Linking Money To Value

This part covers money creation, debt, and banking. These are grouped together as they are very much interlinked and are at the heart of the current financial system.

Money creation

Most money (about 97% in the UK) is made by private banks when they make loans (whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money). Most of that money ends up producing housing market bubbles and feeding financial markets. This has led to the highest levels of personal and corporate debt in history and house prices that many simply cannot afford. When we rely on banks to create most of our money, then the only way of getting more money into the economy is to encourage people to go further into debt, and this is, as already argued, unsustainable. Replacing this system with a more transparent and accountable process seems necessary. The question is how to do it. Going back to the gold standard (or something similar) is not a solution as it is too static, too artificially restrictive. Allowing politicians to determine money production is not ideal either, as they could use this for their own ends. Instead, as the Positive Money movement suggest, we need an independent, non-partisan committee to decide when to create new money and how much. This committee would be accountable to parliament. Its job would be to ensure that the right amount of money is created: not too much, which would cause bubbles and financial crises, and not too little, which would lead to recession. Under this system, private banks could still create some new money under certain conditions (e.g. by lending to start-up businesses) but most of it would be created, as instructed, by the central bank. This would make a huge difference for several reasons: money created in this way would be free of debt – it is crazy that almost all money created now simultaneously creates debt. It would also curb the exponential growth of money that, in effect, devalues money. Furthermore, the new system would help with putting new money into the real economy (rather than into financial markets and property bubbles), which would, of course, stimulate the economy further and reduce unemployment. This all would, in addition, facilitate linking money to real value.

A possible concern – that it would create an insufficient supply of credit – is unfounded. As Ben Dyson, Graham Hodgson and Frank van Lerven, authors of Sovereign Money, explain, in such a system:

…a major source of funding for new loans would be repayments on existing loans. Money would not be destroyed when bank loans are repaid. Instead, loan repayments would transfer sovereign money from the borrower to the bank, and this money could then be ‘recycled’ to finance the demand for new loans. This recycling would be sufficient to maintain the stock of loans at its current level, while the injection of new money by the central bank would allow households and businesses to increase their savings so that the stock of loans could increase in line with the growth of economic activity. (Dyson at al., 2016)

Another concern could be that the transition would be too disruptive. However, as elaborated upon in Sovereign Money, using Transitional Liability could make the transition relatively painless. But what about the psychological factor? Well, this change would only bring the situation into line with what most people already believe and take for granted – namely, that the central bank creates most of the money. This is common sense, albeit not reality in the current financial system.

~ What we can do now~

We can join Positive Money and other organisations such as the International Movement for Monetary Reform that are already working on bringing about these changes, and lobby our political representatives to start debating the issue. However, although such organisations are making strides, establishing this new system is likely to face formidable resistance, not least from the banks themselves. It may not be possible to fully realise such a system before (or perhaps even without) the next financial crisis. So, what matters most right now is that the new blueprint is ready to be put in place when an opportunity arises. In the meantime, it may be a good idea to reduce our dependency on the mainstream currencies, not least in order to have an alternative means of exchange of goods and services in time of crisis. Here are some suggestions:

• Create a local currency: there are already over 400 local exchange trading systems in the UK and local currencies in Brixton, Bristol, Exeter, Cardiff, Hull, Liverpool, Totnes and elsewhere. If they can do it, other communities and cities can do it too. It doesn’t matter if it works straight away or not. What is important is to have a mechanism ready and a community that knows that it can rely on a local one in the event of a breakdown of the broader monetary system (as in the case of hyperinflation of the main currency) (Dietz & O’Neill, 2013, p.108). The Schumacher Center for a New Economics, based in the US, provides guidance on how to start new currencies.
• Barter trade or barter exchanges are already a huge part of the global economy, with deals each year worth the equivalent of trillions of dollars. These are commercial operations with trading platforms organised by an exchange that does the bookkeeping for the system. Their trade is sometimes denoted using an internal, non-conventional electronic currency called barter or trade dollars, usable by members of the exchange, within the system. An international currency called universal is used to barter remotely if local exchanges can’t provide what someone is looking for (Simms, 2013, 147). You may think that barter trade mainly takes place in developing countries, but this is not the case. For example, SolidarityNYC, which uses this system, originated and is based in New York.
• We can also be creative. One example is time banking, or hour exchange, which uses time instead of money (for every hour spent helping somebody you earn an hour in return). Time banking is becoming so popular that in the UK alone, around 75 such banks now exist, and even some universities are encouraging and implementing this scheme.

