In the news recently, the payday lenders Wonga have attracted some much deserved negative attention, due to the fact that they provide loans to some of the poorest people in the UK, at extortionate annual interest rates of up to 4,214 %.
However, there is another part of the story that hasn’t been getting any attention in the press, although it affects almost everything. It relates to a broader question of money creation and inequality. When Wonga makes a loan it is lending money it already has, and charges interest on the money it lends. But how was the money for the loan created in the first place? How is more money going to be created in order to repay the loan plus the interest? Well, a fact that only few people are aware of, is that today, new money comes into circulation not from the government or from the Bank of England but from commercial banks, which create it whenever they make a loan. Unlike Wonga, they lend money that did not exist before they lent it. Now, because the money is created as debt it means that as our money supply increases, so does the level of debt! And consider this: If all the outstanding loans were paid back to the banks, there would be no money in circulation today. Since the only way we can get new money into circulation is to borrow it from the banks at interest (who create it out of nothing) – we are effectively renting our entire money supply from commercial banks.
There are many consequences that arise from this system of money creation, but perhaps one of the most unequal ones is the transfer of money through interest payments. The bottom 90% of the UK pays more interest to banks than they ever receive from them through savings. This effect results in a redistribution of income from the bottom 90% of the population to the top 10%. Collectively we pay £165m every day in interest on personal loans alone (not including mortgages or interest payments to secondary lenders such as Wonga), and a total of £213bn a year in interest on all our debts. In May average amount of household debt was £54,024. The diagram below shows the disproportionately high percentage of income paid to the banks through interest payments for the poorest 10% and the disproportionately low percentage for the richest 10%.
Another effect that this system has on inequality is put very well by Andrew Simms in his new book ‘Cancel the Apocalypse.’ He writes:
‘Generally speaking, the rich already have a lot of stuff, so when they are given the opportunity to leverage assets, like their homes, they buy more assets, more homes. The poor, who have less stuff, given the same chance but from a more modest basis, use their equity to buy household goods and other consumables that depreciate in value.’
High house prices play a significant role in increasing inequality and they are a direct consequence of the current system where banks are allowed to create money when they make loans, including mortgages. As more people buy houses, this fuels a housing bubble, so house prices rise, making the rich, richer. If you are not on the housing ladder, the rising house prices result in rising rents, which actually make you poorer as a larger proportion of your income, has to go to rent. Younger people also lose out, as the cost of buying their first house swallows an ever larger amount of their income, while older and retired people who own houses benefit. This all increases inequality across different income groups and between the young and old.
Businesses are also in a similar situation. The ‘real’ (i.e non-financial), productive economy needs money to function, but since money is created as debt, businesses have to pay interest to the banks in order to function. This means that the real-economy businesses – shops, offices, factories etc – end up subsidising the banking sector. There is a transfer of money from the rest of the economy to the banking sector.
When we consider what banking should be, a place to keep our money safe and provide a payment system and loans when we need them, it seems bizarre that this industry should become the most profitable one. Banks are no longer service-providers but are profit maximising corporations that feel they can justify big bonuses because they have the privilege of controlling the money supply. Martin Wolf, the Chief Economics Commentator of the Financial Times wrote very clearly, ‘we have entrusted a private industry with the provision of three public or near public goods: the supply of money; the payments system; and the supply of credit.’
To rent money in the form of digital numbers, that are created out of nothing from private companies and to pay interest on it is surely not the only – and certainly not the smartest – way of getting money into circulation. There are other – more constructive and socially useful – ways of money creation.
Positive Money is arguing that money should be created free from debt by the Bank of England. We think it should enter the economy via government spending, rather than commercial bank lending. Commercial banks will still be able to lend, but only with money they already have, they will not be able to create new money.
Below is our new, short animation highlighting the negative effect of the current monetary system on inequality and explaining how the current monetary system is one of the underlying causes of increasing inequality.