“How is the present monetary system affecting the economy and thereby society and nature, and why is it failing? I will outline the interconnected malfunctions of the globally prevailing monetary system in ten points.”

This first part of a recommended essay by Mark Joob, is one of the best summaries outlining what’s wrong with the current monetary system. The second part outlines the proposed alternative, a version of the so-called “Chicago Plan”. Read the whole essay here.

Here are the 10 points mentioned:

1. Money is debt.

2. The money supply is under private control.

3. Bank deposits are not secure.

4. The money supply is pro-cyclical.

5. The money supply fosters inflation.

6. Interest on money is a subsidy to the banking sector.

7. Interest on money forces economic growth.

8. Interest fosters wealth concentration.

9. The monetary system is unstable.

10. The monetary system counteracts crucial moral values.

Excerpted from Mark Joob:

“How is the present monetary system affecting the economy and thereby society and nature, and why is it failing? I will outline the interconnected malfunctions of the globally prevailing monetary system in ten points.

1. Money is debt.

Today, money comes into existence exclusively by debt creation when commercial banks borrow from central banks and governments, producers and consumers borrow from commercial banks. Thus, the money supply of the economy can only be maintained if the private or public economic actors get into debt. Economic growth requires a proportionate increase in the money supply in order to avoid deflation that would paralyse business, but an increase in the quantity of money involves a simultaneous increase in debt. This way, economic actors run into danger of excessive indebtedness and bankruptcy. It is not necessary to say that overindebtedness causes serious problems to societies and individuals in the face of the ongoing debt crisis which began as a debt crisis of private homeowners in the United States and then transformed into a debt crisis of commercial banks and insurance companies before being absorbed by national treasuries and so turned into a sovereign debt crisis. Reductions in national expenditure required to pay off public debt often lead to social unrest and are inequitable because they impose burdens on citizens who did not profit equally from debt creation.

2. The money supply is under private control.

Only a small fraction of the money circulating in public has been created by central banks. Central banks issue coins and banknotes which in most countries account for just between 5 % and 15 % of the money supply. Most of the rest is created by commercial banks in an electronic form as account money when granting loans to customers. But all money, whether cash or account money, is brought into circulation by commercial banks. Therefore, commercial banks de facto control the money supply. On the one hand commercial banks principally bear the credit risk for the loans they grant, which should induce them to carefully examine the creditworthiness of their customers. On the other hand, however, commercial banks decide which customers are granted a loan and which investments are made according to their interest in maximizing their own profits. Whether an investment is socially desirable is definitively not the decisive criterion for commercial banks. This way, investments serving the common good but not being profitable enough are not supported by the banking system and have to be financed by government spending that depends on tax revenues and public debt creation. Instead of financing long-term investments in the interest of society as a whole, commercial banks with their credit business nourish short-term financial speculation and over the last two decades actually have established a gigantic global casino beyond any public control.

3. Bank deposits are not secure.

Bank deposits refer to account money which in contrast to cash is not legal tender although it is handled as if it were legal tender. Account money is a substitute for money, just a promise from the bank to disburse the corresponding amount of money in legal tender if requested by the customer. In the present fractional reserve banking system, usually only a very small proportion of account money is backed by legal tender. Banks hold only a few percent of their deposits as cash and reserves at the central bank. That is the reason why banks are reliant on the trust of their customers. In the case of a bank run, when too many customers at the same time demand cash, they would run out of cash and face sudden bankruptcy. Hence deposit insurance systems have been established to avoid the loss of bank deposits. In the case of chain reactions and large-scale bankruptcy as in 2008, however, government bailouts of commercial banks may be necessary, eventually with the assistance of the central bank as lender of last resort.

4. The money supply is pro-cyclical.

Commercial banks grant loans by creating account money in order to maximize their interest revenues. The more money they issue the higher their profits – as long as the debtors are able to pay. In times of economic growth banks most willingly grant loans so as to profit from the boom whereas in times of economic decline their granting of credit is very restrictive in order to reduce their risks. This is how commercial banks induce an oversupply of money in booms and an undersupply of money in recessions amplifying business cycles as well as financial market fluctuations and creating asset bubbles in real estate and commodities which may cause heavy damages to society and to the banking system itself when they burst. Again, the 2008 mortgage-triggered banking crisis after the burst of the U.S. real estate bubble is the most illustrative example.

5. The money supply fosters inflation.

Besides its pro-cyclical character in the short term, the money creation of commercial banks in the long term induces an oversupply of money that leads to consumer price inflation as well as asset price inflation. Principally, an oversupply of money arises if the increase in the quantity of the money in circulation exceeds the growth of the production of goods and services. The long-term oversupply of money results not only from traditional granting of credit to governments, corporations and individuals but also from credit-leveraged financial speculation of hedge funds and investment banks. Due to inflation consumers usually face an annual loss of purchasing power, which means that they have to increase their nominal income in order to maintain their level of consumption. Since the ability to gain compensation for the loss of purchasing power by increasing one’s nominal income varies from individual to individual, inflation causes a redistribution of purchasing power to the disadvantage of unprivileged social groups which are not in the situation to effectively advocate for their own interests.

6. Interest on money is a subsidy to the banking sector.

Since money is debt, it carries interest.

