Vol.6 No.3, 31 January 2006

Creating New Money The Modern Debt-Free Way

Margaret Legum

My friend Joe Bloggs just sold his house for R3.4 m. The buyers got a 100% bond. They are paying the bank R40,000-odd a month in interest alone.

Let’s unpick that. Where did the bank get that money? From others’ deposits? Did they warn other customers not to use their money because it had been lent to Joe? No; the bank created the money out of nothing. They wrote an entry into an electronic ledger in Joe’s name, and told him to go forth and spend it. On the other side of the ledger they wrote, as collateral, the house he was about to buy, which would revert to the bank if he didn’t repay the money it had just sucked out of its thumb – plus of course a rate of interest on that debt.

In that way the banks get, every day of every week, free lunches galore. Of course they will give you technical caveats to contradict that truth – there is a theoretically limit to that out-of-nothing money creation – but the essence is that banks create money out of nothing for commercial purposes.

You might say, so what? Nice work if you can get it, and nothing malign about it. It oils the wheels of production and commerce. If there weren’t an expanding amount of money in the economy it would grind to a halt. Someone has to make it. So why not the banks?

The first part of that proposition is quite right. Money is necessary for people to trade with each other. Money is not a commodity in itself. It is only a means to economic activity; but it is a vital means. Recessions and inflations that have devastated lives and economies arise from getting the supply of money wrong.

It is so vital that it should not be left to banks. The supply of money in the economy should be about how much money is needed to activate a nation’s productive resources – its people, its land, its physical resources – without wearing out the capacity of the planet. The banks’ criteria have nothing to do with those considerations – only with individuals’ credit-worthiness. They do not lend to poor people who can’t repay; and they will lend to rich people even to create ecological havoc.

Here are some other effects of leaving money supply to commercial banks. First, the money they make comes into existence in the form of debt. But banks don’t create the extra money to cover the interest people have to pay – which is fine in a boom when new money is being produced in a steady stream. But when that leads to inflation, interest rates go up, some people can’t pay and recessions threaten. Booms and busts are built into a debt-based system.

Second, growing proportions of debt are created for speculative ventures – either in fixed property or as unproductive financial instruments. The rest is for shopping on tick. Every American owes one and a quarter times their disposable income. As a result, the world is awash with debt.

This is highly unstable – for all of us, because we now live in mutual dependence. In the rich countries as a whole, the book value of financial assets had already reached 5 times their total GDP by 1980, after the fateful decision was taken to allow capital to roam the world at will. In 2000 it had jumped to 10 times the GDP value. That means if the debt were called in only 10% of it would be backed by anything real.

How’s that for inflation? Add the inflation in the price of property globally. South Africa is no exception: the average price of homes here has doubled in 8 years. It suits banks to give vast bonds at hardly any risk to themselves because of collateral - and because ‘investment’ in property is a self-fulfilling prophesy as long as people believe the price will keep going up. That, in turn creates more inflation, because people spend on other consumables on the basis that the value of their homes makes them rich.

That is the classic definition of a bubble, and when it bursts the financial tsunami will be global. It happens because commercial banks are allowed to create money as a commercial proposition.

Who else could do the job? The obvious solution is the government. In fact if you ask most people who they think makes the money we use, they will guess the government.

Given the importance of money, it is vital that the creation of money should be under scrutiny by all the institutions of democracy – elected assemblies, the media, civil society and business. Government should create all new money, including electronic money, debt-free - just as it now makes notes and coins and spends them into the economy without lending them to anyone. Commercial banks should revert to their original purpose of broker between some people’s savings and other people’s need for loans.

Such a system would reduce tax burdens. The new money needed each year would be free to the government, which would spend it directly into the economy without having to borrow it from the banks and paying interest.

The only danger is of governments creating too much new money in the interests of popularity. To guard against that, the decision on how much new money to issue each year should be made in collaboration with an institutionally independent Reserve Bank, and the reasoning made public and accountable. In any case, mistakes would be subject to the wrath of electorates and public scrutiny, Unlike the effects of the operations of the commercial banks.

In closing I want to say that some of my best friends are bankers.

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