Policies to manage and eventually stop money creation

2 posts / 0 new
Last post
retnap's picture
retnap
Status: Member (Offline)
Joined: Dec 30 2009
Posts: 2
Policies to manage and eventually stop money creation

Feedback questions on some of the Crash Course assumptions.

 

I live in South Africa and am busy working through the crash course a second time with my children, who are students.

During my student hood during the 1970s we discovered Marx’s analysis of capitalism, which is a particular interpretation of classical economic theory that money reflects the value of the labour necessary for the production of goods and services in the real economy.

Between the fall of the Berlin Wall and the Crash of 2007/8 classical economic analyses of money (and critiques of capitalism) were seen as outmoded and money was viewed as sui-generis, that is self-creating without any necessary basis in the real economy. This ideology helps to explain how the party in the Pinochioland of global finance and investment could have gone on for as long as it did before the overvalued shares and assets were radically devalued through the destruction of value that was triggered off by the sub-prime crisis.  

With neo-classical theory discredited global capitalism is on the edge of a significant credibility/legitimation crisis. In this context people have started to cast around for concepts that can assist in explaining the changing economic realities happening at sometimes bewildering speed. The Crash Course is a very useful educative tool that suits the purpose of self-discovery of knowledge  about social reality and helps us to understand how our lives are dominated by the tension between money creation and value destruction which defines finance capital.  By providing a portal for feedback Chris is also giving us an opportunity to publicly share our questions and jointly to develop our understanding.

I have specific comments about some of the detail of the Crash Course content which I think could be tightened up – alternatively I might not have fully grasped the meaning of these insights. I would appreciate a response from either Chris or anyone out there to my comments, if there are disagreements or any other insights about the detail of the money creation process.  

The Crash Course identified two cycles during which money is created, effectively out of “nothing”:   1) Reserve bank creation of money, in which there is no corresponding liability entry but just an entry on the asset side of the balance sheet; and, 2) commercial (wholesale or retail) bank created money, in which because a bank only has to hold a small fraction of its deposits it can lend most of these out thereby effectively multiplying the supply of money; the difference with the reserve bank creation is that with bank created money loans (assets) are always balanced by liabilities (deposits).

Fractional reserve banking is possible because depositors (savers) contract to put their money in the bank for a given term (i.e. three, five, ten, twenty years), enabling the bank to lend this money during the term at a higher interest that it has agreed to pay on the deposits. I think that the example in the Crash Course of $10 000 dollars being “created” by banks out of an initial $1 000 dollars deposit is flawed because it assumes that each borrower will save/deposit his/her borrowed amount in a bank, whereas borrowers in reality will either consume and/or invest it (i.e. as in direct investment in plant and equipment) and only save the discretionary income that they earn. So the multiplication effect in this model is in all likelihood quite limited.  In a high inflation environment (like in South Africa) there is a low savings propensity, depleting the amount of deposits still further. Even in the “low” inflation environments of the US and Europe, as Chris points out, there is a long term significant inflation (which has been with us since 1945 and has accelerated from the early 1970s). In the US there is also a low savings propensity while in certain European countries savings is higher due to regulations which require households to save their deposits on their homes, a process which can take up to 10 years. My point is that despite variations in the savings rates between countries national deposits probably offer limited potential to expand money supply. In my opinion the Crash Course model of bank-created money is really applicable to an earlier period of capital accumulation in which money was still mainly tied to gold and silver in the form of coinage and there existed an ethos of savings for investment: your graphs over a two hundred year period in America suggest this, but also show that there was almost no inflation and therefore imply how little economic growth there was (probably driven mainly through productivity improvements, like the industrial revolution).

However over the last two decades internationally the role of deposits in creating money should have been significant because huge numbers of the working people of China and India have had their savings invested in Western Europe and America. However, even in this example there should be a diminishing amount of money deposited from this source of deposits as most of the money will end up being invested in the real economy (in this case in China and India) and consumption (in this case in America and Western Europe).

We should also keep in mind that a commercial bank cannot lend out more money than it already has: fractional reserve banking simply means that it can lend out (say) 90 per cent of its deposits. But these must be repaid and the original amount returned to the depositor at the end of the term (I omit interest for the sake of simplifying the explanation). The Crash Course says as much when it refers to the reverse payments from borrower to lender to depositor as the destruction of the “created” money. When one factors interest payments into the process there will be even less money available for most people as those with the loans will have to appropriate more and more of the already limited supply to be able to meet their interest payments. This places a significant restraint on the growth in money supply before it is periodically “destroyed” through repayments of principals and interest. This is the likely explanation of the no inflation-no growth  economy that characterised America until World Wars One and Two.

The creation of new money is therefore purely through the government, as the Crash Course demonstrates happened during the War of Independence, the Civil War and the World Wars. It is interesting to note the convergence of Wars with large scale government spending, and that the post World War Two period has been characterised by permanent armament and a massive military-industrial sector specialising in weapons of mass destruction. Since the 1913 establishment of the Federal Reserve (and the 1920 establishment of the South African Reserve Bank) the US and SA states set up special structures, as did many other countries, relatively autonomous of the state, as formally private institutions, to manage the creation of the money to ensure continuous growth. The emphasis is on the term “management” of the creation of money, because the carte blanche printing of bank notes will lead quickly to hyperinflation, as in Weimar Germany and currently in Zimbabwe. But managed inflation is significantly high: in South Africa a basic basket of supermarket goods (on which a poor family could subsist) has risen by over 2 300 per cent in the 30 years from 1979 to 2009. I think that in addition to the removal of the gold standard the privatisation of public services and space (of the Thatcher-Reagan era) was a necessary condition for the expansion of capital accumulation and economic growth, the starting point of which was the creation of the extra money. I found the Crash Course interesting because it points to the significant intervention of the government sectors through the armaments industry as a precondition for the massive growth in the post-War period.

