‘If it ain’t broke, don’t fix it.’ Sensible advice, especially when it comes to tinkering with the money supply: with laws about how money is made, how we get it, how we spend it. What would happen if the financial system was dismantled or thrown out of joint? Would we be able to pay the bills, eat, have shelter and live?
Most people don’t even want to think about the system, let alone how it should be reformed. Fear and ignorance reinforce each other. But reasons for reform grow stronger and stronger every day. Besides the massive criminality and corruption that go unpunished even in the complacent West, there are troubles which may not originate in the way we create money, but which are mightily fed by it: war, inequality, unemployment, mental health, drug abuse, environmental destruction, climate change; unaccountable power in governments, corporations and wealthy individuals; loss of moral freedom; misuse of assets and human resources; booms and busts of the ‘business cycle': the list could go on and on.
To understand the connections between the way we create money and the troubles listed above is the subject of this book. Explaining how money is created is no problem: just one sentence will do (see the next paragraph for that). But unravelling the implications is a bit like a detective story. The blunt instrument that did the murder has been discovered, but the human story behind it is what’s interesting. Who did the murder? Why did it happen? What will the consequences be? And finally, the all-important question that lurks in the background of all good detective stories: Will justice eventually be done?
Instead of just one villain, however, the story of how our money is created is a whole history, with good intentions travelling alongside the usual motives of greed and deception. In the past, money was lots of different things in different places: cowry shells, tobacco, precious stones, any number of things. For many hundreds of years, money in the West was gold, silver and other cheaper metals. Today, money is almost all ‘credit’ – numbers in bank balances, representing claims (which we own) on digital money belonging to the bank. Here is a one-sentence description of how credit is created today: ‘Central banks, in obedience to their governments, create digital ‘reserve money’ which they sell to commercial banks; commercial banks are then allowed, by special legal privilege, to create multiple claims on their ‘reserve money’ and to lend those claims to whomsoever they please.’ It is these claims that we call ‘credit’, and which pass from person to person as the money we use every day.
Such simple facts are only seeds when it comes to understanding how this way of creating money affects the workings of our world. But three things stand out right from the start about the system, which uses law and privilege to establish ‘credit’ as a form of money.
- First, it is a source of great profit to governments, who create and sell ‘reserve money’ to banks, and can borrow almost unlimited amounts in the name of their citizens.
- Secondly, it is a source of great profit to banks, who collect interest on the credit that they in turn create.
- Thirdly, money – credit – can be allocated in vast amounts, by mere decision of those who profit from it.
It is pretty obvious that this way of creating money advantages some and disadvantages others.
That money should be created in such a way may seem bizarre, but it makes complete sense when it is looked at in historical context – in other words, when it is read as a human story. What follows is the human story of how banks came to create our money supply.
A banking historian named Loyd Mints – a deeply respectable and learned man – wrote the following:
It would seem that an evil designer of human affairs had the remarkable prevision to arrange matters so that funds repayable on demand could be made the basis of profitable operations by the depository institutions.
Loyd Mints is referring to the fact that once a bank gets hold of people’s money, a host of devilish opportunities open up to it. The situation today, which can only be described as madness, is the culmination of a series of developments in banking over the last three thousand years. A number of clear stages followed on quite naturally from each other, and noticing these stages makes it easy to understand how banks create money today.
Banking can be said to be as ancient as writing itself. Some of the earliest surviving bits of writing are not literature or law or religious stories, but records on clay tablets of how much is owed by someone to someone else. This record is from several thousand years ago: ‘Mannu-ki-Ahi and Babu-Asherad acknowledge that they have 10 minas of silver belonging to Remanni-Adad, chariot-driver, at their disposal.’ This is banking in its simplest form: a person (or institution) accepts money from someone, and issues a credit note (or clay tablet) in return. Temples in ancient Sumer, Babylon, Egypt, Greece and Rome did this: they were religious institutions doubling up as banks.
Once money is in the hands of a banker – ‘at his disposal’ – he can put some of it to use. He can lend it, or invest it, or simply spend it. If he wants to stay in business, he will have to keep enough on hand to pay customers who come asking for ‘their’ cash. So, part of a banker’s skill is to judge how much he should keep handy, to meet his obligations.
The more a banker has on deposit, and the more skilfully he uses it, the richer he may become. He may even pay depositors to leave money with him, so that he can have more to play with. Naturally, his favourite customers will be those who leave money with him for a long time. When he lends (or invests or spends) money that he is ‘storing’ for his customers, the money re-enters circulation. The important point to notice at this stage is that the banker is not creating money; he is just putting some of it back into circulation.
The next development in banking is when bankers start to actually create money. This happens quite naturally, when customers begin using their credit notes as a way of paying other people. A credit note is, effectively, a claim on a bank’s money: so if a bank is generally trusted, a seller might be happy to take a credit note in payment, provided he’s confident he can use it to get cash from the bank. Being paid with a note was popular among rich customers: when cash was silver and gold, a credit note was easier to manage than chests of heavy metal. Credit notes begin to circulate alongside gold and silver: they became a form of money.
It was good for bankers’ business when their credit notes began to circulate because they stayed out longer and fewer were presented for cash. Bankers could use their cash more freely. Credit notes were circulating alongside cash, so there was a clear increase in the money supply. Bankers were not just putting money into circulation; they were actually creating it.
