Dirk Bezemer on Positive Money: A Response

This is a more detailed response to the interview with Prof Dirk Bezemer on The Icelandic National Broadcasting Service, RUV (the interview starts at 38:56 min). (The first response written by Graham Hodgson can be found here.)

We’re fans of Prof Dirk Bezemer’s work (we particularly like this and this and gang8, of which he is a member, is an excellent place for discussions of the economics of money and credit). Dirk is one of  the few economists who understand money and bothers to consider the role that banks have in creating money.

But his interview with Icelandic journalist Egil Helgason, following another interview (which starts at 46:40 min) has a number of fundamental inaccuracies, which I wanted to address here.

1. “Money has always been debt”

Prof Bezemer says:

“Yes, the banks create money as debt and this has always been the case, I mean when you go back 5,000 years or more and you look at the archeological evidence, people have created debt and these debt tokens, these IOUs came to circulate as money, that’s where money comes from. So you’re always going to have money that is a form of debt; having money which is not debt is like wanting to create dry water, right, that is not possible. So, the way that banks create money is by creating deposits which are a liability on the banks themselves, and deposits created by banks cannot be distinguished from deposits created by the public when they put money into the banking system.”

The current monetary system is so different to that of 5,000 years ago that this argument is invalid. As David Graeber’s book Debt: the First 5,000 Years explains, anthropological and historical evidence shows that prior to the use of coins or commodity money, people within communities used to “owe” each other rather than swapping one good for another. But these debts were between individual human beings and could be created by anyone who choose to enter into a debt relationship. This is hugely different from the current situation where the IOUs that we use as money are predominantly created by an oligopoly of 5 large banks (and some smaller ones), and where this ‘debt-based’ money can only be created by institutions that have a banking licence and the full underwriting of the taxpayer.

Also logically the argument that money has “always” been debt and therefore must always be debt is extremely weak. There was a point in history where we had “always” used horses for transport; this does not make the invention of cars, trains and planes impossible. There was a point where wood was the only form of fuel for heating, where pen and paper was the only form of recording information; where candles were the only form of lighting after dark. Human progress has depended on people ignoring the fact that “It’s always been this way” and trying to do things differently .

2. “It’s impossible to stop banks creating money”

Prof Bezemer says: 

“So, as soon as you have deposit-accepting institutions, then these institutions, which are banks, can also create money. So, this is quite technical, but I simply don’t see how banks can be stopped from lending and from creating money. In fact, the core idea of the Positive Money proposals, to separate money creation from lending, is not feasible, because money creation and lending are the same thing.”

We disagree with this analysis. The numbers (deposits) that banks create can be used by you, through the payments system, to make payments to other people. That means that they can function as money. Simply stop banks creating the numbers that can be used to make payments, and you have stopped banks creating money.

Now for the technical version: It is demand deposits, the on-demand liabilities of banks, that we are using as money. When banks can create demand deposits, they are able to create money. The Positive Money proposals prevent banks from having demand deposits. If a customer/depositor wants their money to be available “on-demand” (I.e. Instant access), then instead of having a promise-to-pay (liability) from the bank, they would instead have full ownership of electronic money held in an account at the Bank of England (the central bank). The only liabilities that banks would be able to create would be time-deposits (what we’ve called Investment Accounts), which have maturity dates or notice periods (I.e. they’re not instant access). The bank would create when it borrows money from a saver in order to lend it to a customer. Because these time deposits can’t be used to make payments, they don’t constitute money and therefore this isn’t money creation. Banks would make loans by transferring electronic money held at the Bank of England from the ownership of the bank to the ownership of the borrower, with no new demand deposits or money being created in the process.

3. “This is a Soviet/Communist reform”

The interviewer asks:

“EH – But if you put all of the money creation into the hands of the government, wouldn’t we be having a sort of a, well, we could say, a Soviet system?”

To which Dirk Bezemer replies:

“DB – Yes, actually you would. You would. Basically, what the Positive Money proposals, and also other IMF proposals, what they imply is that you abolish banks, you do away with private banks. You just have one central bank and everyone banks at the central bank, and you have to put great faith in the ability of the governments to create enough money and to make sure that money goes in the right direction. Now, given the recent experience of Icelanders with their government, I don’t think that’s a very good idea.”

Again, we would disagree strongly with this. We’re a long way from capitalism when we have a system where taxpayers underwrite private banking institutions, where badly run banks are not allowed to fail, where banks have the power to create the money that the rest of the economy depends on, and where a small oligopoly determine what parts of the economy get funded, and what parts are starved of credit. What Positive Money’s proposals actually do is force banks back into a free market where they will not be subsidised and will be allowed to fail. Ironically, given that creation of money by the state is often simplistically labelled as being ‘a bit communist’, it is actually necessary to re-apply the principles of capitalism to the banking sector.

Secondly, our proposal does not abolish banks. It removes their ability to create money, and leaves them as true intermediaries between savers and borrowers, which is what most people think they are already.

Finally, how much success have we had relying on bankers to create the right amount of money and ‘put it in the right directions’? We have a system that has evidently failed because:

Banks have no interest in creating the ‘right’ amount of money for the economy; their interest is in creating as much as possible, since creating money via lending is how they maximise their profits.

They’ve manifestly failed to create the right amount of money up until now: we’ve had a debt-fuelled bubble in housing, which has crashed, and now they are creating too little money, causing a recession.

On an almost facile level, we could ask if it is possible to do any worse that what we already have?

More detail on the question of whether the Bank of England could directly manage the money supply better than they do so indirectly under the current system is discussed on page 208 of Modernising Money.

