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The nature of money and debt

The Greek crisis has highlighted how little we as a society understand the nature of money and debt. There have been constant cries from commentators about how Greece borrowed money and therefore they must repay their debts. It is seen to be incumbent upon them: a measure of social responsibility; an obligation they are morally required to fulfil. Our understanding of debt goes hand-in-hand with our flawed understanding of the nature of money. The recent UK general election was a case-in-point. It was won primarily because money and debt were framed as a finite, natural and immutable forces, separate from society and government. Nothing could be further from the truth. Money and debt are social constructions. We made them, and we can unmake them. In this article, I hope to shed some light on how money and debt came to have the properties they do today, and how they shape our behaviour and society.

According to most mainstream economists, money emerged out of barter economies, and credit and debt followed. They would have you believe that prior to money, people exchanged goods or services directly for other goods or services. This would require a double coincidence of wants, whereby two parties had to each want something the other had. As this is clearly a relatively rare occurrence, the system was inefficient. Economists therefore assume money was born almost organically, to better match individuals with the good or service they required. However, there is no historical or anthropological evidence that barter economies ever existed on any large scale, or that this is how money came into existence. Anthropologist David Graeber, in his excellent Debt: The First 5,000 Years, points out that prior to money the dominant mode of economic exchange actually tended to be credit-based. The farmer would distribute food throughout the community, knowing that he could rely on the community to provide him with goods and services in return, as and when he needed them. Individuals built up informal credit ratings within their societies. The huge temple and palace complexes of ancient Mesopotamia formalised these credit systems, quantifying specific debts. Bureaucrats assigned every commodity a value in silver, and money as a unit of account was born. However, the circulation of coins – money as a means of exchange – did not begin until much later. Credit and debt preceded money by thousands of years.

The quantification of social obligations had a profound impact. Personal relationships impacted far less upon debt. As Graeber puts it,

‘if one owes forty thousand dollars at 12-percent interest, it doesn’t really matter who the creditor is; neither does either of the two parties have to think much about what the other party needs, wants, is capable of doing – as they would if what was owed was a favour, or respect, or gratitude. One does not need to calculate the human effects; one need only calculate principle, balances, penalties, and rates of interest. If you end up having to abandon your home… if your daughter ends up in a mining camp working as a prostitute, well, that’s unfortunate, but incidental to the creditor.’

By quantifying debt, morality took a back seat to matters of impersonal arithmetic. But do we really want a society in which we would consign an individual to prostitution, or a nation to unemployment and misery, simply because they were unable to pay their debt?

The notion that debt must be repaid is a deeply entrenched one, but it is a value statement, and has no basis in economics. If debt must be repaid then any drunken gambler could go into a bank and get a loan. If debt must be repaid then there is no risk to the bank. Clearly this is a system that would not work, at least not without banks resorting to demanding, like Shakespeare’s Shylock, a pound of flesh in lieu of payment. There must be an element of risk associated with lending. This is the justification for charging interest on loans. It is also sound macroeconomics to allow debt default. It makes potential entrepreneurs more willing to take loans to start businesses, and it increases aggregate demand by allowing indebted individuals to once again become consumers. The same applies to indebted nations. Without German debt relief and the debt-free money that came from the US with the Marshall Plan, Europe would never have rebuilt so successfully after world war two. It quickly became a market for American goods, as well as re-establishing itself as a producer. The idea that debt must be repaid, is clearly one that has come from creditors, and is an example of Marxist/Gramscian contention that the ruling material class is always the ruling intellectual class too, maintaining control over what is considered ‘common sense’.

When modern money did emerge, it was created by war-mongering statesmen who found it difficult to feed large standing armies. It made sense to pay them coins, and then demand these coins back from the rest of society as taxation. This way, the whole community was incentivised to offer the military what they needed and wanted. The entire economy became, as Graeber puts it, ‘a vast machine for the provisioning of soldiers’. Money and markets were created by states. They did not emerge independently. This has profound implications for the way we look at money today. Our conventional wisdom is backwards. States did not always require tax revenues to spend on goods and services. Rather, spending money into existence came first, followed by the demand for tax. States which create all the money in circulation can self-evidently never run out of money. Yet the notion that the UK was close to running out of money has just decided an election. How did we get here?

It began in the seventeenth century. While the minting of coins had for centuries been a royal monopoly, private banks began to emerge offering safekeeping. Any coins deposited were acknowledged with a note promising to pay out the equivalent sum. After a while these promissory notes began to themselves circulate as currency, as people became to have confidence that they were to all intents and purposes the same as having the coins themselves. When it became clear that this was happening, the banks saw an opportunity for profit. They realised they could issue their promissory notes as interest-bearing loans, in excess of the amount of coins their customers had deposited. There would never be a time when everyone wished to withdraw their coins at once, so the bank had no qualms about not having 100% reserves. This fractional-reserve banking system was the beginning of the privatisation of the money supply: states no longer had control over how much money was in circulation. By lending money that they did not have in reserve, the banks were creating money. As opposed to money created by the state, however, this money was created as interest-bearing debt. For every pound of money the banks lent, they demanded more than a pound be paid back to them (usually a great deal more, thanks to compound interest). The result was that there could never be enough money in circulation to repay all of the debt, because the newly created money always came with its own newly created debt. The artificial scarcity of money had begun.

