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Is Credit Creation a Public Good or a Private Evil?

I have been painstakingly following the events of the Greek sovereign debt crisis, and the article yesterday entitled #ThisIsACoup: Greece bailout demands spark social media backlash against Germany struck a deep chord within me as the issue of our own sovereign debt crisis and our handling of it has been on the forefront of my mind since then. Several twitter comments were posted in the article that stirred up a hornets’ nest of loathing against the private banking system. Here are a few that reverberates with me:

“Give me control of a nation’s money and I care not who makes it’s laws” – Mayer Amschel Bauer Rothschild

“There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt.” – John Adams (1735-1826)

Stripping a country of its assets to sell them to financial industry = modern colonialism.

Birthplace of democracy, to deathbed of democracy. Now arise, zombie creditocracy

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Although the dust has not settled yet and we do not know what will happen next, a reading of the blog articles by the previous Finance Minister Yanis Varoufakis has left me asking myself, “Are there lessons to be learnt for us in our region?” especially given we have an economic and monetary union similar to that of the European Union. In his latest posting today ‘On the Euro Summit’s Statement on Greece: First thoughts’, he wrote:

“Back in 1971 Nick Kaldor, the noted Cambridge economist, had warned that forging monetary union before a political union was possible would lead not only to a failed monetary union but also to the deconstruction of the European political project. Later on, in 1999, German-British sociologist Ralf Dahrendorf also warned that economic and monetary union would split rather than unite Europe. All these years I hoped that they were wrong. Now, the powers that be in Brussels, in Berlin and in Frankfurt have conspired to prove them right.”

What is very topical in our Federation and the OECS as a whole is a New Banking Act proposed by the Eastern Caribbean Central Bank. The St. Kitts-Nevis Proposed Banking Act, 2015 is now available for feedback by the general public. The Antiguan Observer has already written several articles on the issues and concerns raised and have provided a lot of food for thought. (Please see: Proposed ECCB legislation dissected by financial experts; SIR DWIGHT RESPONDS TO BANKING ACT; Belling the banking cat; and The nature of leadership.

Although we are taking steps to strengthen our economic and monetary union and protect the banking industry and its depositors, I am left wondering if the events transpiring in Greece now has relevance for us in the region in terms also of our sovereignty and democracy? It is true that in our region, politicians have taken advantage of weak banking regulations to increase public debt to unsustainable levels. It is also true that when we defaulted and had to ask the lender of last resort to intervene, we were successful in reducing our debt-to-GDP ratio by “financializing” our public lands and privatising our public citizenship. Also given our “success” in debt reduction via these two types of financial instruments, many of our sister islands are following suite. Notwithstanding, I am left to ask one question as it pertains to the Banking Act: By strengthening the Banking Laws to give the ECCB powers to remove managers and/or directors as may deemed necessary, would the necessity of doing so be in the best interest of the creditors, or the communities the banks were commissioned to serve? In other words, just like what we are seeing in Greece, if push comes to shove, is the financial health of the banking system going to be given priority over the health and well-being of the citizens, and should the many among us be punished for the irresponsible mismanagement of the few who were elected or appointed to serve on our behalf?

What is not being addressed in the Greek crisis and in our Banking Act is a fundamental misconception in our money creation system. Most of us think that it is the Central Bank or the Government that creates money, and that commercial banks loan out depositors money with interest. This is farthest from the truth. As explained by the Bank of England in their bulletin Money creation in the modern economy:

“In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.

The reality of how money is created today differs from the description found in some economics textbooks:
• Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
• In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.

Although commercial banks create money through lending, they cannot do so freely without limit. Banks are limited in how much they can lend if they are to remain profitable in a competitive banking system. Prudential regulation also acts as a constraint on banks’ activities in order to maintain the resilience of the financial system. And the households and companies who receive the money created by new lending may take actions that affect the stock of money — they could quickly ‘destroy’ money by using it to repay their existing debt, for instance.”

Professor’s Richard Werner’s paper deals with this issue head-on in his recent paper: Can banks individually create money out of nothing? — The theories and the empirical evidence. where it “establishes for the first time empirically that banks individually create money out of nothing.”

With regards to the implications for bank regulation and monetary reform, this is what he had to say:

5.4.3. Implications for bank regulation

The implications are far-reaching for bank regulation and the design of official policies. As mentioned in the Introduction, modern national and international banking regulation is predicated on the assumption that the financial intermediation theory is correct. Since in fact banks are able to create money out of nothing, imposing higher capital requirements on banks will not necessarily enable the prevention of boom–bust cycles and banking crises, since even with higher capital requirements, banks could still continue to expand the money supply, thereby fuelling asset prices, whereby some of this newly created money can be used to increase bank capital. Based on the recognition of this, some economists have argued for more direct intervention by the central bank in the credit market, for instance via quantitative credit guidance ( Werner, 2002, Werner, 2003b and Werner, 2005).

