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Chapter 8: Objections to Monetary Reform

Many people simply do not believe that the private banking system creates nearly all of our money.

“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.” John Kenneth Galbraith (1908- ), former professor of economics at Harvard, writing in ‘Money: Whence it came, where it went’ (1975)”
The above quotation is one of several that can be found on Anne Belsey’s site: www.moneyreformparty.org.uk

Ignorance and confusion about how new money is now created.


Many people, even in government and parliament, don't know how new money is now created, and what the consequences are.  Most people find it hard to believe, if they think about it at all, that almost all the money in circulation has been created by commercial banks at profit to themselves. In reply to questions, a government spokesman may say that the funds which banks lend to customers “must either be obtained from depositors or the sterling money market, both of which usually require the payment of interest” - thus appearing to deny that banks are allowed to create new money and to profit from doing so.
 
Simon Hughes MP wrote to a constituent on 20 November 2001 that "banks don't print money but create credit".19 More often, however, the government accepts that banks create money and defends this by saying that "if banks were obliged to bid for funds from lenders in order to make loans to their customers, the costs to banks of extending credit would rise significantly." 20
 
Two recent parliamentary Early Day Motions - EDM 1515 on "Using The Public Credit" by Austin Mitchell MP on 26 June 2002 and EDM 854 on "Publicly Created Money And Monetary Reform" by David Chaytor MP on 10 March 2003,21  indicate a growing Parliamentary awareness of the facts – an awareness which David Boyle on "The Strange Rebirth of a Forgotten Idea" (New Statesman, 7 April 2003) helped to spread more widely.
 
People who are in any doubt about how money is created might glance at Chapter 22-3 of a current 'students' bible' on economics.22 It explains "how banks create money" and that "bank-created deposit money is much the largest part of the money supply in modern economies".
 
The action needed is to press Treasury Ministers and the Bank of England to clarify and publicise
  • how almost all new money is now created,
  • who benefits and who suffers thereby, and
  • whether or not the estimates of an annual hidden subsidy of more than £20bn to the banks, and a failure to collect more than £40bn potential public revenue, are broadly correct.
19 I am grateful to Canon Peter Challen for this information.
20 Letter to Archie Norman MP from Treasury Minister Melanie Johnson, 18 October 2000. I am grateful to Brian Leslie for this information.21 These will be found at .
22 David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, McGraw-Hill, 7th edition, 2003, pp 316 and 318.
www.jamesrobertson.com James Robertson & John Bunzl: Monetary Reform - Making it Happen34
 
The above paragraphs are taken from James Robertson's” book on monetary reform.
See www.jamesrobertson.com for a full discussion on the subject.
 
Perhaps the most remarkable example of misunderstanding in the author’s experience was contained in a letter he received in December 1989 from the then Chancellor, John Major, in reply to a proposal the author had made for monetary reform.
 
“Mr Davies states that no bank should be allowed to lend money it has not received from someone else. But no bank would ever do this. Banks can only lend what is deposited with them. Doing anything else would entail cooking their books and would bring the supervisors or the Fraud Squad in in double quick time.”
 
Every elementary economics text book contains a description of how the money supply increases. Most of these describe “the multiplier” which allows banks to lend a multiple of any new “Base” money they receive. Base money is a deposit at the Central Bank or currency notes. The use of base money as a control on the amount of new credit (effectively new money) that banks can create is part of the monetary system in the USA but there is no such formal system in the UK where the liquidity ratio takes its place. See chapters 2 and 6.
 
Descriptions of monetary control in economics text books tend to be confusing and difficult to understand but the fact that banks can and do create our money is clear. In the UK it can be summarised as being limited only by the demand for new loans by people with the necessary collateral and able to pay the interest and capital.
 

If banks can create money why did they not create enough to solve their problems?

 
This seems a serious objection but if you think about the way the money is created the answer becomes clear. In the first place banks can only create new money in the form of loans and they cannot reasonably lend money to themselves. Banks may own the companies to which they loan money but such investments are not liquid assets, they have to be sold before the proceeds can be used to bail out the banks.
 
The banks like the Royal Bank of Scotland that have failed had plenty of assets in the form of loans but very few loans on call. The assets had long maturity dates and in many cases were also of doubtful probity.
 
The ability of banks to create new money depends on the faith people have in their ability to pay back deposits on demand. They do not have to pay in gold or silver but they do have to pay in currency or by credit to another bank in the interbank system. In 2007 a number of banks were no longer trusted by their fellow banks. In the case of Northern Rock they were no longer trusted by their depositors and the interbank market was closed to them.
 
So some banks were no longer trusted by either their depositors or their fellow bankers and as their money was only as good as the faith people had in them their ability to create counterfeit money went in a puff of smoke.
 
Some failed banks were considered “too big to fail” and the government stepped in to save them because their failure would have destroyed vast amounts of money belonging to other people, as happened in he 1930’s, and would have brought down other banks in a chain reaction.
 
In the words of J K Galbraith the way in which money can be created by banks is so simple as to repel the mind, but it is also only as good as their reputation. Good reputations take many years to grow, like a great tree, but can be destroyed in a few minutes.