There are many reasons to change the current money system. To begin with, the current system works less well than its advocates would have us believe. Exhibit number one: the financial crisis of 2008. That crisis is no exception: since the 1980s there have been dozens of large and small financial crises. Apparently the market works less well than many economists and other market adepts would have us believe.
It’s remarkable that economic theory teaches implicitly that financial markets cannot function well. According to that theory the “invisible hand of the market”, a concept conceived by the 18th century scholar Adam Smith, ensures that private undertakings benefit society as a whole when three conditions are met. First, economic actors, meaning people, must always make economically rational decisions. Second, people must be fully informed: they must have all knowledge relevant for making a decision making. And third, there must be perfect competition – meaning an infinite number of producers and consumers.
In the real world, and especially in financial markets, none of these conditions are met. People do not act in an economically rational manner: social, psychological, biological and cultural factors also influence behaviour. Also, the banking sector is not particularly competitive: in many countries there are only a limited number of players, big banks that hold a large part of the market. And it may be difficult to prove, but it often appears that there are tacit agreements to limit competition – for example, by not competing too aggressively on the interest rate paid on savings or the interest charged on loans.
The most important inhibiting factor for markets “doing their work” is that many operators, from small consumers to governments, lack information. Most people not only have no idea of how our monetary system works but also lack understanding of all kinds of financial products. Many even have trouble understanding their own financial situation. For example, a study estimated four out of five people in the Netherlands were unable to judge the benefits and risks of financial products – and that was the best score among the 13 countries surveyed.
In short, the basic conditions for the proper functioning of markets, established by economic science itself, are not met for financial markets (as well as many other ones). Yet the belief prevails that the market, in the form of a system of profit-oriented private banks, is the best way to control money creation and allocation.
Faith in markets for controlling our money supply is mainly based on the idea that the market itself sets limits on the amount of money being created. Governments, so it is argued, can add to the money supply without limit, but private banks cannot do so because they cannot provide indefinite amounts of credit: they can and will lend and thus create money only if they are fairly certain the loan is repaid.
Because there are limits to what banks can lend it is assumed they cannot cause an explosion in the money supply. That’s true only in part. Since the 1990s banks have created huge amounts of virtual money that ended up largely in financial markets. These form a kind of virtual economy with few ties to the “real” economy of the production and consumption of goods and services. Much of the money thus created ended up in complex financial products – famously called “financial weapons of mass-destruction” by American billionaire and “super-investor” Warren Buffett. These products were the basis for the 2008 financial crisis. Post- crisis, after a brief downturn, growth in this speculative financial system has resumed as before, leading to an ever growing risk of a new crisis.
Many economists believe that these problems can be controlled by regulation. Over the past centuries that assumption has been made time and again, after which yet again things went wrong and the next crisis was born. It therefore appears that even with regulation the system is inherently unstable.
Our current monetary system: no way out of the crisis
So where has our current monetary system brought us? The effects of the crisis are still with us. Governments and many citizens are deeply in debt, disposable income is declining, and unemployment is growing or at best, hardly decreasing. Entitlements are reduced, costs for basic services such as education and health care are on the rise. In many countries the national infrastructure is in poor shape, even crumbling, as there is little or no money for maintenance, let alone improvement. And there is barely money for investment for the future, such as reducing greenhouse gas emissions through energy efficiency and the switch to renewable energy.
It’s not as if there is an absolute shortage of money. The problem is that banks and other financial players pump most of the money into the financial or virtual economy, where it is used for speculation rather than production and consumption. At the same time the “real” economy of the production and consumption of goods and services faces a money shortage.
Even if central banks create money to remedy the shortage of money in the real economy, through so-called quantitative easing, the effects are limited if not counterproductive. That’s because in the current monetary system central banks cannot channel money directly into the economy: that is left to private banks. In an economic downturn these banks see more opportunities for making money in financial markets, through speculation. Therefore banks allocate a much larger part of the newly created money to the financial economy than to the real one. This creates new bubbles in financial markets and in housing prices, thus laying the foundations for the next financial crisis. At the same time the money in the real economy remains scarce, resulting in much production capacity lying idle, with bankruptcies and unemployment as a result.
