The future of money

[frank_begbie]

So its either the big die off, or violence?

Frustrating when you know how things could be.

[Lord Beria3]

Well, the way I look at it is that gold/silver have been the main monetary instruments for the majority of history and after our 40 year old experiment with a fiat currency system without any formal link to gold ends, we will probably revert back to gold and possibily silver.

You can talk about other forms of virtual money but gold holds a powerful force in human society as money and more importantly, in the rising Eastern powers e.g. India, Africa, Arab world etc, gold is considered a form of money in a way that has been lost in the West.

[marknorthfield]

A timely discussion (for me, certainly) and apologies for this lengthy post.

I've just spent the past week reading 'Where Does Money Come From - a guide to the UK monetary and banking system' published by the New Economics Foundation. I will probably need to go back and read it all again very soon to try and let the more technical aspects sink in. I cannot recommend this book highly enough for its scope and attention to detail.

http://www.neweconomics.org/publication ... -come-from

Amongst a zillion other things, the book makes clear that the majority of money in existence (around 97%) is created by commerical banks when they extend or create credit. The gradual deregulation of banking and credit from the late 1960s onwards has been responsible for a huge expansion of broad money (M4) in the UK until the financial crash. Furthermore, since the early-mid 1980s, bank credit creation has decoupled from the real economy and expanded at a considerably faster rate than GDP (with a noticeable uptick from around 2004).

In the introductory chapter, the authors write the following:

The power of commercial banks to create new money has many important implications for economic prosperity and financial stability. We highlight four that are relevant to understanding the banking system and any proposals for reform:

1 Although possibly useful in other ways, capital adequacy requirements have not and do not constrain money creation and therefore do not necessarily serve to restrict the expansion of banks' balance sheets in aggregate. In other words, they are mainly ineffective in preventing credit booms and their associated asset price bubbles.

2 In a world of imperfect information, credit is rationed by banks and the primary determinant of how much they lend is not interest rates, but confidence that the loan will be repaid and confidence in the liquidity and solvency of other banks and the system as a whole.

3 Banks decide where to allocate new money in the economy. The incentives that they currently face lead them to favour lending against collateral, or existing assets, rather than investment into production. New money is more likely to be channelled into property and financial speculation than to small business and manufacturing, with associated profound economic consequences for society.

4 Fiscal policy does not in itself result in an expansion of the money supply. Indeed, in practice the Government has in practice no direct involvement in the money creation and allocation process. This is little known but has an important impact on the effectiveness of fiscal policy and the role of the Government in the economy.


They then go on to suggest a whole list of questions to consider for effective reform. These include:

Should the state have more power to determine how much money is issued to the economy and for what purpose?

Should the UK Government set up national banks to create credit at zero or very low rates of interest for specific infrastructure projects? Should the restrictions imposed by direct government credit creation by the Maastricht Treaty be reviewed?

Does it make sense for shareholder-owned and profit-driven banks to have such powers of credit creation whilst financial institutions, such as credit unions, for example, which are owned co-operatively and primarily have a social purpose, are restricted in their credit-creating powers?

One further thought of my own: the UK abandoned the gold standard in the 1930s, but the credit expansion which has caused us so much trouble didn't begin until the banking deregulation of the 1970s and 80s. I think it might be reasonable to ask whether a return to the gold standard is really an automatic route to stability, especially considering that banking crises have not been restricted to the fiat currency era (far from it). It is certainly not something the authors advocate in this book. State 'window guidance' on bank credit creation appears to have been a rather more effective tool to direct credit productively and dampen speculative activity, both here in the 1960s and in other economies around the world at various times (notably China in recent decades).

Other alternatives briefly covered at the end of the book include Government borrowing directly from commercial banks at very low rates of interest (something similar happened during WW2), regional or local money systems ('common tender') to work in tandem with national fiat currencies, and the time-limited and targeted creation of interest-free money by the state (to be taxed out of circulation in due course).

I think anyone wanting to consider how money might evolve in the short to medium term needs to understand how it works right now: the sheer complexity of the system together with the fundamentally simple problem of unregulated commercial bank credit creation. And it's worth remembering that accounting systems of credit and debt existed before commodity money or coinage and so are likely to continue as long as human civilization does.

