Friday, 21 July 2017

Private money creation and private debts.

It might seem that private banks perform a useful function in creating and lending out money. And indeed they do, assuming the state does not create an adequate amount of money. Indeed the latter deficiency arguably existed under the gold standard: i.e. in the 1800s the amount of gold could not be expanded fast enough to keep pace with rapidly expanding output in the countries which were then industrialising.

However, nowadays things are very different: we have a flexible monetary base. Or put another way, governments and their central banks (i.e. “the state”) can print and spend any amount of money into the economy. So does private money printing serve a purpose any longer? Arguably it does not, and for the following reasons.

The state can, at least in theory, create and distribute whatever amount of money is needed to keep an economy ticking over at full employment, i.e. at “capacity”. Getting that amount of money creation exactly right is not easy, but in principle full employment is easily achieved. (Incidentally I’m using the phrase “full employment” in the conventional sense, that is to refer to an unemployment level of roughly 5%: I’m not referring to a situation where there is literally zero unemployment.)

So what does privately issued money bring to the party? Well on the assumption that an economy already enjoys full employment thanks to the latter money printing by the state, the answer is “not much”. Certainly allowing private banks to create and lend out money in the latter economy which already enjoys full employment CAN BE allowed, but the effect is to raise demand and that cannot be allowed if the economy is already at full employment, else excess inflation ensues. Thus some sort of deflationary measure has to be implemented to counter that additional demand, and that will almost certainly consist of confiscating state created money from households and employers via tax. Alternatively the state can wade into the market and offer to borrow at above the going rate of interest, which comes to much the same thing: money is removed from the private sector. The net effect is that some households and employers are driven into debt. And that, lo and behold, provides a ready market for those private banks which want to print and lend out money.

Thus to enable private money creation, households must first be driven into debt. That’s the gist of my latest article at Seeking Alpha. It’s entitled:

“To enable private banks to create and lend out money, households must first be driven into debt.”

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