The main obstacle for public money creation has already been mentioned in the previous post: the fear that the creation of money by government will lead, sooner or later, to large scale inflation. Governments, it is thought, will be unable to restrain themselves, resulting in the excess creation of money, too much money entering the economy, and inflation. We’ve already discussed how this danger can be countered: by delegating money creation to an independent monetary authority.
A bigger problem is the belief of mainstream economists and in their wake, politicians, the media and other pundits in the quantity theory of money. As said this theory parts from the premise that the existing money supply is already in balance with supply and demand. It is therefore thought that even a small increase in the money supply that’s not market driven would lead to inflation. As with much other economic theory there is no factual proof that this theory holds, on the contrary. Yet it has become economic dogma, with among its most dedicated followers the German monetary authorities. Germans in general suffer from a strong case of inflation phobia as a result of the already mentioned hyperinflation in the country in the 1920s. Hence the only goal of the German central bank and, under German influence, the European central bank is controlling inflation. By comparison the US central bank, the Federal Reserve, has a dual objective: fighting inflation and fighting unemployment.
Is it true that the risk of (hyper) inflation is higher with public than with private money creation? Historical research has shown systems based on private money creation lead to more and more severe financial and economic crises, including bouts of hyperinflation. Linking the fear of high inflation to public money creation is therefore unjustified. Which, of course, does not remove the need to structure a new monetary system in such a way that inflation is kept under control. In a system where a public monetary authority is responsible for money creation the opportunities to do so are much greater than in the current, privately managed system.
In current economic thinking money creation by and for the state is a taboo. Mainstream economists assume that only market forces can ensure that the right amount of money is created. Especially right-wing economists place their faith in market self-regulation and preach laissez faire: let the market do its work without being hindered by regulation. The middle and the left are more inclined to various forms of regulation. But the belief that the economy as a whole and money creation in particular should be left to the private sector and thereby the market is untouchable. It is one of the primary tenets of the economic church. In consequence alternatives such as public money creation are not even considered in mainstream economics, not even after a financial and economic crisis that was due largely to irresponsible lending and thus, private money creation.
As indicated creating too much money indeed can cause inflation because as a result of excessive demand producers and workers exact higher prices and wages. And there is an even greater risk: loss of confidence, that is, the loss of the belief that money will retain its value.
The cause of hyperinflation is not so much the creation of excessive amounts of money as a loss of confidence. The German hyperinflation is a good example. Accounts from that period invariably mention that the printing presses could not keep up with inflation, meaning they could not print the money fast enough, which signifies the money lost its value before it was made. The printing of money, therefore, was not a cause but a consequence of hyperinflation.
You don’t have to look far to realise that the quantity of money in itself is of little significance. Both before and after the 2008 financial crisis excessive credit, speculation and all kinds of exotic financial products led to the creation of huge amounts of money – much more than was justified by the increase in output and demand in the “real” economy. It’s safe to say, therefore, that both pre- and post crisis too much money was put into circulation. Yet inflation remains low. There is even fear of deflation: an increase in the value of money because the overall price level drops.
This shows it’s perfectly possible to have a major increase in the money supply without causing inflation – as long as this larger money supply does not translate into an excessive demand for goods and services in the real economy. If that happens producers and workers are likely to increase prices and wage demands, leading to demand-pull and cost-push inflation. This did not happen in recent decades because the excessive amounts of money created did not end up in the real but in the financial economy, where it was used for the kinds of speculation that caused the crisis.
To prevent (hyper) inflation with public money creation, then, requires two things. On the one hand adding to the money supply should not create more demand than the productive sectors of the economy can handle. Second, the general public must be confident that money will keep its value. For both conditions the best guarantee is delegating decision making about money creation to an independent, technically competent monetary authority that inspires confidence – such as the central bank.
However, the value of money is determined not only by users but also, and perhaps more so, on the international financial markets. To maintain confidence in a currency based on public money creation may prove to be the greater challenge.
