Ann Pettifor

Why I disagree with Martin Wolf and Positive Money

The Financial Times is hosting a major debate on whether the private banking system should be allowed to continue creating 97% of the credit or money circulating within the economy. Martin Wolf, its respected economics commentator, supports the ‘Chicago Plan’ that effectively calls for private banks to lend out only as much as they have in “reserves”. “Banks”, writes Wolf  (FT  24th April), “could only loan money actually invested by customers.” Private banks would be prevented from creating money, and instead all money would be issued by the state. The quantity issued would be decided by an independent committee as argued by amongst others, the IMF’s Kumhof and Benes and Positive Money.

Because of the finance sector’s despotic power, about which I have been very vocal, many readers would expect me to support a proposal that prevents private banks from creating money, and to enthusiastically back the nationalization of money issuance. I do not however, and want to explain why.

While Wolf has helped bring the role of private bankers in “printing” most of the money in circulation to public attention, the proposal he advances is deeply flawed. It is not very different from the monetarist or neoclassical understanding of money, as based on a commodity. As such his proposal, like the Chicago Plan, would contract and restrict economic activity – to the level of existing savings. That is why the Chicago Plan was so enthusiastically endorsed by monetarists like Milton Friedman.

To understand why the plan is flawed, one has to first understand that credit is nothing more than a promise to repay, as Schumpeter once argued. Furthermore, the issuance of credit results in deposits, or bank money, as Wolf argues.

Credit or money created by banks does not necessarily correspond to what we understand as income. Nor does it correspond to savings. It does not correspond to any economic activity. The one-to-one link that existed between commodity money and economic activity in the Middle Ages does not exist in today’s banking system. Instead credit merely facilitates transactions – and in that way creates economic activity – investment, employment and income.

Unlike commodity money, which is of necessity scarce, credit is able to facilitate society’s myriad transactions, and to satisfy our varied needs. The issuance of credit enables society to do what we can do. And that is why it is a very good thing. Before the establishment of a banking system, society could only embark on ventures that could be financed by “savings” – inevitably the surpluses built up, stolen or appropriated by the already wealthy. Because savings were scarce, they would be lent out at high rates of interest – inhibiting investment, and above all employment.

Because credit (buttressed by contract law, the criminal justice system, the central bank and an accounting system) can be created with such ease, it is a great power, and must of course be regulated in the interests of society as a whole. If, as now its creation is not properly regulated, the finance sector’s hold over society becomes despotic. It is in society’s interests that credit is carefully regulated and directed at productive activity that generates income for repayment – and not speculation or the self-enrichment of bankers.

If the issuance of credit or money is to be restricted to equal the money set aside in peoples’ piggy banks – the “savings” that Martin Wolf refers to – then society would revert back to the Middle Ages, or to the age of the Gold Standard. We would have to restrict what society can do, in economic terms. That would mean a shortage of money, high unemployment and low economic activity – while those with savings would charge high rates and flourish.

Now many environmentalists want to restrict economic activity – and I agree with them. The creation of “easy” i.e. unregulated money has fuelled unsustainable consumption. Worse, credit has been directed at inflating the value of assets (e.g. property) that have enriched the rich, and impoverished those who do not on the whole own assets. Easy credit has been at the heart of the rise in inequality in western economies.

But while we may want to limit consumption, and re-direct credit to more sustainable, useful activity, it would be a mistake to limit the things that society can do. We need, for example, to tackle climate change, a major threat to a liveable future. That will require huge resources to be directed at transforming and de-carbonising the economy. Carefully managed and regulated credit will help finance those activities. The money in our piggy banks would be woefully insufficient.

This debate exposes a profound misunderstanding at the heart of economics, one heavily promoted by monetarists and the Austrian school: namely that it is possible to manage aggregate economic activity within an economy like Britain’s if an “independent committee” can just pre-determine money growth, and then shrink or expand activity.

This is very close to what monetarists tried to achieve, but failed to do under Mrs Thatcher.

It is also what economists and bankers tried to achieve under the Gold Standard. Then aggregate economic activity was expanded or shrunk to (apparently) equal a quantity of gold buried in the vaults of central banks. The result was predictable: a shortage of money, economic failure, instability, financial and currency crises and rising unemployment.

The reason why the Gold Standard was to Keynes a “barbaric relic” – was that gold in the bank could never be made to equate to society’s economic activity – and potential activity. By contracting economic activity to attempt that false equation – governments shrunk the availability of money, caused unemployment to rise, profits to fall and economic activity to wane.

Wolf’s proposal is problematic for other reasons. First, the idea that society can set up a single “independent” committee of men to make far-reaching decisions about the quantity of money needed by a nation of sixty four million people, all engaged in varied and complex activities – is bordering on authoritarian. First there is no possibility of such a committee being independent. One has only to think of the “independent” UKFI committee – set up to oversee the banks, including RBS, in which the state has a stake – to question the possibility of such a body being independent.

Instead I would argue, we should once again regulate the banks and bankers. We may have to begin by acknowledging that, without the guarantees provided by central banks, most banks are effectively insolvent, and will have to be re-structured. Because of their weakness, caused by their own greed and recklessness, they are unable to provide affordable credit in quantities needed by the economy. This is a major cause of ongoing economic weakness, falling incomes and high unemployment across western economies.

Next, banks’ retail arms should be separated from their speculative, “investment” arms. The creation of credit should be carefully regulated, managed and directed at productive, sustainable activity. Thousands of bank clerks should be put to work assessing the risk of every request for a loan, and determining whether that loan would be put to sustainable use and whether it would be repayable – just as was done until very recently. It was only thirty years ago that restrictions on the creation of credit were lifted under a measure wrongly defined as “Competition and Credit Control” – and bankers were freed up to aim credit at speculation. They were later freed up to use their great powers for their own self-enrichment, when the prohibition on mixing their retail and speculative arms was removed.

Restoring banking regulation to its proper place, and managing cross-border lending would once again restore balance to our financial system, just as it did in the period 1945-71. It would bring to an end the despotic power now exercised by bankers and the finance sector.

By contrast, outlandish proposals for nationalizing money and granting huge powers to a committee of men to decide how much money we should all have, and whether to shrink or expand the money supply and economic activity will only add to the economic confusion that shrouds the banking system.

Above all, it will ensure that things stay just as they are.


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