Money for Nothing

Our economy is probably undergoing the most serious crisis since the founding of the state. People are bewildered and angry at how this has happened. There is a feeling that the banks are responsible for this situation, a sense of betrayal and a lack of understanding as to how governments, regulators and banks allowed this financial collapse to occur. There is a strong possibility of civil unrest. The fraud and mismanagement at Anglo Irish Bank may provide us with at least somebody to blame; a few friends of the government might have to be sacrificed in the “public interest”. While this may or may not be sufficient to keep public order, the ongoing disaster continues to unfold. But what surprises me is that I see little or no debate taking place about the fundamental issue: how should we redesign the banking and financial industry to revive our economy and ensure that nothing like this can ever happen again.

The debate about how we get out of this crisis seems to be limited to a small number of issues: how much money we need to donate to the banks (recapitalisation and guarantees) in order to get them lending again and therefore get the economy moving again. Can we drastically cut public spending and increase taxes sufficiently to avoid the IMF being called in to do it for us? Do we have to (temporarily) nationalise the major banks in order to keep them alive?

In almost all the debate, there is an unquestioned assumption that we must save the banks, at whatever cost, by committing vast, unknown amounts of money to them. In effect, what politicians and economists seem to be saying to the financial industry is, “Don’t worry, we’ll take care of the bill. When you make huge profits you are entitled to them, but when you mess up, we’ll bail you out. You take the winnings, we take the losses, but that’s just the way it’s meant to be. We cannot let you go under because you are too important and too big to fail. We’ll do whatever it takes, accept whatever pain we must, in order to nurse you back to health again. Then hopefully you will start lending to us again”.

This ‘save the banks at all costs’ approach seems a bit strange to me. Nobody, including politicians, economists, commentators, and even trade unions, seems to be addressing questions such as: Why are we so dependent on the banks; why do we need to give them money so that they will then lend it back to us; why can’t we solve this problem in some other way? My thinking might be a bit innocent and simplistic, but many other people have similar questions. Not being able to find satisfactory answers in the media, and frustrated by my lack of knowledge when reading the financial news, I decided to start investigating the subject. And what did I learn?

I learned that banks create money out of nothing. Banks don’t have the money they lend to us in the first place. To the average person this seems absurd and unbelievable. How could this be? Surely banks are places where we put our money which they then lend out to other people? Not quite. Banks actually are legally empowered to create money out of nothing and to charge us interest for the privilege. When somebody gets a loan from a bank, the bank literally creates the money out of thin air. The bank doesn’t have the money, but at the stroke of a pen, or a few computer keystrokes, new money has been created. The only value involved in the process is that provided by the person who takes out the loan, in the form of a promise to pay, or the collateral they provide in case they default on payment. I won’t go into the details of money creation, because they are complex. This complexity suits banks very well, because it hides the facts from unsuspecting citizens, who might start asking some awkward questions if they knew the truth. And the vast majority of the “money” in circulation, over 95%, is actually credit created from nothing by the banks!

I found it difficult to take in the fact that banks create money for nothing – and that governments allow them to do this. I felt I didn’t understand or was missing something. So I read more. Then, gradually, I realised that the reason I found it difficult to understand was that my brain just didn’t want to accept it. Economist John Kenneth Galbraith said, "The process by which banks create money is so simple the mind is repelled."

Most people think of money as something concrete. One Euro is a coin issued by the Central Bank that allows me to buy something. Fifty Euros allows me to buy more things. I may ‘have’ five hundred Euros in the bank, which I can exchange for notes in an ATM machine, or use to pay for something with my laser card. It is surely impossible to create something concrete out of thin air! But when we accept that money is abstract, ephemeral - an idea - it becomes possible to accept that it can come from nowhere. At one time money was based on some kind of commodity, such as gold or silver, and paper notes were exchangeable for an amount of that commodity. But these days money is created by government decree, by fiat. The money we have in our pockets is technically called ‘fiat money’. It is an abstract notion that everybody accepts in order to exchange goods and services. Once we all agree on it, or don’t question it, then we can use it successfully to conduct our business. Fiat money is an advance over commodity-based money so I’m not advocating that we return to carrying gold or silver coins.

The other difficulty with accepting intellectually that banks create money for nothing relates to the question why governments would allow them to do this. To answer this requires some knowledge of monetary history, but in short the process was gradual and required quite a bit of secrecy, corruption and coercion. The battle for the ‘money power’ was won in England in 1694 with the creation of the privately owned Bank of England, and in the U.S. in 1913 with the creation of the privately owned Federal Reserve System. And the money power is an awesome power indeed. "Permit me to issue and control the money of a nation, and I care not who makes its laws", said banker Mayer Amschel Rothschild. Whoever controls the money, largely controls the government, whatever the voters may think.

I always thought that the government, the Central Bank or the ECB, created money. I wonder how many people know that most money is created from nothing by private banks. And I wonder how many people know that when the government wants to create new money it borrows it from private sources that charge interest, instead of the government just creating money itself and cutting out the middleman – and the interest. And I then I wonder also why most people don’t know these things.

