The Future of Money and Banking
Central Bank Digital Currency and Beyond
The Debt and Credit Trap – Professor Steve Keen
One would hope that such convincing proof as presented by Professor Keen, as well as the central bank admission of fact would have already been taken as gospel in economics education. But, given that both Steve Keen and Michael Kumhoff feel it is necessary to make these presentations, that must not be the case.
Steve Keen comments that the public understands money better than the “experts”. To illustrate the truth of that statement, with regards to some people, certainly not all, I would like to tell the story of how I, a member of “the public” and creator of the Money as Debt Trilogy of movies, initially came to understand that borrowers create money by promising to pay it back to a bank; and how I came to the subsequent revelation that has been my mission to communicate ever since.
It was 1993. I was the founding president of a conservancy determined to preserve the central forest and watershed of our island from being clearcut and developed into residential properties. In the process of seeking an economically viable alternative, I was given a free lesson in development economics from Mike, the logger-developer who eventually bought it. Mike told me that he never spent his profits to finance a new logging and development venture. He always went to the bank with his business plan and had the bank create brand new funds simply by his promising to pay it all back with interest. That was revelation #1.
He went on to explain that the mathematical imperative behind clearcutting the forest and rapid development and sales is the need to pay back the principal and extinguish it as quickly as possible because every dollar paid in interest is a dollar of profit lost. That was revelation #2: the “interest clock”, as Mike called it, necessitates environmental rape and rapid development rather than careful, slow and thoughtful development.
At the time I was sitting with him in front of his computer looking at the many millions of dollars of mortgages he owned. He explained that he put almost all of his profits into buying mortgages.
I asked him “Is all money just created by promising to pay it back to a bank?” He answered “ As far as I know, yes.”
I looked at the computer screen again. Suddenly it occurred to me that all of the unknown people who borrowed Mike’s profit money into existence will only have that money available to them to earn and pay back after other people, namely those listed on Mike’s computer screen, have borrowed it from Mike and spent it into the economy. That was revelation #3.
By simple logic, once one knows how money is really created, it follows that, when the original creator/borrowers pay back their loans to their banks, that bank credit money ceases to exist. However, any additional principal debts of that money, like the debts to Mike, continue to exist.
There is no “other” money to make up the shortfall. All money is committed to the principal debt that created it. Therefore, the logical conclusion has to be that this second concurrent debt of the same money constitutes an actual shortage of principal that will carry forward forever unless eliminated by default.
Mortgages can last up to 30 years, and viewing the amortization curve for a 30-year mortgage, it is typical that half of the principal is still in existence after 19 years. During the amortization period of the original bank money creation loan, how many times could non-bank lenders, both institutional and individual, acquire and re-lend money that is by definition someone else’s “current principal debt to a bank”? No one knows. It is estimated that non-bank lending of existing money is bigger than bank money creation.
Ignorance serves Class War
From Professor Keen’s presentation we learn that mainstream economists are stuck back at the completely inaccurate loanable funds model and that government debt is their paramount consideration. This ignorance serves to conceal the truth about money creation from the public and put the blame for whatever is hurting on government spending; thus the rationale for “austerity”.
This misconception, foisted on us by the so-called “experts”, is perhaps the most important stealth weapon in the class war we like to pretend doesn’t exist. But large portions of the public worldwide now see through this game and the central bankers at the mother bank have decided to admit the truth and admonish the economics profession for false teachings.
Both Keen and Kumhoff, self-declared “renegades”, are focussed on proving the loanable funds model wrong which is a most worthy crusade and has to be the first step in grasping the reality of our money system. However, I have been on a crusade of my own against the false simplicity of seeing the money system as a case of either loanable funds or money creation by banks. The real situation is that debt-created money becomes loanable funds.
The whole money system includes a lot of non-bank lenders who re-lend bank credit money they own debt-free. Most are just ordinary folks but some of them are “Mikes” – not just doubling principal debt on every dollar they lend but also adding interest to lending capital in logarithmic fashion, creating massive amounts of impossible principal debt for others (and thus system instability) in the process of enriching themselves.
