Presentation 2/4 from a short course on Ecological Economics by May Mellor, author of The Future of Money.

1. Session 2:Money and Banking
Mary Mellor

2. Summary Session 1
• Money reflects a relationship between people,
it is not a ‘thing’ like gold or silver
• States were once major issuers of money –
particularly cash (notes and coin)
• Banks have taken over that role
• States have become borrowers like everyone
else

3. Money and Banking are not Evil
• Money and banking are social systems that
have emerged historically
• Their flaws are not due to evil intent or a
conscious conspiracy, although participants
have benefitted hugely and there is greed and
some fraud
• Need to understand the flaws in the system to
achieve effective change

4. Banking is very old
• Emerged in Egyptian and Babylonian times
• Based on records of ownership of collectively
held goods such as herds of cattle and crops
stored in common silos
• Early hieroglyphics were records of ownership
and payments such as taxes. Records could be
used to pay for other goods or debts
• Relative values based on standard measures
e.g.240 grains of barley

5. Banking is very old
• Ownership was exchanged through a ‘giro’
system of transfer of ownership records
• 1770 BCE Code of Hammurabi - banking
regulations on the conduct of lenders and
borrowers and payment of interest etc.
• Accounts of ownership, transfers, debt,
payments etc. was much more important than
the actual means of payment which could vary

6. What is a Bank?
• Somewhere to keep our money safe
• A means of transferring money around
• A lender of money
• A discounter of debts
• An underwriter for investments
• A business borrowing and investing its own
money
• These functions can be separated or combined
(universal banks)

7. Banks Also Create Money
• ‘the process by which banks create money is
so simple that the mind is repelled’
• (John Kenneth Galbraith, 1975 Money:
Whence it came and Where it went Penguin,
London p. 29)

8. Money must be Issued
• Money does not just appear in society – it
must be issued
• Historically states have issued money (in
various forms from cash to tally sticks)
through state expenditure and tax demands
• Banks have issued money as discounts on
financial exchanges (paying out ahead of
future payment) or as direct loans

9. The Banking Illusion
• Is that banks are intermediaries taking in
deposits and lending them out to borrowers
• But deposits are ‘on demand’ they must be
returned if requested – even time deposits
(savings)
• How can money be in two places at once?
• Where did the deposits come from anyway?

10. The Gold Story
• People deposited gold/silver (where did they
get that from?) – and got a record of deposit
• The gold/silver was lent out to other people at
interest – later as a paper record
• Bankers ‘cheated’ by creating much more
paper than gold i.e. they lent money they
didn’t have (fractional reserve banking)
• Assumes only gold/silver is money

11. Commercial Banking
• European banks emerged in early medieval
Italy serving states, traders and the rich
• 14th century adoption of double entry book-
keeping for transfer of payments
• Safe storage of precious money and other
valuables – recorded on notes of deposit
• Early banking based on personal trust of the
trader/banker – the bond –

12. Commercial Banking
• Notes recording money deposited circulated
widely and later banks issued deposit notes
for money borrowed as well - greatly
expanding money supply
• Rulers short of money also borrowed metal
and paper money (central to funding wars –
often defaulted)

13. Commercial Banking
• Banks acted as intermediary for trade by
paying trader 1 out on trader 2’s promissory
notes for less than face value (discounting)
and collecting full amount from trader 2 later
• Banks enabled external trade through bills of
exchange (paying out in different currencies
and across distances)
• Relied on family networks across countries

14. National Debt
• Banks become major lenders to rulers e.g. in
Europe the Medici, Rothschild, Barings
• 1694 Bank of England set up to fund wars
against France lent King £1.2million at 8% but
demanded Parliament be responsible for
repayment (private company until 1946)
• This became a National Debt to the private
sector as issuers of money as debt

15. Why Didn’t the King Issue his own
Money?
• Basing money on a valuable commodity
(gold/silver) made holders of that commodity
very powerful
• Often the metal had gone abroad
• Huge shortages of precious metal anyway
• Crown could not issue its own money in any
other form (e.g. tally sticks) as it had run out
of credit/tax capability

16. UK National Debt
• 1694 £1.2 million (8% interest)
• 1816 237% GDP
• 1914 25% GDP
• 1919 135% GDP
• 1937 150% GDP
• 1947 238% GDP
• 1992 25% GDP

17. UK National Debt
• Pre-crisis 40% GDP
• Post crisis 70-80% (60% excluding bailout)
• (Japan 200%, Singapore 105%)
• 1920 interest 7%
• 1980 interest 5%
• 2011 interest 2.0 - 4.0%
• Negative interest rates UK, US, Germany

18. National Debts and Deficits
• Deficit: more expenditure than tax take, need
to increase overall national debt
• A Structural Deficit is one that persists
• Is that a problem? Yes if you see the state as a
household that borrows externally
• No if state uses its money creation power to
‘monetise’ the debt rather than borrow – and
tax the money back later (if necessary)

19. Modern Banking
• Over time early private commercial credit-
debt relations became ‘monetised’ i.e. people
now trusted the paper record money itself
rather than the personal/private system of
credit-debt that lay behind it
• Still many banks failed
• This (eventually) brought bank money into the
sphere of government responsibility

20. Linking State and Banks
• State money (fiat) and trade money (bank
paper) came together in the modern banking
system when the commercial bank paper
system became authorised as legal tender
through the invention of bank notes that
could circulate as cash guaranteed by the state
‘ I promise to pay’
• The Bank of England (a private organisation)
had the monopoly of the issue of bank notes

21. ‘Real’ Money and Bank Money
• Idea that original deposits are real money:
bank money is different ‘credit money’
• Where does real money come from?
• Previously circulating money
• Where did that come from? Good Question
• Argument that real money can only come
from the state (via the central bank) –base
money – high powered money – narrow
money

22. Banking Versus Currency Schools
• Currency School – real money is bank notes
that are limited (e.g. linked to gold)
• Banking School – bank note issue should
reflect needs of the economy
• 1844 Banking Act: Currency School won the
battle, bank note issue was to be limited –
Banking School won the war – ‘sight’ accounts
were not limited – now 97% of money

23. The Multiplier Theory
• Banks are allowed to lend multiples of ‘base’
money (e.g. 10 times)
• They must hold a proportion of deposits as
reserves (e.g. 10%) – fractional reserve
banking
• But states now issue little money
(cash)…….what is going on?

