3: Discussion Paper on Money
Something of value or just a measure?
Mercy Harmer
Highlighting the significant factors in the way our money system has developed is probably the best way to understand the increasingly urgent problems now facing us.
So long as the money to circulation consisted mainly of precious metals those who accepted it received something of “real” value for the goods or services they supplied in exchange for it: (The coinage might be debased, but so long as it contained some precious metal which was limited in supply this kept some sort of relationship between those goods and services and the quantity of money available).
“Account book money”, where the value of goods supplied was recorded against the goods received, without any gold or silver actually changing hands, with money merely being used as a measure of relative values, probably played a significant part as trade developed but would not have upset the relationship between goods and money so long ,as good ,- were being exchanged for goods.
When, in lawless times., goldsmiths agreed to lock away the gold sovereigns and guineas that merchants brought to them for safe keeping - and to hand out receipts that could be circulated in place of gold - the relationship between what counted as money on the one’ hand and what was being traded with it on the other hand did not alter so long as all the gold remained locked away until collected by whoever handed in the receipt to the goldsmith, - provided the receipt issued bore no greater value than that of the old it represented.
Banking began to take its present-day form when goldsmiths noticed two important facts. So long as they themselves remained “creditworthy”, so long as everyone trusted them to have the gold available on demand, very few people wanted their gold back. Paper was lighter to carry around than sovereigns as well as being easier to hide from thieves. Thus it was safe for those holding the deposited gold to lend some of it to those who wanted loans, thereby earning interest and making it worthwhile to pay interest on gold deposits.
Since the new borrowers were generally as reluctant to carry around gold as those who had first deposited it the loans could actually be issued in paper notes rather than in gold. The notes, of course, promised to pay the owner their value in gold when they were returned to the goldsmith, alias banker, but since it was most unlikely that many of the holders would want to redeem their notes at any one time the banker could earn even more interest by issuing notes to à value well in excess of the value of the gold in his vaults.
This money represented neither the value of deposited gold nor the value of goods already produced—except of course for the paper and the cost of producing the notes.
This was the beginning of the widening gap between the price of the goods traded and the price of producing the money with which. they were traded. Some people feared that this practice might cause problems but it soon became accepted since it seemed to stimulate the growth of trade and industry.
As a result of a subtle but significant change took place in the nature of loans.
Hitherto, if a farmer found himself without seed corn after a bad harvest a neighbour who agreed to lend him some might expect to be repaid with something extra to compensate for delayed consumption or sale but a reasonable harvest would provide the wherewithall for repayment.
Similarly if a merchant needed money to pay bills while waiting for his “ship to come home”, or for a customer to pay his debts, a loan of money would help in the same way. Until the loan was repaid the lender would reduce his consumption; his demands on the market, and so lie would expect something in compensation.
However, when a banker handed out notes apparently backed by someone else’s gold this loan was not accompanied by any balancing reduction in demand on the market either now or in the future The notes issued to the original gold depositor did not need to represent anyone’s reduced consumption because they were not a loan—merely at exchange for gold. When bankers issued loans of notes which were supposedly backed by someone else’s gold it was a different matter. It reality these represented nothing except the paper and time needed to produce them.
Like any other loan, they gave the borrower extra time to pay his debts, or the opportunity to produce new value from goods he had acquired before he had to use his own money to pay for those goods. As in any other loan, he would eventually have to repay the banker—with interest—but the banker would not have had to forego the use of anything as a result of making the loan.
While the borrower had had to forego something real in the form of interest, the banker had achieved a redistribution of wealth in his own favour with very little effort!
For the rich this might well be seen as stimulating trade and industry but it stimulated these processes ‘ away which was going to have an important effect on future history.
Desirable products in limited supply always go to those who can offer most money for them so those able to obtain loans were in a stronger position than those who could not, while the interest on loans and on the “unbacked” notes, was not the product of any “real” production and merely enabled certain people to gain rights to goods and services;. while offering nothing “real” in return—which meant that others who had earned the right to a share of these goods and services would find less available for their money than they had a right to expect. Redistribution of wealth was being stimulated—from the poor to the rich!
If all bankers had demanded gold in repayment of the notes thus issued the gold shortfall would soon have become apparent but it was reasonable for bankers to accept repayment in the same sort of currency as had been issued originally and banknotes were here to stay.
I t would not have troubled people at the time that when they banknotes in return for goods they were accepting merely a “promise to pay” rather than anything of “real” value, —unless, of course, they began to suspect the credit-worthiness of the issuer. Then a run on the bank would reveal the true facts. .Bankruptcies would result and that bank’s notes would become worthless.
