Ignorance of money helps bankers and politicians escape

30 June, 2009. This column and its readers have been sadly neglected to meet the demands of other peoples’ agendas. I can only apologise.

For it is other peoples’ agendas that preoccupies me today. There have been many important meetings held this year, in which groups of people have come together to collectively develop ‘grand narratives.’ on the theme of the financial crisis.  These, it is hoped, will help galvanise an apparently mesmerised population into action against those in finance, politics and the world of academic economics – that have helped wreak ruin, bankruptcies, home repossessions, large-scale fraud and unemployment on society.

But most of these grand narratives are characterised by ignorance of the nature of bank money, and credit, and as a result both mis-diagnose the causes of the crisis, and mis-analyse solutions….

This is because most assume that credit = savings, and that only by mobilising savings or surpluses (generated by production of one sort or another) is it possible for banks or financial institutions to lend money to finance economic activity.  In other words, that money (deposits/savings/credit) exists only as the result of economic activity; and those deposits/savings/credit then create economic activity.

On the contrary: it is bank money/credit that creates economic activity – and only then are deposits, surpluses and savings generated.  And not the other way around.

Banks provide lending services, it is often argued, on the basis of savings/surpluses stored/deposited in their vaults by prudent savers. Nothing could be further from the truth. (Remember that we have just lived through a period in the US when private savings turned negative….Where did the money for lending come from then?)

Banks do not need any savings in their vaults before they lend. All they need is a computer that can input numbers; collateral against the loan, and a signed contract – to repay the loan.  For confirmation of this truth, note the following from the most powerful banker in the world – Governor Ben Bernanke of the Federal Reserve, in his interview with CBS on 15 March, 2009 . When asked where the trillions of dollars for the bank bail-outs had come – from taxation? – he said this:

“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. It’s much more akin to printing money than it is to borrowing.”  (While it may be akin to printing money, it does not involve printing money.)

When you understand the full meaning of Governor Bernanke’s words, you understand that to spur economic activity – in poor or rich countries – we do not have to beg powerful barons – or even rich country taxpayers –  to hand over a portion of their savings. We simply have to “use the computer to mark up the size of the account” held by that poor country.

This is what banks were doing for their favoured private clients, and for the less-favoured sub-primers –  with the active support of that great credit bubble-blower, Governor Alan Greenspan of the Federal Reserve.  It explains why effortless and effectively costless credit creation has to be so carefully regulated. So that it is directed towards productive economic activity – not the kind of lazy, rentier ponzi finance capitalism of this past era when bankers lifted not a single productive finger but effortlessly grew richer and richer by the hour….

When you understand how easily credit/bank money is created, you realize that, unlike oil, or gold or Dutch Tulips, bank money is not a commodity.

Its a human construct, and all it requires to make a loan is for a man or woman to enter a number into a ledger/computer, and to check the loan against collateral and a potential repayment stream.  As such there need never be any limit to the creation of bank money/credit. And if there is never ever to be a shortage of bank money, why, as Keynes asked, should its price (i.e. the rate of interest) ever be high?  (Neo-liberals argue that money is a commodity, which is why, they argue, there can be shortages of money. Credit shortages, in turn, force up interest rates.  (The current credit shortage is a function of a paralysed and bankrupted private banking system, bankrupted because borrowers could not repay the high-interest loans they demanded in advance of the crash, and paralysed because governments are loathe to remove their grip over bank lending.)

Alternatively, given their predliction for rentier capitalism –  neo-liberals argue for commodity-based money – e.g. gold – in order to limit or create shortages of credit – thereby allowing the rentier sector to force up the price of this effortlessly created credit. Neo-liberals belong in the dark ages on this subject. The Bank of England has been creating bank money/credit for the more than 350 years it has been in existence….and neo-liberal economists seem never to have noticed.)

This misunderstanding of the nature of money was evident at the UN Conference on the World Financial and Economic Crisis and its impact on Development – sidelined and ignored by leaders of rich countries. The conference, under the guidance of Prof. Joseph Stiglitz issued a largley sound final statement.

But it had a blind spot for the nature of money.

Conference delegates – most from low income countries – undaunted by the campaign against development aid run by a prominent Zambian neo-liberal economist, Dambisa Moyo, made a powerful plea for increased, unconditional aid – ‘resources’ from rich countries.  Indeed the final statement’s appeal for donations almost eclipses all the other sound recommendations in the report. That’s a pity I think, because it makes poor countries the supplicants of those rich countries and their finance sectors – and reinforces the notion that poor countries cannot generate their own credit or money.  That they cannot afford what they produce.

That is patently not true.  Dependence on rich western creditors simply reinforces dependence on colonial power. The governors of the central banks should emulate the governor of the US Federal Reserve:and “simply use the computer to mark up the size of the account that they (borrowers)  have” with the Central Bank of that country.

In another part of the global forest, in Luxembourg, the International Association of Investors in the Social Economy, produced a report earlier this year: “12 Steps to Future Finance: Our Answer to the Banking Crisis. The need for a genuine new Finance Sector.”

Again there is much in this conference statement to commend.  But one sentence stood out: “The basic role of banking is to provide individuals, firms or public entities with investment or savings services as well as lending services, i.e., using short-term deposits to finance long-term loans.

Again, deeply flawed understanding of the nature of lending, credit and deposits. Leading to a flawed analysis – which in turn fails to resonate with, or ignite the interest of the public.