The Duopoly of Money Creation

How is money created?

Fiat money is created from nothing on the basis of a promise – a promise to deliver goods or service in the future. Another word for promise is debt – I prefer promise. Only if we believe in these promises does money have value. The teacher promises to teach. The roofer promises to mend the roof. Money creation facilitates things getting done, but create too much too fast – by promising more than we can deliver – and it looses its value. Therein lies the problem.

Money is created either when the government spends, or when a bank makes a loan. We can think of government spending and bank loans as the beginning of two interconnected money circuits, see Figures below. The government and bank circuits form the duopoly of money creation.

The money circuit

After money is created it flows [1] through the economy and eventually is returned to the issuer. In the government circuit, money is returned to the government via the payment of tax, as in Figure 1. In the bank circuit, money is returned to the bank by the repayment of the loan, see Figure 2.

Figure 1: The government spend and tax circuit. The difference between spend and tax equals private sector saving and is known as the deficit. 

When all the money is returned the quantity of money goes back to zero except that in practice the rate of new money creation is higher than the rate of money cancellation, such that we hardly notice the creation and annihilation process and instead the total amount of money in the economy grows (imagine the lines in Figures 1 and 2 getting thicker over time). Ideally the growth in the money supply should match the growth in economic activity, such that prices remain roughly stable and we maintain confidence in the value of our promissory notes. Control of the rate of money creation and destruction in the government and banking circuits are known fiscal and monetary policy, respectively.

Figure 2: The bank circuit where loans create private debt.

Note that the government circuit is leaky, by design. People are allowed to save – hoard promises – and avoid tax. The part of the government spend that is saved leads to a deficit on the governments books (red in Figure 1). Savings can serve a useful purpose but it is odd that we tolerate other leaks, like lower taxes on capital gains and tax havens, I shall come back to leaks and the deficit in a later post.

Why two circuits?

The obvious question is, why do we need a duopoly? Why do we need both a government circuit and a banking circuit? Why do we need both fiscal and monetary policy? As money is a collective good, should we transfer all money creation powers to government and demote private banks to the role of intermediaries as some propose? Or could we hand over all money creation to private banks as the free market fundamentalists would prefer?

Many people are shocked to learn that banks and government are the source of all money, in particular, that banks create money. By allowing the equivalence of bank money and government money, the government and hence all of us underpin the banking circuit and so we have a democratic right to keep them under control and to take a share of their profits. Still banks do provide a useful service, and those looking for the failings of the modern world as a failure of this system of money miss the real culprits. The duopoly is optimally designed to meet our needs. We just need to manage it better.

The reason for the duopoly is relatively easy to understand. Money creation needs to serve both individual need and those of the country as a whole. The bank circuit exists to serve individuals, while the government circuit exists to provide services to everyone.

  • Two circuits are necessary because there are individuals (private) and collective (common or public) interests.

We do not really want government to get involved in private consumption like car loans and we do not really want the vested interests of private banks to extract rent from public need, so two separate dedicated money circuits are required.

Economists often call our collective interests public goods. The most familiar examples are security and defence, health and education. Education is a public good because its consumption is intended to benefit society as a whole and not only the individual receiving the education. We educate people to become engineers and doctors so that we can all benefit from their expertise in the future. Other examples of a public good include transport and energy – we build roads or power stations such there is a net benefit to everyone.

Democratic control of money creation

We can still ask why we need a separate money circuit to provide public goods? There are many good reasons, but perhaps most important of all is that we should be granted a say on our collective interests – this is the essence of democracy. We elect a government to manage our collective needs. Capitalism and democracy are also a duopoly – each with their dedicated money circuit. The capitalist banking circuit represents private interests but fails completely in the provision of public goods. The democratic government circuit fills the gap. The duopoly of capitalism and democracy exist in parallel to support and complement each other.

The failure of the private interest bank circuit to provide public goods is easiest to understand by looking at specific examples. For example in health care, the market solution is to operate on the patient offering to pay the most. Even worse, the market may deliberately create a scarcity in order to charge a higher price. A market cannot operate effectively in matters of life and death, as Kenneth Arrow – a highly-respected pioneer of neoclassical economics – wrote:

the laissez-faire solution for medicine is intolerable.

The government solution in health care take a long-term perspective and addresses the scarcity in trained doctors such that more patients can be treated. Markets only operate effectively if there is genuine competition. For example, we need at least two – preferably more – companies operating on every bus route in order to give commuters a real choice, but this just creates overcapacity and congestion. In situations where competition is not viable, where demand is unlimited like health, and supply delivers societal benefits then collective democratic control is the optimal solution.

What can go wrong?

The duopoly of individual (or private) and collective (or public) needs leads naturally to the duopoly of monetary and fiscal policy. Those looking for the failings of the modern world as a failure of the system of money miss the real culprits. The failure lies in the inability of politicians to regulate the banks and to appropriately use fiscal policy.

