The End of Credit as We Know It?

August 19th, 2012
in Op Ed, syndication

Written by Bradley G. Lewis


money-bagSMALLJaromir Benes and Michael Kumhof have an IMF (International Monetary Fund) working paper "The Chicago Plan Revisited" which analyzes a plan for banking that was under discussion in one form or another from the time that it was proposed by Henry Simons in the early years of the Great Depression and strongly supported by Irving Fisher (1936), until the modern monetary school at the University of Chicago became largely aligned with Milton Friedman in the latter years of the twentieth century.

Follow up:

The essence of the "old" Chicago Plan is summarized in the Introduction of Benes and Kumhof which contains this:

The key feature of this plan was that it called for the separation of the monetary and credit functions of the banking system, first by requiring 100% backing of deposits by government-issued money, and second by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks.

The conclusions Fisher paper in 1936 are summarized by Benes and Kumhof as follows:

Fisher (1936) claimed four major advantages for this plan. First, preventing banks from creating their own funds during credit booms, and then destroying these funds during subsequent contractions, would allow for a much better control of credit cycles, which were perceived to be the major source of business cycle fluctuations. Second, 100% reserve backing would completely eliminate bank runs. Third, allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances and to a dramatic reduction of (net) government debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt. Fourth, given that money creation would no longer require the simultaneous creation of mostly private debts on bank balance sheets, the economy could see a dramatic reduction not only of government debt but also of private debt levels.

Benes and Kumhof state that the assertions of Fisher are "self-evident" and that the "old" Chicago plan "represents a highly desirable policy."  That is the starting point for this essay.

150 Years of History

The theory is coherent and, in one sense, we had it with the national banking system starting with the National Bank Act of 1863 (and subsequent amendments): national banks could issue bank notes to the extent that they bought, and held as 100% collateral, government bonds. It's worth remembering the outcome of that. The national banks had relatively high capital requirements and, of course, were helping finance the Civil War effort. Part of the Act also taxed state bank notes (banknotes were issued by individual state banks), hoping to knock the state banks out of existence.

The state banks instead switched to getting their funds for their banking by acquiring deposits and creating checking accounts. Lots of places were not served by the national banks; the states imposed lower capital requirements and less stringent other conditions on the banks they chartered and served those places. A regulatory war ensued on two fronts. First, the national and state systems both began to competitively lower their requirements. Second, a coalition of "unit bankers" (states like Illinois allowed only one location for a bank, the better to ensure that there would not be multiple-location banks in Chicago that would eat the downstaters' lunch), and other local interests, got the state governments to do things their way - and when necessary carried their clout to the national level. There's an excellent article and comment in the Journal of Economic History quite a few years back on this process. I've given the citations below.

We ended up with large numbers of unit banks or banks in small networks that had a very difficult time diversifying and, in the absence of deposit insurance, were quite vulnerable.

This history should remind us of the difficulties of setting up a perfectly integrated system that will be unaffected by money politics.

Growth Without Credit?

On a quick look through, beyond the problem of money politics, I have several concerns. The most obvious one is that I think the authors underestimate the extent to which our policymakers will be on the horns of a dilemma with respect to private credit:
  • We had a revolution in consumer credit that made it possible for the average person to buy a house and durable goods on time that I think had a lot to do with middle-class affluence. It would appear that the methods to be used to make the system safe might well roll back that entire movement. There is some soothing commentary on how the features of the system the authors propose would allow inter temporal smoothing, but I frankly doubt they've really done much here except ensure that a lot of ordinary people will have much less access to credit, even if they have good jobs. Could General Motors Acceptance Corporation have done business under the rules given here? (They borrowed cheaply in the commercial paper market and lent to customers and helped revolutionize the industry.) I'm skeptical.

