2
Just Money
How Society Can Break the
Despotic Power of Finance
3 Just Money
© 2014 Ann Pettifor
All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission. Cover design by Jordan Chatwin
The moral rights of the author have been asserted. Commonwealth publishing.
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Introduction
“Modern finance is generally incomprehensible to ordinary men and women … The level of comprehension of many bankers and regulators is not significantly higher. It was probably designed that way. Like the wolf in the fairy tale:
“All the better to fleece you with.” Satyajit Das.1
The global finance sector today exercises extraordinary power over society and in particular governments, industry and labour. The sector dominates economic policy making, undermines democratic decision-making, has financialised all sectors of the economy including the arts, and has made vast profits, often at the expense of both governments and the productive sector.
Yet even as finance capital eludes and defies governments, and as legislators bow to the sector’s demands to cut public services in the name of ‘austerity’, finance has become more, not less, dependent on the state and on taxpayer support. Despite its detachment from the real economy and from state regulation, the global finance sector has succeeded in capturing, effectively looting, and then subordinating governments and their taxpayers to the interests of financiers.
Geoffrey Ingham, the Cambridge sociologist describes the power the sector now wields as ‘despotic’.2
In this short book, I hope to briefly outline how society can begin to unpick the knots of jargon and gibberish that finance has used to immobilise the rest of us, and how society can break the power of despotic finance. I will argue that while the finance sector abuses the monetary system for private profit, the system is also potentially a great public good. Our money and monetary system has evolved over centuries as a public infrastructural resource - just as the sanitation system was developed as a public good. Managed well, our monetary system could enable society to do what we can do. And as a public good our monetary system, like our
5 sanitation system could and should be just – and serve all citizens, not only a wealthy elite.
Unfortunately because most orthodox economists treat money as if it were ‘neutral’ or simply a ‘veil’ over economic transactions, the question of how to control the monetary system and in whose interests it should be managed, has long been neglected. In the words of a leading economist who will remain anonymous money or credit is “a matter of third order importance.” Some think that this neglect by the economics profession is not accidental. It has enabled global finance capital to thrive, untroubled by close academic or public scrutiny.
For the monetary system to be managed as a public good, there must be greater public understanding of money, and how the system works. If we are to reclaim the public good that is the monetary system; if we are to once again subordinate the small elite that makes up the finance sector to the interests of society and the economy as a whole, there must be democratic and accountable oversight of the system. We know it can be done, because in our recent history, after the 1929 financial crash, society succeeded in wrenching control of the monetary system back from a reckless and greedy wealthy elite.
Unfortunately citizens will not receive much help in understanding or taming finance from the economics profession, from regulators or officials because many are either uninterested or ill-informed about the nature of both money and banking.
While the dominant, orthodox or neoclassical school of economists may pay little attention to ‘neutral’ money in designing models of the economy, they also conceive of it as akin to a commodity. Money, in their view is
represented by a tangible asset or commodity, like gold or silver. In this view money can represent a surplus to be set aside or saved, accumulated and then loaned out. In this story, savers lend to borrowers, and bankers are mere intermediaries between savers and borrowers.
Because neoclassical economists conceive of money in this way, and
because all commodities have a scarcity value, these economists theorise as if money is subject to market forces of supply and demand, and like
6 define it as such is to create a ‘false commodity’ as the political economist Karl Polanyi argued. 3
There is an alternative understanding of money, one that is periodically lost to history. This understanding informs the work of some of our greatest and most influential economists.4 They have all understood that money is not
and never has been a commodity, nor is it based on a commodity. Instead money is a social construct – a social relationship based primarily and ultimately on trust.
This gap between the orthodox or neoclassical understanding of the nature of money and, for example, the Keynesian understanding of money is as wide and profound as that between 16th century Ptolemaic and Copernican
concepts of the heavens. It is a gap in understanding that led the 2013 winner of the Nobel prize in economics, the orthodox Eugene Fama to make the response below to a question posed by a journalist on the New Yorker:
Many people would argue that… there was a credit bubble that inflated and ultimately burst.
Eugene Fama: I don’t even know what that means. People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.
So what caused the recession if it wasn’t the financial crisis?
Eugene Fama: (Laughs) That’s where economics has always broken down. We don’t know what causes recessions. Now, I’m not a macroeconomist so I don’t feel bad about that. (Laughs again.) We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity.
……Let me get this straight, because I don’t want to misrepresent you. Your view is that in 2007 there was an economic recession coming on, for whatever reason, which was then reflected in the financial system in the form of lower asset prices?
Eugene Fama: Yeah. What was really unusual was the worldwide fall in real estate prices.
So, you get a recession, for whatever reason, that leads to a worldwide fall in house prices, and that leads to a financial collapse ...5
7 Moving away from an economic orthodoxy based on Fama’s flawed notion of credit as the savings of ‘people that save too much’ will be as revolutionary as the paradigm shift that took place under the leadership of Copernicus.
For John Law, John Maynard Keynes, Joseph Schumpeter and Karl Polanyi amongst others, the thing we call money has its original basis in a promise, a social relationship: credit. “I trust that in exchange for my favour to you, you will (promise to) repay me – now or at some time in the future”. The word credit after all, is based on the Latin word credo: I believe. “I believe you will pay, or repay me for my goods and services, now or at some point in the future.”
Money, and in particular credit (and its ‘price’ – the rate of interest) became the measure of that trust and/or promise – or indeed of the lack of trust. (If I do not trust you to repay, I will demand/expect more from you as collateral or in interest payments.)
Money in this view is not the thing for which we exchange goods and
services but by which we undertake this exchange – as John Law famously argued.
To understand this, think of your credit card. There is no money in most credit card accounts before a user begins to spend. All that exists is a social contract with a banker; a promise made to the banker to repay the debt incurred as a result of spending on your card, at a certain time in the
future, and at an agreed rate of interest. And when we spend ‘money’ on our credit card, we do not exchange our card for the products we purchase. This is because money is not like barter. No, the card stays in our purse. Instead the credit card, and the trust on which it is based, gives us the power to purchase a product. It is the means by which we purchase the good. Your spending on a card is expenditure created ‘out of thin air.’ The intangible ‘credit’ – nothing more than the bank’s and the retailer’s belief that you will honour an agreement to repay - gives you purchasing power. Money in this case is based on the trust your bank has in your ability and willingness to repay credit, and the trust that the retailer has in the bank
8 honouring your debt. As such, all credit and money is a social relationship of trust – between a banker and its customers; between buyers and sellers; between debtors and creditors. Between shoppers and retailers accepting (and trusting) the promise made in return for a transaction. Money is not, and never has been a commodity like a card, or oil, or gold – although coins and notes have, like your credit card, been used as a convenient measure of the trust between individuals engaged making transactions. So, if a banker trusts you more than most others, you will be given a fancy gold or
platinum card. If a banker does not trust you or your ability to pay, you will not be granted a credit card, or you may be given one with a very low limit. As a result you will lose purchasing power.