All of these activities could reduce our dependency on mainstream currencies, which would, in turn, help bring more substantial changes to how money is created. This alone would not be enough, though. There is a dark shadow over all of us (in one way or another) that needs to be addressed: debt.

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Dealing with debt

The capitalist economy is based on debt. Debt is the lubricant of the system. In the UK alone, £192 million is paid in interest every day (this figure includes private and national debt). Because 97% of all money is created electronically by private banks when they make loans, if there were no debt, there would be almost no money. However, debt has some nasty side-effects:

• Because most money only exists in balance sheets, when private debt is reduced, the money supply is reduced too – making it more difficult for those still in debt to repay what they owe (as there is less money around, money becomes, as it were, more ‘expensive’, which is bad for borrowers).
• Debt always involves interest, which is the profit that lenders make, so it is in their interest (no pun intended) to keep the debtors hooked, as in the case of credit card debt – once you fall in, it is extremely difficult to get out.
• Debt has negative political ramifications. It is effectively a form of serfdom. Those who have to pay off their mortgages are less likely to go out on the picket lines and are far more likely to conform to the demands of the ruling elite.
• As a burden carried throughout life, it has negative psychological consequences.
• Debt also has social implications: it increases inequality as the gap between debtors and lenders grows, and it also fosters a parasitic element of the system (as some lenders can live just from the interest they collect).
• It is unsustainable. As debt grows exponentially, at a certain point it will become meaningless (as it will become unpayable), making the money associated with it worthless. That, of course, will have unforeseen ramifications for the economy.

To address this challenge, we need to look at two issues: how to reduce the existing debt (private and national) and how to create an economy that relies less on debt.

Reducing existing debt

Some have suggested that existing debt should just be written off. This would not be without precedent. It has happened in the past and in some cultures periodically (every 10 or so years). This time, though, it would not work for several reasons, one being that the amount of debt, nationally and internationally, supersedes by a large margin anything ever previously experienced. Debt has penetrated every pore of society and just writing it off would be an enormous shock to the system. Furthermore, even if the economy somehow survived this shock, it would not be exactly fair and would encourage the accruing of further debts. Thus, we need to look instead at how to gradually reduce debt. As some suggestions can be applied to both private and state debt, they will be considered together.

Traditionally, the state reduces its debt in several ways: by austerity measures (spending less), by increasing taxes, or by printing more money. None of these solutions are ideal. The first represses the economy, as it decreases both the population’s collective purchasing power and the number of jobs, particularly in the state sector – which increases unemployment[1]. This, in turn, adds to the number of people in need of state help and simultaneously reduces tax revenue, potentially creating a vicious circle. Increasing taxes is unpopular and may further reduce purchasing power and investment; this risk diminishes if the taxation is aimed progressively at those who are wealthy, but that may not be enough. Printing money is also not perfect as it creates inflation, which punishes those who have savings. Furthermore, if inflation gets out of control it can cause an economic collapse, as has happened many times in the past. As no single solution is ideal, it is clear that these options need to be combined and some novel elements added:

