Professor Michael Mainelli
Published by Journal of Risk Finance, Volume 13, Number 4, Emerald Group Publishing Limited (July 2012), pages 280-284.
Analysts slowly rediscover as the various financial crises since 2007 unfold, as they did in the 1930’s, a need to reframe the role of money. Debates about the crises have blamed too much credit growth, too much fiat currency and too much laxity in regulating money. Debates about the cure recommend more credit growth and more fiat currency but, this time, greater vigilance in regulation. Basel III means that fiat currency money supplies are going to be more entwined with international banking regulation [Mainelli, 2011]. Some suggest that taking quantitative easing ‘all the way’ might mean zero-leverage ‘utility’ banks [Mainelli and Manson, 2011]. The implication of zero-leverage would be that the regulatory view of credit would be inordinately focused on fiat currency credit. But there are other forms of credit and money outside traditional banks and regulatory structures. Money is created when people trade debts. A debt is the provision of credit, based on trust. Surely we want to increase trust and credit, but fiat currencies are only one form of credit, and based within a relationship to an issuing government.
Some commentators have begun to raise questions about the need for competition and variety in credit. For example, in a Bruegel blog post, “Europe Needs to Drop its Resistance to Non-Bank Credit”, Nicolas Véron  argues that “encouraging non-bank credit provided through the private sector should be a major public policy objective.” Véron was arguing, mostly, for Europe to be careful about suppressing what the USA would term ‘shadow banking’. Meanwhile, an unintended consequence of the European interpretation of Basel III, the CRD IV, is that corporates who have traditionally traded derivatives on an uncollateralised basis will now need to post collateral reducing credit. Bob Giffords and I [Mainelli and Giffords, 2009] argued that the promotion of competition, then supervision, then regulation should be the order of reform discussion, all with an objective of promoting open markets with smaller, more diverse players. Regulators should distinguish between supervision (knowing what's going on) and regulation (saying what should go on). In derivatives trading there is a great need for supervision. The markets are opaque. But simple supervisory solutions could include mandating the use of a handful of deal registries using a global legal entity identifier system to which regulators had open access. Too big to fail is too big to regulate. Regulators should promote diversity and break up concentrated points of failure, as well as ensure they know what’s going on, before resorting to micro-prudential homogenisation that reduces credit they are willing to provide to one another.
Faced with regulatory initiatives drying up credit, commentators have begun to raise a question reminiscent of the Great Depression, “should people create their own money?” Towns in the USA, Germany and Austria did create their own money. Collectors’ books today show over 1,700 scrips existed in the USA during the Depression Era. Though these movements were repressed, e.g. the Wörgl experiment in Austria, they have left a legacy, most notably in Switzerland, that raises wider, important questions.
In a study on capacity, trade and credit [Mainelli, Rochford and von Gunten, 2011] we explored issues of currency when looking at capacity exchanges. A capacity exchange was defined as “a membership-based system within which companies can trade available capacity in the form of goods, services and infrastructure within and across industries, using common tender as a medium of exchange.” As we examined these systems, e.g. a number of barter and reciprocal trade providers, we found that many issued their own monies, or ‘common tenders’. Most notable of these was the Swiss WIR.
Founded in 1934, WIR (Wirtschaftsring-Genossenschaft - economic circle cooperative) is a cooperative bank facilitating multilateral trading between, and extending credit to, over 60,000 member SMEs. WIR was set up as a result of the adverse economic and monetary conditions of the Great Depression to stimulate trade and create purchasing power between participants, primarily SMEs, thereby enabling local economic growth and reducing unemployment. WIR acts as a “central bank” issuing its own currency – the WIR franc (CHW), which is pegged to the Swiss franc (CHF) and released to members through loans and mortgages backed by collateral. CHW are created on the strength of the contract with the borrower plus the willingness of a community to accept the money as a payment for goods and services, rather than through state/central bank authorisation. The bank regulates the amount of WIR francs in circulation. WIR francs accounted for 0.2 % of CHF M1 in 2009.
WIR acts as a “commercial bank” and has been subject to relevant banking regulations in Switzerland since 1936. WIR provides a range of banking products (including business loans and mortgages) to its clients in CHF or CHW or a combination of both. CHW are used by participants to exchange goods and services within the WIR exchange. Since every WIR credit is matched by an equal and opposite debit, the system as a whole must net to zero. Circa one in five SMEs in Switzerland is a WIR member, of which one third are from the construction industry. While some participants accept CHW as 100% of the payment for their goods and services, the minimum rate of CHW for every transaction is 30% up to a value of 3,000 CHF; and subject to agreement between the parties beyond that threshold. Transactions in CHW amounted to CHW 1.627 billion in 2010, representing circa 0.3% of Swiss GDP for the same year, or involved in over 0.6% of Swiss GDP as CHW’s average rate of acceptance is usually between 30% and 40% of the total amount.
Using 56 years of WIR data on participants, CHW in circulation, turnover and credit, Stodder (2009) demonstrates the counter-cyclical nature of WIR credit, showing that WIR credits are most likely to be accepted when ordinary money is in short supply and suggesting that the purchasing power created through WIR could become an instrument of effective macroeconomic stabilisation. Recent media pieces on Swiss SME WIR participants in the financial crises tell stories of how increasing CHW/CHF ratios have stabilised business.
