The need to reform how money is created
Private banks create too much money when things go well and too little when the economy is doing poorly and really needs it.
Banks make money out of nothing
By Stevie Downs
June 6, 2023

Banks and money go together like bees and honey. And, as bees make honey, so banks make money from money. But unlike bees that make honey out of pollen, banks make money out of nothing.

Every time they give us a mortgage, grant a loan or issue us with a credit card, they create money. Some 97% of the money in our economy is created in this way; cash only makes up the remainder. Banks are in the business of creating debt. It is how they make their money and they charge interest on their loans.

Unlike manufacturers, farmers or service providers, banks don’t produce anything to make their profits. They create money out of thin air and make their profits through creating debt. Without debt, our economy could not function. But in 2007, the commercial banks created too much debt when they contributed to the housing boom and then its slump in 2008.

When the financial crash hit, the commercial banks (the private sector) stopped lending to one another and the world’s financial system faced collapse. It was the world’s central banks (the public sector) that stepped in to prevent a chronic failure. Central Banks performed the role of guarantors and created the money electronically by entering numbers on a computer screen and hitting ‘send’. It was as simple as that. In so doing, they boosted commercial banks’ reserves and reintroduced trust back into money lending.

From this we see that money can be created at will. Where the banks became too big to fail, the Central Banks bailed them out, when Covid led to lockdowns and supply chain disruption, Central Banks staved off wide-scale closures, and when war resulted in huge energy price increases, central funds were again used to mitigate severity.

But the economic instability in 2007 was as a result of the banks following their business model, of making money out of debt. Private banks create too much money when things go well and too little when the economy is doing poorly and really needs it. It needs Central banks to deal with Covid and sudden energy price hikes.

But private money creation is inextricably linked to interest, leading to mounting debts which may become impossible to repay after a slump. The current system of money creation leads to instability and crisis.

Central banks used quantitative easing to create money and direct it through commercial banks and the financial sector as a way of encouraging economic growth. These public funds would go to banks with the expectation that the money would go into the ‘real’ economy of production and job creation. Instead, for every £1 of those funds, only 8 pence of it found its way to the real economy. The rest of it remained within the financial sector in speculation, causing large housing price increases and increases in share indexes.

The main objective and in many cases, the sole purpose of private banks is to maximize profits and not, as should be the case from a public interest point of view, to provide society with the money supply needed for an optimally functioning economy.

Functioning optimally does not mean maximum wealth creation through maximum efficiency – the implicit and sometimes explicit purpose of mainstream economics. From a public interest perspective functioning optimally means achieving public goals as effectively and efficiently as possible. Goals such as providing everyone’s basic needs, creating equal opportunities for all, optimizing well-being, and the sustainable use of natural resources so they’ll be available for both current and future generations.

These goals are incompatible with the profit maximization of private banks.

The current monetary system, where money is created by commercial banks to make a profit, has resulted in the odd situation that money is created only for profitable activities. From a public interest perspective, it may be very important for a government to invest in, for example, better education, a healthier environment, good quality health care and disease prevention and the development and application of renewable energy.

But if such investments are not profitable, no money is created for it. Instead the state has to raise money by taxing or borrowing. It can do so only to a limited extent because it has to finance so much more and, especially after the crisis, already lacks the money to do that.

A major obstacle to monetary reform is mainstream economic science. The belief that market forces will ensure that banks create the right amount of money for an optimally functioning economy leads to the current monetary system not even being questioned. So strong is this belief in markets that even the enormous problems caused by the crisis of 2008 have given economists no cause to look for alternatives.

There is another way.

Money creation should be removed from commercial banks and given to an independent monetary authority. Such a system would allow bringing new money into the economy without creating debt. It would also enable the control of money supply to be placed within a democratic framework and therefore under some public control and scrutiny.

Money creation is a public service which should be under the control of the state.

We are told that the major problem in addressing society’s environmental, social and economic problems is lack of money. That is irrational: since money can in principle be created at will, the lack of it should never be an obstacle to addressing society’s challenges.

Stevie Downs

Stevie downs is an activist and a member of Positive Money, a not-for-profit research and campaigning organisation based in London.