Sovereign Money



I believe we need to transfer the power of money creation from commercial banks to the state. 

The purpose of this is to prevent further economic crises and direct all new money towards the real economy, which encompasses the businesses that provide goods or services that the majority of people use or consume regularly.

The way in which economic crises would be prevented would be that all bank deposits would be backed by reserves. At the moment we have a fractional reserve system, which allows commercial banks to create money without having an equal amount of reserves to back it. This can lead to economic instability when the banks do not make smart lending decisions.

Money will be directed towards the real economy by way of government spending. When money goes into the real economy its effects are multiplied as it gets passed round, and this is good for productivity. Also, taxes will be able to be reduced because government spending will be funded in part by the state’s own power of money creation.

What is Money?

According to the Bank of England (BoE) there are three main types of money:

  • Currency (notes and coins) (Feb 2019 – £82bn outstanding) (Bankstats table A1.1.1)
  • Central Bank Reserves (what the banks use to settle balances between themselves) (Mar 2019 – £474bn outstanding) (Bankstats table B1.1.2)
  • Bank Deposits (the numbers you see in your bank account) (Jan 2019 – £2,332bn outstanding) (Bankstats table A2.2.1 M4 minus table A1.1.1 notes and coin)

The BoE states the 3 functions of money as being:

  • Unit of account
  • Medium of Exchange
  • Store of Value

How Money is Created


  • Notes are issued by the Bank of England.
  • Certain banks in Scotland and Northern Ireland have the authority to issue their own notes. These must be backed by Bank of England notes and/or UK coins and/or Bank of England deposits.
  • Coins are issued by The Royal Mint.
  • Since 1931 UK currency has been fiat money, meaning it is not convertible into gold or any other asset.

Central bank reserves

  • These are created by the BoE. Of the £474bn of central bank reserves, £418bn were created as part of the Quantitative Easing program and a further £10bn as part of the Corporate Bond Buying Scheme.

Commercial bank deposits

  • These are created by commercial banks when they make loans.

UK Money Supply 1844-2016

Source: Bank of England, A Millennium of Macroeconomic Data for the UK

This graph shows that in 1971 there was a significant change in the ability of banks to create money.

Competition and Credit Control 1971

Competition and Credit Control was a deregulation policy implemented in 1971 in order to increase competition across the financial sector. It involved decreasing the liquidity requirements of financial institutions by putting in place a single reserve ratio acros the whole sector.

The authorities, for their part, propose that the impediments to competition arising from the existing liquidity and quantitative lending controls should be replaced by other means of influencing bank and finance house lending in sterling, including the application of a reserve ratio across the whole banking system.

Text of a consultative document issued on 14th May 1971 as a basis for discussion with banks and finance houses, Bank of England

There had been no such freedom in living memory, and, with the benefit of hindsight, the authorities – notably at the Bank of England, and including myself then working as a monetary economist there – failed to anticipate what would happen.

Charles Goodhart, 13 March 2019
The London Institute of Banking and Finance

As Charles Goodhart says, the consequences of this policy were not predicted. However, the massive acceleration in money creation has never been slowed since this policy was put in place.

How Money is Created part 2

This is the first page of a document published by the BoE in 2014. The bullet point I want to focus on is the third one, which states, ‘The amount of money created in the economy ultimately depends on the monetary policy of the central bank.’

This is, I think, a misrepresentation of the significance of monetary policy.

Bank Rate

These graphs juxtapose the official BoE bank rate with the money supply over a period from 1982 to current times. Unless the purpose of the bank rate is to maintain a constant growth in the money supply, it doesn’t appear that the bank rate has much effect on the money supply.


Bank rate data: Official BoE Bank Rate history

M4 money supply data: Monthly amounts outstanding of M4 (monetary financial institutions’ sterling M4 liabilities to private sector) (in sterling millions) not seasonally adjusted LPMAUYM

Statements Against the BoE’s Position on Monetary Policy

Former governer of the BoE Mervyn King has this to say about monetary policy:

The Bank of England’s key role has always been to ensure that the economy is supplied with the right quantity of money – neither too much nor too little. For fifty years, my predecessors struggled to prevent there being too much, so leading to inflation. I find myself in the opposite situation having to explain that there is too little money in the economy.

Mervyn King, Speech to Black Country Chamber of Commerce, 2010

Andrew Jackson and Ben Dyson say this about the BoE’s tool of setting the bank rate to control inflation:

…the empirical and theoretical work suggests that interest rates are an ineffective tool for limiting demand and therefore inflation.

