Tuesday, 4 November 2008

The Banking Crisis and the Ecological Crisis


I approach the banking and financial crisis as an ecological economist. For me the context of the banking and financial crisis is a far more important crisis in the relationship between humanity and the natural world in which we are in severe danger of creating the conditions for our own extinction and the extinction of most other species on the planet.


The significance of the banking crisis for me is that it demonstrates that we have an economic system without a reverse gear - given the nature of the banking and finance system there no means currently exists to manage an orderly contraction and reorganisation of the economy. With the banking and finance system as we have it now the economy either grows or it is collapses - there is no other way.

Money lending in historical overview

In the middle ages and through most of the history of humanity lending of money for interest has been regarded as a sin and as socially and economically destructive. If the economy did not grow, and through most of the history of humanity the economy did not grow for long, the fact that moneylenders wanted repaying with interest inevitably meant that moneylenders ended up with a greater proportion of social production - and that could not continue for long. It was socially and economically corrosive. However, when the economy started growing, at first through long distance trade, and then at the time of the industrial revolution because of the application of fossil fuels to the productive process, the finance system could grow too. In these different circumstances it could share in the increased production and wealth. There was more for everyone - at least in the first mercantile colonial powers and then the industrial colonial powers.

Limits of fossil fuel generated production growth

However, now that we have reached the ecologically sustainable limits of a fossil fuel generated production expansion we return to the old truth. Lending involves a repayment with interest. If the economy cannot grow then the repayment of interest means that bankers will get an increasing proportion of society's product and there are limits to how much that can occur.

From a credit system using physical currencies to the dominance of debt based money

Unfortunately, the situation is a bit more complicated than that. It is not only that we have "too much debt" as some people put it - the problem is that we have a money and payment system that is founded upon debt. Once upon a time currencies were commodities like the precious metals, silver and gold. Money lending involved lending a material object and the credit and money lending was an outgrowth of the money system - now however the credit system is the money system.

Over the last two centuries we have evolved a money system which is almost entirely founded on debt. When I was a boy in the 1950s a half of the money in circulation were notes and coin and a half were bank deposits. Now, however, bank deposits make up 97% of the money in circulation. All of this money came into existence when banks lent it into existence.

Common misunderstandings of money

The common misunderstanding about money is that governments create it and when people get that money they put it in their bank accounts and the banks lend the money on. Actually that's not right. The banks create the money that they lend into existence. One way of seeing that is the banks are monetizing your agreement to repay a loan with interest.

Repayment with interest requires extra income - so stagnation and contraction which bring defaults also represent a threat to the very existence of our everyday payment system.

If the debts aren't serviced the money system starts to collapse...

Thus the money supply is backed, not by gold, but by debt and the maintenance of this entire show depends on households and companies and governments being able to service their debts - which means, obviously, repaying them with interest. And, as we have said, they can only repay with interest if the economy is growing. When incomes and profits start falling the repayment of debts and the payment of interest becomes much more difficult. That means defaults. Defaults mean losses for the banks and if large enough that can create a collapse in confidence in banks and bank runs.

Since banks deposits are effectively the monetization of the agreement to repay it means that when people cannot repay, when defaults occur, the fear takes hold that the value of the assets behind bank money is in melt down. That creates a run on the banks which creates a self fulfilling prophecy. For if banks and others are forced to sell assets to raise cash this creates a fire sale in which asset prices fall dramatically. If they survive the banks then fear to lend - and in those economic circumstances everyone else fears to borrow.

Contractions become self reinforcing

Contraction leads to a debt servicing crisis leads to a further reduction in lending leads to a further reduction in money supply in circulation - a self reinforcing downward avalanche which ultimately always puts the payment system in danger. Thus instead of merely make losses you are always confronted with the possibility of a collapse - in which governments scramble to get growth going again.

This returns me to my original point - given this type of money system the economy does not have a means for orderly retreat. There is no option of managed contraction. Retreats become routs unless a successful big effort is organised get the economy growing again - even if that is immensely ecologically destructive, even if taking out increased productivity in unpaid leisure would be preferable, even if the material resources for growth are heavily in depletion and it becomes more and more expensive to get them out of the ground as with oil, gas and other resources, even if we are in danger of driving ourselves into a climate change driven extinction.

Moral Hazard

Since 97% of our money supply is bank money that means that the bankers have us all over a barrel. The problem of moral hazard is that we all depend on the money system for everyday transactions and exchange. In that sense the money system, which has evolved over centuries, is a commons. However it is a commons that has been privatised by bankers and run in their private interest and these bankers are perfectly well aware that if it looks as if the banking system will collapse there is no alternative but to bail them out. The state must step in to prop up the banks. Unless they are propped up we have no means of conducting everyday transactions so tax payers are called upon to prop up bankers.

