Time for a New Theory of Money

By understanding that money is simply credit, we unleash it as a powerful tool for our communities

The reason our financial system has routinely gotten into trouble, with periodic waves of depression like the one we’re battling now, may be due to a flawed perception not just of the roles of banking and credit but of the nature of money, itself. In our economic adolescence, we have regarded money as a “thing” — something independent of the relationship it facilitates. But today there is no gold or silver backing our money. Instead, it’s created by banks when they make loans (that includes Federal Reserve Notes or dollar bills, which are created by the Federal Reserve, a privately-owned banking corporation, and lent into the economy). Virtually all money today originates as credit, or debt, which is simply a legal agreement to pay in the future.

Money as Relationship

In an illuminating dissertation called “Toward a General Theory of Credit and Money” in The Review of Austrian Economics (vol. 14:4, pages 267-317, 2001), Mostafa Moini, Professor of Economics at Oklahoma City University, argues that money has never actually been a “commodity” or “thing.” It has always been merely a “relation,” a legal agreement, a credit/debit arrangement, an acknowledgment of a debt owed and a promise to repay.

The concept of money-as-a-commodity can be traced back to the use of precious metal coins. Gold is widely claimed to be the oldest and most stable currency known, but this is not actually true. Money did not begin with gold coins and evolve into a sophisticated accounting system. It began as an accounting system and evolved into the use of precious metal coins. Money as a “unit of account” (a tally of sums paid and owed) pre-dated money as a “store of value” (a “commodity” or “thing”) by two millennia; the Sumerian and Egyptian civilizations using these accounting-entry payment systems lasted not just hundreds of years (as with some civilizations using gold) but thousands of years. Their bank-like ancient payment systems were public systems — operated by the government the way that courts, libraries and post offices are operated as public services today.

In the payment system of ancient Sumeria, goods were given a value in terms of weight and were measured in these units against each other. The unit of weight was the “shekel,” something that was not originally a coin but a standardized measure. She was the word for barley, suggesting the original unit of measure was a weight of grain. This was valued against other commodities by weight: So many shekels of wheat equaled so many cows equaled so many shekels of silver, etc. Prices of major commodities were fixed by the government; Hammurabi, Babylonian king and lawmaker, has detailed tables of these. Interest was also fixed and invariable, making economic life very predictable.

Grain was stored in granaries, which served as a form of “bank.” But grain was perishable, so silver eventually became the standard tally representing sums owed. A farmer could go to market and exchange his perishable goods for a weight of silver, and come back at his leisure to redeem this market credit in other goods as needed. But it was still simply a tally of a debt owed and a right to make good on it later. Eventually, silver tallies became wooden tallies became paper tallies became electronic tallies.

The Credit Revolution

The problem with gold coins was that they could not expand to meet the needs of trade. The revolutionary advance of medieval bankers was that they succeeded in creating a flexible money supply, one that could keep pace with a vigorously expanding mercantile trade. They did this through the use of credit, something they created by allowing overdrafts in the accounts of their depositors.

Under what came to be called “fractional reserve” banking, the bankers would issue paper receipts called bank notes for more gold than they actually had. Their shipping clients would sail away with their wares and return with silver or gold, settling accounts and allowing the bankers’ books to balance. The credit thus created was in high demand in the rapidly expanding economy; but because it was based on the presumption that money was a “thing” (gold), the bankers had to engage in a shell game that periodically got them into trouble. They were gambling that their customers would not all come for their gold at the same time; but when they miscalculated, or when people got suspicious for some reason, there would be a run on the banks, the financial system would collapse, and the economy would sink into depression.

Today, paper money is no longer redeemable in gold, but money is still perceived as a “thing” that has to “be there” before credit can be advanced. Banks still engage in money creation by advancing bank credit, which becomes a deposit in the borrower’s account, which becomes checkbook money. In order for their outgoing checks to clear, however, the banks have to borrow from a pool of money deposited by their customers. If they don’t have enough deposits, they have to borrow from the money market or other banks.

As British author Ann Pettifor observes:

[T]he banking system … has failed in its primary purpose: to act as a machine for lending into the real economy. Instead the banking system has been turned on its head, and become a borrowing machine.