Andrew Jackson and Ben Dyson, Modernising Money, 2012

Lending by sector

This graph shows how the money created by banks is split amongst the different sectors in the economy. The majority of the money creation is directed towards the property market. This is why house prices rise faster than wages. Second to the property market are financial corporations. Both the property market and financial corporations are non-productive, yet they have the benefit of the majority of banks loans being directed towards them.

Source: Bank of England statistics released March 1 2019

Average House Price 1968-2019

To prove the suggestion above that large amounts of money being directed towards the property market push up house prices, here are graphs of money supply and average house price from the late 60s to current times.

m4 to house price graph


Reform Proposals

Monetary and banking reform have been proposed from as far back as 1935, when the American economist Irving Fisher pointed out that the reason for the Great Depression was the ability of the commercial banks to create money with only a fraction of it being backed by assets. This is the fractional reserve system that most countries follow today. The devastating consequence of this system is that it is as easy for money to be destroyed as it is for money to be created. All that needs to happen for the money supply to shrink is that banks fail to make new loans as old ones are repaid.

In the following quote he is saying that had a system where all money was backed by reserves been in place, it would not have been possible for the money supply to so drastically decrease during the Great Depression.

100% Money, Irving Fisher, 1935

“The public was forced to sacrifice 8 billion dollars out of 23 billions of the main circulating medium which would not have been sacrificed had the 100% system been in use. And, in that case…..there would have been no great depression.”

This next quote is from Steve Baker MP. He organised a debate in 2014 in parliament about the issue of money creation. He has promoted Irving Fisher’s proposal of a 100% reserve system on the Cobden Centre website.

Bank Reform Demands Monetary Reform, Steve Baker MP, ~2013

“This crisis first emerged in banking. We were then told it was a debt crisis. Shortly, it will be generally realised that most money is created as debt and therefore this is a monetary crisis. Bank reform will then properly become a matter of monetary reform. Any plan for bank reform must therefore also be a plan for monetary reconstruction.”

The next quote is from Andrew Jackson and Ben Dyson and gets to the heart of issue succinctly.

Modernising Money, Andrew Jackson & Ben Dyson, 2012 p23

“The years following the recent financial crisis have clearly shown that we have a dysfunctional banking system. However, the problem runs deeper than bad banking practise. It is not just the structures, governance, culture or the size of banks that are the problem; it is that banks are responsible for creating the majority of the nation’s money.”

How money would enter the economy under National Money

  • The Bank of England would create money to fund government spending.
  • A reformed Monetary Policy Committee would calculate appropriate amounts of money to provide to the government in order for it to achieve pre-established goals. The Treasury Select Committee would have oversight of the process.
  • Helicopter drops could be used to stimulate the economy. The accounts held by the public at the BoE would facilitate these. Alternatively, taxes could be cut.
  • If money needed to be taken out of the economy, taxes could be raised.

Current Accounts

Current accounts would differ under National Money mainly by the fact that the balances would be backed by 100% reserves. This would mean that if a bank failed, all the current accounts could be easily transferred to a healthy bank, with no need to bail out the failing bank.

Because these accounts would be 100% backed by reserves, they would earn no interest. This would likely result in the commercial banks charging for even basic current accounts, to cover administration costs. The ability of every citizen to hold an account at the BoE would prevent the exclusion of people who couldn’t afford the fees charged by commercial banks.

Savings Accounts

Under National Money, savings accounts would be slightly different than they are now. They would no longer be covered by the Financial Services Compensation Scheme (FSCS), which insures balances up to £85,000. The reason for this would be that if anyone wanted to not risk their money they could put it in a current account, which would be backed by 100% reserves.

It could be mandated by legislation that banks offering savings accounts offer varying types of savings accounts, such as accounts of which the funds are only invested in certain types of businesses or certain sectors. Some investment houses already offer ethical investment options.

The Switch

  • The switch would occur on the balance sheets of the commercial banks and the Bank of England.
  • People and businesses would see no practical changes in the way they use their current accounts and debit/credit cards.
  • Savings accounts would either be changed into current accounts for the money to be re-invested, or the funds would be transferred into new ‘default’ savings accounts, with the option to move the funds into the preferred type of savings account.

Previous Examples – Zimbabwe

Zimbabwe under Mugabe was an example of how money creation by the state can lead to economic disaster.