[JavaScriptDonkey]

So if they are creating money out of nothing why do they care so much if the loans are repaid and why have so many commercial banks gone bust recently?

The elephant in the room for the future of money is taxation.

Those that work need a currency in which to pay the tax on their labours.
Once it was a temporal chunk of that labour, then a tithe on the product of that labour and then the monetary value of that tithe.

FIAT currencies work just fine until they collapse...perhaps we need to understand better why they collapse before looking for a replacement.

[Little John]

So if they are creating money out of nothing why do they care so much if the loans are repaid and why have so many commercial banks gone bust recently?

The elephant in the room for the future of money is taxation.

Those that work need a currency in which to pay the tax on their labours.
Once it was a temporal chunk of that labour, then a tithe on the product of that labour and then the monetary value of that tithe.

FIAT currencies work just fine until they collapse...perhaps we need to understand better why they collapse before looking for a replacement.

They care so much because, although the money is created out of thin air, it must ultimately have a home to go to in the form of increased production. If that increased production does not materialise, you get an inflationary or deflationary bust. Which of these two flavours of bust pertains is merely a matter of policy. The bust itself, is not.

All of the above has happened several times before over the last two hundred years or so of rapid growth and it is that growth that has always eventually swallowed up the losses incurred in those busts. The problem now, as all of us on here know, is that future growth is now going to be severely restricted if not fully halted. That being the case, we don't get to grow out of this bust.

It's the BIG ONE.

[marknorthfield]

So if they are creating money out of nothing why do they care so much if the loans are repaid and why have so many commercial banks gone bust recently?

Back to the book (section 4.8, to be precise)

To stay in business, banks must ensure their assets (loans) are greater than or at least match their liabilities (deposits). If the value of the assets falls below their liabilities, they will become insolvent. This means that even if the bank sold all of its assets, it would still be unable to repay all its depositors and thus meet its liabilities. Once a bank is insolvent in a balance sheet sense, it is illegal for them to continue trading.

They then go on to describe the two types of insolvency.

Solvency crisis: If enough customers default on their loans, as happened with the subprime mortgages, banks can become insolvent. They are required to hold a capital buffer, but it may not be enough. In this situation, making new loans doesn't help because it increases the assets (loan contract) and the liabilities (newly created deposits) by equal amounts. To become solvent again, a bank must reduce its liabilities, increase its assets, or both.

Liquidity crisis: This is when there is a 'maturity mismatch' between the rate at which loans (assets) are repaid and the rate at which deposits (liabilities) are withdrawn. A bank has many types of assets, some very long-term and thus illiquid. If confidence fails and there is a bank run, investors are likely to pay less for the bank's assets in a fire-sale, which makes the situation worse. Again, making new loans doesn't help in this situation; every new loan creates new liabilities (new deposits) which the borrower could then pay to customers of another bank. The struggling bank would then need to find even more central bank reserves to settle transactions with other banks.

In summary, there are two liquidity constraints on the creation of new money for individual banks:

1 Having enough central bank reserves to ensure cheque, debit card or online payments can be made to other banks in the Bank of England closed-loop clearing system at any one time.

2 Keeping enough of their demand deposits in the form of cash so that solvent customers can get access to their cash whenever they wish

In practice these constraints are weak under the current monetary policy regime. Individual banks have a number of ways of boosting the reserve balances, including borrowing from other banks on the interbank market.

we don't get to grow out of this bust

In the medium to longer term, sure. In the meantime, how about a debt jubilee on what might be considered to be 'odious debt'? It's not a new concept, as David Graeber points out in his book 'Debt: The First 5000 Years'. (A lengthy review of the book HERE.)

And then perhaps we should keep a firm regulatory lid on credit creation, as mentioned previously, for the no-growth era that lies ahead.

[UndercoverElephant]

Cheers for the great posts, Mark!

[Little John]

So if they are creating money out of nothing why do they care so much if the loans are repaid and why have so many commercial banks gone bust recently?