The next significant step, the foundation of the Bank of “ England, is excellently described in P.W.J. Riley’s Social and Economic History of England, p.149-50, (Bell. and Sons - 1965):
In 1689 England began the first of a series of wars against France which were to continue right into the nineteenth century. This continual warfare caused great expense and financial strain and the government was driven to borrowing on a scale undreamed of before.
To make the borrowing of money easier a bargain was made whereby a group of bankers was given a charter allowing them to set up al. a joint STOCK BANKING COMPANY with certain privileges. They were allowed to borrow £I 200,000, raised from private subscribers, which they lent to the government at 8 pet cent interest. This was the beginning of the Bank of England.
The Bank continued to raise money by deposit and lend it to the government either for short or long periods. This simplified the government’s borrowing because the Bank handled the actual money-raising. In return the bank was allowed to tarry on normal banking business and it was in a very favourable position to do so since, as it was the government’s banker, people regarded . it as being extra safe. Later It received additional privileges, such as that of being the only bank in England, with more than six partners, allowed to issue notes. As a result of this long-term borrowing the government acquired a permanent debt known as the NATIONAL DEBT which was never likely to be cleared, but the government paid the interest regularly and people with spare capital were happy to use it as an investment.”
This clear description should help us to understand the confusion that arises when those interested in monetary reform.
Looking from what we know about the results of founding a national bank, argue about whether or not the notes issued by the Bank of England from then on were issued “debt-free”.
The Bank of England had been set up to act as intermediary between the lenders and the government and in return was allowed to issue banknotes with government backing so the government was the borrower and had to pay interest on the gold which backed .the notes. In so far as the notes represented gold withdrawn from circulation and stored in the bank’s vaults no new money was created, but when the bank began to issue notes in excess of the value of the stored gold the situation was more complicated. Money had been created as debt, a debt which the government owed —with interest!
Whether or not the notes were backed by gold the king was using them as payment for goods and services received so the recipients did not pay interest on them but the king did, at any rate in theory!
These notes, however were not being used to develop a profitable enterprise or to tide over a gap while waiting for taxes or other dues to come in. They were needed to finance a costly war,- ‘so ,how could the king repay either debt or interest except by collecting the money in taxes which the borrowing was designed to avoid? The solution was to raise new loans to repay the old. This was done by selling bonds, (further promises to repay with interest at a fixed date!) again to wealthy citizens happy to make money by lending their spare cash.
The National Debt is with us still. Those who contribute to its growth by buying government bonds may be seen as foregoing the use of money which they have earned in the process of creating real wealth. Thus it would seem reasonable for them to receive interest, but where is that interest to come from? If it is paid out of taxation the wealthy will themselves, of course, pay some of those taxes. It is not only the rich, though, who pay taxes so some interest payments will represent money being redistributed from the poorer to the richer. If, on the other hand, the bank, on behalf of the government, pays that interest with newly created money not backed by gold this; will represent a dilution of the buying power of the nation as a whole, in which case everyone is-contributing towards keeping the National Dept ticking over - without being aware of the fact.
When the Bank of England was first founded what concerned the people of the time was probably not so much the problem of the National Debt as the danger that the issue of too many notes by any bank which were not backed by gold would make that bank’s notes worthless but it was with smaller banks rather than with the Bank of England worthless that this problem was more likely to become evident.
Riley goes on to point out that as well as the other London banks; which became known as private banks, country banks also began to appear, set up by such people as corn dealers, cattle drovers and woolmen who had reserves of capital. These country banks issued notes which were accepted as money in their own districts. These local bankers would have accumulated their wealth through local trade, indicating some link between the money issued and goods being traded but if any of them fell on hard times everyone would get to hear about it –leading to a rush to change their notes for something more reliable, such as gold or Bank of England notes. When the necessary quantity proved unavailable many worthy folk would suddenly find all their paper money worthless.
The cure for that was obviously to curb excesses rather, than to abandon the system which was proving so useful but from now on some people could make money out of nothing except their good name, so long as that good name could be kept intact - AND IN OUR PRESENT MONEY SYSTEM THIS ABILITY OF OUR BANKS TO CREATE LOANS OUT OF NOTHING,WITHOUT ANY QUID PRO QUO IN THE FORM OF GOODS OR SERVICES, IS FAR MG SIGNIFICANT THAN THE FACT THAT INTEREST CAN BE CHARGED ON THESE LOANS.
