A review of ‘Where Does Money Come From?’ (2nd edition 2012). By Josh Ryan-Collins, Tony Greenham, Richard Werner and Andrew Jackson. New Economics Foundation.
Money is at the source of the greatest misconceptions in economics, amongst the general public, trained economists and professional financiers. And yet a proper understanding of money is key to grasping the nature of the enormous economic problems that face us – financial crises, recession, government spending, austerity and unemployment.
The simplest way to view money is through the metaphor of a commodity – a special commodity which we can use to exchange for other goods. This makes intuitive sense in terms of understanding everyday life. We work, and we earn this ‘thing’ or ‘substance’ called money, which we can exchange for other things, for our shopping, clothes, holidays and so forth.
The problem with this view of money is that it is wrong, based on an incorrect understanding of finance that reaches right into the depths of economic theory.
A new book, ‘Where Does Money Come From?’ published by the New Economics Foundation sets out the nature of money and the working of the UK financial system in a way that is concise, easy to follow and highly readable. Early on we are shown how widely misunderstood the true nature of the banking system is.
According to a poll conducted by ICM in 2010 as many as 33% of the UK public understand banks essentially as ‘piggy banks’, that simply store the money deposited with them, without doing anything with it.
And 77% believe that the money that they deposit with banks legally belongs to them, not to the banks. The majority of the public see the banks as financial intermediaries, taking our money in the form of deposits and lending it on, a view set forth in many a textbook.
The authors present an alternative view of money as debt, using what could be described as the metaphor of the IOU. The deposits which we hold in the bank comprise the IOUs of the bank, money which the bank owes us. And it is these IOUs which we use in our daily transactions – and to pay our taxes.
Some 97% of the volume of transactions in the UK now involves direct bank transfers, where no physical cash changes hands. The book explains how the banks create money, more or less out of thin air, and the role that the government and the Bank of England play in the process, anchoring and underwriting the financial system, and ensuring the general acceptability of the currency via taxation – the fact that we need pounds to pay our taxes means that we are also content to use them for all our other transactions.
Whilst standard economic textbooks have central banks setting money supply, we see here that it’s actually the private sector banks that are calling the shots. Central banks supply the private banks with reserves in order to prop up the system, which is set up in such a way as to leave them with little choice.
We also learn how regulatory approaches over the past three decades or so have failed to achieve their stated goals, how effectively regulators have been barking up the wrong tree. As a result banks have been incentivized to neglect investment in creative ventures, preferring to pour money into existing assets, leading to asset price bubbles. And this is at the root of the global crisis that erupted in the Autumn of 2008.
Whilst the book does not present a specific policy blueprint, the concluding chapter outlines a number of potential approaches (which are not mutually exclusive) to rebuilding a financial system that would be more socially useful, and these approaches encompass alternatives to government spending funded through taxation and borrowing from the markets.
The debate about fixing what is wrong with finance is key to building a more just and equitable society and it is important that this debate is not restricted to a narrow circle. Where Does Money Come From? is a must-read for anyone concerned about social justice and building a sustainable economy.
Tanweer Ali is a finance lecturer with the State University of New York, currently based in Prague
photo: S Taggart, Roseville, California, USA