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From the book Global development -
Part 3, Financing Sustainable Development, Chapter XII:Money Creation
Quotes:
"Sustainable development should be financed in ways that do not increase public debt. In addition to the above mentioned traditional ways of financing, the large-scale funding needed to finance a complete sustainable development program should be generated through money creation."
"Money creation is possible without causing inflation as long as total demand does not outstrip the capacity of the economy to produce the desired goods and services. That means that sustainable development programs paid for through money creation should use existing but unused production capacity. Moreover, governments should actively promote the expansion of production capacity for goods and services important for sustainable development."
"The idea of money creation should not only be seen as a way to help finance sustainable development. It should also be considered a first step to adapting economic thought to today's realities. What we need is a new economics, a science that focuses on how to satisfy humanity’s needs in a sustainable manner, by developing and utilizing its productive potential as efficiently as possible."
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The measures proposed in the previous chapter would raise enough money to pay for a basic program for sustainable development, aimed at the conservation of natural resources, pollution control, and the elimination of destitute poverty. They would also allow a start on the conversion to renewable energy, the improvement of education, and the strengthening of government services. It would not, however, be sufficient to cover the cost of a global effort to reclaim agricultural land lost due to erosion and silting. Nor would it allow the building of a global infrastructure for water catchment and management, or cover the cost of providing all people with acceptable housing. More money would also be needed for developing the world’s economic infrastructure (transport, communications and energy generation), for child development guidance starting in the first few months of life and, in poor countries, the pension and child support funds proposed in Chapter VII. For a complete sustainable development program, then, more money would be needed than could be raised by the measures proposed in Chapter XI.
So where to get it? More government lending would be unwise: budget deficits and national debts are already at record highs. Worse, in the coming decades spending by the governments of the rich nations is likely to increase even without investment for sustainable development, as graying populations will make growing demands on health care budgets and social security. In the current context, therefore, the possibilities for large scale public investment in sustainable development are minimal. So what's to be done?
The answer is to create money, to be used by governments for investment in sustainable development. Money creation for the state is, of course, the exact opposite of what economists, politicians, and other experts consider as sound monetary and economic policy. Indeed, it's one of the worst sins against economic dogma: the epitome of financial, economic and political irresponsibility. An explanation is therefore in order. First, we’ll take a closer look at what money really is, and second, we’ll determine what it has become under the influence of mainstream economic thought.
Money was invented to facilitate trade. Using money - be it in the form of coins, bills, shells or other easily handled objects - for the purchase and sale of commodities meant a great advance over the bartering of goods. With barter, a party wanting to trade commodity one for commodity two has to find another party, interested in obtaining commodity one and in possession of and willing to trade commodity two. The use of money, however, makes it possible to sell commodity one to any interested party - independent of whether that party has commodity two, or not. With the proceeds, commodity two can be purchased from any party willing to sell it. Thus, money allows for a much more flexible process of exchange. The idea is so practical that it is used in all but the simplest of societies, with few members and little to exchange.
What money really does, then, is to allow the separation of the two components of exchange: sale and purchase. That has an important additional advantage: it facilitates hoarding, or saving. Money takes up very little space and does not spoil, as many commodities, especially agricultural ones, do. Hoarding also allows for accumulation, and the trade in money. Those needing money - to purchase a commodity or to invest in producing one - can borrow it from those who have accumulated it. Later, the borrowed amount is returned with interest: a premium that makes it attractive for owners to lend their money rather than keep it to themselves.
Money, then, is a symbol depicting a certain value. It is used to facilitate two of the most basic economic activities: trade and accumulation. Its use depends on a general agreement to accept it as an instrument for payment. That was the case in the past, and continues to be so today, in modern society. The acceptance of money is based on the faith that others will accept the coins or bills at some point in the future, in exchange for a good or service. Moreover, to serve its purpose, users of money should be confident that money will retain its value. That is, it should be possible to exchange it for commodities of similar worth as those through the sale of which the money was obtained.
