• The Bank of England Owns Up At Last

    For those of us who have argued for a long time that orthodox monetary policy is fundamentally misconceived, a significant milestone was achieved this week.  In an important paper published in the Bank of England Quarterly Bulletin*, three Bank of England economists have acknowledged that the overwhelmingly greatest proportion of money in the economy is created by the banks out of nothing.

    This finding comes as no surprise to that growing number of economists and others who have recognised, as a consequence of simple observation, that this is the case.  But it will no doubt be hotly denied, in the face of all common sense and evidence, by those (including bankers themselves) who, for reasons of self-interest or sheer ignorance, continue to adhere to the classical view that banks are simply intermediaries between lenders and borrowers.

    The great British public is itself the victim of the confusion and obfuscation that has surrounded this issue for generations.  Most people, if asked, will tell you that what the banks do is to lend out to borrowers the money that is deposited with them by savers.  On this analysis, there is nothing particularly special about banks; they simply charge for the service they provide in bringing savers and borrowers together.

    The truth, however, now conceded by the central bank, is very different.  The banks enjoy a most spectacular and surprising monopoly power.  They alone are able to create new money – vast quantities of it – by the stroke of a pen or, in modern terms, by pushing a key on a computer keyboard.

    When a bank lends you money, it simply makes a book entry that credits you with an agreed sum; that sum represents nothing but the bank’s willingness to lend.  The debt you thereby owe the bank does not represent in any sense money that was actually deposited with the bank or the capital held by the bank.  Nevertheless, when it arrives in your account, and you use it to spend or invest, the overall money supply is increased by that amount.

    The only attempt to regulate the volume of new money created by the banks comes through raising or lowering interest rates – a power exercised not by government but sub-contracted to – you’ve guessed it – another bank.

    This means that, in practice, the only limit on bank lending is their willingness to lend to applicant borrowers at whatever the current rate of interest may be.  The size of the market which provides the huge profits enjoyed by the banks is, in other words, decided by the banks themselves and their assessment of, and willingness to accept, the degree of risk involved.

    There will, in the search for the ever higher profits to be made from lending more and more of the money which they themselves create, always be the temptation to lend more than is prudent in their own interests or desirable in the wider interest – and that is how the global financial crisis came about.


    The astonishing feature of this monopoly power enjoyed by private companies seeking profits for their shareholders is that their decisions as to how much and for what purpose money should be created, made with virtually no external control or influence to restrain them, constitute by far the single greatest (and potentially distortional) influence on our economy.

    The Bank of England paper has now laid all of this out for public inspection.  The authors do not quite have the required courage of their convictions, since they attempt to downplay the significance of their conclusions by using the operations of a single bank to illustrate the process of credit creation, and thereby fail to register the immense scale, when looking at the banking system as a whole, of what they are describing.  Even so, the policy implications of what they say are immense.

    Our macro-economic policy at present is virtually limited to attempting to control the money supply as a means of regulating inflation.  But since the volume of money is a function of bank lending and reflects nothing more than the banks’ search for profits at whatever the current interest rate may be, it follows that the whole thrust of current policy is entirely misplaced.

    The banks, in deciding for themselves how much, to whom and for what purpose they will lend, will always give priority to lending for house purchase since it requires by far the least effort, and is the most secure and profitable form of lending.  Can we be surprised that, as a result, those wishing to borrow for business investment are at the tail end of the queue while house prices – inflated by the volume of new money going into the housing market – go on rising inexorably?

    It is bank-created credit that provides the major stimulus to asset inflation in the housing market, with all of its deleterious economic and social costs, while at the same time diverting essential investment capital away from where it is really needed – in the productive sector of the economy.  If we wish to restrain inflation, why do we not target the most obvious cause, rather than burden the whole economy with deflationary interest rate hikes?  And if we want a stronger real economy, why allow the banks the exclusive power to decide that the new money should go to housing rather than productive investment?

    Our current monetary policy is based, in other words, on a complete misunderstanding of the role of money and its impact on economic activity.  Our economy is awash with money, but it is neither the economically neutral phenomenon – interesting only because of its impact on inflation – that classical theory describes, nor does it provide the stimulus to new productive investment in the real economy that it could and should do.

    Monetary policy need not be just a rather ineffectual tool for controlling inflation.  It has the capacity instead to be a major stimulant and facilitator of real productive investment if we understand and use it properly.  The banks’ monopoly of the power to create money prevents us from doing just that.

