Debt

Most of the money in the UK is created by banks when they make loans. That means that the only way to get money into the economy is to borrow it from banks, leaving us all trapped under a mountain of personal debt and a mortgage.

1. New money is created when people go into debt

Whenever anyone takes out a loan from a bank, new money is created. That means that as people borrow more, more new money comes into the economy. All this newly created money gives people the impression that the economy is doing well, which encourages them to borrow even more. As the debt goes up, so does the amount of money.

2. For every pound of money, there’s a pound of debt

Money is created when banks make loans, which means that for every pound of money in the economy, there will be a pound of debt. So if there’s £100 in your bank account, someone else must be £100 in debt. Across the whole economy there will be as much debt as money.1

3. If we want more money in the economy, we have to go further into debt

If we need to get more money into the economy – for example, to get things going again during a recession – then the only way to do this is to go further into debt to the banks. This is why the government is so desperate to get banks lending again: if banks start lending more, they’ll create more new money in the process, and the people who borrowed will spend this new money. But if the financial crisis was caused by people having too much debt, how can the solution be for people to take on more debt?

4. If we try to pay off debt, then money disappears

When you pay down your debts, the money that disappears from your bank account doesn’t go to anyone else, it just disappears. This is because loan repayments are just the opposite process to money creation: new loans create new money, and loan repayments destroy money.

So when lots of people try to pay down their debts at the same time, the amount of money in the economy starts to shrink. When this happens, it’s like draining the oil from the engine of a car: pretty soon, everything stops working.

This means that it’s almost impossible to reduce our debts at the same time without causing a recession. And you personally can only pay off your debts using money that was created when someone else went into debt. This creates a debt trap, where over time the level of personal debt in the economy has to keep growing.

Let's get out of the debt trap!

Taking the power to create money away from banks and returning it to a public body would mean that newly created money could be used to pay down debt instead of increasing it.
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References

1. Ignoring Bank of England operations such as Quantitative Easing

Further reading

Where does money come from? A guide to the UK monetary and banking system.

  • mitaky

    It is my understanding that money is created as debt by fractional reserve banking where 97% of new money or credit is generated as loan by privatised commercial banking against 3% gold reserve in central bank, IMF, or World Bank. Also when the principal is created the interest is not! This creates artificial scarcity perpetually amid affluence. The interest can exceed actual principal by 150-250% as in 30 year mortgage (means death certificate). This is how wage slavery is created in democratic nations via private corporations tied to big banks. These entitities benefit from big loans and harmful speculative investments (into arms and ammunition, pesticide, tobacco, alchohol, soft drinks, toxic drugs, consumer goods, media, PR, advertisement and entertainment markets). This viscious cycle of greed, war and ignorance can only be broken through developing right understanding of currency.

    http://conscious-capitalism.blogspot.c

  • Vitor Fernandez

    The big question is this: can the government create money without increasing inflation? Are the politics serious persons to be entrusted with money creation?

    • Simon Thorpe

      Well, one thing that could be done with central bank created debt free money with no risk of inflation would be to use the money to pay off debts to the banking sector. For example, the UK government currently owes £1.36 trillion. Any of that money owed to banks could be paid off without increasing the money supply at all, because the banks would just have to cancel out the debt. Apart from anything else, this could save UK taxpayers at least part of the £46 billion in interest charges they paid on government debt in 2012.

    • Mike Dimmick

      Inflation is the devaluation of money, with respect to what you can buy with it. If it does indeed follow the theories of supply and demand, then the way to avoid inflation is to ensure that the supply of money is just sufficient to match the demand for spending money. But as this article notes, just as banks create money by creating loans, money is destroyed when debts are repaid. Similarly, if money is created by government spending, money is destroyed by tax collection. The key is the NET amount of money in the economy.
      I would rather trust politicians, who can at least be kicked out of office (although possibly replaced by another face effectively from the same governing class), than banks who seem to be completely out of control.

  • http://www.facebook.com/virginiahammon Virginia Hammon

    I’m hoping you or someone on the blog can help with a US question.
    I’ve taken 2 spreadsheets from the FED: Money_Stock M3-(available from
    1958-2006, when it was discontinued) and compared the numbers from the
    FED’s “Total outstanding debt by sector,”(which includes a breakdown
    into financial and nonfinancial sectors).

    For the years available for M3, the ratio of debt to M3 ranges from 24.3% to
    46.4%, with an average of 36%. What does this mean? How can there be
    roughly 3 times as much debt as money, if money is created by debt?

    I’m working on some teaching materials, so clarity would be enormously helpful. Thanks.

    • http://www.facebook.com/virginiahammon Virginia Hammon

      Is it possible that the difference is the money lent/created for the derivatives market?

      The US derivatives market risk exposure is $.569 Trillion, and notional value $222 Trillion….(OCC, 2nd Q 2012)….(Curiously, with global estimates of a $1,300 Trillion derivatives marketplace, that must mean you British are doing a bang up job creating play money!….and, I’m going to ignore the Value at Risk measure, because it seems to be BS…pretending that risk nets out, when that’s just not what’s likely to happen..)

      So, $222 Trillion in US derivative notional value….how much was borrowed/created to bring those derivatives into being? Is that a reasonable question?

      Last measured in 2006, US M3 was $10.2 Trillion to outstanding debt of $42.2T (24.3%). 2012 outstanding debt was $56.3 Trillion…at same ratio, say 25%, that would mean M3 would be about $14T, with a difference of $42.2 Trillion.

      Is it possible/probable that at least $42 Trillion was created by debt and put on the balance sheet of Big US banks to make the creation of $222 Trillion in derivatives possible —roughly 20% created for gambling/speculative purposes?…and it is all off balance sheet, so it does not appear in the FED calculations of financial market’s outstanding debt?

    • http://www.facebook.com/virginiahammon Virginia Hammon

      Is it possible the difference is because the debt is counted multiple times?….the financial sector borrows and it’s counted on their tab….then they loan it to consumers and it’s counted on their tab? If so, then, is it accurate to say that the money supply carries an interest burden of triple the average interest rates? What data did you use to figure out how much it costs in interest to have a money system that creates money via interest bearing debt?

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