Confidence or faith in money is crucial, because by itself, money has no real value. That used to be the case even in the time when the value of a coin was reflected in its gold or silver contents. After all, gold and silver are intrinsically worthless: neither of these metals has much practical use. Like any metal, they are unfit for human consumption, and they are too malleable to make any useful tools. The intrinsic value of paper money (bank notes or bills) is even less than that of coins. That was why for a long time its value was guaranteed by gold reserves, held at the bank that issued the bills. With the enormous growth of the global economy, however, the principle of backing up the nominal value of all newly issued money with gold has been impossible to maintain. Now, the value of currencies depends more than ever on the faith people put in it.
On closer examination, doesn't it seem odd that the lack of this artificial, symbolic object that is so often mentioned as the main limitation for addressing the world's problems? If it were lack of natural resources, of labor, or of skills and knowledge, the difficulty would be understandable: changing any of these factors overnight is beyond our capacity. But being nothing more than a concept money can, in principle, be created or destroyed at will. Most of the money going round in the world today does not even exist physically: it does not take the form of either coins or paper money. It only appears in "the books" or, nowadays, the memory chips of computers. Therefore, in creating it there is not even the physical limitation of the capacity of the world's printing presses. A simple statement by the financial authorities should, in principle, be sufficient to create any amount of money.
The fact that today money can be created at will is an important development. In the past the capacity for money creation was limited by the availability of gold and silver - either as a component of the alloys used for coins, or as backing for bank notes issued by banks. If rulers did not dispose of gold and silver they could borrow from those who did. But they could not produce money out of thin air and have it maintain its value. Today, governments can, and do. In countries with stable, internationally accepted currencies money is created by a Central Bank (or a central banking system, such as the Federal Reserve in the U.S.). As a rule, it does so when commercial banks solicit capital to cover the credit needs of their clients. This is the generally accepted basis for money creation. Underlying this principle is a deep faith in the infallibility of the market: if from the many economic actors who make up the market there arises a demand for money, there must be an economic need for it.
Whereas banks can turn to the Central Bank if they need money and thus, can solicit money creation, a government cannot. Governments who do are looked upon with disdain by the international financial community, and their currencies are not internationally accepted. Such acceptance is reserved only for governments who borrow the funds they lack from the private sector. Today, such loans are obtained in national and international capital markets through the issue of bonds.
There are two things wrong with this form of financing. The first is that banks can borrow money from the Central Bank at a lower interest rate than that which the state has to pay on the bonds it issues. That's a sweet deal for the banks: they can borrow at a low rate, buy bonds that will pay a significantly higher rate, and pocket the difference. Thus, the system constantly subsidizes commercial banks which, of course, are privately owned. Those who pay for these subsidies are, obviously, the taxpayers.
The second problem with government borrowing in capital markets is that money is borrowed on commercial terms for financing non-commercial activities. In case of a commercial loan, money is borrowed to invest in something that is expected to yield a sufficiently high return to pay back the loan plus interest and make a profit. The areas in which government operates, though, are not commercial. Education, health care, law enforcement, environmental protection and building roads and bridges are important, but they don’t usually earn enough money to pay for themselves. In the few cases where they do, mainstream economists and politicians immediately call for privatization: if a profit can be made, the activity is commercial, and if it's commercial, it should be turned over to the private sector.
Thus, the state - and therefore, the citizenry - gets a raw deal. It is not allowed to engage in profitable ventures, yet when it needs to borrow money it must do so on commercial terms. Small wonder, then, that both the rich and the poor nations have gotten themselves deeply into debt.
Today, as we've seen, the limits of borrowing by the state have come in sight. Debt servicing takes up huge parts of national budgets. As a result, there is no money left for the large-scale investment needed to finance sustainable development. Therefore, sustainable development should be financed in ways that do not increase the public debt. That can be achieved by making the needed money directly available to the state, without first channeling it through banks and financial markets.
