Today, as I write, the new merged UK banking giant Lloyds has underestimated the loss that is about to be incurred as a result of the merger with HBOS. The banking giant has received a huge bailout selling more shares to the government and is on its way to being yet another private bank doomed to nationalisation.

On the television I hear no mention of why this might be apart from propaganda trying to make the public angry about the CEO’s who have taken too much bonus and ’caused’ all this mess. It is very easy to divert attention away from our unsustainable system by blaming the crisis on greed when you have every newspaper and television show focusing on greed as the cause.

We are in this mess because as mentioned in prior posts we are running our economy on economic theory that does not work. Orthodox economic theory refuses to recognise that almost all of the money in our economy is created as a debt through loans. This is what a banking licence permits you to do. We are in a global financial crisis as our economy thinks that the cause is greed and lack of regulation and the cure is to take on huge fiscal burdens, leading to the nationalisation of banks so we can implement further regulation.

Nobody discusses that our economy is built upon an unsustainable foundation that will inevitably lead to a financial crisis. We do NOT need to nationalise our banks we do need to nationalise our money supply. We are here not because of some conspiracy theory about the banks or excessive greed, we are here because of our philosophy of how we should run our economy and our theory of how we should control the amount of money in our economy.

There is a huge problem with orthodox economic theories – they don’t work in the real world and the global financial crisis is evidence of this. Economists must recognise the significance of the fact that almost all money in our economy has been created through debt, debt that can never be repaid without a complete depression, if we are to get anywhere near a solution and to reach sustainable economics. Economics must question the foundation of theories such as the multiplier and the quantity theory of money and start to look at the facts. This article discusses some of the problems with orthodox economics and how it has contributed to the current global financial crisis and our philosophy of more debt, more bailouts and more bubbles to turn around our economy.

To set the foundation on current thought, as we speak the government is in the midst of decreasing interest rates until we inevitably reach zero (Monetarism in order to stimulate consumer and corporate debt), bailouts and huge stimulus packages (Keynesian fiscal policy in order to increase the national debt) and the new one is quantitative easing (The Bank of England creating money out of thin air to buy government debt). All these policies are aimed at creating more debt, because the reality is – our economy needs more debt to sustain growth and prevent a depression under our current debt based economy – take away the debt and there is nothing because almost all of our money supply is created through debt – no debt, no money. As you all know I am not against debt, I am against mixing up debt with supplying money to our economy – a task that must be nationalised. Money is far too important not to be supplied through the public sector. This system is only justified through orthodox economic theories and our misunderstanding about how to supply money to our economy as discussed below.

Traditional Money Theory

Orthodox economics does not recognise the importance of almost all of the money in our economy being created as a debt to a bank. Under the current system if our economy wants more money, we need to create more debt. More debt means more interest to be repaid. More interest to be repaid means less purchasing power. Less purchasing power means more debt to survive and so on and the cycle continues. These facts need to be incorporated into economic theories of money.

The first thing to recognise in such a debt based system is that money borrowed is not money lent; it is money created. Economists know this, but fail to apply it throughout their discipline. At the heart of the economy is money, and at the heart of modern economies is a misunderstanding about money. This misunderstanding comes from some of the theories outlined below.

The Multiplier

The suggestion that banks create money was once regarded as pure fantasy by both bankers and economists, who insisted that banks merely lend money. However, modern economics textbooks are quite open about the process. The ability of banks to multiply the quantity of money beyond the amount originally deposited with them is given an accepted title – ‘the multiplier effect’.

In conventional theory, the multiplication of money is not seen as being open-ended. Money creation by banks and building societies is not seen as an expanding process in which money created by past loans is perpetually recycled, re-loaned, providing an endless supply of new money, building up into a vast infinitely ballooning total f money and debt. The entire system is supposed to be self-limiting, with controls and restrictions built into it. According to theory, it ought not be possible for an economy to operate on 97% bank-created credit as it is today. According to theory, the money supply ought not to have been able to inflate with no more than 3% contribution from the government. According to theory, such vast multiplication should not have been possible, but the theory does not meet the facts.

Rather than an infinitely expanding balloon, the system of money creation by banks and building societies is supposed to resemble a pyramid. It is sometimes referred to as the ‘pyramid of credit’. At the base of the pyramid is a firm foundation of true money, the coins and notes created by government. Above this is the narrowing pyramid of bank created credit, which, because of the legal restrictions on banking can only reach a certain height.

Chief among these legal restrictions is that known as the ‘liquidity ratio’. This is supposed to set a strict limit to the amount of money that banks can create via loans. For some years, the liquidity ratio was set at 10%. This meant that a bank could only issue loans equivalent to 90% of the money deposited with it at any one time, since it had to retain 10% of its deposits in liquid form, such as cash. The pyramid of credit is built up by stages, at each stage a smaller round of loans leading to a smaller number of new deposits.

At the first stage, only 90% of the original, true money could be loaned, and thus return to the banks as new deposits. Of this new, smaller set of deposits, again only 90% could be loaned, and thus return to the banks as a further set of new deposits. Each round of loans is built on 90% of the previous round, and in the end, after a series of even smaller loans, the final loan is a minute amount, and the pyramid of credit is complete. Once the pyramid of credit is complete, no more money can be created by lending, unless what the books refer to as ‘brand new, true money’ is introduced at the base. In other words, only when the government creates and supplies more coins and notes as debt-free cash can the system start again, building up a further pyramid of loans on the new money.

