Let’s Get Real about Money

by Lindy Davies

There has been a persistent chorus in Georgist circles about the vital importance of money in political economy and social reform. This concern isn’t new, of course — many traditions condemn usury and seek to reign in financial excess in various forms. Lately, also, it makes sense that these issues would be on our minds: we’ve just had a global economic crisis, during which a number of “too big to fail” banks had to be bailed out in order to avoid another great depression! That gambit seemed to work, sort of: the economy has rebounded, more or less. Working people have held onto meager jobs, while the 1% has raked in bigger and bigger shares of the wealth. We’re told that the banks’ control over money — the indispensable economic lubricant, the thing we get in our pay envelopes — is every bit as important as the land monopoly, and that our movement risks irrelevance if it fails to address “the money question.”

The reasons why this is dangerously untrue are complex — but worth unpacking.

Most of us were introduced to political economy by learning the definitions of the three mutually-exclusive factors of production: land, labor and capital. The logic of these definitions leads us to identify land as the limiting factor. It is needed for all production, and not produced by human labor — and therefore the control of wealth distribution in society rests with, and depends upon, the control of land. The ramifications of this are endlessly complex — but the basic analysis really is that simple. The fundamental principles of Georgist analysis are as true now as they ever were, and the thing that makes them more relevant today is the extreme degree of mystification and obfuscation that surrounds economic discussions. But you don’t need a weatherman to know which way the wind blows.*

* Bob Dylan, “Subterranean Homesick Blues”

* Bob Dylan, “Subterranean Homesick Blues”

It’s one thing to say that there are problems with the Finance, Insurance and Real Estate (FIRE) sector of the economy, and that banks have much to answer for, particularly in the wake of the Great Crash of 2008. Banks consolidate; they hedge against risk in ever-more lucrative ways until they wield all-but irresistible political pressure. Banks enjoy subsidized risk, from which they derive unearned profits. They utilize derivatives to wring profits out of transactions that yield little or no benefit to the real economy — so, yes, it’s one thing to say that banking reforms are needed. But it’s quite another thing to say that “the money question” is just as fundamental as the land question. If the banking system were cleansed of all subsidies and rent-taking, if banking unfailingly maintained prudent and fair practices, would the problem of poverty be solved? Or, would our economy, as it benefited from an efficient financial system, simply proceed to generate higher rents?

Specious Claims about Money

It is vehemently proclaimed that we are compelled, in the current corrupt system, to rent our money from the banks. The assertion is that since the vast majority of money is created by being loaned into circulation at interest, any new money which would be used to pay the interest would have to, itself, be loaned into existence at interest. This seems to create two very bad results: 1) that the debt can never be fully paid, and 2) that because it places us ever more deeply in debt, our monetary system addicts us to reckless and unsustainable growth.

If this were true, it would be very bad. But, it is not true. It is a fallacy based on a misunderstanding of how money works.

It is true that most money is loaned into existence by banks. The amount of currency that is printed or minted by the government is a very small percentage of the actual supply of money.* However, it is important to realize that we do not owe interest on money we receive in exchange. We only owe interest on money we borrow. We do not “rent from banks” the money we receive in wages; we receive that money in exchange for labor performed.

Indeed, more US currency circulates outside of the country than inside it; ten nations, including Ecuador and El Salvador, have adopted the US dollar as legal tender, and it serves as an informal medium of exchange in many others.

Indeed, more US currency circulates outside of the country than inside it; ten
nations, including Ecuador and El Salvador, have adopted the US dollar as legal
tender, and it serves as an informal medium of exchange in many others.

Money is borrowed because people are willing to pay to have money now, rather than later. Loans may be short- or long-term, but in every case, some significant interval of time passes between the loan and the repayment. If it didn’t, there would be no point in borrowing money. This means that when money is loaned, the money supply includes that amount of money, plus all of the money that was already in circulation. When a loan is repaid, the money supply includes all the money currently in circulation, minus that amount of that repayment. Money is created when it is loaned and destroyed when loans are repaid.

Because money circulates before it has to be repaid, we can say with certainty that, at any given point in time, there is enough money to pay the principal and interest of all the loans that are due at that time. Some borrowers do default, of course, but most don’t, and lenders carefully evaluate the creditworthiness of borrowers. (Higher-risk lenders, such as credit card companies, payday loan firms or loan sharks, charge higher rates of interest.) Therefore, we know that our monetary system per se doesn’t addict us to crazy growth. What addicts society to crazy growth, actually, is poverty. If we can keep making the pie bigger at all costs, then the rich can keep what they have, while the middle class slowly grows, and the truly discontented remain powerless.