24. Banks Create Money
• Banks create money by making loans
• Every time they make a loan they create new
money by setting up a deposit account
• This money gets transferred to other deposit
accounts (and then becomes ‘real’ money?)
• The amount of money created depends on
demand (people/businesses/ governments
who want to borrow) and the bank’s
willingness to lend

25. Money from ‘fresh air’
• Loans created as sight accounts are ‘fresh air’
money - ‘fountain pen money’ (Tobin, James 1963:408
‘Commercial Banks and Creators of Money’, in D. Carson (ed), Banking and
Monetary Studies, Unwin)
• By 1990s nearly all UK money issue was
through the banking system as loans
(personal, government, business)
• State attempts to control supply (monetarism)
failed

26. Money Issue as Debt
• Bank loans have always been central to
capitalism as they enable the productive
process to start (the money circuit)
• Main growth recently personal/household
loans and financial speculation
• 1969-2009 Annual increase in UK broad
money supply was roughly equivalent to the
increase in debt owed by the public each year
(James Robertson Future Money forthcoming)

27. Instability of Debt-based Money
• Money supply must constantly expand if debt
with interest is to be repaid
• Debt–based money issue must drive growth –
need to repay debts demands constantly
increasing economic activity
• Money supply always threatened by a credit
crunch – contraction of available money

28. The Bank’s Problem
• Depositors think their money is invested – yet
expect it back on demand
• Banks must make a surplus/profit
• Reserves/capital (retained profits and original
equity) is dead money
• Assets (loans and investments) are long term and
can be risky
• Liabilities are ‘short’ (demand deposits) while
assets are ‘long’ (loan maturity)

29. Bank Liquidity - Solvency
• Banks are always susceptible to loss of
confidence and a ‘run’ - the notion of a
reserve is meaningless in a crisis
• Liquidity is the amount of cash or near cash
available to the bank (often very low)- Central
banks lend them money if necessary
• Insolvency is when assets (including bank’s
own capital) do not match liabilities

30. Are all banks affected?
• US Glass-Steagall 1933 separated deposit and
investment functions after 1929 Crash – but
de-regulated in recent years
• Early mass banking was often in non-
commercial banks. In 1970 UK building society
deposits were larger than bank deposits
• However all types of banks got caught up in
the recent speculative whirlwind German
state banks, British building societies

31. States Lose Control
• Many states have lost control of money
creation and the whole money system,
particularly after the deregulation of banking
• Bank issued money has vastly increased the
money supply - this has caused inflation –
mainly in the financial sector- where it is
called capital growth or asset appreciation
• As the national money supply is now based on
bank issued debt it is subject to crisis

32. State Responsibility
• The public clearly sees the state as responsible
for the banking system : Northern Rock,
Icesave, Ireland, eurozone, IMF
• States now have to take on ‘sovereign debt’ to
rescue private debt – ironically borrowed from
the self-same banks and ‘money markets
• States are even seen as responsible for the
avalanche of debt – hence austerity

33. State Responsibility
• It is impossible to distinguish different types of
money – there is no ‘real’ money.
• In a systemic crisis the whole money system
must be supported (Lehman Brothers)
• State responsibility for the integrity of its
national money means it has to continually
bail out the privatised money system
• Major problem if borrowings are in another
currency

34. Undermining the Public
• The public sector is seen as parasitic on the
private ‘money creating’ sector - yet it
underpins it
• All money is based on legal tender which the
state underwrites
• States and monetary authorities support to
financial sector at least $15 trillion worldwide
• Countries bankrupted: Iceland financial sector
10X GDP - UK 5 X GDP (RBS alone = GDP)

35. Debt cannot fund a Money System
• Debt based money issue demands constant
money supply growth to repay debts with
interest
• Without such growth money supply will
rapidly shrink as debts are repaid
• Somewhere in the system money must be
issued that is not reclaimed by the issuer –
debt-free and tax-free state money or unpaid
debt (Jubilee) – default ‘haircut’

36. State Money Versus Bank Money
• Distinctiveness of state issued money is that it
can be issued debt free (although subject to
tax to prevent inflation)
• All bank issued money has to be repaid with
interest (debt)
• As money needs to be issued bank debt
money or state fiat money must start the
process of money circulation

37. Quantitative Easing
• Issue of debt free state electronic money
• Used to buy back government debt : selling
government debt removes money from the
economy: Buying back government debt
increases money supply
• QE has been issued via the financial sector
instead of putting the money directly into the
productive economy or public infrastructure

38. Summary: The Public Nature of Money
• The financial system is not private
• It administers a public resource – money as
legal tender
• Its final resource is the taxation/money issue
capacity of states
• Yet tax avoidance/off-shoring is rife even given
excessive remuneration – undermining the
capacity of states to support the sector

39. Money as a Public Resource
• Money should be seen as a ‘commons’ social
resource like air or water is a natural resource
• Need to reclaim money as a debt-free public
resource with democratically determined
priorities
• Money issue and banking should be a public
service under public control
• Could then create the possibility of a socially
just, sufficiency economy