There is only one trouble with this theory. It doesn’t apply. The liquidity ratio was abandoned in 1981 as part of the deregulation of domestic and international finance. Banks are now legally allowed to lend and re-lend without the restriction of a liquidity ratio. In fact, for years, the banking system had found ways round the liquidity ratio by investing in short-term government securities, (Which are re-deposited in banks once spent and are actively a part of the money creation process) and it had long been functionally meaningless.

The other restriction traditionally supposed to act upon banking is that known as the asset / reserve ratio. It was a requirement on banks to have sufficient sums of their own money as a standby. The purpose was to make sure that the amount of money they possessed as a company – their own capital reserves – was adequate to cover any loans that might default and not be repaid. A reserve / asset ratio of 10% meant that if banks had made loans of £10,000,000, they must have £1,000,000 in their own company reserve. In the UK, a reserve of about 10% has generally been regarded as adequate, and was for many years a legal requirement. However, like the liquidity ratio, the reserve / asset requirement has been abandoned. Today, at the time of this writing, the only legal reserve / asset requirement on banks is that 0.5% of all their assets be logged with the Bank of England in the form of notes and coins. Financially, this is a total irrelevance. As a limitation on banking it is also meaningless, since the Treasury supplies notes and coins to commercial banks to meet the general demand, and this 0.5% simply becomes part of the overall demand for coins and notes!

The reserve / asset ratio has been replaced by the ‘capital adequacy’ ratio. Again, this is a requirement on banks to have sufficient capital of their own, and is set at 10% on international agreement. But there is no requirement that this 10% reserve be held in cash; indeed the bulk of the banks capital is held in the form of investments, especially government bonds. But whenever a bank purchases government bonds or any other investment using money from its capital reserves, the money enters the economy, and then registers as a new deposit. Instead of being a restriction on banking and money creation, the money supply process is actually sustained by such bank purchases from reserves.

Despite the fact that both the liquidity ratio and capital reserve have either been abandoned, or become totally meaningless or counterproductive restrictions, economics textbooks and banking theory still present money creation in the context of these supposed restrictions.

The last thing that is being suggested here is that a restoration of these controls is what is needed. As we speak the government is discussing more regulation as the solution for the global financial crisis. History has shown, there has hardly been a moment in history when the banking system has actually been under control, and this will never work, except to the disadvantage of the majority of the population, the banks themselves and the functioning of the economy. The point about the multiplier theory is that it has allowed economists to believe in and present the current system as one that operates under control, when it empirically does not.

Under this understanding most believe that bank credit only lasts for the duration of the loan, and upon repayment will be cancelled out of existence. This is not what actually happens at all! As any bank manager will confirm, when money is repaid into an overdrawn account, the bank cancels the debt, but the money is not cancelled or destroyed. The money is regarded as being every bit as real as a deposit; it is regarded by the bank as the repayment of money that they have lent. That money is held and accounted as an asset of that bank.

The fact that upon repayment, money that they have created is not destroyed, but is accounted as an asset of the bank, proves beyond dispute that when banks create money and issue it as a debt, they ultimately account that money as their own. The only factor which disguises their indisputable ownership of the money they create is the fact this returning money is usually rapidly re-loaned.

Borrowing in the modern economy almost always outpaces repayments, which is why the money supply escalates. This means that money returning as repayments usually does not accumulate in the banks own account, but is quickly re-loaned, along with more debt.

When borrowing is sluggish, during a recession as we are in today, some banks can be awash with money from past repayments in their own account. This surplus money can be used to boost the banks balance sheet as is badly needed today or can be used by the banks and building societies to make investments, purchasing stocks and bonds available on the world money markets, boosting their company reserves hugely, and placing beyond doubt whose money this is.

The point about repayments is that money is not destroyed, but is withdrawn from circulation. Thus the total of deposits held by the population is decreased. In this sense, a deposit has been destroyed, but not the money. Upon repayment of a loan, money returns to the bank or building society that created it. This money then only re-enters the wider economy if someone else takes out a loan, or if the bank spends the money on an investment. Either way, this money is accounted and treated as the banks own property. Therefore it is true to say that loans are temporary, but the money created by banks is permanent. Once created, it belongs to the banks, constantly returning to their ownership and control, with the repayment of each debt. This is how 97% of all money in our economy is created today and economic theories must recognise this if we are to reach the conclusion that we need to nationalise our money supply not our banks.

Monetarism

As the government does not directly control our money supply and the multiplier effect has ballooned out of control, the Bank of England uses monetary controls indirectly by controlling interest rates and the cost of borrowing. Another element in economic theory relating to banking and the money supply is the use of interest rates. Fluctuating interest rates are used both to influence the rate of bank lending, and as a policy intended to cover almost the entire realm of economic management. As we cannot control our money supply directly we must influence the money supply indirectly through interest rates. The school of thought from which this economic policy derives is the Chicago School, initiated by irving Fisher, and later championed by Milton Friedman. It is the ideology which completely dominates modern economic thought.

The philosophy is to give full rein to the free market, whilst attempting to guide the overall activity of the economy by managing the money supply. This a government does by lowering or raising interest rates through the monetary policy of the central bank. This alternatively encourages and discourages borrowing, thereby speeding up or slowing down the creation of money and the growth of the economy. Low interest rates encourage both industrial investment and consumer borrowing, leading to a growth in the money supply. High interest rates mean that new borrowers are deterred and the growth in the money supply is slowed. The fact that, by this method, people and businesses with outstanding debts can be suddenly hit with huge extra charges on their debts, simply as a management device to deter other borrowers, is an injustice quite lost in the almost religious conviction surrounding this ideology.

