Positive money

A non-profit group called ‘Positive Money’ has created a series of videos describing how money works in the real world. These videos explain how, contrary to the process described in many economic textbooks, most of the money in the economy is created by private banks, and that the central bank is not in control of the money supply. Furthermore they argue that banks are not limited by reserve requirements, and do not need to possess central bank money before they can make loans, nor is the amount of money private banks can create constrained by the total amount of central bank money. The videos are well-executed, and their view is backed up by an impressive roster of people who ought to know, including Mervyn King, former governor of the Bank of England, and various other good-bodies and fair-fellows of the economics profession. This Positive Money group also have a book out, which I have added to the towering virtual stack that is my Amazon wishlist.

Banks have a license to create money

The take away from the videos is that in the real world banks do not lend pre-existing money, but simply create money when they make credit available to their customers. Because the money in your current account is strongly backed by the government through the Financial Services Compensation Scheme, which guarantees all deposits up to £80,000, most of this ‘credit’ created by banks bears as little credit risk as central bank base money, or physical cash money; which is to say, it bears no credit risk. In essence, private banks have a license to create money. This is an important and worthwhile point that needs to be more widely understood (especially by economists, and most especially by those economists who write mainstream economics textbooks).

However I have a few minor quibbles with the arguments presented in the videos. Here follows the first quibble.

Bankers are not the only people in the economy

In this video it is claimed at 0:39 that the shrinkage in the money supply causes the economy to slow down. This is confusing to me because I do not see how the sequence of events would necessarily be from banks choosing to shrink the money supply, to a recession occurring. It seems to me that an equally valid flow of causation would be as follows: consumers choose to spend less, meaning that consumers borrow less, meaning the amount of bank credit/money falls, as people pay down their existing debts. This could happen regardless of what the bankers themselves choose to do. The bankers are not the only agents in the economy, but the videos present a model in which it is the bankers – and only the bankers – that decide what the level of the money supply will be.

This brings me on to my second quibble. In this video it is claimed at 13:20  that “the money supply of the nation depends on the mood-swings of banks and the senior bankers that run them, this is surely an insane way to run and economy”.

It is true that bankers’ moods influence the economy, but it is not clear to me that this is the only problem, precisely because – again – bankers are not the only agents in the economy. As is often the case, the great Daniel Davies says it far more concisely than I can:

Keynes The Master did not fuck up by not including a separate banking industry in his model; the investment decisions and motivations of the bankers in deciding whether or not to provide finance to the rest of the economy are exactly the same as those of industrial capitalists and are equally adequately described by Chapter 15. Bankers make their decisions based on whether loans will succeed or fail, which depends on their assessment of demand in the economy, and the model closes.

So the question is: did the recession begin because banks no longer wanted to lend, or did the recession begin because people no longer wanted to spend? And is our continuing economic weakness a result of unwillingness of bankers to lend, or is it a result of business managers’ unwillingness to invest? These are empirical questions and – as Davies points out – at this level of abstraction it doesn’t really make any difference. Somewhere there is a group of homo-sapiens making decisions about the future, and it doesn’t matter if those homo-sapiens are in a bank credit department or in a company head office.

On Positive Money’s substantive proposals

Positive Money have a bunch of substantive proposals that they outline here. I am not yet in a position to comment on these, but it looks like they might be a stalking horse for green social democracy, of which I am of course entirely in favour; but it seems to me that if you want social democracy, then you might as well do social democracy, instead of footling around with the banking system. I may be completely wrong here, of course.

In summary: contra Positive Money, the problem isn’t that bankers have too much power, but rather that anyone tasked with the business of making investment decisions in an uncertain world will be subject to severe swings in outlook, due to the irreducibly chaotic and non-ergodic nature of the real economic world. This problem runs far deeper than banking, and might run deeper than our particular brand of industrial capitalism itself; it could well be a property of any industrial economy run by agents that resemble human beings.