By J.D. Alt

Sometimes it helps, if you want to see and understand something more clearly, to imagine the world without it. I just finished a book (“Rethinking Money” by Benard Lietaer and Jacqui Dunne) that was so thoroughly confused—and confusing—about how the U.S. private banking system “creates our money” (but perversely refuses to create enough of it) that I felt an overwhelming need to try to clarify, in my own mind, what the private banking system actually is. That’s when I got the idea of imagining a world without private banks at all—and trying to see at what point, and for what purpose, they become useful or, perhaps, even necessary.

It is certainly possible to imagine a monetary system that, up to a certain point, works very well without private banks: A collective government (sovereign) establishes a treasury which issues—at the direction of the collective government—fiat dollars. The collective government establishes a need for the citizens to earn those fiat dollars by imposing taxes which can only be paid with the fiat dollars themselves. Given this set up, the sovereign can now issue dollars to buy, from the citizens, as many collective goods and services as the citizens have time, materials, energy and technology to produce. The fiat dollars the citizens earn by creating these collective goods and services are then used not only to pay their taxes, but also as a means of exchange amongst themselves for things they privately produce, own or consume. Thus, two markets are created, each using the same currency as a means of exchange: the market for collective goods and services, and a market for private goods and services.

The citizen’s desire to “save” dollars for a rainy day could be facilitated by the collective sovereign directing the treasury to issue interest bearing bonds. The citizens could then exchange their excess fiat dollars for these bonds—with the agreement that they would not convert the bonds back to dollars for a specific period of time. This creates the advantageous situation whereby (a) the citizens can grow their savings against the day they will be unable to earn a living through their labor, and (b) the collective sovereign can reduce the number of dollars in circulation—(as a strategy to maintain price stability.)

Thus far, we have no need of a private banking system. The collective sovereign can issue dollars, collect taxes, and issue bonds. The citizens can earn dollars, and then use those dollars as a means of exchange for private goods and services amongst themselves. They can save for the future by exchanging their excess dollars for the interest bearing bonds, and they can “vote” to pay themselves to produce any and all collective goods and services they have the time, materials, energy and technology to produce. It sounds to me very much like a happy and prosperous society.

We should note, however, that the total dollars in circulation which are available for the private exchange of goods and services is limited to what has been paid to the citizens for the production of collective goods and services—minus taxes collected, minus dollars which have been exchanged for interest bearing bonds, plus interest paid on the bonds. It might well be these are not ENOUGH dollars to satisfy the citizen’s efforts to produce and exchange all the private goods and services they need or want. Private things desired, or even desperately needed—and for which resources are actually available—could fail to be provided simply for lack of enough dollars to facilitate the exchanges necessary to produce and deliver them.

It is possible to imagine, under these circumstances, various ways the collective sovereign could add new fiat dollars to the private market other than, and in addition to, the purchasing of collective goods and services. However, whereas democratic processes (when properly working) can reasonably direct the production of collective goods, it seems evident that these same processes (even if they are properly working) are not well suited to deciding what and how many private goods and services should be created. It is not clear, then, how the collective sovereign could properly know how many new fiat dollars to create, nor how to distribute them so the needs for private goods and services are optimally met.

It might well be that a private banking system could solve this dilemma. The collective sovereign might enable a system of private banks to be formed, each endowed with the legal privilege of leveraging sovereign fiat dollars by issuing “loans” to citizens backed by only a fraction of the sovereign dollars the bank actually has at hand. The business model might unfold something like this:

A private bank is given a legal franchise by the collective sovereign. The private bank then creates an incentive for citizens to deposit their dollars-on-hand with the bank—the incentive being the bank’s promise to pay the citizen some rate of interest, or perhaps providing them with free checking and check-clearing services, relieving them of the worry of having to carry around large amounts of cash. The bank is then authorized by its sovereign franchise to issue “loans” to the citizens, denominated in the sovereign’s currency, in amounts exceeding the dollars the bank has on deposit by a specified percentage. For example, the bank might be authorized to issue nine “loan dollars” for every actual fiat dollar it has on deposit. The bank then makes a profit by collecting interest on the loans.