These reserve banks present an interesting conundrum, namely they are private institutions (therefore with private interests in accumulating money capital) charged with protecting the public interest in the value of the domestic currency.  The mechanisms for meeting these contradictory objectives would be most interesting to unpack and understand.

If growth is driven by an ever increasing money supply, and if money is increased through government (or reserve bank) creating money, then policy interventions to start managing and slowing down growth and ultimately stopping it will have to be aimed at public control of the creation of money. This could be through linking it to the gold standard and taking us back to the situation that prevailed prior to the formation of the various national reserve banks. As Chris states in the Crash Course, during America’s almost 200 years of inflation-free economic development there was little if any growth and yet continuous improvements in technology (productivity) and therefore the quality of life. There is therefore no substantial reason to argue against reversing the historical policy trend. But such a move would be vehemently resisted by reserve bank institutions themselves (limiting and then denying them the sole right to “make” money would reduce their private power), their supporters in government and indeed by finance capital as a whole which is dependent on the reserve banks for the expansion of its business and therefore of its power. So there will need to be political organisation and struggle to put these types of money management/control policies on the public agenda. We need to start talking about the organisational politics of these interventions, examples and experiences of which we could share with each other.

Paul Hendler

Stellenbosch

SOUTH AFRICA

30 December 2009

 

GregSchleich's picture
GregSchleich
Status: Silver Member (Offline)
Joined: Jan 16 2009
Posts: 187
Re: Policies to manage and eventually stop money creation
retnap wrote:

I have specific comments about some of the detail of the Crash Course content which I think could be tightened up – alternatively I might not have fully grasped the meaning of these insights. I would appreciate a response from either Chris or anyone out there to my comments, if there are disagreements or any other insights about the detail of the money creation process.  

Fractional reserve banking is possible because depositors (savers) contract to put their money in the bank for a given term (i.e. three, five, ten, twenty years), enabling the bank to lend this money during the term at a higher interest that it has agreed to pay on the deposits. I think that the example in the Crash Course of $10 000 dollars being “created” by banks out of an initial $1 000 dollars deposit is flawed because it assumes that each borrower will save/deposit his/her borrowed amount in a bank, whereas borrowers in reality will either consume and/or invest it (i.e. as in direct investment in plant and equipment) and only save the discretionary income that they earn. So the multiplication effect in this model is in all likelihood quite limited.

Hi Paul

Welcome. Sorry you got ignored for so long

It's not clear to me yet whether you don't fully understand the credit system - how all money is loaned into existence, and extinguished upon repayment, or whether you're simply making a lot of incorrect (even if seemingly reasonable) assumptions about how a real world economy works. I'm sure there are other parts of the Crash Course that can be debated (although I certainly think Chris's research and fact checking is impeccable), but to argue his explanation of money creation and fractional reserve banking is like arguing about algebra or calculus. Unlike global warming (perhaps), it's settled science. It's demonstrably provable, both theoretically, and in the real world.

Let's start with the real world. Roughly 95% of all money in the U.S. is loaned into existence by  banks. I would imagine it's roughly the same everywhere else. In our case, 2 or 3% comes from the Treasury in the form of coinage, and the remaining 2 or 3% comes from central bank (Federal Reserve) fiat money created out of thin air. I'm not aware of anyone ever disputing this (except you, that is!). And although I couldn't quickly find an official source, here are a couple of other sources that corroborate it.

http://www.cosmichours.org/2008/03/money-creation-and-destruction.html 

http://rangerider.blogspot.com/2009/03/money-creation.html

Chris' example is deliberately simplified, but in the U.S. since the 1990's (I'm not sure what has been modified, or how much) there are actually no reserve requirements at all, for time deposits like the ones you describe, only for transaction deposits - demand deposits, and interest bearing checking accounts. http://towneforcongress.com/economy/yes-virginia-there-are-no-reserve-requirements-part-22-1 Similarly, the reserve requirements for the investment banks are almost nonexistent - hence all the exotic derivative instruments leveraged at 30 or 40 to one, heading into last years catastrophe. So, in fact, lending standards are even more lax than it appears.

But it is my understanding that most banks do operate fairly close to the limits of their reserve requirements, which would seem to indicate that the theoretical money multiplier may actually come close to being realized. I am only a generalist (no financial background), and could easily be unaware of other explanations - like accounting fraud! - but even in the real world, large amounts of money can be created from Chris' theoretical example. It may help if you think of the banking system as one big bank, which in a sense it is. So when the first borrower borrows, say $10,000 to buy a car, as soon as he pays the car dealer, the dealer deposits that money in another bank, which then lends that money (or 90% of it) to someone else, who pays someone else, who in turn deposits it in a bank,  who loans 90% of that, and so on. No matter how many transactions there are, and how much the money gets divided up, in how many different ways, it just keeps going in and out of banks, always multiplying. 

Here's another good video, "Money as Debt" by Paul Grignon (although there might be one or two things that could be a little misleading) you might also find helpful.

I hope this helps

Best

Greg

PS: There are others on the site, much more qualified, but if no one else responds, and if I forget to check back (which could definitely happen!), feel free to PM me.

 

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Login or Register to post comments