You wish to buy a house, but can’t afford one – a predicament many face. You approach the bank for a loan, repayable over 25 years. You’d think that the money the bank has loaned is actually other customer’s savings that is held in some ‘physical’ form, yet you’d be wrong. In reality, when the bank made this loan they created the money by inputting numbers into a spreadsheet; bank-created money accounts for over 97% of money in circulation today.
Effectively this means 97% of our money is also debt. When times are good people pay down their debts and the amount of money in circulation shrinks, along with the economy. Government desires to rid household debt is almost impossible; to do so would shrink our economy and wipe out almost all of the money in circulation.
Moreover, history has shown banks are not fair distributors of money; they create too much money (through reckless lending) in a push for profits and most of the money they create is speculated on financial markets and asset bubbles, fuelling the housing crisis. Regulations have proven to not be worth the paper they are written upon, because banks know that no matter how recklessly they lend, they must be bailed out because many people would lose their savings and no government could allow this. Thus the banking sector is a neither free, nor fair, market; its lending is largely monopolised and it is people outside the financial sector that pay the price for its reckless decisions.
This is why the task we face is clear: make banking a genuinely free and fair market. To do this the solution is straightforward – take the power to create money away from high-street banks and put it in the hands of an independent body that is accountable to the government. The money this body creates would be debt-free, and thus could be genuinely invested into infrastructure and jobs, without adding to the pre-existing insurmountable mountain of debt.
I won’t go into the quirks of how such a system would work as a) I’m no expert and b) that would go beyond the word limit of this site, but of course this change would have profound effects for banking. It would not mean banks cease to be important; they are a legitimate means of distributing money in our economy, but they would now have to do so within the limits of the money they hold. To do this, whilst preventing banking remaining a ‘too big to fail’ market, you would have to create a type of bank account that enables money to be stored without gaining interest but without being loaned out, so the money would always remain the customer’s property. If the bank went bust the customer’s money would be safe. There would also be an ‘investment’ account; where deposited money would accumulate interest, with the risk that this money could be loaned out and the customer could get no return, or even suffer a loss on their investment. This would allow the banks and financial speculators to speculate, without risking the savings of those who could least afford to gamble.
Clearly there are benefits in creating a free market for banking, and this article cannot claim to explain them all. I intend to explore these benefits more fully in a future article, and am keen to hear other Liberal Democrats’ opinions on this policy. I would highly recommend reading Modernising Money by Andrew Jackson and Ben Dyson to see a more elaborate description of our current system and what it should be replaced with; most of this article is based upon their recommendations. Positive Money UK is also running an excellent campaign calling for this change to the banking system.
But, for now, recent history shows us the current banking system is neither a free, nor fair, market; something that any liberal should deplore. Taking the power to create money away from banks is the only way to make banking a genuinely free, and fair, market.
* Callum Gurr is a member of the Thanet Liberal Democrats branch and the Policy Officer of the University of Birmingham Liberal Democrats.
Follow @libdemvoice.org on Bluesky
Like us on Facebook
Subscribe to our feed
Sign-up for our daily email digest
How Chancellor Reeves torpedoed the economy
The Disneyfication of Haley Mills
Survation now put Andy Burnham 10 points ahead in Makerfield
Michael Meadowcroft: A Liberal of Intellectual Rigour and Uncommon Integrity
Chris Cory
Ruth Bright
BigTallTim
Daniel Walker
Richard Good
20 Comments
Thank you for an outstandingly important article.
Ellen Brown is also well worth reading as is Michael Hudson.
A different type of bank, as suggested, would also provide much needed genuine competition and real market choice.
This one again…
Lots of issues mixed up together. I get the word limit on LDV is restrictive but surely articles could be allowed to exceed every so often so that the article ca do more than “read this book” and “read this website” it really doesn’t help some of the more meaty topics that need discussing get a decent discussion. The current word limit is good for many topics to keep discussion disciplined and focused but there are times major issues need more than that.