The taboo against creating money for use by the government stems from the fear of inflation. There is good reason for this concern. History is rife with examples of governments engaging in large-scale money creation for their own use. Almost always, this form of money creation led to high inflation. In some cases hyperinflation occurred, with currencies' values being decimated by the day.
Creating money for use by the state, therefore, is not without risk. But that's no reason to disqualify the practice altogether - even though economists will do so out of hand. They'll argue that today, thanks to policies that let the market decide on money creation, the supply of money and that of goods and services are balanced. If the state creates money for its own use, this balance would be upset: there would be too much money. According to the law of supply and demand, where there is excess, the price will drop. That means the value of money would decrease relative to that of goods and services. In other words: prices would rise, and you'd have inflation.
The error in this assumption is that it mixes micro-economic with macro-economic phenomena. It assumes that decision making by individuals and companies on price setting (the field of micro-economics) has direct consequences for prices in the economy as a whole (the area of macro-economics). But in today's complex society, producers have no insight at all on how the total amount of money circulating in the economy affects the price they can ask for their product. When producers lower or raise prices, they do not have their eye on the total money supply. Instead, they look at the competition, at consumer behavior, and at predictions on how the market will develop.
Another error is that the theory on the relationship between the money supply and inflation is based on a closed economy. With millions of dollars in money and goods crossing borders every minute, that condition hardly applies.
The fact that considerable increases in the money supply do not necessarily cause inflation is easily illustrated. Look at the money that is created through speculation in the private sector. Hundreds of billions of dollars were generated in the booms in stock markets and real estate in the 1980s, particularly in the U.S. and Japan. Yet in spite of this enormous infusion in the economy, inflation did not rise significantly. Why not? Partly, because an important proportion of this extra capital was not used to purchase goods and services, but for further speculation. Thus, demand did not grow in proportion to the increase in the money supply. The most important factor in checking inflation, though, was that since the money was created in the (financial) market, people did not lose faith in its value. After all, the market can't be wrong. Which goes to show that, as long as faith is maintained (in this case, through the blind trust in the "infallible hand" of the market) money can, in principle, be created at will without causing inflation.
The "in principle" is an important qualification. Because when money creation generates so much demand that it cannot be met by producers, they'll take notice and raise their prices. Likewise, when workers find there is more demand for their services than they offer, they're likely to raise their price by demanding higher wages. In both cases, inflation will result. The conclusion, then, is that as long as money created for the state is not used in ways that generate more demand than can be satisfied by producers, inflation can be avoided.
Money creation for use by the state would violate one of the most sacred dogmas of the financial community. Still, even some economic and financial specialists appear to recognize that adding money to the world's capital supply is feasible even without the private sector demanding it. Thus, money creation for use by the state was recently proposed by none other than the director of the International Monetary Fund - one of the greatest bastions of conservative economics. In 1994, it requested permission of its shareholders to create an additional $60 billion in so-called Special Drawing Rights: money that can be borrowed by the governments of member nations. Only a fraction of this amount - some $15 billion - was actually approved by the dominant shareholders, the rich nations. Especially the German Central Bank objected to creating new SDR's. The reason was, obviously, fear of inflation. Nevertheless, an agreement for what amounts to money creation for the state was reached - even though the amount involved was small. This fact, as well as the original request made by the IMF director, indicates that the principle of money creation is not as farfetched as it may seem.
Avoiding demand-driven inflation
Now let's assume that the principle of money creation for the state is accepted. The question then becomes how to go about it without causing inflation. One cause of inflation would be that the a program for sustainable development would generate so much demand that producers would feel free to raise their prices at will. That would cause what economists call demand-pull inflation. Also, such excessive demand could lead to producers competing for labor, capital goods and raw materials. That would push up the prices of all three, and therefore, the prices of the products made by and with them. That's called cost-push inflation. Both could occur if demand by the state would outstrip the capacity of the economy to produce the desired goods and services. To avoid this, demand by the state should be adapted to existing production capacity. That means that programs paid for through money creation should aim to use the economy's unused or underutilized production potential.
