, the money flowed in and continues to do so with QE2Infinity, and continues to boost equity markets as bonds start to lose their shine. However, in the last 12 months there has been a gentle stirring amongst policymakers and researchers and a new focus on the process of money creation and how banking works and impacts the real economy. If anything, the GFC can be seen as a crisis of finance itself and this has finally brought the spotlight and interest into a somewhat arcane area, normally populated by monetary reformers.
One paper to catch people’s attention is “The Chicago Plan Revisited”, an IMF working paper by Jaromir Benes and Michael Kumhof. Interestingly, Jaromir was at the RBNZ from 2006-2008 as a research advisor, so I presume they will have read it. It’s an excellent paper and explores themes familiar to anyone who has been reading this blog over the last 5 years. To those new to the subject, it’s a very useful read as to how the banking system is currently structured. Benes and Kumhof investigate the way in which banking works currently and the proposal of Irving Fisher’s 1936 Chicago Plan, which called for a separated monetary and credit function. Again, readers familiar with the research of my colleague, Lowell Manning, will know he has done extensive work on Fisher’s Equation of Exchange and so it’s heartening to see a new look at Irving’s work.
Their conclusions were fourfold and supported the claims made back in the original plan that separation money creation and credit provision would:
1) Lead to much better control of the business cycle by providing a more stable monetary platform.
2) Eliminate bank runs.
3) Dramatically reduce net public debt.
4) Dramatically reduce private debt, as money creation no longer requires simultaneous debt creation.
This is quite a major shift in thinking within the hallowed halls of the IMF (it should be noted that this is not official IMF policy) and signals a recognition that those of us who have been talking about this issue for many years have finally been heard. It has even made the mainstream media and has even provoked some interesting commentary on banking and financial modeling at the Economist. The most important realisation from this research is that the business cycle is completely in the hands of the banks. Put simply, the banks are in charge of the economy. This will surprise many people, including many bankers, but will now allow us to have a proper debate as to what constitute a stable, efficient and equitable monetary system. The understanding that finance has such an enormous social, as well as economic, impact (and of course environmental) will hopefully see this shift transform into major systemic change. It is a long way from where we are now to a full 100% reserve backed system but it is possible that we can take incremental steps along the road.
Here is a video with Michael Kumhof explaining the Chicago Plan Revisited