No Reason to Suffer Through Austerity

Home » Blog » 2011 » October » 26 » No Reason to Suffer…

There’s been an awful lot of mainstream media analysis of the Greek debt crisis, with most economic “experts” incessantly arguing for the necessity of austerity and the apocalypse that will befall us all if Greece defaults. Rather than add to this I want to ask some different questions, like why countries such as Greece have a national debt in the first place and whether or not an austerity package is a sensible idea (even in mere financial terms, to say nothing of how it destroys people’s lives).

So here goes: the reason there are national debts is because governments will go to extraordinary lengths not to create their own money. Rather than write its own cheques and spend them into circulation, the government effectively gets banks to write cheques for it, in exchange for “gilts” – basically government issued IOUs. These IOUs must be paid back with interest to traders, who purchase them on the market, using money originating from bank “loans”. The backing for the government’s IOUs is the future earnings of its taxpayers, so one might think the arrangement has a dubious claim to moral legitimacy from the outset – “gilts” are essentially a market in selling the future labour of our children and grand-children to the institutions of finance.

So why can’t the government (or rather say an independent monetary policy committee) write its own cheques? At this point, the argument that any other system is impossible usually rears its head. After all, as every right-thinking person knows, a government cannot write its own cheques, because this would lead to [insert favourite doom-laden superlative here]-inflation, and the nation / world / universe would be destroyed.

One often hears this argument, but the following fact is always omitted: we already have a system with a tremendous amount of inflation built into it, not because the government creates some money debt-free, but because the banks create much more money via “loans”. Actually, banks do not lend money – a loan would involve the transfer of an existing thing from one person to another – a bank does not transfer already existing money when it “lends” it – rather the bank creates new money: a new bank deposit.

Any system in which an independent and democratically accountable monetary policy committee created, debt-free, the quantity of money deemed appropriate for economic activity, would almost certainly be much less inflationary than “our” current method of money creation – commercial bank loans for private profit – where the only factor “regulating” the increase of the money supply is how much debt the population can be persuaded (coerced? forced?) to take on by banks.

If the monetary policy committee wished to avoid inflation completely, it could perfectly well destroy some amount of money equivalent to an amount the government collected in taxes. An institution creating the electorate’s money supply would view taxes solely as a means of redirecting the flow of that money, not as a source of income to pay the vast sums of interest due on the government’s debts. So we would probably all pay far less tax.

There is also the small matter of whether it is morally justifiable to allow the financial sector of the economy to charge interest on the entire nation’s money supply – which they presently create out of commercial bank debts for their private profit. Allowing the banks to do this gives the financial sector of the economy a hidden subsidy of about £30bn a year – to put this figure in context, the budget of the NHS has just been cut by £20bn, with serious implications for the provision of care predicted by many health professionals.

Under today’s monetary system however, it is quite impossible for a government to pay off its national debt. Where is the money to do this supposed to come from? Taxes? Taxes come from wages, wages come from people having jobs, jobs come from productive investments in the economy made using capital deriving from bank loans, and finally, bank loans come from debt.

Laid bare, any plan to pay off a national debt under the current monetary system amounts to a plan to borrow your way out of debt – it simply cannot be made to work! It might have been somehow feasible back when the public could go into more debt – then the government’s debt could have been swapped for more personal debt. But the level of personal debt today has become so crippling (see for example the plot from my previous post “rethinking economic growth”) that even this frankly absurd strategy is rendered impossible.

Furthermore, the debt on gilts is actually owed twice, once by the borrower of the initial bank loan that created the money to purchase the gilt, and again by the government (i.e. by us, the taxpayers) on the gilt itself. Because of this, if one adds together the national debt and total personal debt, you get a figure that is far larger than the total money supply! In fact, if all the money in the economy were pooled tomorrow to pay these debts, we would still owe around one trillion pounds on them! Also, we would have no money! In the process of trying to repay these debts, every last bank deposit in the economy would have been wiped out.

For all mainstream news sources to simultaneously refrain from any discussion of these points is, well… “elephant in the room” doesn’t begin to cover it. Asking seriously why the media don’t cover these issues can lead to some disconcerting conclusions about both our “liberal”, “free” press and our education system. It doesn’t have to be this way, as it is perfectly possible to have money created debt-free for public benefit rather than as interest bearing debt for the private profit of banks. For example Bill Still, monetary reform advocate and documentary film maker, has proposed a simple legislative solution – to make it illegal for a government to go into debt ever again!

More generally, we should recognise that a national debt is not a sensible concept. It is an absurdity – when economists talk to us in stern tones about how the national debt must be repaid, they should be ridiculed by everyone! Where did the banks get the money to “lend” that generated our national debt in the first place? They made it up! We can similarly make our national debt disappear, over some suitable time period, if we choose to. Nothing was really lent by banks, so nothing is really owed to banks!

Whatever sophistry economists and politicians may concoct in its defence, there is no reason for populations to suffer through austerity. Our poverty exists only on a balance sheet: it is the invention of bankers. We are rich nations in real terms, with vast productive capability and powerful technologies (indeed too powerful, if we do not start using them more wisely). Everything meaningful, industrial, physical, that existed before the financial crisis still exists after it – it is only in the limited imaginations of our economists and politicians that we must now be made poor.

This is why I hope protesters in Greece, and now in other nations with the Occupy Wall Street movement in full swing, succeed in first rejecting a plutocratic austerity, then defining their own democratic alternatives in place of it.

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  • Peter J. Morgan

    You’re right on the button, David!
    I’m an engineer and teacher, but I have passed a couple of 3-hour papers in Economics, and it simply amazes me that so many economists just don’t get it!
    People in the UK may not be aware of the fact that in 1936 the New Zealand government instructed the Reserve Bank of New Zealand (which is 100% government-owned) to create new money out of thin air and spent it on the building of state houses as national assets. Most of them still exist. This is all detailed in the book “State Houses in New Zealand”, by Cedric Firth. It is available on the Internet at https://docs.google.com/viewer?url=http%3A%2F%2Fwww.hnzc.co.nz%2Fresearch-and-policy%2Four-archives%2Fbooks%2Fstate-housing-in-new-zealand-section-1.pdf
    As a result, New Zealand worked its way out of the Great Depression faster than almost every other country. It did not cause inflation. God knows why the program was stopped, but I wouldn’t be surprised if it transpires that pressure was brought to bear by international banks. Maybe there was some trade pressure as well, as New Zealand was in those days utterly dependent on the UK’s taking all our agricultural exports — the backbone of our economy.

