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The fractional reserve monetary system controlled by the European System of Central Banks (ESCB) is the primary source of the current European economic problem. The ESCB controls the money supply of the seventeen nation Eurozone and an additional ten European Union (EU) member states with their own national currencies using a debt based monetary system and supplies liquidity to a group of fractional reserve banks for first use and control in an inflationary wealth transfer and misallocation of capital to the banking sector to the banking sector each time new money is created.

CHART 1 DATA SOURCE: Fractional Reserve Monetary Intermediation Cost Impact Chart. The chart above shows the impact of fractional reserve monetary intermediation unearned wealth transfer.

The monetary intermediation cost of the ESCB/banking system is at least 92% inefficient (1 - bank reserve requirement) and is on the order of 2% to 3% of EU GDP per year, compounded to 29% since the introduction of the Euro in 1999, that could be more efficiently handled by a full reserve credit banking system, development of depositor owned institutions to exclusively hold demand deposits and direct issuance of new money creation to European citizens based on a GDP Index Monetary Standard.

Removing the added intermediation expense of the ESCB Monetary Expansion System, while an improvement and risk reduction to the economy, would not address an additional underlying problem, which is the fractional reserve lending system or more appropriately leveraged credit. It is not believed the added risk from fractional reserve lending or leveraged credit can show that it adds real return to the EU based on the Modigliani-Miller Financial Theorem and therefore the EU should replace it with a more efficient full reserve system that can be operated at a much lower intermediation cost.

CHART 2 DATA SOURCE: Business Cycle with Leverage and Intermediation Added using Excel Sine Wave Graph. The chart above shows the impact of fractional reserve leverage, which adds risk to the system in the form of increased variability of returns but does not change returns to the system, shown above as increased amplitudes of the business cycle. The compounding intermediation cost of the ESCB/ECB System is also shown gradually increasing in size that is actually a reduction to system returns.

A banking business model based on full reserve financial intermediation, time matched funding spread lending, is not a new concept. It has had historical support from at least five previous Nobel Prize winners, Milton Friedman, 1976, James Tobin, 1981, Maurice Allais, 1988, Merton Miller, 1990 and Frederick Soddy, 1921, a former Secretary of Agriculture and Vice President of the United States, Henry Wallace, at least one prominent European central banker, Mervyn King, retiring governor of the Bank of England and numerous distinguished economists and financial writers including Irving Fisher, one of the foremost economists of the first half of the 20th Century.

It is believed that with the discovery of the M&M Theorem in 1958 of the irrelevance of capital structure that proof of the superiority of the full reserve monetary system has existed because of its lower monetary intermediation cost. There is no financial intermediation loss from a full reserve system and there would be a more efficient allocation of economic returns reducing and/or eliminating the current wealth transfer disparity caused by the fractional reserve system.

A shared currency supranational GDP based monetary system could be operated at the national level with only supranational agreement required on the monetary standard to be used. It is not believed any supranational banking or fiscal control of member states is required or desirable because it is not believed the added regulatory cost of supranational supervision could be shown to be more economically efficient than a simple option out/put out agreement for countries failing to maintain the GDP monetary standard. Banking regulation would continue to be maintained at the national level and would be removed as a supranational risk for members of the EU from conversion to the full reserve system. It would also be the least disruptive level if a member state ever departs the EU.

About the Author William Haugen
I have a Masters degree in Finance from Carnegie Mellon University, Pittsburgh, PA in 1983 and a Bachelors degree in Business from the University of Washington, Seattle, WA in 1981. I live in Dallas, Texas. If you have comments or suggestions, please email me at whaugen@flash.net.

European (EU) Economic Recovery Plan

Plan Summary
The attached EU Economic Recovery Plan recommends monetary reform as the best go forward process for economic recovery and maximising growth for the entire EU membership including both Eurozone and non-Eurozone countries. The recommended monetary reform is to convert to a full reserve system based on a GDP monetary standard with seigniorage benefits from GDP growth direct issued to citizens within the EU. Any potentially departing Eurozone member state is recommended to convert to a full reserve system at the time of reinstituting its own national currency regardless of any other country within the EU because of the likely full retirement of its national debt as a result of the conversion and expected 1% to 3% or more annual GDP growth improvement from conversion to a full reserve monetary system.

CHART 3 DATA SOURCE: ECB Annual Monetary Intermediation Cost to Economy 1999 to 2011, Attachment 6. The chart above shows the annual monetary intermediation cost of the ECB to the Eurozone economy that could be saved by replacing the ECB fractional reserve system with a full reserve system.

CHART 4 DATA SOURCE: Direct Issuance and First Use (Seigniorage) Money Supply, Attachment 12. The chart above shows the impact of the ESCB creating debt based money faster than economic growth, transferring wealth from the other sectors of the economy to the banking/financial sector by virtue of its first use and control of the new money.

The GDP based monetary system would be administered at the national level by existing or newly created Ministries of Commerce. This is expected to add approximately 2% to 3% of annual GDP growth to the EU from monetary intermediation cost savings and would eliminate the inefficient and unnecessary intermediation costs of the ESCB central banking system. The estimated financial impact of the existing fractional reserve monetary system on the EU is estimated to have been €2.23 trillion Euros from 2005 to 2011. Elimination of the estimated €9.07 trillion capitalised cost of the fractional reserve monetary system within the EU is estimated to restore on the order of fifteen million jobs as listed by Eurozone country in attachment 11(c) and non-eurozone EU member country in supplemental attachment 4(c). Conversion to a full reserve banking system is also estimated to retire sovereign debt entirely for all EU member states except Italy, Poland and Romania with those countries debt levels reduced by approximately 65%, 76% and 87% respectively as of 2011. Incomplete banking information was available from Eurostat for Sweden and the United Kingdom, however other information was available to complete alternative estimates of conversion for those countries.

CHART 5 DATA SOURCE: ECB/NCB Annual & Compound Intermediation Cost to Economy 2005 to 2011, Supplement 1(a). The chart above shows the expected improvement in EU member state annual GDP growth rates from monetary intermediation cost savings of replacing the ESCB/ECB fractional reserve system with a full reserve system.

EU member states are all recommended to convert to full reserve currencies based on the monetary intermediation cost savings shown in Chart 5 above that are estimated to: 1) reduce debt on the balance sheets of EU member states on the order of €13.84 trillion as of 2011, 2) restore on the order of fifteen million jobs as listed by Eurozone country in attachment 11(c) and non-Eurozone EU member country in supplemental attachment 4(c) and 3) improve annual EU GDP growth by approximately 3% per year, the amount of the reduced monetary system intermediation cost. EU member states are also recommended to continue their current policies regarding joining or not joining the shared Euro monetary system as currency used is not the source of the current EU economic problem.

Member states within the EU would maintain their own independent go forward credit ratings but critically a member state default or withdrawal if it were ever to occur would not endanger the financial intermediation system of the EU. Default risk would be limited to the borrowing member state and its lender(s) without endangering the supranational financial system in the event of a sovereign state default. This would protect other EU member states economies as well as the EU financial system from any potential sovereign state and/or financial institution default.

The complete PDF paper can be viewed and/or downloaded from the link below:
EU Economic Recovery Plan. The version posted was last modified October 15, 2012.
(Adobe Acrobat Required)

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Version 1.0 © 2012 William A. Haugen
Last Modified: March 10, 2013.
Origination date of page July 27, 2012.
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