Thursday, 26 March 2009


image credit:

As I See It.......... by L. Berney


"The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple that the mind is repelled.”

- John Kenneth Galbraith, Economist, in his book “Money: whence it came, where it went”

Sources of the World’s Money Supply

The money of every currency, Dollars, Pounds, Euros, etc, originates from two sources: Government Money and Commercial Bank money.
  • Government Money is the money in circulation that has been issued by that currency’s Central Bank. It consists of coins, banknotes, bills and bonds issued by the Central Bank. This is “real” money.
  • Commercial Bank Money is created by Commercial Banks when they issue loans (mortgages, business and household loans). When a bank makes a loan, it creates additional money, “out of thin air”. This is “debt/money”. When a Commercial Bank makes a loan – issues debt/money – the total amount of money in circulation is increased. When the loan is paid back, the total amount of money in circulation is reduced.
  • Of the total amount of money in circulation globally, the amount of Commercial Bank generated money far exceeds Government money
Excessive Debt/Loan Money and the Credit Crunch

In the history of banking, banks originally lent out only a small proportion of the money that their customers had deposited with them. Gradually, over time, banks lent out more and more of those deposits. Eventually the total amount of debt/money they lent out became more than the amounts that were actually deposited with them. After the banks were “de-regulated” in the 1990s, the amount of debt/money commercial banks were lending out came to bear no relation at all to the amount on money deposited with them. By the time of the credit crunch (2007/8), Commercial Banks world-wide had got into the habit of lending out debt/money amounting to thirty, forty and even as much as fifty times the amount of the money that was deposited with them! At that point, inevitably, the debt bubble burst.

In 2007, the whole of the world’s economic system – the “free market”, capitalism, the living standards we all, both rich and poor, had got used to – depended entirely on the existence of the huge and ever growing amounts of debt-generated money in circulation. When in 2008 the debt bubble burst, the banks suddenly stopped lending. However, outstanding debts were and still are being paid back to the lending banks – the result is that the total money in circulation is being reduced rapidly.

With less money in circulation the world’s economies are slowing down, businesses and factories are closing, people are being sacked and homes are being re-possessed. People everywhere are holding on to what money they have and are spending only on essentials. Everyone’s standard of living is going down. We have a recession, if not a depression.

Mr. Micawber, in Charles Dickens' David Copperfield, summed it up:

Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

With the recession worsening, the world expects governments and politicians to “do something about it”.

What people mean by “doing something about it” is for governments to do whatever it takes to get back to the high living and employment standards of 2007. Clearly, that can only happen if the total money supply and economic activity round the world is returned to what it was in 2007. But we all now know that the level of debt incurred in the 2007 level of money supply is unsustainable.

The Politicians’ Solution

Since the banking crisis of 2008, the commercial banks have learned a lesson; they have returned to the prudent lending practices of 50 years ago (we don’t want to make the same mistake twice!). Moreover, much tighter government “regulation” (i.e. a brake on bank lending, and thus further reducing the money supply) is the political order of the day.

So, what is the solution? Governments and politicians round the world are floundering around to find an answer. The answer they say is, “to get the banks lending again” In the main, two solutions are being pursued: Quantitative Easing and Fiscal Stimulus.

Quantitative Easing

What is “Quantitative Easing?” In brief, it means increasing the amount of Government Money (“real” money) in circulation. As the amount of Commercial Bank debt/loan money shrinks world-wide, the idea is to replace it with Government Money so as to keep the total amount of money in circulation at the level it was before.

The way Governments do this is to have their Central Banks buy up assets - usually government and corporate bonds. How? The Central Banks simply create money out of thin air – just like the Commercial banks did before! The institutions selling those assets to the Central Bank (Commercial Banks, Insurance Companies, etc) will then have "new" money in their accounts, which theoretically should boost the overall money supply so that the Commercial Banks can, “start lending again”.

Fiscal Stimulus

A Fiscal Stimulus is triggered by cutting taxes and/or increasing government spending on infrastructure improvement, major public works and the like. It is so called because this increases the total amount of money in circulation and therefore (hopefully) stimulates a country’s level of economic activity, at least in the short run.

My conclusion

Will the measures being taken work? Will they, as the public demands, get employment and living standards back to the levels of 2007 again, and then go on getting better every year?

No prizes for the answer. You don’t have to be an Einstein to see through the contradiction and the fallacy in the “solutions”.

My opinion is supported by Henry Kissinger, former US Government Minister of State, who summed it up nicely yesterday in a BBC News clip:

What they (the politicians) are doing is substituting a public debt crisis for a private debt crisis...

As I see it, over the last 25 years or so, due to the commercial banks issuing ever more debt/money (phoney money?), the whole world has been living well beyond its means – there has been a BOOM. Now that the inevitable has happened, and as the excess volume of debt/loan money works its way out of the economy down to a sustainable pre-1970 level again, as it must, the world economy is going to experience one-hell-of-a BUST!


An example of “loan-culture” thinking:

Since commercial banks are economising and closing down unprofitable branches, it was recently suggested that the 6,000 UK post offices should offer a banking service. One of the criticisms was that this would not be of any use since, “ office banks, being new, would not have any money to lend out”!!!


Anonymous said...

I definitely agree however I’m sure you will agree that SOMETHING has to be done... we could be looking at the worst depression in history... so, what are the alternatives?

L Berney said...

If you mean, “Something has to be done to bring the global standard of living and the economy back to what it was before the credit crunch”, as I see it there is nothing that can be done -- it won’t happen.

For the last 25 years or so the whole world has been living beyond its means. There is no way, no ‘fix’, no political magic wand, no possibility, that the past ‘cloud cuckoo land’ situation can be reinstated or continued. All the ‘Fiscal Stimuli’ and ’Quantitative Easing’ in the world can not redress the fundamental problem. We have an unsupportable level of global debt which will have to be worked down to a much lower and sustainable level, similar to the debt level of the 1970s.

I liken it to a family who has for years been living beyond its means. Each member has several credit and store cards which they have ‘maxed out’. They have bank loans. They have signed up to a mortgage to acquire a large property with repayment terms they can’t meet. Their combined debt mountain gradually becomes insupportable and, sooner or later, however much they wriggle, the bubble bursts. What to do? They have to drastically cut down on their living standards and work off their excess debts. For example, one car instead of two, two TVs instead of three, take cheaper package holidays (or stay at home!) instead of luxury cruises, no more ‘play stations’ or expensive toys for the kids, make their clothes last longer, don’t buy anything unless it is essential, ‘make do and mend’.

After paying off their debts, which could take years, they must live within their means. From then on, they can only have what they can pay for.

The worst depression in history? Probably, yes. That’s because we have just had the biggest fictitious wealth boom in history – a boom built, not on productivity and earnings. but on debt.

After reading this, I recommend you pour yourself another drink!