What is One-Month Money about?
One-Month Money (buy from Amazon UK, Amazon US, Harriman House) is divided into two parts. Part One — ‘The Case for Change’ — explains why our current economy is inherently unstable, and why our tools of fiscal and monetary policy can only ever hope to moderate, but never eliminate, this instability. This section ends with an explication of secular stagnation in developed economies. Driven by a structural decline in workforce growth, secular stagnation will make our current remedies, already inadequate, even more so.
Secular stagnation means that, even with interest rates at rock bottom, demand will be permanently below the level required for full employment. In other words, the percentage of the productive workforce that the economy is able to employ will shrink over time, creating either persistently high unemployment or lower participation rates. The only “cure” to secular stagnation in our current system is endless government deficit spending. Much like Japan since the 1990s, our economies will have to choose between ballooning government debt and persistently weak demand.
Part Two proposes a solution to our inherent economic instability, whether the problem is one of deficient demand, as in the case of secular stagnation, or high inflation. The solution is a new monetary system that would achieve permanent full employment and stable inflation, without the need for fiscal or monetary stimulus. In the crudest possible sense, the system works by fixing demand at the level required for full employment. How this demand is allocated is determined entirely by the free market, shifting between sectors as our wants and needs change. But overall, it can never fall.
On what principle is the new monetary system based?
The solution is based on the economic idea of “Neutral Money”. The background is simple: Say’s law, which says economies are self-correcting full employment machines, is predicated on the assumption that money is neutral. When money is neutral, it is merely a veil over the real economy, a useful technology that greases the wheels of production and trade without creating any ill effects. In the early thirties, Keynes, quite rightly, tore this assumption apart — money is not neutral, he said, our economies are not self-correcting full employment machines. To combat the effects of money’s non-neutrality, Keynes then proposed his well-known combination of fiscal and monetary stimulus.
I take a different approach: we created money, so why can’t we change it? Instead of endlessly manipulating our system to drive a neutral outcome, as Keynes suggested, why can’t we devise a system of money that is actually neutral, a monetary system that is neutral by design? This way Say’s vision—a self-correcting full employment economy—becomes a reality.
What are the required changes?
Step One: abolish fractional reserve banking and return to 100% reserve banking.
Step Two: implement money expiration. Expiration means that all the money in the economy must be spent once a month, otherwise it expires. From the perspective of a salaried employee, this means that the £2,000 wage that arrives in our current account* on the 1st of November disappears by the 1st of December if it hasn’t been saved or spent. Saving can occur in all forms it does today except leaving money in our current account (or under the mattress). That means we can put money in a savings account, or buy bonds, stocks, real estate or whatever else. We just can’t hoard.**
*The US equivalent of a current account is a “checking account”.
**Please note that BOTH these steps must be implemented, otherwise the system does not work.
What happens to the money we save?
Most first time readers wonder how, faced with expiration, we can save at all. The answer is simple: when we save, the expiring money is transferred to a borrower. For example, if we deposit £1,000 into a savings account, our bank would receive £1,000, which would expire if not spent before the end of the month. The bank would then lend that money to a borrower. And this borrower would face the same dilemma as we did: she either needs to spend the money or save it before the end of the month. The point is that no matter how many hands the money passes through, someone will eventually choose to spend it — otherwise the money expires.
How do the required changes differ from similar sounding ideas?
Step One — abolishing fractional reserve banking — is similar to other 100% reserve banking proposals made over the years, from Fisher and the Chicago Plan in the 1930s, to Positive Money today. The one key difference is theoretical: whereas these groups claim that a fully reserved system is more stable than a fractionally reserved one, I believe that fractional reserve banking is flawed because it makes money intrinsically non-neutral. But it is not the only way that money is non-neutral. Hoarding, for instance, is another. For this reason, unlike Fisher and his heirs, I believe Step One alone is not sufficient. In fact, it could actually make things worse. Under a fully reserved system, money would still not be neutral, and fighting the propensity to hoard would be just as difficult, if not more so, than it is today.
Step Two, instead, is often confused with the form of money expiration proposed by Silvio Gesell and others after him. Gesell’s system was one of money depreciation, in effect a “negative interest rate on cash”. Gesell came up with a specific number, -5.2%, that he believed was sufficient to discourage hoarding and spur spending.
The difference between neutral money and negative cash interest rates is both theoretical and practical. As with Step One, the theoretical underpinning of money expiration is to render our monetary system intrinsically neutral. Gesell’s aim, instead, was simply to accelerate the velocity of money.
But there is also a key practical difference: under a system of neutral money, money only expires each month if it isn’t spent on goods and services.
And what happens when the money is spent? It freezes in a corporation’s bank account until the start of the new monthly cycle, at which point it again becomes “unspent”, and the expiry clock starts ticking. So money, as long as it is spent once each month, always retains the same nominal value.
In other words, there is no negative interest rate on cash — it merely disappears if it remains unspent.
Why is spending always at the full employment level?
First, the move to 100% reserve banking gives the central bank direct control over the money supply (defined as current account deposits and physical cash). In other words, if the central bank wants to boost the money supply from £1 trillion to £2 trillion, it could do so with ease. Today, the central bank does not have this control.
Second, money expiration ensures that the entire money supply is spent exactly once each month. No household or corporation, after all, is going to let their hard-earned money expire.
So all that’s required of the central bank is to keep the money supply at a level that buys the monthly production of a fully employed economy. If inflation is above target, it’s adding too much; if inflation is below target, it’s adding too little. The end result is spending (demand) that is always sufficient to drive full employment without the need for government or central bank stimulus.
In other words, supply creates its own demand; Say’s law holds.
(Read this post to see economist Miles Kimball’s alternative explanation.)
Why is neutral money an improvement on negative cash interest rates?