Faith, belief and trust - that someone is reliable, good, honest and effective - is at the heart of all money transactions. Without trust monetary systems collapse and transactions dry up.
Because trust is so important to the economy, society has developed institutions to uphold trust in, for example, the belief that you will honour the obligations you make when you create money out of thin air and spend it on your credit card. These include the law of contract, a system of
accounting, the criminal justice system, central banks and the banking system – that provide confidence to the retailer and banker that you and all those active within the banking and monetary system, will honour
obligations. In countries without such institutions – like some in Africa - credit is hard to come by, and credit cards are not in use.
The Bitcoin mania
Bitcoins have introduced millions to a currency that appeared from nowhere and is, apparently “cryptographic proof”. Whereas private banks can create money by a stroke of the keyboard, the creation of Bitcoins involves, apparently, vast amounts of computer processing power. This power is capable of deploying a complicated algorithm that approximates the effort of “mining” coins.6
The Bitcoins so “mined” have become the new ‘gold’ and Bitcoiners the new ‘goldbugs’.
9 This new currency (which claims to be a ‘commodity’) is a form of peer-to-peer exchange. It began life in the murky world of the ‘Silk Road’ ‘an online Black Market on the Deep Web’ (to quote Wikipedia) and has generated a great deal of excitement. It was ‘created’ by an unknown computer scientist, a Bitcoin ‘miner’. It is now used for international payments, but also for speculative purposes.
There are two striking things about this new currency: its creators (computer programmers) have apparently ensured that there can never be more than 21m coins in existence. Bitcoin therefore is like gold: its value lies in its scarcity. This potential shortage of Bitcoins has added to the currency’s speculative allure, leading to a rise in its value. However, these rises and subsequent falls in its value has made it unreliable as a means of exchange for merchants. Having to regularly adjust prices upwards or downwards when you are trading goods and services is tricky.
Second, this money or currency is not buttressed by any of the institutions named above. Its great attraction to its users is precisely that it bypasses the state and all regulatory institutions. Indeed it appears to be based on distrust. One commentator notes “Bitcoin was conceived as a currency that did not require any trust between its users”. 7
Equally its scarcity means that unlike the endless and myriad social and economic relationships created by credit, Bitcoin’s capacity to generate economic activity is limited – to 21 million coins. Its architects deliberately limit economic activity to 21 million Bitcoins in order, ostensibly “to prevent inflation”. In reality the purpose is to ratchet up the scarcity value of Bitcoins most of which are owned by originators of the scheme.
In this sense Bitcoin ‘miners’ are no different from goldbugs talking up the value of gold; from tulip growers talking up the price of rare tulips in the 17th century; or
from Bernard Madoff, talking up his fraudulent Ponzi scheme.
As this goes to press, speculators have inflated to delirious heights the value of the Bitcoin. The winners will be those who sell - just before the bubble bursts. In the absence of regulation that reinforces and upholds trust, the losers will be robbed. Trust is central to the millions of
10 good or service. For society and the economy to function effectively, it has to be defended, protected and upheld. This can only be achieved through regulation based on society’s widely shared values of honest and fair dealing, and on the institutions based on those values.
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In 2012 it emerged that bankers were manipulating the rate of interest used to determine the value of trillions of dollars of debt, and known as the
London inter-bank offer rate or LIBOR. Andrew Lo, MIT Professor of Finance said on CNN that the LIBOR scandal dwarfed “by orders of magnitude any financial scam in the history of markets.” 8
However the LIBOR scandal did illuminate several points: first that the rate of interest – the ‘price’ of money - is not, it turns out, the result of the supply and demand for money or savings. Interest too is a social construct, set and manipulated, in the case of LIBOR by ‘submitters’ in the back offices of banks.
In ancient times trust – in money, in units of measurement, in exchanges – was upheld and enforced by respected community and religious leaders and institutions. These included the chiefs of villages, the officers of temples; and senior, trusted members of the Church or Mosque.9 They ensured that
a pound of sugar was weighed correctly; that a pint of beer was indeed a pint; that a yard of cloth was equivalent to the standard, and that money exchanges were fair.
Today trust in our monetary system ought to be upheld by public authorities – the courts, accountants, regulators, central bankers -
accountable to, and trusted by society. However most regulators and central bankers have bowed to the ideology of free markets, and dispensed with powers and regulations to uphold and enforce trust in financial
transactions. Instead transactions are “liberalised” - left to the whims of financiers operating in the so-called ‘free’ market of finance. But that ‘market’ too is false. Financiers trashed our financial system by
11 ‘products’ they could trade and ‘markets’ they could manipulate. By
detaching social relationships from regulation, and allowing them to be enforced by the ‘invisible hand’ of the abstract ‘market’ – regulators, economists and bankers abdicated their responsibility for upholding and defending society’s moral and ethical standards. No wonder fraudsters, cheats and crooks had a field day! Backed by large swathes of the
economics profession, criminals, charlatans, Ponzi schemers and common thieves are effectively granted free rein to rob and loot, to cheat and lie, to evade tax, to launder money, to move vast sums of illicit ‘dirty’ money across borders – and to do so unfettered by law or regulation.
No wonder the ‘free marketisation’ of social relations was welcomed by finance capital and by criminal elites embarked on what has been called “an orgy of thievery” 10. No wonder too that it is a deluded and utopian mission,
one that leads inevitably to serial financial crashes, wider economic failure and social breakdown.
This deluded economic theory (that trust does not need to be carefully regulated and upheld by qualified, publicly accountable institutions like the law) originates in the flawed understanding that so many professional economists have of money. These free market ‘economists solemnly believe that money is “gold coin and bullion” to quote Murray N Rothbard 11; that
credit is just a “surrogate for gold”; that bankers are mere intermediaries between lenders and borrowers, and market forces alone can manage, discipline and regulate the supply and exchange of money.
The whole, vast, shaky edifice of today’s liberalised financial system has been erected on this flawed understanding of money, and on hopeless attempts to transform the social relationships at the heart of money into marketable ‘products’. To paraphrase Keynes’s criticism of the Austrian economist Friedrich Hayek, this is an example of how, starting with a mistake, a remorseless logician can end in Bedlam. 12 It is because of the
flawed foundations of economic orthodoxy – taught in almost every university of the world - that society suffers both periodic shortages of finance, and regular and sometimes catastrophic financial crises.
