Economics and Everyday Life – Part Two


Money. We all know what it is, but who creates money? The answer is actually surprising. 97% of money in our economy is created by private banks when they make loans, and this is carried out by these banks simply typing numbers into a computer. In doing so, private banks invariably divert this newly created money into house price bubbles and other forms of financial speculation.

So, in response to this, a campaigning organisation named Positive Money has sought to raise public awareness about such money supply issues, highlighting, in a recent book named Modernising Money(2012), how house price inflation, high levels of personal debt and widening inequality can all be linked to who has the power to create money.

I went to speak with Positive Money’s founder, Ben Dyson, in their London office. I started by asking about the aims and objectives of the organisation.

Ben Dyson: We’re trying to get a banking system that works for society and not against it. We have seen all of the chaos that the financial system has caused over the last few years and since then there hasn’t really been fundamental change. There’s been a lot of tweaking around the edges, but we haven’t actually addressed the root cause of the financial crisis and also the root cause of many of the social and economic problems that we are facing today.

Christopher Daley: So, Positive Money is therefore looking to bring forth quite radical changes rather than tinkering around the edges of monetary reform?

BD: Yeah, we have got some ideas about fundamental things that need to change, which some people say are radical; in reality they have been done in the past. But, it is a big step further than what the authorities have made with regards to fixing the banking system in response to the crisis.

CD: Ok, could you just outline, very quickly, what those big changes you want to see are?

BD: At the moment it’s really about the power to create money and who has this power and how they use it, and if you ask people in the street, most people are under the impression that money can only be created by the government, because that’s what you see on every £10 or £20 note. The reality is that the government only actually creates 3% of all the money that exists. The other 97% is just numbers in a computer system, it’s those numbers you see when you check your bank balance. They don’t represent any real money, they’re just an electronic entry into a computer. What that means is that those numbers are created by banks when they make loans, so when you walk into a bank and take out mortgage, that money is not coming from someone’s life savings, it’s actually created out of nothing. This has implications for almost everything, from debt to poverty to inequality to how much your house costs to whether there is a financial crisis or whether the economy is growing or shrinking. What we’re advocating is that we shouldn’t be leaving the power to create money in the hands of the same banks that caused the financial crisis and we should remove that power from those banks and return it to a democratic, transparent, accountable body that works in the public interest rather than in the short term interests of the financial sector.

CD: So that led me to ask Ben why, in the aftermath of the 2008 financial crisis, these issues surrounding the control of money supply have not featured more prominently in the news. And I also asked whether these debates about money supply have been seen before?

BD: It’s a good question. There used to be huge debates about this a hundred years ago, particularly around the time of the Great Depression as well, and this discussion of money creation was debated by really high profile economists. In the US, when the New Deal was implemented after the Great Depression to get the US economy going again, the only other alternative that was really being considered was the proposal that we have, which is to remove the power to create money from the banks and return it to this body working in the public interest. So, there has been this huge debate and for the last forty or fifty years it has completely died out. There are a few reasons for that, firstly money creation is not taught correctly in universities so people had a flawed understanding of how it worked and they assumed that the whole thing was under control. The financial crisis has shown that this was not the case. Then there has also been a belief within economists that bankers are the best people to decide whether to make a loan and whether to create money or not. We argue that fine let the banks do the business of lending, but when they are also creating money in the process that has huge knock on effects on the rest of the economy. Banks aren’t even thinking about that, they’re not considering these [social] effects at all. So, basically economists have believed that this was the best way to do things and the financial crisis has shown that it isn’t. Because of that there’s now a lot more questioning of how the system works. The guy who used to be responsible for the Financial Services Authority, Adair Turner, has been giving speeches where he has been speaking about some of these issues. Then, about a month ago, Martin Wolf, who is the Chief Economics Commentator for the Financial Times, wrote an article titled: ‘Strip Private Banks of their Power to Create Money.’ He talked about our book and said it’s the kind of thing we need to be doing before the next financial crisis comes. Suddenly there is starting to be much more public debate about this, but it’s still seen as quite radical even though something like this was carried out in 1844 in the UK. At that time, banks had the power to print paper money and over time they started to print too much, for the same reason, the more paper money they printed to lend out the more profit they would make. But, eventually, this caused a financial crisis. So, in 1844 the government passed the law that now makes it illegal for you to print your own paper money, but that law has never been updated to take account for electronic money and this electronic money created by the banks now makes up 97% of the money in the economy.

