‘’A quote from the Economic Reform Club’s (now part of the ERC) series of papers ‘The Banks and the War’, IIIrd Paper, published in 1943, put the position clearly, describing the situation where Government does not have full control of credit:

“…it is apparent that no new (credit) money can be created except through the banking system, which issues it as an interest-bearing debt owed to them by the Nation.

The result of this has been the piling up of an enormous burden of debt on which succeeding generations of our people will have to pay huge sums each year in the form of interest and Sinking Fund.

As the banking system in creating this money is merely using the Nation’s credit by liquifying it, the right of the Banks to treat such created credits as a loan and to receive payment of interest thereon is unjustifiable, and it is therefore submitted most strongly that they are not entitled to anything more than an agreed fee based on the extra work devolving upon them by the handling of these funds, in a manner similar to that in which the Bank of England is compensated for the management of the National Debt and of the Fiduciary Issue.”

The power to issue bank notes has provided for the Government. since 1945, about £19,OOO million of revenue, of which £9,300 million arises from the increase in notes issued, and £9,800 million from the interest saved on government securities held as backing for the issue.

In 1980, the Government borrowed £11,154 million and spent £8,661 million paying interest on previous debts. The interest payments represented 10.6% of Central Government current expenditure.

The power of the banks to increase credit has meant that the Government has foregone revenue, since 1945, of over£30,000 million, of which £14,OOO million arises from the increase in credit , and £17,OOO million from the interest the Government could have earned if the credit had been issued as notes.

Under the present system the Government could have sold direct to the Bank of England Issue Department government stock and received notes in exchange. Interest paid on this stock would have gone to the Issue Department and in turn been credited back to the Treasury.

The effect on total money supply and consequently on inflation would have been nil.’’

As the debate rages as to how to fix our debt-ridden economy, a novel idea is attracting interest. The problem with our economy is not how to manage bubbles of credit, the problem is credit itself. Most economists are now debating how credit bubbles form and burst and what can be done to manage their impact on the economy. But it is now being pointed out that a credit-based monetary system is inherently unstable – major bubbles and recessions will simply continue despite the best efforts of regulators.

Why so? The reason is that credit is a much more unstable kind of money than cash. Cash, once created by our government, simply circulates around and around permanently. Even tatty notes and coins are replaced by freshly minted ones. Credit is different, entering circulation when it is created by banks and loaned out to customers and leaving circulation when customers repay their loan. Credit creation (by lending) and credit destruction (by repayments) need to be in balance for a stable supply of credit. A boom in lending creates a bubble of new credit that drives up asset prices, sometimes to ludicrous levels. A bust occurs when lending slows and asset prices fall, sometimes sharply if bank losses put the brakes on credit creation.

This ‘credit cycle’ of boom and bust is unstable by its nature and major busts now threaten to collapse our entire economy. Tinkering with the system through regulation doesn’t change its fundamental instability. The only solution for stable economic growth is to reform the monetary system to one based on a government issued permanent money supply. Monetary reformers explain that cash is a form of permanent money, but that cash has lost out to credit over the past century.

How did credit take over our monetary system? In the 1950s cash and credit were circulating in about equal amounts in the UK. But by 2007, cash was less than 3% of the money supply while credit had exploded to more than 97%. The rise of credit is partly due to technology; people prefer exchanging money via computer accounts than via notes and coins. But it is also due to the attractive profits that banks make on that mountain of credit.

Monetary reformers propose that the government takes responsibility for supplying all money into circulation as cash or electronic cash in computer accounts. The creation of credit by banks would no longer be necessary and banks would be required go back to their old business of taking deposits and lending them out without creating credit – the so called ‘100% reserve’ solution advocated by Irving Fisher and other economists. The elimination of credit creation would bring stability and gradually reduce the amount of debt in our economy, alleviating the burdens of mortgage repayments and business debt servicing that currently lead to a chronic lack of purchasing power and high unemployment. Another benefit of a government-issued money supply is that it provides the government with a major source of income, so that citizens can pay much less tax. Finally, inflation can be much better controlled, with the government able to increase the money supply by a defined amount each year, for example: by 3% of the total money supply, so that prices remain stable. This common sense monetary reform takes back the power to issue money from the banks and restores it to government, where it rightfully belongs.