12 There need never be a shortage of finance
The operations (if not the utterances) of bankers demonstrate that they do not share the orthodox economist’s misunderstanding of money. Both central and commercial bankers have known for more than three hundred years (when the Bank of England was founded) that credit and bank money is based on trust between debtors and creditors; that as such, it can, in collaboration with borrowers and lenders, and on the basis of contract, be ‘created out of thin air’ by both central banks but overwhelmingly by licensed private bankers. (Note: not all private banks create credit. Some non-standard financial institutions – like payday lenders, crowd funders and savings institutions - act simply as intermediaries between
savers/depositors and borrowers/investors. Savings banks (that is, old-style building societies in the UK and savings and loans associations in the US) only lend out existing and limited savings or funds deposited in their banks. This is not the case for credit-creating, commercial, licensed banks.)
Central bankers understand that in a well-developed, regulated monetary system in which credit is created ‘out of thin air’ there need never be a shortage of money or finance. The creation by central bankers of trillions of dollars of ‘bailout’ finance via a process defined as ‘quantitative easing’ reminded wider society of this power after the 2007-9 crash. Yet it is a power that the Bank of England, for example, has exercised since its founding in 1694.
Monetary systems as a civilizational advance
Monetary systems are one of human society’s greatest achievements. The creation of money by a well-developed monetary and banking system was a great civilizational advance. As a result there need never be a shortage of finance for private enterprise or the public good. There need never be a shortage of money to invest in, and create economic activity and full employment. There need never be insufficient money to tackle energy
insecurity and climate change. There need never be a shortage of money to solve the great scourges of humanity: poverty, disease and inequality; to ensure humanity’s prosperity and wellbeing; and the ecosystem’s stability.
13 The real shortages we face are first, humanity’s capacity: the limits of our individual, social and collective corruptibility, integrity, imagination, intelligence, organisation and muscle. Second, the physical limits of the ecosystem. These are real limitations. However, the social relationships which create money, and sustain trust, need not be in short supply in a well regulated and managed monetary system.
Within a sound monetary system we can afford what we can do. Money enables us to do what we can do within our limited natural and human resources.
Money or credit does not exist as a result of economic activity, as many believe. Like the spending on our credit card, money creates economic activity.
When young people leave school, obtain a job, and at the end of the month earn income, they wrongly assume that their newfound income is the result of work, or economic activity. This leads to the widespread assumption that money exists as a consequence of economic activity. In fact, with very rare exceptions, credit financed the firm and entrepreneur that employed that young person; and an overdraft probably financed the wage she earned in that first job. However, her employment hopefully created additional economic activity (by e.g. producing widgets) and generated income with which the employer could pay down the overdraft, repay the debt and afford her wage.
In a well-managed financial system, money provides the stimulus, the finance needed for innovation, for production and for job creation. In a well- managed economy, money is invested in productive, not speculative
economic activity. In a stable system, economic activity (investment, employment) generates profits, wages and income that can be used for repayment of the original credit.
There are many constraints on the ‘production’ of this social construct that we call money, and they include inflation on the one hand, and deflation on
14 the other. When the private banking system is not managed, bankers can create more money than can usefully be employed. This can lead to too much credit or money chasing too few goods or services. Equally, as now, the private banking system can contract the amount of credit created, deflating activity and employment. But if the banking system is properly managed by public authorities there need never be a shortage of finance for sound productive activity.
That is why sound banking and modern monetary systems - like sanitation, clean air and water - can be a great ‘public good’. They can be used to ensure stability and prosperity, to advance development and to finance ecological sustainability, as I explain below.
Managed badly, a banking system can fatally undermine social, political, economic and ecological goals – as they do in many low income countries. Bankers and other lenders (including micro-lenders) can charge usurious – and ultimately unpayable rates of interest on society’s greatest asset – trust, expressed as credit. By using their despotic power to withhold credit or finance from the economy, bankers and financiers can cause economic activity to contract, leading to the deflation of wages and prices.
Left to run amok, a banking and financial system can, and regularly does have a catastrophic impact on society and the ecosystem. Managed badly a financial system can usurp and cannibalise society’s democratic
institutions.
We are living through a disastrous era in which the finance sector has expanded vastly – an era in which most financiers have virtually no direct relationship to the real economy’s production of goods and services. De-regulation has enabled the finance sector to feed upon itself, to enrich its members and to detach its activities from the real economy. Productive actors in the real economy – the makers and creators - have periodically been flooded with ‘easy if dear money’ and just as frequently starved of affordable finance. This instability has led to increasingly frequent crises since the ‘liberalisation’ policies of the 1970s; and to prolonged failure since the financial crisis of 2007-9.
15 Many low-income countries are dogged by badly managed and lightly
regulated financial systems, and therefore by a shortage of finance for commerce and production. This is in part because they lack the necessary public institutions and policies that underpin a properly functioning
financial sector. No monetary and banking system can function well without a system of regulation, without sound accounting, and without a system of justice that enforces contracts, and prevents fraud. But while low-income countries have been encouraged to open up their capital and trade markets, and to invite in private wealth, they have been discouraged or blocked outright in their efforts to build sound public institutions and policies to manage financial flows and to regulate the creation of credit by the financial sector.
The role of ‘robber barons’
In countries with weak regulatory institutions and systems, in other words without a sound monetary system, entrepreneurs are obliged to turn for loan finance to those who have acquired by fair means or foul, stocks of wealth or capital. Poor country governments turn to institutions like the IMF and World Bank, or to the international capital markets, for foreign hard currency. As a consequence of dependence on both domestic and international ‘robber barons’ money is dear. It is lent by powerful creditors, with the authority to create credit; with savings or a surplus, at high rates of interest – rates that often exceed the income or returns that can be made on the investment. If it is borrowed in foreign currency, then volatility in currency movements can both increase the cost of the loan, and also diminish those costs. But volatility is a deterrent to promising enterprises. As a result, innovation can be held back, unemployment and
under-employment remain high, and poverty entrenched.
Yet it does not have to be this way. With a sound banking and monetary system, there need never be a shortage of affordable finance to meet a society’s needs.
Our monetary systems have been cut loose from the ties that bind them to the real economy, and to society’s relationships, its values and needs. That
16 is largely because our monetary systems have been captured by wealthy elites who, with the collusion of regulators and elected politicians have undermined society’s trust, and now govern the financial system in their own narrow, rapacious and perverse interests.
