Vol.3 No.12, 07 April 2003
Creating New Money
In South Africa there is a dire shortage of money to pay for government services and development programmes, let alone for schemes such as a Basic Income Grant. This shortage of money is not a problem peculiar to our ailing South African Economy. Many other countries are also experiencing a shortage of money for essential services. Could it be that this is caused by the process by which money is created, i.e. via loans made by commercial banks for government, commercial and personal financing? Could we get the economy humming again by allowing the SA Reserve Bank, as an independent agent for the government, to create and control the money required? Please consider this in the light of the proposal for the creation of money by the Bank of England, as put forward in the authoritative British paper The New Statesman, and transcribed and somewhat abbreviated in this issue of SANE Views.
Aart Roukens de Lange
Editor, SANE Views
by David Boyle • The New Statesman • Monday 7th April 2003
Why is the country so short of money that we can't even rebuild the London Tube? It is because we allow the banks a monopoly to create it, and they charge the earth. As Gordon Brown struggles, on the eve of his Budget, to balance the unbalanceable - a job that was difficult enough even before we went to war with Iraq - a glimmer of an idea is emerging about how to pay for railways, postal services and all the other public service demands that crowd in upon him. It sounds like the search for Atlantis or for zero-point energy - and conventional economists say it's even more mythical than that - but there is a flurry of interest among backbenchers about a proposal for a new source of public finance.
The proposal is very simple - and heretical. It is that the government - or rather the Bank of England - creates the money to pay for hospitals or the London Tube but charges no interest for it. The only requirement is that it be paid back. Having done its work, the money is withdrawn from circulation. There is then no need either for the private finance initiative - the controversial PFI, with its vast payments to financial intermediaries - or for government borrowing, with its debt burdens to future generations.
An outlandish idea? "If the government can create a dollar bond, it can create a dollar bill," said Henry Ford in 1921, proposing a scheme of this sort to finance dams in the Tennessee Valley. In 1914, David Lloyd George, then chancellor, issued Treasury notes to stave off a banking collapse. In 1933, the Yale University economist Irving Fisher - who invented inflation indices - proposed that money should no longer be based on debt.
(In the UK) as recently as 1964, 20 per cent of the money in circulation was interest-free, government-issued notes and coins. The equivalent figure today is 3 per cent. Interest payments account for a third of the cost of some major projects, and they are the biggest single item of national spending after pensions. To create interest-free cash, therefore - today in electronic form, rather than as old-fashioned notes and coins - is a chancellor's equivalent of alchemy.
The traditional economist's objection is that when governments create money in this way, inflation inevitably ensues. But is this true? The answer goes to the heart of an issue that - strangely, given the vast sums we spend on economic research - almost nobody talks about. Where does money come from in the first place?
This hangs on obscure definitions. Some money is created in the form of notes and coins (known as M0) issued without interest by the government via the Bank of England. This is dwindling fast because it is so inconvenient. The rest depends on what you include; but most is created by banks in the form of mortgages and loans - including loans to the government - which eventually have to be paid back plus interest. Banks can lend many times over the money that is deposited with them. In other words, banks create money all the time. And the process by which they do so, as John Kenneth Galbraith observed in 1975, "is so simple that the mind is repelled". Galbraith added: "Where something so important is involved, a deeper mystery seems only decent." But there is no deeper mystery. The banks just do it and make a handsome profit out of it - about £21bn a year, according to the former Inter-bank Research director James Robertson.
Issuing interest-free cash would only be inflationary if money were a finite resource. As it is not, replacing interest-bearing loans with free money might even cut inflation. The share of interest-free money - cash and coin (or M0) - has fallen dramatically compared with the total amount of money in circulation as a proportion of GDP and has effectively been privatised to the advantage of the banks, but to the detriment of the economy."
The issue of who creates money lay behind the rise of Social Credit, following the book Economic Democracy by Major C H Douglas, published in 1920. By the 1930s he was able to command stadiums full of supporters in Australia and Canada, as well as in the UK. Two Canadian states elected social credit administrations. One stayed in power in Alberta until 1971, prevented only by the courts from pushing through its promise to give a monthly dividend of $25 to every citizen.
What's the problem with putting more interest-free government money into circulation? The conventional answer is that the requirement to borrow and to pay interest provides a discipline on governments and big public sector projects. Without this discipline, governments simply delude themselves about how much money it is wise to create. But it's an expensive discipline: investors in the London Underground expect to make about £2.7bn over the life of the public-private partnership, in return for investments of just £530m - and a third of that will go to financial intermediaries.
Nobody could possibly argue that that is financially efficient. It is quite easy to imagine something like the Bank of England's independent monetary policy committee - which at present decides on interest rates - applying some kind of discipline on the government's creation of money at far lower cost.
"New money" may be an idea whose time has come. At the very least, it is healthy that the fundamentals of the money system should be open to debate again.
"The world is full, on the one hand, of monetary cranks each with a patent panacea for setting all our ills to rights," - wrote the influential New Statesman economist G D H Cole - "and, on the other, of orthodox economists, so alarmed at the cranks' proposals as to be wholly unwilling to make any new discoveries at all, for fear of appearing to sanction some of their notions."
After half a century of silence, new discoveries are now rather badly needed.
David Boyle, author of this contribution to The New Statesman, is editor of The Money Changers (Earthscan 2003), and a senior associate of the New Economics Foundation (NEF) in London. His contribution was submitted to SANE Views by Chris Keene via Margaret Legum.
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