So from one side we have local exchanges or barter exchanges growing and increasing the variety of credit, from another we have calls for the shadow banking system to provide more credit. In all cases we have people in trade creating their own monies, leaving us with some interesting questions. Perhaps the biggest question for macro-economists is why should “tax scrip supply, i.e. national fiat currency, plus bank debts = money demand”? A focus on fiat currencies as money, often driven by a simplistic desire to understand and relate tax revenues to the economy, means that fiat currencies are given quasi-monopoly status. But there are other questions, mostly unresearched in any depth:
One of the more interesting excursions into reform was the Freiwirtschaft movement, largely of the 1910’s and 1920’s which inspired the WIR. Silvio Gesell (1862-1930) was a German economist who found fertile ground for his ideas in Switzerland. As an emigrant to Argentina in his twenties he had experience of unstable currencies. He returned to Germany and began thinking about the role of the velocity of money in determining price levels. After the first World War he began writing about monetary reform, with a one week term of office as Finance Minister of the Bavarian Soviet Republic (Bayerische Räterepublik) in 1919 during its very brief lifespan of a few weeks. Gesell’s core ideas for Freiwirtschaft were three. “Free trade, free land and free money.” Personally, I might add “free information” for a modern mantra.
Free trade we understand today, though Gesell also meant free movement of labour, but free land and free money require some explanation. By free land Gesell, like Henry George in the USA before him and with some echoes of the Social Credit movement, meant only public institutions could own land; land was held by communities. Land could only be rented, not purchased, though perhaps on a very long lease. The implications of free land were that longer-term stewardship was encouraged, land prices wouldn’t inflate, and society controlled the basic productive resource, land.
By free money Gesell meant for money to be issued for a limited period at constant value (neither inflation, nor deflation). The implication was that the velocity of money had to be kept up otherwise the issued money expired, and that long-term saving required genuine investment; one couldn’t sit on cash to exploit rents. If you can’t store money then you need to avoid the temporal mismatch and debasement. You need to have a claim on productive assets, not just currency. The idea of demurrage, as popularised by Bernard Lietaer, or negative interest rates on money, means that money has to circulate. We get there awkwardly today with fiat currencies when interest rates are below inflation rates. Gesell and ‘free money’ were explicit. 0% or even negative interest rates keep trade flowing as people need to trade into productive assets. Nobody has a God-given right to sit on money as a store of wealth. Money needs to be a store of value, but a long-term period is not necessarily better than a short-term period.
Gesell’s 1918 warnings included a letter published in Berlin’s Zeitung am Mittag – “If the present monetary system, based on compound interest, remains in operation, I dare to predict today that it will take less than 25 years before a new and even worse war.” A prophetic warning even today. But what was so important about Gesell? Gesell put his finger on the nub of a deep problem. According to Freiwirtschaft, a price system with large volatilities is dysfunctional, price stability is favoured. With more stable prices, “wobbling” is a positive, self-stabilizing, mechanism. But with large swings, asset bubbles and such, our monetary system is about speculation, not price discovery. Cause of boom and bust? Perhaps after being long-overlooked, John Maynard Keynes’ prediction is coming true - “I believe that the future will learn more from the spirit of Gesell then from that of Marx.”
Interestingly, proponents of reform to fiat currency and leveraged banking often fail to realise that in their reforms they may fail to provide governments with effective tax systems. Current taxation systems are intertwined with the idea that the pre-eminent form of money should be tradable tax scrip. Freiwirtschaft would emphasise the importance of land as the basis of taxation, moving away from income and corporation tax, and giving governments a more solid basis of taxation less interventionist in the economy.
From a risk perspective, a wider, more variegated ecosystem distributes risk better and provides more resilience than a monoculture. In the capacity, trade and credit study we simulated a commercial system where goods and services could be purchased for a mixture of fiat currency and common tender (such as the approach of the WIR or Ithaca Hours). The simulation indicated that combining common tender and fiat currency as means of exchange seems to create complex relationships between acceptance and faith in common tender and fiat currency. As evidenced in geographic areas where multiple currencies co-exist, this complexity can be surmounted if the benefits of trade are sufficient. Clearly, in a world where we hardly understand currency fluctuations, the scale of our ignorance is large. However, there are many areas, e.g. biology, where the complexity of interactions is large and our ignorance high, yet we encourage diversity and competition. Unless you believe in some intrinsic value in a global currency, perhaps you should explore a richer multiplicity of currencies.
The key difference between modern local exchange trading systems or modern capacity exchanges from 1934 Switzerland was that the Swiss put regulation of the CHW on a par with the CHF. Both were permitted to co-exist. A modern alternative to government regulation might also be an audited ISO accreditation standard for “good currency” or “good common tender”. Communities form when people are prepared to be indebted to one another. When these debts are traded independently a form of money often arises as the system to manage indebtedness and its obverse, trust. We want to encourage communities, localism and a multiplicity of human interactions in order to generate wealth and well-being. Rather than suppressing common tenders, perhaps we should be encouraging shorter monetary systems that don’t store long-term value and open competition among community and fiat currencies.
[An edited version of this article appeared as "Short Monetary Systems: Take a Risk, Create Money" Journal of Risk Finance, Volume 13, Number 4, Emerald Group Publishing Limited (July 2012), pages 280-284.]
Professor Michael Mainelli, PhD FCCA FCSI, originally undertook aerospace and computing research, followed by seven years as a partner in a large international accountancy practice and a spell as Corporate Development Director of Europe’s largest R&D organisation, before co-founding Z/Yen. Michael’s third book, based on his Gresham College lecture series from 2005 to 2009 and co-authored with Ian Harris, “The Price of Fish: A New Approach to Wicked Economics and Better Decisions”, won the 2012 Independent Publisher Book Awards Finance, Investment & Economics Gold Prize (www.priceoffish.info.) - Michael_Mainelli@zyen.com
Z/Yen operates as a commercial think-tank that asks, solves and acts on strategy, finance, systems, marketing and intelligence projects in a wide variety of fields (www.zyen.com), such as developing an award-winning risk/reward prediction engine, helping a global charity win a good governance award or benchmarking transaction costs across global investment banks.