  • Of course, we could have the government supply all the credit, or arrange to guarantee it, and of course, we did have the Federal Home Loan Bank Board, the Federal land Bank and other institutions to ensure that there was lots of mortgage money; low-cost loans for rural electrification when the private sector found it inadequately profitable to string lines to farms; government provision of water and power at subsidized rates, especially in the West and South; and other programs that arguably had a lot to do with middle class affluence.
But many of the same people who may love this idea because it promises to reduce the national debt are the same ones that find any government "interference" in the markets a problem.


White, Eugene Nelson. “The Political Economy of Banking Regulation, 1864-1933.” Journal of Economic History 42, no. 1 (March 1982): 33-40.

Keehn, Richard H. “The Political Economy of Banking Regulation, 1864-1933: Discussion.” Journal of Economic History 42, no. 1 (March 1982): 41-42.


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About the Author

Brad Lewis is Professor of Economics at Union College in Schenectady, NY, where he teaches courses in financial markets and institutions, international trade and finance, monetary economics, and urban redevelopment. He has also held senior-level visiting positions for a term or more at Carleton College and Skidmore College in the United States and at Kansai Gaidai University in Japan. He is a long-time member of and has occasionally co-chaired the Columbia University Seminar in Economic History and is Vice Chair of the Schenectady (N.Y.) Metroplex Development Authority.
Curriculum Vitae.

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  1. Derryl Hermanutz says :

    I am very happy to see informed, intelligent, up to date monetary understanding working its way up the policy food chain. While the IMF is not exactly "advocating" the Kumhof/Benes version of the Chicago Plan, the IMF imprimatur on their Working Paper nevertheless lends credibility and gravitas to their updated version of Fisher's 100% Money proposal.

    Brad Lewis worries that middle class affluence would regress with the reduction of mortgage lending under the Chicago Plan, but I think as long as we get the fundamental monetary reform accomplished--adding non-debt government issued money into our economies--we can address problems in the new system as they arise later.

    Rodger Malcolm Mitchell asserts that, "Reducing government debt and private debt would destroy the economy.", which is true if you are committed to an MMT debt-money paradigm as Rodger is: one person's or sector's debt is the other person's or sector's "money", so if you eliminate all debt you eliminate all money. But the Fisher-cum-Friedman-cum-Kumhof/Benes program replaces privately created debt money with publicly created non-debt money which Kumhof/Benes characterize as "equity in the commonwealth". This replacement of debt money with equity money eliminates the "infinite debt" problem that Michael Hudson and Steve Keen, among others, have explained is the arithmetically inevitable consequence of maintaining your national money supply as debt paying compound interest. Any scenario that grows at a rate over time is an "exponential function", which follows the familiar sine curve that very soon arrives at its vertical phase where billions become trillions become quadrillions, like the penny a day doubling every day becomes 10s of millions after 30 days.

    Debt money can't work, because a debt money system is zero sum in the best case and becomes negative sum as soon as your nation net imports or as soon as any income earner saves a nickel of his earning or as soon as some banker charges as interest debt an amount greater than the amount of loan principal that he created as money. We need a positive sum money system to accommodate our economy's need for monetary "profits" and to accommodate people's desire to save their income money rather than spend it. The Chicago Plan is one way of achieving this salvatory goal.

  2. roger erickson says :

    Now I'm confused. There seem to be two separate issues being discussed here.

    1) paying interest - to someone other than the state - as the price of creating currency. Yet insiders who study our post-1933 fiat system say that the Treasury sells T-bonds to PD-banks the old way, but then the Fed buys them back in order to stabilize interest rates (and returns the interest profit to the Treasury). Hence, it's a sham way of not paying interest on currency creation.

