Monday, April 11, 2011

The Current Money Crisis - Taking the Conversation Deeper

Nearly all of the discussions I hear about the government's budget crisis and the country's growing wealth inequality omit what is probably the most fundamental consideration of all: What is money's ultimate origin? How does it get into the economy in the first place?

We are hard up for cash to fund critically important public needs like education, healthcare and economic infrastructure. Huge numbers of people with sharp minds, strong hands and good hearts are ready to do needful work -- but they can't get a job because cash is scarce. And yet nobody stops to consider where money actually comes from.

It's an important question, in part because core economic growth and job creation are funded with newly-created money, never with pre-existing dollars. In those strong economic periods that we've all experienced, money was being created in huge amounts to fund the growth and to keep things running at the expanded capacity. But where was all the new money coming from? The answer will surprise most people. What's more, even though the answer is in fact very simple, it goes so contrary to unquestioned assumptions that it takes most people some time to overcome the initial disbelief and to understand how it really works.

When I came to understand a few simple technical details about how money is created under today's monetary system, my entire framework for thinking about money was transformed. Slowly, the ramifications of this new understanding began to branch in many directions. Wonderful visions began to sprout in my mind -- I began to imagine new possibilities for unleashing all the good energy in this country, so much of it misdirected or underutilized, to serve the public good. I began to see the possibility of a world where there was no shortage of funding for the things that mattered most to the health of our society and environment.

HOW MONEY IS CREATED - A SIMPLE TECHNICAL FACT THAT WILL CHANGE YOUR THINKING

Here’s the technical fact about where actually money comes from, followed by a brief explanation of why it's so important to understand. What I am about to tell you is not a secret. It's publicly available knowledge, even described in some old, out-of-print pamphlets published by the U.S. Federal Reserve and the U.S. Congress (some cited in my list of references below). Yet even though this knowledge has technically speaking been available for decades, very few people have had the slightest inkling of why it had any importance. It's worth remembering that the modern banking system is something relatively new and, as with so many new technologies, it was "pushed upon us" before we understood the alternatives or the consequences, without the benefit of thorough-going public discussion, and before we had learned to use or regulate it wisely. Public thinking still hasn't caught up to the banking system yet. The "esoterics" of economic talk have obscured the simple underlying truths. But awareness and understanding is growing today, as the citations below attest.

So here comes the simple fact I've been talking about. If it doesn't make you perk up with interest, it should. Don't leave this page until the importance of what I'm saying starts to dawn on you:

Under our current “fractional reserve banking system”--created in 1913 with the establishment of the Federal Reserve system--the United States money supply today is entirely created by private banks when they make loans. (The actual printing of physically-circulated paper money on government printing presses is irrelevant; it’s entirely secondary to this process of money-creation by banks.)

That's it. All money in circulation today is created by private bank loans.

Now you are probably either curious, startled, confused, skeptical or ready to go to sleep. Assumuing you're at least still awake, you might be asking, "How can this be?" or "What difference does that make?" or "What exactly are you saying?" What I'm saying, in short, is this:

When you “borrow” money--to buy a house, for example--the bank does NOT go to some reserve stash of dollars and lend you pre-existing money they have in their vault. No. The money that is “lent” to you in truth gets created by the bank out of thin air.

Confused? If so, part of your confusion probably stems from the fact that the term “loan” is a total misnomer. Money isn't really "loaned" when you take a loan. It's created. It's created simply through an accounting mechanism: the amount “loaned” is entered into your deposit account, and an equal amount is entered into the bank’s corresponding account as a new “asset,” i.e. what you owe the bank (plus accruing interest).

That’s the technical mechanism I'm talking about. All the money in circulation, with the exception of the metal coins minted by the government, comes into existence through this mechanism of bank loans.

Of course, there is more to the story. For instance, there are restraints on just how much money the banks can create--this is where the "fractional reserve" rules come into play. But none of the pieces that I am leaving out affect this one fundamental fact: the fact that all the money that exists today is created through the loans that banks make. (Many more details, and reliable sources verifying what I have said so far, can be found in the books, pamphlets and videos I list at the end of this blog.)