  • http://www.p2pfoundation.net/Transfinancial_Economics Robert Searle

    Yes, I agree with what is said, but I have come across the claims of Chris Cook, and Steve Keen, a well-known economics. The latter notably believes that fractional reserve banking is bunkum…! It would appear that when banks create a new loan it is “quickly” backed up, or “replaced” from money borrowed from other banks, or the Central Bank..In other words, banks do not create more money than they actually have. The books are balanced at the end of the day…To me so far this seems to be the most credible presentation of modern day banking. Ofcourse, Cook, and Keen could be wrong but I try to retain an open mind on the subject.

    • Nic the NZer

      Hi Robert,

      I have seen that statistical analysis shown by Steve Keen to. This is actually proving what this article is discussing. Basically money loaned by the central bank is new money, one of the mandates of the central bank is to keep enough liquidity (or bank reserves) to keep the banking system solvent and within bank regulations.

      The liquidity gives validity to the commercial banks credit loans, when they exceed their reserve ratios. The analysis also shows that commercial banks frequently loan the money first and look for the reserves later. This means commercial banks have a lot of influence in monetary policy, it’s not all down to central banks.

      The difference with the NZ example given above is that the reserve bank gave the money to the treasury to spend, rather than the banks to loan.

      • RJ

        The banks do not loan reserves (they loan new non Govt debt)

        The just use reserves to settle with other banks and the treasury

        • Nic the NZer

          I am fairly, sure that is what I wrote. I have called the non Govt debt, or bank credit, money.

  • http://www.p2pfoundation.net/Transfinancial_Economics Robert Searle

    Thank you for a speedy response!

    • Steve

      I like a lot of Steve Keen’s analysis but on this I have to somewhat disagree with him.

      As Nick says Keen’s theory is that the Central Bank will always supply enough liquidity to ensure the stability of the banking system and so banks will continue to lend and then seek the reserves later – which the central bank will supply if needed (and they are the only ones who can increase reserves in the system).

      In which case the empirical evidence should easily demonstrate this – when credit is expanding rapidly, then base money will expand rapidly as the central bank is increasing base money to ensure the banks have the required liquidity.

      Take a look at the link to Keen’s own blog..

      http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/

      Look at the chart ‘Annual Rate of Change of Base Money’

      This is the annual change of the US base money supply.

      Now credit expanded rapidly, during the late 1990s and 2000s until the crunch in 2008, therefore base money should have increased rapidly. But the chart shows base money expanded no quicker and actually 2002-2007 when credit expanded the quickest, base money was expanding slower than anytime since the early 1960s.

      This should clearly prove his theory but it very clearly doesn’t.

      • Nic the NZer

        Sorry Steve, I don’t see your point. The chart USA base money supply shows exponentially expanding base money in the US, I expect this is pretty close to a constant fraction of credit outstanding (ignoring 2008 of course), though no doubt occasionally the reserve rules were relaxed as well.

        The chart ‘Annual Rate of Change of Base Money’ shows a compounding expansion, about 2-6% PA.

        I was originally referring to some earlier analysis done in the paper, Kydland, Finn E. and Edward C. Prescott. 1990. “Business Cycles Real Facts and A Monetary Myth.”. Steve Keen has discussed this in one of his lectures. They (probably accidentally) showed using statistical analysis that banks almost certainly loan first and look for reserves later.

        • Steve

          Thanks for the response Nick,

          Both the Fed and BoE target money supply increases to try and keep inflation around the target of 2% – add in economic growth and the average annual increase in the base money supply will be around 5% which is what the chart shows and actually Keen discusses briefly..

          “Friedman argued that Central Banks should keep the reserve requirement constant, and increase Base Money at about 5% per annum; this would, he asserted cause inflation to fall as people’s expectations adjusted, with only a minor (if any) impact on real economic activity.”

          In other words 5% should be seen as ‘normal’..

          So huge expansions of credit (as occurred in the decade pre 2008) should further increase the money supply over and above the normal rate – but quite clearly it has not. This should have been an empirical silver bullet to prove Steve Keen’s theory – but it is not.

          Actually Kydland and Prescott did not show that banks almost certainly loan first and look for reserves later – although their work has been interpreted as showing that (principally by Randall Wray and also Steve Keen).
          What they demonstrated was that in an economic cycle, credit money expansion generally precedes GDP growth and base money expansion increases at a lag.
          Now that could also be interpreted as demand for credit increases which results in increased economic activity, which in turn grows GDP causing central banks to increase base money supply to maintain target rate inflation.

          • Nic the NZer

            I think the simple Keensian explanation for the statistical results is a good one. The critical thing for me, whatever the mechanism, is that

            “Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money.”

            What this means is that the Monetary policy committee does not set monetary policy, they are a back up for the monetary policy set by the commercial banking system. That is still the opposite conclusion to the money multiplier theory.

            It’s also a good explanation for why massive QE in the US has completely failed to produce favourable results.

          • Steve

            Nic – but the key result, the one that would prove the theory beyond all doubt is the one I am pointing out that base money supply growth does to not accelerate when credit is rapidly expanding.

            “Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money.”

            Credit money can absolutely increase first. There is no mandatory reserve ratio, only a voluntary amount that is effectively set by the banking system risk appetite and also the desire to lend.

            Ask yourself what happens to credit money supply when base money remains constant but the voluntary reserve ratio (leverage as the more familiar term in the context of the banking crisis) that the banking system maintains reduces from 10% to 9% to 8% etc. You can calculate and you can see that base money remains stable but credit money increases significantly.
            Then ask yourself what is one of the main causes of the crisis – continually increasing leverage.

            It is not Steve Keens endogenous money that caused the banking crisis and the data does not show it – base money does not increase above the trend.
            The crisis was directly related to the good old fashioned money multiplier theory because the banking system stretched its leverage to allow it to meet the continued demand for borrowing. It is still incredibly important.

            Now of course Steve Keen is dead right that QE has failed – but not because the money multiplier is irrelevant but because the banking system is reducing its leverage for due to its reduced risk appetite and also because there is not the demand for borrowing from good borrowers.

            So he is right that increases in base money does not necessarily drive increased lending – but he is wrong to reject the money multiplier and his theory just does not have the key piece of empirical evidence to support it

          • Nic the NZer

            Still don’t agree with you Steve,

            “Credit money can absolutely increase first.”, that would be rather contrary to the money multiplier explanation wouldn’t it? Regardless of the mechanism.

            In fact this is the conclusion of the paper cited “There is no evidence that either the monetary base or M1 leads the cycle, although some economists still believe this monetary myth.”, although Kydland and Prescott didn’t try to determine the mechanism for this.

