Professional Documents
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Just Money Ann Pettifor
Just Money Ann Pettifor
Just Money
Ann Pettifor
2
Just Money
Commonwealth publishing.
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Introduction
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
4
sanitation system could and should be just – and serve all citizens, not only a
wealthy elite.
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.
5
define it as such is to create a ‘false commodity’ as the political economist
Karl Polanyi argued. 3
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.
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
6
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.
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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.
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’.
8
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.
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.
-----------------------------------------------------------------------------------------
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.
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‘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.
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.
11
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.)
12
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.
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.
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
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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.
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.
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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.
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
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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.
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.
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
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‘manage’ global financial flows across borders – and to do so out of sight of
the regulatory authorities.
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.
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
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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.
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,
Professor of Economics at Harvard University opined at an IMF seminar in
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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.
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
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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.
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
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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
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
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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.
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?
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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.
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.
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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.
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.
Private commercial bankers are not, nor ever have been, mere intermediaries.
Bankers do not use their reserves ‘parked’ in central banks to lend on.
The money for a loan is not in the bank when a borrower applies for a loan.
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Bank credit-money is produced out of nothing more than the promise of
repayment – a promise deemed acceptable by the banker.
Bank money issued as credit does not exist as a result of economic activity.
Paul Sheard23
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.
25
When banks extend loans to their customers, they create money by
crediting their customers’ accounts.
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 is not the Value for which Goods are exchanged, but
the Value by which they are exchanged”.
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
26
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.
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
27
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.
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.
28
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.
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.
29
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.
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.
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.
30
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.
(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?
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.
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
commercial banks, they are ultimately settled, as explained above, by
32
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.
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,
34
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.
Natural resources (like the land, forests and seas of fish) are exploited
at exponential rates, to enable firms and even governments to
35
generate the income needed to repay debts. (Think of Brazil stripping
forests to generate the hard currency needed to repay foreign debts.)
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.
36
Chapter 2: The ‘price’ of money – or the
rate of interest
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.
“... 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
37
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 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.
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
38
the mere act of credit creation is effortless in the way that the manufacture
of, say, a mobile phone, no matter how slapdash or obsolete, is not.
Interest extracts wealth from borrowers and assets from the planet
Karl Marx35
39
Furthermore money-lending at high rates of interest can help stratify wealth
and poverty. The rich effortlessly become richer, and the poor and indebted
ever more entrenched in their debt and impoverishment.
Usurious behaviour is repellent, but high real, rates of interest are accepted
as normal – the necessary ‘price’ paid for ‘easy money’ - in western society.
There was a time when Christianity’s leaders condemned usury, and
punished usurers with ostracism, denying them the chance to be buried in
sacred ground, or married in church. Cosimo de Medici paid for the
restoration of a monastery in return for a papal bull that redeemed him of
past sins, in a clear attempt to absolve himself and his heirs of any potential
charge of usury by the Church.
Even while some branches of Islamic finance circumvent the Koranic law,
Islam has always upheld the Koran’s prohibition of the taking or giving of
interest, or riba – regardless of the purpose of the loan. “Riba” includes the
whole notion of effortless profit or earnings that arise without work or value-
addition production in commerce. In Islam money can only be used for
facilitating trade and commerce – a crucial difference with the acceptance of
interest by the world’s major Christian religions. Islamic scholars were fully
aware that moneylending can stratify wealth, exacerbate exploitation, and
lead to the eventual enslavement of those who do not own assets. Because
Arabs were the world’s foremost mathematicians, having imported the
40
decimal system invented by Hindus they fully understood the “magical”
qualities of compound interest, and its ability to multiply and magnify debts.
This acceptance blinds society to the way in which usury exacerbates the
destructive extraction of assets from the earth. This happens because, as
Prof. Frederick Soddy once explained:
The earth and its assets are finite, and subject to the process of decay.
Nature’s curve for growth is almost flat. The rate of interest’s curve is linear.
Compounded interest’s curve is exponential, as the late Margrit Kennedy
demonstrated in the chart below.38
41
In order to repay debts that have accumulated exponentially, society is
obliged to extract more and more assets from Labour on the one hand, and
Land on the other.
This means, in macroeconomic terms, that Labour has to work harder and
longer, to repay rising levels of debt. It is no accident that the de-regulation
of finance correlated with the de-regulation of working hours, and the
abolition of Sunday as a day of rest. ‘24/7’ – meaning shops are open 24
hours a day for 7 days a week, became an acceptable practice as the finance
sector’s values took precedence over other considerations.
It is not just workers who are hurt by finance capital’s exploitation of their
labour and the extraction of wealth, by way of high rates on debt. Firms,
entrepreneurs, inventors and engineers, innovators, artists of all kinds find
their efforts thwarted by bankers, ‘private equity investors’ demanding
higher rates, and a larger share of the returns on creativity, investment and
innovation. As this process snowballs, rents rise.
42
But high rates have implications for the ecosystem too. First, ‘easy credit’
leads to an expansion of consumption. Shopping malls become the temples
of the High Street. In order to pay for credit-financed consumption, seas
have to be fished out; forests have to be stripped; and the ‘productivity’ of
the land intensified – at the same exponential rate as interest rates rise.
High-yield crops, the use of fertilisers and pesticides; the constraining of
animals indoors; increases in food production, not just for the world’s
growing population, but to make food production more profitable than debt -
all this must be done in order to repay debt. The effects are well known: soil
degradation, salination of irrigated areas, over-extraction and pollution of
groundwater, resistance to pesticides, erosion of biodiversity, etc.
As I have shown above, the supply of money or credit is without limit. Its
over-supply, and the tendency of creditors to lend pro-cyclically, should if
anything, suppress its price. Not so. Interest rates, in real terms, have risen
steadily over the period since Keynesian policies were abandoned. Indeed
high rates of interest have punctured credit bubbles with painful regularity
since central banks abandoned management of rates, and regulations over
credit creation were lifted in the 1970s.
There are very few charts that show the progress of interest rates in real
terms – that is in relation to inflation. Because of this I have chosen to
highlight the chart below, with acknowledgements to the Financial Times. It
shows in nominal terms (i.e. not adjusted for inflation) the official Bank of
England Rate between 1914 and 2009. Central bank rates are on the whole
lower than commercial bank rates. While this chart does not provide the full
picture, note the period between 1933 and1950 when Keynes’s liquidity
preference theories were applied by Britain’s authorities. Over this period
inflation was subdued. Note also, that as finance was liberalised, and the
creation of too much credit chasing too few goods and services led to
43
inflation, the central bank’s rate rose too – both in line with inflation, but
also as a symptom of the volatility caused by liberalisation. The central bank
rate in turn influenced rises in the full spectrum of interest rates – for short-
term and long-term loans; safe and risky loans and in real terms. These
latter rates are not reflected in the chart below.
44
Dr. Geoff Tily in a study published by the Bank for International Settlements
provides the following chart of US long-term real interest rates, which shows
the rise of rates in real terms after the mid-1970s.39
45
to fix rates on that ‘easy money’, so interest rates were ratcheted upwards.
