02 May 2019

Design options of sovereign money – a full overview

The goal of a sovereign money reform is to place the money creation into the hands of a public institution that serves the public interest. However, there are still many different design options how to implement this, i.e. what instruments should be used to steer the money supply or if the payment system should be run by the state or private payment providers. To bring more clarity to the discussion, this article provides an overview of the wide variety of design options for a sovereign money system.

Among the member organizations of the International Movement for Monetary Reform regarding some of the design options there is consensus on best solutions but in other cases opinions vary quite a lot. Obviously though, often it can’t be generalized what is best, as that depends on a country’s specific circumstances and institutions. What’s reasonable for Germany might not be reasonable for South Africa or Canada.

The primary focus on this article though, is to provide an overview of all the options on the table and not so much a thorough discussion of the various pros and cons of the various options. Nevertheless, some basic arguments and considerations are provided together with a description of the status quo and alternative reform proposals if applicable. The design options for the transition from the current to a sovereign money system have been left out due to considerable complexity of this topic – this might be a good topic for another article though.

Part 1: Design of the Monetary Authority

1. How is the institutional setup of the monetary authority and its relation to the government?

Now: There exist no monetary authorities yet but what comes closest are the existing central banks. Their setup is very different from country to country. Sometimes it is a (partly) privately owned institution (Switzerland, US Fed), sometimes it is fully public (Germany). Usually it is relatively independent from the government and not bound to follow its orders.

Discussion: It is a very questionable relic that some central banks are still privately owned and shows the current heavy linkage between central banks and the financial sector. That should be ended. Often there is already relative independence from politics and most money reformers agree that this should be kept in place.

Sovereign money proposal: The monetary authority should be an independent state authority serving the public interest (like the judiciary) and bound by law and statutes. (Of course there is still great room for discussion what this exactly means and how to ensure accountability to the people.)

Different proposal by some Keynesians or Modern Money Theory Proponents: The function of currency creation should be part of the finance ministry so there is no need for an independent monetary authority. (This would make some things obviously easier and allow better coordination of money creation and government spending but entails the risk of power abuse and a dangerous concentration of power.)

2. What goals should be part of the official mission of the monetary authority?

Now: Differs, the ECB has the single target of consumer price stability whereas the US Fed supplements this with the goal of economic growth.

Discussion: One single goal makes things obviously easier but including multiple goals might create a better balance. The monetary authority also only has limited power to achieve some goals and it can be argued that some goals should rather be in the hands of a separate institution of the government. Lastly, the exact wording and definition of a goal is crucial and often there are multiple similar objectives.

Sovereign money design options (multiple are possible):

  1. Consumer price stability (There is agreement that consumer price stability should be the primary goal of the monetary authority but it is debatable if this should be supplemented by other goals.)
  2. Financial stability, asset price stability or preventing asset bubbles (Asset price increases were generally badly neglected during the last financial crisis and there should be an institution that keeps an eye on preventing asset bubbles and ensuring financial stability. But maybe this should rather be put into the hands of the financial supervision institution to limit entanglement and moral hazard. Also, asset prices depend on multiple factors and maybe the focus should rather be on preventing bubbles than ensuring price stability in terms of the level of asset prices.)
  3. Economic capacity utilization and preservation, economic growth or full employment (These are many different terms for the similar and reasonable objective of providing enough money for releasing the full potential of the economy. The goal of economic growth can be criticized for not taking into account the ecological limits of our planet. Economic capacity utilization and preservation might therefore be a better goal. Full employment is usually taken as a sign or indicator for economic capacity utilization but it can also be questioned if traditional full employment is really desirable given that the 4th industrial revolution might make more and more jobs superfluous and we might soon need to shift to basic income and purposeful doing anyway.)
  4. Stable value of the currency in terms of foreign exchange rate

3. Who’s in charge of bank oversight and financial regulation?

Now: In the Euro-area this is also in the hands of the ECB, in other countries it is often a separate state agency.

