Living in Switzerland, one of the local oddities is the quarterly referenda on every conceivable topic. In the highly decentralised Swiss political system, voters are frequently asked to resolve policy debates that the weak and uncoordinated central institutions can't or won't deal with. The frequency of referenda, however, means that voter engagement is extremely low and the whole process lies open to manipulation by niche interests. The next vote is scheduled for June 10, and the top issue is a constitutional amendment on "pleine [or 'Sovereign'] monnaie". Yes, folks, modern monetary theory (MMT) has arrived in Switzerland and given my previously expressed scepticism towards MMT, it's time to take a look at what that looks like practice. 

In 2015, the allegedly non-partisan "Vollgeld Initiative" collected the required 100,000 signatures necessary to put a constitutional amendment directly to voters. The way this is being gone about is quite simple, and rather clever. The Swiss constitution, like many others around the world, establishes a National Bank (the 'SNB') with the sole authority to issue coins and banknotes. Among other minor changes, the proposed amendment inserts 'and electronic money' into the relevant clause of the Constitution. The change may be minor, but the implications for the Swiss monetary and financial system are most definitely not. MMT proponents have found a neat trick: pose simultaneously as defenders of the original intent of the constitution by protecting the Central Bank's monopoly over the creation of money and as reformers who are just 'updating' the constitution to deal with the modern era of electronic finance. 

Sovereign Money and Horizontal Money

In order to know what this seemingly minor change would mean in practice, it's important to know how the money supply is defined. Physical notes and coins (the M0 money supply) represent only a fraction of all currency in circulation; much more is held as bank deposits or loans which are recorded electronically (the M1/M2 money supply). MMT proponents are closely related to monetary circuit theorists (MCT), who describe how private banks increase the supply of "horizontal money" in the economy by issuing loans and creating debt: since both the amount loaned and the debt are units of exchange and account, they are currency. All forms of the same currency are convertible into one another, and under fractional reserve banking financial institutions can loan out (read: create money) in multiples of the deposits or other assets it holds (up to regulatory limits). So long as all its debts aren't called due simultaneously, the system expands the supply of capital and thus economic activity. 

So far, so good. Fractional reserve banking is an established practice with well appreciated risks. Risks that regulators try to manage by imposing reserve requirements and capital adequacy ratios. Can this be done better? The evidence of the Great Recession suggests undoubtedly so. Are there historical precedents for centralising control of money creation to alleviate financial risks? Absolutely: in the middle ages (and still in Scotland today!) banks commonly issued their own bank notes, a function which modern central banks took over for good reason. But the Swiss Sovereign Money initiative goes much, much further. If the central bank has a monopoly on the creation of 'electronic money', then fractional reserve banking would cease to exist (although it would no doubt be resurrected in more opaque and risky forms). Instead, if a bank wanted to issue a loan to a business or investment, it would have to rely on its own deposits or (and here's the kicker) borrow from the central bank, which would create 100 per cent of money which the bank loans out.

From an accounting perspective, transactions appear largely the same under either system; but the risk inherent in expansionary spending is transferred from the balance sheet of the bank to the balance sheet of the central bank, and thus the state. All debt - both public and private - would then carry sovereign or public risk. Now, given the post-GFC bank bailouts and the political imperative to stabilise the economy when the banking sector crashes it, it may be true that horizontal money is in some sense always a liability for the state. Sovereign Money would make that implicit assumption explicit and unavoidable. But if your policy concern is the risks posed to people's livelihoods by the selfishness of the finance sector, then your problem is with capitalism - not they monetary system. Changing the latter does nothing to alleviate the risks posed by the former. 

MMTs true face?

I've said before that there is a vast disconnect between the theory of 'modern' money (which is interesting) and the sorts of policies its proponents advocate. If MMT is just a description of how horizontal finance operates, then why is it being outlawed by constitutional amendment? If sovereign money means governments can already create and spend money more than present, why is a radical restructuring of the finance sector necessary to allow that to occur? The Swiss initiative is rolling out all the usual MMT canards in an effort to sway voters: sovereign money means more spending for things like a UBI, lower taxes, more jobs or more infrastructure [take your pick]! The SNB has called out the Initiative's backers for advocating the funding of public spending through seignorage - exactly the issue I highlighted in my previous blog post on MMT. 

