Under a fully private banking system such as exists in most countries, new money enters the Money Supply when banks make loans. Money leaves the Money Supply when the banks collect interest and repayments. Where this money is first spent greatly influences the economy. The government, on the other hand, collects taxes and spends those taxes. The government does not influence the magnitude of the Money Supply. Any shortfall in this following graph is usually filled by borrowing pre-existing bank credit through the issue of bonds (gilts, securities).
Government expenditures are dictated by the needs of society and are unlikely to vary significantly from year to year. Businesses will set themselves up to service the needs of government for the benefit of society and are likely to run in a fairly steady state. In 2014-15, Australia collected $446 billion in taxation [1] which it spent back into society.
The private banks are quite different. As I write this paragraph, total government debt in Australia is listed as $757 billion. [3] If we use an arbitrary figure of 5% interest to get a rough idea of the magnitude of the interest, we get $37 billion. If the government borrows more through the issue of bonds, the Money Supply will not rise as the government is borrowing bank credit that already exists. Total Australian Debt is listed as $5952 billion on the Australian Debt Clock. [3] If we use an estimated interest rate of 5%, we get a total interest of $297 billion annual interest payment. These are not accurate figures and are a calculation to estimate the magnitude of the money movements likely to alter the magnitude of the Money Supply. If the average loan length were ten years, the principal repayments would be about $595 billion each year. Thus the lenders of the $5952 billion collectively have the power to reduce the Money Supply by ($297 + $595) $892 billion each year. This is listed against a Money Supply of $1912 billion from the same source. [3] Interest and principal repayments have the power to reduce the Money Supply by 46%. New loans of a similar but slightly larger figure are needed each year to keep the Money Supply topped up.
In a situation where there is no government-owned public bank, new money can only enter the Money Supply by:
If public banks exist as national, national development, state, state development, and local public banks, we can add:
When the government wishes to borrow money it tends to issue bonds which are effectively IOUs with a specific end date. If private interests refuse to buy these bonds, the government is in trouble. Long gone are the times when the government created its own money. I have drawn the following to represent a bond. They are printed like bank notes but the government pays interest. Interest is represented by the coupons at the base of the treasury bond. The government issues a million dollar bond to obtain a million dollars. It issues a million dollar bond to obtain a million dollars in bank credit which is credited to a bank account in its name. It could create a million dollar coin to the same effect, but does not do so. It could print a million dollar bank note for the same purpose, but it does not do so.
When the government issues bonds, the purchaser will transfer existing bank credit into a government bank account. The government then spends the money. There is no change in the Money Supply. There may be an advantage in that bonds are bought by entities with ‘more money than they can spend’. There is a strong likelihood that the bond is purchased using Hoarded Money. Thus Hoarded Money is converted to circulating money.
If the citizenry are reluctant to purchase bonds, the central bank may step in and purchase bonds. This is often a sign that something is going wrong with the money system.
The main avenue for new money to enter the Money Supply is through private bank lending. This creates a problem because it then becomes difficult to control the volume of loans issued by private banks. It is also problematic controlling the areas to which banks lend. Some pretense of control can be made by creating a central bank and giving it some almost useless methods of control. The government gets blamed for the resulting economic hiccups, whilst the central bank talks authoritatively about control. The central bank controls the exchange rate and a reserve rate but has no control over lending volumes or lending areas. The government is even more remote from the action.
There are some solutions but the banking industry is effectively able to control the decision makers that make changes.
One solution is to institute a national public bank and carry out ‘countercyclical-financing’. This involves lending fresh credit when the private banks cease to do so.
The last item needs some clarification. Governments have traditionally only created physical money in integral positive units. These are commonly imprinted onto paper as in notes or metal as in coins or wood as in Tally Sticks.
The governments have not created digital money in any of its forms through the treasury. There is an essential difference between a treasury issuing money and a bank issuing money. Treasury creates money by printing, minting or splitting wooden sticks. Treasury creates new money is created at almost no cost and spent into society. However, it has always had a physical form. Banks issue new money in a totally different way. Banks use Double Entry Accounting and create a positive credit in one account and a negative amount in another account. Unfortunately, the negative amount is magnified with interest to exceed the positive amount. Banks make account entries to create money in a virtual form. Governments create physical units of money.
It is time for the government to create a digital equivalent of the currency that it has always produced. My usual example is as follows: The government prints notes of large denomination. These notes are photographed and stored in a vault. The government spends the digital notes into society by sending a unique jpeg image of the note along with its number. The citizen purchases items with the digital note by sending the image file along with the number and its transaction history. No central computer is required because ownership is demonstrated by the image, number and transaction history. These can be verified from time to time on a network of independent computers that update each other like the domain name servers on the internet.
The government thus has two ways of generating money:
Method 1 is advocated by Positive Money.
Method 2 is advocated by the Public Banking Institute.
However, both methods are viable and can be run at the same time.
Method 1 has some problems. When the government creates money and spends it into society as happened when nations were run by sovereigns, business had difficulty getting the start up capital to enter business. Business needs money before it can make money. Business under Method 1 tends to suffer. The solution here is for the government to allocate freshly created digital money to banks to lend out at a mild profit to business. The government retains some control over which area of the economy gets the greatest volume credit. The government also gains control of the magnitude of the Money Supply.
Method 2 has some problems. The big problem here is that the public banks create fresh credit and debt in equal amounts. Again, the debt minifies with time to exceed the volume of credit. However, when a government borrows money from the government, the debt is somewhat irrelevant. China has used this method to propel itself from a backward nation to a world manufacturing power in less than half a lifetime.
Business has expanded dramatically since the church relaxed their strong opposition to usury. Usury being the lending of money and expecting a greater amount in return. Unfortunately, the lending binge and reliance on borrowed money have ushered in an era of unpayable debt. Australia has three times as much debt as there is money and worldwide there is about two times as much debt as there is money.