As a rule, there is enough opportunity to do so. In a recession, as little as 70% of the production capacity of the economy may be in use. Even in a full recovery as much as 15% of production capacity may remain unused. However, public investment financed by money creation should not lay claim to all unused production capacity. In no economy is production capacity ever fully attuned to demand: part of the unused workers and capital goods are accommodated to making goods and services other than those that are wanted. Moreover, if all production capacity is used there will be little or no competition between suppliers, which leads to higher prices and less efficiency. To maintain competition, therefore, only part of the underutilized production capacity should be used
Governments should actively foster the expansion of the country's production capacity for goods and services that, once a program for sustainable development would be set in motion, would prove to be in short supply. New schools, colleges and universities should be created, and the training and research capacity of existing institutions expanded. Tax breaks and where needed, financing should be supplied for investments in research for increasing productivity and a more efficient use of scarce production inputs.
By having producers compete for contracts, the market could be given a key role in attuning money creation to production capacity. With insufficient participation and all contenders charging exorbitant fees, the state should assume that production capacity were stretched to the limit. The program involved should then be reduced in size or postponed, until a sufficient number of competitors would offer to do the job at reasonable cost.
Avoiding inflation through loss of faith
If money creation would make financial markets lose their faith in a currency, its value would diminish. To keep the faith, an international approach would be needed, in which all or a majority of nations with strong currencies would accept and actually engage in money creation for sustainable development. If this were not the case, currency traders, mindful of economic dogma, would be likely to get rid of currencies in which money would be created, and buy those in which it wouldn't. That would reduce the value of currencies of countries engaging in money creation. Money managers would withdraw their capital from the local stock market, and serious economic and financial trouble would ensue.
No country would want to risk that. Therefore, the mandate to create money should not be given to national Central Banks. Instead it should remain with an independent, international agency that enjoys the confidence of financial markets. Such an agency already exists: the IMF.
The IMF could provide funding for sustainable development with something comparable to the already mentioned Special Drawing Rights. Let's call these new units "Allotments for Sustainable Investment", or ASI's. ASI's would be different from SDR's in two ways. SDR's involve loans at commercial interest rates, and can be used as the receiving nation sees fit. ASI's, however, would not require repayment, and would be disbursed only for investment in sustainable development.
ASI disbursements should be made dependent on several conditions. First, with the help of specialists from relevant national and international organizations, IMF experts should judge if a request for ASI financing would indeed concern an investment in sustainable development. Second, the IMF would have to assess the risks of demand-pull and cost-push inflation. If the activities to be financed would make too high a demand on existing production capacity, the IMF should demand rescheduling. Third, the IMF should only approve ASI disbursements for activities that would be part of a national program for sustainable development. This program should define all activities to be undertaken in the different fields of sustainable development. It should establish priorities, according to the availability of the human and material resources needed to carry out the activities. Also, the program should define monetary, fiscal and economic policies aimed at controlling inflation and balancing government budgets. Particularly for poor countries this should include measures for creating a solid tax base, through progressive taxation and the stringent enforcement of tax laws.
Follow-up requests for ASI financing should be honored only if the already allotted funds were spent for the uses for which it was intended. Moreover, disbursement of ASI's should, in principle, be conditioned on adherence to the principles of democratic government. The reason would be, even more than moral, practical: accountability. Without freedom of information, organization, and an independent judiciary, it would be difficult to hold a government responsible for the misuse of ASI funding.
The condition of democratic government should, however, be managed with some flexibility. Some ASI financed programs might benefit large numbers of people even though their government would not be democratic. That could be the case with programs aimed at education, health care, poverty alleviation and natural resource management. Carried out by a reasonable effective civil service, such programs could contribute enormously to sustainable development. Moreover, improved education would contribute to fostering democracy in the countries involved.