The art of economic management is to balance fiscal and monetary policy. An over dependence of one or other is doomed in the long term. Since 1980 both the US and UK abandoned this balanced approach that had worked well up to the oil crises of the `70s. Over reliance on the banking circuit and bank deregulation led eventually to the private debt bubble that burst in 2007-08. Rather then correct their mistake, politicians left it to the central bankers to sort out the mess. The bankers, limited to monetary tools, turned to quantitative easing, but nearly a decade on, with interest rates still stuck at their zero lower bound, we still look on aghast, waiting for someone to wake up to the complete failure of monetarism – if only the younger Milton Friedman could come back to explain it to us all. In 1969, he said [2]:

The available evidence . . . casts grave doubts on the possibility of producing any fine adjustments in economic activity by fine adjustments in monetary policy – at least in the present state of knowledge . . . There are thus serious limitations to the possibility of a discretionary monetary policy and much danger that such a policy may make matters worse rather than better.

In contrast, fiscal policy is a far more powerful, and some may say more dangerous, beast. The collective has an ability not available to any individual. Only the collective has a super charge card where all the spend comes back via tax – the teacher does not cost anything as long as the money spent on them is also spent. In fact, more likely is that the collective will make a profit on employing the teacher by crowding in more economic activity (a multiplier greater than 1). Fiscal policy is intended to get things done. Let’s get on with it!

[1] As Marcus von Skym says: the most important property of money is to flow.

[2] Milton Friedman and Walter W. Heller, Monetary vs. Fiscal Policy, W. W. Norton and Company Inc., New York 1969.


  1. Sean Danaher -

    Thanks Charles
    good stuff. Interesting quote from Milton Friedman, goes to show to be older is not always to be wiser.

    1. Charles Adams -

      Yes the younger Friedman was impressive, but the later writings become more and more in the no-such-thing-as-society camp. I wonder what he would have made of climate change?

  2. Peter May -

    Of course what neoliberal governments have done is to channel the money creation that should have been public towards the private sector. I know bonds are channelled to the private sector but the interest rates are a lot lower than PFI or contracting out. And paying interst or rent for something specific gives the privateers a lot more control over government services than just for a general government bond. Positive Money rightly in my view considers this antidemocratic. Their ideas are another version of ‘taking back control’ but I consider they fail to understand that a banking licence indicates who actually has control.
    The problems all seem to be because Major, Blair and Brown were convinced there were ‘bond vigilantes’.
    Now we know that we can create QE out of thin air how deluded that all seems!
    But it is even worse that it still continues.

    1. Charles Adams -

      I agree public services should not be contracted out as that just becomes a tax/rent paid directly to the private sector and we loose all democratic control.

      I do not mind paying interest on my bank loans because the bank offers me a service and needs to pay their staff, etc. Plus there is pretty good competition as long as there are many banks. However, I do object to too big to fail. We need to make sure that no bank represents a systemic risk to all of us. The old system of building societies, local banks and investment banks was less risky.

  3. Ivan Horrocks -

    Charles, just a minor point. In the paragraph under Fig.2 you state: ‘Note that the government circuit is leaky, by design. People are allowed to save – hoard promises – and avoid tax’.

    You don’t mean to say that people are allowed to ‘avoid tax’ do you? Wouldn’t it be more accurate to say: ‘People are allowed to save – hoard promises – and some people also avoid paying tax.’

    Just a thought.

    1. Charles Adams -

      Thanks, I was not trying to imply anything illegal only that our tax system encourages savings which is a choice about whether we want individuals or society to insure against risk. How is it possible for the government to offer tax free saving and then say that there is not enough money for the NHS? Only because they want to regress to a more primitive system where all risk falls on individuals.

      1. Graham -

        …or because they have been captured by private/corporate interests and opt to channel money to the already well off and the rich and powerful. And they are thinking of their “retirement” fund once they have left politics – too big to fail here I come.

      2. Peter May -

        “The old system of building societies, local banks and investment banks was less risky.”
        Quite – much!
        “How is it possible for the government to offer tax free saving and then say that there is not enough money for the NHS?”
        Agreed. A non sequitur if nothing else on the tax front.
        We really have to decide if the ‘idea’ of saving for a rainy day is psychologically to be encouraged.
        If it is then that suggests a degree of personal responsibility, with which I think most would agree.
        The trouble is this government think it is a protection against penury which it so obviously isn’t.
        So it is, as ever, a matter of degree.
        I think it is also a matter for societal standards – ie no penury – whatever you’ve done.

