The Production of Money

How to Break the Power of Bankers

Ann Pettifor

• Publisher: Verso
• Year: 2017
• ISBN:
  9781786631367
• Topic: Economics
• Subtopic: Monetary Policy
• Index: Economics

According to leading economist Ann Pettifor, one of the few people to predict the 2008 financial crisis, money is not a commodity but a promise. This radical reconsideration of the power of money means that we can reimagine the way the economy works. The Production of Money also examines popular alternative debates on, and innovations in, money, such as "green QE" and "helicopter money." She sets out the possibility of linking the money in our pockets (or on our smartphones) to the improvements we want to see in the world around us.

CHAPTER 1

Credit Power

Modern finance is generally incomprehensible to ordinary men and women … The level of comprehension of many bankers and regulators is not significantly higher. It was probably designed that way. Like the wolf in the fairy tale: ‘All the better to fleece you with.’

Satyajit Das, Traders, Guns and Money (2010)

Finance must be the servant, and the intelligent servant, of the community and productive industry; not their stupid master.

National Executive Committee of the
British Labour Party (June 1944),
Full Employment and Financial Policy

The global finance sector today exercises extraordinary power over society and in particular over governments, industry and labour. Players in financial markets dominate economic policy-making, undermine democratic decisionmaking, and have helped financialise almost all sectors of the economy (except perhaps faith organisations). Financiers have made vast capital gains by siphoning rent (interest) from debt, but also by effortlessly draining rent from pre-existing assets such as land, property, natural resource monopolies (water, electricity), forests, works of art, race horses, brands and companies. As Michael Hudson writes, ‘the financial sector’s aim is not to minimize the cost of roads, electric power, transportation, water or education, but to maximize what can be charged as monopoly rent.’¹

Bankers and hedge funders in Wall Street and other financial centres have made determined efforts to weaken democratic institutions by weakening financial regulation, lobbying for cuts in capital gains taxes and for reversals in progressive taxation. And the sector has used capital mobility to transfer capital gains offshore, to havens like Panama, London, Delaware (US), Luxembourg, Switzerland and British Overseas Territories. Indeed the global finance sector has every reason to be triumphant. It has succeeded in capturing, effectively looting and then subordinating governments and their taxpayers to the interests of footloose and unaccountable financiers and financial markets.

Geoffrey Ingham, the Cambridge sociologist, describes the power the sector now wields as ‘despotic’.²

Unfortunately, because of its opacity and because of deliberate efforts to obscure its activities, there is widespread ignorance of how money is created, of credit’s and debt’s role in the economy, of banking and of how the financial and monetary system works. Most orthodox economists are at fault, because many ignore money, debt and the banking system altogether in their university courses and in their analyses of economic activity. In the words of one leading international economist who will remain anonymous, money or credit is ‘a matter of third-order importance’. Most economists (both ‘classical’, ‘neoclassical’ and many that are supposedly ‘Keynesians’) treat money as if it were ‘neutral’ or simply a ‘veil’ over economic transactions. They regard bankers as simply intermediaries between savers and borrowers, and the rate of interest as a ‘natural’ rate responding to the demand for, and supply of money. As a result of this blind spot for money and banking, it should come as no surprise that most mainstream economists failed to correctly analyse or predict the Great Financial Crisis of 2007–09. Just as worrying, this disregard for fundamental questions relating to the financing of the economy has meant that debates about finance’s ‘despotic power’, and in whose interests the monetary system is managed, have long been neglected. Some think this neglect is not accidental. It has, after all, enabled global finance capital to thrive, untroubled by close academic or public scrutiny.

But it has also led to grave misunderstandings. One of the most serious is the often repeated accusation that central banks ‘print money’ and thereby cause inflation. While it is true that central banks are responsible for both the issue and the maintenance of the value of the currency, they are not responsible for ‘printing’ the nation’s money supply. As the then-governor of the Bank of England Mervyn King once explained, it is the private commercial banking system that ‘prints’ 95 percent of broad money (money in any form including bank or other deposits as well as notes and coins) while the central bank issues only about 5 percent or less.³ In a lightly regulated system, it is private commercial banks that hold the power to dispense or withhold finance from those active in the economy.⁴ Yet neoliberal economists largely ignore private money ‘printing’ and aim their fire instead at governments and state-backed central bankers whom they regularly accuse of stoking inflation. The monetarist blind spot for the link between private banks’ money creation and inflation goes some way to explaining why Mrs Thatcher’s economic advisers found they could not control inflation.⁵ They had aimed only to target the public money supply – government spending and borrowing. Monetarist economists presided over the deregulation of lending standards in private commercial bank credit creation. This deregulation freed up bankers to embark on a lending spree which in turn fuelled inflation. It is the reason why Mrs Thatcher presided over an inflation rate of 21.9 percent in her first year of office. Only in the fourth year of her administration did inflation come down below the inherited rate, and then only as a result of severe ‘austerity’. As William Keegan explains, the ‘defunct (monetarist) economic doctrine led not only to a rise in inflation, but also to a savage squeeze on the British economy and to escalating unemployment.’⁶