Sovereign money proposal: There should be a separate financial supervision agency, focussed on risk transparency and investor protection (It is highly problematic to combine central banking and supervision/regulation of banks in one institution and should be separated to prevent entanglement with private interests and moral hazard.)

4. What are the monetary authority’s instruments to bring new money into circulation?

Now: Usually there is a whole variety of instruments, i.e. at the ECB: Deciding about the level of the minimum reserve ratio, setting the interest rate on various credits facilities to banks and on their reserve deposits, open market operations (including the infamous Quantitative Easing program), defining eligible securities. (The current toolkit is mostly very indirect and ineffective though, causes numerous externalities, creates moral hazard and potential for power abuse and gives way too much power to one institution.)

Sovereign money design options (multiple possible):

  1. New money is handed as seigniorage income to the government for spending, i.e. for infrastructure investments, welfare allowances, tax cuts. The monetary authority would decide about the amount of money creation but not about where it is spend, whereas the government can’t decide about the money creation. (Most sovereign money reformers propose this as the primary instrument to inject new money into the economy as it is fair and should be quite effective to stimulate the economy.)
  2. An equal income from money creation is handed to all citizens directly from the monetary authority, i.e. every month there is a variable amount wired to all citizens. (This instrument would have the advantage of probably having a quicker effect on the economy and there is barely any possibility of power abuse.)
  3. Credit to banks (This could supplement other instruments to make sure there is sufficient credit supply in the economy. However, it would again create entanglement with banks and moral hazard / risk of abuse of power etc.)
  4. Open market operations (This could supplement a) for quick “fine-tuning” of the money supply.)

Part 2: The financial system

5. Are other institutions allowed to create money?

Now: Usually there is a law that defines physical cash as the official currency and gives the monopoly of creating it to the state/central bank. However, private banks are tolerated to create their own private bank money denominated in the official currency and even get backed by government guarantees such as deposit insurance. Usually, the government even prefers this private bank money over its own official currency (cash) for payments of fees or taxes due to its convenience but against the logic of the law.

Discussion: Not allowing private banks to create the official currency lies at the core of a sovereign money reform. However, the differentiation between money (“money is what money does”) and the official currency (defined by law) is crucial and it is debatable if there can still be private forms of money besides the official state currency.

Sovereign money design options:

  1. No, issuance of the official currency and all forms of money (physical and digital cash) is a state monopoly. Anything that functions like money and substitutes the state currency is forbidden. (This is the rather rigid version to prevent private actors to regain any privilege of money creation. Critics wonder in how far this could be implemented and really forbidden and where to draw the line/how to define money)
  2. Yes and no, issuance of the official state currency and general unit of value (physical and digital cash) is a state monopoly. But everybody is allowed to create alternative forms of money or liquid stores of value like local currencies or cryptocurrencies. These though are exempt from state support, have an exchange rate to the official currency and the government would only accept the official currency for tax payments and for handling its expenditures. (This might be a well balanced middle-way allowing for private innovation and freedom but ensuring a well-functioning and crisis-proof payment system.)

Different proposal: “Digital Cash” or “central bank digital currency” (CBDC): Private citizens get access to accounts at the central bank and therefore to a digital form of cash / sovereign money that is totally safe from bank failures. This only exists as an additional option besides private bank money as it is now though. (This could be seen as a first step to sovereign money.)

6. Who performs credit intermediation?

Now: Private and public banks are creating credit and there are all kinds of other forms of credit intermediation through P2P lending, crowdfunding or in some sense also shadow banks.

Sovereign money proposal: Banks lose their special privilege of money creation and become real credit intermediaries. However, anyone could provide this function including public and private credit institutions, funds, P2P lenders. (It is not the task of the monetary authority to do credit intermediation, this is a common misunderstanding.)

7. Does physical cash still exist?

Now: Yes, but in dwindling proportions and there are efforts to phase it out or to abolish it. if successful, this would give even more power to banks and their bank money and also raises great privacy concerns.