The Greenback Position

grnbkThe original Greenbacks were the United States Notes that were issued as legal tender by the Lincoln administration during the Civil War. The idea that the government should simply spend money into existence when it was needed — rather than coining it out of precious metals or borrowing it at interest — became a popular one. It grew into a political party which, under various names, was active in the United States during the 1870s and 1880s. Henry George was familiar with the Greenback Party, and he supported it in the debate against the silver interests, for whom the right to coin silver into legal tender was a tremendous state-given windfall. Nevertheless, “I am a Greenbacker,” George wrote, “but not a fool.” George never believed that monetary reform was the key to solving basic economic problems.*

* Did Henry George believe that banks should not be allowed to loan money into existence? Stephen Zarlenga, in a 2001 paper commissioned by the Robert Schalkenbach Foundation, argued that where George’s views on money were correct, they agreed with his own. Zarlenga held that by voicing his support for the Greenback movement, Henry George affirmed the “sovereign money” position. However, the two ideas are not identical. The basic Greenback position is that money need not be backed by any commodity, that it can be created by government fiat, and will serve entirely adequately as money, as long as its supply is carefully controlled. The notion that banks must maintain 100% reserves is an addition to the greenback idea. The basic process of fractional reserve banking was commonplace in Henry George’s day (indeed it had been practiced for hundreds of years before) and George had to have been aware of this fact. Zarlenga and other “sovereign money” advocates contend that money creation via private bank loans is a monopoly. Henry George was vehemently against all forms of private monopoly, and he was not bashful about stating his views; had he agreed with this characterization of the banking system, he certainly would have said so. What George did say was that he believed it was the government’s job to issue money. He recalled the days when “wildcat banks” had issued banknotes of their own which circulated as money, a practice that created great corruption and confusion. The government, he reasoned, should decide what is legal tender, and issue it in the form of notes. But the money that banks place in the accounts of borrowers is not privately issued; it is legal tender, and if the borrower wanted to get the amount of the loan in $100 bills, she could do so without restriction. Issuing money and loaning it are two different things — and George repeatedly said that “the making and exchange of credits” is a proper thing for private firms to do.

* Did Henry George believe that banks should not be allowed to loan money into existence? Stephen Zarlenga, in a 2001 paper commissioned by the Robert Schalkenbach Foundation, argued that where George’s views on money were correct, they agreed with his own. Zarlenga held that by voicing his support for the Greenback movement, Henry George affirmed the “sovereign money” position. However, the two ideas are not identical. The basic Greenback position is that money need not be backed by any commodity, that it can be created by government fiat, and will serve entirely adequately as money, as long as its supply is carefully controlled. The notion that banks must maintain 100% reserves is an addition to the greenback idea. The basic process of fractional reserve banking was commonplace in Henry George’s day
(indeed it had been practiced for hundreds of years before) and George had to have been aware of this fact. Zarlenga and other “sovereign money” advocates contend that money creation via private bank loans is a monopoly. Henry George was vehemently against all forms of private monopoly, and he was not bashful about stating his views; had he agreed with this characterization of the banking system, he certainly would have said so. What George did say was that he believed it was the government’s job to issue money. He recalled the days when “wildcat banks” had issued banknotes of their own which circulated as money, a practice that created great corruption and confusion. The government, he reasoned, should decide what is legal tender, and issue it in the form of notes. But the money that banks place in the accounts of borrowers is not privately issued; it is legal tender, and if the borrower wanted to get the amount of the loan in $100 bills, she could do so without restriction. Issuing money and loaning it are two different things — and George repeatedly said that “the making and exchange of credits” is a proper thing for private firms to do.

Today’s “sovereign money” advocates, such as Stephen Zarlenga’s American Monetary Institute, or the Positive Money group in Great Britain, believe that all money should be spent into existence by the government; that banks should never be able to lend more money than they have on deposit. Zarlenga believes that the federal monetary authority should have direct control over the money supply and that banks should only handle money that already exists. Under this plan, new money would be spent into existence by the federal government, to buy needed infrastructure and pay for public services.

