AN UNSTABLE MONEY SUPPLY ... OR, HOW THE BANKS CREATE AND DESTROY OUR MONEY
"I am afraid the ordinary
citizen would not like to be told that the banks can, and do, create
money. The amount of money in existence
varies only with the action of banks in increasing and decreasing deposits and
bank purchases. Every loan, overdraft
or bank purchase creates a deposit, and every repayment of a loan, overdraft or
bank sale destroys a deposit."
Reginald McKenna Chancellor
of Exchequer 1915-16 and Chairman of Midland Bank 1919-43 (2)
As most of us
know, only the Bank of England is allowed to produce the
Our friendly
high-street banks certainly don’t manufacture hard cash; but nor do they simply
relocate money from one account to another.
In the
course of their day-to-day transactions they also manage, quite legally, to
multiply the amount of money in existence.
How do they
achieve this?
In the words of J K
Galbraith, by a process “so simple that the mind is repelled”.
Commercial banks “lend”
money into existence. In fact, it is
normal practice for banks to “lend” out far more money -
traditionally around ten times more
- than they actually hold in
deposits.
As you see, this
bank “lending” is very different from ordinary lending.
It is the
mechanism by which the banking system is able to prime the economy with extra
money while staying within the law.
This is what
happens.
When a bank
agrees to “lend” you, say, £50,000, this money comes in the form of credit. A bank clerk simply taps a computer keyboard
and hey presto - the required sum springs into existence as
figures in your bank account!
Nobody else’s account is debited; no depositor is denied the use of his
or her money until you have repaid your loan, nor are you drawing on the bank’s
reserves: yet you have just acquired an
extra fifty thousand pounds’ worth of spending power, along with fifty thousand
pounds’ worth of debt, which you owe to the bank that created it!
Since you
borrowed this money to purchase specific goods or services, it rapidly ends up
in other people’s bank accounts, adding £50,000 to the total deposits
held within the banking system.
Let’s just take a closer look at what’s
happening here.
The bank hasn’t actually lent you £50,000 in
legal tender (or cash, to you and me). It
has simply entered figures in your account which give you the right to claim
£50,000 in cash.
Of course, the bank hopes that you will not
take advantage of this right, but will do most of your business by means of
non-cash transactions, paying by, eg,
cheque or credit card, direct debit or standing order. In this way, no physical money changes
hands: you simply pass the right to claim a stated sum in cash to someone else;
and if they, and subsequent payees, are also happy to do business via cashless
transactions, the system works.
But it is a nominal right to cash that is being circulated, rather than
cash itself.
As long as people continue to trust the
banking system and don’t withdraw excessive sums in cash, banks can continue to
lend into existence far more money than they actually have; and as long as more
credit money is being lent out than is returning to the banks in repayment of
past loans, total deposits continue to grow ….
and so, therefore, does the amount
which the banks consider it safe to
“lend” out to future borrowers.
This is called “the multiplier effect”; and it is in
this way that the high-street banks are able to create money without resorting
to forgery under our present laws.
However, debts
have to be repaid: and, as Reginald McKenna points out in the quotation above,
the process of repayment destroys deposits. In other words, money created as a debt is
continuously being removed from circulation. This means that new borrowers must
constantly be stepping forward to boost the money supply with fresh credit,
flowing into new deposits, if the wheels of the economy are to keep turning.
MORE CREDIT MONEY MEANS MORE DEBT FOR MORE PEOPLE
The irrational
practice of relying upon a steady stream of borrowers to keep an adequate
supply of money in circulation has always caused serious damage, both
to individuals and to the productive economy as a whole; but over the past
fifty years or so, with the decreasing use of hard cash, our irrational
financial system has put businesses and, in particular, the household budgets
of ordinary people, under ever greater strain.
It’s not that
there’s anything wrong with non-cash money as such.
Today we find it
more convenient to use a credit or debit card for expensive items, and for the
weekly grocery bill; and payment direct into a bank account by cheque or
banker’s draft has largely taken over from
“cash in hand” to pay wages and salaries, and even state benefits.
Of course, the
increased use of credit money has many advantages. It would be silly to ban the use of cheques
and cards, and return to the days when hard cash was used for most everyday
transactions.
In the modern
world, the exclusive use of notes and coins isn’t a practical option; but notes
and coins do have one very significant advantage over bank-created
“credit”: they are issued by the state,
and put into circulation, without generating an equivalent amount of
debt.
Traditionally,
we have been able to depend upon government for a substantial input of
publicly-created, debt-free money in the form of notes and coins.
Even at the end
of World War II notes and coins still constituted more than 40% of the total
money stock: but this has now plummeted to a mere 3%.
It used to be the
industrial and business sectors, borrowing to invest, which were principally
forced to take on the expense of creating around half the country’s means of
exchange in the form of credit.
But as the disuse of notes and coins
has led to a smaller and smaller input of publicly-created, debt-free money,
ordinary people on modest incomes are increasingly being forced to abandon
financial prudence and bridge the gap by borrowing credit into existence at
their own cost and risk: in particular, through the huge mortgages which are
now required to purchase even a small flat.
However, as we have pointed out, the credit money conjured up in this
way is not - as notes and coins still are -
given freely to the nation without any need for repayment. Under
the present financial system, all the credit money needed by the
economy (that is to say, almost all the money at present available for trade
and exchange) must be created as an interest-bearing debt against specific
individuals and businesses; and it is owed by them personally to the banking
system.
The shocking fact is that UK governments, abandoning
their responsibility to provide the country with a means of exchange to match
its growing wealth, now choose to rely on ordinary people like
you and me taking out crippling loans in order to provide around 60% of the
total money supply, through the
mortgages on our houses.
But why
should the nation’s money exist only as a by-product of debts shouldered by
private individuals and businesses?
There is no reason why publicly-created, debt-free money in the form of
credit should not be produced as easily as publicly-created, debt-free notes
and coins.
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