Another disadvantage is that if things go wrong the government must intervene: the banks must be saved. This applies especially to the so-called “too big to fail” banks, of which it is feared that should they fail they’d take down the entire financial system and thereby, the economy. To prevent this from happening the government spends huge sums of money on nationalising or supporting banks that are about to fail. And since the government is funded through taxation it’s the taxpayer who foots the bill.
At the same time the national debt increases due to the many billions of dollars spent on the bail-outs. The loans for doing so are partly provided by the same banks that caused the crisis, meaning new money is created that is lent to the government at an interest rate that gives the banks a tidy profit. The money for repaying the loan plus interest must, once more, be raised by taxpayers.
Indirectly, the taxpayer also pays a price: to reduce the deficits created by the bank bail-outs the government has to reduce spending, as a result of which services are cut or become more expensive.
In summary: if all goes well with the banks the (ample) profits are for the shareholders, managers and financial traders, in the form of dividends, exorbitant salaries and bonuses. If things go wrong the losses are passed on to ordinary citizens. This has been described as privatising profits and socialising losses, or socialism for the rich.
The current monetary system leads to an economic see-saw with high peaks and deep troughs in economic performance, or, as economists call it, the business cycle. The variations are aggravated by private banks because in good economic times they give more loans, as they see more opportunities for profit. This boosts the economy further, at some point leading to economic overheating, asset bubbles and a new crisis. Then, in times of economic contraction, banks are hesitant to lend money, meaning less money is created precisely at a time when more is needed for economic recovery. This behaviour of banks makes sense from a business point of view and is, therefore, in line with the logic of private banking. But it is contrary to the public interest, because the economy as a whole gets the opposite of what is needed.
Yet another drawback of the current system is that all the benefits of the privilege of creating money (with a technical term, seigniorage) end up with the aforementioned small group of people: bankers, traders, and bank shareholders. Why this is so has been explained already in the above: it has grown over the past few centuries – not least as a result of intensive lobbying by private bankers supported by the faith of standard economics in markets.
However, there is no reason to continue extending this privilege of money creation to a few privileged companies, executives and shareholders. We’ve already done so for the past two centuries, so why continue to provide a small elite with this boon? It would be much more logical and equitable to have the profits of that privilege benefit society as a whole, by bringing the right to create money back to where it belongs: the state.
For savers a major drawback of the present system is that it exposes them to the risk of losing their money when the bank where they have their account fails. That’s because the bank is allowed to put the deposits on the asset side of their balance sheet, meaning that from there on the money is counted as property of the bank, even though the obligation remains to return the money to the depositor when he or she claims it. However, in a bankruptcy the bank will no longer be able to pay and depositors will loose their money, except for the part that is guaranteed by the state.
Perhaps the biggest problem of money creation by private banks is that it’s inextricably linked to profit-oriented lending and thus, to debt and interest. Lending takes place only if the bank is convinced that in the future the borrower will be able to repay the borrowed capital plus interest. Therefore borrowing is possible only with an increase in profits (for companies), income (for consumers), and tax revenues (for government).
More profit, earnings and tax revenues are inextricably linked to economic growth. Without growth there is no increase in company profits, consumer incomes and government revenues, and loans plus accumulated interest cannot be repaid. There is no or very little growth during an economic downturn, leading to many people, companies, and even countries no longer being able to meet their payment obligations. That can lead to a debt crisis, which is sometimes delayed by further borrowing. But this only increases the debts and thereby the problem. In consequence, without strong growth a new and possibly even graver crisis becomes almost inevitable. Many experts believe that, in the aftermath of the 2008 crisis, with many households, companies and countries (still) deep in debt, another major crisis is looming.
Lending, then, is tied to growth: growth is indispensable to repay debts plus interest. Besides growing indebtedness this causes another major problem: continuing growth can not be reconciled with the finite nature of our natural resources. The money supply can, in principle, grow indefinitely but our stocks of raw materials, fresh water, land, and natural ecosystems are finite. Economic growth is putting ever greater demands on those resources, in an unsustainable manner. Meaning that, if we continue present ways, we ourselves or future generations will face major shortfalls and run out of essential resources such as fresh water, agricultural land, metals, and fuel. This will cause huge problems especially for the have-nots in our world. The rich will be able to handle the price increases resulting from the shortages initially, but they too will ultimately suffer, especially if the deficits lead to popular uprisings.