Just when the economy is getting going, investment is healthy, jobs are being created and production and prosperity are increasing, the economy is deemed to be overheating , and the great bogey, inflation, appears. And the only way that modern economics can think of to cope with a financial phenomenon over which all economists disagree – inflation – is to stamp on the entire money supply, throwing the entire economy into recession, bringing bankruptcy to millions.

This method of controlling banks, inflation and the money supply certainly works; it works in the way that a sledgehammer works at carving up a roast chicken. An economy dependent upon borrowing to supply money, strapped to a financial system in which both debt and the money supply are logically bound to escalate, is punished for the borrowing it has been forced to undertake. Many past borrowers are rendered bankrupt; homes are repossessed, businesses are ruined and millions are thrown out of work as the company sinks into recession. Until inflation and overheating are no longer deemed to be a danger, borrowing is discouraged and the economy becomes a stagnating sea of human misery. Of course, no sooner has this been done, than the problem is lack of demand, so we must reduce interest rates and wait for the consumer confidence and the positive investment climate to return. The business cycle begins all over again.

There could be no greater admission of the total and utter inadequacy of modern economics to understand and regulate the financial system than through the wholesale entrapment and subsequent crippling of the entire economy. If we think that this is better than controlling the money supply directly by nationalising our money supply then it is no wonder we are in a global financial crisis.

Inflation

Orthodox economics explains inflation as ‘too much money chasing too few goods’. Michael Rowbotham believes Inflation is not caused by too much money; it is caused by too much debt-money. He believes Inflation is entirely due to a lack of permanent stable money stock and our reliance upon bank credit to supply the majority of our money. The backlog of debt constantly feeds through into industrial costs, raising prices and depressing consumer spending power. It is this lack of purchasing power – the gap between prices and income -which Michael believes is the driving force behind inflation. His theory seems to be the most consistent with the real world facts too.

Inflation is nothing but the upwards drift of prices and wages in an economy where industry is desperately trying to recoup outlay and cover all the financial costs of production, whilst the consumer is desperately trying to bridge the gap between their income and the price of goods. Inflation is the result of the two sides of the economy – consumers and producers, wages and prices – being set at odds by the perpetual lack of purchasing power, and it is quite endemic under a debt based system

In economics inflation is attributed to the very opposite! Inflation is declared by most economists to be ‘too much money chasing too few goods’. In an economy based 97% upon money that has had to be borrowed into existence, when the total of debt is in excess of the entire money stock, when everyone is competing for what money exists to avoid further debt, when the money in circulation is required both as a medium of exchange and also required to repay the debt that created it, when a booming economy has been financed on the back of consumer borrowing and industrial borrowing for investment, when our everyday experience is that there is never enough money and when there is a superabundance of goods and services of all descriptions – quite honestly, does ‘ too much money chasing too few goods’ sound realistic? Quite honestly, which is the more likely? That inflation is due to excess money or the backlog of debt? Turning their back on debt and completely ignoring one half of the spiralling money supply process, economists deem inflation to be caused by ‘too much money’.

The idea that inflation is due to debt and excessive banking is not a novel suggestion, indeed it is contained in the very word ‘inflation’ which was originally applied to the expansion of money by banks beyond its true amount through the creation of additional credit. However, the suggestion that the action of banks in ‘inflating’ the currency could lead to price inflation has in recent years been completely swamped by a single theory of inflation – the Quantity Theory. This argues that if the quantity of money, or its speed of circulation, rises to the point where more money is available than is necessary for the purchase of goods currently available, then the prices of those goods will rise to absorb this ‘excess’. Inflation is thus seen as an automatic and inevitable result of any increase in the money supply above that needed for the purchase of goods. The quantity theory of inflation, which disregards completely the nature of money and the impact of debt on prices and incomes, is contradicted by almost every piece of evidence we have, whilst the role of debt in causing inflation is confirmed.

Over the centuries, there has been a constant complaint by ordinary people of poverty amidst plenty – not ‘too few goods’ but ‘not enough money’. There has also been a parallel complaint by industry of the difficulty of finding a market for their goods at prices that allowed them to stay in business. A difficulty in producing goods is never industry’s complaint. The difficulty is in selling goods, which strongly argues a lack of money, and in meeting costs, which strongly argues excessive debt. Inflation as ‘too much money chasing too few goods’ seems historically completely different to reality. But it does show a striking parallel with the increasing reliance upon bank debt-money.

If inflation were anything to do with ‘too few goods’ it ought to have died out decades ago with the choice of goods growing exponentially, not increased over the years.

As for ‘too much money’, how can this be said to apply? As we have seen, the average family and the average business is up to its eyeballs in debt of one kind or another mortgage, overdraft, credit cards and hire purchase. What is more, the level of personal and business debt has increased over the last fifty years, at precisely the time that inflation has become an annual feature. Add this to the fact the governments constantly complain of not enough money to spend on pensioners, hospitals, education or whatever.

The economist’s explanation of inflation is riddled with such contradictions and inconsistencies. None of it makes sense, and none of it explains why inflation is so persistent, despite all efforts to control it. In particular, there is a complete failure to account for the fierce price inflation that occurs during a period of economic boom when there is no question of ‘too few goods’. Why do prices soar during a boom? Why is competition deemed suddenly inoperative as a factor holding down prices, just when competitive growth is at its most intense?