Many advocates of monetary reform, including the experts of Positive Money, think it’s possible to have the transition to public money creation take place in a single country. They arrive at this conclusion on the basis of a rational analysis of the economic impact of the transition. However, it remains to be seen how financial markets would react to the announcement of a country planning the transition, or even to the rumour that a country would consider it.
IMF experts Benes and Kumhof also argue that the economic benefits of a new monetary system, in their case the Chicago Plan, are such that the financial markets would not constitute a danger to the country making the transition. They do discuss the possibility of an “irrational speculative attack” after the transition and advice on measures to be taken against such an attack. However, they do not discuss the above mentioned greater danger of such an attack before transition, based only on the transition having been announced or rumoured. That is the greater danger, because such a response would likely be more of a psychological than of a rational economic nature. The greatest danger would be herd behaviour by traders. Some holders of the currency of the country making the transition would, in line with economic dogma, fear that the currency involved would decline rapidly in value and therefore want to get rid of it as soon as possible. Other traders would get wind of this and also become afraid of a drop in value, leading them also to sell the currency involved. In consequence the value would indeed fall, and more quickly as more traders would behave similarly. A self-fulfilling prophecy would result: because traders would expect a decrease in the value of the currency they would engage in the behaviour that would actually cause such a decrease.
To avoid the risk of such a panic in the financial markets it would appear sensible to make the transition in several countries at once, preferably by a majority of countries with internationally accepted, “strong” currencies. This would also allow central banks to coordinate with other central banks the decision making on the amounts of money to be created in different currencies. These days national economies and financial systems have become so intertwined that in any case, decision making on money creation would best be done collectively.
A transition in several countries at once would require an international conference on the establishment of a new financial system. This has been done before: in the last year of World War II, when representatives from 44 countries met in Bretton Woods in the US to agree on the rules, institutions and procedures to regulate post-war international finance. Something similar should be done now.
Besides inflation phobia there are other obstacles that block the creation of a new financial system. These are of a more psychological nature. People, and therefore societies are risk-averse and therefore conservative: we are hesitant to replace something existing with something new. That certainly applies to something as important as our monetary system. That caution is even greater if things are going relatively well – and in developed countries that is, despite the crisis, for most people still the case.
The willingness to change is even smaller if we are not aware of there being a good alternative. And even then there will be suspicion towards something that seems as simple and “too good to be true” as public money creation. As said, the idea that money can just be “made” out of thin air and provided to the state or to companies and citizens is alien to us. It’s against our culture: money must be earned before it can be spent.
In order to overcome these psychological obstacles it’s important to think once again about the character of money. We must keep in mind that money is merely a symbol which serves as the (electronic) lubricant of our economy. We can make as much of it as we need, within the aforementioned limits of maintaining confidence and demand remaining in line with production capacity. We should remember in particular that there is no reason to refrain from addressing society’s environmental, social and economic challenges society because ostensibly there is no money to do so. There is no absolute lack of money, or if there is it can be resolved in no time. What “there is no money” implies is that the state, the institution looking after our common good, does not have the money. That, in turn, is the outcome of our choice for a monetary system in which the privilege and benefits of money creation are yielded to private banks.
Another important way to overcome our psychological barriers to change is to look around us. We then see that left and right companies go bankrupt and public services are downsized or eliminated. This includes companies and services that could provide the goods and services with which to tackle our environmental and social problems effectively. At the same time people lose their jobs, unemployment and economic uncertainty are growing, and large numbers of young people are unable to find steady, reasonably paying employment. When observing this we need to realise again that this is due to the fact that we have opted for delegating the control over the money supply and the right to create money to profit-oriented enterprises. In other words, to our choice for a monetary system that not only brought us the 2008 crisis and many before it all over the world, but also blocks us from addressing our social problems and by doing so, working our way out of the crisis.
We can argue that we have not made the choice for our current monetary system consciously. But we can no longer use this as an excuse when we are aware of both that choice and of the alternative.
Besides inflation phobia and conservatism there is another factor that hinders the transition to public money creation: the vested interests of the financial sector, banks in particular. Especially the huge “too-big-to-fail” banks have enormous political influence and use it to promote bank-friendly legislation. Moreover, in a country such as the United States there is a revolving door between government and large banks: elected officials and public servants in key positions often come from large internationally operating banks, particularly the infamous investment bank Goldman Sachs. After a stint as a public servant the individuals involved usually return to the financial sector. Thus private banking interests are strongly represented at the heart of government.