High rates periodically bankrupted firms, industries and economies.
J. M. Keynes, 1937 40
46
consequence, of the level of economic activity and in particular, of the
level of employment.
A lender or creditor’s decision about where to place, and for how long to hold
her savings, is determined first by a need for cash, for immediate or near-
immediate use in purchasing goods and services. Second, by the
precautionary motive: the desire for security as to the future equivalent of
her cash. And third, by the speculative motive: the desire to secure gains by
knowing better than the market what the future will bring. Here’s Tily again:
However, central bankers long ago abandoned Keynesian policies for the
management of rates to meet investor demands for assets that will satisfy
their need for liquidity or cash, for security and for speculation. Instead this
asset-creation role, and with it the determination of interest rates, was
transferred into the hands of global finance capital.
Today, as this book goes to press, global financial institutions are gravely
weakened by the financial crisis. Investors have lost confidence in these
institutions and their ‘products’, and there is a serious shortage of assets. As
a result savings and surpluses are poured into a small group of assets
regarded as safe by investors: mainly property, gold, jewels, stocks and
shares, government bonds. This has led, predictably, to the inflation of these
assets. Central bankers appear helpless to deal with this inflation – only
because they have abandoned Keynes’s advice of how central banks and
governments can intervene, to manage both the production of a range of
assets needed by investors, and the pricing, or the rate of interest on those
assets.
While central banks have control over the ‘base’, ‘short’ or ‘policy’ rate, they
have not since the de-regulation of the 60s and 70s exercised control over
the whole spectrum of rates: real, short and long-term; safe or risky rates.
Indeed urged on by commercial and central bankers, politicians and
regulators deliberately weakened central bank control over the rates of
interest that could be charged by commercial bankers.
The Bank Rate is of very little relevance to producers in the real economy: no
entrepreneur that needs to borrow from a commercial bank pays the ‘base’
or central bank rate (currently 0.5% in the UK and 0.225% in the Eurozone)
for their overdrafts or loans. Only banks or financial institutions registered
with the central bank enjoy the benefit of the policy rate.
48
The rates on loans made to firms and individuals are determined – socially
constructed - by those engaged in the ‘production’ of loans: commercial
bankers. Bankers make decisions about the rate of interest on a loan based
on their assessment of the riskiness of the borrower, and on the rate of
return themselves; but also on what other creditors are offering borrowers in
the market place. Given that the banking sector is oligopolistic, there is in
reality very little competition, and instead a great deal of collusion on
decisions about rates.
The LIBOR scandal brought to the attention of the general public (and to
economists and the regulatory authorities!) the role played by (a) the cartel
that is the British Bankers Association, and b) back office ‘submitters’, in
‘fixing’ the price of inter-bank loans: the inter-bank rate of interest.
This was Keynes’s point: the rate is not fixed by the demand for savings, but
rather by the demand for assets. For individual loans made by banks to
firms and individuals the interest rate is determined by bankers and
‘submitters’ in the back offices of banks like Barclays.
49
From “The framework for the Bank of England’s operations in the
sterling money markets.” January, 2008.43
Because of its monopoly over the issue of notes and coins, the central bank
today controls just the base rate of interest when it provides an endogenous
(originating from within) supply of cash to commercial banks that in turn
determine the quantity of credit created. It is the sole power to issue notes
and coins that provides the Bank of England for example, with a mechanism
for setting the official, base rate of interest. The central bank does this by
providing cash on demand i.e. without limit to a commercial bank, in
exchange for collateral (assets, e.g. Treasury bills, mortgages or bonds).
The difference between the original value of the asset and the new value – i.e.
5% - is the rate of interest (an arrangement known as a repurchase
agreement or “repo”) on a specified date. In other words, the central bank
takes its cut, returns the assets to the commercial bank, and it is the ‘cut’
that is the base rate.
50
The rate at which these assets are discounted is set by committees of men
and women - public servants – who decide on a base rate intended to suit,
on the whole, all sectors of the economy: Finance, Labour and Industry. In
the UK the committee is known as the Monetary Policy Committee, and in
the US as the Federal Open Market Committee. The interest rate set by
these committees of men and women is known as the Bank Rate.
In short central bank control over the Bank Rate is achieved through the
central bank discounting assets owned by commercial banks in exchange for
cash.
The commercial bank pays the Bank Rate in due course, adds its own
interest to both the cash and the bank money it has created, and passes
both charges on to the borrower.
Note that this ‘price’ is not a consequence of demand for cash. It comes
about as a result of deliberations by a committee of men and women and the
deliberate action of the central bank. That is why it is described as a social
construct, not the consequence of market forces.
The arrangements to obtain cash from the central bank, allows private
banks to expand credit-creation so long as they have sufficient eligible assets
to exchange for just the cash-ratio. Because cash is disappearing from
everyday life in high-income countries, commercial banks are economising
on the cost of obtaining cash from the central bank. Instead commercial
bankers encourage their customers to refrain from using the Bank of
England’s sterling or cash, and instead to use debit or credit cards for
transactions.
Today, just as in earlier pre-banking eras interest rates remain high in real
terms, even in rich countries. But this time rates are kept high not by a
scarcity of money, but by a scarcity of general understanding of the social
relationship that is money.
52
Chapter Three: a brief survey of the
evolution of bank money.
Many historians and economists have described the evolution of money with
more authority, and at greater length, than I can match in this little book. I
refer you to an excellent book Money, Whence it Came and Where it Went, by
Kenneth Galbraith;44 Geoffrey Ingham’s superb The Nature of Money 45 and
to David Graeber’s Debt: The First Five Thousand Years,46. Felix Martin’s
recent Money: the unauthorised biography is a fascinating historical
overview, and is highly recommended.47
Instead I want to sketch the key stages of money’s evolution, as a basis for
what I hope will be greater understanding of key aspects of monetary theory.
Without some understanding of monetary concepts and theory, it is not
possible to analyse events properly; worse it is not possible to devise
appropriate monetary policies that civil society can advocate for, and
politicians, governments and central banks can implement.
And please don’t be put off by talk of ‘monetary theory’. It really is not rocket
science.
One of the reasons the public may be a) daunted and b) confused about
monetary policy is that most orthodox economists are. Believe it or not, for
all their confidence, most economists lack the sound foundation of a full
understanding of money. If pressed they are liable to resort to jargon or an
airy insistence that money doesn’t really matter and that it is eccentric or
even sinister to think it does.
53
Money as trust
In the beginning there was trust. People exchanged goods and services,
swapped things, did deals, on the basis of trust. Even in a world without
coins and notes and banks, this was money as credit. Credit is based on the
Latin verb, credo: I believe. In other words, ‘I believe that you will repay me,
swap something back, exchange my gift for another.’
