In microeconomics the issue of money does not appear at all: indeed, mainstream microeconomics has eliminated money entirely from the supply-demand market model, with the argument that money is just a neutral means of exchange without any effects on the market.
By Andreas Rahmatian
Money in
law is a form of debt
Lawyers are
not much concerned about, and economists have never really known, what money
actually is. In microeconomics the issue of money does not appear at all:
indeed, mainstream microeconomics has eliminated money entirely from the
supply-demand market model, with the argument that money is just
a neutral means of exchange without any effects on the market. In this way
one can avoid addressing economically and politically relevant points.
Image Attribute: Child Putting Money in
Arcade Token Change Machine/ Creative Commons (5346217382)
Money is
a form of legally recognised and legally enforced debt; in fact, it is the
nature of being a debt and its the enforceability by the law which creates
the money. Money is a debt represented by socially recognised reifiers
(coin, banknote, accounting entries, …) which the law orders to be accepted as
payment and extinction of another debt, for example arising from
a contract of sale. Thus money is entirely a creature of
the law.
If we first
look at cash, banknotes have no intrinsic value, and yet people have to accept
them as legal tender in satisfaction of the debt of £10 to him
which a £10 banknote embodies, and they are also forced to accept
the (entirely valueless) banknote as payment and extinction of the debt. This
so-called fiat money or compulsory tender is
an order by law according to which banknotes and coins without intrinsic value have
to be accepted as satisfaction of debts. Bank money (accounting entries)
is as yet not legal tender, but accepted payment as recognised by law.
Since money is
itself a debt (for the payment of another debt), it follows that there
must be debtors and creditors as a result of the debt that moneyis,
not of the debt that money pays in satisfaction of this other
debt. If there is no debt, then there is no money, and a modern economy
would be impossible. It follows further that sovereign debt is not necessarily
bad; it depends on what the debt is for and why it has been created. Thus the
usual terminology ‘sovereign debt crisis’ presupposes certain value
judgments which are not necessarily accurate. Furthermore, one needs to address
the question whether money must necessarily be created in form of a debt
and who should have the authority to create money.
For this
question we must look at the modern money creation process first. Today we have
a two-tier system of money creation. The first form of money creation is
by the Central Banks (such as the Bank of England) which appears most
prominently because of the visible reifiers of the money-debt, the bank notes,
but is very marginal in the modern economy, being at most about 5% of the money
in the economy. The second and economically really important form of money
creation is through commercial banks, which comprises over 95% of all money.1
(1) Money
creation by Central Banks:
The Central Bank is the ‘bankers’ bank’, in that
commercial banks settle their debts between one another via the Central Bank,
and in that commercial banks have their deposits with the Central Bank. This
means, their cash in form of deposits is a liability of the Central Bank
against them. The Central Bank is also the bank of the Government, in that it
can increase its assets by, for example, buying Government bonds and so lending
money to the Government, or it can increase its liabilities by issuing promises
to pay (e.g. banknotes) and acquiring assets. Increase of the Central Bank’s
assets and liabilities increases the money supply of a country which the
Central Bank can determine, theoretically at will and with no limitations, but
practically subject to macroeconomic and financial considerations: the most
typical danger of an unlimited supply of money (if it does not stay within the
banks) is that of hyperinflation, as for example in Germany in 1923.
(2) Money
creation by commercial banks:
This is done through granting loans. When
a commercial bank grants a loan of £ 10,000 to a customer,
this customer obtains £ 10,000 which he transfers to a seller of,
say, a car, who in turn deposits these £ 10,000 in an account with
the same or another bank (so it appears in the other account as a debt
owed by the bank to the car seller). The £ 10,000 are bank money, so money
that exists in the accounts of the bank only – nowadays as a figure typed
into the bank computer. The bank money can be converted into cash (banknotes),
as the customer (as well as the third party, the seller) can at some point
require a pay-out of some or all of the amount in cash. The bank will
have obtained this cash which it pays out now by having reduced its credit
(deposit) with the Central Bank before. (This is one reason why cash is not too
popular with banks.)
The debt of
the bank of £ 10,000 to the customer is money created ‘out of nothing’, by
way of a loan for £ 10,000 given to the customer as recorded in the
accounts of the bank. Thus when a bank grants a loan to its customer
it credits itself with the amount of the loan the customer owes (on the assets
side of the bank’s balance sheet) and at the same time debits itself with the
loan amount as deposit of the customer owed to him by the bank (on the
liabilities side of the bank’s balance sheet), because the loan money has been
paid into the customer’s account and is a deposit, thus newly created
money. It is a curious accounting entry, compared to usual book-keeping,
because it creates a liability or debt of a bank
which consists exclusively of a debt to that very bank.
The bank’s asset is the debtor’s liability to the bank itself, created by the
bank as a bank’s liability to the bank’s debtor.
