Like ‘mutually-assured destruction’, there are some ideas the world may well be better off without. Especially when the idea is a ticking time-bomb…

One such idea is having a monetary system which is based on debt. Even BBC’s Robert Peston is beginning to figure that one out.

Robert Peston, from the BBC

It’s a little-known fact that in the UK only 3% of the money in circulation has been created as ‘credit’ ie. has been minted by the government in the form of coins and notes. The remaining 97% has been ‘created’ as ‘debt’ by private banks. It is a common misconception that banks lend ‘other people’s money’. As the ‘Modern Money Mechanics’ banking handbook states;

“Of course, they [the banks] do not really pay out loans from the money they receive as deposits.”

When you take a loan or mortgage from a bank, the money you are ‘lent’ is merely created digitally on a bank computer and deposited into your account. You can then spend the money into the economy as you wish. The bank counts this outgoing money as a ‘liability’ and waits for it to be repaid with interest. When the loan is repaid, the bank ‘cancels out’ it’s ‘liability’ – effectively removing the money from circulation – while keeping the interest as profit.

Meanwhile, if you deposit (the same or other) money as savings, the bank only has to keep 10% of it in ‘reserves’, in a so-called ‘fractional reserve system‘. This is based on the hypothesis that at any one time only 10% of people will every wish to withdraw their savings. The remaining 90% of your deposit is ‘put to work’ – ie. used to buy real assets for the bank or gambled on the stock markets.

This may seem like nothing more than an obscure curiosity, but the ramifications of this system are immense. As Mervyn King, the Head of the Bank of England, recently said,

“Of all the many ways of organising banking, the worst is the one we have today.”

Firstly, most businesses need to take on debt to start-up or invest, while individuals often need to take on debt to buy our ever-more expensive homes, pay for education, or just to make ends meet. In 2010, the average UK household debt was almost £60,000, and due to the bailouts, by 2015 this is expected to rise to £110,000, with every person paying £100 per month to service the interest alone. Nevertheless, economists often extol the ‘golden rule’ ratio of debt-to-income – such as Gordon Brown’s ‘40% government debt-to-GDP’.

Often intentionally incentivised with low interest rates, a mass taking-on of debt brings a flurry of extra money into the economy, and an ‘economic boom’ begins. However, as always, the debts need to be repaid. If a successful businessperson, a thrifty home-owner, or a diligent government repays their debts, they reduce the money supply for everybody else. When times are ‘good’ many debts will be paid off… leading to a shortage in the money supply and then a recession (this unavoidable cycle is called ‘boom and bust’ or the ‘business cycle‘).

And how do you get out of a recession? Our illustrious politicians fall into two camps:

  • Labour used to say take on extra debt to ‘stimulate the economy’ – a temporary measure which clearly is not sustainable.
  • Conservatives / Liberal Democrats say ‘austerity measures’ are needed to pay off debts – which would reduce the ‘money supply’ further, or pass the debts onto the individual.

The futility and naivety of this discussion is obvious: neither answer does anything to alleviate the actual fundamental problem. As the philosopher Henry Theoreau said,

“There are a thousand hacking at the branches of evil to one who is striking at the root.”

And the root cause of our woes is that the vast majority of our money has been created as debt with interest, compounded by the fact that banks only have to keep 10% of our savings in reserves.

Like a Ponzi scheme, this allows banks to build vast, wobbly pyramids of debt – which redistributes money upwards, creating mega-profits for the people at the top, and mega-problems for everybody else. This includes the planet, as businesses frantically pursues destructive ‘infinite growth’ – lest they stand still and risk letting the interest payments catch up.

This is how we’ve gotten into the situation today, where there has never been more material wealth and productivity, yet almost everyone is in debt to banks – a paper-pushing industry which produces nothing tangible, yet whose assets, bonuses and skyscrapers grow larger every year.

Some economists argue that private banks are the only institution which are prudent enough to be allowed to create money. Other economists argue that allowing banks to gamble your deposits is a good idea – as it ‘puts your money to work’. Yet, this is beside the point – money is merely an idea, and it needn’t be like this.

International Money Pile

International Money Pile by Epsos.de, shared under Creative Commons

To prevent financial collapses, banks should be required to hold full reserves – and only lend out money which they have – as was practised by the Bank of Amsterdam and Islamic banks today. While an independent, non-political government body could then create interest-free ‘credit’ money as it is needed, and give it to the government to spend on building infrastructure and creating jobs, the scale of which has been estimated at up to £130 billion every year (for those who don’t know – that’d cover all our ‘cuts’, plus £40 billion extra). The flowing of credit money would then begin to create the conditions for a sustainable economy, while easing the debt slavery that most citizens in the world currently live in.

If you think this is a more enlightening discussion, rather than the endless haranguing about how bad the cuts should or shouldn’t be, I advise you to join the One Good Cut campaign  – which aims to solve the root problem. Happy digging!

Find Out More

Website:  Postive Money

Documentary:  Money as Debt

Book:  ‘The Grip of Death’ by Michael Rowbotham

2 thoughts on “Money As Debt (MAD)

  1. You state that: “When you take a loan or mortgage from a bank, the money you are ‘lent’ is merely created digitally on a bank computer and deposited into your account.”

    Am I missing something or is there mistake here? The money banks lend out is borrowed from wholesale banks. They have to pay this money back. They are allowed by central banks to borrow and lend ten times what is on deposit in case there is a run on the bank. But they must still repay what they have borrowed. Banks went bust because they were unable to continue borrowing when the American asset values collapsed. If banks could just create money digitally as you suggest then RBS and Anglo Irish would not have gone bust.

  2. Thank you for your question:-

    Under the ‘Rules of Accounting’ Banks cannot create money for themselves directly, but rather through loans and mortgages to others. They also need to be solvent (have reserves) in order to lend.

    The banks went bust because they had ‘lent’ too much created digital money into the economy (which are bank liabilities until repaid), creating a housing bubble. When many of these (sub-prime) liabilities went bad the banks did not have enough reserves to cover their liabilities (especially as the collateral – the houses – were swiftly losing value), so they became insolvent. Central bank money is often brought in to shore up a faltering bank, but due to the size and breadth of the defaults, the central bank(s) did not have enough funds to cover – which is why they asked for more from the taxpayer. Please see this illustration:


    You are right that banks do sometimes borrow money from central banks to increase their lending capacity (which they can then split at least 10 times), but this is only one aspect of what they do. For a more in-depth analysis, I recommend watching these videos:


    I hope this answers your question.

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