50.4 In-place monetary-system conversion

In the following, we describe an approach to converting an existing system using its existing currency and central bank. We will use the U.S. system as an example. Its central bank is called the Federal Reserve (the "Fed"). The Treasury has an account at the Fed called the Treasury General Account (TGA). This currently cannot go into overdraft.

The following steps are taken (incrementally where appropriate to avoid shocks):

  • The Government cannot issue new bonds.
  • As existing bonds mature, the debt is paid from the TGA.
  • Only the TGA can go into overdraft. The overdraft is permanently capped. The cap is specified in the constitution and set high enough to allow existing government debt to be repaid as it matures and the budget to be brought into balance gradually, without shocking the system.
  • Anyone can hold accounts at the Fed.
  • Any account owner at the Fed can send a positive amount to any other account provided the transfer does not make the sending account negative, except that the TGA may draw on its authorised overdraft up to the constitutional cap during the transition.
  • Commercial banks must honour demand-deposit withdrawal requests by transferring the requested amount at face value from their own Fed accounts to the depositors' Fed accounts, reducing the corresponding deposit liabilities by the same amount. This obligation does not confer a public guarantee or a right to newly created currency if a bank cannot pay.
  • Commercial banks must accept Central Bank currency at face value in payment of debts denominated in that currency, reducing the debtor's obligation by the amount paid.
  • All accounts at the Fed, including the TGA, have zero interest. These balances resemble holdings of a commodity such as gold: possession alone earns no interest. This does not set interest rates on loans, which are determined freely by lenders and borrowers in an unfettered market.
  • The Fed cannot buy or sell assets.
  • The Fed cannot lend or borrow, except for the authorised transitional TGA overdraft.
  • The Fed plays no role in interbank loans.
  • State protection of commercial banks, including government guarantees on deposits, is withdrawn.
  • Bank-specific regulation is withdrawn.
  • The implementation of the Fed is converted to a robust, high-performance distributed system supporting millions of transactions per second.

Complete the transition to a fixed currency supply

The capped TGA overdraft is a transitional financing arrangement, not a permanent feature of the monetary system described in Chapter 15: Monetary system. The constitution specifies the conditions for ending this authority once existing government debt has been retired and the budget brought into balance. The cap cannot be raised during the transition. Until the authority ends, receipts can restore overdraft headroom, so the cap alone does not establish a fixed currency supply.

At completion, the transitional overdraft authority expires permanently. Any remaining TGA overdraft and the Fed's corresponding claim are extinguished together as internal public-sector accounting entries, without changing anyone else's currency balance. This treatment must be expressly authorised by the constitutional transition provisions. Thereafter, every account, including the Treasury's, must remain non-negative, and government payments transfer existing currency rather than create it.

Resolve legacy assets and physical currency

The prohibition on buying and selling assets stops new monetary-policy operations. Existing assets must also be resolved under the transition provisions. Treasury securities held by the Fed are retired with the other outstanding government debt. Remaining loans and other claims are transferred to a separate public wind-down account outside the Central Bank before the fixed-supply arrangements take effect. Subsequent repayments transfer existing currency to that account; they do not extinguish currency. Borrowers' contractual obligations remain unchanged.

Physical dollars are exchanged at face value for electronic Central Bank balances over an announced conversion period. Notes surrendered by the public or banks are cancelled as the corresponding accounts are credited, so conversion does not duplicate currency. The transition provisions must specify the treatment of notes not presented by the deadline before the final electronic supply is fixed. Once conversion is complete, Central Bank currency exists only as electronic balances.

Direct Fed accounts alongside commercial-bank deposits

The existing dollar remains the currency. People gain the option of holding dollars directly in Fed accounts rather than as claims against commercial banks. Central Bank currency and commercial-bank deposits can coexist. Banks remain free to make loans and issue dollar-denominated private liabilities, but these are not Central Bank currency.

Exchanging deposits for Central Bank currency with another person merely changes who owns the deposits. Repaying a bank loan with deposits extinguishes them. If a bank itself redeems a deposit in Central Bank currency, it cancels the deposit and pays currency it already holds. A bank's contractual obligation to repay a dollar-denominated deposit remains, but there is no public guarantee that it will be able to do so. A claim against a bank may trade at a discount reflecting its risk; this is a valuation of the claim, not an exchange rate between two sovereign currencies.

