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Switzerland’s weird and wonderful proposal to blow up commercial banking has some merit

Switzerland’s thriving form of direct democracy sometimes takes the wealthy little country in peculiar directions. Don’t want Swiss mosques studded with minarets? Hold a national referendum to try to get them banned, which is what happened in 2009 – no more minaret construction. A more recent vote on providing a universal guaranteed income did not pass.

Next up? On Sunday, the Swiss will, in effect, vote on whether to dismantle their traditional commercial banking system. If it passes, the referendum would trigger a structural banking upheaval like one never seen in postwar Europe. While the so-called Vollgeld (sovereign money) plan is unlikely to win, it’s a bold and intriguing idea on how to end bank crises like the one that nearly felled the global financial system a decade ago.

Members of the sovereign money initiative, a referendum campaign that would abolish traditional bank lending and allow only money created by the central bank, clean up after spraying a slogan on a wall in front of the Swiss National Bank in Bern on April 27, 2018. The slogan reads ‘Dear Swiss National Bank, please remember why we founded you.’

Denis Balibouse/Reuters

Swiss commercial banks shudder at the thought of Vollgeld, which can only mean the referendum is not frivolous. What’s bad for the banks is not necessarily bad for society.

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Vollgeld, in essence, would kill off the commercial banks’ near-monopoly on the creation of electronic cash and hand that job in its entirety to the central bank, in this case the Swiss National Bank (SNB), which already has a monopoly in the creation of paper money and coins. If passed, the Vollegeld would convert deposits at commercial banks into claims at the SNB.

How is money made? Commercial banks do so by extending loans. Suppose you want to buy a Jeep for $40,000. You go to your bank and negotiate a car loan, with the Jeep itself as collateral. The bank credits your account electronically – out of thin air – with $40,000; that amount is plunked into your account and is the bank’s liability to you. At the same time, the amount becomes the bank’s asset, based on the assumption that the loan will be paid back, with interest. The cash is transferred to the Jeep dealer’s account and – voila! – new cash is made and you have a new car in your driveway.

But here’s the catch: “Sight” deposits at commercial banks, that is, the bank liabilities that can be withdrawn immediately by you without penalty, are only partly backed by reserves. The so-called fractional reserve banking system works really well – until it doesn’t.

Problems arise when a bank crisis hits and all depositors want their money back at once – a potentially crippling bank run that often requires a bailout at great cost to the taxpayer and to the economy (the British government was forced to nationalize Royal Bank of Scotland - briefly the world’s biggest bank - during the 2008 financial crisis, and remains its majority shareholder).

The proponents of Vollgeld call their plan “crisis-resistant” money because these sight deposits at commercial banks would become the wards of the central bank – no more fractional reserve banking, no more bank runs. The central bank would have total control over money creation and money supply. Money would be rock solid.

It sounds good in theory, when you consider that banks are distressingly accident-prone. According to the International Monetary Fund, there were 147 individual bank crises between 1970 and 2011, many of which came at gruesome cost to the taxpayer. No wonder the concept of sovereign money pops up now and again and is fairly popular among a large minority of Swiss voters, according to the polls. In 2015, seven years after Iceland’s banks were flattened by the financial crisis, a senior Icelandic parliamentarian suggested a sovereign money system, but the idea went nowhere.

The Swiss banks make the entirely valid argument that sovereign money would inflict terrible wounds on the economy, because small and medium-sized businesses would have trouble finding credit (the big companies could get it anywhere on the planet). Sovereign money might also make monetary policy difficult, because the SNB would have to target money supply growth, a delicate exercise, rather than using interest rates to control the demand and supply of credit. The SNB does not support Vollgeld.

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But perhaps the main reason why Vollgeld will, and should, get voted down is that the launch of sovereign money would trigger the rise of a shadow banking system – financial services companies outside the formal banking sector that often are lightly regulated and therefore risky. Shadow banking includes hedge and private-equity funds, insurance companies and trusts that, for an often-hefty price, will supply credit. China’s shadow banking system is enormous and the source of great anxiety among the country’s regulators.

In other words, the sovereign money would end one big problem – bank crises – and introduce another big problem, namely a thin supply of bank credit and the rise of potentially risky non-bank lenders. Economies need credit to function and to expand - and borrowers will find loans wherever they can.

While sovereign money certainly has its attractions, here’s a better idea: Regulate the banks more tightly to minimize the chances of blow-ups. That means measures such as stronger capital requirements, preventing banks from making market bets with their own money, greater transparency and executive pay packages that reward prudence. But a few countries, notably the United States under the Donald Trump presidency, are trying to roll back regulations that were designed to stop Wall Street’s riskiest practices.

That’s setting the stage for more blow-ups and, once that happens, the notion of sovereign money will make a comeback. Bravo for Switzerland for considering it. The country may be ahead of its time.

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