Importantly, the sovereign ensures these “loan dollars” are just as acceptable in the exchange of private goods and services as the sovereign’s “real” dollars by guaranteeing to convert the “loan dollars” to “sovereign dollars” at any time, on demand. With this infallible promise in place, the “loan dollars” become, for all practical purposes, indistinguishable from the “sovereign dollars.” And the net result is that the quantity of dollars in circulation is dramatically increased, providing a monetary base for a greatly expanded production and exchange of private goods and services.

One could even imagine a kind of ingenious mechanism in this new set up because, if everything works with the proper incentives, the amount of new “loan dollars” created will be very close to the amount of new dollars actually needed by the private market exchanges, helping to keep prices stable. This is because the “loan dollars” issued by the private banks are for the purposes of either producing or purchasing real goods and services the private citizens actually need or desire—and this fact is continuously verified by the issuing bank’s interest in ensuring the high probability of the loan being repaid. Before a loan is issued, then, the bank does research to confirm that what the newly created dollars will produce is, in fact, something that someone wants to purchase, or that what someone wants to purchase is, in fact, something that can be produced for the proposed purchase price. The bank also establishes, to the best of its ability, that the person proposing to do the producing has, in fact, the skills and resources necessary—or that the person proposing to do the purchasing has the projected income-over-time to repay the loan.

So, by adding a private banking system to our imagined world, we have created a situation where both collective and private goods and services can be produced, exchanged, and consumed AS NEEDED, so long as the real resources necessary for their production—time, labor, materials, energy, and technology—are available. Citizens can save against the day they can no longer earn their living with their labor. Prices can be held relatively stable by the continuous draining of dollars out of the market for private goods and services through tax collections and bond issues. It seems like an almost a perfect set up. We should ask, however: are there things that can now go wrong—things that couldn’t have happened before we inserted private banks into the picture?

One thing that could go wrong is if the citizens began using the new “loan dollars” to do things other than producing and exchanging real goods and services. Before the private banks, all the “new” dollars created (by sovereign fiat) were always spent to create real collective goods. But private-bank “loan dollars” could potentially be put to other uses. For example, citizens could begin using the “loan dollars” to place bets on whether a company’s stock price was going to go up or down. Or they could use the “loan dollars” to buy companies whose sales or products are struggling, and then let-go the company’s employees and sell off its assets for a profit. In each of these examples, the problem is that the new “loan dollars” increase the money supply circulating in the private market without ever producing any goods or services the citizens want or need—or, indeed, can even spend their dollars to buy.

This problem could be exacerbated if the private banks decided it was more profitable to engage in these kinds of “investment strategies” themselves (instead of sticking to their original business model of making loans and collecting interest.) They would certainly be in a uniquely leveraged position for doing exactly that. The Directors of the private banks could create bank-owned subsidiaries, and then issue “loan dollars” to the subsidiaries for the purpose of “investing” in financial bets. If something like this happened and, driven by the greedy side of human nature, grew out of scale and control, one could imagine the strange situation arising where a great excess of new dollars would be created but never spent to produce or buy anything real—nor spent to employ citizens to produce those things. Winners of the financial bets might amass huge sums of dollars—most of which can only be used for the purpose of making further bets—while more and more average citizens struggle to find a job to make ends meet.

A worst case scenario might be if the citizen bet-winners began to use their massive financial clout to to “buy” the democratic process guiding the direction and policies of the collective government. If this occurred, this relatively small group of citizens would be in a position to direct toward themselves the private ownership of virtually all the collective goods and services the society owns—essentially enslaving the rest of the population. The strategy for doing this would likely involve something we touched on earlier, but perhaps didn’t take proper note of. This is the fact that the sovereign’s infallible promise to convert private-bank “loan dollars”, on demand, into real sovereign fiat dollars (thereby enabling the private banking system to become functional) renders the two kinds of dollars, for all practical purposes, indistinguishable. It is this undifferentiated confluence of the two kinds of dollars which enables the power-takers to perpetrate two fundamental myths which enable them to take control:

(1) That the private banks, operating in the private market, are exclusively creating ALL the U.S. dollars that exist; and (2) the only way, therefore, the collective government can get dollars to spend for collective goods and services is by taxing or borrowing from the citizens.