The reason the prices rise once recovery is underway is that firms have been investing, and must repay the costs associated with this investment. The debt may be in the form of a bank loan, or it may be in the form of an obligation to pay dividends on a new share issue, but either way, new overheads have been incurred and these must be reflected in prices. The rapid price inflation during a boom is caused by firms charging the true financial cost of goods. Prices begin to reflect what firms actually have to charge in order to meet their costs. As prices rise, incomes get left behind and the lack of purchasing power in a debt economy starts to become apparent. This price rise and lack of purchasing power continues until no more debt can be sustained and we enter a financial crisis as people default on their debts.

Such an analysis also helps to explain the behaviour of prices during a prolonged recession. During a recession, the gap between prices and incomes that would be evident if firms charged the full price of goods is masked. Firms try to hold back costs and so keep prices low. But they cannot do this indefinitely. If a recession continues for a number of years, more and more firms are unable to defer costs, and slowly prices start to creep up to meet costs. The fact that such price increases are due to pasts costs incurred, and not current wage rises, is obvious, yet economists are totally stumped by the phenomenon of inflation during a prolonged recession, or ’stagflation’ as it is termed.

Almost all the instances of hyper-inflation have taken place in economies crippled by their debts. The South American and African countries where inflation has at times ranged between 100% and 500% per year were all, without exception, suffering at the times from huge debts to the IMF and World Bank upon which they had to make substantial annual repayments. The inflation in Germany during the 1920’s, which is often attributed to the German government running up an excessive government deficit, was equally associated with an explosion of debt.

The global financial crisis

As a result of this debt based system growth can only be sustained if we continuously take on more debt to supply the economy with the money it needs. However, the money the economy needs can never be achieved, as there is more debt than money, so we must continually re-finance in an endless spiral of debt. This debt incurs ever increasing interest charges and leads to price inflation as the only way to service past industrial debts.

In a situation where prices are rising relative to income, consumers have three options; either accept that their income buys less, press for higher wages, or borrow to buy. Of these, seeking higher wages was once seen as the ‘least-worst option’; however this simply produced the spiral of wage / price inflation of the 1970’s. A rise in wages can never close the gap between prices and incomes, since the gap is not due to the level of wages, but the effect of debt. All that a rise in wages achieves is to push up prices yet higher, the debt component of prices and the erosion of incomes by mortgages both remain.

Leading up to the financial crisis, people tended to regard ‘borrowing to buy’ as the least-worst option. Of course, all this borrowing meant lower disposable income in the future, whilst all industrial borrowing for investment will be represented in higher prices in the future. We are told that consumers have spent beyond their means and bankers have been greedy. The reality is consumers have re-financed to survive as banks have propped up the unsustainable system for as long as possible by increasing debt levels until the only borrower was those sub-prime borrowers who eventually defaulted. To blame this on consumers overspending and banks over lending is just an inevitable consequence of unsustainable economics and all they did was maintain debt to prop up the system for as long as possible. Now the government steps in and takes on the debt the economy needs to sustain the unsustainable.

This cycle is now over, we must nationalise our money supply not our banks and we need to move towards sustainable economics. Our current policies are all geared towards sustaining the unsustainable through increasing consumer and industrial borrowing (Lowering interest rates), increasing government borrowing (Fiscal stimulus and bailouts) and quantitative easing (Creating money out of thin air and loaning it to the government).

The mathematics of debt is uncompromising and the gap between prices and incomes in a debt economy cannot be concealed indefinitely by ever more debt-buying.

What we are experiencing now is a true deflation, involving falling prices and wages. The result is massive bankruptcies across the economy. This is hardly surprising since, with a general fall in both prices and incomes, the debt component of the price of goods is increased.

Concluding thoughts

To refer to bank credit creation as ‘the money supply’, as both government and economists do is completely misleading. The whole point is that, apart from the government’s trivial 3% contribution of coins and notes, there is no money supply. To call mortgages and loans ‘borrowing’ is also misleading. They are charter for the private creation of credit, charged at interest, and advanced against a person’s future income, allowing the purchase of goods already in existence, but for whose purchase insufficient money exists.

Also, the intermediate squabble between left and right on taxation and spending priorities does not represent the full range of choices. The real political option is embraced by the creation and supply of money by government instead of private banks when we nationalise our money supply. This completely opens up the economic options of extra funding, increases the political choice of expenditure and offers the prospect of true welfare. How dare a government claim it cannot find the money to pay for this or that when they do not bother to create any money?

A full understanding of the financial system provides a solution for so many micro and macroeconomic conundrums and financial contradictions that it can only be described as a revelation. The analysis and proposals for monetary reform offer a leap forward in economic understanding of quite breathtaking dimensions, and promises a revolution in the entire discipline. Academically, as well as in practical terms, to say this is exciting is an understatement.

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As you research this topic further, monetary reform is often presented alongside a full blown conspiracy theory, which claims that the financial system is being shielded from criticism and deliberately employed as a device for keeping people in a state of dependency, so as to advance a high-level political agenda. But this conspiracy theory is far from proven. Certainly, most political figures clearly know nothing of the weakness of conventional economics.

What dominates the world is not a conspiracy, it is a philosophy, a philosophy which tends to be held with unshakeable conviction by those employed in corporate business, high level government and supranational regulatory agencies. The philosophy that economic problems can best be solved, not by the people affected, but by experts.

This is the philosophy by which the personnel at the World Bank have crucified the economies of so many Third World countries by their gross interference. It is the belief that those with power can organise things better than anyone else and when things go wrong, the need is for yet more power. And it is a wholly false philosophy.