It doesn’t take great sophistication to see the flaws in this plan. As things are currently done, the money supply is determined by the millions of individual transactions that make up the “invisible hand” of the market. “Sovereign money” advocates think that the central government can somehow amass and sensibly analyze — in real time — all the information needed to decide how much money should circulate. But it simply cannot. Henry George recognized this, writing that to run a planned economy would be like trying to give one’s digestive tract step-by-step instructions on how to process food. Stephen Zarlenga dismisses people who raise this objection as simply joining an unthinking “drumbeat against government.” Nevertheless, it’s hard to envision this system working efficiently in practice. If there weren’t a real need for market-based dynamism in the supply of money, then we could simply apply a gold standard (or a brick, or a market-basket standard, whatever) and be done with it. All in all, when you consider the immense complexity of its influences, you have to admit that our current monetary system works pretty well.

Except When It Doesn’t

As we all know, economic downturns periodically happen, and when they do, money suddenly becomes scarce. Sometimes, a recession can be triggered as a response to uncomfortably high inflation — as with the
“Reagan recession” of the early 1980s, when interest rates were steeply hiked to thwart a worrisome, double-digit inflation rate.* Inflation is, essentially, a glut of money: as the supply of money increases relative to the supply of goods, its value falls.

* This was done during the Reagan administration under Fed Chair Paul Volcker. The sudden increase in interest rates caused a drastic increase in interest costs to developing nations around the world, which caused great suffering. Many credit the “conservative lion” Reagan with standing tall and ending the Cold War with the Soviets. But if Reagan can be said to be responsible for ending the Cold War, a similar line of reasoning holds him equally responsible for causing the Third-World Debt Crisis — which was, arguably, Reagan’s greatest achievement.

* This was done during the Reagan administration under Fed Chair Paul Volcker. The sudden increase in interest rates caused a drastic increase in interest costs to developing nations around the world, which caused great suffering. Many credit the “conservative lion” Reagan with standing tall and ending the Cold War with the
Soviets. But if Reagan can be said to be responsible for ending the Cold War, a similar line of reasoning holds him equally responsible for causing the Third-World Debt Crisis — which was, arguably, Reagan’s greatest achievement.

We should realize that inflation is not a matter of the government simply printing too much money. If it were, inflation could easily be stopped before it got out of hand. What happens in practice is this: when more money is loaned out during a given period than is repaid, there is inflation. When more borrowed money is repaid (or defaulted) during a given period than is loaned out, there is deflation. (The velocity of money is also part of the picture; faster turnover effectively means more money at any given moment, but the velocity of money tends to move in the same direction as inflation or deflation.) A small amount of inflation is generally thought to be a good thing, because it encourages people to spend money, thus increasing demand for goods and services and helping the economy to grow. If there is deflation, money is increasing in value, which creates an incentive for people to hold money rather than spend it. Problems only come when inflation gets higher than the happy 2-3% rate at which the Fed likes to keep it.

Textbook discussions tend to say that excessive inflation occurs when the supply of money is increased, usually due to a government policy, without any corresponding increase in economic output. This can create a vicious cycle in which people want to spend money ever-more quickly, and thus sellers raise prices ever-higher. Traditional examples of hyperinflation, such as in Weimar Germany, Post-Soviet Russia and modern Zimbabwe, have stemmed from breakdowns of effective governance.

If, however, we recognize the root cause of excessive inflation in the tendency to create more money which is then not spent on goods and services, then we have to recognize that this trend is built into the very structure of our economy. Money that is paid for land is not paid for goods and services; land is not a product of labor. As a greater portion of the aggregate supply of money goes toward land (which it always does in a growing economy), less is available for the purchase of goods and services. Then, only one of two things can happen: either demand for goods and services must fall, or the supply of money must increase.

The Financialization of Land Rent

One reason why this issue gets so confusing — becomes such a looking-glass for Georgists to fall through — is that land and money are intimately entwined. Most land is purchased with borrowed money, and the land being purchased is the collateral for those loans. Add to this the inescapable fact that land tends to increase in value whenever times are good (and over the long term in any case). Thus we have an ever-growing portion of new loans going to purchase a non-productive asset, whose speculative price serves as the collateral for those loans! Under such conditions, the banking system is inherently unstable: inflationary until the bottom falls out. It also means that the main reason for this systemic problem is not the creation of money by private banks; it is the private ownership of land.

