I note an interesting little discussion between Tim Worstall and Ralph Musgrave on money creation in the context of the Northern Rock bank crisis of 2007. Essentially Tim was claiming, against the PositiveMoney view, that the failure of the bank was evidence that it was not possible for banks to create money. Ralph’s point was that it is possible for banks to create money if they move ‘in step’, but since Northern Rock was creating money (by lending) faster than other banks this led to its problems.
In fact both Tim and Ralph are ignoring the role a crucial player here: the Central Bank – in this context the Bank of England (BofE).
The basis of our monetary system is money created by the BofE in the form of notes, coins and accounts held by commercial banks with the Bank of England. Let’s imagine a single commercial bank operating in the UK that holds a certain amount of this BofE money. This bank could certainly create additional money by lending up to the point that it could still cope with demands of depositors for banknotes and coin, or to pay taxes etc. to the government. Most transactions, however, would be between account-holders. All the bank need do for these is adjust its deposit records; no reserves would be required.
I’ve got involved with one or two on-line debates recently in which the issue of money in commercial banking is seen as a fraudulent process by which value is stolen from citizens. Usually the central bank is seen as the government’s enabler in this process, and so to blame for the resultant misallocation of credit or ‘malinvestment’. This is a view to be found among adherents of the ‘Austrian’ school of economics, and ties in nicely with their extreme views of the efficacy of markets and the villainy of governments. Even if they do not believe the only money used should be gold, they believe that its value should be tied to gold and that central banks consistently devalue the currency by setting too low the interest rates at which commercial banks borrow from them.
While the Austrians’ views are so dogmatic as to be fairly easily ignored, there has also been a recent tendency among some campaigners, such as Positive Money or GolemXIV, to blame the current discrepancy between rewards to the rich and punishment for nearly everyone else on the banking’s ability to ‘create money out of thin air’. According to this view the banks then profit from this costless activity by lending it to us at interest, either directly or indirectly via government. Continue reading Is Banking Government-sponsored Counterfeiting?→
In fact, I had avoided answering the points in his previous post partly because I wanted to see the ‘daylight’ of a consensus on reform of the monetary system, with a view to action of some sort – if possibly not ‘imminent’, since it depends on a lot of changed minds first! Secondly I believed I had addressed all of his ‘points’ before. But maybe the argument got scattered across a lot of posts, and so I present a detailed response here to that last substantive post. I hope, also, that this will stand on its own as an explanation of why we need to work with our current system, rather than expecting it to collapse under its own weight or tearing it down to replace it with some new and untried (or failed elsewhere) system.
He accused me of not addressing his points. I don’t accept that, but I do intend to respond in detail to his last substantive post in due course. Since I respect virtual property rights, I shall post that response here!
In a modern state, the government has a monopoly on physical force and so it is natural that the government should provide the final backing to contracts through the legal system. Moreover, the government can use physical force on its own account to enforce its own purchasing and debt-collecting activity, in which State or Central Bank Deposit Money (SBDM) is created and spent, circulates and is destroyed. By imposing liabilities in the form of taxes that must be paid in the money it has created, the state can control the quantity of this money in the economy. This also serves to establish this money as a unit of account and gives it the status of a means of payment. (1)
By insisting on credit payments of taxes taking place in central bank money, the central bank also forces the other banks to hold deposits with the central bank, these deposits being increased when the government makes a credit payment to one of their deposit-holders and decreased when a deposit-holder makes a tax payment in credit money. Transfers of credit money between banks can then occur via their deposits at the central bank, allowing them to settle asset-liability discrepancies that arise as deposit-holders transfer Commercial Bank Deposit Money (CBDM) between each other. Continue reading The Role of a Central Bank→
It examines various theories of money’s origin and sustainability, both ‘orthodox’ and ‘heterodox’, and analyses the link between money and real economic outcomes. Most of it is understandable without advanced mathematical skills!
I note a considerable amount of interest in some ideas by Chris Martenson – who has a website and offers tutorials entitled ‘The Crash Course’. He suggests that the current way we are living is unsustainable and we’d better start preparing for when it all goes pear-shaped (which will be pretty soon according to him). There are three pointers to this alarming turn of events – two fairly genuine, I think, and one based on a misunderstanding.
The two issues I would share his concern about are Climate Change and so-called ‘Peak Oil’ – the impact of the likely future decline in oil production as reserves are exhausted. Their exact impact is, of course, open to ongoing debate.
His misunderstanding involves the impact of interest payments on the monetary system. Now Dr Martenson is a neuro-toxicologist by training, rather than an economist. Otherwise he would probably be aware that the problem of how interest can be paid when all money is created through lending is one that has troubled many economists, particularly those of the monetary circuit school, to which I would describe myself as loosely attached. But in fact it has a very simple solution, once one learns to distinguish between money stocks and money flows. Continue reading On the ‘Impossibility’ of Paying Interest→
It’s important to take a step back and consider the nature of money in the modern economy. It’s taken me about 15 years to get to grips with it – but maybe I’m slow, and it could be done in 5…
All modern money is created as debt – government or private. It’s a symbol of a promise to provide some good or service in the future. Problems arise when promises are unfulfilled, either in the quantity or the quality of goods provided. If there’s a lot of money around and not many goods, prices tend to rise.
Problems also arise when not enough money is created, or the money created is not actually used to purchase enough of the goods provided. Then we have demand failure, recession and unemployment. Continue reading The Nature of Modern Money→
Although income inequality appears to be a fact of life there remains general agreement that there should be such a thing as social justice, if this is given to mean at least an approximation to equality of potential achievement. This apparent incompatibility can only be reconciled if money income is neither the only measure of human well-being and fulfilment nor the only means to achieving it. Yet it may well be that the fundamentals of the global financial and economic system are such as inevitably to both widen income inequality and also to increase the importance of money in achieving individual well-being and happiness. Continue reading Money and Inequality→
Is ‘economic activity’ always a good thing? The banks hit by the bonus tax have raised the spectre of lost incomes and tax revenue if they choose to relocate away from the UK. The British Broadcasting Corporation (BBC) has recently sought to justify the licence-fee by calculating the revenues its commissioning generates for independent production companies. But it’s a deeply misleading idea that the benefit of any activity can be calculated by measuring the quantity of money that is involved in purchasing or producing it. Because money is the definition of wealth to each of us as individuals, it’s easy to forget that in itself it is pretty much worthless paper or more commonly today, an electronic pattern on digital media. For the welfare of the nation in which it is generated money represents no additional wealth whatsoever. Continue reading The banks, the BBC and ‘Economic Activity’→