            As Dr Keen also pointed out in his own analysis the central bank would have 3 choices when approached for reserves “If the entire banking system is at its reserve requirement limit, then the Federal Reserve has three choices:
            refuse to issue new reserves and cause a credit crunch; create new reserves; or relax the reserve ratio.” So he doesn’t preclude this possibility you have suggested in his own analysis.

            So in summary, the exogenous money theory is obviously contradicted by the data, but the endogenous money theory has some very clear evidence supporting it, and a theory which is not contradicted by the data. This also explains the QE failure, commercial banks have significance on monetary policy.

          • Steve

            Nic,
            ““Credit money can absolutely increase first.”, that would be rather contrary to the money multiplier explanation wouldn’t it? Regardless of the mechanism.”

            Absolutely not – that was the initial point of the last post.
            Take base money of 10
            Use a reserve ratio of 10%
            Credit money can reach 100 (10/0.1)

            Now keeping base money the same
            Reduce the reserve ratio to 9%.
            Credit money can now reach 111.11 (10/0.09)
            Credit money has increased by over 11%.

            This is the driver – increasing leverage and I’ll highlight again – the one simple piece of evidence that should prove Steve Keen’s theory does not prove it.

            However on the general point that banks have significance on monetary policy. Yes of course they do – but central banks have tighter control as they can use monetary policy to reduce demand for credit.

          • Nic the NZer

            Steve, This explanation is still highly inconsistent, with the money multiplier theory. Basically what you are saying is that the commercial banking sector drives monetary policy by determining it’s reserve ratios/level of risk. But there is no topping out of the money supply, it just grows and grows. It’s also entirely consistent with what Steve Keen was describing as endogenous money.

            This would also imply that central banks don’t have tight control, because the only method of control they actually have is to create an avoidable crisis by actually enforcing lending regulations. If the central banks place is to support credit and banking this is hardly an option. I think the bailouts show pretty clearly what sort of ‘punishment’ central banks are willing to administer.

            Steve Keen also pointed out the money multiplier is more likely to work in China for example, because there the central bank is more likely to influence the commercial banks there, for obvious reasons.

            A theory doesn’t prove anything of course, but it’s not contradicted at all by this data, while the money multiplier obviously is, it’s also contradicted by your explanation effectively, the money multiplier is not a realistic explanation for the monetary system. Dr Keen’s theory presents the 3 central bank alternatives given in my last post, if there were only 2 options then it would be inconsistent, but there are 3 including the one you have just stated.

          • Steve

            Nic, that explaination is money multiplier. The reserve ratio (leverage) was relaxed and so the money multiplier increased. It could not be more consistent with the money multiplier.
            Steve Keen’s endogenous money theory states that credit money increase results in base money increase as the central bank has to issue more reserves to maintain stability – but the data does not show it to be true. Its that simple. The data completely contradicts his theory – he says X happens first and then Y happens – but X did happen and Y did not happen. The only remaining explaination is the money mulitiplier.

          • Nic the NZer

            No, he didn’t say that, he said that is one scenario. “If the entire banking system is at its reserve requirement limit, then the Federal Reserve has three choices:
            refuse to issue new reserves and cause a credit crunch; create new reserves; or relax the reserve ratio.”

            The point of the money multiplier theory is that the money is entirely exogenous (e.g the central bank has strict control) but they obviously don’t which makes the money highly endogenous.

            This criticism of his work is totally invalid because it argues against a fictitious thesis.

          • Graham Hodgson

            There’s no reason why central bank money should increase at all when bank money expands, as long as all banks expand at roughly the same rate. Overnight settlement only calls on central bank reserves to settle the net positions. If every gross position has risen by the same amount then the net position will be unchanged. It’s only if one bank has gone it alone in expanding credit that its net position may exceed available borrowable reserves and call for base money expansion.

    • David A. Jones (Guest Author)

      @Robert: you write that “banks do not create more money than they actually have. The books are balanced at the end of the day”. This suggests to me some confusion about what is involved when banks “lend” money and balance their books.

      My understanding is that when a bank makes a “loan” its books still balance – despite new money being created. For a bank “balancing the books” means that its total assets are greater than (or at the very least equal to) its total liabilities – its balance sheet balances. When a bank extends a “loan” to a “borrower” it simultaneously creates both a new asset and a new liability. This is described in chapter 3 (pages 55-58) of the book “Where Does Money Come From?” – using a hypothetical “borrower” called Robert as it happens!

      A new “loan” is accounted by the bank as a new asset – this is an asset to the bank since it is what the “borrower” owes the bank. The bank also accounts a new liability for itself, by creating a new bank deposit for the “borrower” – this is a liability because it is what the bank owes the “borrower” on demand. Since bank deposits are money, the bank has just created new money by making this “loan”.

      There is no contradiction involved – new money is created and the balance sheet still balances – all thanks to a little creative (some might say fraudulent!) accounting. I think Steve Keen is right to call Fractional Reserve Banking “bunkum”, because banks first make loans and only later look for whatever reserves are deemed necessary to back them up – “loans” cause new reserves, rather than reserves causing new “loans”! In practice there is no “reserve ratio” or anything like it to limit total money creation.

      I have put the words “loan” and “borrower” in inverted commas because I dislike perverting the English language without apology – banks do not lend money, depositors do not deposit it, savers do not save it and borrowers do not borrow it! Perhaps Positive Money should produce an English to Bank-Speak dictionary!

      • Nic the NZer

        I am pretty sure Robert meant that banks follow banking reserve regulations when they are tested (when he said balanced books).

        The actual bank loans don’t create more reserves, they create more deposits, if banks only loaned when they could do so without breaching the reserve requirements, then the money supply would top out at the money multiplier. Or some number if there is no ‘shared’ reserve ratio.

        The point is that they can tally up later and with the help of the central bank to whoever can’t find the reserves on the interbank market. So if the banking system wants more base money than the interbank lending market can supply, then extra reserves are created by the central bank, expanding the base money supply.

        • David A. Jones (Guest Author)

          “The actual bank loans don’t create more reserves, they create more deposits … So if the banking system wants more base money than the interbank lending market can supply, then extra reserves are created by the central bank, expanding the base money supply.”

          I agree, that’s why I used the word “cause” rather than “create”. What you say above is what I meant by “loans cause new reserves rather than reserves causing new loans” – the new “loans” create new deposit liabilities, causing the central bank to have to create new reserves. I think we agree, I just didn’t communicate clearly enough perhaps?

