A long-forgotten alternative to unfettered credit creation...
AS WEARY TROOPS returned from a protracted foreign war, they encountered a land racked with debt, high prices and a crumbling infrastructure, whose flood defenses were about to be overwhelmed, writes Toby Birch of Blackfish Capital Holdings...
Not some nightmarish news story from New Orleans in the years ahead, but the stark reality faced by the island of Guernsey, just offer the French coast in the English Channel, after the Napoleonic Wars ended in 1815.
To fund Britain's fight against the French, credit creation had become rife in the early nineteenth century. Once Bonaparte was beaten, deficits and inflation in Britain were likewise kept in check by containing the money supply, through the introduction of the Gold Standard.
In theory, the holder of a paper note could demand an equivalent sum of Gold from their bank so money could only be created in proportion to the available bullion. The small annual increase in precious metal supplies helped restrict the growth of money, and price stability became the rule rather than the exception for the balance of the nineteenth century.
While 1815 brought an end to the conflict on the battlefront, however, severe austerity ensued on the home front. The application of the Gold Standard meant that loans issued over many years were then recalled to balance the ratio of money to precious metals. This led to economic gridlock as labor and materials were abundant, but much-needed projects could not be funded for want of cash.
This led to a period of so-called "poverty amongst plenty". And the independent States of Guernsey (or rather, their government), endured similar problems to England, since the Pound Sterling was also the currency of the Bailiwick.
The disintegrating sea defenses were symptomatic of Guernsey's financial woes as the island faced being swamped with hefty debts and interest payments. The situation seemed insoluble; existing borrowing costs were consuming 80% of the island’s revenues. What was already an unsustainable debt burden would need to be doubled to fund the two most essential infrastructure projects.
This was when a committee of States members was formed by the then-Bailiff, Daniel DeLisle Brock, in what proved to be the defining moment for the island’s finances. He is still commemorated on Guernsey £1 notes, as is the Town Market which was one of the first beneficiaries of the Experiment.
Like all great ideas, the principles were straightforward. The committee realized that if the Guernsey States issued their own notes to fund the project, rather than borrowing from an English bank, there would be no interest to pay. This would lead to substantial savings. Because as anyone with a mortgage should understand, the debtor ends up paying at least double the amount borrowed over the long-term.
While some of the committee were merchants, they were not necessarily financial wizards. They did, however, appreciate the risk of previous schemes involving government debt which led to concurrent crises a century earlier – the Mississippi Bubble in France and then the South Sea Bubble in London.
The irresponsible creation of credit is a dangerous game that temporarily benefits the current generation but steals from the next; a lesson that has been forgotten yet again in modernity. To bring balance to the equation, therefore, the people of Guernsey had to find a way to neutralize such deficits while neither contracting nor expanding the money supply.
On a purely practical level, this was achieved by adding a sell-by date to the notes in issue, rather like a maturity date on a bond. For example, on a note issued 21 November 1827, it "Promises to pay the bearer One Pound on the first of October 1830". This begs the question as to how the future obligation was to be honored, but again, a simple mechanism was implemented whereby rent from the resulting infrastructure and tax revenues on liquor was set aside into a sinking fund to pay off the interest-free borrowing.
The end result of the Guernsey Experiment was spectacular – new roads, sea defenses and public buildings were established, fostering widespread trade and prosperity. Full employment was achieved, no deficits resulted and prices were stable, all without a penny paid in interest. What started as a trial led to a string of construction projects, which still stand and function to this day. Money was used in its purest form: as a convenient mechanism for oiling the wheels of commerce and development.
One would have thought that everyone would be happy with such a success story but this was not the case. When you open a closed shop to competition, those with vested interests become highly protective. In those days it was the private banks who were threatened, because they were cut out of the equation. No loans meant no interest and no profit margin. So they may well have been the source of a mysterious complaint made to England’s Privy Counsel which put a ceiling on the issuance of Guernsey notes for the next century.
Why is this story relevant today? Whenever stimulus packages, tax rebates or bank bail-outs are paraded as solutions to the credit crisis they are actually part and parcel of its very cause. It all stems from the quick-fix approach of producing money out of thin air and leaving it for the next generation to pay-off. This has been on-going in the United States since the Vietnam War, when the last vestige of monetary restraint was cast aside; in abandoning Gold as a check on the money supply, the US freed the world from financial discipline. The dissolution of the Dollar has been evident ever since.
Credit creation is possible, and even beneficial today, but only if the money is later retired in a measured manner. This requires restraint and stewardship; qualities that are all-too-rare for those with misplaced incentives.
Like swords to ploughshares, the banking industry does not have to be eradicated in the process of reform. Banks still have a role to play in providing liquidity by matching investors with borrowers. But they can no longer be trusted with unfettered credit creation. The Guernsey Experiment – as it was termed in a booklet compiled in 1960 by Olive and Jan Grubiak for Omni Publications, USA – shows that simple ideas can work wonders. They simply require an unselfish philosophy and a desire to do the right thing for future generations, much like America’s Founding Fathers.
One of their number, Thomas Jefferson – who was US President during the Napoleonic era – had uncanny foresight when he said "If the American people ever allow private banks to control the issue of money, first by inflation and then by deflation, the banks and corporations that grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers conquered."
As the blame game begins once more today, the very people who fostered conditions for the credit crisis will no doubt be implementing knee-jerk legislation. This is not the time for new laws, but for new leaders to match the calibre and insight of our ancestors.