The blind spot for the private creation of credit is part of an ideology that holds that public is bad and private is good. ‘Free, competitive markets’ that are both invisible and unaccountable, it is argued, can be trusted to manage the global finance sector and the world’s economies. This thinking stems not just from an almost religious belief in ‘free’ markets, but also from a contempt for the democratic regulatory state – a contempt actively expressed by supporters of the Thatcher and Reagan governments of the 1980s, and by elected politicians ever since.

Management of the monetary system

While the creation of money ‘out of thin air’ is a fascinating and, to many, a fresh discovery, what matters is not finance per se, but rather, I will argue, the management or control over what Keynes called the ‘elastic production of money’. There should be no objection to a monetary system in which commercial banks create finance needed for productive, employment-generating activity in the real economy. Indeed, commercial banks have a critical role to play in risk assessing, providing and then smoothing the flow of finance around the economy. Bank clerks have critical roles to play in managing myriad social relationships between debtors and the bank, and in assessing the risk of the bank’s potential borrowers. While I am not opposed to the nationalisation of banks, civil servants in big bureaucracies are not best suited to undertake risk assessments of the many applications for loans made at banks each working day. I can think of better functions for our civil servants than assessing Mrs Jones’s application for a mortgage, Mr Smith’s application for a car loan, and a corner shop’s application for an overdraft.

However, the power of private, commercial bankers to create and distribute finance at a ‘price’ (the rate of interest) they themselves determine is a great power. It is bestowed and backed by public infrastructure (the central bank, the legal system and the system of public taxation). It is a power that must therefore be carefully and rigorously regulated by publicly accountable institutions if it is not to become ‘despotic’. The authorities should ensure that finance or credit is deployed fairly, at sustainable rates of interest, for sound, affordable economic activity, and not for risky and often systemically dangerous speculation. Above all, the great power bestowed on banks by society – the power to create money ‘out of thin air’ – should not be used for their own self-enrichment. Nor should banks use retail customer deposits or loans as collateral for the bank’s own borrowing and speculation. That much is common sense, and should inform a democratic society’s regulatory oversight of the banks.

The value of a sound banking system

While it is controversial in some circles to assert this, it is my view that monetary and financial systems are among human society’s greatest cultural and economic achievements. The creation of money by a well-developed monetary and banking system, first in Florence, then in Holland, and finally in Britain with the founding of the Bank of England in 1694, can be viewed as a great civilizational advance. As a result of the development of these sound monetary systems, there was no longer a shortage of finance for private enterprise or for the public good. Bold adventurers did not need to rely on rich and powerful ‘robber barons’ for finance. Instead bankers disbursed loans on the basis of a borrower’s credibility. This led to the greater availability of finance for a wider range of private and public entrepreneurs, and not just for select groups of the powerful. The new and slowly developed monetary and financial systems both democratised access to finance, and simultaneously lowered the ‘price’ or rate of interest charged on loans. As a result, there was no shortage of money to invest in and create economic activity and employment. And that is why today, for those who live in societies with sound, developed monetary systems, there need never be insufficient money to tackle, for example, energy insecurity and climate change. There need never be a shortage of money to solve the great scourges of humanity: poverty, disease and inequality; to ensure humanity’s prosperity and wellbeing; to finance the arts and wider culture; and to ensure the ‘liveability’ of the ecosystem.

The real shortages we face are first, humanity’s capacity: the limits of our individual, social and collective integrity, imagination, intelligence, organisation and muscle. Second, the physical limits of the ecosystem. These are real limitations. However, the social relationships which create money, and sustain trust, need not be in short supply in a well-regulated and managed monetary system.

Within a sound financial system we can afford what we can do. Money enables us to do what we can within our limited natural and human resources. This is because money or credit does not exist as a result of economic activity, as many believe. Like the spending on our credit card, money creates economic activity.

Savings as a consequence, not precondition of credit

When young people leave school, obtain a job, and at the end of the month earn income, they wrongly assume that their newfound income is the result of work, or economic activity. This leads to the widespread assumption that money exists as a consequence of economic activity. In fact, with very rare exceptions, it is credit that, when issued by the bank and deposited as new money in a firm’s account, kick-starts activity. It was probably a bank overdraft that helped pay the wage she earned in that first job. Hopefully, her employment created additional economic activity (because, for example, she helped produce and sell widgets) which in turn generated income and savings needed to reduce the overdraft, repay the debt and afford her wage.

