Bank Robbery: Why are banks allowed to create money?

Imagine a world where huge amounts of money are created out of nothing for private profit and destroyed again once profit is taken, so that new money can be created again (and again, and again) – for private profit.

Imagine a world where governments can borrow huge amounts of money created by private corporations (for their own profit) and charge the debt to taxpayers (without any say-so from those taxpayers); then use the money to do whatever they like, including buy arms, make wars and laws and payments to benefit themselves, their supporters and friends.

Imagine a world where the entire money supply is created as debt, and rented out at interest. Debt rented out at interest? Can such a devious a form of robbery even exist?

It can and does; for this is the world we live in today. A world where eight individuals own more than the poorer half of the world’s population;[1] where government and finance are deep in each other’s pockets; where the desires of most people for a better world are frustrated at almost every turn.

Today’s money consists of debt, created by banks in such a way that productive working people end up with debt while assets go to the rich and powerful. By ignoring the way money works, we have allowed the world to take a downward spiral. Not many people understand the process: so instead of reform, voters reach out to vicious, unstable dictators to rescue them.

The basics of the system are not exactly a secret. Many central bank websites have an account of how money is created as two-way debt.[2] But the subject and its process are so little discussed, they could be the tightest-kept secrets on earth.

For many years now, the subject has stayed ‘under the radar’. Most people in active life – certainly those with success, influence and power – have done well in the system as it is. Naturally, they do not like to think they have prospered from, and given their working lives to, a corrupt system. Furthermore, reform is alarming. Would the world be turned upside down? Would we lose what we already have? The system is unstable. Rocking an unstable boat in an open sea is not a good idea. As for voting citizens, the subject is tricky and time-consuming to understand. Meanwhile, the lives of billions of people are reduced to desperation and misery by ever-greater inequality and unaccountable powers. ‘Globalization’ is not globalization of justice, or democracy, or free trade; it is globalization of money-creation and predatory finance.

What about those people whose job is to tell us what is going on – politicians, the media, economists? There’s an old saying: ‘He who pays the piper calls the tune’. In politics, the media, and academia ignorance – or at least silence – about the unjust workings of the monetary system is a prerequisite for acceptance, let alone advancement.

How the system developed – a tiny dose of history

The foundations of today’s method of creating money were laid in England over three hundred years ago by rich white males – Members of Parliament and others – shortly after they seized power from the monarchy. The new method solved an age-old problem which had frustrated ruling classes for centuries: how to profit more than once, and more than just a little, from the money supply.

The method emerged from banking (which was already centuries-old). The advantage (for the rich and powerful) of banks creating the money supply was that huge amounts of money could be created out of nothing, as loans. Governments wanted money to go to war; rich people wanted money to make more money. Borrowing large sums that already exist is time-consuming and perhaps impossible. It may be necessary to offer high rates of interest, and to ask many different people, who may have many different reasons to refuse. But banks create money out of nothing, so borrowing is quick and easy – and generally cheaper.[3] All that’s required is evidence that the bank will make a profit.

English innovations set the stage for banks to become creators of money across the globe. Parliament passed a few simple laws – the Bank of England Act (1694) and the Promissory Notes Act (1704) – authorizing bank-debt to circulate as money. After that, banks were free to create and destroy money as debt from themselves, rented out at interest.[4] A few years later (1720) ‘bubbles’ (massive over-creations of credit/debt) were causing economic chaos in England and France.[5] It became obvious that the system had to be restrained, or it would ruin those it was designed to benefit. Many restraints, put in place then and subsequently, were removed about thirty years ago in the ‘great deregulation’ of the late 20th century. The situation worsened further as electronic communication networks enabled huge amounts of credit to be created and destroyed at high speed, and bankers to devise new ways of evading regulators.[6]

This is an illustration of relative change in wages, production and financial assets after ‘deregulation’ in one country (Germany):[7]

Why are banks still allowed to create money today?