    *Money Creation in the Modern Economy, by Michael McLeay, Amar Radla and Ryland Thomas.

    Bryan Gould

    22 March 2014

    This article was published in the London Progressive Journal on 25 March 2014.





  • In Our Democracy, It’s Dollars Not Votes That Count

    In what we are pleased to call a democracy, we count votes – one per citizen – on polling day, but on every other day we count only dollars; and when it comes to dollars, the more you have, the more political influence you wield.

    Very few of us seem to realise how thoroughly the power of the purse has colonised and subordinated our supposed rights as citizens to an equal voice as to how we should be governed. Our government (and the present government especially), once elected, pays little further attention to ordinary citizens and makes its decisions according to what might serve the interests of the wealthy.

    The rationale for this approach is presumably the long-discredited “trickle down” theory of economic wellbeing – that if the rich are encouraged to become richer, we will all be better off by virtue of the crumbs we might enjoy from the rich man’s table.

    But the belief that wellbeing is to be measured purely in dollar terms takes us much further than that, and now penetrates almost every aspect of our national life. An obvious example is a trend that has begun to really gather pace over recent years – treating universities and other institutions of tertiary education, not as repositories of learning, mainsprings of new knowledge and the facilitators of a wiser and more far-seeing society, but simply as agents of economic development.

    If an institution’s graduates cannot be shown to be immediately of value to the process of making a buck, it will be marked down and its future funding threatened. Little value is given to a more educated society for its own sake; the only purpose of education, it seems, is to promote a higher GDP.

    Considerable effort is devoted to “educating” the public to accept that the only worthwhile goals are those with a dollar value. The search for profit, we are told, is the only motivation that will produce a higher level of effort and achievement. We see instances of this thinking wherever we look.

    Selling off (or privatising) public assets? Who worries about levels of public service for society as a whole when better-off members of the public can be introduced to the joys of making some unearned income on the stock market?

    The “free trade” deal with the US? Who cares about maintaining some element of control over our own destiny as a nation if some of us can trade that away for increased profits?

    Instances of this kind abound, even at a very detailed level. I came across a further example the other day. This country welcomes immigration as a stimulus to growth, but we have also learned to value its benefits in helping to develop a society with a richer texture and a wider cultural base.

    Commendably, our government set up a few years ago, under the aegis of Immigration New Zealand, a support service for immigrants to help them to settle and adapt to their new country. The service, known as Settlement Support, has done excellent work and has eased the path for countless new migrants so that they can enjoy greater success and can make a worthwhile contribution to our national life.

    Until now, the service has provided face-to-face help to any migrant who cares to ask for it. The help largely takes the form of information on where to go for advice on a whole range of matters, and is of value both to the migrants themselves and to employers who might contemplate employing them. Customer satisfaction (at 91% for migrants and 83% for service providers and employers) is at a high level.

    But someone has decided that the service is too “unfocused”. The inevitable consultant’s report has been commissioned and it has duly served the purpose of those who commissioned it.

    It seems that too many migrants of low economic value are availing themselves of the service. What is needed, the consultants recommend, is a service that focuses on the 12% of “high priority” immigrants; the employers of such people are also to be priority customers. There will be a second category of medium-priority customers (20% of the total) who might one day become “high priority”. It is these categories who will receive a high level of support and attention.

    At the bottom of the heap are the 58% of “low priority” customers. Under the new “Proactive Customer Management Model”, they will no longer have a face-to-face service. They will not be encouraged to seek help; they will have to make do with a web-based service.

    These migrants, whose low economic value apparently makes them undeserving of real help, must overcome their unfamiliarity with the language, their lack of resources to allow them to access the internet, and their sense of confusion about the society in which they find themselves, to negotiate their own way through the maze of agencies and sources of help and advice that might be of use to them.

    Immigrants of “low economic value” might be seen as of little consequence; but are they not just a sub-category of those ordinary home-grown citizens of whom our government makes the same judgment?

    Bryan Gould

    19 October 2013

  • Myths, Politicians and Money


    My new book, Myths, Politicians and Money, was recently published in London by Palgrave Macmillan to coincide with the Labour Party conference in Brighton.  It has been very well received and reviewed, and has attracted a good deal of attention. It is a comprehensive account of what I think has gone wrong for Western democracies over the last three decades; the argument is summarised in a separate posting (called Myths, Politicians and Money) of a piece I wrote for the Yorkshire Post. Find out more here.