In a well-managed financial system, money provides the catalyst, the finance needed for innovation, for production and for job creation. In a well-managed economy, money is invested in productive, not speculative, economic activity. In a stable system, economic activity (investment, employment) generates profits, wages and income that can be used for repayment of the original credit.

Of course, there must be constraints on the ‘elastic production’ of this social construct that we call money. This is because bankers and their clients can help trigger inflation on the one hand, and deflation on the other. When bankers create more credit/debt than can usefully be employed by an economy, this can result in ‘too much money chasing too few goods or services’ – i.e. inflation. Equally, the private banking system is capable of contracting the amount of credit created. This shrinks the supply of broad money, thereby deflating activity and employment. If the banking system is properly regulated by public authorities, and operated in the interests of the economy as a whole, there need never be a shortage of finance for sound productive activity.

That is why sound banking and modern monetary systems – just as sanitation, clean air and water – can be a great ‘public good’. They can be used to ensure stability and prosperity, to advance development and to finance ecological sustainability, as I explain below. Managed badly, a banking system can fatally undermine social, political, economic and ecological goals, as they do in many low-income countries. Bankers and other lenders (including micro-lenders) can charge usurious, and ultimately unpayable, rates of interest on credit. By using their despotic power to withhold credit or finance from the economy, bankers and financiers can cause economic activity to contract, leading to the deflation of wages and prices, unemployment and social misery. Left to run amok, a banking and financial system can, and regularly does have a catastrophic impact on society and the ecosystem. Managed badly, a financial system can usurp and cannibalise society’s democratic institutions.

We are living through a disastrous era in which the finance sector has expanded vastly – an era in which most financiers have virtually no direct relationship to the real economy’s production of goods and services. Deregulation has enabled the sector to feed upon itself, to enrich its members and to detach its activities from the real economy. Productive actors in the real economy, the makers and creators, have periodically been flooded with ‘easy if dear money’ and have been just as frequently starved of affordable finance. This instability has led to increasingly frequent crises since the ‘liberalisation’ policies of the 1970s; and to prolonged failure since the financial crisis of 2007–09.

Many low-income countries are dogged by badly managed and lightly regulated financial systems, and therefore by a shortage of finance for commerce and production and for vital public services. This is in part because they lack the necessary public institutions (for example a sound central bank, a trusted criminal justice system, and a regulated accounting profession) and policies (including taxation policies) that underpin a properly functioning financial sector. No monetary and banking system can function well without a central bank, a system of regulation and of taxation; without sound accounting, and without a system of justice that enforces contracts and prevents fraud. But while low-income countries have been encouraged to open up their capital and trade markets and to invite in private wealth, they have been discouraged or blocked outright in their efforts to build sound public institutions and policies to manage their monetary and taxation systems. Above all, they have been discouraged from regulating the creation of credit (‘leave it to the market’) at affordable rates of interest by the private banking sector, or from managing financial flows in and out of their economy.

The role of robber barons

In countries with weak regulatory institutions and systems, entrepreneurs are obliged to turn for loan finance to those who have acquired – by fair means or foul – stocks of wealth or capital. Poor country governments turn to institutions like the IMF and World Bank or to the international capital markets for foreign hard currency. As a consequence of dependence on both domestic and international ‘robber barons’, money is expensive (‘dear’). It is lent by powerful foreign creditors with the authority to create credit in a stable currency. Alternatively it is lent by those individuals or companies with savings or a surplus, invariably at high real rates of interest – rates that often exceed the income or returns that can be made on the investment. If it is borrowed in foreign currency, then volatility in currency movements can both increase the cost of the loan but also diminish those costs. But volatility is a deterrent to promising enterprises. As a result of the need to borrow in foreign currency, a poor country’s innovative sectors can be held back, unemployment and under-employment will remain high, and poverty can become entrenched.

Yet it does not have to be this way. Monetary systems and financial markets have been cut loose from the ties that bind them to the real...

Table of contents

• Cover Page
• Halftitle Page
• Title Page
• Copyright Page
• Contents
• Preface
• Chapter 1: Credit Power
• Chapter 2: The Creation of Money
• Chapter 3: The ‘Price’ of Money
• Chapter 4: The Mess We’re In
• Chapter 5: Class Interests and the Moulding of Schools of Economic Thought
• Chapter 6: Should Society Strip Banks of the Power to Create Money?
• Chapter 7: Subordinating Finance, Restoring Democracy
• Chapter 8: Yes, We Can Afford What We Can Do
• Acknowledgements
• Notes
• Recommended Reading List