I have been grappling with the discussion regarding money creation by private banks, and have come to the conclusion that it is the best thing that there can be as the backbone of the financial system. All other options centralize power to a condensed authority – say a central bank or a state government – and thus severely limit the potential for innovation and growth in the economy.
Let’s remember that money in the bank is like gas in the tank. Money is fuel for economic activity and carries only potential value until it is being used. Thus, sitting in bank accounts we have the real potential value of money that is not being used – like gas in the tank of a car waiting to go places. Money in a bank account exists as potential value, since in and of itself it is not doing anything. This is not to say that potential value doesn’t have value: the ability to hop in the car and go places at a moment’s notice definitely has a lot of value for the holder of the potential.
There are two kinds of people: those with gas in the tank and those without. Those without are stuck in place without the capacity to go and do. Those with are much freer in the sense that their options for activity in life are broader. This divide of peoples as separated by liquid wealth will always exist – it is just a question of to what extent the divide is there.
What then becomes the main question is how to allow people without gas in the tank to get up, go, and do. The question of access-to-capital is of central importance in practically realizing the freedom of the people. Political philosophy is full of all types of ways of describing freedom and liberty, but in practice the matter boils down to cash. Do you have it or not?
So, to stay true to our words of freedom and liberty – and all such good things that respect the sovereignty of the individual – we must ensure access-to-capital, and since there must always be risk involved in a capital outlay, this means that there must be debt. To all wishing for risk-free capital outlays then let us remember that the first risk is to imagine that there is no risk. Risk is what makes you go. Without risk, you slowly turn into a sack of shit, like a child whose parents aren’t demanding enough and thus raise a human being who lacks initiative. You begin to envelop yourself in a false sense of entitlement when you begin to believe that there is no risk to anything.
Effort creates value, value gives emotion, emotion is power. Risk is really damned good at spurring effort, because behind effort lies the lack of effort, and that’s where the entrance to the cave of real fear begins. Just imagine a world filled with a lack of effort. The risk that lies ahead of effort is nothing like the real fear coming from a lack of effort.
So, thank God for debt. Debt is a great thing at getting people to move, because debt must be paid back with interest, and that means debt is only created when there is some planning involved to ascertain a certain level of understanding about the potential to pay back the debt and interest, and this is why I think people hate debt: they actually have to think ahead and face the risks of taking it on. They actually have to plan things out.
How it works
Now that we understand why debt is a good thing, let’s understand its functionality so that we can close with an understanding of why private money creation is a good thing.
We have already described the real potential value of money – of having cash in the bank. Let us set that aside as given and begin the consideration of the virtual potential value of debt. We begin by assuming the characters of Banker as creditor and Individual as debtor. The Banker creates debt and the Individual takes it on, for whatever purpose.
How money creation works is that private banks magically conjure up debt out of thin air when making a loan, and as the loan is paid back, the banks then destroy said money. In the event of a successful loan – where the debt is paid back with interest – the debt comes into the world and leaves it, leaving behind the equity that was created for the Individual (whatever the loan was taken out for) and the interest that was created to pay the salary of the Banker (and to set the Individual in motion to start paying back the debt – interest is like an ON-button).
What we can see happening is that the virtual potential value of debt exists only during the process of equity creation – of whatever the loan was taken out for and of the interest that pays the Banker’s salary. Debt is virtual because it doesn’t really exist in the real economy – the real economy that consists of equity that has been created with debt. Debt is like a creative spirit, a breath of fresh air that is blown into the financial system, and as it is sucked back out by the pressure of time (the loan repayment schedule), it leaves behind the equity for which purpose the debt was taken out. Debt doesn’t stay in the economy – by its very definition, debt destroys itself, and that is a good thing since it is not the weight of debt that we want, it is the equity that it brings us, after we have worked to earn it.
Money creation through debt – from nothing, back to nothing, leaving behind something that becomes the real money – is the lungs of the global financial system.
This is why private money creation is a good thing. If we were to only have one huge set of lungs – say a central bank with all the power of money creation – then only those with access to the central bank would be able to get up, go, and do. By decentralizing the power of money creation to the private banking system, the very power of creation itself is dispersed into society. By having a competitive money creation market, the forces of competition will ensure efficiency, given a solid regulatory framework correctly incentivizing all parties.
The more access-to-capital, the more egalitarian a society we have. There is absolutely no way around this fact.