The banks suck up cheap money and return it as more expensive money, if they return it at all. The banks control the money spigots and can deny credit to small players, who wind up defaulting on their loans, allowing the big players with access to cheap credit to buy up the underlying assets very cheaply.

That’s one systemic flaw in the current scheme. Another is that the borrowed money backing the bank’s loans usually comes from shorter-term loans. Like Jimmy Stewart’s beleaguered savings and loan in It’s a Wonderful Life, the banks are “borrowing short to lend long,” and if the money market suddenly dries up, the banks will be in trouble. That is what happened in September 2008: According to Rep. Paul Kanjorski, speaking on C-Span in February 2009, there was a $550 billion run on the money markets.

Securitization: “Monetizing” Loans Not with Gold But with Homes

The money markets are part of the “shadow banking system” where large institutional investors park their funds. The shadow banking system allows banks to get around the capital and reserve requirements now imposed on depository institutions by moving loans off their books. Large institutional investors use the shadow banking system because the conventional banking system guarantees deposits only up to $250,000, and large institutional investors have much more than that to move around on a daily basis. The money market is very liquid, and what protects it in place of FDIC insurance is that it is “securitized,” or backed by securities of some sort. Often, the collateral consists of mortgage-backed securities (MBS), the securitized units into which American real estate has been sliced and packaged, sausage-fashion.

Like with the gold that was lent many times over in the 17th century, the same home may be pledged as “security” for several different investor groups at the same time. This is all done behind an electronic curtain called MERS (an acronym for Mortgage Electronic Registration Systems, Inc.), which has allowed houses to be shuffled around among multiple, rapidly changing owners while circumventing local recording laws.

As in the 17th century, however, the scheme has run into trouble when more than one investor group has tried to foreclose at the same time. And the securitization model has now crashed against the hard rock of hundreds of years of state real estate law, which has certain requirements that the banks have not met — and cannot meet, if they are to comply with the tax laws for mortgage-backed securities. (For more on this, see here.)

The bankers have engaged in what amounts to a massive fraud, not necessarily because they started out with criminal intent (although that cannot be ruled out), but because they have been required to in order to come up with the commodities (in this case real estate) to back their loans. It is the way our system is set up: The banks are not really creating credit and advancing it to us, counting on our future productivity to pay it off, the way they once did under the deceptive but functional façade of fractional reserve lending. Instead, they are vacuuming up our money and lending it back to us at higher rates. In the shadow banking system, they are sucking up our real estate and lending it back to our pension funds and mutual funds at compound interest. The result is a mathematically impossible pyramid scheme, which is inherently prone to systemic failure.

The Public Credit Solution

The flaws in the current scheme are now being exposed in the major media, and it may well be coming down. The question then is what to replace it with. What is the next logical phase in our economic evolution?

Credit needs to come first. We, as a community, can create our own credit, without having to engage in the sort of impossible pyramid scheme in which we’re always borrowing from Peter to pay Paul at compound interest. We can avoid the pitfalls of privately-issued credit with a public credit system, a system banking on the future productivity of its members, guaranteed not by “things” shuffled around furtively in a shell game vulnerable to exposure, but by the community, itself.

The simplest public credit model is the electronic community currency system. Consider, for example, one called “Friendly Favors.” The participating Internet community does not have to begin with a fund of capital or reserves, as is now required of private banking institutions. Nor do members borrow from a pool of pre-existing money on which they pay interest to the pool’s owners. They create their own credit, simply by debiting their own accounts and crediting someone else’s. If Jane bakes cookies for Sue, Sue credits Jane’s account with 5 “Favors” and debits her own with 5. They have “created” money in the same way that banks do, but the result is not inflationary.  Jane’s plus-5 is balanced against Sue’s minus-5, and when Sue pays her debt by doing something for someone else, it all nets out. It is a zero-sum game.

Community currency systems can be very functional on a small scale, but because they do not trade in the national currency, they tend to be too limited for large-scale businesses and projects. If they were to grow substantially larger, they could run up against the sort of exchange rate problems afflicting small countries. They are basically barter systems, not really designed for advancing credit on a major scale.