The Swiss initiative is also playing a dangerous game with populist and nationalist talking points. One of the campaigns key slogans is that voters want 'real francs', not merely promises to pay from banks. Rather than educating voters about the complexity of the financial system, the Initiative aims to force finance to behave in accordance with the naive picture voters have of it in their heads. The Initiative is also obsessed with talking about debt, which is an odd position for a economic movement which tells policy makers to massively expand public spending. Voters are being told that sovereign money will 'eliminate' private debt [which sits at more than twice GDP] - which is true only in a very technical sense. Private debt isn't a risk if [most] businesses that are lent to remain solvent and have the ability to repay their loans over time. The Initiative is weaponising conservative talking points to pursue a policy that would socialise private debt and give Switzerland a higher public debt-to-GDP ratio than Greece. 

Best Case Scenario

The best case scenario for Sovereign Money is that it works as advertised and that the disruption to the Swiss monetary system is primarily technical. As a result, the SNB would become the dominant actor in the economy, with vast powers to set the direction of economic and fiscal policy by deciding which economic activities are funded and on what terms. Swiss debt would be 100% backed by the state's printing presses, making the country an attractive destination for foreign capital fleeing systemic risks in the global economy. Banks would be almost totally prevented from adding to systemic economic risks on their own, with the caveat that those risks would be distributed throughout the economy and depend almost entirely on consumers (and international money markets) continued faith in the value of the Swiss franc. 

Now, I'm all in favour of a heavy regulatory hand on banks, and a public option for private banking, but jumping immediately from laissez-faire finance to central economic planning is a bit too much of a leap, even for me. The central bank, and by extension the government, would own all debt - for both good and ill. Anything and everything that goes wrong in the economy will be the state's responsibility, by definition. Whether the economy performs well or performs badly will be seen rightly, as a judgement of whether the government has lent too much or too little. And yet, capitalism and all its structural flaws would remain in place. As I've said before, Sovereign Money is not a panacea that let's us make an end-run around the actual hard work of regulating and reforming capitalism. As the Keynesians discovered in the 1970s, if your only policy tool for managing a downturn is inflation, you're going to eventually encounter a catastrophic collapse of economic activity. 

Worst Case Scenario

The worst case scenario, to me, would appear more likely. Like most government agencies under capitalism, the Central Bank would not use its new powers to tame private markets for the good of voters, but instead become captured by private interests and use its powers in furtherance of private agendas. No government will be able to say no to printing the funds for whatever project enters a key constituency's fancy; banks, in turn, would enjoy unrestricted and completely risk-free access to the public's piggy bank in order to pursue their own private profits - including investing overseas, offshoring local manufacturing or by buying up highly risky or speculative asset classes. In effect, a Sovereign Money system would formalise the kind of developmental capitalism that is still prevalent in some parts of the world where big businesses enjoy privileged or corrupt access to public funds and use those funds to invest in capital-intensive projects of self-aggrandisement with little or no assessment of its benefits for national productivity. And when such projects fail, as some always must, or drive up inflation without producing sustainable economic activity, it's the state that's left to clean up the mess. 

A run on a bank may collapse that bank, if it has structured its debts unwisely and regulatory oversight has been lax in preventing excessive risk. A bank collapse or a bad investment means that excess capital, or at least some of it, is written off and the economic activity supported by that money deflates and self-corrects. But a run on a sovereign currency would mean the [digital] printing presses went to work with all the inflationary implications that entails: every debt, public or private, would *have* to be redeemed, in full, or the national currency would become immediately worthless. Capital could only ever expand, and unprofitable or risky economic activities could continue indefinitely without any mechanism for self-correction ('creative destruction') other than, well, central economic planning. 

For those reading at home worried about all this, I say: don't panic. Almost the entire Swiss establishment opposes the Sovereign Money initiative and I've read interviews with its backers where they say they don't expect to win and are merely testing the public appetite for this sort of policy. But the Swiss referendum provides a preview of the sorts of policies, and tactics in support of those policies, that we might anticipate MMT advocates pursuing elsewhere in the world when given an opportunity to do so.