Chapter 1

1.3 Money: The function of money; positive money or real money versus credits

last revised/edited 11/2010, 1/2012, 10/2016, 4/2017, 5/2019

1.3.1 Role, function and nature of money; need for an appropriate money supply
1.3.2 Ownership of resources
1.3.3 Problems in the modern money supply; consequences of expansion of credit, rising debts and speculation; basic alternatives; some proposals
1.3.4 Basic proposals

• Money functions to
– hold value between selling goods and/or earning income by working, and buying goods and/or services;
– determine agreed-upon values (negotiations are strongly influenced by cultures and powerful entities);
– allow smooth direct economic interactions between strangers.
• Economies have been growing with increasing populations and, thanks to innovations, increased productivity. The middle class, people with reasonable incomes and economic security, increased significantly since the Depression and WWII.
• For the economy to stay efficient, the money supply had to grow.
• Rather than governmental central banks creating an adequate money supply while limiting lending by investors and banks, financial institutions increased lending activities, partly by, in indirect ways, greatly increasing credit card lending.
• While earning much profits, banks ended paying interests on savings and money market accounts that are higher than the rater of inflation; banks accumulate wealth while middle-class people with savings and similar accounts lose.
• Our economy completely depends on lending activities; if most people and industries would stop borrowing, the economy would collapse. Today, many people consider their credit ratings as more important than their savings.
• In effect, people, businesses and even governments pay a high taxation in the form of interests and service charges for the benefit of having an adequate money supply.
• Today, most of the circulating money supply belongs to financial institutions, rather than belonging to individuals, industries, and government entities that work with it.
• Laws from the Great Depression kept the economy fairly stable for half a century and promoted continuous growth. The dismantling of safeguards since the 1980s has allowed wild speculative activities by financial institutions. With the rapid transfers of all types of financial assets, it is no longer clear what accounts and investments have the function of money.
• Particularly in the U.K. and U.S., financial institutions that manage productive entities’ financial assets have become a growing “industry” that sifts huge profits from the activities of the productive economic entities, even at times when productive farmers and industries lose money.

1.3.1 Role, function and nature of money; need for an appropriate money supply
Money serves people in efficient trading of goods and services; prices and fees assign economic values to what is traded. Money represents value, but does not hold wealth in itself. The value of money depends on a functioning economy. People cannot set aside money after their children are grown and then use it at retirement age, unless younger people keep the economy productive.
During much of their productive years, people have to work for themselves, for their parents’, and for their children’s generation. Work includes unpaid childcare and other domestic tasks. People have to work for the maintenance of the economy’s infrastructure, for the protection of their environment, for their health care system, for educational institutions, etc. Working people also have an ethical obligation to care for the disabled, the desperately poor, and victims of accidents, crimes, wars, and natural disasters. Work in research leads to progress; protection of the environment is particularly valuable for future generations.
An appropriate money supply represents savings between earning and purchases. There should be enough money for people and enterprises to save cash between monthly, seasonal, and periodic expenditures, that is, the time between receiving income and the time of expenditures. Society should discourage debts. Luxuries, most durable goods, tools, etc. should be bought with savings and consequently owned by a person, family or corporation that utilizes them. In addition, people should have reasonable cash reserves for times of temporary unemployment, unexpected expensive repairs on a needed car or family home, special needs of family members, etc.
Educating young people is an investment in the future of the economy : the economy needs educated parents and educated workers. The U.S. has not adequately invested in the younger generation and needs to ‘import’ physicians, scientists and engineers to maintain its high standards.
Loans to individuals and families should be limited to very major purchases, such as family homes. Particularly when people spend less and save more because industries do not produce what consumers want, banks must lend to industries to finance research, development, and retooling.
The USA and GB (U.S. and U.K.) have been leading a trend towards more and more credit, including irresponsible consumer loans and international lending. In contrast, in much of continental Europe, particularly Germany and Switzerland, there is a cultural reluctance to go into debt other than to buy a home, and, within their countries, banks followed conservative rules regarding bank reserves, bank capital requirements and lending. At least until recently, consumer loans were much less available and people usually bought durable goods with savings. Most economic transactions used cash and/or checks of the federal postal services. Rather than credit cards, people have been using more debit cards, drawing directly from personal savings. As credit becomes more readily available, many or most people cannot resist borrowing.