Back to the book (section 4.8, to be precise)

To stay in business, banks must ensure their assets (loans) are greater than or at least match their liabilities (deposits). If the value of the assets falls below their liabilities, they will become insolvent. This means that even if the bank sold all of its assets, it would still be unable to repay all its depositors and thus meet its liabilities. Once a bank is insolvent in a balance sheet sense, it is illegal for them to continue trading.

They then go on to describe the two types of insolvency.

Solvency crisis: If enough customers default on their loans, as happened with the subprime mortgages, banks can become insolvent. They are required to hold a capital buffer, but it may not be enough. In this situation, making new loans doesn't help because it increases the assets (loan contract) and the liabilities (newly created deposits) by equal amounts. To become solvent again, a bank must reduce its liabilities, increase its assets, or both.

Liquidity crisis: This is when there is a 'maturity mismatch' between the rate at which loans (assets) are repaid and the rate at which deposits (liabilities) are withdrawn. A bank has many types of assets, some very long-term and thus illiquid. If confidence fails and there is a bank run, investors are likely to pay less for the bank's assets in a fire-sale, which makes the situation worse. Again, making new loans doesn't help in this situation; every new loan creates new liabilities (new deposits) which the borrower could then pay to customers of another bank. The struggling bank would then need to find even more central bank reserves to settle transactions with other banks.

In summary, there are two liquidity constraints on the creation of new money for individual banks:

1 Having enough central bank reserves to ensure cheque, debit card or online payments can be made to other banks in the Bank of England closed-loop clearing system at any one time.

2 Keeping enough of their demand deposits in the form of cash so that solvent customers can get access to their cash whenever they wish

In practice these constraints are weak under the current monetary policy regime. Individual banks have a number of ways of boosting the reserve balances, including borrowing from other banks on the interbank market.

we don't get to grow out of this bust

In the medium to longer term, sure. In the meantime, how about a debt jubilee on what might be considered to be 'odious debt'? It's not a new concept, as David Graeber points out in his book 'Debt: The First 5000 Years'. (A lengthy review of the book HERE.)

And then perhaps we should keep a firm regulatory lid on credit creation, as mentioned previously, for the no-growth era that lies ahead.

I agree with a debt jubilee, but only by default (literally). In other words, if there were no bailouts of banks and no deposit protection then a jubilee is precisely what would, in effect, occur. All spare state funds should then be directed at social security payments/work schemes to ordinary citizens in light of the inevitable economic fallout.

[JavaScriptDonkey]

Back to the book (section 4.8, to be precise)

Which then goes on to NOT answer the question. I know that a bank that either fails to maintain its cash flow or fails whatever capital reserve test is extant must cease trading but you have failed to explain why these masters of money creation do not simply see this eventuality coming and create more money before it becomes a problem.

I'll tell you why....it's because they don't create money.....they offer credit secured against assets.

When you have banks built on assets of highly dubious nature such as the fanciful ability of the poor to repay their debts you have trouble.

Case in point, Cyprus.

[Little John]

Back to the book (section 4.8, to be precise)

Which then goes on to NOT answer the question. I know that a bank that either fails to maintain its cash flow or fails whatever capital reserve test is extant must cease trading but you have failed to explain why these masters of money creation do not simply see this eventuality coming and create more money before it becomes a problem.

I'll tell you why....it's because they don't create money.....they offer credit secured against assets.

When you have banks built on assets of highly dubious nature such as the fanciful ability of the poor to repay their debts you have trouble.

Case in point, Cyprus.

They don't create money from nowhere. They multiply it from central bank base money. Usually by a factor of about 3. The factor is limited by the fractional reserve ratio set on any given bank. This means they are creating money that did not previously exist, but within the constraints of that factor. If they hit the limits of the factor, then either the CB must push new base money into the sytem in order for the banks to re-apply the multiplier to ther new money. Or, the fractional reserve ratio must be reduced to allow them to apply a greater factor of multiplication to the base money already in existence.

[JavaScriptDonkey]

Whichever view you subscribe to the result is the same - banks built on assets that deflate fail. The same is true for debtor corporations and even debtor nations.

Yet we know that asset bubbles are a feature of history. From bronze axe heads to tulips eventually demand feeds over supply and we get a crash.

Even oil had its glut requiring the cartels to limit supply.

And now we get to a real supply squeeze and we're blaming the banking system for the failure? I think not.

