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On the Monetary and Financial Stability Under a Public Money System – Modeling the American Monetary Act Simplified –

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On the Monetary and Financial Stability Under a Public Money System – Modeling the American Monetary Act Simplified – On the Monetary and Financial Stability under A Public Money System { Modeling the American Monetary Act Simplified { Kaoru Yamaguchi ∗ Doshisha University Kyoto 602-8580, Japan E-mail: [email protected] Abstract Our economies are currently facing systemic failures of financial and debt crises. To overcome these, an alternative public money system is proposed by the American Monetary Act. This paper is the third one that examines the feasibility of the public money system. First and second papers have focused on the liquidation of government debt. This paper explores monetary and financial stability under the public money system in comparison with the current debt money system, by constructing a simplified macroeconomic model. It demonstrates through simulation that monetary and financial instability is built into the current debt money system and \booms and depressions" become inescapable. On the other hand, monetary and financial stability is shown to be accomplished under the public money system. 1 The Chicago Plan Revisited This is the third paper that examines the feasibility of the American Monetary Act proposed by the American Monetary Institute1. The Act endeavors to restore the proposal of the Chicago Plan or 100% Money Plan by repealing the Federal Reserve Act of 1913. Specifically, it tries to incorporate the following three features. For details see [7] and [9, 10]. • Governmental control over the issue of money ∗The paper is submitted to the 30th International Conference of the System Dynamics Society, St. Gallen, Switzerland, July 22 - 26, 2012. 1Its full text is available at http://www.monetary.org/wp-content/uploads/2011/09/32- page-brochure.pdf. On Sept. 21, 2011, a bill based on the American Monetary Act was introduced to the US House of Representatives by the congressman Dennis Kucinich. It is called H.R. 2990, National Emergency Employment Defense Act of 2011 (NEED Act). Its full text is available at http://www.govtrack.us/congress/billtext.xpd?bill=h112-2990 . 1 • Abolishment of credit creation with full (100%) reserve ratio • Constant flow of money into circulation to sustain economic growth and welfare The macroeconomic system which meets the above conditions is called a public money system in [8], while the current system is called a debt money system. The first paper [7] investigated how accumulating government debts could be liquidated under the above two different macroeconomic systems. What was found is that the liquidation of government debt under the current macroeco- nomic system of debt money is very costly; that is, it triggers economic re- cessions, while the liquidation process under a public money system can be accomplished without causing recessions and inflations. The second paper [8] expanded the analysis to the open macroeconomies and found that government liquidation can be attained without causing economic recession, unemployment and inflation in both domestic and foreign economies. These two papers have focused on the liquidation of government debts, because national debts are the most imminent issues many OECD economies are now facing. Having solved the liquidation issue of national debts, I've strongly felt that something essential might have been missing in these researches. This reflection has led me to revisit the original Chicago Plan. What is the Chicago Plan, then ? Following the Great Depression in 1929, a mimeograph called A PROGRAM FOR MONETARY REFORM had been circulated among American economists in July, 1939, by Paul H. Douglas, Irving Fisher, Frank D. Graham, Earl J. Hamilton, Willford I. King, and Charles R. Whittlesey. This circulation was well responded as follows; \Up to the date of writing (July, 1939) 235 economists from 157 universities and colleges have expressed their general approval of this \Program"; 40 more have approved it with reservations; 43 have expressed dis- approval. The remainder have not yet replied [1, p.3]." The proposals made in the mimeograph, together with some writings of above economists on monetary reform such as [2], are collectively called the Chicago Plan, as I understand it. The Chicago Plan has indeed fully predicted the fixing power of national debts under the 100% reserve system, as being demonstrated in our public money system, as the following statement of section 17 demonstrates: (17a) Under the present fractional reserve system, the only way to provide the nation with circulating medium for its growing needs is to add continually to our Government's huge bonded debt. Un- der the 100% reserve system the needed increase in the circulation medium can be accomplished without increasing the interest bearing debt of the Government [1, pp.39,40]. (17b) As already noted, a by-product of the 100% reserve system would be that it would enable the Government gradually to reduce its debt, through purchases of Government bonds by the Monetary Authority as new money was needed to take care of expanding busi- ness [1, p.41]. 