5.4.4. Monetary reform

The Bank of England, 2014a and Bank of England, 2014b recent intervention has triggered a public debate about whether the privilege of banks to create money should in fact be revoked (Wolf, 2014). The reality of banks as creators of the money supply does raise the question of the ideal type of monetary system. Much research is needed on this account. Among the many different monetary system designs tried over the past 5000 years, very few have met the requirement for a fair, effective, accountable, stable, sustainable and democratic creation and allocation of money. The view of the author, based on more than twenty-three years of research on this topic, is that it is the safest bet to ensure that the awesome power to create money is returned directly to those to whom it belongs: ordinary people, not technocrats. This can be ensured by the introduction of a network of small, not-for-profit local banks across the nation. Most countries do not currently possess such a system. However, it is at the heart of the successful German economic performance in the past 200 years. It is the very Raiffeisen, Volksbank or Sparkasse banks – the smaller the better – that were helpful in the implementation of this empirical study that should serve as the role model for future policies concerning our monetary system. In addition, one can complement such local public bank money with money issued by local authorities that is accepted to pay local taxes, namely a local public money that has not come about by creating debt, but that is created for services rendered to local authorities or the community. Both forms of local money creation together would create a decentralised and more accountable monetary system that should perform better (based on the empirical evidence from Germany) than the unholy alliance of central banks and big banks, which have done much to create unsustainable asset bubbles and banking crises (Werner, 2013a and Werner, 2013b).

Even Pope Francis has been involved in this debate: As explained in an excellent article by Ellen Brown entitled: A Revolutionary Pope Calls for Rethinking the Outdated Criteria That Rule the World, she quotes him saying in his recent encyclical:

“Today, in view of the common good, there is urgent need for politics and economics to enter into a frank dialogue in the service of life, especially human life. Saving banks at any cost, making the public pay the price, forgoing a firm commitment to reviewing and reforming the entire system, only reaffirms the absolute power of a financial system, a power which has no future and will only give rise to new crises after a slow, costly and only apparent recovery. The financial crisis of 2007-08 provided an opportunity to develop a new economy, more attentive to ethical principles, and new ways of regulating speculative financial practices and virtual wealth. But the response to the crisis did not include rethinking the outdated criteria which continue to rule the world.”

I will leave you with the conclusion of her article that helps to answer the entitled question that motivated this blog tonight:

“…We have bought into this financialization scheme based on a faulty economic model, in which we have allowed money to be created privately by banks and lent to governments and people at interest. The vast majority of the circulating money supply is now created by private banks in this way, as the Bank of England recently acknowledged.

Meanwhile, we live on a planet that holds the promise of abundance for all. Mechanization and computerization have streamlined production to the point that, if the work week and corporate profits were divided equitably, we could be living lives of ease, with our basic needs fulfilled and plenty of leisure to pursue the interests we find rewarding. We could, like St. Francis, be living like the lilies of the field. The workers and materials are available to build the infrastructure we need, provide the education our children need, provide the care the sick and elderly need. Inventions are waiting in the wings that could clean up our toxic environment, save the oceans, recycle waste, and convert sun, wind and perhaps even zero-point energy into usable energy sources.

The holdup is in finding the funding for these inventions. Our politicians tell us “we don’t have the money.” Yet China and some other Asian countries are powering ahead with this sort of sustainable development. Where have they found the money?

The answer is that they simply issue it. What private banks do in Western countries, publicly-owned and -controlled banks do in many Asian countries. Their governments have taken control of the engines of credit – the banks – and operated them for the benefit of the public and their own economies.

What blocks Western economies from pursuing that course is a dubious economic theory called “monetarism.” It is based on the premise that “inflation is always and everywhere a monetary phenomenon,” and that the chief cause of inflation is money “created out of thin air” by governments. In the 1970s, the Basel Committee discouraged governments from issuing money themselves or borrowing from their own central banks which issued it. Instead they were to borrow from “the market,” which generally meant borrowing from private banks. Overlooked was the fact, recently acknowledged by the Bank of England, that the money borrowed from banks is also created out of thin air. The difference is that bank-created money originates as a debt and comes with a hefty private interest charge attached.

We can break free from this exploitative system by returning the power to create money to governments and the people they represent.”

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