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Is it possible for the Money Creation Committee to determine the ‘correct’ money supply?

“To begin with, it is important to note that the MCC would not determine how much money the economy needs from scratch. Instead, it would decide whether to increase or decrease the money supply from its existing level (which has been determined by historical events), given current levels of inflation and economic activity. This requires that the MCC take a view on the likely future path of the economy in addition to reacting to economic events. Essentially the MCC will be guided by both theory and the results of their previous decisions.

There is of course no way for the MCC to predict perfectly what the growth in the money supply ‘should’ be. However, this is true of all monetary and political decisions – including the Monetary Policy Committee’s decision to increase or decrease interest rates in the present system. The question therefore becomes one of who is most likely to supply the economy with the ‘correct’ amount of money: commercial banks in the current system, or an independent committee in the reformed system?

As was outlined in Chapter 2, commercial banks create money when they make loans. Bank officials therefore are not making a decision about how much money they think should be in the economy; they are instead making a decision about whether a particular loan will be profitable. This means that the money supply is currently determined as a by-product of bank lending decisions, made in the pursuit of profit. Because the majority of banks’ profits come from the interest they charge on loans, in relatively benign periods banks are incentivised to lend as much as possible, creating money in the process.

However, although the money supply is determined by the actions of companies in the private sector, it would be a mistake to believe that the money supply is determined by market forces, for several reasons. First, the top five banks in the UK dominate almost the entire market, making it an oligopolistic market. Second, the money supply is not determined by the demand for money, but by the demand for credit. Third, even the market for credit is not determined by market forces – as section 3.5 showed, banks ration credit. Of course, the overall strategies of banks, and therefore their lending priorities, are determined at board level. Consequently, it is a small group of senior board members at the largest banks who determine the growth rate of lending and inadvertently the money supply of the economy. As the “cash vs bank issued money” chart in the introduction showed, these incentives, combined with a lack of constraint on bank lending, led to a doubling of the money supply from 2002-2008.

Banks therefore create too much money in good times, leading to economic booms, asset bubbles and occasional financial crises. Because this money is created with an accompanying debt, eventually the economy becomes over-indebted, with a bust occurring when individuals cut back spending to repay their debts. During the bust, banks’ pessimistic views as to the future state of the economy (which are magnified by disaster myopia – see Box 4.C) lead them to create too little money and as a result the economy suffers more than it needs to. The story of this type of business cycle is therefore one of banks creating too much credit, which causes a boom and eventually a bust when debt gets too high. Then, during the bust banks lend too little, worsening the downturn. In short, there is no reason to think that the level of money creation that maximises banks’ profits will be the level of money creation that is best for the economy as a whole.

In contrast, under the reformed system the decision to create or destroy money will be determined by the MCC, a committee charged with creating the right amount of money for the economy as a whole. While it is unlikely that this committee will be able to get the level exactly right, history has shown that the current system rarely provides the ‘right’ amount of money, and more often than not gets it disastrously wrong. The choice is not therefore between a ‘perfect’ market-determined system on one hand and one determined by a committee on the other, but rather between leaving the nation’s money at the mercy of the interests of banks or organising it squarely in the interests of the national economy. Given the above, it is difficult to imagine that the MCC  could manage the money supply more destructively than the banks have done to date.”

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4. Finally the good points:

Prof Bezemer makes some excellent points here, although again we need to correct some misconceptions.

“DB – As you rightfully say, too much debt is a problem. The important thing is that debt itself is not the problem. Debt is part of the solution, that is invented by humans thousands of years ago in pre-history, to make our economic system work. The problem is, not that debt is being created, but how debt is used. So the fact that banks create debt is good because it helps entrepreneurs who have good ideas but no money to get money from the bank as a loan to, whatever, build a factory, develop energy resources, invest in fishing or tourism, and if it’s a good business plan it allows them to repay the debt, and meanwhile the economy is growing, jobs are being created, and so on. So that’s how debt helps the economy.”

We have no objection to ‘useful debt’, investment in businesses, loans that allow people to buy houses and spread the cost over a long period of time. But this is a fairytale idea of the banking system. In the UK today as little as a tenth of all bank lending actually goes to businesses and the activities that can help the economy growth. Most of the money that banks create is used to push up housing bubbles or fuel financial market speculation.

Besides, there is no reason why we need to give banks the privilege of creating money in order to finance the useful part of the economy. Most larger businesses are funded not by banks, but by other investors who use money that they borrowed from savers. It is only banks that have the exception of being able to create the money that they lend (because we can use the liabilities of banks as money, whereas we can’t use the liabilities of pension funds, for example).

“DB: What has been happening over the last years in many countries, including my own country, and I’m studying this now for many countries, is that too much debt has been created for property and financial markets, not for productive purposes, and this has just inflated house prices, inflated asset prices like stocks and bonds and all kinds of derivative assets and instruments. That is the problem. So the sort of regulation that you need is not a completely new monetary system but you need to go back to the sorts of regulation that were quite common in the 1970s, for instance, adapted to current times. So you need to regulate banks, to encourage them, to incentivise them, to invest more in the sectors that the government agrees are important sectors for the economy. So to leave credit allocation to the market is not a good idea. I think that’s one of the Positive Money points which I fully support.”

We’d mostly agree, apart from the fact that relying on regulators to keep the system safe means that we would be asking the same people who failed to see the crisis coming to spot the next crisis coming. Our proposals have been designed to make the crisis less likely to happen in the first place, even if the regulators are incompetent.