Over time, societies developed a unit of currency with which to measure the
value of goods and services that were exchanged. Even so, as Graeber writes:
54
Today notes and coins make up a tiny proportion of the money we use every
day – bank money. In Britain, only 3% of the money in circulation is in notes
and coins. Instead money today takes the intangible and invisible form of
credit cards, Oyster or Metro cards – or even ‘mobile money’, We never touch
it, or indeed see it – except as a charge on our bank account
And this is how it should be, for money is a measure of the trust we have in
each other. Felix Martin tells a fascinating story of the closure of Irish banks
in1970, as a result of a breakdown in industrial relations. Despite the
closures, the majority of payments continued to be made by cheque – in
other words by transfers from one person’s account to another – despite the
fact that the banks at which these accounts were all held were shut.50 Often
the landlords of bars and public houses acted as ‘clearers’ of the credits and
debts undertaken by their customers – because they had a fair idea of the
financial balances of their customers and of their trustworthiness.
What this incident proved is that society does not need coins, commodities
or even banks to do business; to make undertakings, to give promises and to
create credit. Society does not even need banks to bring together those with
money but no purpose so that they can meet those with purpose but no
money. The Irish experience worked because the communities involved were
close-knit, and lenders and borrowers were well known for their integrity or
lack of integrity. This is not possible in a bigger economy, in which more
people are involved, and more complex transactions and arrangements take
place, which is why banks have been necessary institutions.
Fiat money
The stamp on the coin was the guarantee of a measure of trust, whose value
was uniform across a district, or parish, or kingdom. For the convenience of
traders, but also to ensure uniformity in tax or rent collection, sovereigns
began to establish uniform systems of weights and measures throughout a
kingdom, including a measure for the exchange of goods and services on the
basis of trust.
55
So early on, money or credit and its measure, the unit of account, were given
the imprimatur of the State. To quote Keynes money was:
…State-created in the sense that it was the State which defined (with
the right to vary its definition from time to time) what weight and
fineness of silver would, in the eyes of the law, satisfy a debt or a
customary payment expressed in talents or in shekels of silver.51
The state, backed as it was by the law and by institutions that could enforce
contracts; and keen to collect rents and taxes, acquired the sole power to
issue the currency of a country, or region.
Currency in the economic sense of the term, means the unit of account in
circulation within a country or geographical area. It has a value defined by
the state governing that country. Above all, it is money that has the backing
and enforcement of the laws and institutions of the state and is acceptable
as payment for taxes.
Today that unit of account in Sierra Leone is the leone; in Indonesia it’s the
rupiah, and in Canada it’s the loonie or dollar.
Currency issued, and backed by the state became known as fiat money.
Coinage and the commodities that in those days represented money (gold,
silver) had limitations. Large amounts were difficult to handle, and were
unsafe to carry across distances.
This is where pawnbrokers and goldsmiths stepped in. Their shops had
good security arrangements and soon they began to receive valuables and
gold for safekeeping – in return for receipts – or acknowledgements of a debt.
At first all the gold kept in the (trusted) goldsmith’s vault was available to be
redeemed immediately by depositors. The receipts were exactly equivalent (as
56
far as we now know) to the gold deposited. The gold in the vault came to be
known as ‘reserves’.
Soon the receipts – that could be redeemed for gold – began to circulate as
‘money’, and could be lent out and exchanged.
The business of depositing and lending out only the amount stored in the
vault is known as 100% reserve banking. As such it is not very different from
today’s Peer-to-Peer (P2P) online lending, with intermediation provided then
by a goldsmith, and today by a P2P company.
Soon however, goldsmiths began to multiply the receipts – the claims against
the gold asset for the delivery of a deposit - so that several receipts could be
set against the same bar of gold.
The ‘receipts’ were to take on a life of their own. They became a tangible form
of acknowledgement of a debt. They went on to become the intangible,
invisible bank money on which we are so reliant today.
The important economic development was this: the availability of money for
society’s activities was no longer artificially constrained by limited amounts
of precious metal – such as gold, silver or copper. Society was no longer held
back in what could be done, by a limited money supply. Money was no
57
longer scarce. This development was to have a profound impact on societies
with banking systems.
Receipts that were easy to carry and safe to transport along hazardous
journeys, circulated and were exchanged and accepted in trust. Soon they
were deposited with merchants of other banks, and proved useful in
facilitating transactions across a wide range of economic activity.
At the same time the banker would have liabilities - claims made against his
deposits or assets, for the transfer of ‘receipts’ or money to other banks. For
these purposes, the invention of double-entry bookkeeping was both
formative for the banking system, and invaluable in keeping track of assets
(loans or deposits) and liabilities (debts).
The ‘reserves’ (that is the gold in the goldsmith’s vault) became irrelevant
and unnecessary to the creation of credit. The ‘receipts’ or bank money alone
became money or a guarantee of trust, and could be used to create new
deposits.
58
did not accurately reflect the value of gold held by goldsmiths, and second,
they multiplied the money supply.
However, the receipts were issued in the belief they could and would be
redeemed, and the money supply would be managed – e.g. to prevent
inflation. In other words, faith and trust were at the heart of the goldsmith’s
trade.
This is not to say that money creation could not be inflationary (or indeed
deflationary). Indeed history is littered with tales of inflationary outbursts, of
deflationary depressions, of bank runs and of financial and economic
failures.
In other words, the interests of those with wealth were opposed to the
interests of those engaged in risky innovation, creativity, commerce or
production. The holders of wealth, by demanding high rates of return on
their surplus or savings, effectively suppressed the risky activities of
innovation, creativity, commerce and production.
Slowly, if erratically, the medieval system was replaced first, in Italy and
then the Netherlands and finally in 17th century England, by a hybrid
system of state and private bank money.
With experience, with a sound accounting system, and above all with sound
overall management, goldsmiths began to work their way into the trust of
the public authorities and merchants. By creating money out of thin air they
increased the supply of money and of economic activity, which had
previously been limited to the surplus or savings accumulated by the rich
and powerful. This increased supply of money led to three important
developments. First it began to democratise or open up access to finance to
those who would previously have been denied finance by those who owned
private wealth. Second, it began to lower the ‘price’ of money (interest rates).
Third, it provided an impetus to trade.
Today, thanks to the developed bank money system that evolved and now
exists in most advanced economies, innovators, creatives and traders can
obtain access to credit if, after a risk assessment, the bank believes their
60
promises can be trusted; if they have sufficient collateral, and if they can
demonstrate an ability to generate future streams of income.
Most households receive salaries in bank money, the latest evolution of the
goldsmith’s receipts. Bank money is intangible and often invisible (unless
printed on a statement) - as credits to bank accounts. Taxes are paid by
electronic transfers from firms to government; big purchases are paid for by
direct debit, credit cards, money transfers, mobile phone transfers. Public
transport is paid for by ‘oyster’ or ‘metro cards’. The most tangible of these
money transfers – cheques – is fast becoming redundant in western
economies. Bank money, which has always been intangible, becomes more
so by the day, while the use of notes and coins diminishes. Whereas in poor
countries a large percentage of all the money handled is in the tangible form
of notes and coins, today in a rich economy such as Britain’s, only 3% of the
money we handle is in tangible notes and coins.
Perhaps the most difficult aspect of the theory of bank money is this:
bank money held in banks does not necessarily correspond to what
we understand as income. It does not necessarily correspond to any
economic activity. The link that existed between money and gold in
fifteenth century Florence or seventeenth century London does not
exist in today’s banking system.
