My previous posts highlighted how over 96% of our money is created as debt when private banks make loans. Since these loans incur interest the only way they can be paid off is if the money supply increases and thus more debt has to taken out. This means our economy is hardwired to require endless growth. Endless growth is infinite growth and it just cannot go on forever.

This post is going to look at an alternative approach.

Firstly lets just look more closely at what happens when our government borrows money. To do this the government auctions government bonds. There’s a period where banks bid for this bonds based on yield – this process establishes the interest rate the bonds are issued at. [so not only does the government go to the banks for money but it lets them decide how much profit they should make!]

When the bonds are sold the major buyers are pension funds and banks. If pension funds buy the bonds then it just recycles money that has already been leant in to existence. If banks buy these bonds they merely make an entry in their accounts – on the one side they have the government bonds and on the other they create a deposit for the government. This means money is created. The banks do not remove deposits from anyone else’s account to create these deposit – they create brand new electronic money.

So government borrowing increases the money supply.

It does this by getting the banks to make an entry in their accounts and then the government (i.e. we the taxpayer) pays interest on this to the banks. This probably makes your mind recoil since the cost of making those entries in a computer system are negligible yet we end up paying the banks interest annually for the privilege.

So now think about what happens if the government actually pays off this debt. They take electronic money and pay it back to the banks. The banks reverse the original entries (they reduce the governments deposit and remove the bond) and money is removed from circulation. Our economy needs this increasing money supply due to our need for growth. If the money supply is reduced we will get deflation (I plan to blog about inflation and deflation in a later post). Thus not only do we have the issue that by definition there is not enough money to pay off all the debt but also that if the government does make major inroads into paying it off there will be reduced money supply which will lead to deflation.

How could this be different ? The first thing is that money should not be issued as debt. It seems utterly insane that we (through our government) leave the banks in this privileged position of making the accounting entries to create the electronic money. By doing it this way we need to pay interest on it. Why doesn’t the government itself just make these entries itself and not create the debt and not pay interest ? Rather than the Bank Of England trying to control inflation via interest rates (which in theory either encourages banks to lend more or less thus changing the money supply) they instead could decide how much money should be created. This could then be either spent in to circulation, given through tax cuts or even through a national dividend ( see Major Douglas who proposed this after The First World War ).  [The recent quantitive easing programme “in theory” was the government creating money but they merely injected it in to the financial sector rather than the real economy. If you want to realise what a MASSIVE missed opportunity this was then read this.]

For people brought up with this current paradigm (i.e. all of us) it’s incredibly difficult to imagine another way but please do. Under these circumstances there would be no government debt. Instead of huge amounts of money being brought in to existence through mortgages (thus inflating house prices) it could have been spent on productive capital leaving house prices affordably and investing in productive assets that would provide jobs and real wealth to the country.

This is not without precedent:

• it could be argued that the spirit of The Bank Charter Act 1844 was that the creation of all money should be in the hands of the government. So like notes and coins the government would issue electronic money ‘for profit’. Even after the act it didn’t stop the creation of deposits through lending since cheques still allow payments to be made without conversion to notes or coins
• section 8 of the US Constitution  states that the US Congress has the power to coin money. Though that doesn’t exclude others doing so it does make you wonder whether the intention was the the US congress should be the only body creating money
• Henry I started the use of Tally Sticks which effectively was money issued by the crown free of private bank debt
• During the American Civil war Abraham Lincoln issued “Greenbacks” free of debt after the bankers asked for huge rates of interest to lend.

It’s interesting to note the following is attributed to Abraham Lincoln – it’s difficult to verify whether he definitely wrote this but it appears to state what he was putting in place with the Greenbacks. If this had become the US monetary policy it would have completely changed the way money was created world wide, the power of the banks and we’d be living in quite a different world right now. Lincoln was assassinated shortly after this:

Money is the creature of law, and the creation of the original issue of money should be maintained as the exclusive monopoly of national government. Money possesses no value to the state other than that given to it by circulation.

Capital has its proper place and is entitled to every protection. The wages of men should be recognised in the structure of and in the social order as more important than the wages of money.

No duty is more imperative for the government than the duty it owes the people to furnish them with a sound and uniform currency, and of regulating the circulation of the medium of exchange so that labour will be protected from a vicious currency, and commerce will be facilitated by cheap and safe exchanges.

The available supply of gold and silver being wholly inadequate to permit the issuance of coins of intrinsic value or paper currency convertible into coin in the volume required to serve the needs of the People, some other basis for the issue of currency must be developed, and some means other than that of convertibility into coin must be developed to prevent undue fluctuation in the value of paper currency or any other substitute for money of intrinsic value that may come into use.

The monetary needs of increasing numbers of people advancing towards higher standards of living can and should be met by the government. Such needs can be met by the issue of national currency and credit through the operation of a national banking system. The circulation of a medium of exchange issued and backed by the government can be properly regulated and redundancy of issue avoided by withdrawing from circulation such amounts as may be necessary by taxation, re-deposit and otherwise. Government has the power to regulate the currency and credit of the nation.

Government should stand behind its currency and credit and the bank deposits of the nation. No individual should suffer a loss of money through depreciation or inflated currency or Bank bankruptcy.

Government, possessing the power to create and issue currency and credit as money and enjoying the right to withdraw both currency and credit from circulation by taxation and otherwise, need not and should not borrow capital at interest as a means of financing government work and public enterprise. The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government’s greatest creative opportunity.

By the adoption of these principles, the long-felt want for a uniform medium will be satisfied. The taxpayers will be saved immense sums of interest, discounts, and exchanges. The financing of all public enterprises, the maintenance of stable government and ordered progress, and the conduct of the Treasury will become matters of practical administration. The people can and will be furnished with a currency as safe as their own government. Money will cease to be the master and become the servant of humanity. Democracy will rise superior to the money power.

Abraham Lincoln, Senate document 23, Page 91. 1865.

There are organisations trying to push our government to make changes such as these:

The Monetary Reform Party

Positive Money Org – they have even draft the Bill that would need to be passed in parliament to move to this.

I’ll end with a quote from another US President – Thomas Jefferson

And I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.

from a letter to John Taylor (see here, bottom pg 298)