The original (and still very “operational”) process of sovereign fiat dollar creation for the purpose of creating collective goods and services would be suppressed by the power-takers and publicly denigrated as “printing money”—something, by inference, both illegal and unethical. The citizens-to-be-controlled are then persuaded to believe their collective government is building debt faster than it can ever repay it—and the only recourse is to (a) dramatically reduce the dollars spent on collective goods, and (b) pay off government debt by SELLING existing collective goods—such as roads and airports, sewage treatment plants and water systems, national parks and public schools—to the private citizens who have amassed dollars beyond fortune. Once transferred to private ownership, what used to be free or very affordable collective goods, begin to generate tolls and rents further enriching the power-takers—and further impoverishing the average citizens.

It is hard to conceive, however, a rational citizenry ever allowing their sovereign monetary system—which works so beautifully to create the many collective goods and services they depend on, enjoy, and leverage to such great personal benefit—to become as deceitfully sociopathic and destructive as we’ve just imagined. Surely, if a private banking system were introduced—and it seems there are real benefits to be gained from doing so—there could also be established a few simple RULES that would prevent the nightmare scenario we’ve just envisioned from unfolding.

37 responses to “WORLD without BANKS

  1. JDA, a very interesting thought process but, as in most cases, there are many options for many of the steps. For example if there is insufficient funds for the market needs then one could imagine an agency like the Depression /WWII era RFC to finance large industrial projects and something as simple as a guaranteed income for citizens for increasing demand for surplus products before resorting to private banks. Additionally, in your model, the govt would have sole possession of the records to support analysis of the need for money supply in the economy.

    • Charles,
      While public monetary resources can be readily made available for all economic growth, credit resources are properly a private bank function.
      If the demand is private, why is there any problem with private bank funding.
      Here to differentiate: to fund the private ‘credit’ needs, and not the private ‘money’ needs.
      Public money created, issued and saved is a private credit resource.
      I think that’s the whole idea behind public money. See:
      From U-Chicago Booth School e-library

  2. Spencer Langdon

    Thank you. I love your work.

  3. Clonal Antibody

    @JD Alt
    Why does it have to be a “Private” Banking system. Anything a private Banking system can do, a “Public Banking System” can do just as well. For example the “Nationalized” Banks in India, which are primarily in the business to lend to the private sector.

    • The “national banks” of India are moribund, depressing places, suffering from exactly the same problems as soviet communism. There is no incentive for profit or work or anything, it all devolves into nepotism.

      This is why the private bank system in India is way advanced, way more customer friendly and way more dynamic than the slow as molasses national bank system. The private banks are pretty much what everyone uses…even the office spaces, furniture, modernity of the private banks is contemporary, vs the national banks having furniture (unreplaced) from the 1950’s.

      national banks are not the solution.

      • Clonal Antibody

        Not really! That is ideology speaking. I have gotten much better service at the Nationalized Banks, than I ever got at any of the private Indian Banks – and I have used both, before and since they were nationalized in 1969. The bureaucracies that operated in the Nationalized Banks were also there in the private banks. The corruption in politics in India has existed for more than a few centuries. It existed in the previous government, and it exists in the current government, and, for profit entities — well — well they profit well, from that well of corruption.

  4. The Public Bank Solution –

  5. “the collective sovereign can reduce the number of dollars in circulation—(as a strategy to maintain price stability.)”

    Except that the bonds *don’t do that*. It’s a bit of a myth derived from a fallacy of composition. At any point in time there will be old bonds maturing and new bonds being issued – even if there is no secondary market for bonds. That’s a big pool of liquidity.

    A one time hit is not a strategy for price stability. It is a strategy for delusion that ignores the time-based dynamics.

  6. Someone was in a sarcastic mood…

  7. What a great article, thank you. I just wish we could get people to read it. I know if I sent it to my friends, all liberals who don’t understand how the economy works, they would not read it.

  8. Auburn Parks

    I enjoy your work immensely J.D. but this line is just not quite right…..
    ” (b) the collective sovereign can reduce the number of dollars in circulation—(as a strategy to maintain price stability.)”