  4. Allen Bell -

    “Money is created either when the government spends, or when a bank makes a loan” Oh dear. There are centuries of instances where units of tradeable value to facilitate exchange ( if that is what money is ) have been created in other circumstances. The Adam Fergusson book ‘When money dies’ has many examples.
    The same criticism could be extended to what economists mean by ‘public goods’ or the meaning of ‘zero lower bounds’. Take health – if your neighbour has an accident blocking your street or she has a communicable disease, then that problem could affect you. If your neighbour has MS, that problem only affects you if you care about her. Healthcare itself is not a public good. Some parts of it are, but as a whole it really is not.
    This post reminds me of the Richard Feynman videos about how hard it is to really know something, and the temptations of mystical explanations.
    Adam Smith took decades to work out his 4 principles for a prosperous society, yet there are people who think they can devise solutions for our ills in their part-time hours, solutions which have already been tried.
    Your best point is on fiscal policy being more significant than monetary policy, but you’ve arrived at it from an odd direction. The most common monetary policy is an inflation target – typically around 2%. Once you’ve worked out why that is, and decades of effort went it to this ( it might still be wrong though, and free banking be superior for example, but it’s important to understand how we arrived here ) then you arrive at the conclusion that fiscal policy is so much more significant.

    1. Peter May -

      “If your neighbour has MS, that problem only affects you if you care about her. Healthcare itself is not a public good.”
      So we end up with people with MS dying in the streets. Is that a public good?

  5. Lee -

    I guess Allen Bell is talking about the historical creators of money and the form it took e.g. sea shells, rare feathers, tally sticks etc. Charles is not talking about history. He’s talking about who creates money and the form it takes in today’s economy.

    As for thinking that health is not a public good… I wonder if you should move to a country without any public vaccination programme in place and see how quickly you, your children, friends and neighbours (cared about or not) contract a communicable disease and thus how quickly millions of people will subsequently end up suffering and unable to work in the economy because of it.

      1. John S Warren -

        On the history of money, rather than Adam Smith (see link above), may I suggest reading probably the first profound, modern monetary theorist, John Law, ‘Money and Trade Considered’ (1705). He is acute, and behind the arcane-archaic terminology of his time breathtakingly illuminating. Until recently he has been largely forgotten by scholars and economists (glibly dismissed as a notorious speculator), but is now being rediscovered. His rehabilitation as a great monetary-economic thinker has been long overdue.

      2. John S Warren -

        Unfortunately it is the “Bubble” that attracts interest.

      3. John S Warren -

        Having now watched it, I can only assume that your reference to the 1979 video on Law was intended as irony.

        ‘Money and Trade Considered’ (1705), which was written pre-Mississippi Bubble, was intended to solve the problem of money and credit scarcity in Scotland, through the issue of paper money. Law’s solution was not the cause, but the response to the earlier collapse of another illusory project in the Americas; the Darien Scheme. Now that is irony.

      4. Charles Adams -

        Apologies, if I misinterpreted the intent of your original post. The John Law story often gets associated with the Mississippi bubble which as you say may be unfortunate.

        I agree that modern money theory has made an enormously positive contribution to our understanding. Also, as you suggest, it is not really that modern.

  6. Paul Hunt -

    This is an excellent explanation of money creation and deserves much greater circulation. Because of its brevity it fails to present the dynamic aspect which would explain the overuse of naive Keynesianism in the ’60s and 70’s, the debasement of fiat currencies, the enforcement of rights without corresponding responsibility, the suffocation of the private sector and the suppression of market mechanisms. This led inevitably to what is called “neoliberialism” from the late ’70s which has sought to push back the frontiers of the state, but has led to the acquisition and abuse of market power, the rigging and subversion of markets and the suborning of politicians and public officials. We are now seeing a reaction to this, but it appears fated to repeat the stupidity of the ’70s.

    1. Charles Adams -

      Sounds like you agree Paul that it is all about balance.

      I am a big fan of economic history which tells us that the ’70s was an era of rapidly increasing prosperity, see

      but I also agree that some mistakes were made. As I wrote:

      “The art of economic management is to balance fiscal and monetary policy. An over dependence of one or other is doomed in the long term.”

      We ought to be able to learn from the past and find the balanced path.

      1. Paul Hunt -

        Thank you. I agree. But the current imbalance is excessive because conventional monetary policy is ineffective close to the zero lower bound (ZLB), there is a stupid centre-right aversion to using fiscal policy to get away from the ZLB and the use of unconventional monetary policy as substitute has just increased in equality. But the bigger and more damaging imbalance is being caused by the extent to which rent-seeking is dominating the behaviour of the private sector. The latest British Gas energy price increase is a perfect example.

    2. Bill -

      “…overuse of naive Keynesianism in the ’60s and 70’s…”
      Can you support this statement?

      1. Paul Hunt -

        I’m sure you’re as able as I am to track down the evidence and the analysis of the ’70s stagflation that led to major revisions of the existing Keynesian model, to the development of the New Keynesian model and to the extent to which it has more or less become the dominant source of macroeconomic policy advice – even though this advice is frequently ignored by bone-headed politicians who have been suborned by corporate capitalists and high net wealth individuals.