          • Nic the NZer

            I think I might have miss-read it, sorry.

          • David A. Jones (Guest Author)

            No worries Nic. I was reading chapter 5 of “Where Does Money Come From?” last night and came across a nice quote on page 104 that backs up what you were saying to Steve earlier:

            “In reality, rather than the Bank of England determining how much credit banks can issue, one could argue that it is the banks that determine how much central bank reserves and cash the Bank of England must lend to them. The tail wags the dog. This follows from the banks acceptance of its position as a lender of last resort… When a commercial bank requests additional central bank reserves or cash, the Bank of England is not in position to refuse. If it did, the payment system described above would rapidly collapse.”

          • RJ

            David Agree

            The journal entry when a bank creates a new loan is

            Debit Customer loan (bank asset / customer DEBT liability)
            Credit Customer cheque account (customer MONEY asset /banks liability)

            NO NEW BoE RESEREVS ARE CREATED BY THIS TRANSACTION

          • RJ

            New BoE reserves are created when the Govt spends money

            Reserves are drained by tax payments and new bond issues

          • Steve

            RJ,

            This was discussed on another thread. This is what MMT says could happen but this is not what happens.

            As things stand today (in UK and US) all Government spending is pre-funded through tax or government borrowing (through the issuing of bonds). This results in a transfer of reserves from the banking system to the government – which then spends and the transfer happens the other way.

            As things stand today, Government spending does not increase BoE reserves – it is a transfer of existing reserves back into the banking system.

            Only the BoE can create new reserves (through OMOs/QE) and this is independent of Government spending

          • RJ

            Steve

            I am right on this point

            Govt spending always creates new reserves. This is beyond dispute and can be easily proved (and is explained in the where does money come from book).

            And bonds and taxation remove these reserves. Its a loop where

            Spending adds reserves
            Tax and bonds remove reserves

            So one is dependent on the other. No bonds means too many reserves and cash deposits. No bonds or taxation means the Govt would have too move into an overdraft at the BoE which is forbidden.

          • RJ

            So in other words bonds and taxation results in reserves being removed from the banks.

            The journal entry at the BoE is

            Debit Banks reserve account (RESERVES DISAPPEAR)
            Credit Bonds held commercial Bank

            And the bonds result in new reserves (the treasury cheque account with the BoE) being created for the treasury

            Credit Treasury bank account (treasury asset)
            Debit Bond Govt liability (BoE asset Govt debt liability)

            So the commercial bank loses reserves. You could argue that these reserves have not disappeared but have just moved to the treasury. Which is correct. But the bank loses reserves when they or a company or individual buys bonds.

            Reserves are then transferred back from the Govt to the bank when they spend money

            The BoE

            Credits Commercial banks account (bank asset BoE liability
            Debit Treasury bank account (treasury asset decreases)

        • Steve

          RJ – I think maybe we’re talking about the main thing.

          However just to be clear – current government spending is not creating NEW reserves – it is returning reserves back into the economy that it had previously removed through taxation/issuing of bonds.

          Government cannot create new money. MMT argues that it should do by spending first (i.e. tax/bond sales are not a prerequisite) so genuinely created money.

          • RJ

            We will just have to agree to disagree on this point. (I do not know how I can make it any clearer)

            And the BoE is the bank for the

            Commercial banks and
            The treasury

            Now commercial banks are supposed to have a positive balance (credit balance) with the BoE (they can be allowed to do into overdraft but this is not supposed to be long term).

            If the treasury also has a credit balance. Where does the offsetting debt balance come from?

            Remember that the BoE must have a balanced balance sheet.

            My view is the Govt MUST have initially provide the reserves for the banks. This is then returned

            But if not from the treasury where do you think the initial reserve pool came from.

          • RJ

            “MMT argues that it should do by spending first (i.e. tax/bond sales are not a prerequisite) so genuinely created money”.

            MMT clearly states that Govt spending always creates new commercial bank reserves

            And the US currently has around 1 trillion of excess reserves so they are not even being completely removed by bonds and tax.

  • Simon

    David – excellent analysis, is there any way we can get Mervyn King and George Osborne to look at it and act on it ? Unfortunately backward thinking prevails in the established coterie of politicians, economists, bankers and media. Listening to the BBC News today, I felt the reporter was representing the interests of the politicians, EU elite and bankers, not us tax paying saps who have to pay for it all. It was like listening to a news report from the old Soviet Union. The BBC says the “99%” protestors at St Pauls have no real alternative to the status quo. They are wrong, there is an alternative, it is media outlets like the BBC which needs to educate itself. Unfortunately I think the BBC is now a mouthpiece for the Euro elite and Euro project, and like the main political parties no longer represents us, we who are the 99%.

  • John Morrison

    “Nothing was really lent by banks, so nothing is really owed to banks! “.

    It is not that simple. You can very easily buy a car with the nothing that the bank lent you. If you don’t repay the loan then you have a car completely free – there is something wrong there!

    Defaulting on all debts means you don’t pay for last years gas, so your people will freeze to death next winter. There needs to a proper debt audit so that odious debts can be repudiated and honourable debts honoured.

    Any country can reduce its debt enormously by using its own debt free currency for trades within the country but Euro countries are in a very difficult position for doing this. How can they start to use their own currency while everyone’s deposits and obligations remain in Euros. Repudiating the Euro could also lead to no gas for next winter.

    • John Morrison

      Greece needs answers to this now.

      • RJ

        Greece gave away their monetary sovereignty when they joined the Euro. And are basically stuffed now

        Thankfully the UK did not join.

    • David A. Jones (Guest Author)

      Maybe this was a rhetorical flourish too far on my part! To clarify, I wasn’t advocating everybody defaulting on their bank loans tomorrow – rather I don’t think loans should be honoured merely for the sake of honouring them. I agree with what you say – we should look carefully at which loans it will be socially beneficial to default upon and which it will be socially beneficial to honour.

      I also think we should come up with a clear strategy to extricate ourselves from the current mess – a Gordian Knot of loan contracts woven from the bizarre system of accounting used by banks – and transition to a sensible banking system with clear rules of accounting that the majority of people are aware of, understand and consent to. Perhaps the transition phase could involve some creative accounting solutions, such as inventing new assets to replace defaulted loans? It can’t involve austerity, which solves nothing.

      • RJ

        And changes must be ethical

  • João Granchinho

    David, I couldn’t agree more.

    As Simon pointed, the mainstream media reluctance to even consider debating the worthiness of this idea is something to note. Because of this, I fear that people won’t realize it or demand it. Another issue is the way our society deals with this situation without the mainstream media input. Most people do want a change but won’t be bothered to look for it, because “it’s the politicians job”, as if politicians have problem solving abilities. So people would rather debate sports or tv shows instead.

