3 thoughts on “The Problem With Money

  1. That’s all very well …unless you are an engineer and know that perpetual motion machines do not exist!
    The fact is that banks are just businesses. They make a profit and use that profit to buy goods and services, pay salaries and dividends and pay taxes. The idea that banks simply stash money in some ‘black hole’ is actually nonsense. Why would they?

    As the film rightly says, money is a tool which needs to be invested to make more stuff work. There already is a negative interest rate – and that is the difference between the returns that you can make by leaving your money in the bank and the returns you can make by investing your money in just about anything else.

    I do not agree that debt is necessarily a bad thing. If it is invested to grow businesses which create more fundamental wealth (e.g. by turning raw materials into useful things), then debt is an excellent idea. It allows people to escape poverty and maximise opportunity. Without it, the only people who could invest and grow businesses would be those who already have money stashed away somewhere. Indeed, the provision of debt does exactly the opposite of what the film suggests – it promotes the flow of money and investment in the economy. Oh, and by the way, banks do not create money out of thin air, they can only lend against their balance sheets, which are supported by deposits. In other words, they facilitate rich people lending money to those who wish to invest in the economy. If you think about that – it is an excellent way of re-distributing wealth. Consider Mr Fat-cat who lends £100 to Mr Wide-boy so he can invest in his business. In year 1 Wide-boy has turned the £100 into £110 (or more if he is any good). He gives Fat-cat £1 in interest (or perhaps even £2 if Fat-cat has a particularly good deal). That leaves Wide-boy with £108. By the end of year 10 Wide-boy has £227.50 in the bank (assuming he re-invests his profits and continues to grow the business). He can repay Fat-cat and still have lots left over to continue to invest – or perhaps lend to Miss Penniless to do the same with again.

    In my view, what actually caused the problems in the economy was the inflation of property prices. This really did create money out of thin air – and where you create money at a faster rate than creating value, then you have a perpetual motion machine which we engineers know won’t work.

    • Simon,

      The facts don’t support your view in several respects.

      Firstly, there is about £2,245bn of money in the UK economy (M4).
      Annual investment in the productive economy (the provision of goods and services) is c.£180bn, which represents about 8% of M4.
      The rest of the money is held as a financial asset. Some of it is exchanged for other financial assets (shares, bonds, etc.), but these exchanges contribute nothing to the productive economy (apart from a small amount trickling through as the overheads of the companies that make the exchanges). No wealth, as defined by you, is created.

      Another way of looking at it…

      UK GDP is about £1,500bn per annum, but money is typically spent in daily, weekly, and monthly cycles. Let’s be conservative and go with a monthly cycle. GDP equates to around £125bn/month or c.5.6% of M4.

      Whichever way you look at it the vast majority of our money spends most of the time sitting in bank accounts doing nothing useful, contributing nothing to the productive economy.

      Your assertion that banks don’t create money out of this air is also wrong. As this bulletin from the Bank of England makes clear, when banks issue loans they simultaneously create bank deposits, which are money: http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf. Around 97% of M4 are bank deposits: money created as loans.

      Also, the ability of banks to issue loans is not restricted by customers’ deposits but by its reserves at the central bank. These reserves are routinely increased by the Bank of England to account for additional loans that have been issued by banks in excess of what can be cleared between banks and by existing reserves. So the quantity of loans determines the quantity of reserves rather than the other way around.

      Your example of Mr Fat-cat, Mr Wide-boy and Miss Penniless falls down because, in reality, profits are generally not lent out. They are stored as financial assets. Mr Fat-cat stores his £100 as a financial asset in the bank. The bank creates new money for Mr Wide-boy’s loan. He captures money from his business activity and uses it to pay back the principal and interest, and then stores his profits as a financial asset.

      So Wide-boy has removed the £100 that the bank created (it is destroyed on repayment), and he has removed the interest (the majority of which is profit for the bank, which it stores as a financial asset) as well as removing his profit. All of that money has disappeared from circulation. Where does the money come from to replace what’s been removed from circulation? It’s created when Miss Peniless pays for her shopping with her credit card.

      The problem with money is that we insist on using it as a proxy for wealth. Everyone wants to have more money in the bank, which is in direct conflict with the creation of money as profit-generating (i.e. interest-bearing) debt. We can only become money-richer, in aggregate, by becoming more indebted, in aggregate.

      What’s being proposed in the film is not a perpetual motion machine. It’s a system where tools (units of currency) are being passed from hand to hand to facilitate useful activity.

      Malcolm

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