Economic Instability
Every loan and mortgage that the banks issue creates new bank deposits (the numbers in your bank account). These new deposits then come back to the banks like a boomerang and become the basis for another loan. This means that the more banks lend, the more they will be able to lend!
This leads to massive instability in the economy. As banks increase their lending, it gets easier and cheaper to borrow and debt rises. Bank managers who used to lend money to conservative businesses now start giving credit cards to teenagers. Since every mortgage issued returns to the banks and can be used to fund more mortgages, the banks look for more people to lend to, starting with the ‘highest-quality’ borrowers, and eventually ending up with ‘NINJAs’ (No Income, No Job or Assets). Eventually it gets to the point where some people simply can’t afford the interest on their debt, and then individuals, households or companies start to default, as happened in sub-prime America in 2007.
This inevitability is referred to as the ‘credit cycle’ by central bankers and economists, but could just as accurately be called the ‘debt cycle’:
- increasing debt, then
- too much debt, leading to
- mortgage defaults, leading to
- asset write-downs by the banks
- reduced lending
- recession
This cycle was at the root of the financial crisis and is likely to be the underlying cause of most recessions. If we don’t stop it (by stopping banks from creating huge quantities of money as debt) then we can look forward to endless cycles of boom followed by bust!
The fractional reserve banking system is inherently unstable and highly pro-cyclical. Pro-cyclicality means that underlying changes in the system are amplified until they get out of control and cause a crash. When banks make loans, they create new money, but the new money then allows them to make more loans. This process continues and means that the banks will never ‘run out’ of money – they will just keep lending until the debt burden becomes too high, borrowers start to default, and the banks suddenly become insolvent on paper.
This pro-cyclicality and inherent instability is hugely harmful to ordinary workers. The system first creates a boom that pushes up the cost of essentials such as housing and rent, forcing workers to get into ever higher levels of debt. It then causes a crash that throws millions out of work. Then, as the economy finally starts to recover, employers are slow to hire fearing that they may need to make further redundancies if the recover turns out to be a false start.
All together, this makes it harder for workers to find jobs, makes the jobs that they do find less secure, and significantly increases the amount of debt that they will fall into.
Deficits & the National Debt
The business model that banks use is so unstable that it has to be propped up by the taxpayer.
Taxpayer support ends up increasing the national debt for two reasons.
Firstly, because the government chose to rescue banks that became insolvent as a result of their fundamentally unsound business model, using taxpayers’ funds.
Secondly, because the system is so unstable, it regularly triggers recessions. This means that fewer people are working, less taxes are paid and as a result the government has to borrow more just to avoid slashing a huge amount of government services.
The government cannot keep increasing the national debt forever – at some point people will start to question whether the government can repay, trigging a ‘sovereign debt crisis’ which can potentially bankrupt a country’s government.
The national (government) debt currently stands at roughly £32,800 for every single person in employment in this country. In order for the interest alone to be repaid on this debt every household will pay £1,889 a year. There is no way this debt will ever be repaid unless we fundamentally restructure our economy. Should the government even try to pay back this debt the level of services it would have to cut would mean that millions of people would be thrown into unemployment, and would need to find other jobs.
All these people will require unemployment benefits whilst they look for jobs, and, should they find jobs, they will be paid with money created as debt, should the economy grow (read, indebt itself) enough to facilitate this. As the only end result of allowing banks to continue creating money in this way is another financial crisis, the end result of cutting services and paying back the national debt will only be an even bigger financial crisis, leading to an even bigger national debt.
Blocking Economic Development and Growth
Can a system in which growth in the economy requires growth in household and corporate debt lead to a positive outcome for the economy and society?
Under the current fractional reserve banking system, there are two ‘rules of money’ that cause a real headache for any government trying to generate growth, economic development or a recovery:
- When a bank makes a loan, it increases the amount of money in the hands of the public (by increasing the total quantity of electronic bank deposits)
- When a member of the public repays a loan, it reduces the amount of money in the hands of the public (by decreasing the total quantity of electronic bank deposits)
This system of getting money into the economy effectively means that, under the current monetary system, growth can only occur if it is fueled by rising household and corporate debt.
The two sides of this ‘Catch 22’ situation are explained below:
- Economic growth requires either an increase in the quantity of money, or for the existing money to circulate faster.
- The speed at which money circulates (its ‘velocity’) changes relatively slowly, suggesting that growth requires an addition of new money into the economy.
