October 8, 2013
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Money
creation is a government function. Reversing the privatization of money
creation will render the debt ceiling and government borrowing obsolete.
As I write, the US Congress is locked into a stalemate over the issue
of raising the debt ceiling of the US Government. The issue of an ever
increasing government debt forces us to lurch from one political crisis
to the next. The current government shutdown and the looming default on
US government debt are the handiwork of an irresponsible minority of
ideologues in the House of Representatives using Congress’ power of the
purse to subvert the democratic legislative process. They are
undermining the very foundation of our democracy and endangering our
economy. But, even in the absence of saboteurs in the very halls of
Congress, the problem of an increasing level of government debt combined
with a weak economy presents a very hard problem to solve, at least
within the confines of conventional thinking.
First let’s look at the problem and then at the solution made available by some thinking outside the box.
Let accept for the time being the conventional wisdom that we need
the economy to grow again (in a later blog post I will explore why
economic growth is not the way to address the economic needs of the vast
majority of the population). We measure growth in the economy by
looking at the growth in GDP (Gross Domestic Product). If GDP contracts
for two consecutive quarters we are officially in a recession. So let’s
look at the components of GDP and figure out why growth in GDP has been
anemic since the economy resumed growing in the middle of 2009.
GDP = C + B + G + (X-I)
C stands for consumption, the amounts of goods and services purchased by individuals
B stands for investments made by the business sector
G stands for government investments and spending
(X – I) stands for the difference between our exports to other countries minus what we import from the rest of the world
Our economy is heavily dependent on consumer spending, in fact
C
has historically accounted for roughly 65% of economic activity.
Business investments are a function of the business cycle. In good times
businesses are more optimistic about their ability to find buyers for
additional products and services and invest to increase their capacity
to produce.
B has been fluctuating over the last couple
of decades around 15% of GDP. Government investments and spending has
hovered at around 20% of GDP. The difference between exports and
imports has not been a significant component of the GDP in the last few
decades.
Consumer spending fueled most of US economic growth since the end of
World War II and was made possible by raising real wages in every decade
until the 1980s.
Since then real wages have been flat, in other words the purchasing
power of Americans who worked for a living has stagnated. The growth in
consumption and hence most of the growth in GDP since the early 1980s
was made possible by two strategies the US middles class adopted to keep
up the illusion of the American dream – an ever increasing standard of
living. The first strategy required
more members of the family joining the labor force – mostly stay-at-home moms gaining employment outside the home.
The second strategy was to borrow first to buy homes, then by using
credit cards, by taking out larger and larger student loans and finally
by borrowing against the value of the equity in ones’ homes. Those
strategies are now exhausted. Real wages continue to decline and
the few jobs that are being created of late for the most part pay less
and are less stable than those lost during the recession of 2007-2009.
In other words, for the foreseeable future we cannot count on the
middle class to drive economic growth through consumption.
C is dead in the water. What about
B?
Businesses in the US are currently sitting on about $1,700 B in cash unwilling
to invest it in the US for the very obvious reason that they do not see
sufficient aggregate demand, in other words buyers, for the additional
products and services those investments would create.
In other worlds, as long as
C is dead in the water,
B
is dead in the water. What are we left with? Government spending is the
only component of GDP that can support economic growth at this point
and reverse the downward spiral of our economy. The economist John
Maynard Keynes recognized this problem in the middle of the Depression
of the 1930s and showed how government spending is necessary during
recessions even if it results in higher levels of government debt. Yet
government spending would at this point require either higher taxation
or additional government borrowing. Higher taxation in the current US
political reality would fall primarily onto the poor and middle class as
opposed to the very rich or wealthy corporations that could well afford
it since the latter finance our political process. Such regressive
taxation will exacerbate the problem of stagnating consumption. Higher
government borrowing is opposed by a political class that seems to be
oblivious to basic economics and apparently incapable of simple
observation – any attempt made by governments in recent history to
reduce their debt during a recession has led to an even greater
contraction of economic activity hence exacerbating the country debt to
GDP ratio.
So, if Government spending is the only way out of our economic crisis
and additional taxation or Government borrowing is out of the question
how do we get out of this pickle? As Dwight Eisenhower suggested –
if a problem cannot be solved, enlarge it.