• A necessary systemic change: we saw that as long as private financial institutions such as banks create most of the money by making loans, private debt can never be repaid, as repaying it would reduce the money supply. In order to curb the power of banks to do so, a substantial structural change needs to be made, along the lines suggested above. It is hard to see how the public could otherwise significantly pay off their debt without triggering a recession.
• Cancelling out the circular debt: This is the simplest example of a circular debt: the economic entity A (e.g. a financial institution) owes money to another entity, B; B, meanwhile, owes money to C, but C owes money to A. Much debt is actually circular, which can be reduced if an independent body is established to enable debts to be exchanged with the single purpose of reducing them (e.g. if A owes $1 million, but is owed $400,000 and this latter amount is cancelled out, the overall amount of debt would be reduced by the same amount). A consequence of this would be reducing the velocity of money[2], which would not necessarily be a bad thing. It would allow more money to be printed without causing huge inflation. The mechanisms for implementing such a system already exist, but they are mainly used to make even greater profits from debt (which has become a commodity in the current system) rather than to reduce it.
• Reducing state expenditure: to minimise its negative effects, this reduction should be gradual and minimal. ‘Minimal’ in this case means reducing the state debt at a rate not greater than 5–10% a year. This can be achieved by reducing ‘socialism for the rich’, such as bailouts, tax reliefs, and subsidising corporations that are already making substantial profits (it may not be an accident that most of the super-rich come from countries with a huge debt, such as the US). The scandalous difference between the interest rates when borrowing from and when lending to private companies also needs to be addressed. Cutting down on military expenditure could make a huge difference too. In addition, some savings may also have to be made in the sensitive areas of state pensions and the health service (how to do the former will be discussed shortly).
• Progressive taxation: in a transition period of debt reduction, taxes (at the top end) would need to be increased and probably other taxes introduced (such as tax on financial transactions and tax on wealth). We will see shortly that taxes can be increased roughly as much as they were in the US and the UK during the golden age of capitalism (the 1950s and 60s, before the crises in the 1970s and the neoliberal counter-revolution) without an adverse effect on the economy.
• Puncturing the bubble: a lot of money is locked in a bubble that is accessible only to a small percentage of individuals and corporations. We have seen that money does not trickle down, and if it did significantly, it would cause unsustainable inflation. This can be avoided, though, if that money is used for debt reduction. So, a kind of reversed quantitative easing is proposed, in which corporations, and in particular the financial sector, are asked to bail out the state. But, why would they do it? Surely they would refuse and rebel? Well, not if the alternatives are worse. As most money is electronic money, the collapse of the whole system or / and a revolution, or even the threat of debt annihilation, would be worse. If those who possess a lot of money are confronted with the choice of either giving something away or losing everything, they are likely to choose the former. The expectation is that they would act rationally and in their self-interest. This would not be without precedent. Something similar happened straight after WWII in the UK. It would not be unethical either, as it would effectively be just a repayment for all the bailouts, tax-breaks and other forms of state help that the private sector had received previously.

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Fostering an economy that is less debt dependent

The excessive creation of debt has been a major factor in boom and bust cycles, financial crises and recessions. For this reason, although lending and borrowing need not be completely discouraged, the economy should not depend on debt. The challenge here is, of course, to avoid slowing it down too much. A ‘credit freeze’ is viewed with dread for a good reason. These are some suggestions how to do it:

• Again, in order to rely less on debt, the power of private banks to create money needs to be minimised. To stimulate the economy without creating excessive inflation, it is necessary to control and calibrate the money supply.
• Secured or self-liquidating loans[3] should be made affordable; while unsecured or non-self-liquidating loans, such as credit card loans, should be strongly discouraged (by, for example, gradually replacing credit cards with debit cards).
• It is not always clear though what is secured and what is self-liquidating, so we also need to separate productive investment and unproductive investment (that which does not contribute to the real economy or people’s lives). For example, a loan for buying a house to live in is a productive investment. A loan for buying a second or third house in order to rent it or make money out of a subsequent price rise is unproductive. Similarly, a loan to start a new business is productive (in principle), while a loan to buy shares is not. Productive investments do not create boom and bust cycles – the unproductive ones do. However, right now, the system encourages companies to borrow as much as they can rather than as much as they need, which creates a paradox: the less they need, the easier it is to borrow. Successful companies that do not need to borrow do it anyway, as it is easy for them to get loans because they are successful. Then they invest the money in unproductive activities such as the stock-market. On the other hand, start-up companies and those that are struggling have a hard time getting a loan. This all stifles competition and increases unemployment. To address this imbalance, loans for unproductive activities could be discouraged by introducing extra taxation. It is true that lenders are more cautious with the productive investments, but this would not be such a bad thing – it would further reduce the unhealthy dependence of the economy on borrowing and lending.
• To make mortgages more affordable and easier to repay, the state and building societies should be the major mortgage lenders, because they are not profit driven. The UK Treasury argues that ‘building societies have a natural advantage to banks in being able to return a greater share of profits to their capital base than banks (as they have no implicit commercial responsibility to maximise dividends to shareholders), and societies arguably have a much greater capacity to generate low cost capital whilst profitable.’ (Dunning at al., 2015, p.23). In such conditions, even private lenders would have to keep their interest rate low. This is how houses became affordable for the rising number of professional people in the UK after WWII. Commercial institutions should still be able to provide loans, but they would have to cover any losses by compulsory insurance or by their own assets. This would avoid bailouts that create massive state debt and would discourage these institutions to take huge risks, reducing the possibility of a boom and bust.