        However, I find that, in most instances, those who demand evidence are totally unwilling to seek out or contemplate evidence that might question their deeply held prejudices.

  7. Ralph Musgrave -

    I can’t fault the above article up to the heading “Why two circuits?” But Charles Adams then goes right off the rails when he claims we need two sorts of money for the two basic sectors of the economy, the private and public sector.

    Numerous economists, including at least four economics Nobel laureates have argued for a “base money only” economy, i.e. full reserve banking, or “100% reserves” as Milton Friedman called it – (Friedman was one of the Nobel laureates who advocated abolishing privately issued money).

    Conversely, it would be perfectly feasible to have an almost exclusively “private money” economy. Government could perfectly well collect taxes, plus it could open one or more accounts with private banks, Barclays or Lloyds say. Government would then pay for health, education, etc out of its Barclays or Lloyds account. Indeed, I imagine various government departments or entities actually do have accounts at private banks into which they pay monies extracted from the population by one means or another.

    Personally I agree with Friedman, James Tobin, Positive Money and other individuals and organisations campaigning for the abolition of privately created money. Seems to me that the right to print or create money amounts to a subsidy of the “printer / creator” for reasons I set out here:

    1. Charles Adams -

      I am aware of Friedman’s early writings on this. Initially I agreed but later decided that 100% reserve banking may be too restricting. Money is just information about an unbalanced exchange that allows it to happen now rather than later – it enables the speed up of economic activity. We just need a formal collectively agreed means to operate this information system which could be tally sticks, promissory notes, or computers.

      If a builder wants to build, but the local bank has no reserve, why should everyone have to wait until the government has created the money to flow to the local bank and the builder? Money was not invented to limit what we can do, either privately or collectively.

      1. Ralph Musgrave -

        Thanks for your interest. My answer is that there is no limit to the amount of money the state can create and spend into the economy – into the private sector in particular. Plus there must be some stock of cash in private sector hands (and in government spending department hands) which induces them to spend at a rate that brings full employment.

        Having done that, and assuming market forces work as well as they are going to work in the real world (which of course is in a highly imperfect manner), it is certainly true that there will be builders and their customers who currently don’t have enough cash and who are itching to borrow money and get their project off the ground. But the simple fact that those projects cannot attract funds at going rates of interest proves they are not sufficiently worthwhile or viable to be allowed to go ahead.

        If private banks ARE ALLOWED to create and lend out money to fund those “builder projects”, aggregate demand rises too far, as does inflation, which means the state has to raise taxes and confiscate base money from the population at large so as to damp down demand. I deal with that point in more detail in the paper of mine I linked to above.

        On a totally different subject, I assume you are the “Prof Charles Adams” of Durham University. I’m also based in Durham City and I’ve been an active supporter of the local Positive Money group for years. We have meetings once a month at Broadacre House, Market St, Newcastle and the next one is Thursday, 31st Aug, 6.30 to 8.30. You are more than welcome to come. Normally between 4 and 8 people turn up. Normally there is not much of a fixed agenda: just general discussion. Broadacre House will no longer be available to us after October, so we’ll need to find another venue.

        We are also having a larger meeting on Thursday, 21st Sept (afternoon / evening). We’re in the early stages of planning this. The main purpose is to mark ten years since the bank crisis began, and to react to a debate taking place on Monday 18th September involving Martin Wolf, Fran Boait (of Positive Money) and others. We have got Mary Mellor (former prof at Northumbria University) giving a short talk and may get other speakers. Mary has written two books on money. We’re aiming for an audience of about 50. You are welcome to come to that too. Plus if you have any ideas for publicising the larger meeting in Durham City, I’m all ears.

      2. Bill -

        “…If private banks ARE ALLOWED to create and lend out money to fund those “builder projects”, aggregate demand rises too far, as does inflation, which means the state has to raise taxes and confiscate base money from the population at large so as to damp down demand…”

        The US housing bubble was driven by subprime loans and securitization of those dodgy loans which would not have been possible undervGlass-Steagel regulation. Surely seperation of retail and investment banking must be reenacted.

        The U.K. housing bubble seems a result of insufficient supply.

        Furthermore, you seem to argue that a flat, regressive tax is the only option available to dampen demand?

      3. Ralph Musgrave -

        How safe banking is under Glass Steagel depends entirely on the rules governing the retail and investment halves of the bank industry under those rules. One could perfectly well split the bank industry into two halves as per GS, but have wholly inadequate rules governing the two halves, which would mean that particular brand of GS would not do much good. Ergo the GS type split does not of itself achieve much.

        In contrast, under full reserve banking, which I support and which Positive Money supports (though for some strange reason they don’t care for the phrase “full reserve”) it is plain impossible for banks to fail because loans are funded just via equity or similar (e.g. bonds that can be bailed in). That means if a bank in either half makes disastrous loans, all that happens is that the value of the shares or bonds falls.

