Why does money need to be created by the state?

by | Mar 28, 2015 | Blog | 0 comments

Paper and coin money as we know it, is but one leg of broad money. Most of us use the word money to denote the currency notes and coins in circulation, yet these constitute about or less that 5% of the total money, depending on the jurisdiction. This is government created money, through the reserve bank.

The other money is created from debt contracts (credit money or loans) between banks and borrowers. This money is then transformed into public money via the link banks have with reserve bank. New money is thus created through loans given to borrowers as deposits in the hands of borrowers. Banks do not necessarily intermediate between savers and borrowers, as postulated by the Financial Intermediation Theory and the Fractional Reserve Theory (they don’t necessarily lend money that is saved). Money created through this process of loans is spent out there as public money. It is this money (the +95%) that is created by banks from “nothing” or from “thin air”, ex nihilo.

But what does all this mean in real life? As an example, the mortgage bond you have with your bank is money the bank lent you that was just created by way of a book entry. It is not that the bank sweated for it, yet you are charged interest and they resposses your property should you fail to honour the debt contract. This is true for any other debt contract you enter into with your bank. For both individuals and companies, private banks engage in this sort of money creation from thin air. Furthermore, banks can chose who to lend, thus having given themselves the power to allocate or not allocate this precious resource. And since banks are motivated by profit, credit allocation can only be to those they deem fit, naturally not in the public interest. As we have noted in the recent past, this power has been used by banks despotically and sometimes to the detriment of the entire economy.

Recent cases of banks defrauding the general public with a view to maximising their profits are too many to count. Why should this right to create money be exclusively given to very few institutions? Why have this and other governments (actually parliaments) franchised out the production of money to very few institutions, yet the proceeds of such a franchise do not accrue to the people? MONEY AND DEMOCRACY? Since the abandonment of the gold standard and the Brettonwoods system in early 1970s, there has been unprecedented expansion of finance as a result of the conversion of these billions upon billions worth of debt contracts into currency. And with it has been the expansion of power, corporate or personal by those that have acquired the right to create money. But also, modern capitalism is finance based, hence the term financial capitalism.

Capitalism, especially this type of capitalism is a great source of power, perhaps differential power. Crucially, in modern democracies, whoever has the power to create and control money has the power to direct affairs of the nation. Yet, this power is outside democratic control. Where affairs of any nation are in the hands of powers outside democratic control, it is the interests of those powers that will be served. There can be, and are deleterious consequences that result from this private control of key lever of economic growth and equity. South Africa and Africa have for far too long been controlled from without. If from within there are yet non democratic powers that control the allocation of resources, there can never be any realistic chance to change the economic and social fortunes of the citizenry. It is for these and many other reasons that we say, lets remove the power to create money from private banks to the people, so that the nation as a whole can benefit from this act of creating money.

Redge Nkosi: Founder & Executive Director of Firstsource Money and Public Banking of South Africa. He has previously worked for both central government and private sector. His intellectual focus is in Macroeconomics, Money & Banking & Development Economics. His last qualification is an MBA.