Sovereign money proposal: Physical cash should definitely stay in existence and be supplemented by other digital forms of sovereign money.

8. What gives value to the currency? Is it backed by anything?

Now: Currencies are not backed by gold or any commodity, rather their value is derived from the productive capacity of the economy as measured in GDP (the value of produced goods and services) in combination with their legal status as official currency.

Sovereign money proposal: No proposed changes.

Alternative Neo-Austrian proposal: There should be a return to the gold-standard. (This would link the money supply to the random change of the supply of gold and thereby put the money supply into an inflexible corset, risking deflation and economic depression when gold is scarce.)

Part 3: Technicalities

9. How is the target of consumer price stability defined?

Now: The ECB defines consumer price stability as 1,8% inflation of consumer prices.

Sovereign money design options:

  1. No changes (This could firstly counteract as a security buffer against deflation and could secondly come to function like a “money tax” as a positive inflation target allows more money creation/seigniorage for the public and would therefore redistribute money from top to bottom.)
  2. Consumer price stability = 0% inflation (Arguably total price stability would be a worthwhile goal and can be reached more easily within a sovereign money system but an accidental drop below zero would be harmful which is why a small positive rate might be better.)

10. Is there interest on sovereign money accounts?

Now: Current accounts usually receive no or very low interest, whereas longer-termed deposits receive interest.

Discussion: In a sovereign money system, citizens have the choice to keep their money either in cash-alike and totally safe digital sovereign money accounts or to hand their money to longer-termed savings accounts at lending institutions to be used for credit. The savings accounts naturally receive interest as compensation for reduced liquidity and risk but what about sovereign money accounts?

Sovereign money design options:

  1. There is no interest on sovereign money accounts (This is usually the preferred option and coherent as those accounts are like cash and cash also receives no interest. Also this would still give an incentive to put money on a savings accounts to earn interest.)
  2. There is positive interest on sovereign money accounts

Different Proposal by the so-called“Gesellians”: Negative Interest on sovereign money accounts, also known as “demurrage”. (This would redistribute income to the public and prevent money hoarding. However, it could undermine trust in the sovereign money accounts and create evasion costs or a shift to alternative forms of money. However, imposing such a negative interest might theoretically be an interesting tool for monetary policy in times of crisis to stimulate consumption or investment.)

11. Who runs the payment system?

Now: The central bank typically provides the account and payment system for central bank reserves. In the euro-area this is the so called TARGET2-system, provided by the ECB. Then banks build their own online-banking and payment interface for the end users deposit money on top of this.

Sovereign money design options:

  1. Similar to now, the monetary authority provides the background payment system with an open interface which can integrate private payment systems for online-banking or other services by private financial intermediaries. (This would possibly allow for better privacy, competition and innovation.)
  2. The monetary authority runs the whole payment system including the handling of sovereign money accounts. (For example, every citizen gets a sovereign money account that could be linked with the tax or social security number and ideally there is a well-functioning and free payment system for everyone.)

12. What technology is used for the electronic payment system?

Now: Account based

Sovereign money design options:

  1. Same as now account based
  2. Distributed ledger technology/Blockchain (Depending on the exact design of the software, theoretically this could allow for better privacy and decentralization.)

13. How is sovereign money accounted for in the monetary authority?

Now: Cash (which is sovereign money) is accounted as a liability of the central bank, as if it could be redeemed into anything else than cash. (This is due to the history of money where it was often redeemable to precious metals like gold.)

Sovereign money design options:

  1. Same as now, as a debt/liability in the balance sheet of the monetary authority. (This would require less legal changes.)
  2. Separate from balance sheet in a ledger of the monetary authority. (This is certainly the preferred and more coherent option by sovereign money reformers. Money is then clearly not a debt but an asset that is not at the same time a debt of anyone. However, accounting is not reality but just a form of protocol and theoretically whatever the accounting system, sovereign money could achieve the same goals.)