2 In other words, what is attained in my two papers is, in this way, clearly predicted in the Chicago Plan. Yet, it turns out to be \a by-product of the 100% reserve system." What is \a main-product", then, that we have missed in our previous anal- yses? Revisit of the Chicago Plan this time convinced me that its main concern was the monetary instability under the fractional reserve system as the following section 9 indicates: (9) Fractional reserves give our thousands of commercial banks the power to increase or decrease the volume of our circulating medium by increasing or decreasing bank loans and investments. The banks thus exercise what has always, and justly, been considered a prerog- ative of sovereign power. As each bank exercises this power inde- pendently without any centralized control, the resulting changes in the volume of the circulating medium are largely haphazard. This situation is a most important factor in booms and depressions [1, p.19]. Furthermore, Irving Fisher, a great monetary economist in those days, was ac- tive in establishing a monetary reform to stabilize the economy out of recessions such as the Great Depression. His own plan is known as \100% Money Plan" I have come to believe that the plan, "properly worked out and applied, is incomparably the best proposal ever offered for speedily and permanently solving the problem of depressions; for it would remove the chief cause of both booms and depressions, namely the instability of demand deposits, tied as they are now, to bank loans." [2, p.8] The purpose of this third paper is, therefore, to examine the main-product of the Chicago Plan; that is, how monetary and financial stability can be attained under the public money system that incorporates 100% reserve system or the Chicago Plan. Having inherited the academic tradition of the Chicago Plan, Milton Fried- man, Nobel laureate proponent of free market economy, also supported the plan as follows; One major reform that I recommended in the third lecture to achieve that objective was 100% reserve banking, a proposal that had been made by a group of economists at the University of Chicago during the 1930s and that was strongly supported by the greatest of American economists, Irving Fisher. The proposal is \to require any institution which accepts deposits transferable by check to have one dollar in high-powered money [i.e., currency plus deposits at Federal Reserve Banks] for every dollar in deposit liabilities, ::: that is, to have 100% reserves." [3, p.X] It means that the central problem is not to construct a highly sen- sitive instrument that can continuously offset instability introduced 3 by other factors, but rather to prevent monetary arrangements from themselves becoming a primary source of instability [3, p.23]. In other words, monetary and financial stability has been the most important concern of all economists among different schools of economic profession. This paper challenges to demonstrate how it can be attained under the public money system, while monetary and financial instability of \booms and depressions" is inevitably caused under the current debt money system. This paper, then, completes the validation of the proposals made by the Chicago Plan and the American Monetary Act. 2 Debt vs Public Money Systems Simplified I have already presented two macroeconomic models of the American Monetary Act in [7] and [8] based on the method of accounting system dynamics developed in [5]. To focus on our main concern of the monetary and financial stability in this paper, a simplified model is constructed here, consisting of three economic sectors such as producers, consumers and commercial banks2. Producers Main transactions of producers are illustrated in Figure 1, which are summarized as follows. • Producers' income is, under the accounting principle, booked as an inflow of the stock of retained earnings when production of GDP is completed, and at the same time inventory is increased by the same amount. • Their actual income is realized when GDP are sold out and shipped from the inventory to consumers and bankers as consumption and to producers as investment. • Out of the income thus realized, capital depreciation is subtracted first and interests of their debt are paid to the banks. • Next, a portion of GDP (say, 20%) are assumed to be made as mark-up profits, and paid to their shareholders (that is, consumers) as dividends. The remaining amount is paid to workers (as consumers) as wages. That implies that workers are placed in a relatively weaker position against shareholders. (Surely, this assumption could be reversed in simulation). • Producers are thus constantly in a state of cash flow deficits, since all in- come are paid out to consumers and bankers as factor income and interest income. To make new investment, therefore, they have to borrow money from banks and pay interest to the banks.
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