So why not do it? The objections to such a reform are usually of four kinds. The first is the reluctance to change the status quo. However, the transition to a new monetary system would be surprisingly simple, requiring a small change in bank accounting rules to stop credit creation and for the central bank to be fully nationalised as an independent arm of government that would be responsible for creating new money to meet inflation targets and transfering it to the treasury.

The second objection to the reform is that it might make borrowing money more difficult. Without the ability to create money and lend it, banks could only lend money that already exists. However, if necessary, the government could easily step in to lend out newly created money through a national bank. Interest earned on money lent would be another source of income for the government, further easing the burden on taxpayers. In addition, the reformers point out that as the supply of government issued permanent money rises and bank issued credit falls, money will become much easier to save. This allows individuals and businesses to invest out of their own savings rather than always having to borrow from banks.

The third objection to reform is that government cannot be trusted to create money. But this stands in contrast to the fact that we do trust the government to control the military, police, courts, heathcare, education and wide variety of other crucial elements of society. So why can’t governments create money? Indeed, most people believe that the government is already solely responsible for creating money. At least government is accountable to the people, unlike private banks that are unaccountable corporations motivated by profit rather than by social purpose.

The fourth objection to reform is concern over its effects internationally. Yet history clearly shows us the effects of a steady supply of money, debt-free, into an economy. This occurs every time a nation has a sustained export surplus, such as Germany and Japan after world war II and more recently other asian countries such as China. Indeed, export-led economic growth is now the leading economic growth model in developing countries. However, it is not possible for all countries to have an export surplus, as some countries must have an import surplus. The good news is that monetary reform provides nations with a supply of permanent money, debt-free, just like an export surplus does. This nation can even act as a net importer of goods from other countries, helping alleviate the global export battle and promoting global growth.

Reformers say the time is now ripe for change. Rather than endless attempts to prop up our wobbly credit-based monetary system, let’s reform our system so that it can provide stable economic growth for the long term future.

“If you are claiming it is lack of access to credit I’m intrigued that you think this is the total problem? And then how making that credit more available by the Government would solve what is at the root. I’m not saying that finance is not a problem and does not need a reform. I am saying it is a small part of a far more monstrous wrong.”

In the contrary – it’s not a lack of credit that’s the problem. It’s a lack of debt-free money. We certainly don’t need more credit to add to the already unsustainable levels of debt. We need debt-free money that is spent into the economy and acts as a stimulus on the economy, rather than a drag. (A debt-based stimulus actually slow the economy down in the longer-term, as all that money needs to be diverted from spending and repaid to the lenders).

I think you’re referring to land taxation reform. This is not an area in which I’ve studied at length and therefore not something I will comment on. However, from a strategic point of view, trying to call for a wholesale reform of the tax system at the same time as calling for reform of the banking system is a good way to ensure that no-one will listen to you. There are various reforms that would improve the economy and living standards, but the mistake that most groups make (and the reason why they make very little progress) is that they ask for everything at once, rather than focusing on one achievable reform at once. Hence, land taxation reform is out of my area of expertise and therefore not something that I would be in a position to make recommendations on.

However, I strongly disagree with you that this reform will increase inequality – the more likely result is that it will do just the opposite.

This is a difficult one to understand without seeing the process visually, and I will try to put something together in the future to explain it. However, here’s a simple demonstration.

1. A bank makes a loan of £100,000.
2. The borrower (loan recipient) spends the money with companies that use other banks
3. To fund the borrower’s purchases, the bank has to transfer £100,000 of the money in it’s central bank operational account to the operational accounts of other banks.
4. Each month, the borrower receives his salary (imagine it’s £2000 per month) from his employer. For the money to land in the borrower’s account, the employer’s bank must transfer £2000 from their operational account at the central bank to the operation account of the borrower’s bank.
5. As the bank takes its repayments for the loan, it reduces the balance outstanding on the loan, and at the same reduce the balance of the customer’s current account (when they ‘take the money out’ for the loan repayments). This is essentially an accounting process – they reduce the value of the liabilities and assets side of the balance sheet at the same time. If you only look at this, it appears that the bank is ‘destroying’ the number money on its bank accounts.
6. However, by the time the bank has received its full £200,000 (loan principal plus interest), it has cancelled out the £100,000 liability (the original loan funds, which were ‘placed’ in the borrower’s current account before being spent).
7. Consequently, the bank now has £200,000 of ‘spare’ money in its operational account at the central bank. As this money is excess reserves, the bank will do everything they can to lend it out as quickly as possible.

