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Understanding our broken system of money creation
Unaccountable Private banks today create 97% of the money in our economy. When they give out loans (spendable IOUS is a more truthful description though), they create money from nothing, backed up by word alone. The remaining 3% of our money is created in the traditional sense by central banks printing physical money. Why is this a problem though, and how could this unexciting statistic be indicative of a systemic problem that profoundly impacts our society?
In this day and age banks are much more than financial intermediaries . To understand how banks actually create money, you need to look no further than the former governor of the Bank of England Mervyn King, who said “When banks extend loans to their customers, they create money by crediting their customers’ accounts”. This is why the government is so eager to encourage bank lending.
When Commercial banks extend credit you’d expect there to be a firm nexus between the credit extended and the reserves they possess. In fact this is not the case. To illustrate, at the time of the financial crisis Banks held just £1.25 in reserves for every £100 issued they in credit (this is allowed because of fractional reserve banking). Banks are literally making money out of nothing and using this to keep us debt slaves and help the mega-rich buy up assets. They’re not afraid of the consequences as they know they can rely on taxpayers money being used to subsidise this recklessness if a crisis hits.
It’s illegal for any of us to create money for our own whims; banks should be beholden to the law too. When commenting on the 2008 crash Lord Adair Turner, chairman of the financial services authority, had this to say “The financial crisis of 2007/08 occurred because we failed to constrain the private financial system’s creation of private credit and money”. Change needs to occur to prevent another preventable economic crisis happening in the near future.
This monetary system makes it hard to judge how well the economy is doing since our growth is fuelled by mountains of personal debt. Because all this new money is in debt/loan form, interest is being paid on it. These interest payments mark a monumental shift of wealth, taking from the 90% and giving to the top 10%. This system is all about tremendous inequality. Furthermore, this money is not everlasting and disappears once the loan is repaid, destroying the money in the process.
These powers allow banks to create too much money, at a rate so quick that most of it ends up getting sucked into short term speculation, in lieu of it finding itself circulating into local communities, SMEs and the real economy (i.e. Manufacturing and Small Business). After the recession, these powers should have been taken away from the banks as a condition of the bailouts as a way to deal with boom and bust cycles.
Technocrats and vested interests (that profit massively from the current system) want to keep this topic obscured and out of public debate. But this current system is unsustainable – we need to take back control!
Taking Back Control – Democratising Money Creation
Southampton University’s Professor Richard Werner has suggested several different remedies to this problem. Werner wants to see this privately created money directed away from asset bubbles; he suggests at the very least taking away banking licenses from banks who don’t contribute to the community, and imposing strict conditions on lending. This hopefully would calm the money creation process and re-direct credit towards things with long-term benefits like infrastructure and green technology. More radically Werner has also talked of decentralising banking and making banking local. The big banks could be transformed to co-operative credit unions, or into banks that resemble Germany’s Volksbanks‘ (which have never had to be bailed out with public money).
The Bank of England has shown already it’s willing to create money in the hope of stimulating the economy with its quantitative-easing programme. Whilst this did fail, this monetary policy could, with enough political pressure, be made to work for ordinary people. We need to exert more control over private money creation, and then re-work public money creation to work for everyone. Household debt in the UK is growing at an alarming rate; the magic money tree could be used to defuse this time bomb.
Some will suggest this is Soviet-esque micromanagement and will inevitably lead to Zimbabwean hyperinflation as governments can’t be trusted to be responsible. First, the Banking sector has shown the world it isn’t responsible enough to handle having the privilege of money creation. Its consumer lending model has inflated the housing market and many other asset bubbles. Second, as this series extensively documents other historical factors contributed to Weimar and Zimbabwean hyperinflation. Furthermore, public money creation could dramatically boost GDP and employment. Finally, even if it was to become inflationary, creation could be curbed as the process would be transparent and democratic.
Money creation shouldn’t be privatised to the extent it is or at the very least it should be better regulated to prevent banking crisis and ensure the community gets allocated a fair share of the credit the banks create. During the East Asian Economic miracle, central banks of those nations practiced credit guidance, whereby they encouraged productive bank credit and restricted non-productive bank credit. The Bank of England could easily adopt this model. Sovereignty is a term that has had a real presence in our national political discussion over the last year. It’s time we extended this concern into the realm of monetary policy.