Who should create money and credit?

Shann Turnbull PhD*
Dr. Turnbull is a member of the Ethical Markets Advisory Board.

Three options are considered in this essay as to who should create money and credit. The options are: (i) governments, (ii) banks or (iii) individuals and/or firms who create value.

Today, governments define what is legal tender. However, governments create less than five percent of the money used in modern economies. Banks create more that 95% of the deposits. Customers use bank created deposits as a source of funds to lend to the government by buying its bonds.

The government then taxes its citizens to pay interest on the bonds. This practice is indefensible. It should be the other way around. It should be the government that creates money and lends it to the banks. The government would not then need to tax its citizens and could earn interest from the money lent to the banks.

US Congressman Wright Patman sought to correct the situation by seeking to repeal the Federal Reserve Act as reported at http://www.michaeljournal.org/feddebunked.htm. He was unsuccessful during the 40 years he was a member of the US House of Representatives Committee on Banking and Currency.

If governments created all the money required in an economy in coins and notes there would be no sovereign debt problem. Governments like any body else cannot go broke if they do not borrow money. Governments could also create the money required for their expenses. To control inflation, governments would then need to tax back money not productively invested.

There are some bankers and treasury officials who deny that banks create money out of nothing. It can be a neglected or hidden topic in some economics courses. A customer borrowing money initiates bank credit creation. This can occur when a customer signs a credit card to pay a supplier for goods or services. The bank then makes a bookkeeping entry to create a deposit in the bank account of the supplier.

Harvard economist John Kenneth Galbraith wrote: “The process by which banks create money is so simple that the mind is repelled. Where something so important is involved a deeper mystery seems only decent.”
When banks create money they keep their books balanced. They create both an asset and liability of equal value. The asset is the obligation by its customer to repay the bank for the value of the goods or services purchased. The liability of the bank is the value of the deposit created for the supplier.

Note that no money is transferred in the form of notes or coins. Instead two equal and opposite book entries are created. The customer promises to pay the bank the value of the deposit created by the bank to pay the supplier. The bank charges its customer transaction fees and interest on the credit created and pay little or no interest on the deposit created.

It is by this means that banks make profits on their ability to create credit. Their profit margins would be squeezed if they could only lend notes and coins lent to them by the government. But the banking industry has proved to be too powerful. The US Congress has been incapable of making banks dependent on the government rather than the government being dependent on banks. Bankers have captured democratic interests.

The problem is global . The Governor of the Bank of England, Mervyn King noted that: “Of all the many ways of organizing banking, the worst is the one we have today”

However, cell phone technology could disrupt the power relationship of the banking system . This is because banks have become dependent upon their computer systems. Internet Service Providers (ISPs) are also dependent upon computer systems that can make book entries just like banking computers. In addition Subscriber Identity Module (SIM) in cell phones can store units of value and become a purse. But besides storing value, cell phones can transmit and receive value directly through Bluetooth or other type of wireless connections. Cell phones are widely used in developing countries with few land lines and fewer banks to bypass the banking system.

Cell phone technology now exists for local communities to store, pay and receive various units of account. This provides a way for local communities to determine their own unit value to finance the production and exchange of goods and services. In other words, payments can be made and received in a local unit of value without involving the banking system. Traders and investors would create credit instead of either banks or government.

This is how the Australian economy financed trade in the 18th century before banks existed or precious metals discovered. A customer would write an “I Owe You” (IOU) to pay for loaf of bread and the baker would co-sign the IOU to pay suppliers. The IOU would circulate like a currency note collecting new co-signers to increase its creditability as paper money.
This would not work with digital money. So local credit creation would require someone to insure the integrity of what is accepted as money. Credit insurance would be required and this would require the payment of an insurance fee. In this way locally created money would carry a cost described as “demurrage”.

Cost carrying money was introduced by non-government organizations in Germany in the 1920’s and took off with the Great Depression in a number of European countries and spread to the US . Cost carrying money competed with official money so successfully that the authorities banned it. However, it has now been re-introduced into Germany by Christian Gelleri .
History provides compelling evidence of how privately issued demurrage currencies can obtain the creditability and acceptance. They became highly competitive with what has become fiat funny money not anchored in anything real and established as a monopoly by governments to be legal tender. Cell phone technology now makes demurrage money not just practical but more convenient.
However, the demurrage money created last century, and currently in Germany, is based on legal tender that is not related to anything real, let alone the natural environment. This means that economic values and market forces used to allocate resources are in no way connected to the natural world. This can explain how and why climate change was described as “The biggest market failure the World has ever seen” .

Since the dawn of history money was anchored in produce like grain, salt, tobacco, tea or precious metals. All commodities incurred costs from losses in quality, storage, and insurance. So cost-carrying/demurrage money has been the norm for thousands of years. However modern money is no longer anchored in any thing real so has no carrying cost. This creates an unlevel playing field for investors. Money can become more attractive to hold that most other real assets that depreciate over time.

Compounding interest can make the rich richer while its owners make no contribution to society. This explains why the financial sector has grown out of proportion to real world activities it is suppose to service like agriculture, manufacturing, building and the supply and distribution of goods and non-financial services. Demurrage money reduces the size of the financial sector, wealth inequality, and inequities.

In considering who should create money and credit the basis of its creation needs also to be considered. The above discussion identified the need for any alternative currency to have a demurrage charge and be connected with the natural environment. There are many possibilities to consider for making a connection. The most promising is the retail value of renewable energy measured in Kilo-Watt-Hours (green kWh). Such a unit of value could provide investors confidence that long term contracts defined in green kWh would not diminish in value over time. They might well increase their relative purchasing power to reverse inflation.

No central bank would be required to maintain the value of green money. Nor would the amount of money and credit be limited to the production of green kWh. Traders and investors would create as much credit as they could find insurance. Their invoices and contracts would be defined by reference to local green kWh. In this way relative prices would be defined by a local renewable service of nature. Resource allocation by market forces would then be firmly connected to the local environmental capacity to sustain society with renewable power.

As reported by Goherty & Zitoli power consumption per person correlates closely for many countries with the United Nations Human Development index. By anchoring economic values in a renewable service of the local environment, market forces are created to distribute the footprint of humanity on the planet according to its carrying capacity. By defining economic values in terms of green money, renewable energy becomes more competitive with burning carbon . This in turn reduces the need for carbon taxing and/or trading.

In reviewing the three options of who should create money and credit in society, the most counterproductive is the current system in which private banks are the dominant source. Credit creation by a non-politically controlled unit of government provides a more logical and efficient alternative that the current system. But of course it depends upon how it is established in practice. Any national authority that creates credit, like a central bank, could represent but a specialized form of central planning. This has not had a good press. It would deny regional differences in the demand for credit and money or recognize the carrying capacity of the natural environment.

There are ways in which decentralized banking could be introduced on a national basis. Decentralization creates resiliency and political independence. The idea of the volume of money and credit being determined on a local basis by those who create value has appeal.

Green money could become a global unit of account but with a local unit of value. The need for establishing a local unit of value has been compelling argued by Jane Jacobs in a way not considered by Mundell . So while it might be appropriate for local merchants and investors to create money and credit there could also be need for some government oversight and/or involvement. The Green Money Working Group , that includes the author, is currently considering the most appropriate arrangements.
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