In 1844 the government of the day enacted the Bank Charter Act, which outlawed the issuance of bank notes by the private sector. Unfortunately, the Act was fundamentally flawed. By limiting its scope to paper notes, it allowed private banks to continue to issue other substitutes for money, such as bank deposits, which were simply accounting entries on the liabilities side of the banks’ balance sheets. Cheques were used to make payments without the use of cash, eventually followed by debit cards and online banking.

Today, the digital age has created an unsustainable situation, akin to that which existed before 1844 when the private-sector issuance of paper notes took control of the money supply away from the government. According to Jackson and Dyson’s Modernising Money, between 1970 and 2012 banks increased the money supply from £25 billion to £2,050 billion – an 82 fold increase. Now, a mere 3% of money in the economy is created by the state in notes and coins. The other 97% are bank deposits: liabilities on banks’ balance sheets; electronic money created as interest-bearing debt by bank lending. The significance of this development cannot be overstated. ‘When banks make new loans at a slower rate that the rate at which their old loans are repaid,’ write Jackson and Dyson, ‘the money supply starts to shrink. This restriction in the money supply causes the economy to slow down, leading to job losses, bankruptcies and defaults on debt, which lead to further losses for the banks. Banks then react by restricting their lending even further.’ Money becomes increasingly scarce in relation to debt. At any given time, the amount of money owed far exceeds the amount of money already existing.

Once the means of exchange is scarce, everything is perceived to be scarce: housing, clothing, food. Even if there is an abundance of a particular commodity, if the means of exchange is scarce then we face a challenge to acquire it. In conditions of scarcity, selfishness is a natural reaction. Clearly, not everybody can be debt-free. If everyone repaid their debts there would be no money left in circulation. For every pound in your pocket, someone else has more than a pound of debt. By its very nature, the economy must have more debtors than creditors. It must have more poor than rich; more losers than winners. Yet we tend to blame the poor for their poverty rather than look for structural explanations. We lavish the rich with praise: these ‘wealth creators’ are the victors in our great economic competition. We scapegoat immigrants because if money is scarce, then new arrivals must constitute a threat to our share. Creating 97% of money as interest-bearing debt has created a systemic imperative towards competition and division. Compare this to the pre-money credit economies in which people relied on their communities to provide for them. Kindness, rather than selfishness, was built into the system.

By privatising the money supply and making money artificially scarce, the government has allowed a situation to develop in which it can be one of the losers. It can have far more debt than it has existing money. But is this a bad thing? The debt in the economy has to be somewhere. If the government ran a budget surplus – if it took more money from the public each year than it spent back into the economy – then the money supply would shrink further. The only way to increase it would be for private banks to lend more money into existence as interest-bearing debt. If banks do not increase lending, and the money supply continues to shrink, then the economy is likely to enter a deflationary spiral as less and less money chases the same amount of goods and services. A government budget surplus will therefore either increase private debt, or lower inflation. At the moment, neither alternative is palatable for the UK, meaning the government must run a deficit. A deficit does not necessarily mean that national debt is increasing. Well, that’s not quite true. It would increase in absolute terms, but what is important is the debt-to-GDP ratio. The government ensuring that it taking less money out of the economy that it is spending back into it makes growth more likely, which is the surest way to decrease debt relative to GDP.

It is regrettable that very few people seem to understand this. The Conservatives have carefully cultivated a narrative about government finances being akin to household finances, when they are anything but. Framing the issue in this way serves their ideology: they want to reduce the size of the state in favour of handing over power to markets. By convincing the public that the government is wasteful, they can reduce its impact without opposition. However, their ideology is born of ignorance. They believe that free markets emerged naturally, independent of government, always tend towards equilibrium, and that the state gets in the way of this process. However, as Graeber makes clear, markets were created by states for the provisioning of soldiers. They are not a natural phenomena, but are socially constructed, like money and debt.

Like anything that has been socially constructed, money, markets and debt, and our perceptions of them can all be de-constructed, and reconstructed in a manner more conducive to a happy and prosperous society. The Positive Money campaign aims to renationalise the money supply. This would ensure that money is no longer created as interest-bearing debt, ending the artificial scarcity of money, and promoting more socially-useful investment. Proposals involving negative interest rates – allowing interest-rates to go below the perceived lower bound of zero and introducing a decaying currency – could move us closer to the type of credit economy which was widespread before the introduction of coinage, and which incentivised kindness and reciprocity. Embracing such ideas, or at the very least rejecting some of the current dangerous narratives surrounding money and debt, could move us towards a new era of prosperity. The alternative is the increasing regularity of debt crises like the one which has inflicted so much misery upon Greece.

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2 thoughts on “The nature of money and debt

  1. The basic problem with the Greek situation is that the rest of Europe are the “bankers” and each individual is subsidising the Greek economy – or lack thereof. And what happens when other nations see that Greece has defaulted and got away with it? Do they join that club, thus forcing a rise in taxes in economically balanced countries.

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