The growth imperative and thereby, the unsustainable use of finite resources is inextricably linked to private money creation. In other words, the current monetary system will, sooner or later, cause shortages of finite resources. That in itself is enough reason to convert to another monetary system.
Besides the growth imperative there is another reason why the current monetary system is incompatible with the sustainable use of resources. The main objective and in many cases, the sole purpose of private banks is to maximize profits and not, as should be the case from a public interest point of view, to provide society with the money supply needed for an optimally functioning economy. Functioning optimally does not mean maximum wealth creation through maximum efficiency – the implicit and sometimes explicit purpose of mainstream economics. From a public interest perspective functioning optimally means achieving public goals as effectively and efficiently as possible. Goals such as providing in everyone’s basic needs, creating equal opportunities for all, optimizing wellbeing, and the sustainable use of natural resources so they’ll be available for both current and future generations. These goals are incompatible with the profit maximization of private banks.
The current monetary system, with money being created by commercial banks to make a profit, has resulted in the odd situation that money is created only for profitable activities. From a public interest perspective it may be very important for government to invest in, for example, better education, a healthier environment, good quality health care and disease prevention, and the development and application of renewable energy. But if such investments are not profitable no money is created for it. Instead the state has to raise money by taxing or borrowing. It can do so only to a limited extent because it has to finance so much more and, especially after the crisis, already lacks the money to do that.
The peculiar situation of having given the privilege to create money to private banks thus leads to the situation that government, because of the fact it has to tax to raise money, is seen as a kind of parasitic entity living on the pockets of hard-working citizens and enterprises. And in a sense with the current monetary system that is indeed the case. But this situation stems from our conscious or unconscious choice for our current monetary system in which the privilege of money creation is yielded to private banks. And it is the result of economic faith: the economic dogma of mainstream economics that has made a taboo of public money creation for direct use by government.
A final drawback of private money creation is that it contributes, indirectly, to poverty, deprivation and inequality. Lending money to poor people is not profitable, therefore little or no money is created for them. Even if it is interest rates are high because of the perceived risk of default and high administrative costs (ten small loans are more expensive to manage than one large loan). At the same time, as a result of the delegation of money creation to the private sector governments are withheld the money with which poverty and impoverishment could be addressed. This, of course, is not only a problem of our monetary system: addressing poverty also depends on political will. Yet the current monetary system complicates the political choice for poverty reduction because the needed funding cannot be created but must be raised by taxpayers.
Are there any advantages to the current system? The first argument that its defenders will raise was already discussed: the assumption that with money creation by private banks the market mechanism will ensure the right amount of money is created. We’ve already seen that this is little more than a belief. It is true that the fact that banks only lend if they think the loan can be repaid with interest forms a brake on money creation. However, it’s a brake does that not work well and is limited mainly to the real economy. Things are different in the financial or virtual economy. In financial markets there are almost unlimited possibilities of creating money for all sorts of speculation in financial products. Proof of this are the enormous quantities of money currently circulating in the financial markets.
Defenders of the current system will also argue that private banking has contributed to huge prosperity growth. This also is doubtful. First, as we shall see in the next chapter, both prosperity growth and well-being could have been much greater with the alternative to money creation by private banks, that is to say, with public money creation. Second, much of the wealth created through private banking is unsustainable because it derives from speculation. Such prosperity can indeed grow rapidly – until the next crisis occurs.
Proponents of private money creation and private enterprise in general will emphasize that only competition between multiple providers creates wealth-creating innovation. However, it was such innovative financial products that caused the crisis, showing that the results of this kind of innovation, even if highly profitable to those creating and selling the products, are rarely in line with the public interest. It is also a misconception that innovation is limited to the private sector. If that would be so then why do so many companies cooperate with public universities and research institutes, and contract them to do their research?
