'The Economist' Discusses Money Creation

An unnamed journalist at The Economist seems to have caught on to the significance of money creation by banks, after reading Richard Duncan’s latest book The New Depression. Reporting on the book, the articles makes a few statements that could have been lifted from the Positive Money website, and explains how there has been:

…a massive burst of credit creation. Total credit in the American economy passed $1 trillion in 1964; by 2007, it had exceeded $50 trillion.

Of course, ‘credit’ is the standard economist (with a small ‘e’) jargon for the numbers in computer systems that we now use as our money supply. This massive burst of credit creation is really an explosion in the money supply, as a result of money creation by banks when they make loans. A rising money supply, when money is created by banks, goes hand in hand with a rising mountain of debt:

This debt explosion showed up not in consumer prices but in asset prices, notably in property. The cycle was self-reinforcing: banks lent money to people to buy property, causing prices to rise, making banks more willing to lend, and so on.

I made the same argument in my presentation to the JustBanking conference in Edinburgh – video available here; I talk about housing in the first 8 minutes.

Richard Duncan changes the Fisher equation, which explains the relationship between money supply and prices (MV=PT), by replacing M, money supply, with C, for credit supply. That makes perfect sense – ‘credit’ is now used for over 99% of all transactions, by value, and the economists, hedge fund managers and gold bugs who rail about the creation of a few hundred billion through QE tend to be completely ignorant of the creation of over £2 trillion of credit-money by the high-street banks. But Richard Duncan should also look at Prof Richard Werner‘s work on disaggregated credit, which makes the point that most of the money and credit that is created is now used for financial transactions and purchasing financial assets (including property), rather than actually trading in the real economy. As The Economist describes, this creation of new money to buy or speculate on financial assets was completely ignored:

During the boom, policymakers ignored rising asset prices—and indeed welcomed them as evidence that all was well—and disregarded accompanying private-sector credit growth. But when asset prices collapsed, and the banks got into trouble, some of that private-sector debt ended up on the public balance-sheet, leading to the current phase of the crisis.

The article finishes with an argument that we’ve been making for quite some time.

This is not capitalism, [Duncan] suggests, but “creditism”. It is this system which has broken down, and unless you understand it, you will not be able to fix it.

I haven’t read the book yet, but have just added it to the (ever growing) reading list. The full article is worth a read.