A long-standing fantasy has it that banks exercise enormous power behind the scenes, manipulating governments and lawmakers to do their bidding. No doubt banks will try to do those things when they feel they have to: but mostly, they don’t need to. When banks create the money supply, governments can borrow quickly and easily, no questions asked: or rather, just one question: ‘Will you be able to repay us, with interest?’ ‘Of course,’ answers the government: ‘Our taxpayers will pay!’.[8] And, as if we need reminding, governments make the laws.

Laws that allow banks to create money also allow many other devices which profit those who chase money and power – as will shortly be revealed. The result is impoverishment and dependence for many, hugely increased power for governments, and vast riches for a few. Our ruling classes today: politicians and plutocrats comfortably in each other’s pockets.

Adam Smith, father of economics, declared ‘All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.’[9] It would be more accurate, perhaps, to observe that while some ruling classes are openly and unrepentantly kleptocratic, backing up their regimes with oppression and murder, some try to act with decency, convincing themselves that their rule is best for the sake of all. In most countries, the ruling class lies somewhere between those extremes. Democracy, meanwhile, is mostly an illusion – giving voters the impression that they are in charge. In reality, voters choose between powerful factions, none of which likes to recognise (let alone discuss) the way money is created, for it is the fountainhead of power.

Laws that allow banks to create money

The way banks create and destroy money is strange, destructive and easy to hide: so much so that banking historian Lloyd Mints wrote it must have been invented by ‘an evil designer of human affairs’.[10] The effects are indeed diabolical, but the basics are simple. Complexity grows out of them like the devouring heads of a hydra.

Laws which allow banks to create money are laws that support the buying and selling of debt. Without such laws, debt from a bank could not pass from one person to another to make payment: it could not become money.[11] Debt would be a private arrangement between borrower and lender, and the State would only help to recover a debt on behalf of the original lender. In the case of banking, that lender would be a customer who makes a deposit. The customer would indeed own a debt from the bank; but that debt could not be transferred to anyone else. It could not become ‘money’.

When debt can be bought and sold, on the other hand, whoever currently owns the debt may summon the force and power of the State to help recover it. Fair enough! you might say – or maybe not; but this simple outcome is not the main problem. The main problem is that once debt can be bought and sold, value can be created where it didn’t exist before.

It is easy to show how this works. Imagine that I, the author, lend you, the reader, a thousand pounds. I no longer have the money; you have it. I won’t have that thousand pounds again until you give it back to me, and then you won’t have it. No value has been created.

If, on the other hand, I lend the government (or a corporation) a thousand pounds, I get a piece of paper – a ‘bond’ – equal in value to what I have lent. This piece of paper is effectively a kind of money, limited to circulation among the wealthy, but tied in value to money proper. I can exchange my bond among other wealthy people for other things of value, including money; and I can use it as collateral for further borrowing.[12] Valuable property has been created for the class of those who are already wealthy.

Bank-money is only slightly more complex. Banks create money by creating two equal-and-opposite debts which add up to nothing: a debt from the borrower to the bank, and a debt from the bank to the borrower.[13] The debt from the bank becomes money.[14] Debt from a bank goes into circulation when the borrower makes a payment. The borrower’s debt stays with him (or her, or it) until it is repaid, whereupon the debt and an equivalent amount of money both disappear.

The debt from the bank is a ‘promise to pay’. When you own money, you own a ‘promise to pay’ from a bank. When you make a payment, ownership of the bank’s ‘promise-to-pay’ moves to someone else – to the person you paid: the bank is now ‘promising to pay’ that person instead of you. All our money consists of promises-to-pay, from commercial banks and central banks.[15]

A bank’s ‘promises-to-pay’ are made valuable by laws; but a bank’s ‘promises-to-pay’ are bogus. Banks never pay their customers anything of value – other than more promises-to-pay. Their promises-to-pay circulate as money and are destroyed again without anything else being paid out. Meanwhile, banks charge interest on their ‘promises to pay’. An economist prepared to notice the uncongenial obvious comments that a bank is ‘in the delightful position of living on the interest of what it owes.’[16]

So, bank-money is created as two equal-and-opposite debts, which will eventually cancel each other out. But on one of the debts, interest is going the wrong way. Like water flowing upstream, interest on the bank’s debt goes to the bank, because corrupt laws have enabled it to become money. The simple injustice of these corrupt laws, designed to profit some over others, has filled the world with inequality and debt – and with insatiable, irresponsible powers.