    As QE has demonstrated, issuing bonds (term savings deposits) has very little disinflationary. Inflation is all about the ratio of spending to production, so people who are saving (not spending) do not have much of an impact. Whether they save in the stock market, homes, or Govt securities is almost irrelevant.

    If there were no T-securities and the Govt only issued reserves, this would not change by much (if at all) the savings desire of the public, savers don’t rush out to spend their money when their T-securities mature or are purchased by the Fed, so the logic and evidence indicate that issuing T-securities has a negligible effect on inflation.

  9. “It is hard to conceive, however, a rational citizenry ever allowing their sovereign monetary system… to become as deceitfully sociopathic and destructive as we’ve just imagined.”
    Yes, yes it must be extremely hard, even if at all possible to conceive by a rational citizenry.
    Surely, if it were possible, it would describe our present monetary system.
    Why is it not seen ?
    Why can’t a rational citizenry (with economist included..”Who am I to judge?”)
    reasonably discovery the truth?

    • Inconvenient to the already busy MMT imagination.
      Rather, let’s imagine a world without private banks, BECAUSE nobody is calling for a world without private banks, and we can use our collective MMT wisdom-speak to solve another non-existent problem.

  10. “as many collective goods and services as the citizens have time, materials, energy and technology to produce.”

    Leaving no time, materials, energy and technology for private goods and services.

    It should be “as many collective goods and services as the citizens collectively determine to be in their collective interest to produce, recognizing that some resources will need to be reserved for private goods and services.”

  11. “the total dollars in circulation which are available for the private exchange of goods and services is limited to what has been paid to the citizens for the production of collective goods and services—minus taxes collected, minus dollars which have been exchanged for interest bearing bonds, plus interest paid on the bonds. It might well be these are not ENOUGH dollars to satisfy the citizen’s efforts to produce and exchange all the private goods and services they need or want.”

    If that is the case, then the amount of taxes is too high, and there will be people unemployed. The answer is not to invent banks that can supplement the dollars, it is to reduce the taxes so that the people have enough money to produce and purchase the goods and services they want, and also to save as much as they want.

    But there is still a need for some flavor of banking, for two reasons: to safely store the money used for transactions, for shorter periods of time than is allowed by the government bonds; and to implement a system of electronic money to supplement the cumbersome physical cash. Government could do it, and it may be that starting from scratch it would be considered a collective service, not a private one. If that were the case, there would be no need for any private banks (but a lot more public contact than our current government bank has).

    If private banks were allowed, and given the sort of privileges they enjoy today, the only rule needed is that their operations be limited to making loans and taking deposits. Nothing else is permitted, anything else is automatically prohibited, and doesn’t need to be specified because all the permissible activities are specified.

    • There’s also a need for some sort of lending institutions. These should probably be private, to help the underwriting process work well. There are any number of ways these institutions could operate and fund themselves. The credit union model is most appealing to me. I don’t think we want to go to a 19th Century private banking model, and certainly not to the post-Glass-Stegall fraud and securitization model.

    • “the total dollars in circulation which are available for the private exchange of goods and services is limited to what has been paid to the citizens for the production of collective goods and services—minus taxes collected, minus dollars which have been exchanged for interest bearing bonds, plus interest paid on the bonds. It might well be these are not ENOUGH dollars to satisfy the citizen’s efforts to produce and exchange all the private goods and services they need or want.”

      The nouveau MMT loanable funds theory.

      “It might well be these are not enough”………. or, given a monetary authority’s mandate to identify money needed to achieve national GDP-potential, …….”It might well be that there is too much”

      But, regardless, NOBODY is calling for an end to private banking……….so…..let’s solve that problem.

      “the total dollars in circulation which are available for the private exchange of goods and services is limited to what has been paid to the citizens for the production of collective goods and services….””
      Almost too wrong to address.

      Achieving GDP potential in any year only requires the “addition” of certain amounts of NEW money to add to existing money, which NEW money in that year must come from that part of the public budget not funded by taxes.
      Don’t confuse it anymore than it necessary.
      Guess what? National GDP-potential includes the production and consumption of all the goods and services required for the capital development of the private sector.

      Let’s solve another non-existent problem with private banks.

