Should Newly Created Money Be a Private or a Public Asset?

by: Mansoor H. Khan
One of the basic assumptions of our economic system is that most new money is assumed to be a private asset created by commercial banks. If you don’t understand how this is then see my earlier post: Modern Monetary System: There Is Another Way.
Commercial banks simply issue a loan which creates the new money by crediting the borrower’s bank account. As this money is spent by the borrower it draws on the economic output of the economy at large.
Of course the new money, when it is spent, creates slight inflation or creates less deflation than there would have been otherwise had the new money not been spent. And in the United States (and most countries) the deposits (which are liabilities of the private banks) are implicitly or explicitly backstopped by the government (i.e. the tax payers).
Take an example of an entrepreneur who applies for a $1 million loan with 5 year term at 8% to build a shoe factory. The bank’s loan officer, who is a highly skilled business analyst reviews the business plan and approves the request. The loan is funded by the bank by simply crediting the entrepreneur’s checking account. Money is created out of thin air.
The biggest flaw in the above scenario is that the citizens of the nation had no say in how the re-directed resources by the new money are being utilized. Furthermore, note that the biggest banks create most of the private money. The benefits of this new money are of course shared between the banking industry, the borrowers and the economy at large.
How else could this be done?
Another way to do this (I think a much more fair way) is for the government to determine how much new money should be created in the economy to match the growth of goods and services and the level of inflation on a periodic basis. The government can then simply credit each citizen’s bank account the appropriate amount of cash per capita. The citizens can determine how to deploy this new money. This new money can then be spent by a citizen or saved. Saved money can then be aggregated by the private banks and loaned to our example entrepreneur above.
Why is this seemingly more complicated way better? Because it is more fair. Note that:
  1. New money will redirect and/or draw on the nation’s resources as it is spent.
  2. All citizens of a nation (in most countries) are required to use that country’s money to conduct business transactions on that country’s soil. This restriction is certainly placed on any entity doing business in the U.S.A. This restriction is enforced via legal tender laws. This restriction alone gives the citizens the right to the benefit of any newly created money and/or the right to determine how it is spent in a democratic way.
  3. The current way of having banks create most new money is less fair especially because the largest banks tend to create most of the new private money (this is true in the U.S. economy). Private money creation is very concentrated to large banks with large deposit bases.
The best way to stop private banks from creating their own money is to:
a) Remove government bank deposit protection insurance schemes (e.g., FDIC deposit insurance) and allow “Free Banking”. Allow banks to fail. This will greatly reduce the ability of banks to create bank deposit private money.
b) Give the public the option to “store” money electronically risk-free in a government owned bank which can only “store” electronic money and clear checks but not lend it out. 100% reserve credit risk-free money storage for a small fee.
c) Allow new money creation in all forms (coins, paper bills or bank deposits) by the treasury department.
For the future (5 to 10 years or even more), I believe we will have deflation and not inflation (like Japan since 1990). Businesses and individuals are very indebted and even the credit worthy don’t want to borrow because of fear of deflation (money to be paid back will be harder to earn as wages and business incomes go down). Also, average labor hour productivity keeps going up. This means that the number of unemployed persons will continue to increase. We could easily implement the above thinking in a broader sense to fight deflation and keep increasing the amount of cash distributed until the economy is more balanced between savings and spending. That is correct, contrary to popular belief; there can be too much savings. Also, we must look at this balancing act (between savings and spending) with a global perspective. It is global savings that matters at least to the U.S.A. America is a popular destination for global savings.
I can already hear my critics screaming - why we would want to encourage more consumption? I see absolutely no issue with encouraging more consumption. Lower income strata of our society have not had their incomes increase in tandem with huge productivity increases created by globalization and greater use of information technology. This re-balancing will greatly help these people and stop deflation in its tracks. It is exactly such people (in the lower income strata of our society) who are most likely to spend and stimulate demand which will help all businesses and create more employment.

Disclosure: No Positions