Creating an economy that can contract without collapsing

So how do we re-create an economy with a reverse gear - how can we create a money system that doesn't spiral into collapse during contraction? The answer is to create a money system that is not based on debt.

Taking the right to create money from the banks - two examples

The first thing that is needed is that the right to create money based on debt is taken away from the banks. How would this work? Lets take an example:

Under the current arrangements lets say that I take £10,000 new money and put it into the bank. With that new money the bank will, if it thinks it can do so safely, lend £9,000 extra to a person or a company who uses the loan to make purchases. Their payment goes into a bank and lo and behold a further £9,000 deposits have been added to my initial £10,000. 90% of that £9,000 will be lent and then there will be a further £8,100 money deposits created. That continues until £90,000 extra money exists over and above my original £10,000 deposit.

If one denies the banks the right to do this they could still lend money on but they would not be able to create money. If the bank want to lend on £9,000 of my £10,000 deposits to a third party they must convince me to make them a loan for same period as they want the third party loan to last. In this case I no longer have £10,000 in the bank as a money deposit that I can spend at any time - I will only have £1,000 on deposit and will have made a £9,000 loan to the bank for a particular period of time that matches their £9,000 loan to someone else. In that case the bank would be merely acting as intermediary between myself as a long term saver and someone else as a borrower.

They could still make money doing this and the banking and financial system would be a lot more stable. I could not demand the £9,000 back until the time is up.

Alternative ways of creating money (1) - money backed by physical assets with value

But this then leads to the question - if banks are no longer allowed to create money, how would money be created? In fact there are a number of different ways to do this - both at a local or regional level, at a national and at an international level. I will confine myself to giving two examples:

As I said, there have been moneys for centuries which, like gold or silver have some kind of intrinsic value. One could create other kinds of currency with an intrinsic value backed by real assets. For example, one could create a currency backed by wood. For example, let's say that there is mass unemployment and no money to employ people. So all over the country people are encourage to plant willow as an energy crop. They do not get a payment in sterling but in notes which say that, in 3 years time they are entitled to a portion of whatever is the value of the coppiced willow when it is harvested and sold. The notes could be held for 3 years and would gain in value as
the willow grew - or they could be exchanged here and now as currency notes whose purchasing power would be a discounted value of the estimate for the future value of the coppiced energy crop.

Alternative ways of creating money (2) - money created by state fiat

Alternatively money can be accepted because the state says it must be accepted in payment for goods and services and in settlement of debts. That is so called fiat money meaning that it is made acceptable by state fiat - because the state says it has to be accepted as legal tender for payments and in payment of debts. The amount of such money created could be determined by a public body that was responsible to create money in the interests of society as a whole. How much of the money that is created should be determined by the needs of the economy and society and ecological system.

Once that is decided the money would then be made available - either to the state to be spent into circulation or distributed to citizens on some other basis. For example new money might be given to the state who use it to spend on ecological infrastructure programmes. Or it might be given to elderly people as pensions to help them cope with rising fuel bills.

Money based on the the mobile phone system

Nor do we even need to create money by printing the stuff on pieces of paper - it would be possible to create payment between balances electronically credited to accounts that could be access and used between mobile phones for example - as unique SIM cards and PIN numbers give enough security to operate a full payment system by mobile. All that is needed is that people get the balances to start with. (This is an idea currently being considered by my colleagues in Feasta)

Money creation and inflation

The idea of giving the state the right to print money alarms people who assume, ipso facto, that this will be inflationary. In fact I am suggesting an independent trust has the right, bound by certain parameters. What's more it depends on the context in which money is created, how much is created and on what it is spent. If there is unused capacity in an economy then buying production that gets this capacity into work with newly created money is not inflationary - as long as the spending can be reversed as appropriate. Indeed state expenditure that makes it possible for the economy to avoid using resources will reduce cost pressures - an example would be if buildings are insulated using state grants. This reduces the need to spend on fuels which cheapens the cost of living in the long term. It is also important to note that creating money could absolve the state from the need to raise some taxes or from borrowing money at interest from banks. In that sense it would lighten the burden on people too. Surely one of the biggest absurdities or, alternatively, one of the biggest examples of institutionalised bare faced cheek, is the way that the state borrows from the banks at interest - when the banks create the money that they lend and the state could just as easily create money itself without having to pay any interest on it.

As debt based money crashes it is rather important that alternative sources of purchasing power are brought into existence and the problem is deflation not inflation. There is likely to be social and economic chaos - which is not at all the right circumstances in which to rebuild an ecological society.

Conclusion - a money system in which the economy can contract without chaos ensuing

With these changes we could then contract the economy, which may or may not be a painful process but is necessary to take the pressure off the eco-system, without the extreme danger of a complete collapse, with the payment system going down as well. Please note that this will not be in and of itself a sufficient way to manage energy descent and the retreat from the ecological abyss - but it is very much a necessary part of the process.

Brian Davey

Nov 3rd 2008