Not everyone knows how money in national currencies like Dollars, Pounds and Euros is created. The surprising truth is that money is simply debt created by banks. When you take out a mortgage, you don’t receive funds from someone else’s savings that the bank is holding. The bank creates new money literally out of thin air which enters the economy and gives you a nice fat debt which you must repay with interest. This is not just the case for mortgages. It’s actually how 97% of the money in national currencies was created. That means almost all of the money that people are using to do business, and that you earn in your job. The work you do and the products you buy in the shops are real, but the money we all rely on is based on nothing but a promise that other people will accept it as payment.
This type of money is not all bad. It was the means of exchange that powered the industrial revolution. It made possible the huge capital investments and trading that created our railways, factories, modern medicines and other innovations right up to the modern day with venture capital backed companies like Google. The industrial revolution lifted billions of people out of poverty and created a higher standard of living for ordinary people than at any other point in history.
However, there are some very undesirable consequences. When new money is created by way of debt, the interest that has to be paid back does not get created at the same time. So it has to be found elsewhere by the borrower. But of course almost all of the rest of the money in circulation is also debt, so there is simply not enough money to pay it all back. This means that scarcity is built into the system since at any one time there is not enough money to pay back all of the debts. Bankruptcies are therefore inevitable, not just an outcome of poor money management. The end result is that the economy can only keep going by continually creating ever more debt.
Because money is scarce, banks provide loans more readily to industries that are doing well who can afford the interest than to those in tougher times who are more likely to default. This means that money flows towards places where it’s not especially needed, whilst places where money is needed are starved. This fuels the continual boom and cycles of the economy that we have seen over many decades. The problem is not simply cyclical, it’s systemic due to how money is created. This is why we are unable to break out of the cycle in spite of the best efforts of governments.
Since we have to continually create new money in order to service old debt, the system creates a need for perpetual growth of the economy. This is why all major political parties have growth, growth, growth as their top economic priority. But as we know, on a finite planet it’s simply not possible to exponentially grow consumption forever. If the economy doesn’t grow, or we stay in recession then debt cannot be repaid and we face the prospect of large scale economic collapse. This is what happened in 2008 when the real estate bubble burst. How did we solve the problem? Central banks created even more debt by printing new money (quantitative easing) and governments bailed out the collapsed institutions, transferring debt to ordinary people which they will repay over many years to come. The problem with this fix is obvious. The systemic problem hasn’t been addressed. We got the economy moving again by creating more debt, but unless we have sustained growth for ever, we face the prospect of even larger collapse in the future.
Insanity is doing the same thing over and over again and expecting different results. – Albert Einstein
There’a another problem with money to add into the mix. Over time wealth is transferred from ordinary people (who have to borrow money) towards the already rich. This is why we see ever increasing income inequality in advanced economies like the US.
In the town [Washington DC] that launched the War on Poverty 48 years ago, the poor are getting poorer despite the government’s help. And the rich are getting richer because of it.
Socially minded governments attempt to redistribute wealth through taxation and other programmes, but this does not address the fundamental systemic problems with the type of money upon which we rely. For as long as money is created by debt, we will see problems of increasing inequality.
Due to the scarcity and poor distribution of money, it is often simply not available as a means of exchange where it is needed. In many countries, including rich ones, there is high unemployment which leads to poverty. At the same time there is an abundance of capacity to produce food, plenty of work within the society that needs to be done, and people who are willing and able to do it. The problem as we all know is a lack of money to pay people to do the work. We accept this as fact, but stop and think for a moment. Money is created out of nothing. With so many unemployed and in poverty, clearly money is broken.
So what in the flipping heck can we do about this?
The only viable solution is to stop looking for answers only within the current monetary paradigm. If a system – like the monetary system – has fundamental flaws, you can’t fix it by adjusting its levers. The system has to be changed.
Whilst much better systems have been proposed, a huge overhaul of the banking and monetary system would likely be practically impossible to implement. There are too many vested interests in the status quo; it would be politically too risky; and with such huge changes to a vital global system, it’s impossible for even the top experts to anticipate the secondary and tertiary effects of such large changes.
But there is another option. And that is to create complementary currencies which exist alongside national currencies. Here are three examples:
1. A global currency, The Terra, backed by a basket of commodities so that money has tangible value connected to physical goods rather than being created out of nothing. This is a bit like the Gold Standard, but balanced between a range of commodities to prevent shocks which may affect just one individual commodity.
2. Time Banking, where man hours are used as a form of currency. For example, you could use some of your free time to mow somebody’s lawn, walk their dog or provide care to an older person and then ‘spend’ the hours that you accumulate on things that you might like to do such as taking driving lessons. Interestingly, in Bali, there are well established local currencies based on time which allow very poor societies to enjoy a much higher standard of living than they would otherwise, through cooperation rather than competition. Time Banking allows exchange between people without requiring access to traditional money.
3. Complementary currencies like the hugely successful Swiss Wir (‘veer’) allow businesses to trade with one another without needing access to credit lines from banks. Within their system, buyers and sellers simply go into credit and debit when they buy and sell, but no traditional money has to change hands (unless the parties agree to settle partly in Wir and Francs.) Therefore it’s not subject to credit lines being removed by banks, it is not subject to bank interest, and it reduces the risks associated with shocks to the financial system.
