Session 2:Money and Banking

Mary Mellor

Summary Session 1

• Money reflects a relationship between people, it is not a ‘thing’ like gold or silver

• States were once major issuers of money – particularly cash (notes and coin)

• Banks have taken over that role• States have become borrowers like everyone

else

Money and Banking are not Evil

• Money and banking are social systems that have emerged historically

• Their flaws are not due to evil intent or a conscious conspiracy, although participants have benefitted hugely and there is greed and some fraud

• Need to understand the flaws in the system to achieve effective change

Banking is very old

• Emerged in Egyptian and Babylonian times • Based on records of ownership of collectively

held goods such as herds of cattle and crops stored in common silos

• Early hieroglyphics were records of ownership and payments such as taxes. Records could be used to pay for other goods or debts

• Relative values based on standard measures e.g.240 grains of barley

Banking is very old

• Ownership was exchanged through a ‘giro’ system of transfer of ownership records

• 1770 BCE Code of Hammurabi - banking regulations on the conduct of lenders and borrowers and payment of interest etc.

• Accounts of ownership, transfers, debt, payments etc. was much more important than the actual means of payment which could vary

What is a Bank?

• Somewhere to keep our money safe• A means of transferring money around• A lender of money• A discounter of debts• An underwriter for investments• A business borrowing and investing its own

money• These functions can be separated or combined

(universal banks)

Banks Also Create Money

• ‘the process by which banks create money is so simple that the mind is repelled’

• (John Kenneth Galbraith, 1975 Money: Whence it came and Where it went Penguin, London p. 29)

Money must be Issued

• Money does not just appear in society – it must be issued

• Historically states have issued money (in various forms from cash to tally sticks) through state expenditure and tax demands

• Banks have issued money as discounts on financial exchanges (paying out ahead of future payment) or as direct loans

The Banking Illusion

• Is that banks are intermediaries taking in deposits and lending them out to borrowers

• But deposits are ‘on demand’ they must be returned if requested – even time deposits (savings)

• How can money be in two places at once?• Where did the deposits come from anyway?

The Gold Story

• People deposited gold/silver (where did they get that from?) – and got a record of deposit

• The gold/silver was lent out to other people at interest – later as a paper record

• Bankers ‘cheated’ by creating much more paper than gold i.e. they lent money they didn’t have (fractional reserve banking)

• Assumes only gold/silver is money

Commercial Banking

• European banks emerged in early medieval Italy serving states, traders and the rich

• 14th century adoption of double entry book-keeping for transfer of payments

• Safe storage of precious money and other valuables – recorded on notes of deposit

• Early banking based on personal trust of the trader/banker – the bond –

Commercial Banking

• Notes recording money deposited circulated widely and later banks issued deposit notes for money borrowed as well - greatly expanding money supply

• Rulers short of money also borrowed metal and paper money (central to funding wars – often defaulted)

Commercial Banking

• Banks acted as intermediary for trade by paying trader 1 out on trader 2’s promissory notes for less than face value (discounting) and collecting full amount from trader 2 later

• Banks enabled external trade through bills of exchange (paying out in different currencies and across distances)

• Relied on family networks across countries

National Debt

• Banks become major lenders to rulers e.g. in Europe the Medici, Rothschild, Barings

• 1694 Bank of England set up to fund wars against France lent King £1.2million at 8% but demanded Parliament be responsible for repayment (private company until 1946)

• This became a National Debt to the private sector as issuers of money as debt

Why Didn’t the King Issue his own Money?

• Basing money on a valuable commodity (gold/silver) made holders of that commodity very powerful

• Often the metal had gone abroad• Huge shortages of precious metal anyway• Crown could not issue its own money in any

other form (e.g. tally sticks) as it had run out of credit/tax capability

UK National Debt

• 1694 £1.2 million (8% interest)• 1816 237% GDP• 1914 25% GDP• 1919 135% GDP• 1937 150% GDP• 1947 238% GDP• 1992 25% GDP

UK National Debt

• Pre-crisis 40% GDP• Post crisis 70-80% (60% excluding bailout)• (Japan 200%, Singapore 105%)• 1920 interest 7% • 1980 interest 5% • 2011 interest 2.0 - 4.0% • Negative interest rates UK, US, Germany

National Debts and Deficits

• Deficit: more expenditure than tax take, need to increase overall national debt

• A Structural Deficit is one that persists• Is that a problem? Yes if you see the state as a

household that borrows externally• No if state uses its money creation power to

‘monetise’ the debt rather than borrow – and tax the money back later (if necessary)

Modern Banking

• Over time early private commercial credit-debt relations became ‘monetised’ i.e. people now trusted the paper record money itself rather than the personal/private system of credit-debt that lay behind it

• Still many banks failed • This (eventually) brought bank money into the

sphere of government responsibility

Linking State and Banks

• State money (fiat) and trade money (bank paper) came together in the modern banking system when the commercial bank paper system became authorised as legal tender through the invention of bank notes that could circulate as cash guaranteed by the state ‘ I promise to pay’

• The Bank of England (a private organisation) had the monopoly of the issue of bank notes

‘Real’ Money and Bank Money

• Idea that original deposits are real money: bank money is different ‘credit money’

• Where does real money come from?• Previously circulating money• Where did that come from? Good Question• Argument that real money can only come from

the state (via the central bank) –base money – high powered money – narrow money

Banking Versus Currency Schools

• Currency School – real money is bank notes that are limited (e.g. linked to gold)

• Banking School – bank note issue should reflect needs of the economy

• 1844 Banking Act: Currency School won the battle, bank note issue was to be limited –Banking School won the war – ‘sight’ accounts were not limited – now 97% of money

The Multiplier Theory

• Banks are allowed to lend multiples of ‘base’ money (e.g. 10 times)

• They must hold a proportion of deposits as reserves (e.g. 10%) – fractional reserve banking

• But states now issue little money (cash)…….what is going on?