  • In 1997 Mugabe increased pensions for war veterans who fought for the independence of Zimbabwe.
  • He also committed troops to the conflict in the Democratic Republic of the Congo in order to protect mining operations, in which the Zimbabwean elite had invested.
  • At the same time he began confiscating land from white farmers.
  • The first two of these increased expenditure and the third decreased productivity and thus tax revenue.
  • The confiscation of land caused several consequences:
  • Foreign investors left. By 2001 foreign investment was zero.
  • The non-enforcement of land titles removed a source of collateral for bank loans, reducing the amount of lending to farmers. This caused a drop in farm productivity.
  • Farmers who were evicted were unable to pay back loans. This combined with a loss in income from new farm loans caused dozens of banks to collapse, affecting the wider business community.
  • The elites cherry picked the best land.
  • Commercial farmers left and crop yields fell, resulting in famine.
  • Land values fell, causing much of Zimbabwe’s wealth to disappear.
  • In 2001 the Government defaulted on its loan from the IMF.
  • Food needed to be bought from abroad because of the drop in agricultural production, but the Government could not get loans because its creditworthiness was bad as a result of the defaulted IMF loan.
  • The Government then started issuing its own currency and using it to buy US dollars.
  • This led eventually to hyperinflation in 2007 (50% increase in prices each month). The hyperinflation peaked in 2008 at 79.6bn% per month.

Previous Examples – Guernsey

The money creation that the Guernsey state did was an example of how money creation by the state can unlock productivity in an economy and increase the wellbeing of the people.

  • In 1815, after the Napoleonic wars, Guernsey had economic troubles.
  • Annual tax revenue was £3,000 and annual interest payments on government borrowing were £2,390.
  • It was consequently agreed that £4,000 was to be created by the state to pay for roads and a monument to the deceased governor, General Sir John Doyle.
  • After the £4,000 was created, more was created to finance the building of a marketplace and many further projects.
  • Around 1826 the Bailiff of Guernsey, Daniel de Lisle Brock, said that the new money caused no inconvenience because of the care with which it was issued.
  • In 1830 a new bank, The Commercial Bank, was founded. Along with the old bank, this bank began issuing its own currency.
  • In response to this, in 1836 de Lisle Brock gave a speech in which he said, “…we must realise the necessity of limiting the issue of paper money to the needs and customs, and the benefit, of the community in general. Permission cannot be granted to certain individuals to play with the wealth and prosperity of society.”
  • Inexplicably, de Lisle Brock eventually agreed, at the request of the commercial banks, to limit the state’s issuance in circulation to £40,000, cease further issuance, and withdraw £1,500 from circulation.

Source: How Guernsey Beat the Bankers, Edward Holloway 1981

An Opposing Argument

There are opposing arguments to the type of reforms suggested here. Here is an excerpt from a speech given by Thomas Jordan, Chairman of the Governing Board of the Swiss National Bank.

…it would be naive to hold out too much hope on the financial stability front. Investors and borrowers will always make misjudgements. A switch to sovereign money would thus not prevent harmful excesses in lending or in the valuation of stocks, bonds or real estate. Also, while the sovereign money initiative targets traditional commercial banks, let us not forget the role played by ‘shadow banks’ in the global financial crisis of 2008/2009. More importantly, when governments and central banks were rescuing systemically important financial institutions, they had not only the protection of sight deposits and thus payment transactions in mind, but also borrower-lender relationships. They feared that if systemically important financial institutions were to suddenly fail, financial sector lending might collapse and the economy implode. So the sovereign money initiative, with its focus on payment transaction accounts, does not resolve the ‘too big to fail’ issue. Regulatory adjustments, of the kind that are already being implemented, offer a better solution.

Thomas J. Jordan
Chairman of the Governing Board
Swiss National Bank, 2018

He says that switching to a sovereign money system [such as National Money] would not increase economic stability because misjudgments will still happen, and it would not prevent harmful excesses in lending or valuations. Misjudgments will happen under any system. But the harmful excesses have been driven largely by the ability of commercial banks to create money. The graphs above showing the correlation between house prices and the money supply display this. Removing this ability would remove the major driver of harmful excesses. This also relates to the issues with the shadow banking sector. This sector had problems because it was trading in the mortgages issued by the main commercial banks. If these banks no longer had the ability to inflate housing bubbles, this would help prevent the shadow banking sector finding itself with bad assets.

Jordan goes on to mention the lender-borrower relationships, which he says need to be taken into account in any reform. This is true. But if systemically important financial institutions fail and credit dries up, the BoE has the ability to find solutions. For example, it could provide low or zero interest funding to the remaining banks, with the requirement that they lend it on.