    For all the talk of freedom and democracy in western countries, we increasingly let someone else decide what’s best for us without questioning. Let the politicians decide, let the political parties decide. Maybe people want a “freedom” of not having to worry about “governance type issues” (the things that really matter and have the most impact in our lives, and way of life), unfortunately letting the big decisions that control most of their lives be taken by the most voted group-entity, representing a vague ideological sense. To me that’s just as irresponsible as the politicians society often blames when things go wrong.

  • Woden

    Has anybody come up with a diagram or diagrams showing the way money/debt is created/flows in the current system? This would make it much easier for everyone to understand the arguments.

    • David A. Jones (Guest Author)

      Hi Woden, there was an article about this on the PM blog a while back by Michael Reiss called “Visualising Money Circulation”.

  • John Morrison

    David – We have to be careful with rhetorical flourishes because we will be whipped with them.

    We are all agreed, at least many of us, that ‘austerity’ is unacceptable and solves nothing. So if staying dependant on the Euro gives us austerity and leaving the Euro gives us austerity then we need a more creative solution. A solution in which we stay with the Euro but reduce our dependence on it. Here is one:

    The government introduces a new national currency, a modest supplementary currency to circulate alongside the Euro. Instead of making it legal tender, which is impractical with so many Euro obligations around, it decrees and enforces that:

    Every wage or salary earner must receive say 10% of income as new national currency.
    Every business entity whose national currency income exceeds 10% of its total income may redeem the amount over 10% with the government as Euros at a nominal loss of say 1%.
    The government initially fixes and publishes the value of the new currency against the Euro for pricing purposes.
    It is illegal to sell or buy goods with national currency at anything other than the published rate.
    It is illegal to settle Euro obligations with the national currency.
    It is illegal to exchange between national currency and Euros except with the government as part of its monetary control program.

    Those are the rules. Here is the most concise description I have managed yet of how it works.

    It starts with the wage and salary earners who, anxious to keep their Euros for standing Euro obligations, will want to spend their new national currency as full payment for uncommitted spending, that is shops, cinemas, zoos etc. They will be doing this constantly with 10% of their income, few will think it sensible to save it. Shops etc. will accept the national currency but they may ask the government to redeem 90% of it as Euros and accept the 1% loss of value in the exchange as the price of the extra business. Shops etc. will still be left with 10% of their income as national currency which they will have to spend purchasing from each other. Once you have businesses within the nation purchasing from each other, you have permanently circulating currency. Only 10% of the money issued, that is 1% of incomes, is coerced into permanent circulation in this way. That is good because coercion is dangerous and should be applied lightly. Permanent circulation will increase as businesses find opportunities to spend their excess national currency and avoid the 1% loss on redeeming it as Euros. Any permanent circulation of the national currency is a reduction in the nations Euro borrowing requirements and the foundation of monetary sovereignty.

    I would be interested if anyone else thinks that this makes sense.

    • John Morrison

      Perhaps I don’t have the authority to caution anyone on rhetorical flourishes. I have been waxing poetically about the good old days of steady inflation and indexed linked wages and I doubt that this has helped my credibility. I meant it though.

      • David A. Jones (Guest Author)

        RE “rhetorical flourishes”: while it’s good to be cautious to some extent and I appreciate your advice, I think we shouldn’t tie ourselves in knots trying to appear “credible” to the mainstream economics profession – that will only make us appear irrelevant to the public!

        I think I can defend myself from the whips, if later required to. The statement “Nothing was really lent by banks” is literally true – banks do not lend money, they create it. The statement “So nothing is really owed to banks” is put in context by my previous sentence: “We can similarly make our national debt disappear, over some suitable time period, if we choose to”. My “rhetorical flourish” was clearly advocating a protracted erosion of national debt, not a sudden default on all commercial bank debt.

        My point was that our focus should be on making the national debt disappear, as it has no basis in logic or ethics, not on repaying it. In this sense, all national debt is “odious debt”. My aim would be to make the transition from a debt-based to a debt-free monetary system in the fairest and most painless way possible.

        • John Morrison

          Hi David. I agree wholeheartedly agree that much debt, particularly national debt is essentially fake and really we should be repudiating a great deal of it according to moral and social criteria. The problem is that while we are totally dependant on borrowing to survive, even just to trade with each other, the priority in debt repayment tends to be to not upset important creditors and potential lenders.

          Without some active monetary sovereignty in which the nation is able to issue its own currency to mobilise and safeguard its internal economy, it is in a poor position to objectively judge the validity of its debts. Positive Money is an initiative to activate the dormant monetary sovereignty of the UK.
          I am outlining here a way that Euro zone countries can establish some monetary sovereignty to mobilise their own economies without offending the Euro.

          I would be interested to hear your thoughts on this. Its seems it might work and I can’t think of any other way of dealing with the difficult situation that Euro zone countries face.

    • Peter J. Morgan

      I’ve thought of exactly the same solution for countries such as Greece. However, I’m interested to know if doing that is withing the rules of membership of the EU. Does anybody know?

      • Peter J. Morgan

        Sorry about the typo! here’s my submission again, without it: I’ve thought of exactly the same solution for countries such as Greece. However, I’m interested to know if doing that is within the rules of membership of the EU. Does anybody know?

        • John Morrison

          I doubt that it is within the rules but it is within the practical requirements of membership of the EU and in a time of crisis that it what you have to look at. It is not hostile to the Euro or any other nation. The new currency will simply flow where the Euro has become reluctant to flow. It does require a unilateral act of sovereignty but it is one designed to be acceptable to other parties.

    • João Granchinho

      John, wouldn’t the government need sufficient funds in euros to redeem for the national currency at a large scale, in the beginning while the people are uncertain about this new currency? Unless I’m missing something this funding implies further government debt. Maybe government credit issued in this new currency would be better?

      • John Morrison

        Yes, while people are uncertain, the government will have to hold Euros against 90% of the currency they issue. This means there is little reduction in its borrowing requirement at this stage but there is definitely no increase. The Euros backing the national currency do not have to be borrowed they are extracted from the economy as the new currency is issued. It works like this:

        A private company is paying a wage of 100 Euros. The government now obliges it to pay 90 Euros and 10 new currency. To pay that new currency the company must exchange with the government the 10 Euros it was paying for 10 new currency. The government created the 10 new currency from nothing and is left holding 10 Euros, 9 Euros of which must be kept ready for redeeming the new currency issued.