The banking market is not how liberals would design it as it is clearly not a free market and aspects of it have the incentives misaligned. There is plenty to discuss in these terms but the claim that “abolishing fractional reserve banking will sort it all out” never seems very credible.
The question arises – who do you give the new money to if not the banks. I suggest it is given to the government who can either spend it or give it to citizens for them to spend.
Banks have always created money back to the Lombard banking houses who were given gold and then issued paper money. They soon learnt that they could issue more paper money than they had gold to cover, because many people never returned the paper to exchange for gold.
If you believe that bank regulation can’t be enforced how do you ensure banks don’t lend more money than is invested in them? The only solution seems to be to nationalise them so they are run in the way you wish them to be. Then only to allow individuals or credit unions to lend money and to go bust when they fail.
Thank you for an interesting article which addresses a fundamental of economics.
Ellen Brown and Michael Hudson are worth reading too.
A national basic bank would provide a genuine market choice and real competition.
A basic “Vanilla” banking system such as that of The Bank of North Dakota, USA, which is state owned, efficient and never “bailed out or in” is a good functioning example to follow.
It has been done already!
Thank you for all the comments so far.
Psi – I completely agree re word limit and whilst I am thankful to LD Voice for allowing me to publish this article I believe the word limit has made this a weaker article than a more flexible limit would have done. On the ‘fractional reserve banking will solve everything’ point – I’m not trying to claim this, I just believe we could see less hard-hitting busts than we currently do because the ‘boom’ would not be built upon quicksand
Michael BG – excellent points but the point is it would be against the law for the banks to create money under this proposal, that would be the deterrent I’d hope
Steve Trevethan – I will be sure to check out those works and the Bank of North Dakota example
Callum
What is the problem that you are proposing a solution to?
David Evershed – Mainly the problem of the catastrophic lending decisions often undertaken by banks that lead to devastating economic consequences for the rest of the population, yet the banks pay little price for that. In a free market a failed bank would be allowed to fail and go bust, but it would be political suicide to do that under the current system.
A brave and important article.
The City and big banks have held our economy to ransom over and over again, only for the state to bail them out without any mandate.
Until we have an open market in every private sector we won’t have access to the heights of the economy in any real or democratic way.
Democratising the ownership and supply of money is a fundamental step towards a fairer economy based around people’s needs and aspirations rather than debt. Rewarding producers with interest-free loans (abolishing usury) and rolling back the creed of consumerism is, IMO, a worthy goal.
This would effectively revolutionise the capitalist system we live in.
What’s you’re referring to Mr Gurr, is a cryptocurrency backed up by the state. Cryptocurrencies are entirely under the control of the owner with no bank intermediary required as in the current monetary system.
Or you could go in the opposite direction: http://oll.libertyfund.org/titles/selgin-the-theory-of-free-banking-money-supply-under-competitive-note-issue
Sorry, Psi, to do a ‘just read this website’.
The best way to avoid busts and booms is to have a level target for the growth of nominal income (ie Nominal GDP).
Forgive the second comment but a comment with two links probably triggers the automatic moderation button.
Scott Sumner has recently provided a short intro to NGDP level targeting here: http://www.themoneyillusion.com/?p=32339
The idea of a national investment bank financing infrastructures and manufacturing is not really free market, it is state intervention to redirect capital flow to productive ventures, but Britain is really in need of that kind of bank. Actually that idea was proposed by Keynes in 1928 and was known as National Investment Board.
A socially owned bank acting as a competitor would also be a start but doesn’t fully address the problem of big finance holding a monopoly on the economy. Interest has grown to resemble a form of blackmail, where the banks create money out of nothing and charge us for the privilege. To start making the economy more democratic we’d do well to tackle the injustices touched upon here – even if money’s the root problem.
“take the power to create money away from high-street banks and put it in the hands of an independent body that is accountable to the government”
So the Bank of England?
@ Callum Gurr and PSI
The word limit on articles is often exceeded. I suppose it depends on who is the daily editor on how flexible LDV is.