And that’s not mentioning the billions spent by banks on lobbyists, who are expected to push decision makers and members of parliament into approving legislation favourable to banks and blocking or mitigating legislation that is seen as harmful to financial interests.
The enormous influence of the financial lobby is shown by the fact that the largest US banks, largely responsible for the financial crisis of 2008, have had to pay only minor damages in comparison to the damage caused. Even in cases where banks were fined and damages paid the amounts involved were only a fraction of what the banks earned with the practices for which they were fined. In almost all cases those amounts were part of an arrangement that freed the banks from having to plead guilty. Not one of those responsible has gone to jail.
At least the US has done something: other countries have done nothing at all, or worse, are blocking measures to reign in the sector. The prime example is the UK, where the financial sector (“The City”) is of such importance to the economy that the British government is doing everything it can to block European measures to get a somewhat greater hold on the banks. Money is power, and the ability to create money only increases the power of the financial sector.
It may be expected, then, that the financial sector will do its utmost to block the transition to a new system in which they would lose the financial benefits linked to money creation. Yet banks are fortunate in that it’s hardly necessary for them to engage in the fight against public money creation. For that they can count on economic science: the belief of economists and in their wake, policy makers, politicians and the media that only markets can determine the right amount of money for the economy. It is the belief that no man, group or organization can match Adam Smith’s invisible hand of the market. This dogma of market infallibility is an even bigger obstacle to change than the power of the financial sector. For mainstream economics not only idealizes the market but also, and in line with the faith, is sceptical about government. On the one hand because the state is not subject to market discipline and therefore to the restraint exercised by the invisible hand. On the other because actions of government usually involve some kind of market interference, which is perceived as a threat to the perfect balance of the market that especially conservative economists so ardently believe in. Thus the practitioners of conventional economics, consciously or unconsciously, form the first, formidable defence against change.
But if fractures occur in that line of defence, if at least part of the economics profession is able to look beyond the dogmas of their science and start thinking seriously about another financial system “for the people, by the people”, it can be expected that the financial sector will throw everything it has into the fight to maintain the current system. It will, therefore, be a tough fight, but it should be possible to overcome the influence and power of the financial sector. After all, very few people benefit from the current system and would lose from the transition to a new financial system based on public money creation. It’s only those traders and bank managers who in addition to already high salaries receive or award huge bonuses to themselves and their colleagues, and speculators who are lucky enough to make money from the ups and downs in the financial markets. This group amounts to at most a few tens of thousands of people.
Shareholders of banks also would be likely to suffer from the transition to a new monetary system, as bank profitability would be reduced to the level of normal enterprises. In consequence bank stock would almost certainly lose value if the financial boon resulting from the ability to create money out of thin air is taken away. Among those shareholders will be institutions that serve a public purpose, notably pension funds. However, under a new monetary system these organizations could be compensated for this decline in the value of their bank stock.
Everyone else would benefit from public money creation. Citizens would enjoy more, better and cheaper public services, tax cuts, lower debt and possibly, a citizens’ dividend. Governments would be able to invest much more for the future and thus, for future generations. Producers, especially of goods and services required for the transition to a more sustainable society and economy, would benefit from increased government demand. Small and medium enterprises would benefit from the increased demand from government and consumers. Public money creation would also greatly improve access to credit, especially if combined with a public banking system. And due to increased demand and economic activity many of the currently unemployed would be able to go back to work, if need be after retraining.
One would expect that with so many benefits for such a large proportion of the population it should be possible to generate a massive popular movement and overcome the vested interests of a small group, however powerful and influential.
Perhaps the biggest obstacle to change is that we leave something as crucial as thinking about and deciding on our monetary system to those we consider knowledgeable. We figure we know too little, it’s their job, and accept what they say. If they do not question the current system, who are we to do so?