    2) Agility in matching currency supply to public initiative. This is what a fully fiat currency system is for. If we require all credit decisions to wait on accumulation of full-reserve accumulation .... we only create more bureaucracy that is constantly trying to make dynamically changing valuations wait for static-value reserve balances. That just alters the game for entrepreneurs, but doesn't change the net game of business, where rapidly betting on emerging value based on insufficient data is the whole point of a community numbers game.
    What's the difference? 100% fiat reserves only seems like a more cumbersome way of doing the same thing. Instead of better/faster/cheaper, it's only cheaper - and even then, only on paper! :)

  3. roger erickson says :

    A community or whole market "lives" by constantly trading patterns of old stuff for different patterns of new stuff, whether the "stuff" is products or services.

    Values are therefore inherently dynamic. Old stuff is traded based on the expectation it is depreciating, directly or by association. New stuff is acquired based on the expectation that it is part of a net appreciating repertoire or culture.

    Given the dynamic nature of value, what's the point of being overly anal about static reserves? The decision to have turnover in products & services is itself a dynamic process. Therefore, delays in accurately meeting static-value requirements prior to executing dynamic decisions strikes me as somewhat of a maladaptive concept. The time lost if meeting static reserves constrains acceleration of dynamic value decisions. That's unproductive when the kinetics of decision-making is itself a dominant value.

    Instead of worrying about static-value reserves prior to dynamic-value decisions, why aren't we defining the equivalent dynamic "reserve," as the knowledge prepared & speed of distributed feedback that allows a dynamic-value decision to be made better/sooner/cheaper?

    For some reason, this whole concept makes me think of the Heisenberg Uncertainty Principle. In a dynamic world of infinite repercussions to any decision, the more succinctly we try to titrate static-value reserves the more we constrain the dynamic-value consequences. Like all things, surfing a static waveform between dynamic contexts involves tolerance limits, not absolutes. The whole point is to surf the wave, not precisely define either it's instantaneous, static point of momentum, nor it's long preceding/leading tails. We only want to stay near the top of that fleeting wave long enough to jump on to yet another one.

  4. Derryl Hermanutz says :

    You have to understand the motives for advocating a move to publicly issued equity money from our current privately issued debt money, including:

    -to reduce the severity of the boom-bust cycles created by our current debt-money system, where banker sentiment acts as a procyclical pendulum creating then uncreating credit money. The corporate bankers ARE a "bureaucracy" who are presently controlling our money supply. The public money initiative seeks to reintroduce a public component to the regulation of changes in the money supply. Humans are going to be making these decisions. There is nothing natural or automatic about money. The century from 1913-2012 is the "proof" of how "agile" private money creation is at "matching currency supply to public initiative". What private money has done is corporatized and financialized the world, concentrating wealth and power, and thus the power to dictate which way "humanity" will respond to every exigency, in the hands of a few thousand massively interconnected global corporatists who share the single value and objective of increasing and maintaining their personal and collective power. So Roger, either you believe that this direction of increasingly concentrated ownership and operation of the world is "good" and you want to see it amplify even more; or you have to acknowledge that private money creation has amply demonstrated its malefic colors by its century of dysfunctional history. You can "imagine" benevolently agile private money all you like. I have the 20th century of world history backing my opposing perspective, that private money is only benevolent to plutocrats and is detrimental to everybody else. What do you have, aside from counterfactual theory, supporting your faith in private money?

    -to free humanity from limitless debt to the bankers who create all our money as loans of bank deposits. If you don't see this as a problem, then you don't see that the status quo money system is the CAUSE of our current economic, political and social plights, and that there can be no viable solutions to our current ails without reforming the system. Kumhof/Benes offer a reform proposal that would work. Bees and ants all work and die to serve their queen. Humans don't want to work and die to serve our bankers, as our private debt-money system forces us to do. Humanity is not biology. We are not a "colony" or a "hive" or any other kind of homogenous "group". We have "individual" values. We pursue individualist life paths. We don't embrace some communist "group" values and agenda as our own private values and agenda. THERE ARE NO UNIVERSAL "HUMAN" VALUES. Religions and ideologues and reformers and prophets and myopic ego-blinded do-gooders all try to impose "their" values as "universal" values, but these people are always at war with each other because THERE IS NO AGREEMENT. So there can be no universally acknowledged "optimum" human agenda. Publicly issued money can free us from the tyranny of private money debt-peonage and from service to the collectivists/corporatists who increasingly rule us by owning the world that we live in. This is a big deal. It is not trivial. Kumhof/Benes recognize this, and devise their program accordingly.