Whenever possible programs and projects financed through ASI's should aim to become self-sustaining. That is, after the initial investment, they should yield sufficient benefits to cover all costs. That would be the case particularly for projects aimed at stimulating production, such as roads and bridges, land improvement, and water supply. After having received ASI financing for the initial investment, all costs for operation, maintenance and replacement should be covered in the normal way: through user fees, taxes, and the project's economic proceeds.
Repeated ASI contributions should be reserved exclusively for programs that would not yield direct benefits, and would require support over longer periods of time rather than a major initial investment. Examples would be programs for education, health care, ecosystem management and the pension and child support funds described in Chapter VI. Here also, though, ASI financing would be temporary, to be replaced gradually with regular funding. All ASI agreements would have to include a timetable for this substitution.
ASI's could also be used to pay back the interest and principal on national debts. This would free government resources for more productive uses. The idea would not be to pay off all debts in one move: an injection that size into capital markets would create financial chaos. Rather, ASI's for debt servicing would be issued according to existing repayment schedules.
ASI's for debt relief should be tied to the obligation for the beneficiary governments to balance their budgets. Even better would be if governments created some reserves for contingencies, such as natural disasters and downturns in the business cycle - when due to stagnating economic growth revenues drop and spending on social security rises. Creating such reserves would call for budget surpluses in years with sturdy economic growth.
The IMF should not honor requests for money creation if, in the country involved, inflation would be on the rise. Rising inflation could be caused by excessive wage demands from workers, or by producers raising prices. Thus, money creation would be dependent not only on the responsible behavior of governments, but also on that of employers and workers. All parties involved should come to see that avoiding inflation would be in their own best interest. Workers and their unions should understand that moderate wage demands, linked to gains in productivity, would not only maintain the value of their pay, but also keep their country eligible for ASI financing of new projects and programs. Similarly, producers should realize that reasonable profit margins, gained over a number of years and high turnover, would yield more than high profits for a short period, on lesser volumes. If a majority of workers and employers could be convinced of these benefits, unions, business and government could create a climate in which sustained money creation for sustainable development would become possible.
Obviously, governments would also profit handsomely from money creation. Sustained, sustainable economic growth would generate more jobs, wealth and overall well-being. The result: a satisfied electorate. More jobs and economic growth would also mean more tax revenues. In the longer run, this might allow the lowering of taxes, making voters even happier. For all parties involved, then, financing sustainable development through careful money creation would provide obvious benefits and thus, incentives to behave responsibly.
ASI's would be created at the international level, by a global financial institute. However, money can also be created at the other end of the scale: at the local level. The use of local currency can stimulate local economies by fostering the production, exchange and consumption of goods and services within the community. This is already happening today: since the early 1980s several hundred communities, mostly in Australia, Ireland, England and North America, have initiated so-called Financial Micro Initiatives, or FMI's.
The local money created through FMI's exists side by side with national currencies. Its economic effects are particularly strong in places where national currency is in short supply, such as areas with high unemployment. There are also environmental advantages: satisfaction of individual and communal needs will take place more sustainably if decisions on the use of local resources are taken within the community. Locals are more likely to use their natural resources rationally than outsiders, who tend to come in, exploit and move on. Moreover, since production and consumption take place in the same locality, transport needs are minimal, which saves non-renewable energy. Thus, economic activity resulting from FMI's is as a rule more environment-friendly than that financed by regular money.
Local money is, of course, nothing new. In fact, money first appeared at the local level: in villages, towns and cities. The dominance of national currencies is typical only of the last century; the world-wide acceptance of a single means of exchange, the dollar, is more recent still. This internationalization of money has contributed greatly to the free movement of capital across borders. In turn, this has led to the growing concentration of the global capital supply in international financial centers, at the cost of economically less favored places. In poor countries and in "pockets" of poverty in rich ones, the lack of regular money and consequently, demand, depresses economies. To counter this requires a return to our financial roots: the payment for community produced goods and services with local currency.