Private Banking is really a legalised Ponzi scheme. A Ponzi scheme is a pyramid scheme in which earlier investors are paid with the money of later investors rather than from real profits. Bernie Madoff (who was recently in the news for defrauding investors to the tune of €50 billion) will most likely face a lengthy stretch in prison. But a bank operates on similar principles to Madoff’s scam. It doesn’t have sufficient money to cover withdrawals of deposits. It loans out multiples of the deposits it receives and it gets away with this through people believing that the bank really has the money and through the legal protection of the government. If there is a “run” on the bank, whereby everybody tries to take their money out at the same time, it won’t have the money to pay depositors. Fortunately for depositors, and unfortunately for taxpayers, Central Banks usually step in with government funds to rescue the bank faced with a run. Now banks do indeed hold some ‘real’ money, but only a small percentage (the fractional reserve) of the amount deposited by their customers.

But government bailouts of banks only work if the government has, or can borrow, sufficient funds to meet the banks’ debts. And the current situation is that the total liabilities of the global financial system (and I include here the various financial institutions such as investment banks, insurers and hedge funds) far exceed the entire domestic product of all the countries in the world. This seems logically impossible, but it is possible due to banks and financial institutions betting with money they don’t have. (I will explain hedge funds, derivatives, Credit Default Swaps, and other esoteric terms, which are behind the collapse of the worldwide banking system, in a separate article). Britain, for example, has already committed more than it’s own total GDP in its bank bailouts to date, and there is no indication that this will be enough. The system is broken. The sooner we wake up to this unpleasant fact, the sooner we can begin to create something that works.

Now this debt-based money-creating situation leads to very undesirable consequences:

We are perpetually indebted to private interests. With the current system, we can never, ever, get out of debt. Some of us can, but as a whole the system requires ever increasing amounts of debt in order to function. There simply isn’t enough money created by the system to pay off all the principal plus interest. If we did manage somehow to pay off all our debt, plus all the interest, there would be no money available in the economy! Again, difficult for the average person to accept, but that’s how it works. With our system, no debt equals no money, because banks create 'money' by creating debt! So in order to keep the economy going we are forced to continually borrow more and more money.

Private debt-based money-creation ensures that wealth is relentlessly transferred from the majority to a small minority, mostly without peoples’ knowledge. The financial industry actually produces little or nothing of value to humanity. Making money from money drains resources from the people who actually create value. Goethe summed it up best when he said, “none are more enslaved than those who falsely believe they are free”.

The system leads to a recurring cycle of credit growth (bubble) and credit crunch (recession/depression), which wreaks havoc on economies, businesses and people’s lives. And perhaps most crucially, the interest payable in long-term loans such as government debt is increasing exponentially (and must increase exponentially due to the nature of compound interest). This means that we need ever increasing production and use of natural resources just to service the debt/interest burden, creating an unsustainable cycle that will, if brought to its logical conclusion, eventually destroy our planet as a habitat and bring the creditors to ruin in the process.

The financial system has malfunctioned because of an insatiable demand for short-term gains accompanied by an irrational belief that the bubble would never burst. The bubble took the form of risky loans backed by ‘securities’ that were illusory and betting with money that didn’t exist! As long as everybody played the game and believed that the party would go on forever then the bubble could continue to expand. But reality caught up with the illusion when ordinary people (the ones who create real value rather than making money from money) couldn’t make their loan payments. Suddenly the party was over and the banks and financial institutions knew it. They knew that they were ‘leveraged’ (i.e. had borrowed in order to bet) beyond their ability to pay on their bets so trust broke down between them, threatening to bring down the financial institutions one by one like a row of dominos.

The banks are now desperately seeking to remain solvent and therefore hoarding money, resulting in the credit crunch. But since over 95% of the ‘money’ supply in the economy is in the form of bank-created credit there is a huge shortage of money in the economy. This is what is causing the worldwide economic depression.

What most commentators and politicians are debating is the best way to get this insane and inequitable system working again! I have to ask why should we pay to restore the banks to health, putting ourselves into more debt in the process, in order to create another bubble when the credit crunch recession ends. Why are we not debating alternatives to this system that only benefits a small minority while it impoverishes the masses and destroys the planet? I have to ask myself if our politicians, of all persuasions, actually understand what is going on. If they don’t understand, then why are economists not telling them? Do the economists understand - or do they even wish to? If our politicians do understand, why are they not openly questioning the system and looking at alternatives? Recapitalisation, temporary nationalisation, blank cheque guarantees, and proper regulation might just get the system going again, but nobody really knows if it will work or if we are approaching a limit to the exponential growth in debt.

Where are the politicians and commentators who are asking questions about where we want to move collectively as society? Why are we not debating whether we want to continue to worship growth and profit (symbolised by the financial industry) above all else? Do we want our economic future to be in the hands of a small number of bankers, investors and ‘the market’ to the exclusion of all other concerns? Are we happy that we have lost our sovereignty to the extent that many recent political debates have been about whether the market, investors or rating agencies (privately owned, publicly unaccountable concerns) have confidence in us? Do we need to reach a point of total collapse before we take a look at our priorities?

I believe the time has come for opening up this debate. This crisis may lead to ruin for many people, followed by a painful recovery and repeat of the cycle. Or it may provide us with the opportunity to redesign our financial system in ways that benefit the greatest number of people, including the indebted people of the “third world”, in ways that protect quality of life and our environment for future generations. Are we willing to look at our own priorities as citizens and to question our values? What measures of well being do we use? Is money the measure that we value most? We need courage, honesty, intelligence and the willingness to challenge current models and belief systems in order to engage with these issues. But if we want to free ourselves to create a better, more just world for our children then we must act sooner rather than later. The decision is ours.