Tax-funded UBI payments into Fed accounts and their use in taxation and commerce encourage adoption of direct Central Bank balances. Unlike the founding distribution in 50.3 Monetary-system conversion, this approach does not create a new currency through UBI issuance. UBI redistributes tax receipts. As customers switch, banks have a commercial incentive to offer services and arrange loans settled in Central Bank currency. They can obtain currency from savers, investors, loan repayments or asset sales. Private bank liabilities may lose acceptance or trade at a discount, encouraging banks to rely less on them. Banking and credit continue, while the change is driven by customer choice and competition.

Is the conversion inflationary?

The permanent TGA cap and eventual fixed currency supply prevent continuing monetary expansion from driving long-term inflation, making Central Bank currency more attractive as savings.

Households should not have to learn how to invest merely to preserve their savings. Central Bank currency lets them hold money directly, without commercial-bank default risk or, after the transition, dilution through further issuance.

As the economy grows against a fixed currency supply, the currency's purchasing power would tend to increase, encouraging people to save. Holding larger balances rather than spending them exerts deflationary pressure: less money is actively chasing goods and services.

Government bondholders are expected mostly to carry their savings over into Central Bank currency. Repayment changes the form of their savings, not their intention to save. Replacing bonds with spendable balances therefore need not produce a surge in spending or inflation.

Government should manage inflationary and deflationary pressure through the balance of spending and taxation. Taxing more than it spends withdraws currency from circulation; spending more than it taxes returns currency to circulation. Under the fixed-supply system, deficits must be funded from accumulated government balances, so this policy redistributes existing currency rather than creating more.

Phase out protection and regulation

During the transition, both State protection and bank-specific regulation are phased out smoothly according to a predetermined schedule. Deposit guarantees, compulsory acceptance, guaranteed conversion rates, lender-of-last-resort support, and taxpayer bailouts are progressively withdrawn. Capital requirements, reserve requirements, lending limits, and other regulations intended to control risks ultimately borne by the State are reduced in parallel.

At the end of the transition, commercial banks receive no special protection from the State and are subject to no bank-specific regulation. Subject to the ordinary laws applying to everyone, including contract, property, fraud, and insolvency law, they may choose their own capital and reserves, lend as much as they wish to whomever they wish, and accept whatever risks they wish.

Applying the conversion in Australia

The same conversion approach applies to Australia, retaining the Australian dollar. The Reserve Bank of Australia (RBA) takes the place of the Fed, and a designated Commonwealth account within its Official Public Account (OPA) arrangements takes the place of the TGA. The monetary steps described above are otherwise the same; implementation would require corresponding changes to Australian law.

Applying the conversion in the United Kingdom

The same monetary approach applies to the UK, retaining sterling and using the Bank of England in place of the Fed. A designated Treasury account within the Exchequer arrangements would take the place of the TGA. The UK already has a government overdraft mechanism, the Ways and Means facility for advances to the National Loans Fund; it would need to be brought under the proposed cap and permanent expiry rules.

There is an additional constitutional issue: under parliamentary sovereignty, future Parliaments can change existing legislation. Entrenching the monetary constraints against ordinary legislative reversal would therefore require a new constitutional settlement.

Central Bank currency will displace bank deposits as money

The following features give people strong reasons to move their savings and everyday payments from bank deposits to Central Bank currency.

  • Banks cannot force people to use their deposits. The explicit rules require banks to redeem demand deposits into customers' Central Bank accounts and accept Central Bank currency in repayment of debts denominated in that currency.
  • Taxes are collected in Central Bank currency, giving taxpayers a direct reason to obtain and hold it.
  • UBI is paid in Central Bank currency, putting it directly into recipients' accounts for saving and spending.
  • Constitutional commerce requires Central Bank currency, giving people a reason to receive and use it for everyday transactions.
  • Bank deposits become unprotected and carry bank default risk. Central Bank currency carries no issuer-default risk, so people can hold and spend it without lending their money to a bank.

Ultimately, demand deposit accounts are expected to see little use as people hold their monetary balances directly at the Central Bank, ending commercial banks' role as the account providers through which everyday commerce must pass. Their function would migrate towards lending existing Central Bank currency as financial intermediaries between savers and borrowers. Banks cannot create Central Bank currency when extending credit: the payment system permits them only to transfer currency they already hold. As their deposits cease to circulate as money, banks would lose the ability to fuel asset bubbles through the creation of widely accepted deposit money. Removing this source of credit expansion is expected to substantially reduce banks' power over the economy and the severity of booms and busts.