Monetary systems that allow for negative cash interest rates have been proposed by a number of economists, including Gesell, Kimball, and Buiter. All these proposals rely on the central bank to manipulate interest rates and financial markets to achieve their goal of full employment and stable inflation. Neutral money, on the other hand, achieves this dual outcome without relying on a flawed system of central planning.
In the vernacular used on this blog and in the book, the goal of central banking is to match the actual interest rate, which is the rate it controls, to the ideal interest rate, which is the rate that would lead to full employment and stable inflation. By doing this the central bank drives spending to a level consistent with full employment. The central bank, in other words, is trying to force a neutral outcome on an intrinsically non-neutral system.
But in our current system, this is well nigh impossible. The central bank, for one, simply doesn’t know what the ideal rate is. What’s more, the ideal rate is constantly changing, so even if the central bank is able to hit its target, it can’t do so for very long or with any consistency. What does this mean for negative cash interest rate systems? It means that even if the central bank were able to target negative rates, we would still suffer from business cycles—those swings from unemployment to inflation that are so damaging to our economy.
Under neutral money, on the other hand, demand is always at the full employment level. No longer would our economies rise and crash from changes in demand.
Are there any other benefits to neutral money?
Neutral money offers more benefits than just full employment and stable inflation. A full list is provided in the book, but here are a few:
A free market solution to inequality
Our current monetary system is subject to constant recessions. Whether these recessions are deliberately inflicted by the central bank (e.g. the Volcker recession in the 80s), or simply the accidental product of flawed central planning, many years pass where unemployment is nowhere near full. During this time, the negotiating power of workers is unjustly impaired.
Add to this the fact that lower income workers suffer disproportionately during recessions and we can see why the poor have the worst negotiating position of all. In other words, executives and business owners carry all the clout.
Neutral money would reduce this source of inequality by ensuring that employment is always full, not because of government diktats, but because of the invisible hand. Just how much inequality is caused by the weak negotiating position of workers? It’s impossible to say. But before unions and wealth redistribution, we should first consider neutral money.
A more democratic society
In our current monetary system there are times when large governments deficits are a necessity for full employment. And in times of secular stagnation, as we’ve seen with Japan, these deficits may well become permanent. Put another way, voters are never free to choose between a big government and a small government, but a big government and a crashing economy. And can we really call ourselves democratic if we no longer have this choice?
Neutral money, instead, allows us to choose our governments based on our values, not our economic circumstances. We can adopt a more free market approach, like the US, or a less free market one, like Denmark. Either way, employment will always be full and inflation always steady.
We can continue to worship technological advance
It seems that every day brings a new article warning us of the looming technologies that will replace workers. Here’s the latest. Ever since the industrial revolution, such arguments have been dismissed as Luddite. While unemployment may rise in the short term, the counter-argument goes, these laid-off workers will eventually find new jobs. The end result is a richer economy that better suits our demands.
In this blog post, however, I argue that secular stagnation could make the Luddite argument valid. My reasoning is this: as economies grow richer, the gap between saving and borrowing at full employment inevitably widens. But unlike in previous times, interest rates are already close to 0%, and so the central bank can’t lower rates further to close this spending gap. As a result, any future gains in productivity translate into higher unemployment (or lower participation rates).
A neutral monetary system, instead, ensures that inadequate demand is never a problem. Technological advance may well cause supply side problems such as skill mismatches, but under neutral money, it would never cause demand-driven unemployment. As a result, the supply side can adjust free of encumbrances, and we can continue on our beloved path of productivity improvements without fear of economic repercussion.
Emerging markets would have a clearer path to prosperity
Neutral money can also facilitate the flow of savings from rich countries to poor ones. While it’s true that many poor countries face real problems (i.e. supply-side problems), they also face significant monetary issues, especially high inflation. By adopting neutral money, however, these third world countries would be just as stable as developed ones, and so domestic savers would be much more inclined to chase higher rates abroad, rather than sit on low or even negative ones at home. As a result, emerging economies would be able to escape poverty with the full force of rich-world savings behind them.
The added bonus would be that secular stagnation would no longer be an affliction, but a great global boon. With the US, the UK, Europe, and Japan’s full employment economies generating far more savings than they can employ, third world countries could grow with much greater velocity than before. In return, domestic savers receive positive, instead of negative, interest rates at home. And so, far from leading to negative interest rates, neutral money could bring us positive interest rates for longer.
Could neutral money be implemented now?
Neutral money is undeniably a radical proposal. That said, it is politically agnostic. Neutral money should appeal to both sides of the political spectrum. The left will like the fact that the economy can never deviate from full employment, while the right will appreciate that this outcome is achieved entirely through market forces. The right will also appreciate the permanent end of inflation.
So politically, the theory should have broad appeal. The radicalness instead stems from the necessary change to peoples’ lives. Because of money expiration, everyone will have to pay more attention to their finances. No longer will we be able to save simply by leaving money in a current account or under the mattress. This change is radical enough that, barring the most severe and prolonged economic calamity, it is unlikely that a democratic government will ever convince its citizens to adopt this system.
That doesn’t mean, however, that we should discard it. To simply fall back on the response I’ve received from certain readers — “no one will agree to money expiration so forget it” — is both too easy and a disservice to those who may be helped by the new system.
Instead, we should ask ourselves whether we can all agree that neutral money comes with these benefits. If we do, the next step should be to figure out how to make the system work for everyone involved. This essentially means developing technologies that make coping with expiration simple and hassle free. For instance, we need software that allows for one-click saving and borrowing, or even adaptive software that learns from our behaviour and saves automatically on our behalf. In my book, I list a few promising technologies on the horizon. We need more. And more debate. The sooner we start, the sooner we’ll finish.