Articles

[Back to Money - An Overview]

Executive Summary
Money is something we all need and cannot do without; it is a necessary part of modern society. The bald truth of it is that the financial system that governs how money works is generally a product of human endeavour and invention. This construct has been moulded to serve various human objectives and purposes, with few necessary constraints on how it works. And yet, we all think of this system as a factual given, set in stone, and one that cannot and must not be changed. This is not the case - it is just a system, just like any other created by people. For example, most of us have various forms of bank loans, such as direct loans, mortgages and credit cards, all of which eventually involve using the banks in one way or another. The vast majority of modern money creation is performed in the private sector by commercial banks whenever they grant loans. Banks don’t lend from their own (or anyone else’s) reserves. Instead, they use double-entry bookkeeping to create money in your account, together with a corresponding debt obligation to be paid back with interest. The fact that the mechanisms underlying the modern financial system (fiat currency, loans as money creation, etc.) seem to work so well opens up the possibility that similar mechanisms could be re-targeted instead towards directly improving human welfare more widely. It is this possibility that we should be discussing. 

Introduction
This article outlines what I’ve been finding out about the financial system, how it works in practice and what may need to change for finance to be consistent with human welfare in general – because it isn’t at the moment.

I've written this article as a companion to a video (unlisted here) that has been provided separately.  Hopefully, these contributions together help make sense of the overall message. Broadly, this article contains some follow-up references, pointers and related links to help your own research on this topic.

What I’m trying to grapple with here is how the financial system might be rearranged to serve human welfare more widely—that is, for the many, not just the very few. We will have something to say about that later, but first we have to talk about money itself.

What is Money?
It turns out that money is really quite a complicated subject.

Money is something each of us is inevitably involved with -- but equally, we probably don’t understand it terribly well. Sure, we get paid, mostly buy things, and may even sell things. We use it, but do we understand it, where it comes from, or even what it is? As I’m no professional inn this - I’m not an accountant, an economist or someone in financial services by trade, all I can do is tell you what I've found out so far.

However, this means we do need to get a bit more technical. The companion video covers most of that technicality.

I should perhaps declare that, from a personal point of view, I dislike needing money and certainly dislike talking about it—it's definitely not a favourite topic for me. However, the thing I really dislike even more, of course, is the lack of money.  It's probably the same for you, too.

Where did all this start?

Two places.

"Universal Basic Income"
We have already had at least one discussion about Universal Basic Income (or UBI), what it could be, how it might work in practice, and so on.

This was quite a robust discussion if I remember correctly!

For example, I don't agree that cannibalising the welfare system to provide basic income would be a good idea—basic income needs to be added to the welfare system and not replaced.   The point is that, in my opinion, UBI isn’t a panacea for social problems—we all need good healthcare, good education, and so on.

Instead, UBI should act as a basic floor for income – ensuring that everyone has the dignity of some income and enabling people to participate and engage more fully within society. It goes without saying that many (and probably all) would need to supplement this further, depending upon one’s circumstances. Most likely, UBI would not provide an adequate Living Wage on its own.   In reality, the payment isn't really an income - but instead, it would be tantamount to an annual “goodwill” gift to each citizen to be used however they please.

My core belief is that to create a non-zero income floor for everyone, we need to make UBI a reality without means testing and without increasing tax liability. To do that, I believe that society will need to re-engineer the financial system to better serve the people—more about that later.

Money isn’t what you thought it was
The second place that all of this came from was another of our JustHuman discussions, in which someone described the economic system and how money flows around via spending and borrowing. Not just that, interest and general inflation also need to be taken into account. This means that, generally speaking, the value of money tokens inevitably decays over time.

Economists distinguish between the so-called “Real Economy,” i.e., the actual goods and services that are bought and sold, the source of all value, on the one hand, and how these are then valued in financial terms, driven by market conditions, on the other.

Where does inflation come from? Simple – it comes from economic activity overall, where supply and demand pressures force price rises, leading to increased wages and increased business costs, and then businesses charging what is perceived as a fair price to cover their costs. All of these generally lead to price rises. Prices generally fall only due to pressure on businesses to undercut their competition within a market.