Mason Gaffney, among others, extols the “English banking school position,” a.k.a. the “Real Bills Doctrine” of banking. Their thinking is that land should never be used as collateral; instead, loans should be backed by self-liquidating assets such as inventory or accounts receivable. This policy facilitates the kind of economy-feeding credit that everyone worries will dry up in a recession. As more money gets sucked into the vortex of speculative real estate loans, less is available for these everyday loans that keep businesses running smoothly. Of course, there would be no better way to remove land value as an unhealthy collateral base than to keep it out of private hands in the first place, by collecting it for public revenue.

What About Public Banking?

Another prominent group of monetary reformers allow that, while perhaps the creation of money via a multiplicity of market transactions is a worthwhile process that confers benefits, these benefits should accrue to the community, rather than to private companies. They reason that since banks create money out of thin air, the interest they charge for access to this money is unearned, a form of monopoly income.*

* “Seigniorage” is the term for the income derived from the privilege of issuing money. It is the difference between the face value of the currency and the cost of producing it. Seigniorage is not the same thing as interest, which is the charge for making liquidity available at the time it is desired. Banks do not get seigniorage on the money they create with loans, because that money is destroyed when the loans are paid back.

* “Seigniorage” is the term for the income derived from the privilege of issuing money. It is the difference between the face value of the currency and the cost of producing it. Seigniorage is not the same thing as interest, which is the charge for making liquidity available at the time it is desired. Banks do not get seigniorage on the money they create with loans, because that money is destroyed when the loans are paid back.

This position sounds like something Henry George would approve of, for he held that natural monopolies — enterprises that in their nature do not permit competition — should be run by the community. Roads are generally recognized as natural monopolies, as are various utilities such as the electric power grid. Land ownership is a monopoly, because each site is unique, and the rights that attach to it are codified in law and secured by the state.

Is money creation a monopoly? If we think clearly about the basic nature of money and banking, I think we must admit that it is not. Banks provide liquidity — access to money when most desired — and they compete to do it. If banks collude to thwart competition, by cartelization, or securing subsidized risk, they gain monopoly rents from those practices. But such things are not in the basic nature of banking. In fact, it can be argued that such privileges amount to interventions in the free market that tend to make banking less efficient and serve consumers less well. If that is the case, then banking is a competitive business — which should be left to the free market.

The most basic form of subsidy for banks is federal deposit insurance — which was put into place after the Great Depression, when financial volatility wiped out the saving of millions of people. But, as we have seen, the underlying cause of that volatility is not the nature of banking, but the fact that the financial system was allowed, even encouraged, to collateralize things that never should have been private property in the first place.*

A Theory on Why this Debate Persists

* When slavery was legal in the United States, slaves were often used as collateral for loans. “Financialization” of their human property gave wealthy slaveowners considerably greater access to capital than they would have otherwise had. See “Slavery’s Invisible Engine: Mortgaging Human Property” by Bonnie Martin in The Journal of Southern History, November 2010.

* When slavery was legal in the United States, slaves were often used as collateral for loans. “Financialization” of their human property gave wealthy slaveowners considerably greater access to capital than they would have otherwise had. See “Slavery’s Invisible Engine: Mortgaging Human Property” by Bonnie Martin in The Journal of Southern History, November 2010.

It could be that this issue is less theoretical (something that seeks to describe reality, and is disprovable) than it is ideological (something that expresses a political agenda and seeks to move society in a particular direction). Karl Marx referred to the Single Tax as “capitalism’s last gasp.” If it is truly possible to address the problem of poverty by means of a public revenue policy, then it is actually possible for a market economy to be sustainable. This simply does not square with Marxist thinking, in which the capitalist economy must only be a rung on the dialectical ladder. Dr. Michael Hudson has been telling us for years that in a modern economy, “rent is for paying interest” — in other words, that over time, the banking sector seizes control of the economy and the land issue declines in importance. (This doesn’t completely jibe with the fact that Hudson continues to advocate the public collection of land rents — but then again, Marx and Engels did that, too, in the Communist Manifesto.) If the basic problem includes not just the institution of private property in land, but also the entire banking and credit system, then we aren’t left with much of a basis for a market economy. Zarlenga and the Positive Money folks do, after all, advocate a planned economy in terms of the money supply.

The “orthodox” Georgist position, on the other hand, maintains that the private collection of land rent is “the robber that takes all that is left,” and that solving the land problem, via the Georgist remedy, would facilitate other needed reforms — the financial, environmental and political measures needed to make a democratic, market economy work.

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