The stealthy transfer of power to finance capital
Many orthodox economists are opposed to managing and regulating finance in the interests of society as a whole. Acting consciously or unconsciously on behalf of creditor interests, many effectively provide justification for ‘easy’ (that is
unregulated) but ‘dear’ (at high rates of interest) credit, the worst possible combination for society and, I will argue, the ecosystem.
Orthodox economists also have an unhealthy obsession with the state, which they accuse of ‘rent-seeking’ while ignoring the rent-seeking of the private sector.
As recently as October 2008 former Governor of the US Federal Reserve, Alan Greenspan made the ideology explicit under cross-examination by a Congressional Committee, chaired by Henry Waxman. 13 The chair of the committee reminded Mr
Greenspan that he had once said:
I do have an ideology. My judgement is that free, competitive markets are by far the unrivalled way to organise economies. We've tried regulation. None meaningfully worked.
Greenspan later went on to explain that he had
found a flaw in the model that I perceived as the critical functioning structure that defines how the world works, so to speak ... That's precisely the reason I was shocked, because I had been going for 40 years or more with very
considerable evidence that it was working exceptionally well. Over this period of 40 years, and thanks to the pervasive influence of the ideology, western governments used ‘light-touch regulation’, ‘outsourcing’ ‘ globalisation’ and other policy changes to effectively transfer power and regulation over the public good that is the monetary system and the
nation’s finances to private wealth. This transfer conceded two great powers to the private banking system. First the power to create, price and manage credit without effective supervision or regulation. Second the power to
17 ‘manage’ global financial flows across borders – and to do so out of sight of the regulatory authorities.
By this transfer, democratic and accountable public authorities handed effective control of employment, welfare and incomes to remote and unaccountable financial institutions and individuals – e.g. global bond markets - seeking usurious capital gains.
This hand over of great financial power took place by stealth. There was virtually no public or academic debate about the impact of this transfer away from public, accountable regulators to private interests. Instead, the public were offered reassuring platitudes about the self-correcting power of free markets. Competition, we were told, would eliminate cheating and fraud.
The result was entirely predictable. Small groups of individuals and
corporations in the private finance sector made historically unprecedented capital and criminal gains. Vast wealth was extracted from those outside the sector. Those engaged in productive activity experienced low growth. Profits fell relative to earlier periods, unemployment rose and wages declined as a share of GDP. Inequality exploded. Trust and confidence in the banking system and in democratic and other public institutions waned. The reason is not hard to understand. The transfer of economic power away from sound, elected, accountable institutions to wealthy elites had hollowed out democratic bodies and placed key decision-makers – like the heads of global banks - beyond the reach of the law, of regulators and politicians.
The economics profession and the universities stood aloof, as enormous powers were concentrated in the hands of small, reckless financiers. Academic economists focussed myopically on micro-economic issues and lost sight of the macro-economy. They obliged the finance sector by largely ignoring its activities. To this day, the economics profession remains distanced from the crisis, and almost irrelevant to its resolution.
While our universities turned a blind eye to this capture of a great public good for private gain, knowledge of the monetary system was scant, and
18 sometimes deliberately buried. Politicians and the media were dazed and confused by the finance sector’s activities. Gillian Tett, one of the few journalists bold enough to explore and challenge the world of international financiers and creditors, blames a ‘pattern of “social silence”…which
ensured that the operations of complex credit were deemed too dull,
irrelevant or technical to attract interest from outsiders, such as journalists and politicians.’ 14 Finance was too dull and arcane to attract the interest
of mainstream feminism and environmentalism.
As a result of this ‘social silence’ citizens were unprepared for the crisis. They remain on the whole ignorant of the workings of the financial system and its operations. They were made ignorant of ways in which money or credit can be deployed as a public good. It is this widespread confusion and lack of understanding that enabled the private financial sector to seize control of, and manipulate the global monetary system.
It is obfuscation and confusion that led the financial sector to abuse one of society’s greatest assets: trust.
Overcoming the defeatism of economists and politicians
This book has been written in the belief that money and the monetary system are not difficult to understand. Second, that a broad understanding of money and credit, and of the way in which the banking system operates is essential if citizens of democratic states are to reinvigorate and empower the democratic process, and override the despotic, unaccountable power of today’s financial plutocracy. Such knowledge or understanding is vital if we are to see through the academic obscurantism and economic ‘quackery’ of much debate around monetary systems. We need such understanding as a basis for sound financial regulation and policy-making. It is also vital if we are to overcome the defeatism of democratically elected politicians, leaders and economists. Politicians are quick to abandon democratic processes and the interests of those they are elected to represent. Economists are defeatist about the possibilities of recovery from crisis, and about reform – offering us only business as usual, or “secular stagnation”15 as Larry Summers,
19 2013. Too many gladly subordinate the interests of society to the interests of global finance capital; others wrongly believe that there is no alternative. This is hardly surprising, given the financial sector’s grip on how it is described, not to mention the lavish rewards that await politicians on retirement.
Karl Polanyi frequently reminded his readers that ‘militant liberals – from Maucaulay to Mises, from Spencer to Sumner – expressed their conviction that popular democracy was a danger to capitalism.’ 16 Many of the
architects of the Eurozone’s monetary system share that scepticism of democracy, as explained below.
This book takes the opposite position: today’s rampant financialisation of the global economy is a grave danger to the revival of employment and economic activity, to the values societies hold dear, and to democracy. The experience of financial de-regulation has shown that capitalism insulated from popular democracy degenerates into rent-seeking, criminality and grand corruption.
We have done it before. We can do it again
We have been here before. In the 1930s economists and politicians insisted that democracy be placed above the power of money; that finance should be servant, not master, to the economy and society. The economic cataclysm of the Great
Depression came to be regarded as the direct consequence of the financial
liberalisation (or ‘globalisation’) policies that prevailed in the 1920s. When the UK economy slumped in the 1930s the Bank of England refused to act proactively, which is why it was nationalised in 1945 and remains to this day under democratic control, even if that control is not always exercised.
After 1931 control over the finance sector in the United States was wrested from private wealth and placed in the hands of the transparent and accountable state. Under a later mandate (the 1944 Bretton Woods Agreement) the democratic state and central banks were charged with a responsibility to manage, and maintain stability and balance in international trade and finance. All aspects of interest rate, exchange, banking and financial market policy became a matter for government. Central banks were brought under increased public control, even - as in Britain
20
and France - nationalised. The drivers behind these policies were elected politicians: Franklin Delano Roosevelt, France’s Leon Blum and, later, Clement Attlee’s Labour Party. But it was the British economist, John Maynard Keynes that provided the intellectual underpinnings of this re-ordering of society.