Banks, as Felix Martin has explained, are institutions that write IOUs
on the one hand (deposits, liabilities) and accumulate IOUs (loans
etc.) on the other. These IOUs are not equivalent to the quantity or
quality of economic activity currently undertaken by actors in the
economy.
61
heart of much orthodox and monetarist confusion about money –
leading to vain attempts to ‘limit the money supply’.
Within a well regulated monetary system, the receipts, the promise to repay,
and the manner and trust with which ‘receipts’ were valued and then
62
exchanged, were sufficient to spur the investment, employment and
economic activity of which society was capable, and to generate income for
repayment.
The banker’s shrewd judgment of character, his reputation for sound risk
assessment and his sharp mathematical and accounting skills are the basis
of the trade’s mystique. It’s a mystique bankers still trade on, even though
many lack sound judgement and depend on taxpayer-backed bailouts to
compensate for their flawed mathematical and algorithmic models.
By these halting steps was the modern banking system developed. Economic
activity, and in particular employment, was no longer constrained by the
63
quantity of gold in vaults. More ‘receipts’ or money in circulation meant more
investment and employment.
Loans were granted based on the goldsmith’s assessment of the ability of the
borrower to undertake activity that would earn the sums needed to repay; and
of the integrity of the borrower’s promise to repay.
64
The increase in the quantity of credit created out of ‘thin air’ had a
profoundly radical, and progressive impact: it lowered the ‘price’ of money –
the rate of interest. In his History of Interest Rates, Sidney Homer (1977)
shows that in Britain from 1700 onwards, yields (the returns on investment)
declined slowly. Starting at 6-8% they finally broke through 3%, which
culminated in the flotation of the famous British 3% consols (government
bonds) in 1751.52
65
money as a neutral instrument that underlies all modern macro-
economic monetary analysis and practice by government and their
central banks derives from this foundation.53
The big questions that arose were these: how could society maintain control
over this great public good? And to what ends should it be put?
66
Chapter Four: The defeatism of the meme:
“there is no money”.
67
Bernard Vallageas points out in his paper: Basel III and the
Strengthening of Capital Requirement.54 Yet, despite the fact that the
banks did not ‘hold capital’ against their lending in the period before
1988 – there were no financial crises between 1945 and the 1970s.
‘Curiously’ writes Vallageas, ‘the adoption of capital requirements
(took place) at the same time as the liberalisation of the financial
system, and yet, despite their adoption, they did not prevent financial
crises, particularly the major 2007-9 crisis.’
Let that be a lesson to regulators and the general public. For all the
serious-sounding jargon that emanates from the Basel Committee
responsible for regulation, the economic orthodoxy relies on studied
indifference to the evidence.
68
interest that were the result of central bank action, or reaction to the
2007-9 crisis. However, as noted earlier, central banks can only
strongly influence the ‘base’ or ‘policy’ rate – and loans at this rate
are only available to institutions in the finance sector. Rates on loans
to small businesses, firms and households are influenced by base
rates, but also by global financial markets in for example, US
Treasuries. (The yield on the US 10-year Treasury bill serves as a
reference for global interest rates set by commercial banks.) Finally
rates are fixed or set by commercial bankers according to their own
assessment of the risk of a lender, and the rate of return on a loan.
These interest rates remain high in real terms, that is, relative to the
inflation or deflation of prices and wages.
However, they are expected to rise even further when central bank
rates rise, causing bond yields in global capital markets to rise
further. Rises in rates on longer-term assets (bonds and mortgages)
will have a punitive impact on household and corporate debtors –
especially in the Anglo-American economies. Indeed each time the
US or UK economy appears to improve, recovery is choked off by
rising bond yields in global capital markets. These in turn raise
expectations and justifiable fears that long-term interest rates on
mortgages will follow.
69
that enrich the few, while impoverishing the majority; policies based
on the interests of ‘robber barons’ and on the flawed theories of
‘defunct’ economists.
“There is no money”
Mrs Thatcher, whose views on the economy still inform the policies of
many Conservative and Social Democratic OECD governments, gave
clearest expression to the conviction that ‘there is no money’ in a
1983 speech.
The state has no source of money, other than the money people
earn themselves. If the state wishes to spend more it can only do
so by borrowing your savings, or by taxing you more. And it’s no
good thinking that someone else will pay. That someone else is
you.
Today this assertion sits strangely with the facts of the recent bailout
of the global banking system. While politicians try to persuade
electorates that ‘there is no money’ something quite different
70
happened under the guise of ‘Quantitative Easing’. Central bankers
created trillions of dollars ‘out of thin air’, and did so ‘overnight’ to
bail out the banking system.
Please note that not a cent of these trillions of dollars was raised by taxing
Americans, although the liquidity created by the Federal Reserve is backed
by US taxpayers. Second, note that the beneficiaries of all this American
taxpayer-backed largesse included German, British and French bankers.
a trillion (that is, one thousand billion) pounds, close to two-thirds of the
annual output of the entire (British) economy”58
had been mobilised (again, almost overnight) to bail out the British banking
system.
71
Despite this evidence that the state does indeed have “other sources of
money” – other that is, than taxation - many have adopted Mrs Thatcher’s
reasoning, including those on the progressive end of the political spectrum:
Dear Chief Secretary, I’m afraid to tell you there's no money left.
The British government has run out of money because all the money
was spent in the good years …
The root cause of the crisis that led to the bankruptcy of Lehman’s
and other banks in 2008 was the bursting of a vast bubble of
unaffordable credit. ‘Easy’ (unregulated to the point of recklessness)
credit was generated by commercial bankers and by others active in
the shadow banking system. Commercial banks vastly expanded the
amount of money in the economy. When this ‘easy’ credit became too
expensive (‘dear’) to make repayment affordable, borrowers defaulted.
In other words, it was high, not low interest rates that ‘debtonated’
the vast bubble of credit. This is a contested view, as most
economists and commentators locate the cause of the crisis in the
72
low rates of interest set by central bankers after the bursting of the
dot-com bubble in 2000-02. However, these rates were set low as a
reaction to the bursting of that asset bubble – and while it is true that
low rates laid the ground for the next crisis they were not the
immediate cause. Vast amounts of easy, dear money unrelated to real
economic activity, triggered the crisis.63
Very few economists blame the cause of the crisis on ‘easy’ or poorly
regulated and mis-managed credit-creation. Even fewer propose
increased regulation of credit-creation. Most focus on the low interest
rates that prevailed after the bursting of the 2001 dotcom bubble as
causal of the crisis. But it was ‘Easy credit’ that blew up the credit
bubble, including variations on ‘liar loans’ or ‘no documentation
mortgages’; or the packaged and re-packaged pools of mortgages,
‘sliced and diced’ into securities by banks like Goldman Sachs. The
risks on these were then sold and cynically passed on to the ‘little
people’ – borrowers and shareholders - as well as to big institutional
investors.
73
the run up to the crisis.
(%)
8
Australia
7
UK
6
3
EU
US
2
Japan
1
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Sources: BOJ, FRB, ECB, BOE and RMB Australia. As of Mar. 23, 2012.
