Does expanding the amount of debt free money reduce indebtedness?

Money can be split into numerous different categories. But one type of categorisation is to split money into so called “debt free” money, and in contrast, money which consists of a debt which is passed from hand to hand.

Central bank created money (monetary base) is essentially debt free. In THEORY this money is a debt owed by the central bank to the holder of such money, but central banks make absolutely no promise to give anyone anything (e.g. gold) in exchange for this money. Thus it is essentially debt free.

In contrast, commercial bank created money is essentially a debt which is passed from hand to hand. I’ll call this “debt-encumbered” money.

There is a wide-spread perception that banning debt-encumbered money and replacing it as necessary with debt-free money would reduce the total amount of debt. (The latter “replacement” equals imposing full reserve banking.). E.g. see here.

That perception is mistaken, and for the following reasons.

1. Under full reserve there is nothing to stop borrowers borrowing or to stop lenders lending as they see fit.

2. People and firms incur debt precisely because they “see fit” to do so. E.g. people looking for a place to live don’t HAVE TO BORROW with a view to buying a house. They can always rent. Indeed, renting is particularly popular in the wealthiest large country in Europe: Germany. The rate of owner occupation in Germany is the lowest in Europe.

3. I see no reason to suppose that the proportion of the population who choose to buy rather than rent will change just because a country abandons fractional reserve and goes for full reserve. Ergo the total amount of indebtedness will remain unaltered.

4. One argument for the idea that debt-encumbered money causes indebtedness runs as follows. The economy needs a form of money and about 97% of the money in circulation is debt-encumbered. Therefor to obtain money or to obtain an increased supply of money, participants in the economy are pretty well forced to go into debt. E.g. as Michael Rowbotham puts it in Ch 1 of his book “The Grip of Death”, “Thus the supply of money depends on people going into debt….”

Well that argument has been comprehensively demolished by events over the two or three years. That is, households and firms have deleveraged over recent years, which has cut the amount of debt-encumbered money. And to compensate, central banks have vastly increased the amount of central bank money!

Or take it to the extreme, if for some strange reason it became unfashionable to incur any debt at all, and households and firms paid off all or nearly all their debt, the effect would obviously be deflationary. But there’d be nothing to stop the central bank stepping in and supplying whatever amount of money was needed to get the economy back to full employment.
  

P.S. (same day). Here are more authors who seem to accept the idea that debt encumbered money increases indebtedness.

According to Joseph Huber and James Robertson in their New Economics Foundation publication “Creating New Money”:

“More specifically, many advocates of monetary reform (e.g. Rowbotham 1998, Armstrong 1996, Kennedy 1995) argue that issuing an overwhelming proportion of new money as interest-bearing debt has damaging social impacts. One argument, briefly, is that issuing money as debt creates more indebtedness in society than issuing it debt-free will do….”


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