  • Myths, Politicians and Money

    In 1989, the American political philosopher Francis Fukuyama published a famous essay which he called “The End of History”. In celebrating what he believed to be the more or less permanent triumph of liberal democracy, he saw the “free market” and democracy as not only compatible but as mutually supportive. The market was in his view the equivalent in economic terms of political democracy, achieving the same dispersal of economic power throughout society as democracy achieved in political terms. He saw no need for democracy to act as a restraint on “free-market” outcomes, and he saw no danger that the “free market” might in some ways prove inimical to effective democracy.

    He was confident that the rest of the world would flock to the democratic banner. Just over twenty years later, that expectation has been confounded. Confidence in democratic processes – both here and abroad – is at a low ebb. So, what has gone wrong?

    The seeds of the problem had already been sown by the time Fukuyama published his essay. The received wisdom of the immediate post-war years – that full employment should be the prime goal of economic policy, that collective public provision was needed to guarantee basic standards of essential services, and that market excesses would have to be restrained by careful regulation – had been replaced by new ideas.

    The individual, rather than society, was seen as the pivotal point of human endeavour and progress; writers like Hayek and Nozick questioned the need for or appropriateness of an extended role for government or the acceptability of meddling in “free” market solutions; redistributive taxation, the provision of taxpayer-funded benefits to the disadvantaged, and the power of organised labour came to be seen as obstacles to economic growth rather than as guarantees of an equitable distribution of wealth; economists like Milton Friedman questioned the efficacy in peacetime of Keynesian intervention and promoted the idea that macro-economic policy was really just a simple matter of controlling the money supply in order to restrain inflation; while global developments such as the oil-price shock of the early 1970s meant that inflation rather than full employment was seen as the primary issue for economic policy.

    Many of these ideas had been carried into government by Ronald Reagan in the United States and Margaret Thatcher in the United Kingdom. The two leaders made common cause at the beginning of the 1980s in taking a step whose significance perhaps even they did not fully grasp at the time. The portentous decision was taken in the United States and in the United Kingdom to float their currencies and to remove exchange controls. The way was now clear not only for an explosion in international trade and foreign investment, but for a determined assault by international capital on the political power of democratically elected governments across the globe.

    The ability to move capital at will across national boundaries not only meant that international investors could bypass national governments but also enabled them to threaten such governments that they would lose essential investment if they did not comply with the investors’ demands. This shifted the balance of power dramatically back in the direction of capital, and set the seal on the triumph of those “free-market” principles of economic policy that became known as the “Washington consensus”.

    It became accepted that the “free market” was infallible and that its outcomes should not be challenged. Any attempt to second-guess the market would inevitably produce worse results. Everyone – it was thought – would be better off if the rich and powerful were subject to no restraint in manipulating the market to suit their own interests.

    But the whole point of democracy – that the legitimacy enjoyed by elected governments allowed them to defend the interests of ordinary people against the otherwise overwhelming economic power of those who dominated the market – was thereby lost.

    We see the outcomes of this shift all too clearly. Virtually the whole of the increased wealth of the last three decades has gone to the richest people in our society; poverty, even in the “rich” countries, has risen while inequality, with its attendant social ills, has widened; the rights of working people at work have been weakened; joblessness is endemic; and the “free market” free-for-all achieved its culmination in the global financial crisis.

    A “Europe” imposed by an elite and constructed in the image and to suit the interests of international capital has come unstuck and flounders in recession and unemployment. The austerity demanded by Europe’s leaders makes a bad situation worse. Popular support for the European Union has nosedived. Major decisions continue to be made by big corporations and not by elected governments. Faith in government and the democratic process is at a low ebb and attempts to consult the people on Europe’s future continue to be resisted.

    “History”, in other words, has continued to unfold. Very few seem to realise how thoroughly our civilisation has been transformed by the triumph of the “free-market” ideology. They do not see that western liberalism, which has informed, supported and extended human progress for perhaps 700 years, has now been supplanted by an aggressive self-interested doctrine of the individual which leaves no room for community and cooperation. Even the victims of this comprehensive and fundamental change seem hardly aware of what has happened.