Anyone can be a Non-Bank Lender
Anyone can use existing money (someone else’s principal debt to a bank) to purchase shares in money market mutual funds that then lend out the existing money they received from investors. The inescapable conclusion is that the re-lending of existing bank credit, be it through a bank, a mutual fund, or person-to-person, must always create multiple concurrent principal debts of the same “money”.
Bank Savers are also non-bank Lenders
And now to take this further, I will illustrate why, despite the fact that banks always create new money for their borrowers, there is no difference between the money creation model and the loanable funds model when it comes to the matter of bank savings and system stability.
To start with, let me define savings from the borrowers’ point of view. Savings are “someone else’s current principal debt to a bank that is not available to be earned and extinguished”.
Savings are deferred liabilities of the bank at which they are deposited. In a fixed term deposit, the term of deferment is defined. In more flexible savings offerings, the full term of deferment is incentivized by a higher interest rate. Early withdrawal is a calculated risk of the bank. The point to grasp is that, once money has been saved at a bank, the bank’s liabilities are deferred but the original borrower’s liabilities are not. The principal debt that created that money is not deferred. Principal and interest payments must be made on time. Deferred liabilities of a bank are not “money” to anyone. Only current liabilities of a bank are “money”. Therefore savings always represent someone else’s impossible principal debt for as long as the bank’s liabilities remain deferred.
As the bank creates new loans, it “replaces” those savings creating a total principal debt that is double the amount of “current liabilities” that are possibly available to be earned to repay it. From the borrowers’ and system stability point of view this is mathematically identical to the savers’ funds being lent directly person-to-person: there are 2 concurrent principal debts of the same money either way you look at it.
The unavoidable result is that we can borrow from Paul to pay Peter and we can borrow from Peter to pay Paul but we can never get out of debt without default – and if either lender lends less than the original amount, for any reason, the resulting default is as mathematically inevitable as someone losing out in musical chairs. In the real world, it is more often the borrowers failing to borrow at least the original amount on time that stops the music.
So long as there are savings there will be a need to pass the resulting principal shortage onto the next borrower. The greater the ratio of savings to checking, the greater the shortage of principal, and the greater the need for more monetary/debt expansion by borrowers on time to meet current repayment schedules.
Federal Reserve Statistics tell the Tale
In the USA, M2 – total savings plus checking (i.e. total current principal debt to banks) is normally 4 times M1 (total money in checking accounts). During the very prosperous part of the 90s the ratio fell to 3:1. After a steady divergence due to increased corporate savings and income inequality, the M2/M1 ratio hit an unprecedented 5.26:1 at the start of the Crash of 2008.
This means that for every dollar of “current liability of a bank” (i.e. money) there was $5.26 in principal debt to banks on a fixed schedule to be extinguished. And that was just within the reported banking system. How many debts of this same bank credit were outside the reporting system? If we go by the estimate of non-bank lending (excluding bank savers) being at least as big as bank credit creation, then there would be at least another 5 or 6 principal debts of the same money to add on. I’ll estimate the total at 11 concurrent principal debts of the same money.
This is a fundamental reason for the magnitude of the Crash of 2008.
The “impossible principal debt” was too large to service with velocity – and bank credit creation failed to keep up with bank credit destruction.
Economics and Ecocide
This was (and remains) a highly fragile situation. A $1 shortfall of new money on time has the potential to result in a much larger multiple of defaults. At all times, the potential for a disastrous economic crisis drives the desperate need for ever more bank credit to avoid mathematically inevitable default on a massive scale. In turn, this requires constant growth of the real economy with its resultant stress on the environment.
This expansion-dependent money system cannot be allowed to continue if humankind hopes to reduce our environmental demands upon the Earth and stop the Sixth Great Extinction currently underway.
Misunderstanding the money system has deadly consequences for All Life on Earth.
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