Liberalised finance with the support of orthodox economists, has once again weakened democratic oversight of the economy and hollowed out the
institutions of states that oversee and regulate the finance sector. If we are to prevent the kind of cataclysm that befell the world in the first half of the 20th century, then greater public understanding of how the financial system
operates, and how it can be reformed, is vital.
Challenging taboos about money
I hope to shed some light on what Keynes called capitalism’s “elastic production of money”, and to indicate how monetary reform can restore oversight of the finance sector to democratic institutions.
I have two overriding objectives, First, to challenge and nail the argument that ‘there is no money’ for society to address major threats, to fight poverty and to meet human needs. Money and monetary systems, I will argue, are social constructs, and can and must be managed, mobilised and deployed to serve the wider interests of society and the ecosystem.
Second, I want to force into the open a subject that is taboo: the role of private, commercial banks in the creation of money ‘out of thin air’. For too long orthodox economists have misled politicians and others, and focussed only on central bank money creation. They have deliberately down played the role of the private sector: in credit creation or ‘printing’ money; in providing or denying finance to productive sectors; and in generating inflation.
Monetarists, such as those that advised Mrs Thatcher’s government, never accuse the private commercial banking system of ‘printing money’. Yet the private banking system ‘prints’ 95% of the money in circulation in Britain, according to the governor of the Bank of England. It is they who hold the power in an unregulated system to provide or withhold finance from those active in the economy.17 Yet neoliberal
21 economists largely ignore private money ‘printing’ and aim their fire instead at governments and state-backed central bankers whom they accuse of stoking inflation by the excessive creation of money.
The blind spot for the private creation of credit is part of the ideology rooted in the belief that “free, competitive markets” are the best way to organise the finance sector and the economy. This belief is in turn rooted in contempt for the democratic state – a contempt actively expressed by the Thatcher government of the 1980s. The monetarist blind spot for the link between private banks’ money creation and
inflation goes some way to explaining why Mrs Thatcher’s economic advisers found they could not control both the British money supply and inflation. 18 They had
aimed only to control the public money supply – government spending and
borrowing. Partly as a result of monetarist doctrine, the Thatcher administration presided over a rise in the inflation rate to 21.9% in its first year of office. Only during the fourth year did inflation come down below the inherited rate. As William Keegan explains, the “defunct (monetarist) economic doctrine” led not only to a rise in inflation, but also to a savage squeeze on the British economy and to escalating unemployment.19 Unsurprisingly, “the private sector did not respond…because the
methods chosen by the evangelicals made the economic outlook much worse, so that there was no incentive for it to respond.” 20
Management of the monetary system
While the creation of money “out of thin air” is a fascinating, and to many a fresh, discovery, it is not finance per se, but rather the management or control over the ‘elastic production of money’ that matters. There should be no objection to a monetary system in which commercial banks create
finance needed for the real economy. Indeed commercial banks have a critical role to play in providing and smoothing the flow of finance around the economy. Bank clerks have critical roles to play in managing myriad social relationships between debtors and creditors, and in assessing the risk of the bank’s borrowers. Assessing Mrs Jones’s application for a
mortgage, Mr. Smith’s application for a car loan and a firm’s application for an overdraft is not a role best suited to civil servants in government
bureaucracies. However, the power of private, commercial bankers to create and distribute finance must be carefully and rigorously regulated – by publicly accountable institutions - to ensure that finance or credit is
22 deployed for sound, affordable and sustainable economic activity; and not for speculation. The great power bestowed on banks by society – the power to create money ‘out of thin air’ – should not be used for their own self-enrichment. Nor should customer deposits and their assets (loans) be used as collateral for their own borrowing and speculation.
Like doctors and dentists, bankers’ roles must be carefully defined and regulated, and their rewards must be modest. Incompetence, fraud and theft must likewise be punished.
Money’s rent
It is not just the creation of money and the sustaining of trust in money that this book focuses on, but also the price at which the public good that is bank money is ‘rented’ out to what can broadly be defined as Industry and Labour. That is the rate of interest applied by private bankers to the real economy. A low rate of interest is a moral imperative. But it is also an economic imperative, as it allows private industry to thrive. For capital investment projects to expand, for creative or innovative activity to be sustainable, depends on affordable finance, and affordable finance is cheap finance.
Sustainable finance must also be affordable in ecological terms. Our concerns should not be limited to the way our rentier economy uses high rates to extract additional value from citizens, firms and the public sector. As worrying is the way in which high rates of interest lead to rising rates of exploitation and extraction of the earth’s limited supply of assets (forests, fish, land, minerals, clean air etc.) to finance debt repayments.
In other words it’s not finance per se that is the most important factor, but how money is managed and spent. Does affordable finance flow to
productive, sustainable, employment-creating, income-generating investment? Or is costly credit directed at reckless, de-stabilizing, unaffordable consumption and speculation?
23 Above all, there should be wider understanding of how a monetary system can be managed to serve the interests of all sectors of the community, and not just the privileged owners of private wealth.
Monetarist and other orthodox economists encourage politicians to persist in a form of despair; that society is helpless to control a man-made, socially constructed, globalised, and increasingly anarchic financial system. ‘The clock’ we are told by the World Bank ‘cannot be turned back.’ 21 Instead economists persist in the lie that:
‘there is no money’ – a lie repeated endlessly by politicians of all colours.
This book is written to challenge that dominant flawed ideology.
In mounting a challenge to finance we must gain confidence from this truth: finance capital has no greater fear than democratic regulation and reform of the monetary system. This is because monetary reform will transform the balance of power between democratic societies, the ecosystem and finance – in favour of democracy, society and the ecosystem. And it will do so in a way that one-party communist states, for example, were not able to achieve.
Knowing that should give us courage: another world is indeed possible.
24
Chapter One: So how is money created
today?
It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.
Ben Bernanke explaining in a TV interview how $85bn had been
created to bail out AIG. 22 The journalist had asked if it was tax
money?
Most orthodox, neoliberal economists would have us believe that banks and bankers are mere ‘intermediaries’ between borrowers and savers; that
savings are needed for (and prior to) investment; that loans are made from deposits; and that the price of money – defined as the ‘natural rate of
interest’ – is a function of the supply of, and demand for, money or savings.
Economists such as John Maynard Keynes, Joseph Schumpeter, JK Galbraith, Victoria Chick, Geoff Tily, Cullen Roche and those who define themselves as Modern Monetary Theorists (MMTers); sociologists, central bankers, commercial bankers, presidents and politicians have long known that none of this is the case. Nor has it been so since before the founding of the Bank of England in 1694.
