Whether they are implemented in Latin America (1970-90s), in the UK (under Thatcher) or in Greece (since 2012), austerity measures are all justified by the fact that “there is not enough money.” People are told that “there is no alternative,” and that the state needs to implement structural adjustment programs—usually including across-the-board spending cuts—to restore investors’ confidence and to hope for a better future.
What if this shortage of money could be overcome? What if this problem was ultimately the wrong one? What if we could have money for everything we needed?
In her latest book, The Production of Money: how to break the power of Bankers, Ann Pettifor argues that:
- YES the society can afford everything that it needs,
- YES we are able to ensure enough money for education, healthcare, sustainable development and the well-being of our communities,
- YES we can discard money shortage, contrary to the human or physical (land and resources) ones.
However, one condition needs to be fulfilled: our monetary system should be well-regulated and managed.
To understand how and why, Ann Pettifor takes us back to basics. She starts by defining money as a “social construct based primarily and ultimately on trust”. One of the reasons why we use money in the first place is because we know that others will accept it in the future; it is the means “not for which we use to exchange goods and services, but by which we undertake this exchange” (Law). Your 100-dollar bill would be worthless if others didn’t accept it. The value of money depends on the “acceptance” of money, i.e. on the trust you and others have in money.
Contrary to popular belief, 95% of (broad) money (i.e. cash and coins + bank deposits) is created by private banks and not by the central bank. When a bank makes a loan to a firm, it creates simultaneously a deposit account from which the firm withdraws the loan. Money is therefore created “out of thin air” when the account of the borrower is credited—i.e. when loans are made. This has two implications:
- When money is created, so is debt. This debt needs to be repaid. Ann Pettifor uses the example of a credit card which allows you to purchase goods and services today. The spending (= purchasing power) on a credit card “is created out of thin air”. You will ultimately need to pay back the amount spent plus a pre-agreed interest rate. Money is therefore a promise of a future productive value.
- The money supply depends on private borrowers and their demand for loans. Central banks influence (but do not control) the money supply by increasing or decreasing the cost of borrowing with their policy interest rate. Money creation is therefore a bottom-up process rather than a top-down one.
Does this mean that we should create as much money as people want loans? Of course not. According to Ann Pettifor, there are constraints that make unlimited borrowing impossible: inflation (and deflation). Indeed, if money is not channeled toward productive purposes, the claim associated to it might not be reimbursed. In other words, the promise of a future productive value might not be fulfilled. When there is too much money “chasing too few goods and services”, reflecting over-confidence in the economy, it results in inflation, eroding the value of assets (such as pensions). Similarly, when there is not enough borrowing (either because borrowers need to repay their debts, as it has been the case in Japan and the US right after the last recession, or because the cost of borrowing is effectively too high), reflecting distrust in the ability to repay debt, deflation steps in.
Therefore, as money can be created “out of thin air”, there is no reason to have a shortage of money as long as it is channeled towards productive purposes. An unlimited amount of money can be created for projects that will ultimately result in the production of value, which will allow the repayment of debt. However, the author does not define what “value” or “productive purposes” are, which in my opinion is the main drawback of the book.
Although Pettifor does give some hints by opposing “productive purposes” to “speculative” ones and by associating “value” to the notion of “income, employment and sustainability”, her approach is rather imprecise and in this sense disappointing. To her credit, defining value is a difficult task, especially if we want to define what is valuable to the society as a whole. Pinning down the definition of value is, in my opinion, ultimately a political debate. If one considers that democracies reflect “collective preferences”, it can be said that societies decide through elections on what is most valuable to them at a given point in time.
Unfortunately, the current monetary system does neither enable nor guarantee that money and credit are used for productive purposes. It is characterized by “easy” and “dear” money; the former refers to unregulated and easy access to borrowing, while the latter conveys the idea of expensive borrowing, i.e. with loans charged at high interest rate. The issue with this system is that (1) with unregulated borrowing, money will be used for unproductive purposes, (2) with high interests, debtors will meet difficulties reimbursing their loans.
Such a system is harmful to society. In the words of Ann Pettifor:
“If rates of interest are too high, debtors have to raise the funds of debt repayment by increasing rates of profits, and by the further extraction of value. These pressures to increase income at exponential rates for the repayment of debt implies that both labor and the land (defined broadly) must be exploited at ever-rising rates. Those who labor by hand or brain work harder and longer to repay rising, real levels of mortgage or credit card debt. It is no accident therefore that the deregulation of finance led to the deregulation of working hours.”
A sound financial and monetary system would precisely have opposite features, with “tight but cheap credit” (Keynes), in which loans are regulated but cheap. “Tight credit” would ensure the soundness and creditworthiness of loans, while “cheap credit”, secures the affordability and thus the repayment of loans.
Hence, Ann Pettifor makes a remarkable argument by providing an in-depth but accessible insight into the workings of the monetary system and the debates surrounding it. Both economists and non-economists should give it a read.
It is indeed quite astonishing that money, ever-present in our lives, is so poorly understood; even by many economic experts themselves. According to Ann Pettifor, this incomprehension stems from the deliberate efforts of the financial sector to “obscure its activities” in order to maintain its omnipotence. The Production of Money aims at addressing this “crisis of ignorance” by providing an intelligible and comprehensive overview of money in the hope of empowering people against finance’s grip over society.
By Céline Tcheng
Disclaimer: views are my own.
About the Author
Céline grew up between Paris, China and Singapore. After graduating in a Master’s degree in Economics and Public Policy, she now works for a public policy institution in France. In her free time, she coordinates INET (Institute for New Economic Thinking) YSI (Young Scholars Initiative)’s Financial Stability Working Group and performs with her dance crew “Slash Art”. Her main interests are: macroprudential policy, financial stability, monetary policy. Follow her on Twitter: @celine_tcheng
Good article thanks.