    Those are 2 of the main motives behind monetary reform.

    If the Fed bought ALL outstanding Treasuries and remitted the interest to the Treasury, then your first point might have some validity. But banks and private wealth hold almost all the Treasuries, and the Fed holds only a small fraction, so interest is paid from taxpayers to private wealth owners. What you and MMT also fail to see is that the public component of bank debt is a small fraction of total debt, most of which is the private component. And nobody is giving the interest money back to private debtors who are paying trillions per year of interest to the bankers who created the money with keystrokes. Americans write off mortgage interest against their taxes, which Michael Hudson explains allows that interest income to flow directly into the pockets of bankers, while forcing the government to borrow from the bankers and tax everybody else to pay for government spending (spare me the wistful delusion that debt and taxes don't "really" fund government spending). Collecting interest on 'loans' of something that you don't actually "have" is nothing more than legalized extortion.

    This is the principal means by which global plutocrats have managed to concentrate the wealth of the world into their own hands: bankers financing monopolists who are able to pay banker interest because they enjoy the monopoly/oligopoly power to fix the prices of the goods they sell. A monopoly of private money creation and global feudalism are of a piece with each other, because the former can lead to no other outcome than the latter. Money is the real government of the world. A government that does not issue its own money is about as "sovereign" as a Grade 8 "shadow government" in social studies class. To exercise any real power you have to pay money (unless you exercise the power personally by your own muscles, but that's vanishingly irrelevant here), and whoever issues the money controls what gets paid for, and thus what gets done in the real world.

    You wrote, Agility in matching currency supply to public initiative. This is what a fully fiat currency system is for. At present this is simply not true. The fiat currency system is for enriching private wealth, not serving public initiative. In the subprime bubble fiat money was created in the trillions by mortgage originators who were motivated by the bonuses they collected for creating more money. "Public initiative"? No, money creation in our current system serves PRIVATE initiative. Once again, Roger, let's remember to keep separate the world as we would like it to be and as we think it should be, as contrasted with the world as it actually is. To get from the current world where a monopoly of private control of fiat money creation serves private interests contrary to public interests, to a "better" world where publicly issued fiat money could actually serve "pubic initiative", requires REVOLUTIONARY REFORM of the current system of private money issuance. MMT wants to skip this "revolution" step and make believe like we have already arrived at public control of money. But we haven't, and this very hard if not impossible monetary reform step remains to be taken before any public good can come of our fiat money system. Kumhof/Benes are advocating monetary reform, acknowledging the reality of where we are at right now. And I support them if for no other reason than that their perspective on reality is not obscured by wishful dreaming.

  5. EconCCX says :

    Derryl, do you have a citation for your point that Keen recognizes the infinite debt problem with debt-based money? I've understood Keen as arguing that overindebtedness derives from a Minsky phenomenon, where profitable borrowing and lending inspires the confidence that leads to imprudent borrowing and lending.

  6. Admin (Member) Email says :

    EconXX - - -

    Derryl may have more to add but I will jump in to suggest that you read Steve Keen's "A Primer on Minsky" ( )

    In the section entitled Endogenous Money, Steve writes (quoting from his 2012 INET paper) my emphasis added:

    If income is to grow, the financial markets, where the various plans to save and invest are reconciled, must generate an aggregate demand that, aside from brief intervals, is ever rising. For real aggregate demand to be increasing, . . . it is necessary that current spending plans, summed over all sectors, be greater than current received income and that some market technique exist by which aggregate spending in excess of aggregate anticipated income can be financed. It follows that over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets.