        Re your idea that the UK housing bubble being caused by inadequate supply, I quite agree. Land with planning permission changes hands for about a HUNDRED TIMES land without such permission. That’s absurd. Two or three times I don’t mind, but a hundred? Completely absurd.

        Re regressive taxes, you certainly could argue that that’s what I’m advocating: i.e. along with Positive Money and other advocates of full reserve, I advocate a system that would raise interest rates somewhat, and that would hit the less well off. But the answer to that point was given by the Italian philosopher and economist Pareto. He made the point that all that matters as regards a change in any policy is the effect on GDP. If the result of the change is increased inequality, that can be rectified by measures like increased income tax, a beefed up social security system, and in this particular case, maybe something like enhanced “Help to Buy”. Having done all that, then as Pareto explained, one can arrange (at least in theory) for EVERYONE to be better off.

        Also note that those with mortgages in the 1980s were paying almost THREE TIMES the rate of interest they pay nowadays. The sky did not fall in in the 1980s. Indeed growth was better than it’s been since we started enjoying the dubious benefits of low interest rates about 8 years ago.

      4. Sean Danaher -

        Sounds interesting. I am also in the North East and know Mary Mellor from my time at Northumbria. Once you have more details we can advertise if interested. If I’m available and there is space I’ll try to make it

      5. Ralph Musgrave -

        Thanks. Much appreciated. Can you give me your email address? If you don’t want to plonk it here, text it to me at 07950 466 362.

      6. Peter May -

        “But the simple fact that those projects cannot attract funds at going rates of interest proves they are not sufficiently worthwhile or viable to be allowed to go ahead.”
        Shows a touching faith in our lumbering banks. If the banks were more diverse and even local the entrepreneurs might be approved for the loan.
        Don’t forget that the UK is unique in the developed world in having such enormous world banks – and almost nothing else whatsoever.

  8. Charles Adams -

    Here’s an excellent summary from Lee posted on Richard Murphy’s blog.

    Lee writes –

    Key points for me included:

    a. Money is created and destroyed (cancelled) and that this is an essential feature of the economy to make it function.

    b. Debt is a promise. A promise is a debt. Without which the economy cannot function. Ergo, debt is not automatically a “bad thing”. Unmanageable or poorly managed debt is however.

    c. It is the rate at which we make promises and money – and then destroy it – that needs to be carefully managed (if we are to keep the economy bubbling along nicely).

    d. The deficit is simply the difference between what is spent and taxed, but that difference isn’t necessarily or automatically a “bad thing” – as is often reported in the media – and that difference does not in any way stop the government from creating more money and issuing more promises.

    e. All government-created money makes its way back to the government eventually through taxation.

    f. We don’t have to allow private banks to create money if we don’t want them to. We have a choice. They do not have an inalienable right to create money; they do it under licence from the Bank of England. But since we allow them to create it on our behalf, we have a duty and right to hold them to account and tax / share in their profits.

    g. The duopoly exists because it is thought that government-created money is there to serve the public (or national good), whereas privately-created bank money is there to serve private individuals e.g. supplying mortgages and other loans for purely personal or commercial needs.

    h. The real risk to the economy is the lack of political will to use fiscal policy to regulate the economy and private banks more effectively, because monetary policy is weaker than fiscal policy. That doesn’t necessarily mean having more regulation is the answer, just better regulation and the will to use it.

    Conclusion: the optimal strategy to create a successful economy i.e. one that will benefit both the public and private individuals/organisations, is to have a well-balanced duopoly. Having one or the other – or imbalanced duopoly – seems to produce undesirable, unfair, unjust and distasteful effects.

  9. Vince -

    I am a Positive Money supporter.This is a good model to show how money works in our economy,.Only we should be aware that the two are not at all separate.Both types of money created this way are indistinguishable,which is very fortunate for private banks and unfortunate for the rest of us. The public cannot tell the difference between a pound created by a private bank and a pound created by Gov spending. Our current money system ensures that all money ends up in private bank deposits whatever its origin.We have to use banks if we wish to use money.

    This gives banks a most advantageous position at the cost to the taxpayer. In a nutshell it gives them the right to print money with the confidence of having the state acting as the backstop.(via deposit insurance, central bank emergency liquidity schemes,bailouts,QE etc etc).

    Not only that, the state forgoes around £20 billion per year in allowing banks to create this money,when it could quite easily create the money itself and save the taxpayer a hefty bill.And what do we get for all these private bank subsidies?Well a reckless banking system that causes deeper boom and bust cycles than otherwise would be the case.This is largely down to banks “overcreating” money in the good times (according to Adair Turner) and of course not creating enough in the bad.This is the opposite of what we need!Even Mervyn King said of the current banking system that of all the ways of doing banking the one we have now is the “worst”.