Anne talks about ‘money’ rather than about ‘complementary currency’.
The latter is being developed here in the UK to serve the common good. It is intended to counterbalance the negative effects and impacts of money.
Where money is lent into existence, our currency will be earned into existence.
Earned as a credit for a contribution to the common good and measured in units of time.
I.e. time spent contributing to the common good.
I.e making community (teaching, giving, learning, volunteering).
Yes, a democratic process but one that is devolved from government and ‘owned’ by the producers of the value (i.e. those in community).
You say: “However, the author does not define what “value” or “productive purposes” are, which in my opinion is the main drawback of the book. ”
I say value = productive purposes = defined community contribution.
Tokens are issued for the production of value. They store and account for that social value and the markets can invest in it because it is a safe haven compared to other assets that are underpinned by the worth of money which as we all know is hobbled by debt.
So, there is a move from financial capital which is unsustainable to its more sustainable cousin called social capital.
The former is backed by debt and the latter is backed by credit.
Credit that is pre-paid because it is earned into existence for contribution to the common good.
I am a bit tired of seeing the claim that banks create money (from thin air or by any other means). The amount of money the banks are permitted to lend is limited. If it were not so, they could have bailed themselves out of the financial crisis of 2008. (Which was caused by private lenders/savers claiming back what they previously loaned to the banks–not that they could do much with it except for it to find its way back to the banks again after a short period, because nobody wants to keep money that is not earning some interest!) Had the banks sufficient ability to create money from nothing, this bail-out might otherwise have been without temporally borrowing from the government. The permission from the Treasury to create money is itself a kind of money, which the government has truly created and its supply and duration are limited too.
You can write a post-dated check and this promise for a specific time allows business to proceed which otherwise would not. This is temporary money creation, but the sums are time-dependent and limited in size by one’s anticipated income, so this kind of temporal money is different to the coins and notes mentioned above in the article, and even if it were of an electronic kind the same limitations apply.
On this basis one might claim that banks can lend money to each other in the form of post-dated checks or other promises, thereby creating money from nothing. I claim that this kind of money is not the same as the currency we normally use for trade and exchange, because of the time limitation and degree of control from the Treasury. When discussing money we need to examine which of these two kinds we are dealing in and for us to to appreciate that temporal-money is limited in amount and time for its duration. The banks have some chances here, but they cannot continue to do it and the above-noted need for bail-out loans proves it! .
“The amount of money the banks are permitted to lend is limited. If it were not so, they could have bailed themselves out of the financial crisis of 2008.”
They did bail themselves out. But like the Bank of England buying Gilts they have to do it via a third party so it doesn’t look too obvious what they are doing.
So when you dig around you’ll find that Banks provided loans to third parties with the express intention of purchasing capital bonds and equity in the Banks.
Most of the banks got the government to step in instead, since that provides them with a nice safe asset that pays a regular income as well as an equity stake that won’t really require a dividend. The private sector drives a harder bargain.
All banks create deposits from loans. When that hits up against capital limits they get some people to swap their deposits for risk equity and bonds. Rinse and repeat.
There is never a quantity limit with banks. It’s only ever a price limit.
Two quick comments (even though I haven’t yet read the book).
– Money can be created in unlimited amounst, but resources are still limited.
– The value of things depends on what people think about those things. And people can quickly change their views on that. That’s why we need economic democracy, i.e. the market, to tell us what the relatove values of things are.
=> I don’t see an easy way to radically change the system we have now.
I think the idea that resources are limited is a red herring, a distraction. Oil was supposed to be limited in supply, but the Saudis are taking the position that “the Stone Age did not end because of a shortage of stones.” The limits on physical resources are so far off into the future that scarcity thinking is the real problem, not physical scarcity. The 2008 financial crisis was not precipitated by any physical shortage, for example. It was purely a psychological crisis.
Regarding value, I do not accept the “exchange theory of value”. There are too many examples throughout history of ideas that later turned out to be very valuable being mistakenly devalued by people at the time. Aristarchus of Samos had a heliocentric theory of the solar system in the 3rd century BC, for example, but because none of his contemporaries valued it, it took some 1800 years for the theory to be accepted as valuable. Markets should have nothing to do with finding the value of things, because markets are perversely incentivized and morally hazardous. Market prices are essentially arbitrary as Fischer Black notes in Noise (http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.1986.tb04513.x/abstract):
> However, we might define an efficient market as one in which price is within a factor of 2 of value, i.e., the price is more than half of value and less than twice value.11 The factor of 2 is arbitrary, of course. Intuitively, though, it seems reasonable to me, in the light of sources of uncertainty about value and the strength of the forces tending to cause price to return to value. By this definition, I think almost all markets are efficient almost all of the time. “Almost all” means at least 90%.
Oil today could thus be $25/barrel or $100/barrel. That’s a 300% inflation range, due to noise alone. And 10% of the time it can be outside of even that wide range, according to Mr. Black.
“I don’t see an easy way to radically change the system we have now.”
No there isn’t an easy way. It’s a massive undertaking but one that is necessary.
Money is no longer fit for purpose.
You nail it by reminding us that the money supply is infinite whilst resources aren’t.
We always suppose that money = resources. That money equals the value of resources.
With so much human resource going to waste when it could be teaching, giving, caring or learning, that clearly isn’t the case.
It’s as much the culture that needs changing as it is the system.
It’s time to ‘show’ the world what good looks like. That’s the way to change a system.
Show, not tell.
I am still not clear in my mind what causes unemployment. Given that it exists in most countries, except in some dictatorships, I would think that something fundamental about having an efficient economy causes unemployment.