        The government is paying a salary of 100 Euros. It is now obliged to pay 90 Euros and 10 new currency. It creates 10 new currency from nothing and keeps the 10 Euros it was paying, 9 Euros of which must be kept ready for redeeming the new currency issued.

        In each case the government gets to keep 1 Euro clear out of the issue of 10 new currency which can be a 1 Euro reduction in its borrowing requirement.

        • Joao Granchinho

          I see. It looks good regarding the government debt issue.

          What would the government base the value of this new currency on? Because, if the government redeems a fixed amount of national currency for a fixed amount of euros, you’re pegging the value of the new currency to that of the euro. Well, you won’t be buying foreign goods with this national money, so its relative value to other foreign currencies wouldn’t be troublesome, I suppose. But what other consequences arise from this?

          • John Morrison

            Hi Joao – I’ve tried to answer you concerns below. Please raise more.

            The value of the new currency is that you can buy national goods and services with it that are useful or essential for day to day living and business. That is all it is good for and that will be enough. Usually legal tender provides a simple and legally convincing assurance that it will be accepted. In this case the government and its monetary institutions have to work quite hard to incentivise its acceptance instead. This will never convince international investors to accept it, it has no legal bond, but that does not prevent its acceptance by its own citizens who in any case have to trust the competence and goodwill of their own government.

            The redemption in Euros for concentrations of national currency that exceed 10% of income is not there to give the money value. It is there to ensure that those that accept it as full payment are still able to meet their Euro obligations (I’m guessing they could have 90% of their income going on unavoidable Euro payments). The redemption in Euros is incomplete, only the new currency that exceeds 10% of income will be redeemed, and at a loss of 1%. Furthermore the redemption is not available to everyone, wage and salary earners will receive exactly 10% and therefore will have no case for redemption. The new currency itself carries no promise of being redeemable. It is only the circumstances of a business that gives it the right to redeem it as Euros – a decision of the tax office that already monitors incomes.

            The promise of the new currency is that you can buy things with it and no more, but it is accompanied by a promise to businesses that they will not be overburdened with it. As the need for Euro redemption falls away it will be clearer that its value is what you can buy with it within the country.

            It is not by nature pegged to the Euro. The government may change and must publish the value equivalence rate between the new currency and the Euro. This is used to set prices and the exchange rate for Euro redemption and also for anyone who needs the government to change Euros into national currency. As the new currency represents the goods and services of the nation it should aim to give them stable prices. If Euro prices remain stable then it may appear to be pegged to the Euro but that has no relevance to its destiny. It is not the Euro nor openly exchangeable with it, so even if it has the same value as the Euro it will not be counted amongst Euros. It has a completely separate destiny.

            There is a cost in introducing such a supplementary currency:

            The Euro redemption office will be very busy and will have to be adequate, prompt and willing to provide front line retail businesses with the confidence to accept full payment for sales in the new currency.

            There will need to be notes and coins to represent nearly all of the new currency issued. It will be the currency of uncommitted spending on small things.

          • João Granchinho

            John, I can’t find anything wrong with what you proposed. I would support it. It would cut government debt-financed spending, while maintaining overall spending needed to keep the country running – so no austerity needed. I think the percentage would be viewed case to case, depending on how much that country would have to cut back. Later, the country could just rise this percentage gradually as it realized it wouldn’t need so much debt (as euros stand) to keep the country going.

            I have two questions though: first is, when you say “There will need to be notes and coins to represent nearly all of the new currency issued” – why ‘nearly’? The second is, what about digital money? Maybe this could be accompanied by free access to digital national currency accounts for every citizen – provided by the government? And perhaps (as I suggested before), when people are accustomed to this new currency, have government credit (at a very low interest for consuming purposes, or zero interest for worthy, job creating or infrastructural national projects) in this new currency. Everything full reserve, of course. What are your thoughts on this?

  • John Morrison

    JoO – I see from your first paragraph that you have fully grasped the idea.

    The new national currency would appear first in wages and salaries. People will either receive it as a pay packet with notes and coins inside or they will need digital national currency accounts for it to be paid into. Accounting of national currency should be completely separate to that of Euros and it most definitely must be subject to strict one to one accounting laws, no extending of credit, no money multiplication.

    It seems that only about 3% of money circulating is expressed as notes as coins. I guess that normal wages and salaries do not represent all of this so maybe we withdraw a bit more than 3% of our incomes as cash, but it probably doesn’t reach 10%. The emergence of the new national currency may change this. People will want to withdraw all of it as cash, though perhaps not all at once, and spend it. This is its most immediate benefit, to increase the amount of circulating cash looking for something to be spent on. This will increase the opportunities for small businesses and those on the margins of survival who are shut out completely by the world of electronic credit transfers. Larger electronic holdings and electronic transfers of national currency will emerge when businesses start using it to trade commodities between them.

    I think the government should be very careful about creating any of its national currency by lending it into existence. This creates the circulation of money that is stressed by the need to be repaid with interest. Certainly to begin with it is better to allow the new currency to distinguish itself as always ready to be spent rather than already spoken for by debt. Being beyond the reach of debt will be a useful and popular quality in an economy stifled by debt anxiety.

    • RJ

      Don’t forget the other side though

      Govt interest expense = non Govt interest revenue

      This revenue is often pension fund revenue.

      Pension funds (which are now huge in total) really should hold a sizeable portion of their fund in Govt bonds. Otherwise pension savings will cause asset inflation with more and more pension bank credit chasing the same size of real assets.

      We need Govt deficits and Govt bonds (debt) to fund pension savings. To avoid asset inflation Govt’s must issue Govt bonds.

      Many completely and utterly overlook this point. The world has completely changed and we all need to now hold FINANCIAL assets for our old age. And we are dying older.

      So who will lose out when Greek defaults. Take a guess.

      (Taxpayers or pension funds).

      • Joao Granchinho

        We were discussing an alternative to austerity measures, in particular in eurozone countries. We are assuming government is going to keep issuing bonds (in euros) just as it does today. The only exception is instead of cutting spending altogether (austerity), the government funds the portion that would have been cut with a national currency issued by itself and accepted throughout the country. As soon as this new currency is spent into circulation, it will be accepted by other businesses, so a government employee will be able to spend this new money to buy national products and services. This will keep the national economy going, while saving jobs and brushing austerity away. My advice is: go back to Morrison’s original post and read on from there.

        • John Morrison

          Joao – I echo what you are saying. As you say, the continued use of the Euro will continue to provide a bond market. There is however a ‘Freudian’ slip in your comment:

          “Government employee will be able to spend this new Money…..”

