Martin Wolf, the chief economics commentator at the Financial Times, has recently argued that we should “strip banks of their power to create money”. In his column, he refers to proposals in the book I co-authored, Modernising Money (see below). The book explains how the power to create money can be removed from the banks that caused the financial crisis and returned to a democratic, transparent and accountable body working in the public interest.
Last month, I explained how banks create more than 97% of the money in the economy. This power to create money, in the hands of banks, has been highlighted as one of the root causes of both the Great Depression of the 1930s and the financial crisis of 2007-2009. Even the former chairman of the UK’s Financial Services Authority, Lord Adair Turner, has argued that: “The financial crisis of 2007/08 occurred because we failed to constrain the private financial system’s creation of private credit and money”.
But what can be done to address this problem? Is it possible to democratise the creation of money, and prevent this power being used to blow up house price bubbles and inflate financial markets, as is happening today?
We’ve put forward detailed proposals to do this, based on ideas that originally came out of the Great Depression. Last year a couple of economists at the International Monetary Fund (IMF) modelled a similar proposal for the US economy and found that it could lead to a significant increase in economic growth. There are some variations between different proposals, but the big idea is as follows.
Firstly, banks would lose their power to create money, and the power to create all money, both cash and electronic, would be restricted to the Bank of England. Banks would still be able to lend, but only using money that they had acquired from savers, rather than by creating new money in the form of deposits in people’s bank accounts.
Second, we would separate two crucial functions of modern banks: a) providing the payments system and current accounts, and b) providing savings, investments and loans. In the crisis these two functions were mixed together: the funds in current accounts which people thought were safe were actually backed by risky loans. When the loans went bad, it threatened the existing of the entire payments system on which the real economy depends. This is why we had to use taxpayer funds to rescue the banks. Protecting the all-important payments system from the foolish actions of banks can be done with some relatively simple changes to the rules governing banks, and with very little disruption to customers.
After these changes, the Bank of England would be exclusively responsible for creating as much new money as was necessary to allow the economy to grow, so long as it does not cause inflation. It would manage money creation directly, rather than by using interest rates to influence borrowing behaviour and money creation by banks. Decisions on money creation would be taken independently of government, by the Monetary Policy Committee (or a newly formed Money Creation Committee).
Finally, new money would be transferred to government and injected into the economy through four possible ways:
- 1. to finance additional government spending
- 2. to cut taxes (by substituting for the lost revenue)
- 3. to make direct payments to citizens, with each person able to spend the money as they see fit (or to invest or pay down existing debts)
- 4. to pay down the national debt
A fifth possibility allows the central bank to create money for the express purpose of funding lending to businesses. This money would be lent to banks with the requirement that the funds are only lent to businesses outside the financial sector (rather than property or financial sector companies). The funds could also be lent to other intermediaries, such as business-focussed peer-to-peer lenders. This ensures that a floor can be placed under the level of lending to businesses, guaranteeing support to the real economy.
The transition to a system in which money creation is done in the long-term interests of the wider economy – rather than the short-term interests of the banks – could be as rapid or as gradual as we wanted it to be. But it would have huge benefits. It would mean that economic growth no longer relies on people going ever further into debt to the banks.
It would limit the bubbles which are currently making housing unaffordable in the UK. It would end ‘too big to fail’ in banking and ensure that banks aren’t given special privileges over all other businesses and industries. It would provide more revenue for government, making it possible to reduce taxes. Most importantly, it would ensure that newly created money goes into the real economy, where it can support businesses and create jobs, rather than going into property bubbles and financial market speculation.
Labour should be seriously considering these ideas for its Manifesto in advance of the 2015 general election. The risk is that sticking with our current system, in which money is created by banks when they make loans, will result in ever-rising personal debt, more expensive housing, and ultimately, another banking crisis.
Ben Dyson is the founder of Positive Money [www.positivemoney.org ] and a co-author of “Modernising Money: Why our monetary system is broken, and how it can be fixed“
This is second of two articles by Ben Dyson on modernising our money system. Part 1 can be seen here.