The grant of
the loan happens in principle independently of the amount of deposits
a bank has obtained from customers’ savings, contrary to the erroneous
belief that credits supposedly come out of existing, previously collected,
deposits. In addition, banks can then multiply the money, because the £ 10,000
which were given as a loan are used for payment and paid into another
account of another bank (or into another account of the same bank). The other
bank can use the money to give credit of £ 10,000 to another customer.
Hence there is really money creation, not just moneysupply,
and there is almost no limit to this possibility to create, except by the
existing fractional-reserve banking system: the law requires banks to maintain
reserves equal to a small fraction of their deposits, usually less than
10%. Even these less than 10% are not necessarily backed by tangible scarce
assets since the abolition of the gold standard. Reserves in excess of this
amount may be used to increase earning assets (loans/deposits and
investments). They are not backed by anything of value at all. If
a non-bank did something equivalent, it could attract criminal liability.
Why is it
possible that banks can create money by way of lending while anybody else who
lends money cannot? The reason is that a non-bank which lends money
reduces the funds from elsewhere in the firm to disburse the loan, while banks
only effectively re-label their liabilities: before the loan it is ‘accounts
payable’, after the loan it is ‘customer deposit’. This is possible because the
banks are exempt from the normal client money rules which require that client
money must be kept in separate accounts, well segregated from the firm’s own
money (e.g. solicitor’s accounts).2 In
this difference lies the privilege of the banks which confers far-reaching
economic and political powers on them.
The
inevitability of ‘debt’, whether sovereign or private debt
As
demonstrated, money is debt, and so there are necessarily debtors and
creditors; if there is no debt, then there is no money and no economy. This is
a finding arising from basic book-keeping, but does not seem to be
realised much: If I own a £ 10 banknote, then I am creditor to
the amount of £ 10, and somebody else must be debtor of these £ 10
plus, importantly, interest and compound interest, because loans are never
given interest-free, although this would be legally possible. The major
difference between the ordinary debt created in private law (for example
payment under a contract of sale) and a money-debt is that the
correlation between a determinable creditor and a determinable debtor
cannot be ascertained: I as the owner of the £ 10 banknote cannot
define who exactly ‘my debtor’ is, because the debt relationship is mediatised
by the banks (Central Banks as well as commercial banks). We have seen that the
creation of the money-debt is through a loan. If I save money, then
somebody else must become indebted, if the state saves money, for example by
reducing its sovereign debt, then either its citizens, its enterprises or its
foreign economies as trade partners must become indebted. This can become
dangerous for the ‘rich’ creditor state in the long run, because either the businesses
and/or the individuals as debtors become insolvent or lose their employment
which reduces tax income for the state and shrinks the domestic economy, or the
foreign economies can no longer repay the debts to the state or stop importing
the state’s goods because they are increasingly unable to afford this. Germany
currently faces this problem within the EU.
The state
could issue banknotes of its own accord, without having a debt created
against itself. One could think of replacing debt-money by state-issued money
that is not the creation of a debt, or if it is to be a debt, then it
should be one which does not attract any interest at all. This also means that
commercial banks should be barred from money creation at all (as everyone else
is), or, if loans are granted and the money is provided in form of bank money,
not cash, such a loan should not be able to attract interest. But such
a reform is obviously not likely to happen.
Thus
‘austerity measures’ which are so popular in current politics these days are
meaningless in the present monetary system: if the states repaid their debts
(which they theoretically could, and fairly easily by raising taxes,
a remedy not open to any private person or entity), they would either
destroy money at a large scale (extinction of assets of creditors). They
would also provoke a breakdown of the economy, or non-state entities,
individuals or enterprises, would have to get indebted much more. Thus
sovereign debt, if one accepts the present system of money as a form of
debt at all, is not necessarily objectionable. However, as debts do not only
trigger the duty to repay the capital of the debt, but also the interest and
compound interest – and compound interest does not grow in a linear, but
in an exponential way3 – the
spiral of the indebtedness would increase to astronomic proportions far beyond
the present (already high) level of state debts, and individual and corporate
indebtedness. But the monetary system aims at exactly that.
The
enforcement and maintenance of the debt relationship
The reason why
this method of money creation is that this system creates and maintains an
enormous power over people and whole economies, states and political systems.
First, the
idea of debt also involves the idea of guilt and can be used for emotional blackmail:
he who is indebted must repay his debts if he wants to remain an honourable
person. For example, in the debate of the European Parliament of 8 July
2015, the leader of the European Christian Democrats, Michael Weber, pointed
out reproachfully to the Prime Minister of Greece Alexis Tsipras (who was
present) that a haircut of Greek public debts will have to be paid by the
people of (poorer) countries in Europe, not by financial institutions.4
Secondly, one
can convince easily in the prevailing neo-liberal political debate with the
simple argument that if the debts are too high it is necessary to save money.