          It should be:

          “Any employee will be able to spend this new Money…..”

          I say Freudian because we are accustomed to the idea of government spending new money into existence by paying its own employees. In this case the national currency is limited in scope compared to the Euro and it would not be fair to do this – Government employees also have mortgages, cars and aspirations for a foreign travel. This is why the 10% of income as national currency must be imposed on everyone equally.

          The complexity of the Euro redemption program is required to reconcile this equal participation in the use of the currency with the need for it to act as full payment of goods and services in the sectors of the economy in which it is providing liquidity.

  • David A. Jones (Guest Author)

    Hi John, I took a look at your proposal like you asked. It looks interesting and might well work as a way of gradually eroding debt and weaning us off a debt-based money system. As JoO said, once people figure out through their own experiences exchanging it that properly regulated debt-free government issued currency is both safe and indeed improving matters, the door is opened for further reforms.

    My initial concern was that in a volatile globalised market the new currency would suffer at the hands of currency speculators, but you appear to have addressed this with the following regulations:

    “The government initially fixes and publishes the value of the new currency against the Euro for pricing purposes.
    It is illegal to sell or buy goods with national currency at anything other than the published rate.
    It is illegal to settle Euro obligations with the national currency.
    It is illegal to exchange between national currency and Euros except with the government as part of its monetary control program.”

    However, I would worry whether the above national regulations will be enough to fend off financial attacks against any country adopting such a proposal, or if new international regulations are also needed. In a deregulated international market like ours money can be used politically, to veto policies speculators don’t like! I can’t really say anything sensible about this though, as I know very little about the current state of international financial regulation. I think the economics profession, who in principle are able to say something sensible about it, ought to be discussing how proposals like yours might be implemented safely.

    • John Morrison

      Thanks David

      Any move we make to free ourselves from the bondage of banks must leave us in a position to defend ourselves against the retaliation it might provoke. I think this one does.

      Although it is introduced as a humble supplementary currency that leaves the Euro to deal with the big money, should the Euro loose value or be withdrawn from us then the national currency can be expanded as necessary to take its place. In the short term it will help the banks to rebuild their solvency by reducing the pressure on them to overextend their credit. It will reduce the risk of defaults. Maybe they won’t see it as so hostile, after all the system they are running now is collapsing on them as well as us. The financial world finds our hunger inconvenient, we can help them by dealing with it ourselves. We have given the banks too much responsibility and they can’t handle it. We have to take some of that responsibility on ourselves and then everyone will be happier.

      I think this system would suit Greece very well. For a business to be eligible for Euro redemption it will have to allow the government to examine its income and that will bring it under scrutiny for taxation. If you don’t pay your tax, you get no Euro redemption. Of course you are free to insist on Euros but your customers will go to the shop across the road that accepts the national currency that they want to spend.

      Great care must be taken to prevent counterfeiting!

      • John Morrison

        David . Do you know any economists that would look at this?

        • David A. Jones (Guest Author)

          I don’t know any personally. You could try contacting Prof. Richard Werner I guess – and perhaps he would know some continental economists that would give your proposal a fair hearing. His contact details are available on the University of Southampton’s School of Management website.

  • http://www.consciouseconomics.org Torrey Byles

    Per Woten’s request,
    Keen does have a clear model, based on ordinary differential equations, that shows how money is created and flows through the economy (viz. households, enterprises and banks).

    Also, nobody seems to have mentioned Keen’s very “keen” (!) observation that:

    The repayment of loans does not “destroy” money [like many economists, including Paul Krugman believe], but transfers it out of income accounts—where it can be used for expenditure—to a reserve account. Once there, it is an unencumbered asset of the banks which can then be re-lent—though not spent directly on commodities or services. This adds an important additional insight to the concept of endogenous money: not only do “loans create deposits”, but “the repayment of loans creates reserves.

    p. 18, Keen, Steve. in Keyne’s ‘Revolving Fund of Finance’ and Transactions in the Circuit.

    And finally, David all that you say about the ‘illusion’ of debt is true enough, however, any form of currency, whether based on national bond issue, frac reserve, time dollars, mutual credit, etc. due to its function as a “store of value” will always reflect a debt. As a store of value, money is a claim on future exchange or production. Money is a promise to be fulfilled in the future. Debt in itself is not bad. Only when the future promise of currency units today cannot be fulfilled by underlying activity, does debt go bad.

    • RJ

      “The repayment of loans does not “destroy” money [like many economists, including Paul Krugman believe”

      Keen is completely and utterly wrong on this point. His mistake si assuming that notes and coins held in a bank vault is money.

      It is not as any first year economics student should know. (vault held notes and coins does not form part of M1 M2 OR M3)

      Loans repayment does very clearly destroy money for the obvious reason that bank credit (money) must be used to repay the loan.

    • John Morrison

      “The repayment of loans does not “destroy” money [like many economists, including Paul Krugman believe], but transfers it out of income accounts—where it can be used for expenditure—to a reserve account. Once there, it is an unencumbered asset of the banks which can then be re-lent—though not spent directly on commodities or services.”

      This is astounding if it is true. Can anyone throw any further light on this ?

      I have always wondered how reserves have been built up. I always thought they were entirely composed of currency issued by the nation. It seems that this may not be the case.

      • RJ

        Surely you know enough about this now to be able to work it out for yourself

        Is Keen right or other economists who knows anything at all about money and banking.

        And what about common sense. If loans create new money (as they do). Then surely loans repayments do the opposite. (But not in Keen’s make pretend world).

  • David A. Jones (Guest Author)

    RJ, this is not something one can “work out”, if the rules of “loan” issuance and repayment are in fact asymmetric! Why couldn’t they be? The bizarre rules of banking certainly don’t match any “common sense” of mine!

    Mike Rowbotham has this to say, in chapter 2 of The Grip of Death:

    “According to this argument [that repayment of loans destroys deposits] banks were able to claim that, yes, they did create money, but not for themselves. This bank credit was, in principle, temporary. Bank credit only lasted for the duration of the loan, and upon repayment was cancelled out of existence.

    But this is not what actually happens at all! As any bank manager will confirm, when money is repaid into an overdrawn account, the bank cancels the debt, but the money is not cancelled or destroyed. The money is regarded as being every bit as real as a deposit; it is regarded by the bank as the repayment of money that they have lent. And that money is held and accounted an asset of the bank.

