[R-G] [BillTottenWeblog] How Money is Created

[Bill Totten]

Abridged from the works of Michael Rowbotham

Prosperity (April 2000)


The financial system currently adopted by all nations is often
described as "debt based", since the process of going into debt is
relied upon almost exclusively to create and supply money to their
economies. By the action of lending to borrowers, commercial banks
create credit and advance this to industry, consumers and
governments. This "bank credit" circulates in the broader economy
until such time as the loan is repaid. Such "bank credit" now forms
96% of the money stock in most industrial nations, with a mere four
per cent the notes and coins created by government, and free from a
parallel debt.

Thus, almost the entire money stock is supported in circulation by
vast debts in four main sectors:

* Private debts - for example mortgages, loans, overdrafts,
credit-purchases

* Industrial and commercial debts

* Government "national" debts

* International, including Third World debt

The supply of money is a direct product of borrowing, and debt
maintains this money in circulation. Modern debt is, in aggregate,
quite unrepayable. Furthermore, difficulty is experienced in the
repayment of individual debts in all four sectors. {1}

Money is created in each of these four areas ...

How Banks Create Money for Private and Commercial Needs {2}

If a bank makes a loan, nothing is lent, for the simple reason that
there is nothing of substance to lend. The bank makes what it terms
a loan against the amount of money deposited with it at that time.
This is all done with the utmost ease. The bank has simply to agree
that a person may take out a loan of, say, GBP 5,000. The person
taking out the loan can then spend GBP 5,000 and hey presto! GBP
5,000 of new number-money has been created. No one with a bank
account is sent a letter telling them that the money in their
account is temporarily unavailable, because it has been lent to
someone else. None of the original accounts in the bank has been
touched, reduced or affected. Nobody else's spending power has been
reduced, but GBP 5,000 of new spending power has been created; GBP
5,000 of new number-money enters the economy at the stroke of a
bank managers pen, but GBP 5,000 of debt has also been created.

Thus, whoever takes out the loan will then make purchases and
payments to other people, who will pay that new money into their
bank accounts. Result: more bank deposits! As soon as the loan in
the example above is spent, GBP 5,000 will find its way into the
bank account of a car dealer or grocery store; GBP 5,000 of
apparently new money. This is money which has supposedly been
loaned but the banking system doesn't distinguish this fact. It
simply registers a new deposit, and regards it as new money. Total
deposits in the banking system have therefore increased by GBP
5,000. This is the boomerang effect of a bank loan by which a loan
rapidly creates an equivalent amount of new bank deposits in the
banking system. This effect was neatly summarised in a statement by
Graham Towers, former Governor of the Central Bank of Canada:

    Each and every time a bank makes a loan, new bank credit is
created - new deposits - brand new money.


The new money will provide the banking system with the collateral
for more lending. This is the bolstering effect of a bank loan. As
the total money held by banks and building societies becomes
swollen by loans returning as new deposits this provides them with
the basis for further loans.

Perhaps the best description of this process of money creation was
provided by H D Macleod:

    When it is said that a great London joint stock bank has
perhaps GBP 50,000,000 of deposits, it is almost universally
believed that it has GBP 50,000,000 of actual money to lend out as
it is erroneously called ... It is a complete and utter delusion.
These deposits are not deposits in cash at all, they are nothing
but an enormous superstructure of credit.


How Banks Create Money for National Needs {3}

A country's national debt is completely separate from, and
additional to, the level of private and commercial debt directly
associated with the money supply. The United Kingdom national debt
in 1998 stands at approximately GBP 380 billion. If the private and
commercial debt of GBP 780 billion and the national debt are added
together, the total indebtedness associated with the UK financial
system stands at some GBP 1,160 billion, which dwarfs the total
money stock of GBP 640 billion! How did this condition of overall
negative equity come about? This excessive indebtedness - which is
a blatant misrepresentation of the real state of economic wealth
enjoyed by the nation - is a position shared by all the developed
nations.

The national debt is actually composed of thousands of pieces of
paper called stocks, bonds and treasury bills. These stocks and
bills, known as gilt-edged securities, or gilts, are essentially
elaborate forms of government IOU. These IOUs are issued because
each year the government fails to collect enough in taxes to cover
the costs of its public services and other spending - and it
borrows money to cover this shortfall. All government budgets
overshoot by many billions of pounds, dollars or deutschmarks
annually. This leads to what is called the borrowing requirement
for that budget year. A country's national debt is therefore the
total still outstanding on all past years' borrowing requirements;
thus the UK national debt consists of GBP 380 billion of these gilt
edged IOUs, in the form of outstanding treasury bills and stocks.

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.
This is done throughout the year to meet the shortage of revenue as
it arises, and the announcements, in the form of government
advertisements, can be seen regularly in the financial press. These
stocks and bills are bought because they promise to repay a larger
sum of money at some future date, and are sold at a price that
promises a good return to whoever buys them. They are usually
denominated in considerable sums of GBP 1,000 or more per bond and
are bought by insurance companies, pension funds, banks and trust
funds ... anywhere that money accumulates as savings. By selling
these stocks, the government obtains the additional money it needs
for the public sector, making up the annual shortfall in what it
can gather by taxation.