Wouldn’t some of these measures slow down the economy? Most likely, but this would not necessarily be a negative development. There is consensus that the growth economy, in the present form, is unsustainable anyway. Furthermore, the real economy, being chocked by the financial sector, is already very much stagnating or, in fact, shrinking in countries such as the US and the UK (see, for example, The finance curse by Shaxon, and Financialisation: a primer by Thomson & Dutta). Curbing the financial sector along these lines may actually contribute to revitalising it.

~ What we can do now ~

You can make a start by tearing up your credit cards if you have them and never looking back (debit cards can do everything that credit cards do except put you in debt). The quicker you learn to live within your means, the better. If you now think that this is hard, consider that it will be much harder when saddled with debt and gargantuan interest rates. Some more systemic changes we’ve suggested can be stimulated by engaging with governmental and non-governmental organisations that are already dealing with the issue of debt, such as Eurodad.

Banking

How do banks make profit? At the most basic level, they borrow money with a lower interest rate than that at which they lend. So, you lend them money (in the form of your savings) at one interest rate, and then you borrow money from them (in the form of a mortgage or loan) at a higher interest rate. This is justified because the risk in ‘lending’ money to the bank is supposed to be smaller than the risk of the bank lending money to individuals. Furthermore, banks are also able to multiply the money they borrow from us because of so-called fractional interest banking – they are obliged to keep only a fraction of what they get from their customers (10% in the US); the rest they can invest or lend to other customers. They capitalise on the fact that normally people will not try to withdraw all their money at the same time – that is, as long as they believe that their money is safe (in the UK, deposits up to £85,000 are guaranteed by the state). Through these devices, banks can make huge profits just for being banks. The trouble is that banks and bankers have behaved badly ever since the first ones appeared in Renaissance Italy. J. K. Galbraith’s words in The Great Crash 1929 still ring true: “The sense of responsibility in the financial community for the community as a whole is not small. It is nearly nil.” (Simms, 2013, p.127) Although many bankers are detached from reality, this is a more systemic issue than one of their character. After all, the system dictates that making profit should be prioritised over other concerns. When this is coupled with deregulation, banks that push as far as they can in this respect have a competitive advantage. This is unlikely to change. If left to themselves, the mainstream banks will not suddenly become socially conscious and ethical, but will continue doing more of the same. None of this, however, is a call for abolishing banks. They should continue playing an important role, but their excessive powers need to be curbed and they need to be regulated so that they serve society and the economy rather than the other way around. These are some steps that can be taken to achieve this goal:

Limiting the size of financial institutions: allowing banks and other financial institutions to become too big or too systemic[4] to fail has serious consequences. For example, Lee Hale, a senior HSBC executive, has privately admitted that the bank’s size made large-scale breaches a virtual inevitability and the bank is “cast-iron certain” to have another major regulatory breach in the future. American senator Elizabeth Warren recently asked for one of the world’s biggest mega-banks to be broken up, not only because it has too much economic power, but also because it has too much political power. In short, real, lasting financial stability requires reducing the degree of concentrated risk in a mere handful of giant institutions that may be Too Big To Manage and Too Big To Regulate, as well as Too Big To Fail. The following measures are recommended:

• The existing banks that are too big or too systemic should be broken up into smaller ones (as another American senator, Bernie Sanders, suggests) and reduced to a size at which their failure would not threaten the wider economy. Creating smaller banks with strong regional identities out of the retail activity of big banks can have many benefits and is already the case in some Western countries. For example, in Germany, the small or community banking sector (the so-called Sparkassen) has 70% of the market. Decisions are made at the local level, where branches develop substantial local knowledge, rather than deferring to protocols set by a remote national or global HQ (Simms, 2013, p.162). In contrast, in the UK, most of the market is covered by just five major banks, although there are already around 400 community banks and similar credit unions that first appeared in the 1960s.
• In the same vein, the mergers of large banks need to be averted. However, to enable easy access for the public and to cut costs, bank services and postal services can merge, as has happened in France, Germany and Italy.
• Generally speaking, private banks should not be allowed to become international – they should remain within their national borders. Existing international banks should retract to their countries of origin, at least until a consortium of international regulators is established. In addition to the reasons given above, this is also because, at present, regulating international banks is so complicated that it is, to all intents and purposes, impossible.

Self-solvency: it is now taken for granted that the state should step in and prop up commercial banks in times of crisis in order to maintain the trust of customers and prevent a ‘bank run’. This, to a great extent, relinquishes them from responsibility and also kills competition – bailing out the banks and other financial institutions distorts the competitive landscape. For these reasons it is suggested that:

• No private institution should be given implicit or explicit protection by the government and every private institution should know that it will have to bear the full cost of its mistakes.
• Regulators could put more emphasis on debt that converts into equity when the institutions or the system are in trouble or when certain triggers are met (known as contingent capital). One way of doing so would be to have systemically important banks issue debt that would automatically convert to equity when the bank’s capital ratio falls below a certain value. Alternatively, there would be a requirement for financial institutions to buy fully collateralised insurance policies that would infuse capital into these institutions when they are in trouble.
• Every systemically important institution should meet with regulators periodically to review its ‘living will’, a plan that would enable it to be resolved quickly – ideally, over a weekend – in the event of imminent failure (Rajan, 2010, p.174-6). The regulator could ensure, through command and control, that the system is not overexposed to any single source of risk, institution, or class of institutions. Additional capital surcharges can be imposed on systemically risky financial institutions, and firms that cannot produce credible living wills can be broken up.
• To prevent banks from gambling with clients’ money, a firewall between clients’ assets and the banks’ own funding activities (akin to the Glass–Steagall Actof 1933, that separated commercial and investment banking) can be introduced.
• Commercial banking (reducing the use of borrowed money for investments) should be deleveraged perhaps with as much as 80-100% bank reserve. That banks doubled leverage in just a few years before the 2008 crisis indicates how important this point is.

Accountability: regulations need to ensure that profit making is aligned with the social and economic purposes of banks to facilitate the exchange of goods and services; to allocate capital to financially sound activities that generate higher long-term well-being for society with the least environmental impact; and to redistribute and share risk. (Simms, 2013, p.159) Here are some ideas for how to achieve this:

• Under the current system, depositors are not the legal owners of the money in their accounts – the customer has a claim on the bank instead. This means that the bank can use your money as it pleases without your consent. This is very different from the pensions industry. The Pensions Schemes Regulations 2005 require that the trustees of occupational pension schemes disclose “the extent to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investment.” Why don’t we apply the same requirement to banks? Depositors should retain the ownership of their money and they should have access to information about where their money is invested, so that they can move their money elsewhere if they are not happy with it.
• Banks should have a legal obligation (as is already the case in some parts of the USA) to lend money in places from where they are prepared to accept deposits. To do so, banks would be obliged to disclose their lending patterns.
• Generally greater transparency for all financial markets should be established by, for example, requiring all alternative asset managers to publicly disclose holdings, returns and fee structures.
• The shadow banking sector (those who are not subject to regulatory oversight, such as hedge funds) needs also to be fully regulated. (King, 2014, p.233).
• To encourage competition and enable small players to enter the game (for example, through apps that enable banking by mobile phone), progressive regulation of the financial sector could be introduced. This means much simpler regulations (than now) for small firms that use simple transactions, and more complex regulations for those that carry out complex transactions.