Banks Create Money

• Banks create money by making loans• Every time they make a loan they create new

money by setting up a deposit account• This money gets transferred to other deposit

accounts (and then becomes ‘real’ money?)• The amount of money created depends on

demand (people/businesses/ governments who want to borrow) and the bank’s willingness to lend

Money from ‘fresh air’

• Loans created as sight accounts are ‘fresh air’ money - ‘fountain pen money’ (Tobin, James 1963:408 ‘Commercial Banks and Creators of Money’, in D. Carson (ed), Banking and Monetary Studies, Unwin)

• By 1990s nearly all UK money issue was through the banking system as loans (personal, government, business)

• State attempts to control supply (monetarism) failed

Money Issue as Debt

• Bank loans have always been central to capitalism as they enable the productive process to start (the money circuit)

• Main growth recently personal/household loans and financial speculation

• 1969-2009 Annual increase in UK broad money supply was roughly equivalent to the increase in debt owed by the public each year (James Robertson Future Money forthcoming)

Instability of Debt-based Money

• Money supply must constantly expand if debt with interest is to be repaid

• Debt–based money issue must drive growth –need to repay debts demands constantly increasing economic activity

• Money supply always threatened by a credit crunch – contraction of available money

The Bank’s Problem

• Depositors think their money is invested – yet expect it back on demand

• Banks must make a surplus/profit• Reserves/capital (retained profits and original

equity) is dead money• Assets (loans and investments) are long term

and can be risky• Liabilities are ‘short’ (demand deposits) while

assets are ‘long’ (loan maturity)

Bank Liquidity - Solvency

• Banks are always susceptible to loss of confidence and a ‘run’ - the notion of a reserve is meaningless in a crisis

• Liquidity is the amount of cash or near cash available to the bank (often very low)- Central banks lend them money if necessary

• Insolvency is when assets (including bank’s own capital) do not match liabilities

Are all banks affected?

• US Glass-Steagall 1933 separated deposit and investment functions after 1929 Crash – but de-regulated in recent years

• Early mass banking was often in non-commercial banks. In 1970 UK building society deposits were larger than bank deposits

• However all types of banks got caught up in the recent speculative whirlwind German state banks, British building societies

States Lose Control

• Many states have lost control of money creation and the whole money system, particularly after the deregulation of banking

• Bank issued money has vastly increased the money supply - this has caused inflation – mainly in the financial sector- where it is called capital growth or asset appreciation

• As the national money supply is now based on bank issued debt it is subject to crisis

State Responsibility

• The public clearly sees the state as responsible for the banking system : Northern Rock, Icesave, Ireland, eurozone, IMF

• States now have to take on ‘sovereign debt’ to rescue private debt – ironically borrowed from the self-same banks and ‘money markets

• States are even seen as responsible for the avalanche of debt – hence austerity

State Responsibility

• It is impossible to distinguish different types of money – there is no ‘real’ money.

• In a systemic crisis the whole money system must be supported (Lehman Brothers)

• State responsibility for the integrity of its national money means it has to continually bail out the privatised money system

• Major problem if borrowings are in another currency

Undermining the Public

• The public sector is seen as parasitic on the private ‘money creating’ sector - yet it underpins it

• All money is based on legal tender which the state underwrites

• States and monetary authorities support to financial sector at least $15 trillion worldwide

• Countries bankrupted: Iceland financial sector 10X GDP - UK 5 X GDP (RBS alone = GDP)

Debt cannot fund a Money System

• Debt based money issue demands constant money supply growth to repay debts with interest

• Without such growth money supply will rapidly shrink as debts are repaid

• Somewhere in the system money must be issued that is not reclaimed by the issuer – debt-free and tax-free state money or unpaid debt (Jubilee) – default ‘haircut’

State Money Versus Bank Money

• Distinctiveness of state issued money is that it can be issued debt free (although subject to tax to prevent inflation)

• All bank issued money has to be repaid with interest (debt)

• As money needs to be issued bank debt money or state fiat money must start the process of money circulation

Quantitative Easing

• Issue of debt free state electronic money • Used to buy back government debt : selling

government debt removes money from the economy: Buying back government debt increases money supply

• QE has been issued via the financial sector instead of putting the money directly into the productive economy or public infrastructure

Summary: The Public Nature of Money

• The financial system is not private• It administers a public resource – money as

legal tender • Its final resource is the taxation/money issue

capacity of states• Yet tax avoidance/off-shoring is rife even given

excessive remuneration – undermining the capacity of states to support the sector

Money as a Public Resource

• Money should be seen as a ‘commons’ social resource like air or water is a natural resource

• Need to reclaim money as a debt-free public resource with democratically determined priorities

• Money issue and banking should be a public service under public control

• Could then create the possibility of a socially just, sufficiency economy