CD: That’s really fascinating, but the thing that strike me immediately is how did you come up with the idea to form an organisation campaigning on these issues?

BD: Well I was studying economics at university and to be honest finding it not particularly applicable to the real world, it was very abstract and ignored a lot of things that common sense would tell you. One day I was looking through the library for a book on the reading list, but I came across another book called The Grip of Death. The title of that book is a play on the word ‘mortgage’, so if you think about the French, you combine ‘engage’ with ‘mort’, or death. It was a play on the fact that mortgages never used to be a common thing, they were a contract you entered into if you messed up financially and needed to take a loan and the counterpart to that loan was that non-payment would mean your house would be taken. So, mortgages were an emergency measure for people and the book was all about how we had gone from a point where debt wasn’t really a part of life to where debt is just a fact of life – you start your life in debt already from a student loan and then you have more debt from a mortgage. The key thing that this book explained was how money was created by banks and whereas people think it goes into businesses and to helping the economy grow, most of this money actually goes into the property market and financial markets. When I read this back in 2006 it really seemed obvious that this wasn’t a sustainable system and couldn’t last indefinitely. In 2007 the financial crisis started with Northern Rock and some of the banks in the US having problems, and then in 2008 the whole thing really picked up. I thought, at that time, that this issue of who creates money and how they decide to use it would be in the press in no time; MPs would be talking about it, because it was such an obvious thing and at the root of the financial crisis that it would surely be what everybody was talking about. By mid-2009 I got really frustrated by the fact that all the papers were talking about how we had borrowed too much, about how there was too much debt and how we had lived beyond our means, and almost nobody was asking the question ‘where did all this money come from?’ The answer is it doesn’t come from anywhere it’s just created by banks when they make loans. In 2009 I started blogging about this and about a year after we had about 500 people signed up to the blog but I realised there is only so much you can do without proper organisation so I founded Positive Money. We have just grown from there.

CD: How quickly has the organisation grown over the last four or five years?

BD: It’s been about four years since we launched Positive Money and it has grown quicker than we could have really expected, so we now have about 25,000 people on Facebook, about 18,000 signed up to the newsletter, we’ve got 30 groups around the country and it has also spun off to about 17 groups internationally. We’ve had some good successes: we started off realising that the way universities were teaching about money creation and the banking system was about 30 years out of date and that was part of the reason why we ended up with the financial crisis, because the economists and so called experts didn’t understand the basics of banking and the basics of money creation. So, we worked with the New Economics Foundation to produce a book called Where Does Money Come From? . For a while, this was the most accurate source on how money is created – we had to write that because the Bank of England hadn’t released anything explaining how money was created – we had to go through hundreds of documents to piece together this information. A couple of months ago the Bank of England released a paper called Money Creation in the Modern Economy where they basically confirmed everything we said in the book. It’s starting to have an influence on what the authorities are actually using to explain how the system works. A lot of the dangers that we have been warning about like the build up in personal debt, the fact that it was debt that caused the crisis but that’s also the government’s answer to get a recovery again (go out and borrow more, get larger mortgages). So, we’ve been arguing that could lead us into another financial crisis and now Adair Turner has been giving speeches where he has been talking about the same issues – that banks create money, that they don’t use much of it in the real economy, but most of it is for the speculative economy and that this could lead us into another financial crisis.