1.3.2 Ownership of resources
The question, to whom the money supply should belong, is rarely asked. Most people would probably agree that the money supply should be owned by the people, their industries, and their governments. People probably would also agree that their government should create and maintain the money supply. Particularly in the USA and GB (U.K.), an inordinate part of the money supply is created by lending and owned by financial institutions. Individuals do not own much money; they borrow much of the money they spend and then have to pay it back with interests and service charges. In larger transactions, bank officers or investors influence how a person or business uses borrowed money. Even governments are severely indebted.
The question, to whom goods should belong, is equally important. Being indebted means that the financial institution has property rights over what was bought with a loan: cars, business buildings and machinery, etc. belong only partly to the people working with them. If payments cannot be made, financial institutions may repossess them, which creates stress and uncertainties. In a well-functioning economy, people, businesses and governments own most goods and tools they work with.
The credit-based international trade is particularly problematic. In the Eurodollar market, banks lent to newly independent Third World countries outside the jurisdiction of any country and without obeying judicial guidelines. Irresponsibly issued credit became the money supply for much international trade. A branch of a U.S. bank in London could, with a small investment, lend the same money to 30 Third World enterprises and governments to buy industrial products form U.S. companies. These loans never left the U.S. banking system since it paid for American machinery, weapons, etc., but the borrowers had to pay back in U.S. dollars, principle plus high interests. Many loans did not lead to greatly increased productivity or other economic benefits; sometimes, agricultural productivity increased much, but the value of the crops diminished and loans could not be repaid. Many Third World countries suffered severe economic and financial crises, followed by extremely damaging interventions by the International Monetary Fund. To avoid further financial crises, Third World national banks were compelled to building dollar reserves; consequently, U.S. dollars earned from exports to the USA have been put into bank reserves rather than used to buy American products, which resulted in a huge trade deficit. In effect, the USA keeps borrowing, paying very low interests; thus, the Third World subsidizes the U.S. economy rather than developing aid helping poor countries1.
Rather than money representing what people inherit and save between major purchases, much circulating money represents a debt to the financial institutions. Interests, dividends, and profits represent a flow of resources from the poor, through financial institutions, to the wealthy. Interests in effect represent a heavy taxation for the convenience of a money supply, paid by the Third World to highly industrialized countries and by poor and middle-class people to the wealthiest members of society.
Evaluating the ratio at which people save is difficult since home ownership versus living in rented houses or apartments varies greatly between countries and regions. It is relevant to distinguish between loans for the home a person/family lives in versus loans for consumer goods or vacations, loans for durable good, for a family or larger business or for speculative investment. Borrowing to keep up a living standard one can hardly afford is most problematic for families. In all lending, the financial institutions should share in the responsibility if bad loans cannot be paid back without creating severe hardship to involved families and local populations. For instance foreclosing a home makes usually little sense: banks forgoing high interests, possibly devaluing the property, and/or allowing delayed payments makes generally more sense.
Psychological consequences of ‘living on the edge’ and of severe indebtedness have been described above, 1.2.2, .3, .4.