Therefore, on all the money in circulation interest has to be paid for and virtually nobody can escape paying interest. Primary, of course, the customers who take up loans from commercial banks and thereby ensure the money supply are obliged to pay interest. Second, everybody who pays taxes and buys goods and services makes a contribution to the interest payment of the original borrower because taxes have to be raised partly in order to finance the interest payments on sovereign debt and corporations and individuals providing goods and services must include the costs of their loans in their prices. This way, by using money society pays an enormous subsidy to the commercial banks, a part of which they pass on to their customers as interest payments on deposits. Interest is a subsidy to the banks because the account money they create is handled as legal tender; and it is a hidden subsidy because it is not subject to public discussion. The magnitude of the subsidy society pays to the banks is reflected in the disproportionately high salaries and premiums of bankers as well as in the disproportionately big banking sector which is dominated by a few giant banks. These giant banks hold assets that exceed the size of large national economies, so they really are too big to fail since their collapse would have disastrous social effects on a global scale.

7. Interest on money forces economic growth.

Interest forces monetary growth and consequently the growth of the real economy. When customers repay their loans to the commercial banks, the banks write off the returned amount of money and the quantity of money in circulation correspondingly decreases. But the money that over time has been paid as interest on the loans does not disappear; it becomes the property of the banks. Debtors need more money than they have borrowed in order to not only pay back their loans but also pay interest on them. The additional amount of money needed for interest payments, however, can only be available to debtors if additional loans are granted by the banks. Otherwise the money supply would not be sufficient for the real economy to work properly and be profitable. It follows that the money supply must continuously increase to avoid economic crises. A financial system that cannot function unless it grows is nothing else but a Ponzi scheme. Yet, an even more detrimental effect of forced monetary growth is that it exerts a heavy pressure on the real economy to grow incessantly in order to back the additional money supply by additional economic production. The forced perpetual growth of the real economy involves an increasing exploitation and destruction of nature and thus impedes a sustainable development of humanity. This way, growing financial indebtedness caused by the monetary system leads to growing ‘ecological indebtedness’. Furthermore, the quantitative growth of the real economy will sooner or later inevitably end since the Earth’s resources are limited.

8. Interest fosters wealth concentration.

Interest is commonly seen as a lending charge for using the money of someone else. Not only the customers who borrow money from banks but also the banks which hold customer deposits pay interest. When commercial banks create money by granting loans, they credit customer accounts and thereby expand the total of bank deposits. Since accounts usually carry interest, the banks spend a part of their interest revenues for interest payments to the account holders. Now, bank deposits and loans are not equally distributed among the customers. Some have mainly loans they pay interest on whereas others mainly have deposits they earn interest on. Because in general poorer people have more loans than deposits and richer people have more deposits than loans, interest payments are in toto a transfer of money from the poorer to the richer people, especially to the few super rich. Interest thus fosters wealth concentration. This concentration of wealth to a great extent favours the commercial banks which on the one hand make investments themselves and on the other hand earn the amount resulting from the considerable interest spread between borrowing and lending rates. Moreover, interest is added regularly, for the most annually, to the initial investment and thus carries interest itself turning into compound interest and generating an exponential growth of monetary assets. But monetary assets do not grow in value by themselves since they are per se not productive. Value-increasing interest on monetary assets can only be generated through human labour; and human labour is permanently under a monetary pressure to increase its productivity and lower its costs so as to satisfy the demands of exponentially growing compound interest. Interest is therefore a value transfer that favours capital investments to the disadvantage of labour income.

9. The monetary system is unstable.

There is clear empirical evidence showing that the monetary system suffers from structural instability arising from the mechanisms described above. The financial crisis that started in 2008 and is still lasting, if not even worsening, is not a unique phenomenon. In the last decades, numerous crises related to the monetary system occurred around the world. Between 1970 and 2010 a total of 425 financial crises affecting IMF member states was officially recorded: 145 banking crises, 208 monetary crashes and 72 sovereign-debt crises (cf. Lietaer et al. 2012:51). The multitude of financial crises and their contagion effect on separate national economies plainly demonstrate their structural-systemic character. The present monetary system inevitably evokes crises in finance and consequently in the real economy which in turn is the basis for the monetary system. Briefly, the instability of the monetary system is largely due to the fact that the monetary system is not compatible with a finite world.

10. The monetary system counteracts crucial moral values.

A moral value is something that is seen as valuable from a general perspective after careful consideration. Moral values hence embody the most rational and most important values of society. Moral values and monetary values do not fully overlap; monetary values represent only a limited number of moral values. Money as a means to satisfy basic human needs, for example, is morally valuable whereas money harming the needy by speculative investments is certainly not. Since money, respectively the monetary system, rules the economy and dominates society, moral values not contributing directly to the profitability of business are systematically suppressed in policy making. This way, the current monetary system counteracts crucial moral values, such as solidarity, amicable relationships and a fulfilling life.

My analysis above clearly demonstrates the failure of the globally prevailing monetary system. The monetary system undeniably fails to ensure stability and security in finance, to enable a consistent and sustainable development of the real economy and thus to serve society as a whole. My analysis also shows that the apparent deficiencies of finance and the real economy can not be remedied without radically reforming the monetary system. Hence, it is about time to fundamentally redesign our monetary architecture. As Joseph Stiglitz and other experts, realising the prime importance of monetary reform, note in their recent UN-report: “The current crisis provides, in turn, an ideal opportunity to overcome the political resistance to a new global monetary system.” (Stiglitz et al. 2010: 166)