- The only method, under the current system, of injecting new money in the hands of the public is for the public to borrow money from commercial banks (since bank deposits are only created when new loans are made).
- Therefore, significant growth can only take place if an already over-indebted public goes into even further debt.
- Excessive debt was the trigger point for the recent financial crisis, and the total indebtedness of the public has risen even further since 2007. It is questionable whether the public can afford to take on more debt in order to stimulate a recovery.
To add to the challenge:
- High household debt will serve as a barrier to growth, as much of the public’s income is absorbed in servicing debt rather than spent into the real economy
- So to stimulate economic growth, household debt needs to fall
- Falling household debt results in a falling quantity of money in the economy (see the second rule of money).
- A falling quantity of money in the economy triggers a recession
- A recession leads to job losses and higher indebtedness, as people turn to credit cards to buy necessities and take payment holidays on mortgages
- Higher household indebtedness is a barrier to growth
The conclusion is that significant growth or economic development is almost impossible as long as commercial banks have a monopoly on the supply of money to the economy.
Unnecessary Taxes
When the Bank of England’s Issue Department creates new £5 or £10 notes, the profit is paid over to the Treasury (the profit being the difference between the cost of printing the physical notes and the face value of the note itself). In the 2009 financial year, this profit was £2.2 billion, meaning that £2.2 billion less had to be collected through taxation, saving the average voter £48 in that year.
However, cash makes up a continually declining proportion of the money supply. When banks create money, they – and not the government – receive the profits (profit in this case being the interest that can be charged on that money every year from then on).
Consequently, by allowing private banks to issue the nation’s ‘digital’ money supply, the government is losing hundreds of billions every decade. Specifically, in the 1990s, the government missed out on £398 billion, while in the last decade the government missed out on £1.2 trillion.
Logically, if the profits of printing bank notes mean that the public has to pay less tax, then by handing responsibility for creating digital money to private sector, the government is imposing a huge tax burden on the public, in order to effectively subsidise the banks. The £1.2 trillion created by the banks between 2000 and 2009 represents not only £1.2 trillion of extra debt piled up on the public, but also £1.2 trillion of taxes that would not have been necessary had the government created this money itself. This represents around £27,000 of unnecessary taxes per member of the electorate over the last decade.
Manipulating Interest Rates
To encourage people to borrow more, the Bank of England sets the base rate of interest. They then lend money to the banks at this rate of interest, and this interest rate generally feeds through into loans and interest rates on ‘tracker’ mortgages. This method of ‘steering’ the economy using interest rates is another great cause of instability. It is a little like driving a car by stepping on the brake and the accelerator at the same time. When the economy is ‘overheating’, the banks have their foot on the accelerator (creating more money as debt) while the Bank of England has its foot on the brake (raising interest rates to slow down the borrowing). When the economy sinks into a recession, they swap pedals, the banks slam on the brakes (refusing to lend) and the Bank of England steps on the accelerator by cutting interest rates to their lowest level.
This type of management of the economy will never lead to economic stability. In the recent financial crisis, the lowering of interest rates harmed savers, who were now earning less on the money they had invested, in the hope that banks would be able to get more people into debt. It is completely unsustainable.
There is another huge social cost to managing the economy in this way. When interest rates are cut pensioners who were living off interest income from their savings are plunged into poverty. Interest rates are kept low to encourage people to get into debt in order to stimulate the economy. When the economy successfully pulls out of the recession the Bank of England then increases interest rates, almost bankrupting the very people who rescued the economy by borrowing when interest rates were low. This is exactly what happened in the sub-prime crisis.
Wasted Opportunities
When new money is created, it eventually creates inflation – pushing prices up and reducing the value of existing money (unless the money is pumped into productive investment). But before that happens, whoever creates the money is able to spend it and get something in return.
At the moment, the banks have a near-total monopoly on the creation of money. Three quarters of the money they create goes directly into the housing and commercial property market – doing very little other than making existing houses extremely expensive.
If the public did have a democratic say over how newly created money should be spent, would they choose to pump it all into increasing the cost of housing and pushing up the rents on commercial property, as the banks have done year after year? Or might they choose to fund hospitals, education, research into medicine and technology, high-speed rail, reducing poverty and reducing the tax burden on enterprise?
Whoever gets to creates money is able to get the benefit of creating that money. At the moment that benefit goes directly to the banks, at the expense of everyone else. From their track record, we can see that banks can’t be relied on to use this money, and this benefit, wisely.