Alternatives: the competition should also be increased by offering alternatives to privately owned banks. This can take several forms:

• State (or public sector) banks – recent studies have shown that they are more profitable, safer, less corrupt, and more accountable overall than private banks. Furthermore, state investment banks can finance long-term projects that may not have immediate benefits but are nevertheless essential for the well-being of society. Many countries already have them. Even in the US, a number of states have produced legislation to establish their own public sector banks and one already exists. According to the Wall Street Journal, the Bank of North Dakota, set up in 1919 and currently the only publicly owned depository bank in the US, is more profitable than Goldman Sachs or JPMorgan Chase. No local banks that work in conjunction with this bank went bust after 2008, nor did they need a bailout, as they usually invest in local economies rather than in the stock market. (Simms, 2013, p.163) Furthermore, public banks do not need to be state banks. For example, a campaign is underway to create a New York City public bank, owned and operated by and for the city, which could serve as a public trust invested in social justice, accountable to the public.
• Credit unions too can be an alternative to the mainstream banks. The UK even has a charity bank that provides finance, support and advice to charities and social enterprises.
• Banks with social and environmental objectives, such as the Dutch-based Triodos bank, with branches in Belgium, Germany, the United Kingdom and Spain, or co-operative banks that already operate in many countries. The Global Alliance for Banking on Values (GABV) has 54 members across the world that are focused on using money to deliver social good. GABV members collectively have close to 50 million customers, almost 60 000 employees, and manage around $163 billion. Its members sign up to a triple bottom-line approach: people (e.g. financial literacy and education), planet (clean water, organic farming and alternative energy), and prosperity (economic self-sufficiency and creating jobs).
• Mainstream banks should be encouraged to engage with similar alternative practices. Some already do. For example, by 2020, Dutch bank ING financed €35 billion worth of so-called ‘sustainable transitions’, and Barclays has pledged to issue £1 billion in green bonds. (Scott, 2017, p.63)

This all may look good, but do the alternatives actually work? David Korslund, senior adviser at GABV, says “We compared the results of our member banks with those of the largest banks in the world, those that are seen as too big to fail, and the data show that our members’ financial returns are better and less volatile. So, we are delivering not just social good but financial performance as well.” The idea that focusing on people inevitably means sacrificing returns is a myth and the result of ideological manipulation to which we have been subjected for decades.

~ What we can do now ~

• We all have an opportunity to vote with our feet. If your bank does not have a wall between investing in assets such as mortgages or industry and its financial services (investing in the stock market) or if it is implicated in unethical dealings, move your money elsewhere.
• We can check banks’ certifications and associations. If your bank is a certified Community Development Financial Institution, Community Development Credit Union, or Certified B Corporation, or a participant in the Global Alliance of Banking on Valuesor Community Development Bankers Association, there’s a good chance they’re a values-based bank.
• We can start our own ethical bank. This seems far-fetched but is possible. In Croatia, for example, where cooperative banks are not even permitted, a group of socially conscious entrepreneurs created two legal entities: a bank, and a cooperative which will own the bank as the 100% shareholder (you can find out more about it from this instructive interview with one of its founders).

[1] Or reduces the quality of employment. Technically speaking, unemployment in the UK did not rise during the latest austerity period (due to the gig economy, zero-hour contracts, and the creative ways in which unemployment is calculated), but real wages and working conditions have suffered greatly.
[2] The rate at which people spend money. It is usually measured as a ratio of a country’s GDP to its total supply of money.
[3] Secured loans are made against an asset, such as a property, which acts as collateral. Self-liquidating loans are investments in activities, such as new businesses or training, which are likely to enable the loan to be repaid (i.e. those who complete training or a degree are likely to have higher earning power).
[4] ‘Too systemic’ means that they are in a position to endanger the whole system through their interconnectivity (if they fail, they can bring down many other institutions and individuals, causing a domino effect).