The problem is that, as we have already seen, the experts do not come up with better alternatives for our money system. Not because economists consciously keep us from addressing the problems society faces: most believe sincerely that the current system of private money creation is best for us. They feel this way because their education and professional careers have given them a distorted picture of reality and tunnel vision. In consequence few economists are aware of the limitations and misconceptions of their science and of the policy recommendations based on them, and fewer still are able to see economic reality from a different perspective than that ingrained by their faith.
That is not to say that there are no critical economists who question certain components and assumptions of their science. However, this is a minority that thus far has had little impact on professional practice and even less on policy making. And even most members of this group do not go so far as to question the dogmas of their faith. Yet it’s precisely there where the problem lies.
 For 2014 the Center for Responsive Politics reports for Washington for the financial industry (securities, investment and insurance) a total of some 1600 confirmed lobbyists; expenditure by the sector amounted to about $250,000,000. (https://www.opensecrets.org/lobby/top.php?indexType=i&showYear=2014). Corporate Europe Observatory indicates in a 2014 report that at European Community HQ in Brussels the financial sector employs some 1700 lobbyists to influence decision making on financial issues, with a total budget of €123,000,000. (http://corporateeurope.org/sites/default/files/attachments/financial_lobby_report.pdf)
 A major question is whether under a new monetary system pension funds should continue to exist in their current form. With public money creation the need for mandatory pension saving would disappear or diminish. The problem would no longer be, as now, that without a pensions saving system pensions have to be paid from current worker contributions and taxes (“pay as you go”), leading to an increasing drain on worker’s payrolls and government budgets especially in countries with greying populations. With public money creation government would have more financial leeway to pay pensions because much public investment would no longer be financed through taxes but through money creation. The challenge would no longer be a monetary one but rather, to ensure that sufficient goods and services are produced to meet the needs and demands of both workers and non-workers. That challenge already exists in countries with greying populations but is obscured by the ongoing debate on the financial aspect: the size of pensions and other benefits, their coverage and whether or not to compensate for inflation. Public money creation would allow a shift of focus because the financial dimension would become much less important. Thus policy makers, science and industry could focus on the real task, which should not be money but the challenge of meeting, with a diminishing work force, the growing demand for goods and services from the non-working population and government for goods and services produced by the working population. That’s not a question of money but of production capacity, of the more effective and efficient use of the available labour and technology.
Abolishing or greatly diminishing the size of pension funds would have another advantage: it would sharply reduce the amount of money that flows into financial markets in search of yields. The large scale (obligatory) saving for pensions contributes hugely to too much money chasing too few investment opportunities: the recipe for a financial crisis. This problem already plays today but would be even greater if all countries would establish “responsible” pension systems such as those of Denmark, Sweden, Australia, Switzerland, The Netherlands and Canada, and to a somewhat lesser extent the UK and US. Most European countries, including France, Italy, and even solid Germany have partial pay-as-you-go systems in which a large proportion of pensions is paid directly from the state budget. In the coming years, due to aging populations and the current monetary system, this will lead to major financial challenges for the countries involved. On the other hand, if France, Italy and Germany and a range of other countries with pay-as-you-go systems would have pension systems as in the earlier mentioned nations, the amount of money in search of yields in financial markets would increase hugely without a rise in investment opportunities. Put simply, (pension) fund managers would not know what to do with all that money. The conclusion is that current pension systems are incompatible with the actual monetary system, firstly because broad international application of pension savings schemes would lead to excessive hoarding of money, and secondly, because a pay-as-you-go pension system is unaffordable in a monetary system in which money creation is tied to debt and interest.
 Further substantiation of this critique of mainstream economics and its practitioners will be given in the booklet Economy: science or faith? (in preparation). A detailed explanation is found in the book Crisis, Economics, and the Emperor’s Clothes (Frans Doorman, 2012), which indicates why mainstream economics fails as science, the consequences of that failure, and what should be done about it. The book can be ordered in hardcopy on www.lulu.com, and can be downloaded for free as a pdf from www.new-economics.info.
This was the 7th chapter of the booklet “Our Money” by Frans Doorman. 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.