In other words, Rowbotham is essentially right, once you understand the full system (which takes a while). Looking at the bank balance sheets alone, it can seem like the money is being destroyed when it the loan is repaid. However, in reality, the money repaid to the bank is not destroyed – it becomes the property of the bank and will be used again to fund further loans.

As I mentioned, this is easier to understand visually, and I’ll try to put something together in the near future to explain it.

One side effect of this is that the level of debt is more of less a one-way process. If we all suddenly cut back on spending in order to pay down our loans, banks would end up with huge amounts of ‘excess reserve’. Excess reserves are useless to the bank – they only make money if the funds are out on loan. Consequently, to encourage more borrowers they will simply end up dropping the interest rate as low as it needs to go. Since everyone is cutting back on spending in order to clear their debt, the economy will be in a severe state of recession, and consequently there will be people who need to get into further debt due to lack of income. In other words, the increase in debt is a one-way process.

Following on from this – the banks have of late being building up their reserve (hence all the talk about ‘banks refusing to lend’). However, once they feel that things are back to normal, and they forget what just happened, they will start trying to lend these excess reserves again. Expect a new credit book kicking off in a the next few years, followed by a crash even worse than the one we’ve just had.

Just watched the short video from Chicago in which you say Rowbothams book got you on this track. My story is jhust about the same.

There is a few pages in “the grip of debt” that needs clarification. I am curious to hear how you interpret Michaels lines about the issue of “banks creating money for themselves” on pages 28-30.

Some people in a discussion group claim Michael is wrong..and I am having a hard time defending him as I dont know the exact magic behind the way banks do their book-keeping when a loan is paid in full.

Here is a few lines from the groups discussion:

“While it is true that the inherent deficiency of purchasing power revealed by Douglas’s analysis of the price-system results in increasingly un-repayable community debt which ultimately becomes incorporated in the form of permanent fixed government debt, this does not appear to be what Michael Rowbotham seems to be discussing. He is saying that money used to repay bank loans in not actually cancelled but is held in permanent account to the credit of the bank. Does he mean the the money equivalent of all bank loans issued since institution of the modern banking system is somehow represented in some gigantic account within the banking system? This would appear to be quite ludicrous. Michael’s book “The Grip of Death” (1998) had much good content.. However, his claim that money used to repay bank loans is never cancelled seemed to be a strange anomaly. ”

Please comment.

rgds

Lars

I’m delighted you have reinforced that we are nowhere near limits to most natural resources yet. Though you do mention we maybe on some. What are these? I can see none!

If labour is abundant, capital is abundant, producers want to make things still, consumers still desire those things and want to buy them, what then is it that is stopping us ?

If you are claiming it is lack of access to credit I’m intrigued that you think this is the total problem? And then how making that credit more available by the Government would solve what is at the root. I’m not saying that finance is not a problem and does not need a reform. I am saying it is a small part of a far more monstrous wrong.

If you are an economist you must understand David Ricardo’s law of rent. A natural law that applies in all times and all places. And the more production rises, the greater that law applies.

This says that whatever is available beyond the margin of production ALWAYS goes to rent, when land is owned privately and exclusively. And as production rises,the proportion that goes to rent will rise and the proportion going to wages and interest will fall. This is known as “The Wedge”. The divide between rich and poor, non producer and producer, as you are seeing in South America. But it is visible even in Western democracies. Have you not been looking?

The only things that can check this are increases in the ability of the economy to produce greater wealth either through population growth, improved technology and trading practices and better government and social structures.

So making finance work better would certainly then improve production, allow wages and interest to catch up with rent for a time. Until the rent is irresistibly raised to take the new gain and competition for labour and capital once again reduces returns to the other factors.

The wedge will have been driven home yet further. Concentrations of assets in land and capital will become ever greater and the folks you talk about living on the margins of subsistence will grow to new levels

All this is highly predictable. While the institution of private property in land remains. To avoid these new heights of injustice, your proposals might call for the integral approach to include the end of the current system of land ownership, through the collection of the economic rent in land, currently worth about 6 times the profits of banks and seigniorage forgone by governments .

Safe travel