What currently dominates world politics is not a true conspiracy; it is a mistake. It is a conspiracy of error. We are witnessing the collective pursuit of an impossible political ideal and an enormous economic paradigm, built on a inadequate, misunderstood and almost unchallenged financial system. To cry conspiracy is easy; the far greater challenge is to tackle the vast numbers who are now convinced of the validity of conventional economics and the merits of more bailouts, more regulations and miss-guided anger, and attempt to persuade them that their economic and political practice is misguided. And for them to realise it is false, they need to be aware of the political alternatives. I remain optimistic with the recent events of the global financial crisis that economists and politicians alike are ready for a new paradigm, new beliefs and an entirely new system altogether. If monetary reform is to come out of the global financial crisis then we are on our way to a more prosperous, fair and sustainable society.

The nature of the economic dictatorship from which we suffer only becomes apparent when the financial system is fully understood and the alternatives are considered. This ignorance doubles the difficulty and makes it far harder to tackle them if there actually were a conscious conspiracy. One first has to convince people, who have achieved positions of power by accepting conventional economic dogmas, of the weaknesses of convectional economics. One then has to convince them that their policy, whether or not they are aware of it, is effectively tyrannical. Next one has to convince them of the vitality and workability of an alternative economic model. Finally one must persuade them to implement policies which are often in principle, the reverse of those they have for so long pursued, and which will involve them in a more subordinate role. This is no easy task, but if one good is to come from the pain caused by the global financial crisis, it is that they will certainly question there old paradigm and I have faith that if this message spreads the public will be able to support them in a new alternative that involves monetary reform for the good of us all in a new paradigm of sustainable economics.

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Our debt based monetary system is directly responsible for world export warfare and third world debts. In order to understand the need for exports it is necessary to understand that there is no such thing as a supply of permanent money to the economy, and the vast bulk of money within the economy has its origins in loans and is represented by a matching domestic debt. When goods are exported, foreign money is brought back into the economy, but the debt behind that money remains overseas, in the country of origin. Through exporting, money that has been borrowed into existence in another country is brought into the economy free of debt. The money can easily be turned into domestic currency via the foreign exchanges. However, when goods are imported, money created in the domestic economy goes abroad, but the debt associated with that money remains in the economy. Money that was borrowed into existence in the home economy has left the country, but the debt remains.

If a country exports more than it imports, there is a net gain of additional debt-free money within the national economy. The influx of money provides a boost of purchasing power to the entire economy, which means that home sales boom along with the foreign sales.

However, if a country imports more than it exports, there is a net outflow of money but the debt associated with the creation of that lost money remains. That country’s entire economy is threatened. Consumers are buying goods from abroad, which means that some domestic goods remain unsold. To make matters worse, purchasing power has left the country, depressing domestic sales further, while the debt that created the money remains.

Being a net exporter means the economy is vigorous and healthy, enjoying an influx of purchasing power without having incurred a debt, although the country is effectively losing real wealth with a net outflow of goods. Despite the fact that such countries are losing in real terms, in a world run on debt they are gaining something invaluable – successful sales, and a supply of debt free money boosting domestic purchasing power within the economy as a whole.

In summary, in order to thrive, countries fight to be a net exporter resulting in exchanging actual goods that an economy can use in exchange for debt-free money. The countries economic goals, should they become successful, are counter-productive to the needs of its citizens. Only nations like America and Britain can run an economy importing more than it exports and paying with money continually created into existence that everybody accepts as payment, eventually leading to a collapse in their currency as we are experiencing at the time of writing.

As the third world export all their goods while starvation remains a problem it becomes apparent how our monetary system is no longer serving us.

In order to enhance world development the World Bank and the IMF were founded in 1944. The World Bank was intended to aid post-war reconstruction, especially in the poorer countries, by providing them with loans. The purpose of the IMF was to provide an international reserve of money – a financial pool upon which all member countries could call, whether rich or poor, should they hit temporary balance of payments difficulties. In the 50 or more years since their formation, these two institutions have largely replaced direct country-to-country lending, and have advanced loans mounting to billions of dollars to developing nations.

However wealthy a country may appear to be, all nations are in debt and trade from a position of insolvency. As a result the wealthy nations, far from being prepared to accept debtor nation’s goods, have been looking to the Third World as a continued outlet for their own goods. How can debtor nations be expected to repay their debts by exporting more goods than they import, when the creditor nations are both resisting imports and vigorously trying to maximise their own exports?

The very willingness to lend money to developing nations was based on the knowledge that such loans would benefit the wealthy countries who wanted to find markets for their own exports, and so improve their earnings. Loans would be made on the condition that purchases were made in wealthy nations. Loan policies like ‘tied aid’ were conditions on loans that ensured the creditor countries obtained a market for their exports by issuing loans on the condition that the money was spent with certain nations, equivalent to the value of the loan they advanced. Once this money is spent on imports, the money already advanced to them as loans is absorbed back into the developed countries of the world, leaving the developing nation with a unpayable debt.

Where did the money for these loans actually come from? The World Bank raises money by drawing up bonds, and selling these to commercial banks on the money markets of the world. The money raised is then loaned to nations who require money for development.

The IMF presents itself as a financial pool; an international reserve of money built up with contributions (known as quotas) from subscribing nations. However, the total funds of the IMF were massively increased and its entire function and status radically changed when, in 1979, the IMF created Special Drawing Rights (SDRs). These SDRs were created and intended to serve as an additional international currency. Although these SDRs are ‘credited’ to each nations account with the IMF, if a nation borrows these SDRs it must repay these SDRs, or their equivalent (initially 1 SDR equalled 1 US Dollar), or pay interest on the SDR loan.