CD: It’s really interesting that you mentioned house prices there as much of the conversation in the media tends to talk about supply and demand issues, citing low levels of house building, for example, as the prime reason for rising prices. You’re therefore arguing that this is somewhat misleading and instead we should focus on issues surrounding money supply – particularly in this instance the oversupply of mortgage credit by private banks – as one of the major reasons for house price inflation?

BD: If you don’t understand money creation or the fact that every new mortgage creates new money, then your natural assumption is that house prices are going up because there are too many people and not enough houses. Now, there are problems in the UK in that we haven’t been building enough houses to keep up with the population, but it’s interesting to see what has happened in other countries where they have been building lots of houses. For example, in Spain and Ireland, house prices shot up just as quickly as they did in the UK, it resulted in a lot of building and now because they have built more houses than they need in those countries house prices have come crashing down again. In the UK, there is a shortage of housing but there’s also this huge amount of new money which has been created by the banking system and pumped into the housing market. So, 30% of all the money that banks create goes straight into residential property, another 20% goes into commercial property. That’s probably the greater driver of house prices going up – the amount of money banks can create to put into the property market.

CD: You have also tapped into the way economics is taught in universities and that this is somewhat of a problem. As a former economics student could you just elaborate on how economics is taught in universities and what is going wrong?

BD: There’s a lot of different problems and one of the best people to read about this is Professor Steve Keen at Kingston University and his book Debunking Economics. Without generalising too much, economists have spent a long time ignoring the real word, so they make theories about how people behave and how the world works but never test these theories with reality. That’s one of the reasons why in the area that I know best, the creation of money, economics course have been teaching a model of banking that advisors to the Bank of England have been saying is completely inaccurate since the 1980s. They’ve been saying since the eighties that this is the wrong thing to teach, yet if you look at the modern textbooks now, most of them are still teaching this same out of date model which – if it ever did apply – it hasn’t applied for a hundred years. Instead of going to the Bank of England to get the actual documents to find out how it really works today, economists generally, haven’t done that. They’ve been teaching that the amount of money in the economy is completely under the control of the Bank of England or Federal Reserve and they can just put a little bit of money into the system and this get multiplied up and is very controllable. When you look at how the system actually works it is the banks who have the control and the Bank of England has to react to that. So, once you understand that, that [private] banks have control over how much money there is in the economy that raises a whole load of implications, but because it is not taught in universities, the professional economists never question those implications. This is one of the things we are trying to do: getting people to understand that what is being taught is inaccurate and until we get back to a better understanding of how things work we are not going to find an answer to the problems we face today.

CD: To do that, you have produced a book called Modernising Money. Could you just tell us a little bit about what Modernising Money argues precisely?

BD: So, Modernising Money. We’ve basically taken some ideas that came out of the Great Depression of the 1930s and we’ve updated them to account for the fact that we have an electronic money system today. The basic idea is that we should take the power to create money away from the banks and return it to a transparent democratic, accountable body that’s working in the public interest. To do this there’s a number of changes you make behind the scenes to the way that banks work that stops them from being able to make new money. From the perspective of the customer there’s no real big different you will still use your debit card, you will still have an account for the money you want to spend and the money you want to save. But, what it does do is it means that when banks make loans they would no longer create new money, they would actually take money from savers and lend it to borrowers. The question is that if you stop banks from creating most of the money that we use, who is going to create it? The problem with banks creating money is that the more they create the more profit they get because of the more they can lend. If you were to give that power to politicians the problem is the more that they create the more of their manifesto pledges they can pay for. You’ll see in the years running up to the election you get more and more money created and that can be bad for the economy as well. What you need is that the people making the decision about how much money to create do not also get to decide how to spend it, because as soon as they do they can benefit from creating this money. So, you need some kind of body where those people creating money are completely in the public eye, can be held to account by parliament and they also don’t personally benefit from creating money. They decide how much to create, how much the economy needs as whole but they don’t decide where to spend it.

