SANE Views

Vol.6 No.10, 23 March 2006

Creating New Money Debt-Free

Margaret Legum

This is the fifth in a series of six articles comparing old and new economics that was published in the Business Report on the internet http://www.businessreport.co.za/index.php?fSectionId=553&fArticleId=3110251)

Current economists assumes that the current economy is pretty well inevitable. New economics seeks replacements for policies that produce malign results. Growing debt, for example. Is it inevitable – always with us, like the poor? In fact it is not inevitable, but a symptom of a distressed global system, and a danger to us all. Nor is it inevitable.

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 the bank 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 that it had just sucked out of its thumb – plus of course a rate of interest.

In that way the banks get, every day of every week, free lunches galore. There is a theoretically limit to that out-of-nothing money creation, but it is easily surmounted.

You might say, so what? Nice work if you can get it, and nothing malign about it. It oils the wheels of the economy. 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, but a vital means to economic activity. Recessions and inflations that have devastated lives and economies arise from getting the supply of money wrong.

Therefore, it should not be left to the commercial purposes of banks. The supply of money in an economy should be about how much money is needed to activate its productive resources – its people, its land, its physical resources – without wearing out the capacity of the natural environment. The banks’ criteria have nothing to do with that – only with individuals’ credit-worthiness. They do not lend to poor people who can’t repay; and they will lend to rich people without regard to the purpose.

Moreover, the money that banks make comes into existence in the form of a debt. But they don’t create the extra money to cover the interest. That doesn’t matter in a boom when new money is being produced. But when it 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. Needing perpetual growth is also built in – the only way to prevent bust. That is impossible in an over-exploited planet.

Growing proportions of debt produce nothing. They are created for speculative ventures – either in fixed property or in unproductive financial instruments. The rest is for shopping on tick, or desperately keeping the wolf from the door. The world is awash with debt. Every American owes one and a quarter times their disposable income.

This is highly unstable and dangerous to all of us, because the financial system is global. 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 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 price of property globally. In South Africa the average price of homes has doubled in 8 years. Banks can give huge bonds at hardly any risk to themselves. That creates more debt inflation, because people borrow to spend on other consumables, calculating 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. Government’s theoretical control instrument – the interest rate – is not only blunt, but clearly ineffective.

Who else could do the job of creating money? 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 its importance, 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 publicly 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, it should create electronic money.

Commercial banks should revert to their original purpose of broker between some people’s savings and other people’s need for loans, which is what most people think banks do.

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. It would be available before taxes were levied. With transaction taxes, government revenues would be assured and taxpayers better off.

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.