In the nineteenth century increasing worries that money matters could get dangerously out of control led to the passing of The Bank Charter Act of 1844. The banking department of the Bank of England was separated from the issue department, (to keep the latter under strict control), and from now on only £14,000,000 could be issued without gold backing—and even this had to have the backing of government securities. thus from now on all Bank of England notes were supposed to represent money withdrawn from circulation to lend to the government. Further, restrictions were placed on the number of notes that could be issued by the few old-established banks which were allowed to continue doing so.
Although the Bank Charter Act had to be suspended from time to time these controls were adjudged to have established a workable and reliable money system but it would be naive to assume that they had curtailed the ability of banks to issue loans which effectively created money out of nothing. This was because an alternative to both coins and paper money was becoming increasingly popular for the payment of large debts., Bank notes in large quantity were as attractive to robbers as gold had once been so owners found it wise to deposit most of them with a bank and pay their debts by cheques drawn on that account. Thus, when the holder of a bank account required a short-term loan, all the bank needed to do was the write the amount of the agreed loan into the borrower’s account. This loan now represented part of the bank’s assets - money to be paid to the bank when required. The entry in the borrower’s bank account represented, of course, a bank liability since the bank would have to settle cheques drawn on that account as the borrower spent the money. (Sometimes this would involve handing out notes and coins when someone decided to cash one of these cheques instead of paying it straight into another account so banks ha to allow for this when deciding how much “numerical” money it was safe to create).
If all went according to plan the borrower would repay the loan in due course and his debt would be cancelled, - but would this “cancel” the newly-created money? This was now sitting in other people’s bank accounts or circulating as notes and coins where cheques had been cashed. The loan, then, had put new money into circulation and its repayment merely redistributed a part of the new total in favour of the banker. It did not put the total money supply back to where it was before.
The main constraint on the issue of such loans was the the fact that the borrower or his creditors would need to use cash for a number of their transactions. Until relatively recently most salaries and wages were paid in cash and people used notes to pay most of their bills as well as for everyday expenditure. As time passed, however more and more transactions were being carried out with “numerical” money without the intervention of notes or coins. Salaries were increasingly paid into the recipient’s bank account and regular bills such as water and electricity were paid by cheque rather that by cash, with the increasing use of standing orders and later direct debit encouraging the trend towards using numerical money. Increases in the money supply during the twentieth century are well worth studying and comparisons with the growth of the National Debt give even more food for thought. Supporters of monetary reform tend.to see the increasing use of numerical money rather than notes and coins as resulting from the issue of too much debt-based money but this is not a simple “cause and effect” relationship. The falling demand for notes and coins is the result of ever-increasing facilities for using numerical money and the use of this money need not have been accompanied by escalating debt-based loans though it did, in fact, greatly facilitate this process.
Loans, then, might produce increases in the money supply with tile resultant danger of inflation if production did not increase to absorb this extra buying-power but the ever-present and increasing demand for these bank loans needs to be explained. Those needing capital for long-term projects could raise it by selling shares on the stock exchange so why should credit-worthy people need expensive short-term loans to keep their businesses going, to keep themselves afloat?
In economies where competition between individuals and firms is the main economic motivation there is an endemic problem seldom mentioned and difficult to solve, a problem I discussed in some detail in A Green Look at Money. Money is paid out to all those who provide goods and services, including those who make profits from organising these provisions. As the recipients spend this money on goods, services, taxes and so on it should eventually return to the market to pay for the next batch o goods produced and thus, if the routes it follows have a reasonably stable time-scale, it should steadily return to the market to pay for everything on offer. (In this argument I am treating the total cost of goods produced as being equal to the cost of all the services used by the economy that produces them—that is to say wage-work, organisation, all social infra-structure,-because levels of earnings have to take account of the cost of all the services the recipients are financing, either out of their own pockets or via taxation. The more services a society provides, whether publicly or privately, the higher the wage and income levels need to be).
The problem with this process of keeping money circulating steadily is that in sophisticated societies there is, in fact, MORE THAN ONE MARKET. When people have incomes which allow them to buy substantially more than the necessities of life they tend to spend a certain amount on high-class purchases that the rest of us are unable to afford,-fine-quality furniture, clothes, health treatments, works of art, and so on. Those who supply such requirements will be well-paid by their wealthy clients and so also tend to spend a part of their earnings in this “upper circuit” market. When the money in such .”upper circuits” fails to return to the level of the market which has produced the profits and paid out the interest contributing to upper circuit expenditure that basic market must experience a shortfall of income needed to pay production costs plus profits and interest.
Solutions to this problem may include expanding t a market to bring in new customers with “outside” money., developing more efficient production methods or encouraging the use of hire purchase or credit card facilities to encourage customers to spend money they have not yet received. As the customers join the ranks of borrowers they need ever higher wages if the are not to cut future re expenditure or default on loans. To pay these w age rises production costs must be cut, perhaps by producing ever cheaper goods, preferably produced in low-wage countries. Short-term loans may be needed until adjustments can be made.