CD: So, in the book you talk about this idea of a Money Creation Committee, which is a centralised committee holding the power to create money. This is an interesting one because I can’t help feeling this is a kind of technocratic solution that might pose a couple of practical problems, notably that its neutrality may come under constant threat from political elites or lobbying groups who wish to push a particular agenda? Secondly, politicians win elections on the back of economic promises. By creating this Money Creation Committee wouldn’t you be running the risk of this organisation vetoing particular government economic pledges that they had made in a manifesto, which may then lead to politicians and the public considering this committee somewhat authoritarian?

BD: No, not really. Firstly, the decision is not ‘the government wants to pay for this, so let’s create some money.’ That’s absolutely not the way you should do it. The question for this body, however you structure it and whoever is on that body is: ‘given the situation of the economy today how much additional money needs to be put in to keep things growing at a steady pace?’ That money then gets transferred to the government and is added to the tax revenue that they get, and whatever they choose to borrow. And it’s not going to be a huge amount of money, it might be an extra 5-10% depending on how the economy is doing at the time, but yet if no money is created because the economy is doing really well the government still has the option to borrow – it doesn’t give the money creation body any control over what the government does, that’s why it’s so important to separate these two decisions. It’s difficult to get any kind of structure that’s perfect, but you’ve got to look at what we’ve got today: we have a monetary policy committee that’s supposed to stop the banks from creating too much money, but because of the way the system has evolved they don’t actually have the tools to control what the banks can do, so you saw they couldn’t stop it getting out of control before the crisis and then after the crisis when the banks had panicked and they stopped lending, they stopped creating new money, there was nothing the Bank of England could do to get them lending again. So we have a system at the moment where it’s the banks that control how much money there is and how much money is created, we have no way of controlling them in the public interest. Within those banks some people have this idea that these banks are made up of networks of local branch managers who understand local business and how to invest in the local economy: that’s a complete fairytale. What we have is these banks where the decision on whether to grant a loan or not is computerised, it’s a tick-box exercise – the computer says yes or no, and the ultimate power in this whole arrangement rests with the guys at the top of the bank because it’s those guys who say either we’re not going to lend at the moment because we want to see what the economy is doing, or we’re going to aggressively lend to try and become the biggest bank in the UK. If the guys at the top decide they’re going to lend aggressively then they pump a lot more newly created money into the economy, but also a lot more debt and that’s what leads to financial crises. So at the moment you have something as important as how to create money in the hands of people who have no interest in the effect it has on society or the economy and that’s the worst possible arrangement you can have.

CD: So where now for Positive Money? Where do you look to go in the next few years with your campaign? What’s forthcoming?

BD: One of the big things we’re doing in the run up to the General Election in 2015 is we want to make sure that we don’t have another election where politicians are making these arguments about what we can spend money on and what we can’t without understanding that money is being created by the banking system every single day. So for example, one of the things that really annoys me is that in 2010 the coalition cut £700 million from the budget to rebuild schools, but at the same time the banks had been creating many times more than that to put into the property bubble. So, we have this weird situation where we’re not allowed to create money to pay for rebuilding schools or for flood defences but we can allow banks to create money to build luxury flats in the centre of London, and this is a crazy situation for us to be in. So we want to try and stimulate this debate about who should be allowed to create money and how should that money be used. Should it be used in the public interest or should it be used to push up house prices and speculate on the financial markets? So in the run up to the election, we’re asking people to email their MPs with some specific questions to make sure that they understand that the banks create 97% of the money that we use, that they create it when they make loans which means that if we want to get more money into the economy, we have to go further into debt with the banks – even though that could lead us into another financial crisis; that most of the money they create doesn’t go to businesses, it goes to the property market and the financial markets and that actually we could change this system if we wanted, we could make it work in the public interest. So we’re really trying to make sure that MPs understand these, actually, quite basic things about money and about the economy, that at the moment most of them don’t understand.

You can find out more about Positive Money through the following links:

Twitter: @PositiveMoneyUK