As these government stocks mature and become due for payment, the
government has to find the money promised on those stocks, and pay
it to the financial institutions that bought them. But governments
are unable to pay this money owing on their past stock issues.
Indeed, each government is confronted by the current year's annual
shortfall in taxation receipts. The whole reason for the government
issuing stock in the first place was because it could not cover its
expenditure through taxation, and this annual shortfall is
constant. There is no way a government can pay the money it owes.
How then can the government pay up on its maturing stock? It has
underwritten promises it cannot keep. What happens is that the
government obtains the money to meet the payments due on maturing
national debt stocks by selling more government stock to the
financial institutions - 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. Of course, when this new stock matures it too has to be
paid off from the sale of yet more stock. The government manages to
pay off the national debt, and not pay it, at one and the same
time ...

There is a pretence that this is not the true arrangement, since
repayment of national debt stocks is actually accounted as coming
from taxation, not from the sale of more bonds. But this repayment
from taxation creates such a massive shortage in government
revenues that can only be made up by the sale of more bonds so the
net effect is that repayment is constantly deferred by the sale of
further government bonds. This is what is referred to as interest
on the national debt although it is not really interest in the
conventional banking sense, but a constant rescheduling of a
completely un-repayable debt. This deferral is not, however, the
end of the story ...

At the same time as deferring and re-mortgaging the existing level
of national debt, the government has to sell yet more stock to
cover the amount by which taxation falls below what is needed to
support its public services. The national debt therefore escalates,
increasing by the amount required to re-mortgage the past national
debt, plus the shortfall in revenues to fund the public sector. In
1960, the UK national debt was GBP 26 billion; by 1980 it had risen
to GBP 90 billion. The national debt in 1998 stands at nearly GBP
380 billion, and is likely to reach a trillion pounds within the
next twenty to 25 years. In America, the national debt in 1960
stood at $240 billion; by 1997 it had reached the level of $5,000
billion, or $5 trillion!

It should also be remembered that the money held by pension funds
and insurance companies, or whoever buys the government stocks, is
money that had to be borrowed into existence in the first place. In
other words, by this process, governments borrow money which has
already been borrowed into existence, and they thus create a second
massive institutional debt in respect of money which already has a
debt behind it! Adding the national debt to the total of private
debt places a country and its people in a position of overall
negative equity, owing far more on paper than the amount of money
that exists in the economy.

So, in summary: Governments draw up official treasury bonds, and
these are auctioned on the money markets. The bonds are bought by
both the banking and non-banking sectors. When the non-banking
sector (pension and insurance funds et cetera) purchases the bonds,
saved monies are recycled into the economy through government
spending. When the banking sector buys government bonds, banks and
lending institutions create credit: There is an increase in the
money stock. This money is spent into the economy through
government spending. {4}

How Coins and Notes are Created {5}

The significant point about coins and notes money created by the
government is that this money is created debt-free, and spent into
the economy by the government. This is a vital consideration, and
it is therefore important to appreciate precisely how this
injection of debt-free money is managed. Coins and notes are minted
and printed by the government at no cost, apart from that of
materials. Of course, governments have no particular need of these
coins and notes; banks are the institutions requiring a supply of
cash. The government therefore sells the coins and notes that it
creates to banks, who pay by cheque, and the government acquires
the face value of those coins and notes in number-money. The sum of
money which the government obtains, and which is debt-free so far
as the government is concerned, is then added to whatever taxation
revenue has been raised to fund the public sector. Thus, coins and
notes are created by the government, and an amount equivalent to
the face value of those coins and notes is spent into the economy
as a direct, debt-free input.

How International or Third-World Debt is Created

The financial position of even the wealthiest nations is one of
acute financial pressure, with massive private and national debt,
and budgetary difficulty dominating the economy. How can the
wealthy nations, from a position of such perpetual monetary
shortage and insolvency, lend money to the developing nations? The
answer is that they do not. The money advanced to Third World
nations is not money loaned from the wealthy nations. These sums
consist almost entirely of monies that have been created, via the
commercial banking mechanism, specifically for the purpose of the
loan concerned. In other words, the same debt-based, banking
process used to supply money to national economies is also employed
for the creation and supply of funds to debtor nations.

Thus, these monies are not owed by debtor countries to the
developed nations, but to private, commercial banks.

The World Bank

Holding only a nominal reserve contributed by the wealthy members,
the World Bank raises large quantities of money by drawing up bonds
and selling these to commercial banks on the money markets of the
world. Thus, the World Bank does not itself create the money it
advances to Third World nations, but sells bonds to commercial
banks which, in purchasing these bonds, create money for the
purpose. The World Bank therefore functions along the lines of a
country's national debt. Just as with the government bonds of a
country's national debt, when a commercial bank makes a purchase of
World Bank money-bonds, the commercial bank creates additional bank
credit. In essence, the World Bank acts as broker for commercial
banks, who are the actual money-creation agents and who hold World
Bank bonds in lieu of monies they create in parallel with debts
registered against Third World nations. Although these loans may be
denominated in pounds, dollars or Francs, such loans advanced under
the World Bank have no connection with respective national
economies, and in no sense represent monies loaned by these
nations, nor debts owed to them by developing nations. The debts
are owed to private, commercial banks (via the World Bank) in
respect of money they have created through the purchase of debt
bonds.

