Lecture Notes: Understanding Money Creation and the Monetary System

Key Questions Addressed

• How is money created?
• Where does money come from?
• Who benefits from the money system?
• What purpose does money serve?
• What constitutes a money system?
• What underlies the money system?

Overview of the Monetary System

• The mechanics of the money system are often hidden from the public.
• The monetary system is foundational for national and international control.
• Recent crises highlight the need for open discussions about the future of the monetary system.

Economic Crisis Analogy

• The current economic crisis is likened to cancer, emphasizing the necessity for proactive measures.
• Governments are not the ultimate rulers; institutions like Goldman Sachs wield significant control.

Historical Context

• Emergence of Banking:

  • The cyclical boom and bust pattern became evident around the 1700s with the establishment of the Bank of England.
  • Prior to 1844, private banks issued their own notes without government profit.
  • The 1844 law transferred money creation power to the state.

• Transformation to Digital Money:

  • Shift from physical cash to digital and electronic forms of money.
  • A significant portion of the money supply today is commercial bank money (97.4% in 2010).

Money Creation Process

• Two Types of Money:

  • Physical Cash: Only 2.6% of total money supply.
  • Commercial Bank Money: Created by banks primarily when issuing loans.

• Seigniorage:

  • Profit made by the government from issuing currency.
  • Example: A £10 note costs only a few pence to print; the profit goes to the Treasury.

• Demand Deposits:

  • Money held in bank accounts that banks use to create credit.
  • Most money in circulation is now digital and not physically held.

Misconceptions about Banking

• Many mistakenly believe that banks lend deposited money. In reality, banks create money through loans.
• Most people do not understand that banks can create money out of thin air through credit creation.

Current Money Creation Dynamics

• Approximately 97%-98% of money is created as "debt money" through loans.

• The banking sector plays a pivotal role in the economy by determining how money is allocated.

• Debt Cycle Dynamics:

  • There is a paradox where personal savings can lead to economic recession.
  • The system is designed such that the economy depends heavily on debt.

Economic Implications

• Inflation:

  • Occurs when too much money is chasing too few goods.
  • Rapid credit expansion leads to asset bubbles, especially in housing.

• Distribution of Wealth:

  • The money system redistributes wealth from the poor to the rich, exacerbating inequality.
  • The focus on housing as an investment rather than a necessity contributes to economic disparity.

International Monetary Considerations

• Global Currency Dynamics:

  • International economic crises often lead to currency wars, where nations devalue currencies to boost exports.
  • The absence of a stable currency backing creates volatility and imbalances in trade.

• Financial Imperialism:

  • Developing countries often face debt crises, leading to dependence on foreign capital.
  • Structural adjustment programs imposed by institutions like the IMF have often harmed local economies.

Path Forward

• Reform Proposals:

  • Advocate for a new monetary system that prioritizes productive investment over speculative activities.
  • Create a more equitable financial system by controlling how money is created and allocated.

• Potential for New Currency Models:

  • Suggestions include backing currencies with renewable energy or a basket of commodities.

Conclusion

• The current financial system benefits a select few while imposing heavy burdens on the majority.
• A significant rethinking of how money is created and used is essential for future stability and fairness.
• The necessity for reform is urgent and critical for sustainable economic health.