    Positive Money are asking that the state create ALL the money we need in an open and democratic way so that money creation serves the wider public,not the interests of the few bankers and the City.We can still have banks to lend money just we need a steady and plentiful money supply,something we do not have right now.

    1. Charles Adams -

      Thanks Vince. I agree the two circuits are connected but I do not think that this has to mean bank subsidy (the subsidy is in too big to fail which we should remedy via regulation). Yes, we have to deposit our money in a private bank but the bank pays us, not the other way around.

      Interest payment on bonds is a direct transfer from workers to owners of capital and is essentially a subsidy to the financial sector. In the long run this can only end in crisis and I would restore stability using capital taxes.

      I also agree that banks do not always get money creation right which is why we need fiscal policy too. However, we also know that democracy does not work perfectly either and government money creation could also be a source of instability, plus there is a danger of crony capitalism dominated by powerful vested interests.

      Consequently given that no system is perfect, the tension between democracy and capitalism (fiscal and monetary policy) – a mixed economy – with the right checks and balances is better placed to cope with both macro (collective) and micro (individual) needs and fluctuations. It worked well at times in the past – only over the past few decades have we got the bank regulations wrong and neglected the fiscal part.

      1. Vince -

        We have 5 big banks in the UK,all now classed a “Globally significant banks” so they will be bailed out come another crisis regardless and as such are by definition too big to fail.We are simply stuck with that situation. No amount of Gov. propaganda changes that,they can talk about bailins and better buffers till the cows come home but is mere bluff because when the winds come, they will throw the kitchen sink at the banks once again to keep them going.The problem is that the banks hold the whole payments system to ransom here.

        The way central banks are working(with Gov approval) is towards making us use electronic money.Try getting a job without a bank account or pay your taxes or get your welfare payments. The drive globally is toward a cashless society (which very much favour banks), since we must put our money into deposits in order to live in the modern world.This drives reserves into the banks hands and is thus yet another subsidy to them.
        Banks only pay small amounts on bonds and deposits(if any at all now).Reason being is that it is cheaper than borrowing from the central bank or another bank to fund their lending.These are simply cheaper reserves for them.
        In fact the more you look the more subsidies you find the banks get from the state/taxpayer.
        As to Gov spending causing instabilty,your first money cycle is largely neutral as taxes equal spending,so not alot of new money being created overall,the big sorry is that second circuit where all the money inflation comes in.Politicians overall do not cause inflation with money creation,private banks most certainly banks do,inflation in house prices and stock markets.
        We would very much agree though that interest ends up siphoned from workers to the owners of capital via interest payments and as such it is very much unsustainable.Taxation is a method by which a gov can redistribute wealth,but governments are loath to use tax to deter lending for mortgages and share purchases.In fact they are doing the reverse,actively encouraging them for short term growth,it is very dangerous.The rich grow richer with no counterbalance.

        Fiscal and monetary policy working hand in hand is key,(not one nor the other, as you also do say) and that is what a Positive Money solution would promote.
        For a start Positive Money’s idea of money creation would NOT be going into bubble making asset markets like property and shares.Only a truly independent central bank would decide on the quantity of money in circulation considering the wider econimy(monetary policy) and politicians only get to decide where that gets spent/cut(fiscal policy).It is a wise separation of powers.That would really make money creation democratic.
        We have about 80 bank execs currently deciding how much private money to create and where it is invested in the UK,this is totally undemocratic…and they have done an awful job so far.My money is on the state doing a better job there, though mistkes will be made,it’s just a matter of scale.

        We have been struggling with this problem since banks began.This is not a recent phenomena and is why we need a different tack now.Banks have been causing booms and bust for centuries when you look back through history and in all that time we have, as yet, failed to come up with a decent regulatory system.We have tried banning printing of notes (1844)reserve systems(now abolished in UK)and capital reserve limits,none have been successful.

      2. Charles Adams -

        Vince, I actually agree with quite a lot of your points here, in particular the status quo is not tolerable. However, I worry that complete government control of money creation would be too limiting and not be as democratic as we would hope as there are always vested interests that have more power than individuals – would you really trust our current government to do a good job of this? Consequently I prefer a dual system with many small private (local) banks constrained in size and power but still the ability to risk lending against a fractional reserve. If these local banks ran as cooperatives even better. It is a case of creating a regulatory framework where cooperative democratic banking can prosper over anything else which is really what you believe as well I think, it is just a question of the means to get there.

      3. Vince -

        Yes I do like the localised banking solution too,as I outlined in another post.Richard Werner is championing that as a way forward,I have no objection to it at all ,it may be the solution who knows.I also liked David Fishwick,(Bank of Dave fame)these are sustainable local banks.

        Not sure if they will be sufficient for all our banking needs but the Germans have managed a simliar system to the one you envisage so it may well be a way forward.But we are a long way from their banking model,plus the Germans have strict land price/rental caps which keeps the price of property firmly under control.We would have to have a complete revolution the way we manage land/housing and banking.

