Governments and central banks have little control over the amount of money in circulation because their policies are based on the false assumption that money generates money. They depend on banks to implement policies based on this assumption to the extent that they allow banks to misappropriate new money from borrowers so that loans appear to generate new money.
Central banks state that the only way they have to control inflation and deflation (too much or too little money) is to alter the interest rate, as this will reduce or increase the money supply depending on the money market. Changing the interest rate may or may not increase or decrease the money supply. One thing we do know for sure is that if governments have a target rate of inflation, then we will have inflation.
The story of money is that money makes money. This makes sense when looking at businesses or individuals who invest money to increase their wealth. Investing in profitable enterprises transfers money from buyers to investors, leaving the money supply the same. Profits do not create money, and losses do not destroy money as profits change the distribution of money.
However, investing will require more money in the economy as more goods and services are sold. If profits do not create money in the total economy, money has to come into the economy another way.
Unfortunately, the financial system is built around the assumption that money creates more money and has led to today’s dysfunctional system, where secondary stock markets are 250 times the primary market that raises new money.
Mosler’s Description of Money Creation
Mosler, in the 1990s, described how money is created. Central banks around the world have confirmed this. Money is created when a bank credits a customer’s account. Banks are permitted to do this if the credit is a loan because this has been the traditional way that banks have appeared to create money. However, when the loan is repaid, the money made by the loan is cancelled. So how is the money supply increased?
If the bank does not have enough money to lend, it goes to other banks and gets a loan. If no other banks have excess money, it goes to the central bank, which gives the bank a loan. The central bank creates new money with its loans. The money stays in the system unless the central bank reduces its debt.
If the government paid off its debt, the money supply would drop, and there would be a recession, so governments keep paying interest, which increases the money supply. The alternative for the government is to increase taxation or sell off community assets.
Another way to reduce the money supply is to slow down the movement of money. Central banks try to control the money supply in this way.
Central Banks Slow and Speed up Money to Control Inflation
Central banks try to decrease the money supply—not by taking money out but by slowing the rate at which money moves by increasing the interest rate at which they lend. Higher interest rates slow the rate money moves—not by reducing demand but because, it takes longer for borrowers to repay a loan. Slowing money movement is the same as reducing the money supply.
However, it does not work because banks introduce new money into the economy by misappropriating interest from borrowers and never paying it back.
Banks misappropriate money from borrowers, including governments, by requiring them to pay interest and other bank fees twice. For details, read Hidden Fees on Bank Loans. Banks debit bank loan accounts with interest, but instead of crediting the borrower's account, they credit their own and increase the money supply because they treat it as a capital gain.
If central banks stopped banks from misappropriating interest and fees, they could set a target rate of zero inflation. The money banks create is new money, and increasing the money supply counteracts the objective of slowing the economy. It is no wonder that central banks have little influence over inflation and resort to quantitative easing to increase the money supply and interest rate rises to decrease the money supply.
Unfortunately, banks receive interest, which is new money that causes an increase in the money supply.
Loans are an Expensive Way to Increase the Money Supply
Money is created when a bank makes a loan. It is supposed to be destroyed when the borrower repays a loan. However, today, banks also increase the money supply by collecting interest and fees by debiting the borrower's loan account, generating money but not destroying it. The interest would be destroyed if the borrower used the newly created money to pay the interest. Instead, it goes to the bank as a “capital gain”.
Stopping banks from generating unnecessary hidden fees will reduce the increase in the money supply, as will reducing the use of new money to buy and sell existing assets.
Money is removed from the supply when deposited in a bank and not invested. It is also removed when governments tax more than they spend and when an asset is purchased and not resold.
Money decreases when a capital loss occurs, or an asset depreciates.
Money increases when a bank credits a bank account, and the account owner uses the money to build an asset.
Using loans to increase the money supply is an expensive, difficult-to-control system. There is a better way.
Increasing the Money Supply
Instead of increasing the money supply with loans, the central bank should give new money to community groups to build new assets. The main community groups are government and quasi-government organisations; instead of collecting taxes, governments should introduce new money into the community to replace most existing taxes while benefiting all.
Instead of setting interest rates to control the money supply, the central bank has a fixed interest rate that all banks must use. This lets banks compete by charging lower fees—not interest. The interest rate is set at the desired growth of the economy — say, 5%.
To control inflation, the central bank sets the amount of money the government can introduce into the economy through community groups.
Outcomes
Changing how money is introduced into the economy will dramatically improve the productivity of any community. Taxes will drop, productivity will at least double, markets in goods and services will flourish, and the community will increase its wealth at a constant fixed rate. The new approach can start tomorrow by preventing banks from misappropriating interest and fees from borrowers.
It can also start with communities lending existing money to each other without charging interest twice and introducing new money into a closed system with superannuation and other external savings. Once the money is in the “closed” system, it circulates by giving investors fixed annuities, and ownership moves to the borrowers. The profits can remain in the system, leading to more investment that offers a return to participants without consuming capital.