Now, it is abundantly clear from this that the IMF and the World Bank are not just lending money; they are involved in creating it. Although SDRs are described as amounts ‘credited’ to a nation, no money or credit of any kind is put into nations accounts. SDRs are actually a credit facility, just like a bank overdraft – if they are borrowed, they must be repaid. Thus the IMF has itself created, and now lends vast sums of a new currency, defined in dollar terms and fully convertible with all national currencies. Thus, the IMF is creating and issuing money as a debt, under an identical system of that of a conventional bank, – its reserves being the original pool of quota funds.

Money creation is also involved in the loans advanced by the World Bank through the selling of bonds. The World Bank does not itself create the money, but draws up bonds and sells them to commercial banks which, in purchasing these bonds, create money for the purpose. When a bank makes any form of purchase it does so against the deposits it holds at the time, but does not reduce those deposits; hence additional money is directly created.

To appreciate the consequences of the IMF and the World Bank, the detail of money creation and the path of the supply of international debt money must be traced. The World Bank draws up bonds to raise the money for its loans. These are bought by the commercial banking sector, and purchased against the deposits held by those banks at the time. An amount of number-money, usually denominated in dollars, is then paid to the World Bank by the commercial bank. None of the individuals or institutions with deposits in the bank buying the bonds has their deposit reduced, or affected in any way. Thus the loan is a creation of additional number-money. This new bank credit is then advanced by the World Bank to a borrowing nation, and the debt recorded against the borrowing nation. When paid into bank accounts in the borrowing nation, it becomes clear that the total of global bank deposits has increased. Total global debt has also increased.

When nations borrow using SDRs, the IMF creates and issues a sum of additional money in the form of an international currency, fully convertible into other currencies. Thus the total of global monetary deposits has risen, along with the equivalent debt.

These loans are always associated with a need for revenue to purchase foreign goods as part of an investment, so the money received by the borrowing nation will then be spent abroad, generally in more wealthy nations. It may well be that the money will be used to make purchases back in the country whose banking sector bought the World Bank bonds, returning as export revenues to the wealthy nation whose banking sector created it. This loan money will register as an increase in the total deposits of that nation, confirming beyond dispute that money has been created.

Since these loans are advanced in dollars or pounds, they are advanced without having any of the debtor nations currencies on the foreign exchange. The money advanced as a loan thus instantly becomes part of the money stock of the wealthy nations. Meanwhile, the debt remains registered to the Third World country.

In summary, by loans being advanced to a Third World country, the wealthy nation has found a market for its goods, its economy is boosted, and its money stock increased, whilst the burden of debt has been assumed by another country crippling their economies and leading to mass poverty.

There is a singular difference between national debt and international debt, a national debt is run up at will, and under the control of the national government. International debt, and the rate of its increase, places an entire nation under the financial control of agencies outside its borders. This entire process has made a financial playground and economic disaster area out of the developing nations.

These debts have been used to buy out private and public companies, pension funds, life assurance firms and many other forms of Third World equity – even for entire industrial sectors. Many Third World countries have privatisation schemes in place, and many more are planning them. Thus, the cream of developing nation’s domestic industry is passing into foreign control.

It is easy to question the morality of the wealthy nations once aware of the consequences of a debt based system; however, the beneficiaries of Third World debt are not the people in richer nations, nor the nations themselves. As a result of this system the wealthy nations are in a desperate scramble to service debts. It is easy to blame the commercial banks who benefit from the interest on such loans, however, we are now seeing that their business models are collapsing and they are wiping out all the profit gains in the global financial crisis. Who are the banks anyway? They are public companies that consist of thousands of shareholders, me and you, remember our pensions invest in banks. There is no beneficiary. This system benefits nobody. The IMF and the World Bank are all in a system of sustaining the unsustainable. Until we recognise that a debt based system will not work and cannot work we are doomed to destruction and Third world poverty will worsen.

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As a direct consequence of a debt based money supply our entire economy is plagued by intense competition for money to pay interest in an economy that suffers from an impossible lack of purchasing power. The chart below that plots the growth of money stock (M4) and domestic debt over a 33 year period in the UK clearly highlights that the total debts carried by consumers and industry is greater than the money that exists in the entire economy.

As a result the entire economy is completely dependent upon borrowing to supply money and debt is doomed to continually grow forever as it is strapped to a financial system in which both debt and the money supply are logically bound to escalate as there is not enough money to pay off all the debt. The only way to survive is to accumulate more debt. Those who are unable to continually re-finance are rendered bankrupt. Those unfortunate who cannot keep up with the inflation that occurs as a result of this unsustainable system get their homes repossessed and their businesses ruined as millions are thrown out of work as the economy sinks into recession when people cannot sustain the growth of the money supply by taking on ever more debt.

The situation of a debt based money supply where there is more debt than money means that sufficient people must be driven to borrow in order to maintain the circulation of money. The best that most people can hope for is to hang onto their jobs to pay their mortgage. The best that most businesses can hope for is to be able to offset their debts against their assets, and stay solvent on paper.

The consequence of a lack of purchasing power must be explored further. One of the first things I was taught in Economics is that industry serves two purposes: Produce goods and services and to distribute wages and salaries to enable these goods and services to be purchased. A lack of purchasing power means that consumers end up with insufficient money to buy the goods and services being produced in the economy.