A remarkable example of local money creation is that of the small island of Guernsey, situated between England and France. Between 1816 and 1829 a total of 48,000 "States Notes" were issued, each with a face value of one English pound. At a time of deep economic crisis, they were used to finance sorely needed public works such as roads, a market place, schools and sea defenses. The resulting demand for skilled and unskilled labor and raw materials greatly helped in pulling the island out of its economic depression. In later years more States notes were issued; today, some 14 million pounds worth of notes and coins circulate side-by-side with the English pound.
The U.S. also has a long history of local money creation. At the height of the Great Depression, in 1933, more than 300 communities, mostly in the Mid-West and North-East, used local currencies. However in March 1933 President F.D. Roosevelt, answering to pressure from national financial authorities who feared they would loose control over monetary policy, forbade further issues. A similar fate struck many FMI's that in the early 20th century appeared in Europe, especially in Scandinavia and Germany. Here also, national financial authorities feared loss of control over the money supply and consequently, inflation.
Today FMI's are once again gaining popularity. Most of these initiatives do not actually involve the physical creation and use of a local currency. Instead measuring units, such as hours of work, are earned, registered in a local banking system, and spent on locally produced goods and services. FMI members are issued chequebooks and receive regular statements of account through a computer based cheque clearing system. Since no actual money is involved, it's a system with which even the most orthodox financial authorities will find it hard to find fault.
FMI's, then, are both complementary to, and offer an antidote for today's growing concentration of capital. They are an alternative that becomes all the more important when one takes into account that whereas FMI's are already operating today, capital creation through ASI's is still a long way off.
Money creation would be important even without a program for sustainable development. That is because at some point, money creation without taking on debt will become necessary. The reason, as was discussed throughout this book, is that for economic growth to be sustained, increasing productivity must be matched by an increase in demand. The market is unable to generate this increase. In the past two decades, demand has held its own largely because of deficit financing, in the private as well as the public sector. With humanity now deeper in debt than ever before, the limits to this strategy have come in sight. A radically new approach to economic development is therefore needed: money creation through ASI's and, at the local level, FMI's.
ASI's would eliminate chronic budget deficits and create the demand for goods and services that is needed to close the growing gap between productivity and demand. Increased demand would also limit the competitive rat race that now results in declining living standards for all but the top layers of society. Moreover, by creating investment opportunities in the productive sector of the economy, money creation for sustainable development could curb the concentration of capital in the international financial markets. That would reduce speculation and thus, diminish the chance of a financial crash.
The idea of money creation, then, should not only be seen as a way to help finance sustainable development. It should also be considered as a first step to adapting economic thought to today's realities. What we need is a new economics, which will enable us to satisfy the world's needs by developing and utilizing its productive potential as efficiently as possible.
This need becomes all the more urgent when we consider the enormous progress that has been made, in the past few decades, in technology and the natural sciences. In stark contrast, economics is still mired in theories developed in the 19th century. Today's economists apply these theories to today's situation as if they were universal and timeless truths. As a result society's productive capacity is increasingly oriented towards the satisfaction, often in unsustainable ways, of the demands of the already well-off. Simultaneously, the needs of the poor and of future generations go unanswered.
Instead of being used for the benefit of all of humanity, then, technology serves only the needs of those able to pay for it. Much technology that could greatly contribute to sustainable development is not or insufficiently exploited because according to traditional economic reckoning, it's "uneconomical" to do so. Economic policies based on outdated or false assumptions help to widen the gap between have's and have-not's, contributing to continued mass unemployment and poverty. And we're only at the beginning: as things are going, we're in for more human misery, a major economic and financial crisis, and a seriously disrupted global ecosystem. What's needed, therefore, is a new approach to economics, with as its central question how to use society's resources to optimally satisfy humanity’s needs in the short, medium and long run.
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