In this episode we look at the changes that are necessary to bring about the end of the current 'Global Financial Crisis' and to make sure that we never again find ourselves with the current problems.
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Welcome to Money Myths Episode 2 – Cure for the Credit Crunch.
My name is Brian Leslie and I'm the editor of Sustainable Economics magazine.
Before we get started, I have a couple of things to mention.
First: This is part two of the series but, if you've not yet seen it, I would suggest that you look at the website (www.moneymyths.org.uk) where you will find information about the series and a list of episodes.
On the site you’ll find a "Subscribe via iTunes" link to subscribe and get all the episodes as they become available, as well as full transcripts of each show and any relevant links to other information. You’ll also find a "Donations" button, if you’d like to contribute directly.
Second: If you haven't seen the Series Introduction and part 1, I would suggest that you watch them first as we aim to build the series on the basis that viewers have seen the episodes in order.
Although I am referring to the British Banking System for this series the system in most countries is the same and has a similar history. I leave it up to you to substitute your own Central Bank, Government, Ruler, and so on.
OK, so on with part Two:
As you will by now realise, there is growing anger at the way the British and American governments seem to be handing over, at taxpayers’ expense, vast sums of money to the very banks and financial institutions which caused the trouble in the first place.
What is not made clear is which taxpayers will have to pay for this, and how they will be able to pay. This is no surprise.
The well-known American economist, J K Galbraith, made perhaps the most appropriate comments about the money system, when he wrote his book, Money - Whence it came, where it went, in 1975. He said that: “The study of money, above all other fields in economics, is the one in which complexity is used to disguise truth or to evade truth, not to reveal it”.
I explained in the last episode, the way money is created by the banks and as Galbraith put it, “The process by which banks create money is so simple the mind is repelled. Where something so important is involved, a deeper mystery seems only decent.”
Nearly all our present money is created by banks, by making interest-bearing loans. Politicians and economists are reluctant to admit the possibility of the government itself creating money, instead of borrowing it and paying interest on it. This, despite the fact that the government does, even now, still create some of it: the notes and coins.
We are told that if the government created more money, this would cause inflation. That is only true if it creates too much, or if banks continue to use it to increase their reserves, which then allows them to create even more money, as you saw in episode 1.
In the past far more of our money was created by government, and spent into circulation without creating any debt.
For most of history, inflation was only very slight.
Before we can hope to fix any system we need to understand what the system is.
So, what is the current system?
Well, governments need to pay for services. They pay for the schools & hospitals, they give money to local authorities, they pay the military, and so on. The governments collect taxes to cover these expenses but the amount of tax they get is never enough to cover them.
They make up the shortfall by borrowing from banks and individuals. They have to pay interest on the money they borrow. The total of the money borrowed is known as the National Debt.
The total National Debt in the UK is now about £650 billion, and the annual interest on it is over £31 billion. This works out at an average of about £500 a year for each man, woman and child.
The government’s actions so far have been desperate attempts to stave off the collapse of the banking system, rather than to deal with its primary fault, which has caused the problem, due to its underlying instability.
In doing this, they are rewarding the very people who created the crisis in the first place, while doing little if anything to help the victims.
As I explained in episode 1, the banks create both new money and debt when they make loans; surely, this is legalised counterfeiting!
The banks have, for years, been encouraging individuals and businesses to borrow more and more with offers of credit cards, ‘cheap loans’, re-mortgages, HP agreements, etc.
Reginald McKenna, Chairman of the Board of the Midland Bank, and former Chancellor of the Exchequer, said: “I am afraid that the ordinary citizen will not like to be told that banks can and do create money...And they who control the credit of the nation direct the policy of Governments and hold in the hollow of their hands the destiny of the people”.
If this process of money creation was banned, without doing anything else, the money supply would collapse, even faster than it’s now doing.
However, the government could, and should, compensate for the banks’ failure by creating more of its own money, as it used to.
As Robert Hemphill, one-time Credit Manager of the Federal Reserve Bank of Atlanta said: “If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash, or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless situation is almost incredible -- but there it is.”
The government should, itself, create and spend the money, not to prop up the banks, but on socially valuable things, such as building new schools, hospitals and public transport systems (and fixing the ones we have).
It could also be spent on providing solutions to many of the other problems we face, such as tackling the dependence on oil by funding the development of renewable energy, and the insulation of all homes and offices. All of these measures would create employment and lead to a better future for all of us.
Banks do serve a useful purpose in handling people’s accounts, transferring money between them and taking in or paying out notes and coins.
They should also be able to lend out the money that is deposited with them by savers.
However, they should not be able to lend more than they have in existing assets.
This would be the end of Fractional Reserve Banking.
We use notes and coins far less these days because it’s so much easier to use ‘account-entry’ money, that is, credit or debit cards, cheques, standing orders, direct debits and so on. These are all ways of using money without using notes and coins.
It is no use the government just creating loads of new notes and coins.
There is however no reason why the Bank of England can’t create account-entry money, just as banks do, but then credit it to the government to be spent it into circulation rather than lent.
The money it spends would prop up the ‘failing economy’ and help the surviving banks to get back the money they have already lent out.
The Bank of England is guided by a ‘Monetary Policy Committee’, whose job it is to advise the Bank on adjustments to the ‘Base Lending Rate’ of interest. The Base Rate is the interest rate that the Bank of England charges the commercial banks for their borrowings from it.
The Bank increases the rate to limit inflation and decreases the rate to encourage borrowing.
If you remember from episode 1, banks have to keep a reserve. If they have to hold a bigger reserve, this limits the amount they can lend. If the reserve is allowed to be small, they can lend more. This is the ‘Fractional Reserve Ratio’.
Instead of using the Base Lending Rate as the control, the Bank of England should be adjusting the fractional reserve ratio, which should again be made a legal requirement.
This would limit how much banks could expand the money supply.
The committee (which should be a totally independent body) would advise the Bank of England on how much account-entry money to create and to pass to the government, for it to spend into circulation.
By this method the Bank of England would be able to maintain the amount of money in circulation needed by society.
We need to end the banks’ privilege of money creation.
The debts they create by this process seriously distort the ‘economy’ and the distribution of wealth.
So, in summery, the things that need to happen are:
1. The Government needs to remove the ability of the banks to create money.
2. There needs to be an independent, publicly accountable body set up to oversee the creation and possible removal of money from the system to ensure that there is enough but not too much money in circulation.
3. A mechanism is needed to oversee the transition from the current system.
How to make this change-over will be the subject of the next episode.
I will leave you with one final quote, from Sir Josiah Stamp, who was Director of the Bank of England from 1928 to 1941.
He said, when speaking at the University of Texas in 1927: “The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in iniquity and born in sin. Bankers own the Earth. Take it away from them, but leave them the power to create money, and with the flick of the pen they will create enough money to buy it back again... Take this great power away from them and all great fortunes like mine will disappear, and they ought to disappear, for then this would be a better and happier world to live in. But if you want to continue to be slaves of the banks and pay the cost of your own slavery, then let bankers continue to create money and control credit.” (Sir Josiah was reputed to be the 2nd richest man in Britain at the time)