[R-G] [BillTottenWeblog] The Guernsey Experiment

[Bill Totten]

A long-forgotten alternative to unfettered credit creation.

by Toby Birch

goldnews.bullionvault.com (May 19 2008)


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.

Not some nightmarish news story from New Orleans in the years ahead, but
the stark reality faced by the island of Guernsey, just off 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 eighty per cent 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 One
Pound 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.

_____

Toby Birch is managing director of Birch Assets Limited in Guernsey.
Educated at the City University in London and a Fellow of the Securities
and Investment Institute, he also holds the Securities Institute Islamic
Finance Qualification and is author of The Final Crash: Addictive Debt &
the Deformation of the World Economy (Pendula Press, 2007), written under
the pen-name Hugo Bouleau.

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