Where Does Money Come From?

By Guy Dauncey –

Guy bamboo copy

Where does money come from? It’s a simple question that creates a lot of confusion.

It’s important since, depending on the answer, Canada can either create its own money without needing to borrow it, or it can’t; and, a future Public Bank of British Columbia could offer zero-interest loans to students and farmers in Williams Lake or Cranbrook—or it couldn’t.

I am writing a new book titled The Economics of Kindness—The End of Capitalism and the Birth of a New Cooperative Economy, and as part of my research I am digging into the various theories of money to try to fathom the answer.

You would think it would be easy. After all, economics claims to be a science, and how can a science not agree on the origin of its most fundamental substance? That would be like physicists not agreeing on what an atom is.

Only three per cent of the money we use is coins and bank notes; the rest is electronic money, which we pass around using cheques, credit cards, debit cards, and e-transfers. Some people think there’s a store of gold that backs the money, but not any more: Canada has only 77 ounces of official gold reserves. For a period during the 19th century money was backed by gold, but as an economy grows it needs more money, and that’s not easy with a physical thing like gold.

Others will tell you that a bank keeps a reserve of money on which it bases it lending, known as a fractional reserve. Globally, banks are required by the Bank of International Settlements to keep 4.6 per cent of the loans on their books in reserves—but that doesn’t explain where the other 95 per cent comes from.

In 1975, the economist Keynes wrote, “The process by which banks create money is so simple that the mind is repelled.” If you go to the bank to borrow some money, they’ll check your financial assets and your credit rating, and if you’re good to go they’ll give you a line of credit. They simply click the mouse and create it, which you can then use to buy an electric car, a solar system, or a house, paying interest for the privilege. They don’t need to have it before they lend it. They just create it, out of thin air.

If it’s that easy, why doesn’t everyone do it? And why can’t the government do the same, instead of having to borrow at market rates? The problem is, if anyone could create money, Williams Lake would soon be awash with it, and prices would quickly rise. In 1923, when Germany’s Third Reich attempted to buy its way out of a massive financial hole following the disaster of the World War by printing money, the value of the German mark fell so rapidly that people needed more than a trillion marks to buy a dollar. That put a lot of economists off trusting governments to create money, and led to today’s widely accepted neo-liberal assumption that money-creation is best trusted to the private sector, not the government.

To prevent inflation, the supply of new money needs to grow at the same rate as the economy: no faster, no slower. But where does the new money really come from?

Where it comes from, I have realized, is simple trust. It goes back to the time when our ancestors lived in clans of hunter-gatherers, when trust was the second most important social asset they possessed, after nature’s ecological wealth. When individuals acted selfishly it disrupted the social trust, weakening their strength as a group. The glue of a clan’s existence was the gift, and gifts needed to be reciprocated to retain trust and balance.

The origin of money lies with the understanding that if I receive a gift of 10 fat salmon from my friend, I need to find a way to repay it. If I was to scratch that understanding on a piece of bark, signifying, “I owe you the equivalent of 10 fat salmon,” and give the bark to my friend, we’d have the world’s first bank-note. New money is not created out of ‘thin air’ as many monetary reformers claim—it is created as a measure of trust.

Fast-forward to 2008, and the near-collapse of the global economy because of rash and greedy money-creation by the big banks to lend for extremely risky mortgages, and collateralized debt obligations (CDOs) so complex that Anthony Haldane, executive director of financial stability at the Bank of England, said that to fully understand one you’d need to read and understand more than a billion pages of information. Obviously, no-one did, and many investors got hurt when their CDOs turned out to be toxic. Clearly, trust was not on the bankers’ minds when they created the new money.

So what stopped the total collapse of the economy when the bankers abused our trust? Our governments, who hastily created sufficient money to bail them out. The central banks of Britain, Canada, the US, and Europe did not need to have the money: they just invented it, knowing they needed to prevent a collapse, and trusting it would all work out for the good.

In other words, when the banks abused their private monopoly on creating money, the public sector bailed them out. Which leads to the question: if the central banks can create new money to bail out the banks, why can’t they do the same to tackle the housing crisis, or to finance the transition to 100 per cent renewable energy to tackle the climate crisis?

The simple answer is: they can—or they could, if they were not dominated by advice from neo-liberal economists who insist that, no, only the private sector can be allowed to create money, even if the government (through its central bank) has to be there to pick up the pieces when the banks’ lending causes a crash.

The Bank of Canada is already owned by the people of Canada, and between 1938 and 1974 it created some of the money needed to fight the war and build the St. Lawrence Seaway and the TransCanada Highway, as well as various schools and hospitals—and there was no outbreak of inflation. Ever since 1974, however, when private banks have been in charge of money-creation, we have seen inflation, most recently in the price of housing, which is where much of their new money is flowing, to the distress of those who live on the wrong side of the housing crisis.

So what happened? Why does Canada’s government now have to borrow money and pay interest on it to the private sector? In 1974, the Bank of International Settlements persuaded the Bank of Canada’s governor, Gerald Bouey, to cease creating money and instead (without consulting the government) embrace a monetarist approach, borrowing all money from the private sector. Canada’s debt has since grown to $634 billion, much of which is accumulated interest payments.

So here’s the moral of the story. We need new money to be created as Canada’s economy grows. The Bank of Canada has the legal right to create at least some of the new money to spend on affordable housing, renewable energy, and whatever else is deemed important. In this way, the money would enter working people’s pockets directly, instead of causing house price inflation, and that would have to be good for everyone.

For further reading, I recommend Debt or Democracy by Mary Mellor (Pluto Press, 2016) and Beyond Banksters: Resisting the New Feudalism, by Joyce Nelson (Watershed Sentinel Books, 2016).

Guy Dauncey is author of Journey to the future: A Better World is Possible, and other titles. He lives near Ladysmith, on Vancouver Island.

 

Guy Dauncey’s most recent book, Journey to the Future: A Better World is Possible. See more at www.journeytothefuture.ca Cover photo: Marsha Batchelor

Guy Dauncey’s most recent book, Journey to the Future: A Better World is Possible. See more at www.journeytothefuture.ca Cover photo: Marsha Batchelor

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