1.3.3 Problems in the modern money supply; consequences of expansion of credit, rising debts and speculation
Problems in the modern money supply have two main causes:
1. the government’s failure to create an adequate money supply and
2. the financial institutions’ legal right to shamelessly lend/invest money wherever they see potential profits and to lend even money deposited in checking (draft) accounts2 while counting on governments to guarantee losses to savers and even bailing them out in case of crisis.
What functions as money has become much more complicated. For daily interactions, we traditionally used coins and bank notes or checks from checking accounts, which have the same function as cash, except that banks lend checking account money to borrowers. Saved money was usually deposited in savings accounts that were mostly used to lend to bank customers; however money market accounts have partly replaced savings accounts but are used for speculative short-term investments. Today there are many complex instruments for saving financial assets, most of them can be transferred to checking accounts without delay. However, most people do not own significant assets and use credit cards in place of money.
Following the Savings and Loan crisis of the late 1980s and particularly following the crisis of 2008, the Federal Reserve System created much new money, but it was injected into banks as reserves, to prevent bank failures. Banks having adequate reserves combined with very low interests should have stimulated the economy, but progress was slow. Developments are complicated by shadow banking systems, extremely complex forms of investments, etc. – bankers, brokers and investors hardly understand the complicated “instruments” (layers of complex, with borrowed assets financed, derivatives that gamble with the anticipated future valuation of commodities, currencies, etc.). Regulators have not interfered with these shady, secretive deals that undermine the relative safety of financial systems and economists had little constructive advice for the needed government actions.
Banks largely usurped the government’s role of creating money to support the growth of the economy. However, banks perform unpredictably. Their allocation of money ignored many of society’s needs3.
Growth should have been primarily financed by government-issued money, not private financial institutions. Money brought into circulation earlier should have been allocated to support people and institutions that created modern wealth, including the people who raised and educated children, improved the land, provided healthcare, built railways and roads, etc.; some newly issued money may also go to local governments and their agencies, colleges, universities and other institutions that contributed to scientific and technological developments. More recently, new money could have paid for large government projects, e.g. employing people to construct a nationwide, comprehensive rail system, including high-speed, light-rail and narrow-track lines.
Governments should reclaim their responsibilities to create the money supply, and to participate in its allocation; and governments should limit and strictly regulate financial institutions’ activities to prevent inflationary lending. Private banks should be nonprofit cooperative institutions.
A main problem with a credit-based economy is that financial institutions and investors determine how money is allocated within an economy. Financial institutions pretend to allocate money in the interests of society and pay themselves large commissions. In reality, they sift profits from the economy’s productivity wherever they can, adding costs and creating instability; they endanger the world’s financial system; further credit crises are likely to lead to widespread hardships, famines, possibly wars. The financial institutions’ profits are huge and rising, and many intelligent and highly educated people waste their brains speculating and gambling with others’ savings.
It is extremely problematic that on speculation based complex ‘financial instruments’ obtain the function of money in that they are highly liquid but are used for investments of varying risks and duration.

1.3.4 Basic proposals
• Computerized buying and selling of securities is extremely rapid and unpredictable; traders must be aware of the importance and impacts of stock, bonds and derivative trading; we need to security sales taxes – virtually all other types of sales are taxed, including valuable used products.
• Financial institutions must not have a legal rights to create and sell ‘financial instruments’ that lump different kinds of debts and investments together that are not transparent and easily understandable, where informed decision-making is essentially impossible.
• Banks must not be allowed to invest savings in stocks, bonds, derivatives and other securities.
• Brokers investing people’s savings and retirement money in complex ‘instruments’ is inappropriate; instead, elected development bank or credit union officials should use such savings in ways that represent the needs and values of the people in their area.
• Rather than brokers creating instruments that protect farmers and businesses from losses by buying crops or other products before they are on the market, farmers and small businesses need non-profit insurance corporations.
• If debts cannot be paid back as contracted, banks must acknowledge partial responsibility and work with buyers, lower the debt by devaluing the purchased good, lowering interest rates and allowing delayed payments.
• With these and other goals in mind, politicians may implement changes in multiple steps.
1  Compare Selling Money, by S. C. Gwynne, 1986, and Making Globalization Work, p. 245ff, by Joseph E. Stiglitz, 2006
2  Compare
If by a government issued money is mostly held as bank reserves or reserve capital, virtually all money owned by a person or enterprise constitutes also a debt by another person or institution. For virtually all money that is in circulation, somebody pays interests to a financial institution.
3  To explain the growth of the money supply: suppose a bank was opened in a pioneer town with $1,000.00 in coins and dollar bills (federal reserve notes).  The bank could then lend money to a borrower, creating a checking account.  As the borrower spends the money, e.g. paying contractors who build his shed, the checks are likely to be redeposited in the bank; the money may not even leave the bank, or it stays in the banking system of the region.  In this way, the same money has been lent to many borrowers.  A bank may at some time have $1,000,000 in reserves, $10,000,000 in checking and savings accounts, and $10,000,000 lent to borrowers.
Every loan a bank issues creates money.  For people who are paid with checks from the borrowed money, that bank money is as good as coins and bank notes.  When the borrower pays the loan back, that money disappears, until the bank issues a new loan.  Since banks earn considerable interests from loans, they have an incentive to issue loans that they expect to be paid back and loans that are backed by property.  Limitations on bank lending is set by legal reserve and bank capitalization requirements; however, there is no requirement to issue loans.  As bankers care mostly about their income from interest payments, banks are least likely to lend money, when the economy is in transition and is most in need of a stable money supply.  It appears incredible that bankers and loan officers have the power and responsibility to allocate and regulate the money supply.


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