  10. Peter May -

    “We have about 80 bank execs currently deciding how much private money to create and where it is invested in the UK, this is totally undemocratic…and they have done an awful job so far. My money is on the state doing a better job there, though mistakes will be made,it’s just a matter of scale.”
    But the banks have banking licences granted by the government so the government should direct the banks as to where to lend and to what. That is what I favour. You and PM want the govt to create the money directly and I really think that is a job that is too large, uncertain and unecessary. If you control and direct banks as to how they should lend – as was done very successfully post war – then they can do the detail and the government does the general policy.
    But I agree we are basically arguing about methods rather than objectives (on which we agree). Although we also need to know that we are spending first and taxing after – so austerity is never ever part of the equation!
    And that is a major worry about Positive Money – on what basis do they limit the UK’s money creation?

    1. Vince -

      Hello Peter,
      Yes the banks were given lending guidance(corsets) back in the 70s but after a while the banks worked round it by using other lending channels and foreign banks still could make loans.The main negative issue seemed to be that funds for mortgages just dried up nationally and some banks complained the waiting list for a loan was up to 2 years! So no one is using it globally nowadays.This is a problem for a PM solution too but we would have to ban foreign banks making loans in the UK if they were not full reserve.There is a global problem here.Credit crunches could be addressed by the BoE either extending credit for certain sectors or allowing the Government to increase fiscal stimulus.

      My view though is that we have to nail banks down to the floor ,you just cannot give them an inch.They have proven beyond all doubt to be reckless, not to mention morally and ethically challenged,you only need look at the rate fixing,PPI,money laundering and tax evasion going on.Can we trust them again?

      Prof Richard Werner has a very good policy at the moment advocating and setting up public local banks that will not lend to mortgages or for shares ,only lending to local businesses.This is more in the form of the German local banking system that has served the German SME sector very well.With very few bankrupticies.I do personally favour that as well though it not a PM policy.

      As to limiting the money supply it really is quite simple in the mechanics.The current Monetary Policy Commitee that currently sets interest rates would no longer do that,since we would not need a base rate any more(it is an artificial rate anyhow.Private Banks could then be allowed to set real market led interest rates for loans).Instead the MPC would be tasked with looking at the wider economy(as it does now) and deciding in any given period whether stimulus is needed or in fact some deflation was needed.They would then assess how much money would serve this target.This would be passed to the Government to spend into circulation(democratically) or maybe to cut taxes.Or they may have to face raising taxes and cutting spending should the MPC so dictate.The MPC would not decide where the money is spent or cut and the Gov could not affect the money creation process,ensuring a separation of powers. Though the Treasury and BoE could certainly learn to work together to find the most suitable/effective ways to use the money for the benefit of the economy.To be honest once money is in circulation and the economy not subject to major shocks ,I can’t see the need for dramatic changes.Maybe a bit of tweaking now and again.Certainly we should see less volatile economic cycles.

      The monetary discipline would be far better than we currently have. It would be more open and accountable too, compared to having this happen in the boardrooms of the big banks, who are only looking at their short term returns and have no real concern for the wider consequences of their actions.

      1. Peter May -

        Agreed re the morality of banks. If we hive off the merchant and speculative bits though I think they’ll quiten down.
        Richard Werner’s idea that their loan contracts would not be legally enforceable if they didn’t issue a loan in accordance with the credit guidance seems fine to me and fixes any loans under English/Scots law. It also allows government to direct finance to certain areas which would help to avoid bubbles. If foreign banks came in they’d have to rely on enforcing their loans under another jusisdiction, which I doubt would be popular…And whilst endorsing the idea for local banks the system has now been rather taken over by events at the RSA ( see here ).
        Thanks for filling in the PM policy. It’s a big constitutional change which could well work eventually, but I think it would be a long and difficult road. I don’t really think we need to do it that way. Imagine instructing this government – for example – to institute a fiscal stimulus – they might well try and suggest they have a democratic mandate for austerity. And if they were instructed to cut taxes it would probably be for the already wealthy.
        PM are really creating an additional arm of the state: Legislature, Executive, Judiciary and MPC and that additional one is unelected, which I find worrying, and with considerably more power than they have now.
        If we created a lot more banks for a social purpose and not for profit I’d feel more reassured because I think they’d give our existing banks a run for their money (as it were!) And it would allow diversity of supply, which we have lost with the big 4, and avoid the heavy handedness of what would in effect be a single source.