The functional equivalent of a community currency system can be achieved using the national currency, by forming a publicly owned bank. By turning banking into a public utility operated for the benefit of the community, the virtues of the expandable credit system of the medieval bankers can be retained, while avoiding the parasitic exploitation to which private banking schemes are prone. Profits generated by the community can be returned to the community.

A public bank that generates credit in the national currency could be established by a community or group of any size, but as long as we have capital and reserve requirements and other stringent banking laws, a state is the most feasible option. It can easily meet those requirements without jeopardizing the solvency of its collective owners.

For capital, a state bank could use some of the money stashed in a variety of public funds. This money need not be spent. It can just be shifted from the Wall Street investments where it is parked now into the state’s own bank. There is precedent establishing that a state-owned bank can be both a very sound and a very lucrative investment. The Bank of North Dakota, currently the nation’s only state-owned bank, is rated AA and recently returned a 26 percent profit to the state. A decentralized movement has been growing in the United States to explore and implement this option. [See here for more information.]

We have emerged from the financial crisis with new clarity: money today is simply credit. When the credit is advanced by a bank, when the bank is owned by the community, and when the profits return to the community, the result can be a functional, efficient, and sustainable system of finance.

Ellen Brown is an attorney, founder of the Public Banking Institute, and author of twelve books, including the best-selling Web of Debt, The Public Bank Solution, and Banking on the People: Democratizing Money in the Digital Age. She also co-hosts a radio program on PRN.FM called “It’s Our Money.” Her 400+ blog articles are posted at EllenBrown.com. This article was first published in Scheer Post. Read other articles by Ellen.

12 comments on this article so far ...

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  1. ajohnstone said on November 1st, 2010 at 8:21am #

    Trouble with many contributors on this site is that they seek out solutions without understanding the causes. Marx wrote extensively on money and banking and credit yet how convenient it is to forget his conclusion that it is the entire capitalism system not simply individual aspects of its functioning that is the problem. There is no new clarity. Simply another economist’s cul de sac. Theorists seem to forget that the capitalist system remains, in all essentials, the same as it was when Marx studied in the British Museum. Lest we forget, the source of all Rent, Interest and Profit is the unpaid labour of the working class.

    Who are the people who find a difficulty in paying for the money they use? Not the working class in any sense of the word. Not the large capitalists, for they control the powers of government and have a currency suitable to their interests. There is left the small capitalist and shopkeeping section, who, fond of calling themselves the “middle” class, find themselves unable to hold their own positions against the giant production and “chain store” system of distribution that is crushing them out in all directions. Hence this howl for an extension of “credits” and the introduction of “cheap” money for the purpose of paying their debts. There is no chronic shortage of purchasing power. Sufficient to buy the product is generated as wages and profits in the course of production. Slumps are not caused by an absolute shortage of purchasing power but arise when, because of falling profit prospects, capitalist firms choose not to spend all their profits on fully renewing or on expanding production.

    Money! What is money? Money is a ticket that enables one to buy goods with, just as a railway ticket enables one to ride on the train goes the argument . The more tickets one has in one’s pockets, the more he can buy. These tickets are, therefore, merely media of circulation, purchasing power. They may be made of anything . The material is of no consequence. What is of consequence, though, is the quantity of money in circulation. The mortal sin of the banks is that they refuse to issue enough money, or credit, to enable the “common man” to procure the necessities of life. Therefore, the power to issue money and credit based on social wealth must be taken over by a state-owned . Money, it explains, causes commodities to circulate, but herein it is certainly deceived by appearances. In reality, the movement of money is simply the reflex of the circulation of commodities. Money only realises the prices of commodities. Given the velocity of money, among other things, the quantity of money required in a community is just the amount sufficient to realise the prices of the goods to be exchanged. More than this the system cannot and will not absorb. For money, in the sphere of circulation is an effect not a cause. Hence, there is nothing seriously wrong with money, as such. Consequently, to increase the quantity of money will not put more goods into the hands of the people. Such an increase, in place of causing a greater quantity of commodities to circulate, can only have the effect of cluttering up the machinery of exchange. To advance as an argument for such an increase that many people are suffering because they have not the money with which to buy the necessities of life is not an argument for the relief of distress. Many are deeply moved because many are scarcity amidst plenty. It is a condition the reason for which baffles them. They can see easily enough that the products of labour are not properly distributed. That does not require much brain work . But they do not have sufficient insight into the capitalist system to be able to understand that this condition arises from the fundamental contradiction of the system. This fundamental contradiction is that goods are socially produced, but individually appropriated by the private owners of the means of wealth production. The profit system, albeit appropriately modified, must be maintained at all costs. Hence, they want to retain the capitalist system, but at the time escape the inequalities and distress which it produces. So when they speak of changing the system, what they have in mind is an indefinite idea of correcting some of its faults. Yet those faults will only end when the means of production are brought into common ownership and democratic control so that they can be oriented towards directly satisfying people’s needs – when banks, money and all the rest of the buying and selling system will have become redundant.