Because of this advantage granted by law – a license to charge interest on what they owe – banks easily out-compete other forms of money. They share some of the profits from creating and re-creating the money supply with their customers, providing some services free of charge and paying for others (such as storing money long-term). Other forms of money – gold, giro accounts – are pushed out of circulation: what rational person is going to store their money elsewhere, when a bank will pay? Today, cash is under assault (it is a cost to commercial banks).[17]

Laws allowing debt to be bought and sold are nothing new. In various guises, they have been introduced into many civilizations in the past, always with catastrophic results.[18] Before such laws are introduced, prosperity for all is in everyone else’s interest – rulers included. Afterwards, a new order of people is empowered whose business is ruining other people and claiming their assets. One result has always been a corruption of the ruling order.[19]

Creating money is creating value. A national currency is a claim on the work and assets of a nation. The significance of money is not whether it is ‘redeemable’ in gold or silver; it is redeemable in the produce of the nation or ‘currency area’ that uses it. Today, money is created out of virtually nothing: 97% of it is mere numbers, the other three percent is paper and cheap metal. Its creation should be the most scrutinized process in any society, particularly any society that thinks itself ‘democratic’. Credit that circulates as money increases the wealth and power of some at the expense of others.[20] Today’s money system transfers wealth from working people to governments, banks and financial predators. How else could eight individuals come to own more wealth than half the world’s population – that is, more than 3,600,000,000 people?[21]

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This was the first part of Chapter Eight of the book Bank Robbery. Next parts will be published in the next few days.

(You can read the previous chapters here: Chapter 1, Chapter 2, Chapter 3, Chapter 4, Chapter 5, Chapter 7)

[sws_blue_box box_size=”630″] These are the personal views of the author, they don’t necessarily reflect the views of Positive Money; they are intended to stir up the debate. [/sws_blue_box]

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[1] Oxfam report: http://www.oxfam.org.uk/media-centre/press-releases/2017/01/eight-people-own-same-wealth-as-half-the-world

[2] E.g. the Bank of England: http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf The German central bank has only acknowledged this recently (to declare itself not responsible for creating too much money): http://www.bundesbank.de/Redaktion/EN/Topics/2017/2017_04_25_how_money_is_created.html?startpageId=Startseite-EN&startpageAreaId=Teaserbereich&startpageLinkName=2017_04_25_how_money_is_created+397964

[3] An example from early days of the Bank of England. During the recoinage of 1696, the Bank was temporarily short of cash. King William III was wanting to go to war with France. ‘Ministers of State went from shop to shop and office to office’ offering up to 30% interest; but the King was so short of funds that ‘he could not even despatch a certain diplomatic agent, being actually unable to defray his travelling expenses.’ A few months later, the Bank was out of trouble and came to the rescue; ‘bullion was pouring into the King’s coffers, the Allies presented an imposing front in the field, and a decision of the money-market had, not for the last time, exercised a momentous effect upon a military campaign.’ And all at 8% interest! Cambridge Modern History (1908), vol. 5 pp. 267ff: and Sidney Homer, A History of Interest Rates 1977 pp. 149ff.

[4] Richards, R.D. The Early History of Banking in England (1958); Holdsworth. A History of English Law Vol 8 (1925) pp. 177-192; Coquillette, Daniel, The Civilian Writers of the Doctors’ Commons, London (1988).

