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Money creation made easy

Apr 23 2014 07:11
*Edward Ingram
CONTINUING from last week's column Curing money supply ills:

Over the years people, including some economists, and including myself, have made the mistake of thinking that there is a limited supply of money to spend and to borrow in the economies of nations.

But the fact is that the banks can create as much money as they are able to lend.

Around 95% of all money in circulation is in the form of deposits that have been created by the banks in this way. They find a borrower, they offer a loan, and the loan immediately becomes a new deposit.

That deposit gets spent and is dispersed among the rest of the economy. In due course, the borrower takes back some deposits from others in return for services rendered, and uses those deposits to pay off the loan. The result is that there is no loan and total deposits reduce.

The problem is that there is no limit to the credit that can be created in this way, so last week I wrote that a possible answer would be to create a money supply authority (MSA) that has sole authority to create new deposits.

The question to ask now is: “How can this changeover take place without causing any dislocation to the system? How smooth can the changeover be?”

The money making mechanism

The newly-created MSA will take custody of the capital that is repaid to the banks in the form of a deposit with the MSA. There it will remain until a new borrower is found to borrow that same deposit again.

When the new borrower is offered a loan by the bank, the bank will take the deposit back from the MSA and give it to the new borrower.

And so there will be no catastrophe. Everything should proceed smoothly as before, with one major difference: too much money will not be created.

And that means that the nation’s capacity to deliver goods and services will be enough to supply the demand for them. Too much money cannot be created this way unless by the deliberate action of the MSA, in breach of its mandate not to do that.

There will not be a balance of payments/trading deficit as imports come in so as to find a home for surplus money. There will not be inflation of asset values as money seeks other places to go. There will not be an exit of capital as asset prices become unrealistic and investors seek other parts of the world in which to invest.

There will not be distorted exchange rates as a result of all that, and interest rates around the world will not be pulled down in that process. That part of the business cycle (the biggest part) caused by a lack of good control over spending in the economy, because of too loose control over the amount of lending that can be done, will no longer be there.

Large parts of economic theory that described economic cycles, and the human behaviour associated with them (greed, panic, herd instinct, fear of borrowing, etc) and much of intervention theory, including the need for a Keynesian stimulus, will become extinct and of no further value - or will it?

We have looked at the stimulus idea before. There is a much better way.

In fact, the result will be very much more stable interest rates. Is all this too much to expect? What are the assumptions being made here? The main one is that there will be little or no intermingling of money flowing from one economy to another, and that the balance of trade between nations is relatively stable.

Next week I will return to the issue of currency stability, mingling of currencies through foreign investment, ending currency wars and enabling traders to get on with more confidence in doing their international business.

 - Fin24

There will be a seminar on the new Ingram Economic Model in London on May 12, aimed at the financial services industry. Click here to find out more.

* Edward Ingram has a strong and growing support base. One American has started a petition asking President Barack Obama and/or his senate committees to look into these ideas. Ingram says: “Why not here in South Africa? The ideas are universal.”

edward ingram  |  money  |  investments

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