Ann Pettifor

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.


13 thoughts on “Ignorance of money helps bankers and politicians escape”

  1. Ann
    I am completely convinced by your analysis of where new money comes from, and the ensuing policy options. It seems quite easy to

    understand. But I just have a nagging doubt. Can I really be correct and Joseph Stiglitz and other eminent economists completely wrong.
    Why do

    they have this blind spot? Do they think you are wrong or simply that it is unimportant, or what?


  2. Yes, yes and yes! How can we educate the people to take some responsibility for the money system?

    The commodity money definition (a feudal definition)is so deeply discredited yet many “experts” still believe that money is – or should be – a


    If we could explain that money is a means of exchange and a measure of value (and nothing else) we would surely be halfway

    there. Then the diffence between money and credit would be easy to distinguish. Credit is a dysfunctional form of money (in fact it’s money

    created in parallel with debt, so it can be perceived as more than dysfunctional).

    The current narrative – that spending cuts have to take

    place in order to repay our debts – is flawed because of this assumption of a limited supply of money and the consequent need to issue credit.

    There’s also a prevailing assumption that government needs to balance it’s budget in the same way as individuals do.

    Well, I despair.

  3. Thank you Ann-as I recall, at Bretton Woods Keynes argued for a gold standard that was the benchmark by which all currencies would be

    measured. US President Nixon ditched this for the US dollar when oil prices and the vietnam war got too costly. Given that the greenback has become

    the de facto gold standard wouldn’t it be better for us all to return to Keyne’s original idea? Money is a powerful psychological concept-you

    need to highlight this and its relativities by the lifeboat analogy- amongst the survivors one man has a bag of oranges, the other gold-who is the

    wealthy one? who is better off?

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  6. Andy Murray….Thanks for your comment….No, Joseph Stiglitz and others can be wrong…or at least can ignore this

    reality. It is also the case of course, that while the IMF e.g. permits rich countries like the US to create money out of thin air (Queasing as my

    friend Colin Hines calls it), they frown on this being done by poor countries…But to get back to your point: More than fifty years ago, the

    economist Joseph Schumpeter noted that
    “it proved extraordinarily difficult for economists to recognise that bank loans and bank investments do

    create deposits…An even in 1930, when the large majority had been converted and accepted the doctrine as a matter of course, Keynes rightly felt it

    necessary to re-expound and to defend the doctrine at some length…and some of the most important aspects cannot be said to be fully understood

    even now. “ History of Economic Analysis page 1114. (Allen and Unwin).

    Things have not changed much since then. Economists still have a

    blind spot for money/finance/credit and the role that credit plays in creating deposits…and I sometimes think this ignorance suits the finance

    sector, so may they be behind the determination to keep the process mysterious – and beyond the curricula of economics departments?


  7. David I share your despair. That is why the Green New Deal Group are working on a new report to challenge the

    inevitability of AUSTERITY – the punishment of the innocents for the crimes of the rich. Cheering on Austerity – as all our political parties are

    currently doing – would be economically disastrous. – we would be cutting the legs off the economy in order to bring down the deficit!!! we

    need to get out there and educate people and explain: the government deficit will decline when the government generates new income. And new income

    can only be generated by creating employment.

    Gordon Brown does try to articulate this point – but he is not getting it across, and is of

    course challenged in these views by the Treasury and the Bank of England – so its a helluva fight!


  8. Martin, thanks for your query…My understanding is that Keynes did not argue for gold as a benchmark for all currencies –

    although this was what was finally adopted by the Bretton Woods conference. Keynes’s preference was for an International Clearing Union – to act

    as an independent clearer of cheques between trading nations, and to discipline countries that built up large imbalances – whether they be deficits

    or surpluses. As I say, his ideas were overruled at BWoods…..

    I am keen to revive his proposal for an International Clearing Union – as it

    would the most fair to poor countries….But out in the real world there’s a lot of talk of messing about with baskets of currencies that make up

    the IMF’s Special Drawing Rights…That does not to me seem to be the answer…


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  10. Ann, that all sounds terribly impressive. You seem to have not addressed a couple of issues. The first would be, if printing money is a positive

    activity, and if money is just an arbitrary construct, why ever limit its printing? Just lend money without limit. Then, print some more to pay it

    back. Simple! The whole world can be rich overnight. What’s the flaw here?

    Suppose you just marked up every account in the world. By a

    factor of ten, say. What would happen then?

  11. I agree totally that there is a general misunderstanding about the nature of money.

    I take

    the view that the pervasive spread of the direct instantaneous connections of the Internet is leading to the emergence of new tools, and a

    transition away from transactions to service provision.

    Peer to Peer

    (P2P) architecture has the potential to enable the organic creation of a networked International Clearing Union, from the ground up.


    difference from Keynes’ ICU vision of a Bancor unit issued by a global institution (from which God preserve us) is that there would be no

    centralised issuer as a monolithic middleman and single point of failure.

    Instead we would see a networked model based on the sort of credit

    clearing architecture exemplified by the Swiss WIR, where goods and services change hands not FOR “fiat” Swiss Francs, but essentially BY REFERENCE

    TO Swiss Francs as a unit of measure or Value Standard.

    Wherever a barter accounting system incorporates credit, or “time to pay” the

    outcome IS a monetary system.

    The new P2P finance solutions I have been working on – lately with considerable success – were presented


    in the FEASTA annual lecture

    last year, and recently in Norway at a Philosophy festival, the theme of which was Money.

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