Assuming you can absorb this crucial fact, which may or may not seem a little mind-bending, you are ready to understand why this money-creation mechanism is much more than a mere technical detail, and is of such enormous consequence for the public well-being.

ALTERNATIVES HAVE EXISTED IN MODERN INDUSTRIAL NATIONS

First, it’s useful to understand that it doesn’t have to be the way it is today. Although today’s “debt-based” system is the way money-creation now works all around the world, robust, alternative methods of money creation have in the past existed in the United States, Canada and elsewhere, funding energetic economies that gave people meaningful work and built schools, hospitals, roads, etc., without creating inflation or painful boom/bust cycles. Under the alternative system I am here referring to, money was created not by banks, but by the government itself, and it was created, not as loans tied to debts, but as money existing independently of debt that was spent into existence to fund public projects.

Such a system of government-issued money operated, for example, in Canada from the Great Depression until 1972, and in the United States, to take the most recent example, during the decades after Lincoln created the government-issued “Greenbacks” to fund the Civil War without going into debt to banks. Indeed, the alternative of government-issued paper currency is as American as apple pie: government-issued paper currency was an American invention. It paid for the American Revolution. Before the Revolution, the American Colonies had invented such money as a way of dealing with the extreme monetary scarcity imposed by England. It was on the basis of this American-government issued cash, the Colonies built prosperous economies and the foundation of American independence. Ironically, the current monetary system, based on private bank debt, was a later importation from England -- an importation, some argue, that made its way to our shores through rather nefarious means. The story of how the banks acquired the money power in the United States, even though the U.S. Constitution specifically reserves the nation's money-power to Congress, is a story worth reading.(For the Canadian system, see the Bill Abram's videos on You Tube; for dicussion of the Greenback currency and American monetary history generally, see Zarlenga and Brown. For the story on how bankers achieved the passing of the Federal Reserve Act that established the current system, see Rothbard.)

WHY IT MATTERS -- SOME DISASTROUS CONSEQUENCES OF THE CURRENT MONETARY SYSTEM

Why should we be interested in alternatives? Because the architecture of our monetary system has as profound consequences for the moral fabric and well-being of our society as does our culture or our politics. And because the present monetary system gives rise to many of the worst features of our current political-economic system, for example:

1) Under the current system private banks, by deciding where to make loans, decide the direction of the country’s primary energy and activity — Will they fund war industries? Housing bubbles? Environment-exploiting companies? The top 1% of earners? Or education, hospitals, roads and bridges, green technologies, and healthy democracy? To whom will the money be made available? Of course, banks choose to lend the money in whatever way will make them the highest return. Whatever the banks decide, that’s where the money will be, and the energy and action of the people will follow, because people need jobs. Will our national energy be dedicated primarily to achieving what the world most needs? Or instead to achieving the private-enrichment schemes of a very few? This decision is in the hands of those who have the money power. Today, that would be the world's private banks. Ever notice how much the financial sector has grown in comparison to all other sectors of industry over the past 100 years?

From the perspective of job-seekers, one result is that we are all generally constrained to line up for a job at the door of those whom the banks deem worthy. There are few jobs, and to take a high-paying one too often means working to achieve goals that are not necessarily in the best interest of all. A just monetary system, in contrast, would put all of the people into action in building the common well-being. Full employment should signify nothing more than mobilizing the available energy of every person in constructing the wonderful world that we all want. Our present monetary system instead funds the most powerful private interests, those who are best at exploiting others, and these folks, in the short term, benefit from high levels of unemployment that keep wages low.

2) Under the current system, if we the people (the public sector or government) need money, we must borrow it from the banks and pay the banks back with interest. This makes no sense. As Thomas A. Edison and others have realized, if the government can issue an IOU to the banks in return for money, it can just as well issue the money directly, without having to pay interest. (That's why Lincoln created the U.S. Greenback currency 150 years ago, to pay for the Civil War without having to put the government in debt to banks. It worked.) The current system presents an absurd situation where we have delegated the money-power to private interests, who then charge us a whopping price for the extraordinary privilege we (for the most part unknowingly) have granted to them. One disastrous consequence is that public projects cost us taxpayers a multiple of 3 to 5 times more than they need to, due to interest charges. Money needed for education, roads, hospitals could be many, many times more abundant, helping to secure our future prosperity for generations. Instead the money is in short supply.