All the devices for maintaining this never-ending need for expansion such as built-in obsolescence and stimulating the demand for new types of short-life products are having devastating environmental effects. This is one of the important reasons for developing a Green approach to monetary reform because changing our money system will be part of the process of ending the need for continuous monetary expansion—while unless we can end this need monetary reform is unlikely to be successful.
This need for expansion is likely to continue so long as the process of buying and selling is a win-lose activity linked to linear, either-or ways of thinking—so long as the. seller’s aim is to get as much profit as possible from the customer while the customer in turn aims to pay as little as possible for purchases. Changing this to a win-win process, in which buyer and seller have shared interests, would in the long run be in everyone’s interests. We all suffer from the effects of environmental pollution and most of us would prefer reliable, long life goods to cheap rubbish the former were . affordable and if suppliers of good quality products were riot being undercut by rubbish-merchants. We take out present system so for granted that many people would find it well- igh impossible to imagine it being replaced by something more suited to the needs of the twenty-first century but the only way to escape from present dilemnas would seem to be the development of co-operative structures with distributors acting as benign links between suppliers and consumers instead of feeling the need to exploit both—as supermarkets and multinationals do now.
Alongside such developments the first aim of monetary reform would need to be to end the creation of money out of thin air.
To suggest that governments need to take over the creation of money may be premature. What is this money supposed to be for? We have to find a way of relating buying-power to the value of goods and services available, and to distribute that buying-power tin such a way that needs are met and effort rewarded, and so on. Is new money needed for this if existing money can be kept circulating efficiently (or should we talk about buying-power rather than ‘money’, to get away from old-fashioned concepts)?
Then there is the problem of how to deal with the existing debts which have been created by the proliferation of debt-based money. Do we deal with these by handing out for the debtors to use, or can we change the accounting rules in some way, recognizing the real value of whatever these debtors have received and what they have had to forego as a result? This would probably make most of this indebtedness disappear. (We should of course have to help out the banks and others whose cash-flow has depended on the payment of the interest on these debts!)
Then we have to consider the possibility that large organizations could regularly be ‘creating’ their ‘own’ money when exchange of goods among themselves is recorded in money terms, but no use of actual money from banks or elsewhere is involved, since the ‘money’ exchanged has always been represented by goods and services.
To what extent does the increasing use of ‘account book’ money, debit cards, etc., dispense with the need for inputs of money from banks, governments, etc., so long as the players do not get into long-term debt?
We will continue, perhaps, to need banks to record our transactions, our credits and debits, but how much new money from them is really needed?
Meanwhile governments creating money to pay their own expenses might create more problems than it solves if our main aim is to keep a steady relationship between money and the goods and services on offer. Would this depend on keeping existing money circulating efficiently without any new influxes?
Lending to those who need extra funds should, I suggest, involve the lenders relinquishing the use of their own money for the time being. This means that banks would have to change their accounting rules so that loans are made only from money actually deposited with them. Credit cards, which encourage people to spend money they have not yet got would have to be replaced with debit cards which cash machines would only accept for sums which the holder’s bank account would cover. Governments would have to raise taxation to meet all expenditures instead of using the borrowed, interest-bearing money which keeps.. swelling the unrepayable National Debt.
With these changes in place there would be no need to outlaw the payment of interest on borrowed money. (It would, in any case, be impossible to enforce such a requirement because interest payments can easily be disguised for accounting purposes as part of the original loan, and higher prices can be charged on goods likely to be supplied on credit).
Co-operative schemes, linking buyers and sellers, would help to ensure the efficient circulation of money between producers, distributors and consumers. Co-operative arrangements would enable those needing loans for capital projects, renewal of infrastructure and so on to obtain these from those who would benefit from the results. Apart from this those growing rich through earning interest on surplus money would return a reasonable proportion of this to the . “main” market via income tax. Could such changes be made acceptable? A massive education system, together with small-scale experiments, would be needed to make clear why they would in the long run be beneficial for everyone and for the environment. How would they affect foreign exchange and foreign trade? Could they be implemented in one area or one country or would they need to be world-wide? How would the internet help or hinder the understanding and implementation of what needs to be done? As Greens we have a lot of hard thinking and discussion ahead of us before we can come up with comprehensive and workable monetary reforms, but we are, I believe, well ahead of most or all others in this field.
I now look forward to reading other peoples’ comments and suggestions for carrying forward our understanding of what is required.