These ideas, none of which are new, are systemic fixes to the problems with our broken money systems. We need policy makers and private companies to ramp up the use of complementary currencies before we suffer further huge economic collapse.
If you’d like to read more about this, check out the book New Money for a New World where most of the ideas in the post came from.
Tom Nixon 
What a fascinating article. I wonder how many people actually know how the monetary system works – I certainly didn’t. What a strange and tangled mess we’ve got ourselves in! Thanks for the enlightenment Tom!
Cheers Tim! I completely agree it’s a mess for sure, and it’s amazing that you don’t hear the Obama’s, Osbourne’s and Milibands of this world talking about it. Heads buried in the sand. But there’s an exciting better future ahead if we create complementary currencies, and it’s very doable too.
I suspect the reason those people don’t talk about it is because (like any other risky, radical or controversial subject) it would take longer than a 4 year term of office to fix – so there’s no incentive to even try. Re-election is always the highest priority. And right there is a whole other can of worms!
Very clearly written Tom (and nice point Tim)
I especially like your points about the difficult of introducing change into the system.
I think complementary currencies are very interesting (eg The Lewes Pound). But I think there must also be other leverage points for the system. (See Donella Meadows book “Thinking in Systems” for a bestiary of systems and a simple intro into “leverage points”).
Some creativity is required.
best
Pete
Thanks for this Pete, I’m sure there are other leverage points as well which need to be uncovered and explored. Funnily enough I had been meaning to tap you up for a recommendation on a good systems book so I will definitely read the one you suggest.
Tom Nixon: When new money is created by way of debt, the interest that has to be paid back does not get created at the same time. So it has to be found elsewhere by the borrower. But of course almost all of the rest of the money in circulation is also debt, so there is simply not enough money to pay it all back. This means that scarcity is built into the system since at any one time there is not enough money to pay back all of the debts. Bankruptcies are therefore inevitable, not just an outcome of poor money management. The end result is that the economy can only keep going by continually creating ever more debt.
Jct: And my claim to the last Nobel Prize in Economics is for putting this game theoretical problem as an equation! When everyone borrows Principal P and everyone owes P+Interest, with only P money and P+I debt, P/(P+I) survive their mort-gage death-gamble and the remainder I/(P+I) get knocked into foreclosure so the survivors can use his borrowed Principal to pay off their loan Interest. I/(P+I) was dubbed the Miracle Equation by some media and also gives us the confiscation of foreclosure of collateral backing up the chips. So inflation could be more money chasing the goods, Shift A, or same money chasing less goods, Shift B.
http://johnturmel.com/bankmath.htm explains the whole derivation proving your point.
What are your thoughts on BitCoin? I own an auction company and want to help rid the world of usury. While not an expert I feel either doing aucitons with BitCoin as payment and/or creating a LETS system would help. I welcome your thoughts on this. Thank You. Alan Anthony Armstrong, Auctioneer/Entreprneur
Jct: Bitcoin is based on an hour of wasted computer time. LETS timebanking is worth an Hour of neighbor’s promised labor. Which do you think has the better value?
Totally with you here Tom, allowing our financial systems to control and get rich on should be a fair system of exchange of time and effort has been the downfall of this era.
We need a clearer system of exchange which doesn’t allow for parasitical behaviour. Bitcoins seems to be the clear winner when we looked into sustainable community exchange systems a few years ago, but I’ve never heard of some of the others you mentioned, so interested to see how they compare. We’re playing around with ideas for offline personal networks which could work well digital currencies and be a sustainable way to see them being exchanged. Talk more at City Camp!
Daniel Herrera: We need a clearer system of exchange which doesn’t allow for parasitical behaviour. Bitcoins seems to be the clear winner when we looked into sustainable community exchange systems a few years ago, but I’ve never heard of some of the others you mentioned,
Jct: A Bitcoin worth an Hour of time wasted by your computer mining for online gold was never a winner compared to any other token that was worth something of value.
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Hi Tom. What a great read, and I’ve also been fascinated by The Secret of Oz documentary that we talked about when we met (http://www.youtube.com/watch?feature=player_detailpage&v=swkq2E8mswI#t=6537s).
I’m glad that you’re optimistic about change because history certainly doesn’t paint a pretty picture of te attempts that have been made to do this in the past. Maybe we can persuade the queen to do this behind the governments back to reclaim her sovereignty!
It is extraordinary though that the warnings have been written on the wall ever since money was invented. Here’s an Aristotle quote (from the documentary… from 325 BC!):
“Money was intended to be used in exchange, but not to increase at interest. And this term interest, which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent. Wherefore of all modes of getting wealth this is the most unnatural.”
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Good article here Tom, I am surprised no mention of the big financial family’s that also contribute to the rise and fall of the global economy. Global infrastructure is so tight that you can change money from any currency you like and will always end up with the same amount if you take current market rate for that minute. Something does need to change and the idea of time banking seems like a fair way to trade skills.
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