Private commercial bankers are not, nor ever have been, mere intermediaries.
Savings are not needed for investment.
Commercial bankers do not lend the deposits of their customers on to borrowers.
Bankers do not use their reserves ‘parked’ in central banks to lend on.
25 Bank credit-money is produced out of nothing more than the promise of repayment – a promise deemed acceptable by the banker.
Credit creates purchasing power.
Bank money issued as credit does not exist as a result of economic activity.
Instead, bank money creates economic activity.
Private bank loans issued by commercial bankers (with a stroke of the computer keyboard) create deposits.
It is the loan application together with a risk assessment, the borrower’s promise of both collateral and repayment over a specified period of time at a specific rate of interest - that creates deposits. This was confirmed in the summer of 2013 by Paul Sheard, the chief economist of Standard and Poor’s, in a note headed Repeat After Me: Banks do not Lend out Reserves: -
Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit "creation"-- credit is created literally out of thin air (or with the stroke of a keyboard). The loan is not created out of reserves. And the loan is not created out of deposits: Loans create deposits, not the other way around.
Paul Sheard23
After a risk assessment, a contract agreement, and the offer of collateral, money is created by simply entering a number into a computer and charging the sum to the borrower’s account. (In bygone days this bank transfer was made using a fountain pen or quill to make an entry into a ledger. It was then known as ‘fountain pen money’.)
The overwhelming bulk of credit is ‘bank money’ created in this way. It exists as nothing more than a promise to repay over an agreed period of time. At the most tangible, it is the quantities expressed on a bank statement.
26
When banks extend loans to their customers, they create money by crediting their customers’ accounts.
Mervyn King, Governor of the Bank of England in a speech to the
South Wales Chamber of Commerce at The Millennium Centre, Cardiff, 23 October 2012.24
In the Eurosystem, money is primarily created through the extension of bank credit… The commercial banks can create money themselves.
Bundesbank25
The Euro’s introduction in the form of notes and coins dated from 2002, but it existed as a means of setting prices, contracting debts & a means of payment for over a year before [being] embodied in these media of exchange.
Geoffrey Ingham26
Money’s quality, its acceptability and validity is simply due to its
being able to facilitate transactions - as the genius and Scottish
economist, John Law, was first to fully recognise.
“Money is not the Value for which Goods are exchanged, but the Value by which they are exchanged”.
Joseph Schumpeter, History of Economic Analysis, attributes
this quote to John Law.27
The delusion of ‘fractional reserve banking’
Those who grasp this much still sometimes fall into another popular
misconception, the idea that commercial banks can only create credit or lend on the basis of a fraction of ‘reserves’ or cash or ‘capital’ in the bank. In other words, so it is said, to lend £1000, banks need a reserve requirement of £100 in their vaults, or in the vaults of the central bank. The reality is
27 exactly the opposite. Reserves are created as a result of, and to support
lending.
Banks keep reserves in the central bank, in reserve. Reserves are funds provided by the central bank, which banks need on a day-to-day basis to settle accounts with other banks, as part of the cheque-clearing process: for no other reason.
Frances Coppola has it right:
Bank reserves never leave the banking system. They are not "lent out", as is often claimed. When a bank lends, it creates a deposit "from nothing", which is placed in the customer's demand deposit account. When that loan is drawn down, the bank must obtain reserves to settle that payment - but the payment simply goes to another bank (or even the same one), either directly through an interbank settlement process, or indirectly via cash withdrawal and subsequent deposit. The total amount of reserves in the system DOES NOT CHANGE as a
consequence of bank lending. Only the central bank can change the total amount of reserves in the system. This is usually done by means of "open market operations" - buying and selling securities in return for cash.28
Money’s quality, its acceptability and validity is simply due to its
being able to facilitate transactions.
The deregulated financial system – and liquidity
It’s important to understand that under our deregulated financial system bankers can create credit or liquidity (i.e. assets that can easily and readily be turned into cash) effectively without limit. There are now few regulatory constraints on the creation of credit by commercial bankers. Furthermore de-regulated finance also encourages financiers in the ‘shadow banking system’ to create or ‘securitise’ more and more artificial or synthetic ‘credit’ products or assets. This has led to a new type of financial engineering known
28 as the ‘originate and distribute’ model for packaging and ‘originating’ financial instruments or collateral that were ‘synthetic’ in that (unlike property or works of art or other forms of collateral) they were created artificially. These packaged ‘assets’ were then used to leverage further borrowing, which in turn generated massive amounts of liquidity for those active in shadow banking. These assets and associated borrowings create tremendous wealth and are often hidden and managed off balance sheets in ‘special investment vehicles’ or SIVs.
Central bankers failed to understand these dangerous self-enriching
activities, or intentionally turned a blind eye. Some cheered on the finance sector’s increasingly godlike financial engineers. Alan Greenspan in 2004 said that under the deregulated system
“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” 29
Where do notes and coins come from?
While banks are not on the whole constrained in their ability to create credit there is one thing bankers cannot do. They are not licensed to issue notes and coins as legal tender.
Only the central bank can issue the legal, tangible stuff: notes and coins.
So if Joanna Public takes out a mortgage for say, £300,000, and needs
£3,000 in cash, the commercial bank has to apply to the central bank for the
tangible notes and coins she wishes to withdraw. £297,000 of credit is
granted as intangible bank money, and is deposited in Joanna’s account.
It is important to understand that central banks place no limit on the cash made available to private commercial banks to satisfy a loan application.
Because the central bank provides cash on demand, there is therefore no limit to the cash, bank money or credit that can be created by commercial
29 banks. In other words, there is no ‘fractional reserve’ or ratio. In fact, the demand for cash is falling; but during the long boom the demand for credit accelerated – and central bankers turned a blind eye. They neither limited the quantity of credit created, nor did they offer guidance to private bankers on the quality of credit issued. So banks were freed up to not only lend for productive, income-generating activity, but also for risky, speculative
activity.
Just as importantly, central bankers in the 1970s relinquished control or influence over the full spectrum of interest rates made on loans by bankers. These include rates on short-term and long-term loans, as well as on safe and risky loans. They abandoned tools and policies used during the
Keynesian era to regulate credit creation, and to influence rates across the full spectrum of lending. The purpose then had been to ensure that rates for productive activities were kept low for all borrowers, and therefore repayable. These policies were based on Keynes’s theory that employment, economic activity and profits could only be assured if credit was affordable. His liquidity preference theory was used as the basis of policies that ensured that interest rates during World War II were kept low, to help with affordable financing of the war. They were stunningly successful. More on that below.
