As spending cuts begin to bite, we need to ask what is wrong with our economic system that has caused it to fail so badly. All developed economies are struggling with the twin problems of reducing national debt, and recovering from economic recession. The UK is making deep spending cuts, amid concerns that it will damage the recovery; others are tackling it the other way round – injecting more borrowed money to stimulate growth, in the expectation of greater future tax revenues to pay off the debt. Who is right, which approach will work?
Well, maybe both approaches will fail in the end! Money is debt – that sounds strange, but money supply and debt are two sides of the same coin, you cannot increase one without increasing the other. To understand this, we need to ask where money comes from, and the surprising answer is that virtually all money in circulation has been created not by the Bank of England or any other authority, but by high-street banks through the mechanism known as ‘fractional reserve banking’ (FRB). When you borrow money from a bank, they just type the figures into your account as a loan, with only a small fraction of the amount being backed by ‘real’ money which was deposited by a saver. They create credit from thin air.
Less than 3% of our money is in the form of notes and coins, the other 97% is electronic money held on the banks’ computers and created through the FRB mechanism. Virtually ALL money was created as credit; for every pound that’s yours, someone else owes a pound to a bank. Household debt now stands at an astronomical 1.5 trillion pounds, and government debt has topped 1 trillion. The banks create additional lending at the rate of around £150bn each year; some of this new money goes to fund economic growth, some goes to the government in taxes, and the rest goes to shareholders and bankers’ pay. Still the debt keeps going up, and so do the repayments.
Fractional Reserve Banking means you can EITHER reduce the debt burden OR stimulate growth but not both! Our politicians have failed to find an answer to this dilemma.
Debt-free money is the only way out. The New Economics Foundation and the Positive Money campaign have called for an end to the commercial banks’ licence to print money; instead, all new money would be created only by the central bank. Crucially, this money would not require repayment or incur interest; the new debt-free money created each year could be injected directly into the economy, and the debt burden would be gradually reduced. without draconian cuts.
Spending cuts are avoidable; with radical banking reform, we really could have our cake and eat it!