Joseph Huber & James Roberton’s “Creating New Money”.

Summary.

The above work (published around 2000) is a very worthwhile and widely cited contribution to the debate on how we ought to organise banks. One central claim is that commercial banks can lend at below the free market rate of interest because they can simply create or “print” the money they lend out. In the paragraphs below, I argue that actually there is no LONG TERM effect on interest rates, or the total stock of money, or the total amount of debt, however, the ability of private banks to have their money displace state issued money still results in the absurdity that having displaced most state money, the state is left with the job of having to stand behind privately issued “funny money”. And that of course raises the question as to whether that funny money should be permitted at all. In other words, the article below arrives at the same conclusion as H&R but in a slightly different way.

Moreover, Huber (but not Robinson) also claims that the issue of “debt based money” by commercial banks, as is current practice, does not increase debts (p.33). So that’s a second way in which the arguments below are not vastly different to H&R’s. 

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On p.31 of their work, Huber & Robertson (H&R) say, “Allowing banks to create new money out of nothing enables them to cream off a special profit. They lend the money to their customers at the full rate of interest, without having to pay any interest on it themselves. So their profit on this part of their business is not, say, 9% credit-interest less 4% debit-interest = 5% normal profit; it is 9% credit-interest less 0% debit-interest = 9% profit = 5% normal profit plus 4% additional special profit. This additional special profit is hidden from bank customers and the public, partly because most people do not know how the system works, and partly because bank balance sheets do not show that some of their loan funding comes from money the banks have created for the purpose and some from already existing money which they have had to borrow at interest.”

H&R certainly have some sort of a point there. To show why, take a hypothetical economy where the only form of money is state issued money. Also assume the state issues enough money to induce everyone to spend at a rate that brings about full employment, while avoiding excess inflation.

In that scenario, people and firms would lend to each other, plus commercial banks would doubtless set up and accept deposits and lend on a portion of those deposits. In that scenario there is no obvious reason why the rate of interest would not be some sort of genuine free market rate.

But if commercial banks then start creating and lending out their own home made money, clearly they can do so at below the free market rate, as H&R suggest. But that’s not the end of the matter (as H&R seem to suggest). 

That additional lending (and the additional spending that derives from it) will raise demand. Ergo the state will have to rein in demand somehow or other, e.g. by raising taxes and confiscating a portion of the private sector’s stock of state issued money.

But note that that additional spending is only a temporary phenomenon: to illustrate, if I borrow to have a house built, that will raise demand as long as bricklayers, plumbers etc are involved in building the house. But once it is built, the demand increase that derives from building the house ceases. Likewise, the demand increasing effect of additional lending stemming from commercial banks issuance of their home made money will in the above hypothetical scenario also cease: i.e. some sort of fixed and higher level of lending will on the face of it then be established.

There is however another demand increasing effect, which is that the money I spent having the house built is still in circulation and will presumably raise the population’s stock of money to more than the above mentioned “maximum that is consistent with acceptable inflation” level. Same goes for the extra lending that stems from commercial banks starting to issue their own money.

In contrast to the latter extra dollop of financial asset in the hands of households, there is of course extra “negative financial asset” in that my debt is still in existence. But that won’t necessarily have much effect on borrowers weekly spending: reason is that if (and taking a simple case) the percentage rise in borrowing is the same as the percentage fall in interest rates, then the amount that borrowers pay by way of interest every month will remain unaltered. Ergo their total weekly spending will remain about the same.

Moreover, the fall in interest rates will probably induce creditors to want to hold an even smaller stock of money than they started with: why hold more money than you want unless you get paid a decent rate of interest for doing so? And that’s an ADDITIONAL inducement for them to spend away their excess stock of money, and thus exacerbate the rise in demand.

The net effect, unless I’m much mistaken, is that while the money supply increasing phenomenon to which H&R refer may operate temporarily, in the long run, the money supply and rate of interest will simply revert to their original levels, or at least something close to those original levels.

So the overall and final result is that totally secure state issued money is replace with insecure private bank issued money which the state then has to make secure via taxpayer backed deposit insurance and billion dollar bail outs for banks in trouble.

And that of course is a farce and it’s a farce which Prof Mary Mellor often alludes to in her two books “Debt or Democracy” and “The Future of Money”.

The solution to that farce is to return to something like that above starting point, where the only form of money is totally secure state issued money. As for LOANS AND INVESTMENTS, those who want their money loaned out or to invest their money (whether it's via banks, mutual funds, private pension schemes or to make stock exchange investments etc) are free to do that, but those investor / lenders carry the risks involved. And that results in a level playing field as between banks on the one hand, and other financial institution, in contrast to the present set up, where banks get privileged treatment in that those who lend or invest via banks enjoy protection gratis the taxpayer.

The latter arrangement is of course what is normally called “full reserve banking or “Sovereign Money”, exactly what H&R advocate, only the exact way in which I arrive at that conclusion is a little different to H&R’s.

Moreover, the latter set up (full reserve banking / Sovereign Money) is entirely consistent with a very widely accepted general principle, namely that it is not the job of government (aka taxpayers) to stand behind or in any way subsidise or assist strictly commercial activities, unless there is a clear social reason for doing so.