Generally, the most desirable situation is that the economy simply purrs along with low inflation of a few percent or so. High inflation creates difficulties with the extreme danger of hyper-inflation, leading to a runaway explosion of ever-increasing prices. Negative inflation or deflation is also very dangerous since, in that situation, the economy would collapse as prices fall, leading to a potential downward spiral of economic activity. Quantitative easing by central banks was introduced primarily to prevent deflation.

Then somebody pointed out: Doesn’t all this mean that money in terms of value is not really conserved - this point was generally acknowledged by everyone for all sorts of reasons. The basic point is that money is merely some socially agreed-upon token representing value. In this way, money isn't intrinsically valuable in itself – what's important is the value it purports to represent. When money is paid out for something, the tokens represent standard agreed quantities of value to be exchanged for whatever has been bought.

This notion of value is clearly a psychological, subjective construct. Despite a price having been agreed upon via the market (perhaps by the forces of supply and demand), the value that something has is necessarily different in the eyes of the buyer and seller. For example, the buyer only buys when the price is less than the value they have for it, whereas the seller only sells when the price is greater than the value they have for it. Buyers and sellers necessarily have different valuations.

Ultimately, given all of this complexity, where does money come from, how does it come about? Observations like those above provoked me to find out more about it for myself.

However, most of the discussion concerning Money Creation is given in the companion video in the form of clips from other sources and isn’t covered in much detail here. Listed below are some related (hopefully helpful) resources.

Video excerpts and resources:
The Bretton Woods Monetary System (1944 - 1971) Explained in One Minute
https://www.youtube.com/watch?v=RtFz9q26t5A

Why is everything getting so expensive?
https://www.youtube.com/watch?v=qlKx8uc_ppU

Why Economists Don't Care About the Debt
https://www.youtube.com/watch?v=XC5vdEhlhbI

Why Can't We Just Print Money to Pay Off Debt?
https://www.youtube.com/watch?v=EobPnLZiOo8

It's the banks, stupid
https://www.youtube.com/watch?v=l2gv3Y

Enough is Enough: Full Film
https://www.youtube.com/watch?v=jgo-eTTmuLk

The economics of enough: Dan O'Neill at TEDxOxbridge
https://www.youtube.com/watch?v=WIG33QtLRyA

The System of Money | Documentary Money Creation | English | Finance System
https://www.youtube.com/watch?v=kw0QVwt7LVI

Books:

Rethinking Money: How New Currencies Turn Scarcity into Prosperity
https://www.amazon.co.uk/Rethinking-Money-Currencies-Scarcity-Prosperity-ebook/dp/B00B4IJFNU

Where Does Money Come From?
https://www.amazon.co.uk/Where-Does-Money-Come-Ryan-Collins-ebook/dp/B00FFAKEQU

Prosperity without Growth: Foundations for the Economy of Tomorrow
https://www.amazon.co.uk/Prosperity-without-Growth-Foundations-Tomorrow-ebook/dp/B019H4HKZW

Enough Is Enough: Building a Sustainable Economy in a World of Finite Resources
https://www.amazon.co.uk/Enough-Rob-Dietz/dp/0415820952

Fractional Reserve Banking - The “Money Multiplier” Effect
One topic I omitted from the companion video is so-called Fractional Reserve Banking.   This is a way that banks, typically in the US, could use to create money by making loans.  This approach seems to be used now mainly in the US.   Below is a short video describing how this worked.

Fractional Reserve Banking Explained in One Minute
https://www.youtube.com/watch?v=-09ap6zIB6I

But is this true?
You may now be wondering how all of this could possibly be true. Well, I did some further digging and found this article from the Bank of England, published in 2014, which broadly confirms what we have heard about Money Creation.

Money creation in the modern economy
By Michael McLeay, Amar Radia and Ryland Thomas of the Bank’s Monetary Analysis Directorate.
https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy

• This article explains how the majority of money in the modern economy is created by commercial banks making loans. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.

The article itself goes through more of the mechanisms concerning money creation in more detail.

Conclusion
This is as far as I want to go here - so it's now over to you to take it further. I have two questions to take forward, though:

1. First of all, what do you think about this analysis? Is it all totally barking mad, completely wrong and misguided in drawing attention to such ideas? If so, can you put your finger on where it all goes terribly wrong? For instance, is the group Positive Money pointing us in completely the wrong direction?
2. Secondly, what needs to happen to make the financial and monetary systems more fit-for-purpose in terms of human welfare?

Looking forward to a great discussion!