Chart taken from presentation by Richard Koo, Chief Economist, Nomura Research
th
Institute, Tokyo, to the INET Conference, Berlin, 14 April, 2012.
74
- by bankers. That is until the individuals, households and firms at
the heart of the CDOs defaulted, the debt bubble popped – and the
‘sub-prime’ crisis erupted.
To imagine the role that sub-prime debt played in the crisis, it helps
to think of sub-primers as positioned at the base of a vast, upside
down pyramid of debt. Although their debts were not substantial in
the grand scheme of things, nevertheless they were the poorest, most
vulnerable borrowers in the market – and most likely to be the first to
go under. Balanced precariously above sub-prime debts, were huge
sums of ‘structured’ and often ‘synthetic’ debt, made up of
collateralised securities, credit default swaps and other complex
financial products. These financially ‘engineered’ products created
artificially by the shadow banking system in the run-up to the crisis,
were explosive precisely because they bore no relation to the real
world of productive activity. However, they were tenuously linked to
the properties and mortgages – the assets - of poor workers.
The crisis began when it became obvious that banks were sitting on
significant non-performing loans in a housing market where prices
were already falling. At the same time the merged retail and
investment banks had built up their own enormous debts – not
75
permitted before the abolition in 1999 of the US’s Glass-Steagall
legislation of 1933. The problem was made much worse because of
the use of ‘exotic instruments’ like CDOs and CDSs. The cynical
irresponsibility of lending at usurious rates of interest to those
defined as ‘sub-prime’ borrowers was just the most visible part of
their greed and recklessness. Huge loans made against all kinds of
property and other risky assets were exposed as unpayable.
Years after the ‘credit crunch’ of August, 2007, the global economy
struggles to recover from that crisis and the easy (unregulated) credit-
fuelled bubbles that were violently burst by rising (real) rates of
interest. Indeed some argue that western economies are living
through the longest period of economic failure in peacetime history.
Only during periods of war was economic failure so prolonged. And
yet far from re-regulating the financial system, governments stand
idly by as the global credit bubble – which was never fully deflated
after 2008 – is reinflated by central bank operations. Having done
little to re-structure or re-regulate the global finance sector, central
bankers have used a range of tools at their disposal – including
76
Quantitative Easing – to help bankers clean up their balance sheets.
Commercial bankers have been able to do this by drawing on QE and
other forms of cheap finance, and to use these resources for
speculation. Speculation, unlike patient, long-term lending, leads to
quick and sometimes exponential gains for bankers. These gains are
reflected in the way in which QE and other central bank operations
have re-inflated the value of assets - owned by wealthy elites.
Simultaneously, in the real economy, investment, wages and salaries
have fallen, and the poor have become poorer.
Open market operations have been undertaken by, for example, the
Bank of England since it was founded in 1694. As already noted,
these routine operations are used to achieve policy targets – e.g.
lowering or increasing the base (or policy) rate of interest. For some
reason QE has attained a sort of mythical status, when really it is
what central banks do, and always have done. What is new about QE
is the scale of central bank operations. Central banks have
purchased or swapped trillions of dollars of assets since 2008-9.
About $4trillion of this liquidity has flooded into emerging markets,
inflating the value of their currencies, and of assets such as property,
77
stocks, works of art etc. As it is mobile, this money may just as
quickly flood out of low-income economies, and out of such assets.
78
i.e. reserves. If both Bankia and Real Madrid go bust, the ECB would
be in ‘possession’ of the two footballers.65
1 A bond that pays out $10 a year and costs $100 has a ten percent yield. If the bond doubles in
price to $200, the $10 annual payment represents a five percent yield.
79
recession. In economies practising ‘austerity’, orthodox economists
(backed by their friends in political parties) actively discourage the
only viable borrower - government – from borrowing to substitute for
the absence of private borrowers.
Richard Koo, an economist who is best known for his work in Japan,
explains why QE did not work in Japan: “If there were many willing
borrowers and few able lenders, the Bank of Japan, as the ultimate
supplier of funds, would indeed have to do something. But when
there are no borrowers the bank is powerless.”66
The multiplier 67
80
workers on the wind farm stimulate more demand for food,
entertainment, clothes and so on. ‘If the resources of the country
were already fully employed, these additional purchases would be
mainly reflected in higher prices and increased imports,’ wrote
Keynes. ‘But in present circumstances this would be true of only a
small proportion of the additional consumption, since the greater part
of it could be provided without much change of price by home
resources which are at present unemployed.’ 68
But the process continues: ‘The newly employed who supply the
increased purchases of those employed on the new capital works will,
in their turn, spend more, thus adding to the employment of others;
and so on.’ 69 These cumulative repercussions are a virtuous reverse
of the vicious cycle brought on by financial failure and the
contraction of economic activity caused by policies for ‘austerity’.
The reason central banks are able to create large amounts of liquidity
for the banking system and to rescue the private finance sector at
times of crisis is because they are state institutions, backed by
taxpayers.
81
continue to exist and to function. It is in this sense that nations and
governments are different entities from firms.)
82
The failure of commercial banks to lend
The bottom line is that you can only really make serious inroads
into the size of the state during an economic crisis. This may be
pro-cyclical, but there is never any appetite for it in the good
times; it can only be done in the bad.70
The global banking system has not been fixed, re-structured or re-
regulated. Debts in the Anglo-Saxon economies have not, on the
whole, been deleveraged (written off, or paid down). This overhang of
private debt is one of the major barriers to recovery.
The failure to lend and thereby create new deposits arises in part,
because, thanks to de-regulation of the banking system (on the
initiative of the Clinton administration) bankers were freed up over
the last few decades to expand their activities beyond lending; and to
engage in speculation. They did so with large sums of borrowed
money. The result was another historically unprecedented
development: the vast build-up of debt owed by private banks and
other financial institutions. That bank debt, combined with defaults
83
and ‘non-performing’ loans and mortgages on their balance sheets,
brought many to the brink of bankruptcy.
Given these conditions bankers dare not risk making new loans to
firms and households – especially given the declines in profits,
incomes and wages. However, bankers continue to engage in
speculation – undeterred by regulators - in the hope of making quick
capital gains which can be used to help clean up their balance
sheets.
Many big global corporations also have high levels of debt, but have
simultaneously built up a stockpile of cash. These corporations are
‘hoarding’ the cash instead of investing in productive, employment-
creating activity. Fearful that interest rates on corporate debts will
rise and that the crisis will be further prolonged, corporations are
sitting on cash, and not investing. They are imitating the South East
Asian countries that after the 1997/8 financial crisis began to hoard
foreign reserves, fearful of yet another crisis, and of the power of
global capital markets to attack their currencies. The prolonged
nature of the crisis, the volatile financial system combined with
austerity policies have all served to undermine confidence in lasting
recovery by those active in the productive, corporate sector.
Furthermore most big firms and corporations are heavily indebted as
a result of the easy money era of the 90s and 00s. The result is
84
predictable: companies will not take risks by investing their cash or
surplus.
