A surprising new IMF research paper entitled The Chicago Plan Revisited by Jaromir Benes and Michael Kumhof is making waves in economic circles, especially with monetarists. The paper suggests that the world would be much better off if we adopted a system where the banks did not create our money. So, instead of a system where more money is only created when more debt is created through the money-multiplier effect, we would have a system of debt-free money that is created directly by the central government. There have been others that have suggested such a system before, but to have an IMF research paper actually recommend that such a system be adopted is a big deal.
One of the fundamental problems with our current financial system is that it is based on debt. Just take a look at the Indian monetary system. The way our system works today, the vast majority of all money is created either when we borrow money from a bank or the central government borrows money. Therefore, the creation of more money creates more debt. Under such a system, it should not be surprising that the total amount of debt of the Indian government has increased more than 3.5 times in the last decade.
The IMF economists argue in the paper that we dont have to do things this way and that there is a better alternative. The central government can directly issue debt-free currency into circulation. For instance, if the central government spent debt-free money into circulation, it could conceivably never need to borrow a single rupee ever again. If the government wanted to spend more money than it brought in, it would simply print it up and spend it. In a way, the IMF model corroborates the Quantitative Easing programmes that the US government has carried post-crisis. While it is interesting to read the arguments for and against by monetarists, and healthy debates are always welcome if they help understand our financial system better, they seem to be missing an obvious lesson from history.
Most do not or try not to recall German history before the ascent of the Nazi Party, Third Reich and Adolf Hitler in 1933. Maybe because holocaust is a taboo word or that mentioning the genocide of six million Jews is considered impolite, even in India. However, there is a small history lesson that is pertinent to current timesthat of the Weimar Republic that existed between 1919 and 1933. The Republic comprised predominantly of present day Germany and parts of neighbouring Poland. The Republic was formed after the German Revolution of 1918-1919 and the subsequent military surrender in World War I and existed till the Third Reich was proclaimed in 1933. The Weimar Republic tried to do something similar to what the IMF economists are suggesting in their paper.
After World War I (1914-1918), inflation was growing at an alarming rate in the region, and to pay the bills the government simply printed more and more currencyGerman Papiermark. To see how bad the inflation was, consider this. In 1919, one loaf of bread cost 1 Papiermark. By 1923, the same loaf of bread cost 100 billion Papiermark. Annual inflation was 50,000%. On average, in a day prices increased by more than 100%, i.e. prices doubled daily.
Workers were striking and the government paid them benefits so as to suppress unrest. The Republic had no goods to trade and it printed money to deal with the crisis. This meant payments within the Republic were made with worthless paper money, and helped formerly great industrialists to pay back their own loans. Circulation of money rocketed, and soon banknotes were being overprinted to a thousand times their nominal value. Over two hundred factories were working full-time to produce paper for spiralling banknote production and every town literally had its own money producing factory so that transportation cost of money wasnt too much. There was an old joke from those hyperinflation days that if you left a briefcase full of Papiermark sitting around in the Weimar Republic, thieves would take the briefcase and they would leave the money behind. The value of the currency had declined from 4.2 per US dollar at the outbreak of World War I in 1914 to 1 million per dollar by August 1923.
Benes and Kumhofs suggestion is not without its merits but it hinges on one key assumptionthat the government would be restrained in printing currency, unlike the Weimar Republic. Recent US history, especially after the Quantitative Easing programmes, seems to suggest otherwise. The IMF economists may believe that they can prevent the next great collapse from happening by implementing this new monetary framework, but history suggests that the suggested framework would only make the collapse in that monetary regime far worse.
The author, formerly with JP Morgan Chase, is CEO, Quantum Phinance