Any business that has borrowed must repay its debts, and the only way it can do this is through selling its goods and services. This requires that the firm sets a price on its goods which includes the gradual repayment of this loan, or interest on the loan. But this is economic disaster. It means that prices are being set which are higher, in total, than the wages and salaries being distributed for the purchase of these goods. In an effort to obtain sufficient money to fund its debt repayments, or pay interest charges on standing debts, a company is forced to set prices that are higher than the income it is distributing. In economic terms, this is absolutely catastrophic, because it means the goods and services cannot be bought with the money being distributed for their purchase! In summary, industrial debt elevates the prices of goods and services above distributed incomes. At the same time interest repayments on mortgages and credit cards and other consumer debt reduces their disposable income as they take on ever more debt to survive.

The combined result of debt on businesses and on consumers is to raise prices and reduce disposable income. This is a lack of purchasing power where consumers do not have anywhere near enough money to meet the total price tags of goods on sale in the economy. Just as debt grows, so does the gap between prices and income – the lack of purchasing power.

As the inevitable happens and some are rendered bankrupt and laid off in the guaranteed recession under a debt based system with a lack of purchasing power, some are forced to seek government support. However, the government has enormous difficulty in raising revenue to support the needy in an economy riddled with debt. Taxes levied on industry simply results in higher prices, taxes on earnings hit consumer spending, depressing demand, leading to business closures and more unemployed. The government is forced to take on debt in order to supply an essential lifeline to a debt based economy.

This is why average household debt has rose from less than 30% in 1963 to 135% of total annual income today. In other words, the household debt throughout the entire country, embracing rich and poor alike, represents more than the entire gross annual income of our country. Consumers have borrowed, and made purchases against their future earnings, equivalent to more than the entirety of our national income!

When governments step in to inject a lifeline to an unsustainable economy with a lack of purchasing power they have no choice but to increase the national debt. A country’s national debt is the total sum outstanding on all past years borrowing requirements. It consists of thousands of outstanding pieces of IOU paper called in the UK gilts or treasury bills in the US. You might hear them commonly referred to as bonds or government stock.

The method of issuing these IOUs and administering the national debt is quite simple. In order to obtain money to cover its annual spending shortfall, an appropriate number of government stocks and bills are drawn up by the Treasury. These are then sold – in fact they are auctioned off in the money markets to the highest bidder. These stocks and bills are bought because they promise to repay a larger sum of money at some future date. As the government promises to repay this higher amount of money the government obtains the money to meet the payments due on mounting national debt by selling more stock promising even more money in the future! The government draws up enough new stock to cover the repayments due on the old stock, sells this, and uses the money to pay off the old stock.

Now this might seem a quite sufficiently barmy arrangement. But it should be remembered that the money held by pension funds and insurance companies, or whoever buys the government stock, is money that had to be borrowed into existence in the first place.

In other words, by this bizarre process, governments borrow money which has already been borrowed into existence, and they thus create a second massive institutional debt in respect to money which already has a debt behind it! This is why the addition of the national debt to the total of private debt places a country and its people in an absurd position of overall negative equity owing far more on paper than the amount of money that exists in the economy.

No nation in history has ever succeeded in reducing its national debt by more than the nearest fraction, whilst efforts to even restrict the growth rate of these debts has regularly plunged countries into recessions so savage as to take them to the brink of total economic collapse, frequently ushering in starvation and war.

There is abundant historical and contemporary evidence that, under the debt money system, countries are completely dependent upon their national debts. When the effort of constricting the national debt is considered, our reliance upon these debts becomes clearer. The consistent evidence of the last three hundred years is that, under a debt-based financial system, a national debt is unavoidable, indeed essential to prevent the economy from depression, recession and collapse. A country’s national debt is, in fact, a vital part of the money supply of the economy.

To summarise, the national debt supplies money to the economy either by drawing on our savings, and mortgaging the economy to its own pension and insurance funds (As pension and insurance funds purchase most government stock), or by allowing banks to create additional money as a debt (As banks buy government stock). In both cases, the debt is registered against the public assets of the nation and payment is dependent upon the future income of the economy. Thus the purchasing power distributed via the budget deficit compensates for, and covers up to some extent, the lack of purchasing power throughout the entire economy as a whole.

So here it is – to obtain the additional revenue our economy needs to make up for its lack of purchasing power, and upon which the economy is completely reliant, the government sells IOUs which increase in value with time. And when the time comes for them to be cashed, the government sells even more IOUs and uses this money to pay off the old ones. The government operates in an absurd system of debt-stocks which constitute a meaningless and utterly un-repayable debt to the future. This provides the government with a small amount of money now on the condition that they repay a much larger sum in ten or twenty year’s time. The government then proceeds to flood the market with these meaningless promises to pay, which can only be redeemed by the issue of yet more promises. The government draws on money already created as a debt, and relied upon for future payments on insurance claims and the pensions of the elderly, and allows banks and other lending institutions to purchase their bonds, conceding to these private institutions the right and power to create additional money, which is then loaned to the government at interest. Meanwhile, we must all work harder and harder, and the economy must become ever more productive and efficient to try to compete with other nations operating under the same lunatic structures, whilst the national debt inflates like a balloon.

I ask, every day, the following questions – why don’t we just nationalise our money supply, not our banks, and the government can create money debt-free? And, if we were to engineer this system from scratch, would we really operate under the same system, or would we choose a sustainable system? Is it possible that we have just fallen into this system because we don’t want to break the status quo? Are we really going to wait till the whole system self-destructs till we think about changing it? Do we really need more bailouts, more debts, more bubbles, more regulations and complete nationalisation of our banks just because we refuse to address the real issue that our money supply is created through debt? Where will this all end?

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As the financial crisis grows more and more intense, it seems increasingly certain that many of our major banks will be taken into state ownership. This is a mistake – if we are to nationalise anything, it should not be the banks, but the money supply itself.