Of course, handling the power of creation is not to be taken lightly. I would posit the assumption that most people of power understand this completely and are honest human beings of significant dignity and moral stature. I would also posit the assumption that most rage towards the financial system is based on a lack of understanding – on both sides of the table – about its nature and functionality, since it is such a ridiculously complex system.
So here it is that I should venture to take a guess that the best solution for Banking Peace would be for all to realize that the Banker and the Individual operate on the same side of the table. The Banker wishes to make successful loans to produce interest with which to pay a salary. The Individual wishes to make successful loans to create cool stuff into reality and avoid default notations on the personal financial record. It is hard (impossible) for me to see how, in the process of capital outlay, the Banker and Individual are not on the same side of the table, just as Customer and Supplier are in any other industry.
To close, then, we must take note that creating money by being vested with the capacity to blow debt into the economy and suck it out again is a job of the highest responsibility, requiring immense understanding of how value is built and operated in reality – of how business works. The oversight of the lungs of the financial system is a task on par with any position of power.
I believe, with a clear understanding of why money creation by private banks is a good thing, it is possible to write a Banker’s Constitution that sets out the role and limits of the financial system as a part of society, making it understandable for everyone and ending the rage against the machine that has gone on for eternity – probably because there hasn’t been egalitarian access-to-capital!
Egalitarian access-to-capital: being brought to you now by private money creation.
Private money creation requires a few changes to the way we see risk from the perspective of the Banker, and I believe not seeing this has been one of the main reasons why private money creation has been questionable. It used to be that banks took deposits and lent them onward to other people, meaning that if loans weren’t being paid back, then other people’s deposits were at risk. Now – with private money creation from nothing, back to nothing – the default of a loan doesn’t put another person’s deposits at risk. The debt came from nothing, and it is going back to nothing – so it doesn’t really matter whether less debt is destroyed than was created, because it is all being destroyed, nonetheless. The only thing at risk is that the Banker gets a smaller salary because less interest has been paid (and isn’t as hot shit within the Firm), and that the Individual who held the loan gets a default notation for not having been able to pay back the debt in full, which will hurt their credit rating.
So it is important to see that – for private money creation to work – we must separate the holding of equity (the maintenance of the real economy, of what already exists) from the creation of debts (the maintenance of the virtual economy, of what is coming into existence). The storage business and the creation business are two different things, no longer dependent on each other in operation per se, but of course fueling the motions of each other – as the real economy loses old players, more demand arises for new debt to fill whatever gap was created in whatever market where some player died. (added note: Thanks to some great help from the Bank of Norway, I’ve now learned that the term narrow banking exists and deals with this same separation of the storage and creation sides of banking).
But probably the best side of private money creation from nothing, back to nothing is that it has so many moral benefits for all involved, as it removes unnecessary punishment from the list of risks inherent to debt-induced economic growth. If the loan isn’t being paid back in full, this means that it is not generating returns, which means operative failure deflates the economy, just as it is supposed to. With debt conjured from nothing, back to nothing, we are also able to remove fear-inducing enforcement requirements from the system: we don’t need to force defaultees to keep paying unpaid debt back anymore, since the debt would be being destroyed anyway. This wasn’t the same thing when debt was considered as having been outlayed against the deposits of others, creating a situation where Bankers also played police, because they had to get the money of their other customers back. The Banker’s smaller paycheck and the Individual’s hurt credit rating is enough punishment, and the banking system can have a clean moral conscience and say “at least you tried – sorry it didn’t work out, we must now stamp your forehead with this mark of default which will wear off in a while, but you don’t need to keep paying us back. Go out and get a salaried job until the mark wears off your forehead, and then you’re ready to try again, if you so wish.”)
The final thing to realise is that the basis for the existence of interest is generally held as “a money today is worth more than a money tomorrow.” This puts value on the potential value of having gas in the tank, making interest compensation for the removal of liquidity which investing existing capital into an interest-bearing asset does. By separating the storage of equity from the creation of debt, however, this is left as only one side (the storage side) of the argument. On the creative side of the interest argument, where there is no longer a need to consider the liquidity of a depositors standing (as debt can be created as completely separate from depositors) the rationale for the being of interest is to motivate the debtor into motion, and to motivate the creditor to ensure the loan is repaid, as the interest pays salaries.
Realising the dualistic nature of interest – on the storage side and on the creative side – is really important, because it shows how interest works both ways: holding depositors’ equity in place and compensating for the loss of liquidity (the time-value of money), and setting a debtor in motion to create more equity (the money-value of time). Needless to say, the Banker takes a deserved cut, whichever way the interest is going, as compensation for operating the system.
© 2018 Jens J. Sørensen