To solve the problem we need to think outside the box and enlarge the
scope of the problem to include the design of the money and banking
system.
Most lay people if asked “who creates the money used by the nation?”
may respond “the Government”. Some might think that the Central Bank
(the Federal Reserve in US) creates money and that the Central Bank is
part of the government. Very few pause to reflect on the fact that if
the government
creates the money we all use either directly or through its central bank then there would be no need for the government to
borrow
money. It turns out that the subject of money creation has become a
taboo in our society. The main reason for this taboo is the spectacular
injustice of a fundamental government function – money creation, being
almost completely privatized considering that such privatization
represents the largest transfer of economic wealth and power in the
history of human kind from the public at large to a private elite.
To gain a basic understanding of the current design of the money and banking system please
check out this link.
The key point to understand is that more than 95% of our money supply
is electronic money created by the private banking sector when it lends
it into existence. There are a couple of ways to look at this process.
One way is to say that the private banking sector monetizes borrowers’
promises to repay – in other words, it turns borrowers IOUs into
spendable bank IOUs. Another is to say that the private banking sector
created upward of $9 Trillion dollars of electronic money (demand
deposits and time deposits in the picture below) with which it purchased
its income generating assets in the form of commercial and individual
loans, real estate loans, treasury bonds, MBSs, CDOs and other
investment assets.
All the money we use, physical currency and electronic money created
by the private banking sector is backed by the full faith and credit of
the US and is accepted in payment of taxes by the US Government. The
Government is also periodically called to guarantee a portion of the
electronic money created by the banks (those representing FDIC insured
deposits each $250,000 or less) or to rescue the too-big-to-fail banks
when their reckless lending threatens the entire national system of
payments. So while the US Government, through its full faith and credit
and taxing power, therefore all of us collectively, guarantees and bears
the risk of the money creation process of the private banking sector,
it has to borrow that same money from those that either have the
privilege to created it – the private banks, or from those that have
accumulated substantial wealth in their hand- rich individuals, wealthy
corporations and central banks around the world.
The solution to our economic conundrum is therefore very simple. The
Government needs to reclaim the quintessential government function of
money creation. During the Civil War the US Government issued through
the US Treasury debt-free money in the form of paper currency known as
Greenbacks with which if financed the war with the South. It is time the
US Treasury resumes the issuance of debt-free money as long as
inflation is low and stable.
The new money could be used to launch a
massive government employment program similar to the WPA to rebuild the
70,000 structurally deficient bridges in this country, to rebuild the
crumbling national infrastructure, to hire a new generation of young
farmers that will transform the wasteful and destructive industrial
agriculture into sustainable small scale organic agriculture, to invest
in education and health care (as opposed to the sick care) of the US
population, to support the basic human needs of the most vulnerable in
our society. Another idea, which
will soon be put up for a vote by the Swiss government, is to provide a national dividend to all adults in the country.
Once the economy is stabilized with the debt-free government spending
outlined above, we can start using additional debt-free money creation
to gradually retire some of the government debt. Regardless of the use
of such debt-free money, reclaiming for the Government money creation,
which is a fundamental government function and privilege, will be the
best way to finally address the needs of regular people in this country
while at the same time removing the weapon of the debt ceiling from an
irresponsible minority in Congress bent on sabotaging our democracy and
the rule of law.
Marco came to the US as a
Fulbright scholar in mathematics and economics at the University of
California in Berkeley. After a stint in the financial industry, Marco
worked as visual artist on a full-time basis for 5 years and obtained a
MFA focusing on the intersection between public art and ecology. He
later worked for 6 years for Grantham, Mayo, Van Otterloo & Co. LLC
(“GMO”), managing investment equity portfolios primarily on behalf of
large foundations and endowments. In April 2009 Marco left the finance
industry and has since been instrumental in the formation and
development of the Slow Money Northern California chapter where he
currently leads the investor working group. Marco also serves on the
Slow Money national steering committee and represents Northern CA in the
national Slow Money Chapter Council. In the second half of 2012 Marco
led the design and launch of the Soil Trust, a Slow Money philanthropic
revolving fund investing in small food and farming enterprises around
the county. Marco is currently developing an Economics for Transition
curriculum for engaged citizens and activists.
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