Seventh Policy Switch: Local and Central Creation of Money

“The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government’s greatest creative opportunity.” Abraham Lincoln (1865)

8.1   Where does money come from?

Almost all new money is issued into national economies as credit via the 500 year old fractional reserve system (UK Parliament, 1931) that was set up for metal money. In this digital era governments issue only small portions of the money supply as notes and coins. The Federal Reserve Bank of Dallas (2009) explains the recursive lending in fractional reserve banking, “Banks actually create money when they lend it. Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank … holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”

Image: Histories , oil on linen 80 x 200 cm by Kathryn Brimblecombe-Fox

8.2   Harvesting the money trees

This basic information about where money comes from is generally unknown to the public and rarely mentioned by financial professionals as it makes money seem unreal, like something growing on trees. (The ‘money trees’ of money issuance are known to economists technically as ‘seigniorage’.) Banks don’t keep the new money they create by fractional reserve banking but they do profit from the interest charged when loaning it out. The creation of almost all money as credit means that as money supply grows so does the debt of the economy. The pressure of keeping up with repayments of loans and interest squeezes economic activity towards speculation and unsustainability. During global recession, debts by vulnerable individuals, organisations and nations will be unpayable on a scale that invites global shocks. Governments and communities can choose between waiting to experience these shocks and rethinking money.

8.3   Over-Harvesting

Allowing financial institutions to harvest the money trees creates incentives for over-issuance of credit by competing banks (Gersbachd, 1998). Other players in the economy have the incentive of easy credit and governments have the incentive of tax revenues from permitting ever more credit used for ever more spending. Unreal salary and bonus incentives for financial bosses and whizz-kids ensured that the money trees were over-harvested until the financiers themselves lost faith in the process and the credit crunch began. The credit crunch and recession might not be escapable without sufficient attention to the underlying systemic errors. The rethinking of finance should start with asking whether the money trees (money creation) would be best harvested for private or public benefit?

8.4   Money trees can provide Public Benefit

“The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government’s greatest creative opportunity.” wrote Abraham Lincoln (1865), who won the American Civil War by printing and spending into circulation 450 million dollars of green printed (‘greenbacks’) full legal tender treasury notes. Hitler built his ill-fated inter-war popularity in Germany by creating money used for employment in work-creation projects (Liu, 2005). The UK’s recent practice of ‘quantitative easing’ (making up for the scarcity of money supply from bank credit) is money creation by the Bank of England. The public benefit in this case depends upon the extent that the new money begins to support ‘bottom-up’ employment and productive activity rather than ‘top-down’ bail-outs and institutional asset purchases.

8.5   The Money Trees Can be Switched from Private to Public Benefit

The financial benefit to banks from being keepers of the money trees is modest, estimated at only £21bn annually for the UK (Huber and Robertson 2000). It is also evident that a private casino ethos is unsuited to the responsibilities of preserving economic stability for the benefit of bankers and non-bankers alike. Money creation can be permanently switched from private to public benefit by creating money in future centrally (by a public owned and accountable body) and locally (by local public-interest bodies or self-organised communities). The resulting public benefit would be the sum of all the new money that is created by spending it into the economy, plus the savings on interest by reducing debts. It is also possible for central and local bodies to create money as interest-free credit. Local currencies can avoid the trap of being ‘play money’ (vouchers swapped for national currencies) by spending, discounting or loaning new money into productive use.

8.6   From More Debt to More Positive Development and Global Security

Any economy dependent on creating money as interest-bearing debt cannot escape a future of mounting debt. Even when the entire planet is exploited for short-term profit the debts still grow. Keeping the economy going has become a confidence trick of preserving faith despite the spread of distrust, systemic instability and predatory profiteering. Given this situation, harvesting the money tree for public benefit may seem too good to be true. Yet it can be done without fear of inflation or disruption to banking business (Huber and Robertson, 2000). It can provide the necessary supply and circulation of money, solidly underpinned by the lasting value and meaning of activities that contribute towards global security.

References

• Federal Reserve Bank of Dallas 2009. Everyday Economics. http://www.dallasfed.org/educate/everyday/ev9.html
• Gersbachd H 1998. Liquidity Creation, Efficiency, and Free Banking. Journal of Financial Intermediation. Volume 7, Issue 1, January 1998, Pages 91-118
• Huber J, Robertson J. 2000. Creating New Money. New Economics Foundation 2000, pp 29-32. http://www.neweconomics.org/publications/entry/creating-new-money
• Lincoln, A. 1865. Personal letter published in Ludwig E, Lincoln. Little Brown and Company 1930. http://www.xat.org/xat/usury.html
• Liu, H. 2005. Nazism and the German Economic Miracle. Asia Times, May 24, 2005. http://www.atimes.com/atimes/Global_Economy/GE24Dj01.html
• UK Parliament 1931. Report of the Committee of Finance and Industry (Macmillan report) Parliament Paper no 3897 H. M. Stationery Office, London 1931 pp 34

This text is part 8 of 8 of my Advanced Research Workshop paper, Seven Policy Switches for Global Security, for the NATO Science for Peace and Security Programme. Please see the abstract, full list of parts and downloads here. Comments welcome below.

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