A Post-Script to Newsletter 23
Money for nothing
Banks should be repositories for our wealth – and not be free to create money at will. We should take monetary reform seriously
Ann Pettifor is right: nothing in that lengthy communique suggests the G20 is prepared to engage with the underlying causes of the financial crisis, nor the chronic instability and injustice that characterise the current economic system. Chief among these is the deeply flawed mechanism by which money is created.
Mainstream economists like Joseph Stiglitz are calling for a new financial architecture, but none acknowledge that the monetary system, and in particular the way money is created – as debt by commercial banks – dictates the way that architecture functions. Cif contributor Chris Colvin recently described the idea of monetary reform as a "wacky fix" and an "extravagant idea that involves removing the ability of private banks to create money and forcing them to adopt 100% reserve banking". Yet the respected alternative economist Herman Daly wrote recently: "I would certainly advocate 100% reserve requirements for banks (approached gradually). All banks should be financial intermediaries that lend depositors' money, not engines for creating money out of nothing and lending it at interest."
Daly's argument for movement towards a just and sustainable steady-state economy offers a comprehensive solution to the current crisis. Colvin, by contrast, follows a long tradition of economists for whom the parameters of the discipline are set by academic orthodoxy.
Colvin's principal complaint – that unless banks are able to create money through traditional means there would be insufficient cash in circulation – misses the point completely. Cash comprises just 3% of the money supply. The rest exists only as entries in banks' electronic ledgers. If banks can create electronic money at will through the process of fractional reserve banking, why shouldn't a democratically accountable central authority do the same. In this paper for the New Economics Foundation, James Robertson and Joseph Huber argue that central banks should determine the quantity of new non-cash money. Under their scheme, the central bank would credit new money to the government as public revenue which would then be spent into circulation.
Bryan Gould is among the few public figures prepared to speak out in support of monetary reform. As he wrote here recently, "privately owned banks have been allowed to develop a virtual monopoly of credit creation for more than 200 years". Gould got a hard time in the thread for his suggestion that "only governments have the capability and the duty to act in the wider interest" in respect of money issue. In a properly functioning democracy, governments would represent the interests of the majority of citizens. As things stand, they don't. This helps explain why bankers are given a licence to create money, and are then bailed out when their actions bring the economy crashing down, while the rest of us face a pay freeze or redundancy.
There is a direct link between the way money is created and the enormous debt bubble that preceded the credit crunch. The objective of monetary policy should be to ensure that the money supply accurately reflects the quantity of real wealth being created in the economy, and is sufficient to provide funds for new investment in real businesses to keep the economy ticking over. This is a difficult calculation to make, but under current arrangements nobody even attempts to make it. Central banks would be better placed than profit-motivated commercial banks to make that assessment.
Chris Colvin is free to mock the Money Reform party for its candidate's poor performance in a 2006 byelection. But anyone wanting to better understand the impact of debt money could do worse than consult the party's website which includes a compelling explanation of the mechanics of money creation and its impact on society. If you like what you read, you might consider petitioning the prime minister to take monetary reform seriously by adding your name here.
Money for Nothing - www.guardian.co.uk/commentisfree/2009/apr/03/g20-economics-banks.