    Steve has proposed that a logical solution to this problem are debt jubilees (also discussed in the Minsky primer).

    John Lounsbury

  7. EconCCX Email says :

    Thanks, admin. I did take a look. The words you've quoted are Minsky's rather than Keen's. I think they suggest that debt is an engine of economic growth, not that bank debt is an unsustainable form of money.

    But now consider Keen's article "Solving the Paradox of Monetary Profits."

    Keen maintains that those who believe that interest is unpayable in the aggregate are confusing stocks and flows, not recognizing that the capitalist turns working capital over several times over the term of the loan, each providing an opportunity for partial interest payment.

    This allows us to specify the general conditions under which equilibrium monetary profits will exceed zero, given the existence of a physical surplus from production. They are far from onerous: the rate at which the bank transaction account turns over each year has to exceed the rate of interest on loans and the rate at which the workers’ deposit account turns over has to exceed the rate of interest on deposits. Reasonable values for these parameters easily meet these conditions...

    Keen also writes:

    I maintain the practice established in the Free Banking model that money is not destroyed when a loan is repaid, but is instead transferred to the bank’s capital. As noted earlier, I dispute the conventional Post Keynesian belief that money is destroyed when debt is repaid, but –as with issues such as the source of money’s value—that is a peripheral issue to the one I wish to consider in this section.

    Keen couldn't be more wrong about this, by the way. Commmercial bank debt is a form of money entirely distinct from Reserves, i.e. Central Bank Money. Much more is owed than is created, and it vanishes not only on repayment of debt but through, for example, bank fees. These extinguish the bank's liability to the depositor without any corresponding movement of reserves. Thus new money must always be borrowed from the banking system to repay old debt.

    I look forward to seeing what Derryl comes up with.

  8. Admin (Member) Email says :

    EconCCX - - -

    Sorry I didn't "sign" my last comment. That has been corrected.

    I have not read the 2010 paper.

    I am concerned (as you are) about repaid principal for a loan becoming bank capital instead of being destroyed in retiring the loan.

    The loan is an asset and the money it created is a liability (for the bank). Repayment of the loan removes from both accounts. If the money repaid could be returned to capital it would become an asset. How can that happen? Where is the liability? I can see that interest is outside of that direct cancellation process - but not the repaid principal.

    I have seen some detailed discussion that I have not read on the topic of whether Steve Keen's ideas meet an accounting standard. I now think I know what those discussions may have been about - I'll have to track them down and pay some attention to them.

    I too await Derryl's response.

    John Lounsbury

  9. EconCCX Email says :

    Hi John

    Suppose you have a business checking account of $1000 and it has a $10 monthly service fee. If you think of that account, incorrectly, as a bailment, you'd imagine the bank holding $1000 of Federal Reserve Notes for you, taking $10 from this for service, and booking it as income.

    But a deposit account isn't bailment; it's an IOU. It's just a promise from the bank, though guaranteed by the FDIC. So the bank earns its $10 by extinguishing its liability to you in that amount. If it also gained $10 of income, it would be being paid twice. No question the bank is $10 ahead in net worth as its debt is reduced. But liquid money, the circulating medium of exchange, the wherewithal to pay obligations to others, has been destroyed.

    Thus in the aggregate it is impossible to pay principal and interest on debt-based money without further borrowing, deeper indebtedness. Not to achieve growth, but to forestall collapse. The fees accrue, the interest compounds and that's the world we're in. And it's why we read stories like:

    I don't believe Keen sees this at all. I believe he sees a phenomenon of overconfident, uneconomic borrowing and lending as described by Minsky rather than a problem with the engineering of money. This typically comes from seeing bank deposits as a positive bag of marbles rather than merely a promise of marbles.

    Truly sustainable money, in my view, would be service-backed and service denominated. Digital bridge tokens, transit tickets and Forever Stamps as a circulating medium of exchange, deriving value from the daily performance of the issuer, not the compounding obligations of the borrower.




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