As developed economies throughout the world continue to struggle with spiraling debt problems, it is time the rethink the model of money creation.

The world's major money printers are in trouble. Just a year after producing trillions of dollars with a wave of their magic wands, Europe, the US, and the UK cannot get their wands working again. Captive to the science of economics and its limitations, captive to a model of money creation that is grounded and founded on debt, captive to the banking industry's agenda and actions, the existing monetary architecture is facing a serious structural problem.

The impediment to improvement and growth lies in the very model of money creation used. Money is backed by government debt. The central banks print banknotes and balance the entry in their liabilities with assets that are mainly government bonds. Money is created by debt and then grows through credit. Credit, through the fractional banking system, creates new money. This is achieved by creating new deposits based on debt agreements and contracts that banks sign with their clients.

At the creation level and at the expansion level, money is driven by debt and credit. Growth implies being bigger, larger or more active than previously. From a monetary perspective, in our current model, growth in the supply of money implies growth in debt somewhere in the system.

Monetary rethink

The nature of the paperwork between the central bank and the government – the exchange of banknotes for government bonds – is the key structural issue that must be addressed. This equation must be transformed to allow governments to inject new money without additional debt. The solution needed right now, to be real and effective, must have a positive and immediate impact on employment, investment, income, deposits, and finally, must not increase the governments' already high level of debt.

I believe that the solution rests in designing and issuing a new financial instrument – which I call the 'public capitalisation note' (PCN) – and using it for monetisation purposes. PCNs are designed as profit-sharing instruments attached to real economic projects in different industries, whereby the central bank and the government jointly undertake an investment in the very fabric of society.

Using such an instrument for monetisation implies that the government treasury issues PCNs and the central bank purchases them directly with new money. The monetary and real impact of such an instrument used for money creation would directly and positively affect income, expenditure, employment, bank deposits, capital formation and real productive activity.

The use of PCNs between the treasury and the central bank is equivalent to a symbiotic merger of monetary and fiscal policy. Adding a new channel of money creation to the current debt-based system would allow the countries in crisis to inject new money without adding more debt to their balance sheets.

Allaying inflation worries

Moreover, PCNs have no more impact on inflation than standard bonds. Inflation relates to the quantity of money injected, not the method of money injection. Indeed, if there is to be further quantitative easing (QE) in the US, it must be done via PCNs for it to have a direct impact. At this point, it really does not matter if banks have more money or not, because they are not willing to lend to an over-indebted economy. QE must have a direct impact on aggregate income to ensure that the fragile recovery does not end up as another unprecedented recession.

Interestingly, the Bank of England issue department actually implements a mechanism that allows it to back its bank notes with what it calls a 'deposit with banking department' on its asset side of the balance sheet. This accounted for more than 50% of the UK pounds in circulation in 2010.

If money can be backed by a deposit in the other branch of the same bank (the Bank of England), then it can surely be backed by PCNs that have a direct impact on the economy. The struggling advanced economies need a systemic breakthrough in order to transform the current equation once and for all. This is particularly urgent given the paradoxical sequencing of bailouts, quantitative easing and austerity measures. We cannot possibly think that we are going to achieve more growth with less money.

Instead of backing money with public debt, which is untenable without ever-increasing debt levels, we could also back it with public investments, which means wealth. PCNs can do the job just fine.

Armen Papazian is an economist and founding CEO of financial modelling consultancy Keipr

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