  12. A good and thought-provoking post J.D.

    I was struck by your last paragraph and wish I could agree with it. But I think the notion of a “rational citizenry,” while appealing, is painfully far from reality…which speaks to the great political challenge facing MMT and other sensible and progressive policy perspectives that could have broad and deep benefits if adopted in Washington.

    For one thing, there really isn’t a “citizenry,” but rather a diverse collection of individuals with a wide range of interests, levels of intelligence and available attention, biases, distractions and emotions (subject to well-paid expert manipulation), etc.

    The more serious challenge to achieving the simple rules you suggest is the corrupt sausage-making process that is so deeply ingrained and even institutionalized in Washington (actually it’s probably more accurately described as a reelection-focused fundraising process that sometimes spits out legislative sausage when campaign funders are either hungry for pork or have eaten so much of everyone else’s lunch that the appearance of decency requires a public hand-slapping).

    Then there’s the mass media, where rationality tends to be assaulted more than it is supported.

    Fortunately, the Internet and related technologies provide a platform for challenging these mutually-reinforcing negative dynamics and the big-money control of media and politics, allowing MMT and other potentially game-changing breakthroughs in policy thinking to seed and feed the minds and hearts of enough citizens to improve the odds that we’ll see the simple, rational sets of rules you suggest in your closing…hopefully before the rulebreakers break the system even more fully and painfully next time.

    But I can’t say at this point that the odds look especially good to me. Which is why I’d still like to see continued exploration of the kinds of “complementary currencies” that Lietaer and Dunne write about. I’d offer Europe as a painful example of this…the ignorance and corruption of elite policymakers has pushed some segments of the population to the point where more localized complementary currencies are among the only ways these populations can apply grossly underutilized human resources to desperately unmet needs.

    In my view, we need to keep banging the MMT drum (and ever more effectively), but we also need to keep people fed and cared for–however we can–as long as elite policymakers ignore or even exacerbate their suffering via ignorant or intentionally cruel economic policies.

    And though some might disagree, I suspect even modest success of complementary currency efforts can help open the minds of more people to some of the core principles of MMT/functional finance. The message would be “If a small-scale non-fiat currency can help mobilize resources to meet human needs, imagine what a fiat currency could do if applied to the same general purpose, but on a much larger and more potent scale.” I’d like to think that this could trigger (at least for some) a vision compelling enough to overpower the deeply engrained emotional pull of deficit fears, at least long enough for the seeds of a rational MMT understanding to be planted and begin sprouting.

  13. David Chester

    Even without the use of public facilities as take-over means for the few getting rich (a described in the night-mare here), the situation about land values has not been covered. In fact it applies even before this new private banking concept is put in place. By monopolizing land ownership, an investor can today and would when involved in this new system, be able to exploit the way that local developments (using taxpayers money) cause the land to become more valuable and productive. But the result of this improvement should morally be shared by the public, not go into the pockets of the monopolists! So in fact the use of nationalized money has not properly or fully solved the basic problems of unequal opportunities in our society that are caused by speculation in land values.

  14. It’s sad that so many people prefer to shoot in their own feet rather than trying to understand this.
    Good article!

  15. Two remarks:

    1) I’m a bit confused by the step to the private banks as loan providers – surely a government bank could do precisely the same thing, obviating the need for private banks. Is the assumption that the profit motive will make for better vetting of loan applications than would happen in a public bank? Because this seems to be the only difference.

    2) “Citizens can save against the day they can no longer earn their living with their labor.” won’t work for low-income workers, as we see empirically all around the world. This is why there should be unemployment support and public pensions (and I know that you know that, I’d just like to change the narrative a bit). So saving for deferred consumption — in the form of large purchases, holidays, whatever – should be accomodated (and could be by the same mechanisms you describe) but saving for future income substitution should be removed from the narrative, I believe.

    • Saving for future income substitution works for anyone, low or high income. From the worker point of view, the system of payroll taxes and public pensions we have today, in which they are forced to participate, works almost as well as saving for future income substitution.

      But even if it didn’t, it works well for middle and higher income groups, and must be included in a realistic proposal.

  16. Umm… just to let you know banks when creating loans, make the loans first then look for the deposits later, as has been proved by Basel,Steve Keen and the Bank of England. So the money multiplier model you described above doesnt actually exist in reality.