    Commodities express the amount of labor time embodied in them and that is how Marx has defined money.

  2. bozh said on November 1st, 2010 at 8:57am #

    First comment i read to date that mentions the untouchables: causes. There was a piece on DV that listed causes. I have’n seen a pice like that on any site i had been on.
    I am no sure that i have come across even one postulated or affirmed proposal that wld earn the label “solution”.

    I am not saying that blaming cannot lead us on to solving; however, i cannot understand why solving is not mentioned also!

    It can be proved that thinktanks, orgs, movements, sites, blogs; having their pet peeves or particular goals, have actually made things worse and for ‘aliens’ more so.
    I wonder if most of these sites haven’t been taken over by people with money or even send people on their ‘missions’ to destroy what is left of any good writing. tnx

  3. bozh said on November 1st, 2010 at 10:06am #

    Ok! We can deem money a “relation”. I suggest we also cld deem it as symbol and as such standing for trust.
    Flag is a symbol. It to stands for trust between individuals. As a citizen u trust, among many other things, that ur needs wld be covered; u’l obtain an education, work; have peace, etc.
    And the trust being our greatest asset, yet utterly destroyed by clerico-noble class of life.
    So, this leads to a conclusion that money does not stand for trust. Has it ever? At one time, a hand shake stood as symbol of trust between people.
    A deal wld be closed by handshake: i’l hoe ur vineyard when the time comes but give me ten geese for it right now.
    So, in short, we can deem money or flag as weapon! Both ‘symbols’ symbolizing criminal behavior.
    If people only knew this, it wld be a giant leap to sanity. tnx

  4. Don Hawkins said on November 1st, 2010 at 10:46am #

    INDIANAPOLIS — Armed security guards will be on hand at 36 unemployment offices around Indiana in what state officials said is a step to improve safety and make branch security more consistent.
    No specific incidents prompted the action, Department of Workforce Development spokesman Marc Lotter told 6News’ Norman Cox.
    Lotter said the agency is merely being cautious with the approach of an early-December deadline when thousands of Indiana residents could see their unemployment benefits end after exhausting the maximum 99 weeks provided through multiple federal extension periods. INDIANAPOLIS

    Ellen some radical ideas you have then again maybe they are not radical at all but sensible you might have used reason, known knowledge and imagination.

  5. Don Hawkins said on November 1st, 2010 at 11:12am #

    I read your witting again Ellen and you did you reason, known knowledge(somewhat of a lost art), and imagination and very radical indeed in old twenty ten. It does appear what we do see is and more on the way many scraping by on the fringe, the day-laborers, odd job men, buskers, the peddlers pushing carts, even the homeless, for they are the point men and women, the pioneers of our time and this all done while nothing is real any more. Nothing is as it seems better known as a prison for the mind. Did I just use Linh Dinh and George Monbiot’s words yes I sure did and will use any words I can to melt that prison for the mind and yes it only takes a though and help me am melting am melting.

  6. Don Hawkins said on November 1st, 2010 at 11:16am #

    Sorry I missspelled thought forgot the t thought that’s thought heck let’s capitalize it, THOUGHT.