3) Because under our system all money is created through "loans," more money is always owed than is actually created. Whether you look at an individual loan or the aggregate of all loans, the bank creates (i.e. "loans") x amount of dollars, and always demands back “x + interest.” In other words, as a structural necessity of the system, more money is always owed to banks than exists. This creates a situation of inherent scarcity and competition, with terrible moral and environmental effects, harming the social fabric and the ecosystem.

The only way for any person or business to pay its debts is to get money from others, which increases the general monetary scarcity and competition, and also means that some must by necessity go bankrupt. The current system places us all in competition with one another to get scarce money, supporting rapacious practices and fueling exploitation of the environment and of people.

Since the only way to expand the money supply is to borrow more money, this system locks our society onto a path of exponentially increasing growth-and-debt. It’s not an accident that people and governments have been accruing exponentially-growing debts over the past century.

This monetary system has its deep and pervasive psychological effect: at some level we are all vaguely aware, even if we don't understand the reasons why, that there is not enough money to go around. This breeds fear and cynicism in the culture generally and in our individual psyches: the fear that any one of us could fall victim and discover ourselves in abject poverty (the system as structured requires that some must go penniless), and the cynicism that the law of the world is tooth and claw, with individuals ultimately out for themselves alone. It doesn't have to be this way at all. The goodness still left in our hearts, and the hope we hold out for a different future, derives from a past when things were different.

MONETARY REFORM & INNOVATION -- FINDING SOLUTIONS TO SUPPORT HUMAN WELL-BEING GLOBALLY

Our world can’t shift its current unsustainable course without radically reforming the monetary system. It's an essential piece of the puzzle.

I am aware of one movement for radical reform at the national level, and thousands of movements at the local level. At the local level, new community currencies are helping to relieve communities from their dependency on conventional, bank-controlled money, and to provide new ways of unleashing local, self-directed energies and capabilities. There are many varieties and experiments with local currencies going on today — some are only extensions of the current system; others hold the promise of creating something truly new and exciting. There are even glimmers of possible new exchange mediums that, some think, could even eventually replace money as I have spoken of it altogether.

At the national level, the reform effort of most interest to me is the one being pushed by the American Monetary Institute and Stephen Zarlenga, in alliance with Dennis Kucinich.

REFERENCES

I hope you're interest is piqued and that you'll enjoy learning more. Here are a number of books, videos and authors who treat some or all of the things I’ve been discussing. Stop by again and tell me about what you're learning.

1. Stephen Zarlenga, The Lost Science of Money. See Zarlenga's American Monetary Institute for additional publications and links. (See: www.monetary.org)
2. Ellen Brown, The Web of Debt (See: http://www.webofdebt.com/)
3. Bill Abram on Canada’s Banking System, parts 1-4 on YouTube
- Part 1: http://www.youtube.com/watch?v=jghiU55O5eY
- Part 2: http://www.youtube.com/watch?v=FyHpaHo71mQ
- Part 3: http://www.youtube.com/watch?v=1ixeDP5LEEQ
- Part 4: http://www.youtube.com/watch?v=hLtretltL3I
4. Robert de Fremery, Rights vs. Priveleges.
5. Bernard Lietauer, The Future of Money.
6. Paul Grignon, Videos (available on YouTube):
- “Money as Debt,” parts 1 & 2;
- Website: www.moneyasdebt.net
7. Murray N. Rothbard, The Case Against the Fed.
8. Thomas Greco, The End of Money.
9. Peter North, Local Money.
10. "A Primer on Money: Subcommittee on Domestic Finance, Committee on Banking and Currency", [Wright Patman (Texas), Chair], House of Representatives, 88th Congress, 2d Session, August 5, 1964. U.S. Government Printing Office, Washington, 1964.
11. Modern Money Mechanics: A Workbook on Bank Reserves and Deposit Expansion, Federal Reserve Bank of Chicago. (Online at: http://en.wikisource.org/wiki/Modern_Money_Mechanics)

______________________________

Marc Tognotti, Ph.D.,
Co-Director, Institute of the Commons
http://www.iotc-hub.org
E: marc@iotc-hub.org