[5] The Mississippi and South Sea Bubbles, both 1720.

[6] Jonathan McMillan, The End of Banking – Money, Credit and the Digital Revolution (2014). ‘Banking that is not or only lightly regulated is often called shadow banking. Within a few decades, shadow banking became more important than traditional banking.’

[7] Source: Helmut Creutz, The Money Syndrome www.TheMoneySyndrome.org

[8] Here is a paraphrase of a paragraph from a book praising banking and other forms of debt-creation: ‘Negotiable debt is not just a way of oppressing the lower classes. It has other functions too. Firstly, by creating large concentrations of capital, it allows governments to create military power and exercise control over wide areas. Secondly, it involves wealthy people in government where they all profit together. Third, it creates a system of dependence, poor on rich, that ensures social stability. Fourth, when debt itself becomes money, a huge variety of speculative techniques is opened for the wealthy to increase their wealth. Lastly, negotiable debt enables governments to reward their supporters with stable and long-lasting incomes.’ This paragraph, shorn of economese, is from The Origins of Value (2004) p.163.

[9] Wealth of Nations Book III, Chapter IV.

[10] Monetary Policy for a Competitive Society (1950) p. 5.

[11] The legal development of debt negotiability in England culminated in the Promissory Notes Act of 1704. See Chapter 3 of this book.

[12] A fact noted in 1776 by Adam Smith, the ‘godfather of economics’: ‘The security which it [the government] grants to the original creditor is made transferable to any other creditor; and from the universal confidence in the justice of the state, generally sells in the market for more than was originally paid for it. The merchant or moneyed man makes money by lending money to government, and instead of diminishing, increases his trading capital.’ Wealth of Nations, Book V, Chapter 3. Also, Alexander Hamilton in Report on Public Credit (1790): ‘It is a well-known fact, that in countries in which the national debt is properly funded, and an object of established confidence, it answers most of the purposes of money. Transfers of stock or public debt are there equivalent to payments in specie; or in other words, stock, in the principal transactions of business, passes current as specie.’

[13] The Bank of England describes how this works in its Quarterly Bulletin, 2014 Q1. ‘The process by which banks create money is so simple that the mind is repelled’ wrote John Kenneth Galbraith. Money: Whence it came, Where it Went p. 29. He then goes on to describe the process in a rather complex manner! Banks also create money (deposits) when they purchase assets.

[14] The official euphemism for this debt is ‘liabilities’ – which simply means debt.

[15] Again, the Bank of England states this quite clearly in its Quarterly Bulletin, 2014 Q1.

[16] Frank D. Graham, ‘Partial Reserve Money and the 100 Per Cent Proposal’ in The American Economic Review (1936).

[17] Banks rent or buy ‘reserves’ from the central bank or equivalent: cash is part of ‘reserves’.

[18] Other, more ancient examples of negotiable debt are debt slavery and tax farming. With debt slavery, the debtor became the ‘negotiable property’ of the creditor. With tax farming, tax liabilities of citizens were sold off by States to the highest bidder: brutality, corruption and excessive demands were common results. Republican Rome and pre-Revolution France were casualties of tax-farming. Debt-slavery led to social dislocation and catastrophe in many parts of the ancient world.

[19] This has been noted again and again. An example from 1832: ‘The direct tendency of the principles of the Economists is to destroy the intermediate links of society; or, more correctly, to consolidate them in one end of the chain; —to replace the feudal aristocracy, from which Europe has suffered so much, with a monied aristocracy more base in its origin, more revolting in its associations, and more inimical to general freedom and enjoyment.’ From John Wade, The Black Book, An Exposition of Abuses in Church and State, 1832.

[20] For more on this, including how banks are exempt from various rules of law, see Chapter 3.

[21] Oxfam: http://www.oxfam.org.uk/media-centre/press-releases/2017/01/eight-people-own-same-wealth-as-half-the-world