After the collapse of the Bretton Woods era, credit creation and the ‘pricing’ of credit was left to the whim of the ‘invisible hand’. Private bankers were unfettered in their power to create credit (debt) effortlessly and if they
wished, for speculation in property, exotic derivatives, works of art, football clubs, and so on. They were freed up to charge high real rates of interest. The result was entirely predictable. A vast bubble of credit was used to speculate in, and inflate the value of assets: for example, works of art, classic cars, footballers and football clubs, yachts, brands, property, stocks and shares. Assets are largely owned by the wealthy, and can be used to increase wealth when used as collateral for further borrowing. The inflation of assets vastly and effortlessly increased their wealth, and the ability to use that wealth as collateral with which to leverage further borrowing.
30 At the same time, and predominantly in the Anglo-American economies, ‘easy’ but ‘dear’ credit buried companies, firms, households and individuals in largely unaffordable debt.
Credit creates deposits
Deposits are created when a banker, having assessed the risk associated with the loan; having confirmed by legal contract the promise to repay,
backed by collateral (e.g. property) at a rate of interest and over a fixed period
of time; and having obtained the cash proportion of the loan from the central
bank, then enters numbers into a ledger or computer. After entering the amount of the agreed loan into the computer, the banker credits the funds to the account of the borrower.
This, as Ben Bernanke explained in the interview quoted at the beginning of this chapter is what the Federal Reserve accomplished when it created $85 billion ‘out of thin air’ and credited that amount to the account of a near-bankrupt insurance company AIG, one day in the winter of 2008-9. The
money was not raised from taxation, as Chairman Bernanke made clear to
the journalist who questioned him. Furthermore, AIG is not a bank, and should never have had an account with the Fed, but major concessions were made to reckless, effectively insolvent firms that posed a systemic threat to the economy during that period.
When the loan created by entering numbers into a keyboard is drawn down by the borrower, the payment goes either to the same bank, or to another, either through interbank settlements, or by withdrawing cash from bank A and depositing it in bank B.
In accounting terms, these deposits are liabilities for the bank that issued the loan. The reason for this is that claims can immediately be made on deposits, for both the tangible notes and coins and for the intangible bank money element of the loan. Bank A will have to ‘clear’ any payment to Bank B.
31 The loan itself, however, becomes an asset. The reason for this is that the bank expects to earn interest or a rate of return on the loan when it reaches maturity – in other words, over time. The task of the banker is to ensure a match between income earned from lending, and liabilities incurred from deposits.
Once the loan is drawn down the bank proceeds to drain a share of the borrower’s income, in interest payments.
By these means do commercial banks create the overwhelming bulk of deposits, and earn interest on a process that costs them little.
Andy Haldane, Executive Director, Financial Stability at the Bank of England explained recently that by fixating on inflation targeting, central bankers had turned a blind eye to what was really going on in the credit-fuelled financial system:
“Inflation targeting assumed primacy as a monetary policy framework, with little role for commercial banks' balance sheets…what happened next was extraordinary. Commercial banks' balance sheets grew by the largest amount in human history. For example, having flatlined for a century, bank assets-to-GDP in the UK rose by an order of magnitude from 1970 onwards.”30
(To remind readers: assets in this context means bank lending.) In 1980, UK bank credit or lending was just 36.2% of GDP. By the year 2000, bank credit had risen to 136% of GDP. In 2008, bank credit was a whopping 212% GDP, according to the World Bank.
Mervyn King confirmed the role of private banks in expanding the money supply in an interview (14 June, 2013) with Martin Wolf just before his retirement as Governor of the Bank of England. Wolf asked the Governor about quantitative easing – had that worked as he hoped?
“I’ve always seen this as a way of increasing the broader money supply. And the thing that’s so extraordinary is that, for the past few
32 years, the banking system, which is normally responsible for creating
95 per cent of broad money has been contracting its part of the money
supply. And since we at the (Bank of England) only supply about 5 per cent of it, the proportional increase in our bit has to be massive to offset the contraction of the rest.”31 (My emphasis)
Banks and bankruptcy
If bankers can create credit out of thin air, I hear you ask, how can they be bankrupted? When a banker elicits a promise of repayment on a loan from a customer, and then creates credit for the customer, this immediately
becomes a loan asset and a deposit liability on their balance sheet. The loan is an asset because, over time, it will earn interest for the bank. The deposit is a liability because it is immediately owed by the bank to the customer or depositor – who may withdraw it to make payments to another bank. (Time management is a critical function for bank managers.)
The bank has to manage its assets and liabilities carefully to ensure funds are available when the depositor wishes to withdraw her deposit. It does this by obtaining reserves from the central bank system each time it creates a
deposit. Reserves are used for clearing and settling inter-bank financial
transactions.
The banking system as a whole has to manage financial transactions and ensure that cheques and other payments are cleared between those receiving payments and those making payments.
This is the critical role played by the central bank – e.g. the Bank of
England, the Federal Reserve or the Bank of Japan. Central banks perform important roles in helping to maintain balance in the financial system by clearing and settling interbank payments. The central bank helps settle payments between bankers by debiting the accounts of banks making payments and crediting the accounts of banks receiving payments. When payments are made between the accounts of customers at different
33 transferring central bank money (reserves) between the reserve accounts of those banks.
In normal times these payments cancel each other out, with only a small amount of central bank reserves needed for settlement at the end of the day.
But bankers can get into difficulties, and times are not always normal. If owing to mismanagement a bank finds its liabilities begin to exceed its assets, then no amount of central bank reserves can help it: it is facing bankruptcy. If the public get wind of any difficulties, then there is a ‘run’ on the bank; deposits are quickly withdrawn, and liabilities begin to mount. (Remember though, all licensed banks have deposits up to a specified limit guaranteed by the state, so deposits are on the whole, protected. In this respect banks are very different from corporations, whose customers, in the event of bankruptcy, are not protected by the state.)
Until recently commercial banks were prohibited from mixing their lending and deposit arms (commercial banking) with their more speculative
investment arms. Then in 1999 President Clinton, under pressure from big
bankers, and aided by the economists Larry Summers and Robert Rubin, repealed the Glass-Steagall Act which after the 1929 financial crisis had enforced separation between commercial and investment banking. Other central bankers soon followed suit. Commercial bankers were then freed up to link their own borrowing and speculative activity to the more sober day-to-day role of assessing risk, and supplying credit and deposits to those engaged in the real economy. Because these two sides of banking became so closely integrated, excessive borrowing for reckless speculation by private bankers exposed all those who used the banking system to major – or systemic - risks, costs and losses.