By borrowing cheap from the central bank and lending dear into the
real economy, private bankers are able, with the help of public
servants at central banks, to re-capitalise their institutions and to do
more to clean up their balance sheets. These ‘repairs’ to the finance
sector’s own finances are made at great cost to society, and to the
productive economy as a whole.
86
High interest rates are like daggers aimed at the asset bubbles
created by renewed financial speculation. Borrowing on margin to
gamble is fun while you’re winning; but costly when the gamble is
lost. That is why rising interest rates once more pose a grave threat to
the global financial system.
During the Bretton Woods era regulators set strict rules on the
amounts lent and borrowed, relative to incomes. In some countries
such rules still apply. There have been times in western monetary
history, most notably after 1933 in the UK and the US when
governments and central bankers set out to manage interest rates,
and to keep them low for all forms of lending.73 And after the Great
Crash of 1929, American regulators insisted in 1933 on the
separation of retail banking from investment (speculative) operations.
As noted above this legislation was repealed in the US 1999 and
encouraged bankers to go on borrowing sprees prior to the crisis. By
failing to re-regulate and re-structure the banking system, policy-
87
makers have exposed citizens of the global economy to further
financial crises and economic failure.
Nor do politicians have the political will to regulate and stabilise the
mobile, footloose flows of international capital “governed” by the
private global banking system.
88
dangerous for taxpayers, given that many question the solvency of
the world’s biggest commercial banks. The Financial Times columnist
Wolfgang Münchau recently used a ‘back of an envelope’ calculation
to assess the extent to which banks are bust.75
89
These facts are widely known and understood, but not acted upon.
90
Chapter Five: The capture of the
public good that is banking
Geoffrey Ingham explains that this capture includes control over the
production of money:
“Money expands human society’s capacity to get things done, but this
power can be appropriated by particular interests. This is not simply a
question of the possession and/or control of quantities of money – the
power of wealth. Rather, as we shall see, the actual process of the
production of money in its different forms is inherently a source of
power.”76
Under a well-managed banking system, and with the sagacious use of bank
money, surplus wealth is no longer needed for loans and investment.
Furthermore, under a well-managed monetary system, and as explained
above, interest rates can be kept low by the authorities (the central bank and
the Treasury/finance ministry) to benefit society as a whole.
While capitalists may invest to create new capacity, the rentier simply
exploits existing assets for cash flow. The rentier purchases an asset e.g.
land, which does not have costs associated with its production (because land
after all, is created by nature), and charges rent on it. These rights to an
asset enable the rentier to, for example, install tolls and extract fees from
travellers; or to purchase hospitals or schools or football clubs and then
drain rents from the users of those institutions – much as a landlord charges
rent on a property. Here’s Michael Hudson, a scourge of the bank-friendly
orthodoxy:
U.S. banks don’t make loans for what can be produced in the future.
They make loans against collateral already in place – including entire
companies with high-interest “junk” bonds. Instead of extending loans
to create new factories to employ people, new means of production,
bankers look at what can be pledged as collateral on which they can
foreclose.77
Today’s ‘robber barons’ under the pretext of ‘equity investment’, borrow huge
sums of money to purchase e.g. a football club like Manchester United, or a
company like Boots the Chemist. They then drain rent (debt repayments)
from the corporate body, by diverting cash flows. These cash flows are
92
created and provided by the producers, managers, retailers and customers
of, for instance, Boots, or by Man United football fans. Fans provide the cash
flows by buying the club’s t-shirts or kit. By these means do rentiers (with
little effort) drain the wealth of those with limited amounts of cash, but
without collateral or other assets.
This parasitic behaviour is bad enough, but to increase the capital gains to
today’s ‘robber barons’, governments make this kind of borrowing tax
deductible. The result is a double whammy: massive exploitation and
appropriation of the assets of companies like Boots, or football clubs like
Manchester United. And declining tax revenues for governments from
rentiers disguised as ‘private equity finance’ or ‘debt leveraging’ companies:
e.g. Kohlberg, Kravis, Roberts, CVC Capital Partners, or the Blackstone
Group.
And so the parasitic behaviour of the rentier gradually weakens the body
fiscal, and with it the body politic.
Manchester United was taken over in 2005, at the height of the credit boom
by the Glazer family of Tampa, Florida. The transaction was a ‘leveraged
buyout’ which means that United was acquired, not with the existing wealth
of the Glazer family, but with borrowed wealth, i.e. debt. By June 2010 this
debt had escalated to over £784m.
The debt was secured primarily against the football club itself – meaning
that the Glazers borrowed against an asset - the Man U football community -
that could be ‘milked’ to generate regular, high returns, in the form of
93
revenue streams from the sale of e.g. rising ticket prices, Man U kits, TV
rights (paid for by subscriber fans) and T-shirts sold, as I have personally
witnessed, to already impoverished child fans in remote parts of Africa.
These revenues repay the high real rate of interest on the debt, but they also
finance dividends for the Glazers.
The interest bill from Man U’s debt of £784 million over eight years, is
estimated at £350m and the total cost in that short time (including fees,
derivative losses and debt repayments) is estimated at almost £600million.
The blogger ‘andersred’ believes that Man U’s total costs from the Glazer
structure will top £1bn by 2016.
94
Finance capital despotically in command
“… the state has lost control of the currency as central banks allowed
barons in banks and shadow banks to create money from
securitisation and quantitative easing. The state lost control of
markets as the Securities Exchange Commission (in the US) and the
Financial Services Authority in the UK allowed those same barons to
set up alternative trading platforms beyond any public scrutiny and to
bastardise public exchanges with algorithmic trading and synthetic
instruments priced against fraudulent reference rates.” 78
In the place of ‘the state’ we argue that democracy, operating through the
state, has lost control of the public good that is the currency.
When academics and beneficiaries of the public purse like Otmar Issing
collude with creditors and financiers to grant finance capital such despotic
power over society, democracies are inevitably hollowed out and
democratically elected politicians rendered irrelevant and powerless. This
leads to disillusionment and despair with the democratic political process,
and recourse to populism, fascism and other forms of protest.
This loss of democratic control over the financial system in general and
private credit creation in particular means that the state cannot regulate in
the interests of society as a whole. This is partly a result of powerful lobbying
and manipulation by bankers; but also of public ignorance of the basic
elements of credit creation and bank money. Because the system of bank
money evolved behind a veil of deception; and because this deception suits
the interests of bankers and speculators – the “neo-feudal rentier class” -
there is still widespread obfuscation about the creation of money by
commercial bankers.
This confusion does not just persist in the public mind but also in the minds
of professional neoliberal and even ‘Keynesian’ economists: the guilty men
(and they are mostly men).
They will not understand until the public around them does.
96
Chapter Six: Subordinating finance, and
restoring democracy
The crisis of finance capital’s despotic power is one that Italian economists
Massimo Amato and Luca Fantacci explain as the result of western society’s
subjugation to ‘the yoke of ideology’.80 In other words, this is a crisis of
ignorance and political impotence in the face of a set of ideas serving the
interests of the few.
