Thursday, 10 March 2016

Two sorts of money: public and private.

There’s two sorts of money: state issued money and private bank issued money.

It costs nothing to issue state money. In contrast, private banks have to check on the credit-worthiness of customers before giving them money. And that involves significant costs: in fact the only reason private banks charge more interest to borrowers than they themselves pay bondholders, depositors etc is to cover those costs (plus something for profit, i.e. for shareholders). So state issued money is better. But if state issued money is cheaper to produce than private money, why does private money predominate?

Reason is that private banks can lend without having to endure the full costs of lending, so they can undercut the going rate of interest.  In particular they don’t have to ABSTAIN FROM consumption in order for borrowers to consume more. Of course it can be argued that where private bank lending rises and the economy is at capacity, the central bank will raise interest rates so as to forestall inflation. And that encourages saving or “abstinence”. True, but by that time private money has got into the economy. Put another way: how do central banks raise interest rates? They do it by withdrawing base money from the private sector (selling government debt).

Net result: private banks have managed to have their money displace base money.

Moreover, government will not necessarily counter the above inflation with interest rate increases: it may go for fiscal tightening, e.g. raising taxes. In that case, again, the state is simply WITHDRAWING its money from the economy in order to make room for privately printed money. 

The net result of letting private money displace public money (aka base money) is an artificially low rate of interest and an artificially high level of debt.

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