      2. Vince -

        You make some valid points,there are no comprehensive answers.We each have to go with what we feel is right.
        PM’s solutions are an enormous ask and they have realised that it will likley take many years before enough momentum got behind it.It will probably take another monumental banking crash before folk really took note and demanded change.
        In the meanwhile they have changed focus away from the hard “Full reserve/Sovereign Money” two pronged solution to a “softer” halfway stage.They are pushing the idea that the BoE could be allowed to create some money as they have through recent QE (this would actually be QE for the People) and allow the Gov to spend a small amount into the real economy(direct fiscal stimulus).This would help boost demand/grwoth and circumvent the current QE programme which simply ends up with money pumped into financial markets creating assets bubbles in stock and property markets as well as increasing inequality.Areas proposed being a citizens dividend or PAYE tax cuts.Once politicians and the public realised that this was possible without causing significant infaltion, that particlar taboo would be broken.Adair Turner also advocates a similar “outright monetary financing” policy in times of need.This is an area of huge controversy but we need to relook at it in my view.

      3. Peter May -

        I think we are both agreed on everything except the method. I certainly like the Positive Money idea that money could be issued without interest as a Citizens Dividend but then we are really back to Universal Basic Income (and certainly not PAYE tax cuts!)
        In some ways PM is clunky and not radical enough! Though we certainly need them and I admire their promotion of the idea that money is society’s and for the common good. That needs all the publicity possible.

  11. David Laws -

    I like this summary very much. A quibble: Figure 2 indicates that bank profits enter the private sector and deposits fund loans. In order to be consistent with Figure 1, shouldn’t ‘loans’ created by banks be at the top of the circuit which in turn leads to deposits appearing in the private sector. Annual bank profit would then be analogous to the Government deficit and be fed by the repayment of loan plus interest by the private sector?

    I’d very much like to use this summary as the basis of an article to explain the affordability of the NHS for fellow medics. Can I send you such a version?

    1. Charles Adams -

      The diagram may be imperfect. I was trying to convey the following:

      Loans go from the bank to the private sector (borrowers).

      Loan repayment + Interest + Deposits go from the private sector to the bank.

      The bank pays costs (wages, etc) plus makes a profit which goes to shareholders who are also in the private sector.

      I am happy to have a look at your article. Will contact you.

    2. Tony_B -

      I for one would be interested to think about @DavidLaws version, if this tread will publish it. Charles’s diagram is easy to understand and no doubt be incrementally improved.

      @Charles great thread, and discussion from PM. Your figure cuts through to a simple view -clarity from an experienced tutor. I’ve learnt from this exchange and combined with recently finishing ‘The Production of Money’ by Ann Pettifor I realise how far our political parties (except the Greens) are from adopting or debating such policies.

  12. Sue Holden -

    It would seem from reading the above exchanges, that there are risks on both sides:
    Charles: “I worry that complete government control of money creation would be too limiting and not be as democratic as we would hope as there are always vested interests that have more power than individuals – would you really trust our current government to do a good job of this?”
    Praps there would have to be a real change of heart to close the revolving door between independent Money Creation Committee & Party Politicians. However, such risks are surely outweighed by what we have now as pointed out by :
    Vince: “[Money creation decisions] would be more open and accountable too, compared to having this happen in the boardrooms of the [5/6] big banks, who are only looking at their short term returns and have no real concern for the wider consequences of their actions.” It seems to me to be such a glaring choice in favour of bringing this decision under the umbrella of an albeit imperfect democratic system, than to leave private, profit seeking institutions responsible for deciding how our economy is run and our money is spent [deciding what 97% of all the money in our economy is worth creating/lending for.]
    Charles: “(the subsidy is in too big to fail which we should remedy via regulation)” When it comes to dependence on ‘regulation’, I gather the Frank Dodds Act contains 2,300 pages with more than 400 new rules and mandates [& thus 400 new opportunities to find regulatory loop-holes] – It would also appear that the Frank Dodds Act has enshrined ‘too big to fail.’ into law. Interesting stats about unintended consequences & numerous oversights of DFAct Implementation can be found at:
    Tony – “I realise how far our political parties (except the Greens) are from adopting or debating such policies.” I believe even the Greens are teetering, with a strong internal lobby to remove ‘100% reserve banking from their manifesto. The big question is, how do we get this money creation debate out into the open big wide world, in the face of minimal help from the political parties?
    As you will have gathered I am a PM supporter.

    1. Charles Adams -

      Thanks. I agree Positive Money have done excellent work in raising this issue. Everyone – at least every politician – should watch the debate with Steve Keen, Adair Turner, and Chris Giles, and come to their own view on the desirable level of the reserve. I suspect in a vote we would chose somewhere between 0 and 100% but probably higher than now. Also we should not forget the bigger issue that whatever the system of money, capitalism is fundamentally unstable with more and more resource tickling up to the top end unless we do something about it.

  13. Pingback: Can we afford the NHS?
  14. Pingback: David Laws and Charles S. Adams – Is world-leading NHS healthcare an affordable proposition? – Brave New Europe
  15. Pingback: Is world-leading NHS healthcare an affordable proposition? - Positive Money

Comments are closed.