The next development in banking occurred again quite naturally. Bankers realised they could write out new credit, even when no new cash had been deposited. If the credit was in the form of notes, they could sell the notes, or lend them, or buy things with them and become instantly a great deal richer. If the credit was just a couple of lines in a banker’s ledger books, the result was the same; payment could be made by transferring credit from one customer to another, either within the same bank or between banks. The Venetian banker and Senator Tommaso Contarini wrote in 1584:
“A banker may accommodate his friends without the payment of money merely by writing a brief entry of credit; and can satisfy his own desires for fine furniture and jewels by merely writing two lines in his books.”
In 17th century England, the practice of credit creation came under intense and public scrutiny. Banking developed fairly late in England, and when it arrived it expanded quickly. ‘New-fangled’ bankers began writing notes in large amounts and getting very rich off the proceeds. The old landed class felt threatened, and the practice was highly disapproved of by many contemporary lawyers and economists. Such notes ‘represented nothing'; they were ‘fictitious credit'; in the words of Bolingbroke (English political writer, and major influence on the ‘founding fathers’ of the United States): a ‘new sort of property, which was not known twenty years ago, is now increased to be almost equal to the terra firma of our island’.
Battle lines were drawn. The Lord Chief Justice, Sir John Holt, ruled that the credit notes of bankers, passing from person to person as currency, were not to be enforced at law. Many in Parliament, however, which at that time consisted of rich men voted in by other rich men, liked the new money. As individuals, it offered them opportunities to get richer; as a body, it made it easier for them to finance war. Parliament passed a law (the Promissory Notes Act of 1704) stating that bankers’ credit notes should be enforced regardless of who presented them. Notes could pass from hand to hand as currency, and the law would enforce their payment. Centuries of legal attempts to prevent fraudulent contract were overturned in favour of capitalists, bankers, and the government’s need to finance war.
Bit by bit, this bankers’ privilege was incorporated into legal systems across the world. In 1845, the American judge Joseph Story wrote: ‘Most, if not all, commercial nations have annexed certain privileges, benefits, and advantages to Promissory Notes, as they have to Bills of Exchange, in order to promote public confidence in them, and thus to insure their circulation as a medium of pecuniary commercial transactions.’
This last development is normally considered to constitute the foundation of modern banking: credit-money manufactured by banks for first use by capitalists and governments. However, there were two significant stages still to go before the madness of today could be arrived at.
At this point in banking history, the difference between the two forms of money – cash and credit – was obvious: ‘cash’ was valuable metal and ‘credit’ was just written words and numbers. But an owner of credit could legally demand something valuable in exchange – gold. Paper could be easily created, words and numbers are easily written, but gold was hard to come by. Nations and their bankers had to amass gold if they wanted to be trusted. The ‘gold standard’ lasted pretty intact until the First World War, when the need for money to finance war could not be met by taxes or loans. Nor could it be met by claims on gold, for the fighting nations (and their banks) were running out of gold. So governments adopted a recipe which had been tried a few times before: they issued paper promises to substitute for the gold, with the assurance that after the crisis passed, gold would be accumulated and once again supplied.
Production of this government paper was so prolific that after the war, the ‘gold standard’ was ‘smashed to smithereens’, as one commentator put it. Subsequent attempts to restore it were sporadic, half-hearted and hedged around by conditions. Meanwhile, it had become apparent that an economy could function well on money that was just paper and numbers in bank accounts, so long as the amounts were restricted.
Once money became just paper and numbers, we can, with hindsight, see a choice: should ‘money’ be restored to its old character, as property to be owned outright; or should it continue along the path it had travelled for so long – towards being a commodity rented out by governments and banks? In reality, the question was barely posed. Credit-creation was the fountainhead of power: it operated in shadows of obscurity, far from public scrutiny, not quite understood even by those it advantaged and even less understood by those it disadvantaged.
Now that credit and cash are mostly digits in computer systems (with a few notes and coins thrown in – roughly 3% of the money supply – as if just to confuse us) the difference between them is less than obvious. But the system is structurally the same as when it was based on gold. In retrospect, it may seem an act of genius that a group of people (governments, bankers, capitalists) have established a money supply manufactured by themselves and lent to the public at interest. Had it been a conspiracy, it would have been the most diabolical conspiracy ever made. But it was not a conspiracy: it was merely the continuation of a system which had worked well for the rich and powerful, and would now work for them even better.
Before banking reached its modern status, however, it had still one stage further to go. This was deregulation. At the beginning of 1971, one last vestige of the gold standard still survived: payments between nations could still be demanded in gold. This last vestige was put to rest in August 1971, when U.S. President ‘Tricky Dick’ Nixon refused to honour a demand from France for payment in gold. He gave them dollars instead.
At this point, some extra regulation might have been a good idea, to give some protection to those of us who ‘merely wish for a normal existence’. What actually happened was deregulation – as if to remind us of Adam Smith’s words: ‘All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.’ The fundamental privilege of banks, allowing them to create multiple claims on the same asset, was allowed to other ‘depository institutions’. Accounting practices went one step further, allowing two different persons to actually ‘own’ the same asset. Madness had struck – or, in Hollywood-speak, greed had become good, even God: a new Commandment replacing all the older Ten.
Multiple claims on multiply-owned assets now enable ‘shadow banking’ to create financial assets equal in nominal worth to fifty (or more) times annual global production. The relationship between these ‘financial assets’ or ‘near-moneys’ to the lives and freedoms of those who ‘merely wish for a normal existence’ will, I hope, be addressed in a later chapter. For now, enough!
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