Our present monetary system, then, has many disadvantages and no clear advantages – except of course for bankers, traders, consultants, lobbyists, and private bank shareholders. Yet the system is firmly ingrained primarily because, as already indicated, the general public, the media, politicians, administrators and economists accept the current situation as an immutable given. The blame can be put with mainstream economics which, as a science, may be expected to engage in unbiased analysis and debate. However, very few economists seem to be interested in putting our monetary system up for discussion and thus support the status quo.
If the topic is brought up at all it is not so much to analyze in an objective manner the advantages and disadvantages of different monetary systems in support of political decision making. Instead it is attempted to stifle debate in the bud with the selective use of examples and unsound arguments. Alternative systems, in particular money creation by and for the government, are rejected out of hand with the argument that money creation by government will lead to financial and economic disaster. The favourite bogeyman is hyperinflation; the best known example is the hyperinflation in Germany in the 1920s. Ironically, sound historical research has led to the conclusion that although the German government did not go scot-free the hyperinflation was caused mainly by private banks. Also, usually not mentioned are the many examples of successful public money creation that did not lead to hyperinflation.
In the aforementioned IMF study of the Chicago Plan Benes and Kumhof demonstrate with many examples that generally, throughout history, governments have handled the privilege of money creation more responsibly than private banks. Major economic and financial problems, in the form of periods of excessive growth followed by a crisis and an economic downturn occurred primarily when the right to create money was granted to private parties.
 The IMF counted, between 1970 and 2010, 425 banking, sovereign debt and monetary crises (cited among others in Lietaer, B.A., Arnsperger, C., Goerner, S. & Brunnhuber, S. (2012). Money and sustainability : the missing link ; a report from the Club of Rome – EU Chapter to Finance Watch and the World Business Academy. Axminster: Triarchy Press with The Club of Rome.
 Study discussed in the Dutch newspaper De Volkskrant, December 23, 2009
 Monetary expert Bernard Lietaer estimated for 2010 that of the 4 trillion dollar traded daily in currency transactions only 2% was of significance for the “real” economy, e.g. for importing or exporting goods and services; the other 98% was used purely for speculation. See Bernard Lietaer et al., Money and Sustainability. The Missing Link, 2012; Report of the Club of Rome.
 Quantitative easing is a central bank policy aiming to stimulate the economy. It involves central banks buying financial assets from commercial banks and other private institutions, thus increasing the supply of money available for consumption and investment.
 It is an open question whether what banks are doing is legal: the British expert Richard Werner points out that in England, according to the “Client Money Rules”, companies should always keep customer funds separate from equity, meaning they are not allowed to put it on their balance sheets. This may apply to other countries too. However, banks are permitted to put deposits on their balance sheets, exposing depositors to the risk of loosing their deposit if the bank goes under. Werner points out that the removal of this privilege of the banks by also forcing banks to adhere to the “Client Money Rules” would deprive banks of the privilege of money creation. Werner and other experts also point out that banks have no official mandate to create money: neither in the current manner nor in a different way. See Werner, RA, How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking. Pre-publication; Publication expected in the International Review of Financial Analysis in 2015.
This was the 6th chapter of the booklet “Our Money” by Frans Doorman, author of the books Crisis, Economics and the Emperor’s Clothes, Global Development: Problems, Solutions, Strategy – A Proposal for Socially Just, Ecologically Sustainable Growth and The Common Sense Manifesto.
This booklet explains, in plain English, what money is and how our current monetary system came about. It discusses the problems inherent to the present system and proposes an alternative.
It also explains how the current monetary system restrains us in addressing our economic, social and environmental problems, and even worsens them. It discusses the transition to a system that would work better, the main traits of that system, and the reasons why such a better alternative is hardly considered at present.
This booklet is intended for a broad audience: anyone with an interest in the solution of society’s social, environmental and economic challenges. People who are concerned about the continuing impact of the economic crisis that started in 2008 and about its aftermath: growing economic insecurity, inequality, and poverty. And people who are distressed about the environmental problems our global society is facing: the degradation of ecosystems and the environment in general, the depletion of natural resources, climate change, loss of agricultural land, and looming fresh water shortages. People who, even though they do not expect to be affected by these problems directly themselves are concerned about the future of their children and in general, of future generations.
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