    The fact that upon repayment, money that they have created is not destroyed, but is accounted as an asset of the bank, proves beyond dispute that when banks create money and issue it as a debt, they ultimately account that money as their own… The point about repayments is that money is not destroyed but is withdrawn from circulation. Thus the total of deposits has been decreased, but not the money… Therefore it is true to say that loans are temporary but the money created by banks is permanent. Once created it belongs to them, constantly returning to their ownership and control, with repayment of each debt.”

    I have read apparently contradictory statements in different places about exactly what happens when a “loan” is repaid – perhaps Ben or one of Positive Money’s researchers would be able to throw further light on this, as John asked?

    • Graham Hodgson

      I’m hate to have to admit it, but RJ is right for once. The mistake that Keen makes, I think, is thinking in terms of money, something which is passed from payer to payee. With such a concept it seems unreasonable that a payment from a borrower to a bank in repayment of a loan should not end up in the possession of the bank.

      There are two situations to consider: the repaying of a loan from a current account and the clearing of an overdraft on a current account. A loan is a separate account in the borrower’s name from which the amount of the loan was paid into the borrower’s current account. The loan account is in permanent deficit and constitutes an asset of the bank – the bank can expect that the account will receive payments in the future. The current account is in temporary surplus and constitutes a liability of the bank – the bank can expect that it will in the future be called upon to make payments. Repayments are transferred from the current account back to the loan account until eventually the loan is discharged and the account closed. The payment is recorded as leaving the current account and directly entering the loan account. In these circumstances the bank is not called upon to settle payment. Repayments don’t go anywhere near the bank’s own operational accounts.

      Current accounts generally are in surplus and are therefore liabilities of the bank, but when a bank agrees to allow a payment which would overdraw the account, the account moves into deficit. Now it is no longer a liability but an asset. The bank may have had to settle the payment overdrawing the account with a transfer of reserves to the payee’s bank, but can now expect that the account holder will endeavour to earn payments which could attract reserves back from payers’ banks. As further payments are received into the overdrawn account it moves back into surplus and becomes once more a liability of the bank. Settlement reserves might have been acquired in the course of processing these payments, as with any payment, but no payment was made by the overdrawn customer to the bank for the bank’s use.

      There is a strained position from which Keen’s concept of a lendable reserve could be discernable. When a loan is paid off or an overdraft cleared assets decline and therefore the ratio of capital (which is unaffected) to assets increases. This increase in capital/asset ratio gives the bank leeway to acquire more loan assets within its regulatory (or self-imposed) constraints. The hole left by repayment can be filled with more loans. But this is not the same as saying that the “money” used to repay loans can be relent.

  • David A. Jones (Guest Author)

    I think John really hit the nail on the head in a post on my previous article. He said:

    “We are constantly getting lost trying to figure out the exact rules by which banks work… The exact rules are irrelevant and you cannot really expect them to be coherent when they are based on fraud.”

    Ursula Le Guin understands fractional reserve banking! From her novel The Dispossessed:

    “He tried to read an elementary economics text; it bored him past endurance, it was like listening to somebody interminably recounting a long and stupid dream. He could not force himself to understand how banks functioned and so forth, because all the operations of capitalism were as meaningless to him as the rites of a primitive religion, as barbaric, as elaborate, and as unnecessary. In a human sacrifice to deity there might be at least a mistaken and terrible beauty; in the rites of the moneychangers, where greed, laziness, and envy were assumed to move all men’s acts, even the terrible became banal. Shevek looked at this monstrous pettiness with contempt, and without interest. He did not admit, he could not admit, that in fact it frightened him.”

    • RJ

      Fine but reform must start with an proper understanding of the current system

      And unfortunately most are badly confused

      This book hopefully contains some good information although I have not read it yet

      Where Does Money Come From?

      Understanding how banking really works is 99% of the battle. Once understood the solution is very simple.

      • David A. Jones (Guest Author)

        Agreed. I have that book. I haven’t had time to read it carefully yet, but from a quick read I got the impression that money is destroyed when a loan is repaid, as you say. As I said, there are “apparently contradictory statements”, made by Mike Rowbotham for example. He might well be confused on this point. I know Ben Dyson has read his book – Ben, would you say Mike Rowbotham is wrong here?

        • David A. Jones (Guest Author)

          I’ll just add that I think “most are badly confused” because this system IS confusing! I don’t think it necessary for all of us to understand every aspect of the current system in order to demand a new one that is transparant, accountable and comprehensible to non-specialists; which the current system manifestly is not!

  • RJ

    “ut this is not what actually happens at all! As any bank manager will confirm, when money is repaid into an overdrawn account, the bank cancels the debt, but the money is not cancelled or destroyed”

    Sorry but this is just completely wrong.

    If people peddling this fiction (including Steve and MR) understood basic double entry bookkeeping (and unfortunately neither do) they would know this

    The banks balance sheet MUST balance.

    1 When a loan is repaid the journal entry is

    Debit Customer deposit (DEBT LOAN IS REPAID)
    Credit Customer deposit account (MONEY is reduced)

    This is beyond dispute and easily provable. Talk to any bank accountant who understands how journals work

    2 When a overdraft is reduced. The journal entry is if person A pays B. B has an overdraft

    Credit Bank account of person A (MONEY is reduced)
    Debit Bank account B (DEBT OVERDRAFT IS REDUCED)

    B MUST GET MONEY FROM SOMEONE ELSE WHO LOSES MONEY to repay an overdraft.

    • RJ

      Ops its

      1 When a loan is repaid the journal entry is

      Credit Customer loan (DEBT LOAN IS REPAID)
      Debit Customer deposit account (MONEY is reduced)

      2 When a overdraft is reduced. The journal entry is if person A pays B. B has an overdraft

      Debit Bank account of person A (MONEY is reduced)
      Credit Bank account B (DEBT OVERDRAFT IS REDUCED)

  • Gordon Wilson

    Surely the argument about what happens when a loan is repaid becomes pointless when 97% of “money” is now created as debt.
    The old debt is really paid by a new debt for someone in the system, which is then further magnified by the Fractional Reserve system. An analogy is a chain reaction.
    There is a local effect but it is one system.

  • http://www.consciouseconomics.org Torrey Byles

    Here is Keen explaining why one person’s liability is another’s asset does not mean that private debt has no impact on the greater macroeconomy. (at minute 3:50 into the video) http://www.debtdeflation.com/blogs/2011/11/13/capital-account-interview-2/

  • Gordon Wilson

    Here is a good answer to “plutocratic austerity” from Marc Blyth, a Scot and a professor at Brown University, USA.

    http://www.youtube.com/watch?v=go2bVGi0ReE

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