The International Monetary Fund

The IMF presents itself as a financial pool an international
reserve of money, built up with contributions, known as quotas,
from subscribing nations - that is, most nations of the world.
However, credit creation accompanies almost every aspect of IMF
funding ...

Twenty-five percent of each nation's IMF quota is paid in the form
of gold, the remainder in the nations own currency. The 25% gold
quota is the only component of IMF lending capacity that does not,
in some way, constitute additional money created in parallel with
debt.

The 75% of a nation's quota payable in national currency is
invariably funded by the government concerned through the sale of
bonds, thus adding to that nation's national debt. Therefore the
IMF, whilst not itself creating credit, places monetary demands on
member countries for quotas that can only be funded via each
country's national deficit. This involves the sale of government
bonds to commercial banks, leading to money creation by those
banks. This source of revenue forms the main fund of IMF monies
available to developing nations.

Since the monetary demands on the IMF are constantly increasing,
due to rising demand for Third World loans, the quota demands by
the IMF have reached the point where (so-called) creditor nations
such as America and Britain are reluctant to undertake yet more
bond issues and further national debt to supply these funds. So, in
recent years the IMF has begun to circumvent the restrictions of
its overall quota. By co-operating directly with commercial banks
to organise more substantial loans than it can fund from its own
quota resources, the IMF administers loan packages made up in part
from its own quotas and in part from commercial sources. For
example, of the $56 billion loan advanced under the IMF to South
Korea in the wake of the Asian crisis, only $20 billion was
contributed by the Fund; the remaining $36 billion was arranged by
direct co-operation with international commercial banks, which
created money for the purpose.

The total funds of the IMF were substantially increased and its
function and status as a money-creation agency clarified when, in
1979, the IMF instituted 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 (defined in dollars)
it must repay this amount, or pay interest on the loan. Whilst 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 is now creating and issuing
money in the form of a new international currency, created in
parallel with debt, under a system essentially the same as that of
a bank ... the IMF reserve being the original pool of quota funds.

In summary, of the $2,200 billion currently outstanding as Third
World or developing country debt, the vast majority represents
money created by commercial banks in parallel with debt. In no
sense do the loans advanced by the World Bank and IMF constitute
monies owed to the creditor nations of the World Bank and IMF. The
World Bank co-operates directly with commercial banks in the
creation and supply of money in parallel with debt. The IMF also
negotiates directly with commercial banks to arrange combined
IMF/commercial loan packages.

As for those sums loaned by the IMF from the total quotas supplied
by member nations, these sums also do not constitute monies owed to
'creditor' nations. The monies subscribed as quotas were initially
created by commercial banks through the agency of national debts.
Therefore both the contributing nation and the borrowing Third
World nation carry a burden of debt associated with these sums.
Both quotas and loans are owed, ultimately, to commercial banks {6}.

Notes:

{1} The Drive Behind Globalisation (1998), pages 3-4.

{2} The Grip of Death, Jon Carpenter Publishing (1998), pages 11-13.

{3} The Grip of Death, pages 96-98.

{4} Creative Accountancy, 1998, page 29.

{5} The Grip of Death, page 14.

{6} The Invalidity of Third World Debt (1998), pages 14-17. Also
see article here for how Third World debt can be cancelled:
http://www.prosperityuk.com/prosperity/articles/cantwd.html _____

Please print out, photocopy and distribute these articles. Also
copy and paste them to emails, and circulate widely, and please
include all the essential contact information below. Thank you.

Essential Further Reading:

Prosperity: Freedom from Debt Slavery is a four-page quarterly
journal which campaigns for publicly-created debt-free money.
Prosperity is edited and published by Alistair McConnachie and a
four-issue subscription is available for GBP 10 payable to
Prosperity at 268 Bath Street, Glasgow, Scotland, UK, G2 4JR. Tel:
0141 332 2214; Fax: 0141 353 6900, Email:
contactus at ProsperityUK.com http://www.ProsperityUK.com All
back-issues are still available. The forty-page Report, Clarifying
our Money Reform Proposals, launched at the 2006 Bromsgrove
Conference, is available for GBP 10 payable to Prosperity and is
essential reading for beginners.

The Grip of Death: A study of modern money, debt slavery and
destructive economics by Michael Rowbotham [Jon Carpenter
Publishing, 1998], Goodbye America! Globalisation, debt and the
dollar empire by Michael Rowbotham [Jon Carpenter Publishing,
2000], and Creating New Money: A monetary reform for the
information age by Joseph Huber and James Robertson [New Economics
Foundation, 2000] are all available from Prosperity.

http://www.prosperityuk.com/prosperity/articles/moneymake.html


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