The task therefore is political: society must reject the marketization of social
relationships and of the social construct that is credit. Instead we must once
again restore these social relationships to the fields of law, ethics, and
standard setting. By regaining democratic oversight and regulation of the
great public good that is our monetary system, society will by political means
(that is by mobilising political will and enacting legislation and regulation)
once again subordinate finance to its proper role, of servicing real markets in
goods and services. Today those operating in markets that trade in goods
and services struggle to operate efficiently, fairly and sustainably in a world
of liberalised finance, as the economist and free-trader Jagdish Bagwati
argued in his famous essay: The Capital Myth: The Difference between Trade
in Widgets and Dollars. 81
97
The question is this: how to subordinate finance? Below I offer some
suggestions – none of them new or original. However they are all tried and
tested, and have proven effective in limiting the power of finance – which is
why perhaps, they are so little discussed and examined.
Business Dictionary82
Capitalists do not have any control over whether they will invest (they have
after all to do something with their savings/capital!) but they do have control
over the period they are willing to invest for; the period during which they
give up the ability to convert their wealth quickly into ready cash. As Dr.
Geoff Tily explains:
98
households’ differing preferences towards holding and borrowing
wealth with different degrees of liquidity/illiquidity.85
Keynes’s great insight was his understanding that the rate of interest is a
social variable, one that can be deliberately managed by the public
authorities, while at the same time holding finance capital at bay. Just as
the social construct that is the central bank’s discount rate (described above
in relation to the provision of cash to banks) is managed by the public
authority that is the Bank of England’s Monetary Policy Committee.
99
Tily explains how Keynes directed the management of public debt during
World War II, and helped manage the rate of interest.
The ‘taps’ of each bond were held open so individuals and institutions
could purchase the maturity of their choice, when and to whatever
quantities they desired. The system therefore enabled the public to
choose the quantity of debt issued at each degree of liquidity at the
price set by the Government.”86
The suite of policies that arose from the theory, established a permanent
long-term rate of 3 per cent on bonds set against a short-term rate on bills of
1 per cent, from 1933 onwards. This was an extraordinary achievement, and
played a significant role in Britain’s ability to finance the war effort.
100
However, management of the financial system and of interest rates in
particular will be subverted if capital is mobile and lenders in international
markets offer higher or lower rates beyond a country’s border – rates not
appropriate to the economic conditions in-country. Keynes advocated
controls over the mobility of capital, because “the whole management of the
domestic economy depends upon being free to have the appropriate rate of
interest without reference to the rates prevailing elsewhere in the world.
Capital control is a corollary to this”, he wrote in this letter to R. F. Harrod:
Keynes understood that under a bank money system, not only was reliance
on foreign capital ended, but that in order to manage the economy, countries
should actually close their borders to footloose, mobile international capital.
To do so he advocated capital control: the taxing of cross-border capital
flows. (Capital controls are taxes, and differ from exchange controls. The
latter place limits on the amount of a nation’s currency that can be taken
abroad. The Financial Transaction Tax (or Robin Hood Tax) is a form of
capital control, a tax or ‘sand in the wheels’ of capital flows.)
Professor Jagdish Bhagwati has argued persuasively that China and Japan
Keynes also understood that the modern-day practice of using the rate of
interest to manage the exchange rate of the currency would hurt the
domestic economy, because central bankers are obliged to focus on the
interests of the ‘robber barons’ - international capital markets - instead of
the interests of ‘the makers’ and exporters of the domestic economy. He
argued that instead, central banks should manage exchange rates over a
specified range by buying and selling currency rather than by manipulating
and ratcheting up interest rates to attract foreign capital. This would both
allow interest rate policy to be focussed on domestic interests, and at the
same time, ensure stability and transparency in exchange rate
arrangements.
102
Keynesian monetary policies managed the banking system in the interests of
society as a whole, ensuring that all major stakeholders in the economy
enjoyed ‘a share of the cake.’
However, soon after Keynes’s death his theory and its practical application
were neglected and discredited. In its place the Hayekian (neoliberal) and so-
called ‘Keynesian’ schools of economics restored the old Classical theory.
This once again asserted that savings are needed for investment; that
bankers are mere intermediaries between savers and borrowers etc. Above
all, the Classical theory elevates the role of finance capital and capital
markets in the lending markets, and restores to private wealth the power to
determine interest rates. It is a collection of plausible fantasies – an ideology
- that has enriched the rich, and systematically replaced more democratic
policies and financial management.
Today central bankers retain a tenuous hold over the ‘short’, ‘policy’ or ‘base’
rate charged to banks (and not to other borrowers); but do not exercise
influence or control over the full spectrum of interest rates. These are fixed
by ‘the market’. As a result rates on the whole spectrum of lending are
socially constructed - fixed or manipulated - by finance capital’s minions –
by ‘submitters’ in the back offices of banks like Barclays, and by banking
cartels such as the British Banking Association.
They are not fixed to suit the wider interests of Industry or Labour.
103
Neoliberal theorists and practitioners (like Jens Weidmann and Otmar
Issing, respectively President and former Chief Economist of the
Bundesbank) while aware of the nature of credit-creation, appear to have
little understanding of bank money, and deliberately ignore the role of
commercial banks in credit-creation.90 The effect of this ‘blind spot’ concedes
and reinforces finance capital’s power - think of the bond markets - to fix
the ‘price’ of money. That helps explain why the neoliberal economic policies
of the German Bundesbank and the ECB have placed Eurozone economies
at the mercy of the reckless and unfettered speculation of capital markets,
and their usurious rates of interest.
Keynes knew well that his monetary policies, based on the conviction that
low interest rates were pivotal to prosperity, were hardly attractive to those
who wanted to maximise returns on their capital. Finance capital
understood that his liquidity preference theory would eventually lead to the
‘euthanasia of the rentier’. Because he represented a profound threat to
finance capital, and to the interests of the City of London and Wall Street in
particular, his theories were inevitably attacked and marginalised.
Enormous sums were, and still are, invested in think tanks, bank research
units, academics and universities that oblige finance capital by labelling
Keynes as an ‘inflationist’ and a ‘tax and spender’, or caricaturing him as
being exclusively concerned with fiscal policy.
104
And so his liquidity preference theory has been quietly buried – with the
acquiescence of both ‘Keynesian’ friends and neoliberal or monetarist foes.
Instead Adam Smith’s classical view of money is revived and used to inform
the work of influential ‘Keynesians’ like Paul Samuelson, N. Gregory Mankiw
of Harvard (and even Paul Krugman) as well as that of the monetarist
Chicago School.
Keynes’s fiscal policies for full employment and for recovery from financial
crisis were then presented as his sole outstanding legacy – isolated from The
General Theory of Employment, Interest and Money.
This campaign against Keynes was part of a wider effort by finance capital to
undermine our democracy. A renewed appreciation of Keynes’ legacy will not
be sufficient to break the power of finance, but it is certainly necessary.
105
Chapter Seven.
How can we restore to our democracy the public good that is the
modern banking system? And how can we avoid the confiscation of
this public good in the future as we deal with the threat of climate
change and energy insecurity?
