Hello!
In previous posts I have explained how money today is not notes and coins, but a huge spreadsheet maintained by commercial banks. When an electronic payment is made, the banks adjust the spreadsheet, adding numbers to one cell, and removing them from another. Importantly, when you “borrow” money, the bank simply adds the money to your account; no existing accounts are affected – it is brand new money. This is a brilliant system, allowing money to be created at a stroke as it is needed, and removed from the system when it has served its purpose.
For example, the system allows you to buy clothes today, with newly created money, and pay back the money tomorrow by working for the retailer. The money is created on purchase, and destroyed on repayment. This system drives our whole economy, by allowing things to happen that can only happen if there is money available. With hard money, economic activity is suppressed by the limited amount of money in the system – it takes time for the money to circulate. In a debt based system it is impossible to run out of money. Our economy is a churning foam, constantly creating and destroying money in this way, enabling the whole economy to run. It is brilliantly simple! The only catch – banks charge interest on this made-up money, siphoning off a percentage of all money in existence into their own accounts.
To take another example, suppose “we the people” decide to build a hospital. In order to mobilize ourselves, “we the people” (through our government) can borrow money from the banks to pay ourselves in wages. As the work progresses, the money is collected in taxes, and repaid. In the end, all the money is destroyed. The “big picture” is that money is created, used and destroyed, and by using this accounting system we call money, we have facilitated ourselves to build something that we want.
But the banks simply create the money, they “lend” to us by changing numbers in a spreadsheet! (in the case of government borrowing there are a few layers of obfuscation, but this is essentially what happens). When this is understood, it is obvious that we could cut out the middleman, create that money ourselves (through the government), and use it in the same way, with exactly the same effect, at no cost at all! Yes! There may be some merit in allowing private banks to handle private transactions (though the fees they earn in interest are outrageous); but the idea that the government has to “borrow” money from the banks for interest is nothing but a swindle. The banks create and destroy that money for interest; we (the people) could achieve exactly the same effect by creating and destroying the money ourselves.
Some of you will think no doubt that I am crazy. But what I have said is completely true, and well documented, as you can verify for yourself by reading the documents on the Bank of England website referenced in my first post. If you read some of the books on the subject you will find that this has been understood for many decades. Many serious economists have proposed exactly this as a solution for the Greeks to escape from the clutches of the IMF. The Greeks cannot lawfully create Euros to pay off their debt; but they can simply default on the “loan”, and create their own new system of money. The only people to be affected would be the banks, who would be deprived of an indefinite income stream of unearned money from Greek debt. Yes, they would claim catastrophe, and the destruction of finance – it is not true. Money is an accounting system, and it should be a matter of democratic will to organise that system to work in our collective best interests.
The banks earn interest on money they create for nothing, and in that way get rich. But their ability to create money has other destructive effects. In this post I want to look at how bank money has affected house prices.
It is sometimes said that the increase in house prices is due to increased demand. After all the population of the country has increased greatly over the last 10 years. But we must be careful; in economics, “demand” is not simply wanting something; it is having the money to pay for it. The clearest demonstration of this that I know is the Ethiopian famine. In the ’80s hundreds of thousands of Ethiopians watched their children starve to death. It is not possible to image greater “demand” for food in the usual sense. But there was no shortage of food; at the same time, thousands of tons of vegetables were flown to the UK. And the fields were full of tea and coffee plants. And food prices did not increase as a result of Ethiopian demand – they increased as a result of European demand – because the Ethiopians HAD NO MONEY. And in economics, it does not matter how many people want something, or how desparately – if you have no money, your collective demand is big fat zero.
So if house prices went up, it is because there was more money available to buy them. Where did the money come from? It was created by the banks. Banks have a strong incentive to make large loans, because they earn interest on them; but they have to be cautious that the loans can be paid back, otherwise they go bust. During the boom, banks invented ways of packaging loans up, taking out insurance against default, and selling them to investors at a high prices, as top-notch assets. The loans were taken off their books – and it no longer mattered if the loans defaulted, because there was insurance, right?
Because banks no longer cared about default, they started lending 4, 5, 10, even 12 times salary – and they demanded less and less collateral from less and less credit worthy people. In the end, they would make a loan to a casual worker on 12 times their salary for more than the house was worth – after all, the price would go up, right? Vast amounts of money were created!
At last, they reached the limits of what people were prepared to borrow – prices stopped going up – and the loans went bad. The insurance company could make a payout on a hundred bad loans, but not a million – it promptly went bust, and caused a meltdown.
What happened next is very interesting. Actually we have a two tier money system; the money in circulation is created by the commercial banks. But settlement of loans between banks is made using money created as loans to the banks by the Bank of England. This M0, “base” money cannot be put into circulation; it is used purely for banks to settle accounts between themselves. In the crisis, many banks found themselves totally bankrupt – and so the bank of England created hundreds of billions of pounds in loans through “Quantitative Easing” to bail them out. This “newly printed money” was not for us – it was for the banks alone. The banks new perfectly well what they were doing by the way; the head of Citibank said before the crisis that he did not like to think what would happen when the music stopped, but as long as the music played, the banks had to “keep dancing”. And Goldman Sachs had the chutspah to make a fortune betting that the loans they sold to their customers would go bad! This is illegal by the way. Even more illegal is the fact that the banks set up “Robo signing” factories to forge signatures on documents that they had not bothered to keep track of during the crisis. Yes, it sounds impossible, but it is true. And the fact that not a single bank executive went to jail tells you everything you need to know about the power of the banks.
And what happened to all the money that was created, but not paid back? Money is destroyed when a loan is repayed, or when a bank goes bust – but no banks were allowed to go bust, and the loans were not repaid – so that money must still be out there in the spreadsheet, as interest-free money. Unless the “QE” money was somehow used to turn common money into M0 bank money… perhaps a reader could explain?
What did the banks learn from the crisis? That if they were too big to fail, and too big to jail, they could make out like bandits – or “Robber Barons” as they like to think of themselves. A Baron sounds so much more respectable than a crook. So here we are again. This time it is student loans and government debt that will blow the powder keg.
Who benefits from high house prices anyway? People who want to take out debt, but not repay it. And of course, the banks, who charge interest on those loans. But without loans, there is no money. A huge amount of money would be taken out of circulation if prices went down – so governments have frantically tried to keep prices high, to avoid all this money being taken out of the system, and the economic engine seizing up through lack of the oil of “liquidity”. To the great benefit of the banks.
So if you want to thrive in a crisis – become a bank.