  7. jimekai said on November 1st, 2010 at 3:43pm #

    An article that starts by saying that money concerns the relationship it facilitates and then proceeds to limit that to the lowest common denominator of a barrow-boy’s debit and credit mechanism is nothing but mind control written by a member of the controlled opposition.

    … and if you’re intrigued by the below snip from this link, translated from Russian, you can read later why the debit and credit system needs to be replaced. These aren’t my words and today’s supercomputer AI concepts go far beyond modeling consumption of goods and services into the realms of law and the environment, but they’ll do for the time being.

    Whilst price lists and value lists may at first sight seem equally useful in cost accounting, credit account lists imply something quite different. Here money appears not as a neutral metric, but as, what Smith called, the power to command the labour of others. Credit accounts encode social hierarchy. Throughout history the index of membership of the upper classes was the ability to command others to do things. Thus the persistence of such accounts in socialist societies is an index of the survival of capitalist forms of domination, of lordship.
    A more useful syllogism might be Catalism [?kæt??l?z?m]. n. Derived from catalist n. One who uses this said mechanism for being able to command the labor of cats.

  8. kalidas said on November 1st, 2010 at 3:48pm #

    “When you have usury, who needs alchemy?”

  9. Deadbeat said on November 2nd, 2010 at 12:44pm #

    I don’t have too much time but I agree with ajohnstone assessment of money. Money is a commodity and it is totally unnecessary and anachronistic. People should have access to the socially necessary goods and services and these “tickets” if you will are part of the indoctrination and system of Capitalism.

  10. cruxpuppy said on November 5th, 2010 at 8:22pm #

    Capitalism refers to a condition when money is concentrated in the hands of an elite few and this condition arises when the financial system is owned and operated by this same elite. Marx critiqued this condition as it prevailed in his time and ajohnstone is correct to claim it has not changed much.

    Capitalism can masquerade as economic democracy, as it does in the US, but the private central bank that claims to operate in the public interest to maintain maximum employment and stability, defrauds the public instead, making credit available to the self-perpetuating crony elite, while keeping the majority in a desperate subsistence mode.

    Ellen Brown is attempting to change this state of affairs by advocating public banks, owned and operated by the people in the public interest, state-owned banks that would allow for a more equitable distribution of credit. This would change our economic system radically. It would cease to be the ogre of capitalism that Marx described.

    The means of production would be held in many private hands, not in the few hands of oligarchs.

  11. Deadbeat said on November 5th, 2010 at 9:00pm #

    cruxpuppy writes …

    Ellen Brown is attempting to change this state of affairs by advocating public banks, owned and operated by the people in the public interest, state-owned banks that would allow for a more equitable distribution of credit. This would change our economic system radically. It would cease to be the ogre of capitalism that Marx described.

    Aren’t you advocating debt? That implies the inability to access needed resources in order to participate in the economy. That is the only reason for “credit” which has to be repaid. It would seem to be much more efficient and effective to remove the need for credit. In other words conceive of a society that goes beyond the commodity fetish of money. Money IMO is an anachronistic concept and totally useless in today’s technological world.

    Ms. Brown’s ideas still maintains the requirement for “tickets” in order to participate in the economy. Isn’t it time to consider a society that can get beyond money?

  12. cruxpuppy said on November 6th, 2010 at 8:34am #

    You’re right, Deadbeat, credit implies debt, and to get on the money merry-go-round, you need to have your tickets to ride. Money has a cost, which is fundamentally, labor. The state bank funds its infrastructure and essential services and its citizens provide the labor to earn their tickets to ride. The state issues credit to do this, but the debt incurred is owed to itself, not the central bank, or other private sources. This public debt is then paid in taxes. The public sector then becomes a zero sum game.

    The state bank is owned by the people, not a private cabal. It is essentially a non-profit corporation. It creates money ex nihilo through fractional reserve banking, as the private banks do now. The difference is that the private cabal is replaced by the people, the public interest. The cost of money created is considerably reduced. It is no longer a private corporation with a mandate to enrich private owners and the money is no longer private money.

    The private sector continues on its merry way. The economy is not state-owned, as ajohnstone would have it. The operations of the state-owned bank control the money supply, making it impossible for the private bankers to impose deflation and squeeze liquidity out of the system as they do now.