In this way the cut of expenses in politically undesired areas, such as health,
education, public transport can be justified effortlessly. Among German
politicians, this purely microeconomic perspective is referred to prominently
as the argument of the ‘Swabian housewife’ who also understands perfectly well
that she will have to make savings if she has less money. One major flaw of
this analogy, among others, is that banks, and indirectly the state, can and do
create new money, while a Swabian housewife in need of money cannot. To
continue with this pre-feminist metaphor, her saving may rather put her
bread winning husband out of employment or business.
Thirdly,
across a country’s economy it is impossible to repay money debts because
of the exponential growth of the interest which accrues with the debts. The
impossibility is systematic, not accidental. Some individuals can repay, but
never all debtors in a whole economy. If the debtor cannot meet the
payments, the debt plus interest will be enforced by the law, through the usual
enforcement methods: sale, auction etc. It is in this moment, and in this
moment only, when money genuinely transfers real value and not just an
expectation to value, to be realised at some later point in time. If there is
a large number of insolvent debtors which may endanger the liquidity of
banks and it is felt that a collapse of banks may lead to a systemic
failure of the banking system, political representatives are now prompted to
rescue banks with taxpayer’s money to keep the banks afloat, as has happened
from the financial crisis of 2008 onwards. The result is a shift of banks’
debts to public debts (‘sovereign debts’), to be serviced by tax payers. The
creditors of these public debts are again, banks, which, in turn, can enforce
these monetary debts against all their customers and states as debtors, and
everything starts again. In this way private enterprises, with governments as
their agents, can blackmail and intimidate whole countries. This has been
demonstrated impressively in the case of Greece during the seventeen-hour
bail-out negotiations with EU representatives from the 12th to
the 13th July 2015.5 It
is quite possible that this coercion of one EU Member State (with no
future chance of economic improvement) is the beginning of the demise of the EU itself,
because the peoples of Europe may increasingly see the European Union as
a threat to their national democratic systems. Euro-sceptic and extremist
parties exploit this sentiment for their political ends with growing success.
Thus
ultimately the monetary system is an expropriation device, and the present
construction of money as debt continues to be maintained for the preservation
of this power of the richer over the poorer. Whether that debt is
a public/sovereign or a private debt is a secondary point. What
matters is that any reforms, economic or social, do not touch the fundamental
principle of money supply through debt creation, and political parties of all
colours seem to abide by this unwritten rule.6 The
purpose of mainstream economics is then to clothe this system with an
unassailable scientific garb.
About The Author:
Andreas
Rahmatian is Senior Lecturer in Commercial Law at the University of Glasgow.
Publication Details:
This article was first published at Critical Legal Thinking on November 30, 2015 under Creative Common License 4.0
Footnotes:
1. For the following brief outline, see in more
detail e.g., Federal Reserve Bank of Chicago, Modern Money Mechanics (Chicago,
Il., 1994 version), 7 – 10; Bank of England: Michael McLeay, Amar Radia and
Ryland Thomas, ‘Money creation in the modern economy’, Bank of England
Quarterly Bulletin, No. 1 (2014), available at: h
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
(visited on 11 Nov 2015); Deutsche Bundesbank, Geld und Geldpolitik (Frankfurt
am Main: Deutsche Bundesbank, 2008 edition), 59 – 63.
2. Werner, Richard A. (2014), ‘How do banks
create money, and why can other firms not do the same? An explanation for the
coexistence of lending and deposit-taking’, 36 International Review of
Financial Analysis, 71 – 77, at 74 – 75.
3. This is according to the formula M =
P×(1+i)n, whereby M is the final amount, P the principal sum, i is the interest
rate per year and n the number of years. So the principal sum of 100 invested
for 10 years with 5% interest will be the final amount of 100×(1+0.05)10 =
162.89, thus almost an increase of 63%.
4. Conclusions of the European Council (25 – 26
June 2015) and of the Euro Summit (7 July 2015) and the current situation in
Greece (debate):
http://www.europarl.europa.eu/sides/getDoc.do?type=CRE&reference=20150708&secondRef=ITEM-003&language=EN
5. The coercive aspect of this deal was
generally noticed, see e.g. ‘Tsipras faces clash with Syriza radicals opposed
to Eurozone bailout for Greece’, Phillip Inman and Jennifer Rankin, The
Guardian, 13 July 2015, available at:
http://www.theguardian.com/business/2015/jul/13/athens-and-eurozone-agree-bailout-deal-for-greece
(visited 11 Nov. 2015). See also Paul Krugman, 12 July 2015, ‘Killing the
European Project’, The New York Times available at:
http://krugman.blogs.nytimes.com/2015/07/12/killing-the-european-project/
(visited 11 Nov. 2015).
6. However, the problem of money creation was
debated critically and illuminatingly in the British Parliament from all sides
of the political spectrum: Money Creation and Society (backbench business),
Hansard, 20 Nov. 2014: Columns 434ff., available at:
http://www.publications.parliament.uk/pa/cm201415/cmhansrd/cm141120/debtext/141120 – 0001.htm#14112048000001
(visited 15 Nov. 2015).