The answers I would suggest are as follows. First, the public must
develop a much greater understanding of how the bank money
system works. Knowledge is both powerful and empowering. Today’s
dominant flawed economic ideology will undoubtedly be weakened by
wider public understanding of the financial system. Sadly, we cannot
look to our universities for greater understanding. Departments of
Economics are overwhelmingly staffed by ‘classical’ or ‘neo-classical’
economists. These have no firm foundation of monetary theory on
which to develop appropriate theory or policies. Furthermore
university departments are packed with micro-economists who study
economic processes in detail, and often in isolation, and then wrongly
draw macroeconomic conclusions from such processes.
Let’s say that we are trying to measure tide height at the beach.
We know that the sea is filled with fish, and so we exhaustively
model fish behaviour, developing complex models of their
movements and interactions … The model is great. And the
model is useless. The behaviour of the fish is irrelevant for the
question we are interested in: how high will the seawater go up
106
the beach? … By building microeconomic foundations we are
focusing on the fish when we should be studying the moon.91
107
If the people lead, the leaders will follow
For women the issue is central because first while women are largely
responsible for managing household budgets, they have on the whole
been excluded from managing the nation’s financial system and its
budgets. Thankfully this is changing with the appointment of women
to critically important posts within the economy. However women
students, working women, the members of for example, Mumsnet,
business women, all largely stand on the sidelines of debate about
monetary theory and policy. At present the networks that dominate
the financial sector are overwhelmingly male, and often shockingly
sexist. Their dismissive attitude towards half the population and their
enjoyment of an unequal distribution of knowledge are not
coincidental. They are part of the same despotism that harms the
great majority, male and female and that feminism is uniquely well
placed to challenge. If nothing else, feminists should want to
challenge the friends of finance every time they say that ‘any
housewife will tell you that you can’t spend money you don’t have’. I
hope I have shown that this is nothing more than a ruse to obscure
the realities of credit creation, and to enlist prudent women of modest
108
means to support policies that serve the interests of wealthy and
reckless men.
The second group that stands to benefit from engaging in the issues
raised by the management of the monetary system are
environmentalists. It is my contention that there is a direct link
between the de-regulated, uncontrolled expansion of credit, increased
consumption and rising greenhouse gases. By isolating consumption
from the creation of credit, environmentalists are fighting a losing
cause. By failing to understand how ‘easy money’ finances ‘easy
consumption’ and with it rising toxic emissions, eco warriors are
missing a trick. By failing to understand that repayments on high
levels of expensive debt lead to, and demand rising exploitation of the
earth’s scarce and precious resources, environmentalists will fail to
check rising greenhouse gases and the depletion and extinction of
species.
109
But to be armed with knowledge and understanding is not enough.
We must go further. We must reinvigorate our political and
democratic institutions, because they are the vehicles by which
society collectively and democratically agrees to legislative and
regulatory change. We must understand that if our democratic
institutions have been hollowed out by liberalisation and
privatisation; if our politicians have been co-opted or captured,
stripped of policy-making powers, and of the power to allocate
resources – then that is not accidental, but the deliberate result of
finance capital’s actions, its lobbying and its consequent despotic
power over us all. To challenge finance, it is essential that we engage
in, rebuild and strengthen democratic political parties and
institutions; that we participate in political debate and in elections,
and in loud, open discussion about issues that have a profound
impact on our lives.
110
revolution. We simply have to reclaim knowledge and understanding
of money and finance; knowledge that has been available to society
for many centuries.
We need to reform and adjust monetary policy. We can turn the clock
back, and move forward. Of course finance and their friends in the
media, the universities and the establishment will resist, because
monetary reform is the thing they fear most – even more than the
revolts and occupations of city squares by citizens. Protest without
concrete proposals for policy changes, and indeed for a
transformation, pose no threat to the invisible, intangible global
financial system.
But it need not be this way. I have tried, in this short book, to explain
that for those privileged to live in societies with a developed banking
system, and with the public institutions needed to uphold the
integrity of banks there need never be a shortage of finance.
111
But that great transformation can only happen if we the people equip
ourselves with a full and proper understanding of money-creation,
bank money and interest rates – and then begin to demand the
reform and restoration of a just monetary system, one that makes
finance servant to the economy, and removes it from its current role
as master of the economy.
112
Acknowledgements
Finally sincere thanks are due to Rachel Calder my agent, and Dan
Hind, patient editor and publisher of this book. Both believed in me,
and in the book, and that confidence is a gift for any author.
113
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4 These include: John Law, John Maynard Keynes, Joseph Schumpeter,
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7 Jonathan Levin, Governments will struggle to put Bitcoin under lock and
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8 Remarks reported by CNN Money, July,10, 2012.
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9 See also Michael Hudson and Cornelia Wunsch (eds.): Creating Economic
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20 As above.
21 See for example, this editorial from a World Bank publication:
116
24Mervyn King, cited by the New Economics Foundation: Banking
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25Jaromir Benes and Michael Kumhof: The Chicago Plan Revisited.
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26 Geoffrey Ingham: The Nature of Money. Cambridge Polity Press 2004,
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27Joseph Schumpeter: History of Economic Analysis. Oxford University
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28 Frances Coppola: There's a problem with the transmission. Coppola
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29 The Reckoning: Taking Hard New Look at a Greenspan Legacy. by Peter S.
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39 Geoff Tily in, BIS Papers, No 65. Threat of Fiscal dominance? Keynes’s
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40 John Maynard Keynes in, The General Theory of Employment, published
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44John Kenneth Galbraith: Money: Whence it came, where it went.
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45Geoffrey Ingham: The Nature of Money. Polity Press, 2004
46David Graeber: Debt: the first five thousand years. Melville House
Printing, 2011.
47 Felix Martin: Money: the unauthorised biography. Bodley Head, 2013.
48In Debt: The First Five Thousand Years, by David Graeber, Melville
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49 Graeber: Debt, p. 47.
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58 Mervyn King in a conference speech. Sky News Report and Video.
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59 Ibid.
60Liam Byrne quoted in Paul Owen: Ex-Treasury secretary Liam Byrne´s
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http://www.theguardian.com/politics/2010/may/17/liam-byrne-note-
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61 George Osborne, Britain’s Chancellor of the Exchequer on Sky News on
119
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71 Bank of England, Financial Stability Report, November, 2013.
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x
72 Micheal Steen: Draghi pledges to keep interest rates low. Financial
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83For more on ‘illusory liquidity’read Fragile Finance: Debt, Speculation and
Crisis in the Age of Global Credit by Dr. Anastasia Nesvetailova. Published
by Palgrave Macmillan Studies in Banking Oct 2007.
84 For a detailed exposition of Keynes’s Liquidity Preference Theory, see
Goeff Tily: Keynes Betrayed: The General Theory, the Rate of Interest and
´Keynesian Economics`. New York Palgrave Macmillan, ch. 7.
85 Ibid.
86 Ibid., p. 202.
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120
88 Professor Jagdish Bhagwati: The capital myth: The difference between
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89 Eichengreen and Lindert, The International Debt Crisis in Historical
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91Stephen Cecchetti: Threat of fiscal dominance? Bank for International
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92 Robin Harding: Central Bankers have given up on fixing global finance.
121