[peaceful_life]

http://www.youtube.com/results?search_q ... NBC+Cyprus+

Steve Keen, 'blowing capitalism's brains out'.

He covers a few pertinent topics here.




http://www.mindcontagion.org/worgl/worgl1.html
This would suite for local level, but obviously would need intertwined with an economy of ecological regeneration, otherwise the velocity could wreak havoc.

[peaceful_life]

Whichever view you subscribe to the result is the same - banks built on assets that deflate fail. The same is true for debtor corporations and even debtor nations.

Yet we know that asset bubbles are a feature of history. From bronze axe heads to tulips eventually demand feeds over supply and we get a crash.

Even oil had its glut requiring the cartels to limit supply.

And now we get to a real supply squeeze and we're blaming the banking system for the failure? I think not.

The entire thing is built of infinite growth, yes it's happened many times in the past, wasn't that meant to be a lesson learned by 'expert economists', wasn't that what the physical workforce of nations entrusted was being taken care of, and in return even tolerated the huge disparity of earnings and privelage?........wasn't that the deal?

It wasn't the Nurse, electrician, teacher, bricky, hairdresser, chippy etc etc... that stepped up to the mark to trade in assets, commodities and speculative derivatives.

I'm not big on the blame game tbh, but come on......of course it as the money men designers fault, in fact.......it's embarrassing that you should suggest otherwise.

[Little John]

Whichever view you subscribe to the result is the same - banks built on assets that deflate fail. The same is true for debtor corporations and even debtor nations.

Yet we know that asset bubbles are a feature of history. From bronze axe heads to tulips eventually demand feeds over supply and we get a crash.

Even oil had its glut requiring the cartels to limit supply.

And now we get to a real supply squeeze and we're blaming the banking system for the failure? I think not.

In the case of FRB, you have got that precisely the wrong way around. An over-supply of FRB money directly feeds through to an over-demand for it. This is a special feature of money (and of FRB money, in particular, due to the ease by which it can be oversupplied) because it is not a good or service in itself, but the means by which goods or services are obtained. This is because of the special universality of exchange of money. In other words, people do not seek money for its intrinsic value. They seek it for it's exchange value.

For example, in the case of, say, cars; if there is an over-supply, demand will fall relative to that over supply because people will only want or need so many cars. However, if you over-supply the money necessary to purchase a car, the decrease in value of money due to its oversupply means that people will inevitably chase that new money just to be able to keep their purchasing power equitable with what it was previously.


As sure as night follows day, the more money is pushed into an economy, the more people will want it and, in the case of an FRB based monetary system, more money really means more debt.

You are obviously intelligent JSD. Yet you seem to have some kind of weird blind spot on this topic. What gives? Do you work in the financial sector or something?

[kenneal - lagger]

JSD and Steve, when the bank creates a loan agreement, and magics the money out of thin air, the moment you sign that loan agreement the bank has an asset to loan the magic money against. Your promise to pay the bank the capital plus the interest goes down on the books as a asset. The new money is no more than two balancing entries in an account book.

If that asset fails to materialise, i.e. you don't pay off the loan, the bank has an imbalance in its books which it can remedy, in the case of a mortgage, by chucking you out of your house and selling it. If the asset against which the loan is secured, say your house, goes down in value, and thousands of others do as well, the bank has a problem because it can't write off the loans by selling the houses to cover the liability.

The 2008 crisis happened because thousands of people defaulted on their mortgage payments and the houses dropped in value. The banks were left sitting on a book of assets which were worth only a fraction of their book value. The books no longer balanced, hence crisis!

The Cyprus banking crisis happened because the Greek government defaulted on its repayments to the Cyprus banks. These loans were many times the deposits which the banks held because of Fractional Reserve Banking, which allows the bank to leverage its assets. The reserves held by the Cypriot banks no longer cover the losses made on the Greeek loans. the banks must be recapitalised to enable the banks to cover the losses.

The real injustice of this system is the fact that the bank charges you interest, and gets very rich, on money that it never had in the first place. It's the same when the government borrows money from banks for capital projects: the bank charges the government, that is you and I as taxpayers, interest for something that it hasn't got and which the government should be providing, new money.