    Fukuyama failed to recognise, in other words, that the threat to western democracy came from within those democracies themselves. It came from the greed and self-interest of the rich and powerful and their ability to manipulate the “free” market to their own advantage, but also from the quiescence and apathy of that much greater number who fail to understand that democracy is necessarily sidelined if the market cannot be challenged. The substance of democracy has been hollowed out, so that only the shell, the forms, remain, because we have not cherished and made a reality of what was our most valuable protection and greatest achievement.

    Bryan Gould

    19 September 2013

    This article is based on my new book, Myths, Politicians and Money and was published in the Yorkshire Post on 20 September

  • The Deal-maker

    Our Prime Minister revels in his reputation as a deal-maker – and with good reason. His success in making a personal fortune as a foreign exchange dealer is, it seems, a major factor in establishing his claim to be an expert in how to run our economy.

    It may not be immediately obvious that the short time horizon of the foreign exchange dealer – perhaps at times only a few hours or even minutes – is necessarily the best qualification for making good long-term strategic decisions about our economic future. But few would doubt John Key’s ability to close a deal.

    It is only when we look closer at the deals that the Prime Minister concludes that doubts might arise. It seems that his negotiating stance in approaching a potential deal usually begins with, “The answer’s yes, now what’s the question?”

    Those doubts might seem to be well-founded when we look at some of the deals he has concluded in recent times. The “negotiation” with Warner Brothers over The Hobbit seems to have been a process in which the Hollywood moguls dictated their requirements – $67 million in tax relief and a change to employment law that reduced the rights at work of actors and film crews – and John Key’s government “negotiated” by meekly complying, with the passage of overnight legislation.

    We see a similar pattern in the “negotiation” with Sky City over a convention centre in Auckland. The Sky City offer was made conditional by the gambling bosses on the award of a significant number of new pokie machines – something strongly opposed on social and health grounds by those rightly concerned at the damage done by gambling to families who can ill afford it, but immediately conceded by John Key.

    On this form, we can be confident that we will see the same pattern in future “negotiations” with, for example, overseas firms wishing to drill for oil, or mining companies wanting to operate in conservation areas, or foreign buyers proposing to purchase national assets. In all such cases, we can expect our “deal” maker to take whatever is offered and run.

    “Show me the money” was John Key’s election campaign challenge to Phil Goff; in his mind, it seems, “showing the money” is the essential and only condition needed to settle any deal on offer.

    Peter Dunne’s blog last week, in which he warned that there were real dangers in the Prime Minister’s propensity to “cut through” obstacles to a deal, was making a similar point. John Key, it seems, is quite ready to set aside legal safeguards, as well as commonsense considerations, if that is what is needed to close out a “deal”.

    The defining characteristic of the Prime Minister’s big-ticket deals is that they typically involve large firms, preferably from overseas. He seems so impressed at being involved with such entities that any concern about whether or not a “deal” offers good value for New Zealand goes out the window.

    The worry is that, in negotiations like those with the US and others over a Trans Pacific Partnership, the Prime Minister will take a similarly cavalier attitude to the protection of our national interests. We are already being softened up for what seems now to be an inevitable outcome – that, on a range of important matters, such as a continued and unchanged role for Pharmac, the “negotiations” will end up with an abject capitulation by our government. For John Key, the outcome that matters is putting the signature to the “deal” – not the practical (and possibly adverse) consequences thereafter for our economic wellbeing.

    A similarly short time horizon is in evidence when it comes to asset sales. It is almost as though the Prime Minister is so dazzled by the potential price tag of billions of dollars that he is blind to any longer-term disadvantage. Yet, selling assets that generate a minimum return of 7% per annum at a time when the government can borrow at roughly half that rate is simply to put a short-term gain ahead of a much larger longer-term loss for future generations.

    As on so many other issues, John Key seems not to understand that the sale of our income-producing assets into foreign hands is to deny future generations important (but dwindling) national income streams. Their loss makes us poorer, increases our need to borrow from overseas and weakens still further our power to decide our own future.

    We have travelled a long way from the time when New Zealand was prepared to take a stand and stick to it, even in the face of condemnation from powerful overseas interests. Ask yourself a simple question. If John Key had come to power before our non-nuclear policy had been decided, would he have taken the initiative and introduced it on his own account, and then maintained it against all the odds? Or would keeping in with the Americans have been his first priority?

    Bryan Gould

    8 March 2013