Contrary to popular belief, most money in our economy is not created by the government or the Bank of England. It is created by the commercial, high-street banks every time they issue a loan, mortgage, credit card or overdraft. This is made possible by the fact that most money these days is not cash or coin, but simply electronic numbers in computer systems. Whenever a loan is made, these numbers are not actually transferred, but simply duplicated. This sounds unbelievable, but happens simply because the current method of accounting within banks is 500 years old, and has not been updated to take account on this new, non-physical money.

You might initially be thinking that it does not really matter if money is paper or electronic computer entries and you would be right. There is nothing, inherently wrong with number-money, just as there is nothing wrong with paper money. There is however something wrong with how it is created and who creates it. Not just wrong, but catastrophic and I don’t use that word lightly.

How is money created?

The process that allows commercial banks to create 97% of our money supply through debt is what is known as fractional reserve banking. Fractional reserve banking involves the issuance and creation of money through a commercial bank, giving banks the ability to increase our money supply through loans.

Through fractional-reserve banking banks keep only a fraction of money deposited in a bank in reserve and lends out the remainder. This practice is universal in modern banking.

To highlight the process through a simple example imagine you deposit £100 into Bank A. Assuming a 10% fractional reserve ratio, Bank A then takes 10 percent of it, or £10, and sets it aside as reserves and then loans out the remaining 90 percent, or £90. At this point there is actually a total of £190 in the system, not £100; because the bank has loaned out £90, kept £10 in reserve, and substituted a newly created £90 IOU claim for the depositor which charges interest and is a profit loan for the bank. At this point Bank A still holds £100 reserves on its books, but £90 of those reserves are soon going to be needed to satisfy the loan recipient. The loan recipient soon spends the £90. The receiver of that £90 then deposits it into Bank B. Bank B demands £90 to be delivered from Bank A to Bank B.

Bank B is now in the same situation as Bank A started with, except it has a deposit of £90 instead of £100. Similar to Bank A, Bank B sets aside 10 percent of that £90, or £9, as reserves and lends out the remaining £81, creating £81 of IOUs to its depositors. As the process continues, more electronic number money is created.

Although no new money was physically created in addition to the initial £100 deposit, new commercial bank money is created through loans.

As this process continues, more electronic number money is created. The amounts in each step decrease towards a limit. When the reserve rate is 10%, as in the example above, the maximum amount of total deposits that can be created is £1000 and the maximum amount of commercial bank money that can be created is £900. This money is lent out plus interest and is counted in the profit of a commercial bank. This is how 97% of the money in the UK is created – as debt.

The effect that fractional reserve banking has on the money supply has far-reaching ramifications for monetary inflation, price inflation, interest rates, and the business cycle.

Only 3%

As a result, we have arrived at the point where less than 5% of money in existence is actually issued by the government and the authorities. The remainder, many hundreds of billions of pounds, has been created through individuals and companies taking out loan after loan, mortgage after mortgage, and borrowing money that has already been borrowed many times before.

This problem is at the heart of the financial crisis. All the currently proposed reforms – including better regulation, state ownership of banks, bonus/malus schemes for the City boys, or a complete end to capitalism – are simply treating the symptoms of a problem that is barely being discussed, but in history has been one of the most topical issues.

Who is to blame for the crisis?

The key question is this: did the banks’ privilege of creating bank-account money to lend to us and one another play a significant part in fuelling the credit bonanza, subprime market and financial boom that led to bust, leaving such a tangle of international interbank indebtedness that central banks and other authorities like the Financial Services Authority could not assess the potential consequences if it unravelled?

The answer, of course, is yes. There is a particularly perverse effect of this current monetary system: common understanding would state that, as the banks lend more and more money, they will eventually run out of money to lend, and any lending boom would eventually run out of steam. In reality, the more money that the banks lend, the more money they have available to lend. Every loan they make returns to the banks, is recorded as new money, and then can be lent again, indefinitely. A lending boom therefore fuels itself and accelerates, until things become unsustainable and it all comes crashing down. That collapse is exactly what we are seeing now.

Is capitalism dead?

So is capitalism dead? I don’t think so. The current problems are not a result of capitalism – they are a consequence of using a banking system that still assumes that all money is either cash or coin.

Under the current, debt-based monetary system, the growth of our economy depends entirely on the amount of debt that we can support. Is there any clearer evidence of our economy’s reliance on debt than the fact that the main concern of governments at the current moment seems to be re-open credit lines and re-ignite lending?

So what should we do now?

We need to nationalise our money supply and we need a monetary system that does not rely on debt.

The reform is not especially complicated – the most practical proposal simply involves changing the internal accounting practices of banks and would require no real change for the average member of the public.

Estimates by Huber and Robertson back in 2000 suggested that the loss to the government of allowing commercial banks to create money was in the order of £49bn per annum. Add to this the cost of servicing the national debt, at £32bn per annum, and the cost of stimulating recovery during recession after recession, which runs to hundreds of billions, and the absurdity of allowing our high street banks to create our money supply should be clear.

If this is your first introduction to the issue of monetary reform, your head may be spinning right now. The reaction that I see when I present this topic to students or those currently working in the City is usually one of puzzlement – as though they had just heard the Earth was round in the time of Galileo. As I ask them to question some of the key assumptions of economics and the monetary system, they soon come to an understanding that something is very wrong, and I expect more and more of the public to come to the same understanding over the next few months.

This is a serious issue that needs serious discussion. When the G20 meet in London this coming April I suggest this problem should be top of the agenda. There can be no recovery from this crisis until these problems are addressed and our debt-based monetary system is reformed.

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