As sure as night follows day, excessive borrowing and speculation by
bankers helped precipitate the global financial crisis of 2007-9, when most banks faced the threat of insolvency. They were bailed out by
taxpayer-backed governments with barely a rap on the knuckles, and with virtually no ‘terms and conditions’. To this day no banker has been jailed, or been held
34 criminally responsible, or had to admit any wrongdoing for his role in
precipitating global financial meltdown in 2007-9 – or for subsequent frauds and failures. Where fines have been administered, they have represented but a fraction of the cost to society of financial failure and wrongdoing. Andy Haldane, responsible for Financial Stability at the Bank of England, argued once that even if bankers were to compensate society for the losses endured, “it is clear that banks would not have deep enough pockets to foot this bill.”
32
Despite massive bailouts by taxpayer-backed central banks, I contend that most global banks are still effectively insolvent. Government guarantees and backing, coupled with the manipulation of balance sheets, is what stands between today’s global banks and insolvency.
The good news: credit creates economic activity
The good news is that when the banking system is properly regulated and managed, bankers create all the credit society needs for purposeful economic activity. When this credit creates new deposits at low, repayable rates of interest, then if used for productive activity, deposits create economic activity (investment and employment). These in turn – if the money is invested in ecologically sustainable activity - generate income (wages,
salaries, profits and tax revenues). This income can be used to repay loans and debts.
This virtuous economic circle in which debtors and creditors engage at a fair rate of interest, and on the basis of trust in order to invest and generate jobs and income, to create and to innovate, to finance vital projects, and then to settle debts, is how an advanced, sound and stable monetary system can work. It is how a monetary system can be used to finance services vital to for example, women; or to fund the transformation away from fossil fuels to more sustainable forms of energy.
It is under the strains of speculation and high rates of interest that the system quickly becomes unstable, and likely to ‘debtonate’. In other words,
35 the system becomes unstable if credit is largely wasted on creating vast bubbles of unpayable debt; or on illusory liquidity. The latter can be defined as fictitious capital or ‘Ponzi finance’ where risks are underestimated, buyers disappear and value quickly evaporates in a crisis. Liquidity becomes
illusory when the owner of an asset finds no buyers for his asset, at a time he urgently needs to sell. So for example, I might purchase expensive
diamond watches, or collateralised debt obligations (CDOs) believing they are largely ‘liquid’ i.e. can quickly be turned into cash in a crisis. That ‘liquidity’ evaporates when buyers for diamond watches or CDOs disappear from the market – often because a generalised loss of confidence, and because they too are heavily indebted.
The ecological impact
In the run-up to the crisis of 2007-9, firms, individuals and
households, but also banks in mainly Anglo-American economies took on huge debts at rates of interest too high to make repayment affordable. These debts were used to purchase an explosion in financial assets, in property and consumer goods.
The rise in consumption led inevitably to a rise in greenhouse gas emissions.
In order to repay rising debts, firms and households are obliged to exploit natural and human resources in a way that is damaging in the medium, never mind the long, term. Employees are expected to work longer hours, to generate more goods and services, and to do so at lower rates of pay. Hence the rise in the 1980s and 90s of the phenomenon of 24/7 – shops and firms open for long hours, with workers expected to work unsocial hours.
Natural resources (like the land, forests and seas of fish) are exploited at exponential rates, to enable firms and even governments to
36 generate the income needed to repay debts. (Think of Brazil stripping forests to generate the hard currency needed to repay foreign debts.)
These developments add social insecurity and ecological instability to the mix of financial volatility.
Society must learn from these grave errors, that the great public good that is the ‘magic’ of credit-creation by the private banking system must be managed and carefully regulated if lending is to be
affordable, sound and sustainable, and if society as a whole is to benefit. Management of the rate of interest plays a key role in the regulation of a stable financial system.
37
Chapter 2: The ‘price’ of money – or the
rate of interest
While the creation and management of credit was indeed a revolutionary advance for society, perhaps just as important was the impact the greater availability of finance had in lowering of the ‘price’ of money, or the rate of interest. 33
The rate of interest on credit is fundamental to the health and stability of an economy, which is why much attention is paid to it in this book. The level of
employment and activity in an economy depends critically on the rate of interest. Too high a rate stifles enterprise, creativity and initiative and
renders debts unpayable. There is also a moral dimension to the relationship between those who own assets, the creditors, and those in need of money or credit, but without assets, the borrowers. This moral dimension has been at the heart of the condemnation of usury – exploitative rates of interest - by faiths, including Islam and Christianity
A low rate is also fundamental I argue, to the health of the ecosystem. Too high a rate demands ever-rising extraction of the earth’s assets, to generate resources for repayment.
Given there is no necessary limit to the volume of credit and debt that can be created by private, commercial banks then credit is essentially a free good – not subject to finitude, or the market forces of supply and demand.
From this it follows, as Keynes argued in his Treatise on Money, that:
“... if the banks can create credit, (why) should they refuse any
reasonable request for it? And why should they charge a fee for what costs them little or nothing?” 34
38 Keynes recognised that once the system of bank money evolved, and credit became more widely available, society no longer needed to rely on existing wealth holders for finance. Barons in the castle – owners of a surplus of capital - were no longer sole providers of loan finance to the rest of the economy. Savings were no longer needed for investment. The powers exercised by the owners of wealth could be subordinated to society’s wider interests. Credit creation by banks could provide borrowers, entrepreneurs and innovators with the finance needed for investment – at affordable rates of interest. Creative artists and designers, entrepreneurs and innovators no longer had to turn to wicked, wealthy ‘robber barons’ for usurious finance.
The ‘price’ of money vs the price of smartphones
The rate of interest on this bank money is determined in ways quite different to the way in which the price of (say) tomatoes or a smartphone or a pair of shoes is fixed. It is different, and cannot be subject to the forces of ‘supply and demand’ because of the very nature of bank money, and of the largely effortless way in which it is created; and because rates are fixed by
committees of men and women.
To manufacture a product such as for example a smartphone requires manufacturers to engage with first the Land – in the broadest sense of the word. Minerals and crucial elements for the phone have to be extracted from the earth, and then transported to manufacturing sites. The extraction, supply and transport of these minerals are subject to both geological and geographical, but also geopolitical, constraints.
Second, the manufacturers of the smartphone have to engage with Labour – in the broadest sense of the word. Labour has to be found and trained; wages have to be negotiated; and sometimes disputes have to be managed.
The creator of credit faces none of these challenges. The banker engages with neither the Land nor Labour in the creation of his financial product. Sound banking requires good judgment, a conscience, and accounting skills. But