  17. jerry hamrick

    In my soon-to-be-published book, Faction-Free Democracy, I propose an entity called the “Universal National Bank,” otherwise known as UNB. This bank merges the functions of the Fed, the Treasury, and all private commercial banks, except for the big Wall Street banks which will labor under a set of enforceable regulations. The people will be able to fund all public projects through a democratic planning process called the National Planning System, a private planning process called the Individual Planning System. Individuals can borrow money from the UNB by going to local branches which can “create” money as loans are made. The UNB will also pay guaranteed interest for money that will be deposited in a national investment account that can furnish money for these private business loans (fiat funds will be created as needed). Taxes to raise money or combat inflation will not be needed because the system has a method for removing excess cash from the system and also for slowing spending should inflation seem to be on the rise. Taxes will be used to discourage certain economic bad habits. In addition the UNB will be the single payer for health care, all ordinary utilities, housing maintenance, installment payments of other kinds, rent and mortgage payments, college tuition, and will offer interest-free mortgages and car loans with friendly, flexible repayment rules. The UNB will also manage an economic stimulus system which will put cash into the accounts (all checking accounts will be furnished by the UNB–there will be no other checking account businesses) of all citizens regardless of age, gender, race, sexual orientation, or faith. This stimulus package starts at birth and ends at death, and can be managed to provide better retirement than Social Security–ultimately Social Security as it is now constituted will be phased out. This set of systems is part of a new system of government.

    • Jerry, I’m looking forward to this book! When will it be available?

      • jerry hamrick

        I am waiting on a friend to send me his review of one chapter. He is an expert on its content. He has had it since July 11, so I expect it to be back soon. I understand that it will take 4-6 weeks to be finished and ready for sale.

    • Intriguing. Is this going to be world-wide right off the bat, or will there be a demonstration project in a small economy first?

  18. India? Really?

    • jerry hamrick

      ?????????????????????????????????????? ?

      • India is the “I” in the BRIC nations with the great economic growth records…and all 4 have learned that in a sovereign nation resources, not money, is the limitation. It is time for Americans to get smart too and throw out the know nothing bean counters.

  19. Pingback: J.D. Alt: World Without Banks | naked capitalism

  20. What I found missing from this otherwise fascinating thought experiment was any mention of commercial or consumer credit. A great deal of commercial trade is still financed by accounts receivable and accounts payable rather than immediate payment for service, and I am old enough to remember when it was not unusual to carry a tab at the local butcher or grocer. In the nineteenth century when retail baking was largely undeveloped circulating notes/IOUs were a standard non-bank, non-sovereign currency means of transacting business as well as a dominant plot device in Victorian novels. The discounting of such notes was a big part of the financial services industry for firms like of Scrooge & Marley. During the It would not be too difficult to imagine in the age of the internet sophisticated trading and clearing systems for such notes with no banks involved. Indeed during the Irish banking strike in 1970 the Pubs did a remarkably efficient job of keeping the money economy functioning., leaving one to wonder if banks are really needed at all.

  21. “collective” sovereign?
    Why not just ‘sovereign’ ?
    Or, sovereign government ?
    What’s the point of using ‘collective’ here?
    Or, is it the obvious one?

  22. This might not be terribly on-topic (though I do think it is relevant), but I just thought of this good analogy for batting-down people who say “government use of money creation will lead to hyperinflation” – you could say in response:
    “Saying government use of money creation will lead to hyperinflation, is like saying turning on the tap on your sink will lead to your house flooding.”

    Seems a good base for making a succinct and easily-understood analogy.

  23. Brian Vercoe

    The book edited by Christopher Simspon,War Crimes of the Deutsche Bank and Dresdner Bank, office of military US reports,shows why private banks shouldn’t exist.Anyone who whats to reform banking should read.This is where our modern banking practices really took off.The people who undertook this investigation concluded that both banks should be liquidated.The responsible officials be indicted and tried as war criminals.The leading officials of said banks be barred from positions of importance or responsibility in German economic or political life. OMGUS Report 1946.As they drolly note in the book these officials put the heil hitler into banking.Suffice to say none where indicted or convicted.