Could this be a solution to our debt crisis?

Ambrose Evans-Pritchard describes a radical proposal that claims to offer a solution to our debt crisis.

So there is a magic wand after all. A revolutionary paper by the International Monetary Fund claims that one could eliminate the net public debt of the US at a stroke, and by implication do the same for Britain, Germany, Italy, or Japan.

One could slash private debt by 100% of GDP, boost growth, stabilize prices, and dethrone bankers all at the same time. It could be done cleanly and painlessly, by legislative command, far more quickly than anybody imagined.

The conjuring trick is to replace our system of private bank-created money -- roughly 97% of the money supply -- with state-created money. We return to the historical norm, before Charles II placed control of the money supply in private hands with the English Free Coinage Act of 1666.

Specifically, it means an assault on "fractional reserve banking". If lenders are forced to put up 100% reserve backing for deposits, they lose the exorbitant privilege of creating money out of thin air.

The nation regains sovereign control over the money supply. There are no more banks runs, and fewer boom-bust credit cycles. Accounting legerdemain will do the rest. That at least is the argument.

Some readers may already have seen the IMF study, by Jaromir Benes and Michael Kumhof, which came out in August and has begun to acquire a cult following around the world.

Entitled "The Chicago Plan Revisited" [link is to an Adobe Acrobat document in .PDF format], it revives the scheme first put forward by professors Henry Simons and Irving Fisher in 1936 during the ferment of creative thinking in the late Depression.

. . .

The original authors of the Chicago Plan were responding to the Great Depression. They believed it was possible to prevent the social havoc caused by wild swings from boom to bust, and to do so without crimping economic dynamism.

The benign side-effect of their proposals would be a switch from national debt to national surplus, as if by magic. "Because under the Chicago Plan banks have to borrow reserves from the treasury to fully back liabilities, the government acquires a very large asset vis-à-vis banks. Our analysis finds that the government is left with a much lower, in fact negative, net debt burden."

The IMF paper says total liabilities of the US financial system - including shadow banking - are about 200% of GDP. The new reserve rule would create a windfall. This would be used for a "potentially a very large, buy-back of private debt", perhaps 100% of GDP.

While Washington would issue much more fiat money, this would not be redeemable. It would be an equity of the commonwealth, not debt.

The key of the Chicago Plan was to separate the "monetary and credit functions" of the banking system. "The quantity of money and the quantity of credit would become completely independent of each other."

Private lenders would no longer be able to create new deposits "ex nihilo". New bank credit would have to be financed by retained earnings.

"The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business," says the IMF paper.

"Rather, banks would become what many erroneously believe them to be today, pure intermediaries that depend on obtaining outside funding before being able to lend."

. . .

Arguably, it would smother freedom and enthrone a Leviathan state. It might be even more irksome in the long run than rule by bankers.

Personally, I am a long way from reaching an conclusion in this extraordinary debate. Let it run, and let us all fight until we flush out the arguments.

There's more at the link.

It's a very convoluted case indeed.  I recommend that interested persons read the IMF's proposal in full to get a broader picture.  I'm not sure if it could work as described, or whether it's desirable . . . but it has this going for it - it would dethrone the banksters.  That's a good start, right there!

This discussion will be worth following.

Peter