@ Callum Gurr
If you wish do it via legislation rather than regulation you need to state why it is not possible to make the current regulations into law. Also you need to state how the government would check every bank to ensure it wasn’t lending more than people invested while you state that they can’t check the banks under the current regulation which sets how much they need to keep back.
Callum – You explain that it is bad lending decisions due to the failure of baks to pay a price which is the problem to which you are proposing a solution.
Bank owners (the shareholders) have paid a high price for the bad lending and lending at interest rates too low for the risk. Sharehoders in Alliance and Leicester, Northern Rock and Bradford and Bingley have lost all their investment. Whilst shareholders in RBS, HBOS (Halifax/Bank of Scotland), and Lloyds have lost 90 – 95% of their investment.
It is the bank depositors and customers who have been saved by the government bailouts not the owners.
Ownership of banks by the government would not make lending decisions any better.
Had the Labour government left bank supervision with the Bank of England instead of setting up a new weak FSA to take it over, then i believe the problem would have been less severe. Supervision is now back with the Bankd of England and bank capital reserves are now nearly twice as high, which means government should not have to step in in future.
As one who had been interested in “seignorage reform” as it was then usually called before the marketing machine that is “Positive Money” got a hold of it, I have some sympathy with the idea.
But it’s not the best way out of this iniquitous and mostly fraudulent money system we have. When Charles I promulgated his Statute of Monopolies he left money out because they had already discovered how state controlled money gives governments, and so those who would rule us and interfere with our economic welfare and decision making much power.
I no more trust a body “accountable to government” to create our money than I do the venal operators of the square mile. So I’d be more radical. If bankers want to create quasi money, let them do it, but let it be their own currency – the Barc, or the Honker, or the valueless RoBaS 🙂 And let them fail when or if they fail to maintain the value of their scrip: https://geomutualist.review/a-new-financial-operating-system-an-open-source-alternative/
And then at the other end of the scale, mutual banking along the lines promoted by Pierre-Jospeh Proudhon or W B Greene: https://geomutualist.review/mutual-banking-william-batchelder-greene/
And of course, there is a chicken and egg issue here too. Much of our money is backed by land, mortgages. The availability of easy credit has pushed up land values probably more than anything else. If the right to collect the future increases in ground rent were not privatised as it is, bankers would not be able to create this money. Positive Money is a response to a symptom. Land reform to take that source of credit creation away permanently is probably the more important.
Jock Coats – Agree
David Evershed – State control of capital flows and keeping interest rates artificially low for industrial businesses at least direct funding to industries and other productive sectors instead of speculative ventures. They were among the chief policies of all countries that succeeded in getting pass the middle-income trap to join the developed country group during the last century (like South Korea under Park). Both are illiberal to the extreme, but are indispensable for countries that want to industrialize or reindustrialize. The UK would need these kinds of policies if it wants to rebuild its manufacturing.
I’m no economist (fortunately) but is the premise that banks “create” money correct? I know that central banks do, but not high street or merchant banks which is who I assume you are referring to.
The high street or merchant banks borrow money on the money markets or from central banks, and then lend it to others. When they get it right they profit by charging a higher interest rate to their customers than they pay to the central bank or the money markets, whilst also not lending to people who later fail to pay it back.
The 2008 crash happened because they got the last bit wrong, and so were no longer able to meet their obligations to pay interest on the money they borrowed and give money back to savers.
They weren’t able to just simply create more money to meet these obligations, so central banks did and in general in the UK the high street and central banks were refinanced by the Government buying large stakes in the banks in exchange for the money that the Bank of England created.
But I’m pretty sure Barclays, Lloyds, HSBC etc. don’t have their own printing presses to create money, not even in a virtual “spreadsheet” sense.
Nick Baird
“is the premise that banks “create” money correct?”
A more realistic description is that the process of banking creates additional money and at times destroys money. The amount that the process creates is obviously heavily affected by other factors. Often the way this is explained makes it sound like the bank just have a spread sheet where they just add some new digits and wooo hooo bonus time, but no it isn’t quite like that.