New Year’s resolution: change the way you think about money in 2014. And start thinking about how we could make it work for everyone. Fran Boait from Positive Money explored the possibilities in our Revolver Issue…
Positive Money – by Fran Boait
Despite George Osborne’s overly optimistic diagnosis that ‘Britain is turning a corner’, people living in the real economy know the crisis isn’t over yet. We still have 2.5 million people desperately seeking jobs, and almost 1 million of those are between 16 and 24. There are also about 500,000 people who rely on food banks. Yet there is no shortage of work that needs to be done: Britain has a huge shortage of houses and a looming energy crisis. Dealing with these problems alone would immediately create jobs and boost the economy. So, we have jobs to do and we have people to do them – the problem seems to be money. Apparently there isn’t enough of it. But where does money come from? How is it created and how come it doesn’t seem to reach the places that need it the most?
How does money work?
If you ask a person in the street how money works, they will suggest that money is deposited in a bank, and then lent on, and then deposited in a bank, and then lent on, like a system of tokens that circulate forever. If you suggest that when you repay a loan to your bank the money disappears from the system, they are likely to think you are pulling their leg. However, only 3% of all the money in circulation does circulate forever as tokens. This type of money is cash, and you can find it in your wallet as notes and coins.
So what about the rest of it? The remaining 97% is a kind of temporary money, continuously being created and destroyed. It exists as accounting entries in a computer system, a form of electronic money; it is created when banks make loans and destroyed when those loans are repaid. The result of this strange arrangement is that the total amount of money that exists in the economy is always fluctuating. At any one time, thousands of people may be creating new money by taking out loans, while at the same time thousands may be destroying money by repaying existing loans. The total amount of money in the economy is therefore rather analogous to the amount of water in a bath when the plug has been removed, letting water pour out, and there is a tap running with water flowing in. The water flowing out corresponds to money destruction as existing loans are repaid, and the running tap corresponds to new loans being made. If these two rates are exactly the same then the total amount of money we have would remain constant, but that’s rather tricky to arrange. In general, the total amount of money is either growing or shrinking.
For a long time (at least the last 40 years), banks have had the freedom to make as many loans as they like. When someone repays a loan to a bank the money disappears, whilst the banks keep the interest as profit. Therefore banks will choose where to lend based on their own profits rather than the needs of the economy, and they will lend as much as they can to maximize their profit. In the 10 years running up to the financial crisis in 2008, banks doubled the amount of mortgage lending. This resulted in house prices increasing by more than 300%. Thinking back to the bath, the tap was turned on as far as it could go, pouring water in the bath.
When the financial crisis hit it was like the tap being turned off, or at least being turned down dramatically, as banks panicked and stopped their lending. But the water carries on pouring out the plughole at just the same rate because all that earlier borrowing still has to be repaid. If the government does nothing then the water level would start to fall. This is exactly what happened in the US in the great depression in 1929. During the years of the great depression, the total amount of money in the US economy shrank by a third. The money wasn’t ‘going somewhere else’, it wasn’t ending up in somebody else’s hands: it was actually disappearing out of existence. Fast forward to 2008 and the same thing happened again. A decreasing money supply is agonising for an economy. People go round scratching their heads, wondering why everyone seems to have less money than they used to.
Now imagine for a moment that all of the money in the system was converted to a system of tokens that circulate forever. Under this system the plug would be put back into the bath and the tap turned on only as and when it is needed, instead of lurching from pouring water into the bath to being switched off. Under this system there is no such thing as a collapsing money supply. Crucially, the control of the tap should also move from being in private banks’ hands to public hands – to a place that is transparent and democratically accountable.
Although it is unnerving to think about, most economists and politicians do not fully understand why the financial crisis happened. Recently, a former regulator told us that he only started thinking about the creation of money in 2010, three years after the crisis started. This admission is of great importance because it shows that there is simply a huge lack of understanding in both policy-making circles and the finance sector about how the current system works. The creation of money was not even considered as a possible culprit for the 2008 crisis. Very few mainstream economists are looking at who is creating the money and where it’s going, even though money affects everything that happens in our economy. The type of economics taught widely across universities today essentially ignores money creation. If you ask any economics student to explain the exact process of money creation, chances are they won’t have much of an answer. We think this is a huge problem.
Five years after the financial crisis, UK businesses and households have hardly reduced their debts. A fall in the level of household and business debt is essential for a sustainable economic recovery but, given the government’s commitment to lowering public sector debt, this scenario is unlikely. Since most politicians do not have a full analysis of the crisis, they do not know how to get the economy started again. The big problems facing the UK today won’t be solved by passively waiting for the economy to recover. We need to demand that the government do something new and different – something that will create jobs, deal with the shortage of housing and allow people to reduce their personal debts. Current government policies are failing and it is time for a change.
We believe that money should serve the people, rather than the people serving money. To achieve that we think legislative change is necessary to fix the monetary system, but politicians will only act when academics, economists, business leaders and the public see the need and demand change; we need the media to understand and debate the issue. We’ve outlined our proposal for reform in a book called Modernising Money.
Finally, the UK is in a situation where banks are not lending enough to job creators, whilst increasing their lending for mortgages. This increases the level of private debt, which was the original cause of the financial crisis. We need new money, free from debt, to be spent on areas like green energy, which create jobs in the real economy. We know that the big banks can’t do this, and we think that the public and politicians are starting to realise this, too. Therefore we have a big opportunity to shift the status quo away from banks dictating our economy. We have people that want to work and jobs that need doing. Goliath has been beating David for a long time now. It’s time that David picks up his sling shot.
Fran Boait is the Campaigns and Operations Manager for Positive Money.
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