Lino Zeddies: Money creation and inequality – an underexposed topic

Wrong!  It is not only governments that create money. Financial institutions such as banks do too. Who controls the economy and how? Here some answers to the questions.

Lino Zeddies is an economist

Cross-posted from the International Movement for Money Reform website




Some weeks ago our German sovereign money reform organization „Monetative“ held its annual conference on “Money. Power. Inequality.” to discuss how the current money system with private banks power to create deposit money affects the distribution of power, income and wealth. In this article, I would like to share my most important take-aways from the conference with the money reform community.

It is beyond doubt that the current money system has a huge impact on the distribution of power and wealth and heavily contributing to systemically worsening inequality. Even though there is growing public awareness and debate about the problem of inequality, so far the focus has been on the distribution of existing money and wealth, while the distributive effect of how and for what purpose money is created in the first place, seems to be a complete blind spot.

To raise awareness for these neglected dynamics, this article provides in the following an overview of the several direct and indirect channels through which the current money system worsens inequality and how a sovereign money reform could improve matters. Some of the mechanisms might seem at first glance not to be connected with bank money creation but it can be argued that they are part of the current money systems logical unfolding and would probably not, or to a much lesser extent, exist in a sovereign money system.

Obviously, only a very superficial sketch of the various mechanisms can be provided here, even though every single one of them would deserve a research paper on its own. However, if an idea of the gravity of the monetary systems influence on the distribution of power and income can be conveyed, triggering further research, the aim of this article is achieved.

How the current money system amplifies inequality

  • Boom/bust credit cycles

The current money system enables banks to fuel asset bubbles and subsequently booms through extensive credit creation into asset markets. During the boom, this creates huge profits for banks themselves, financial markets and “the haves” in general. This effect can be aggravated through the practice of creative accounting (i.e. using special purpose entities, derivatives and lots of other ways to inflate the balance sheet) and thereby faking gains or hiding losses.
If the rules were fair, the bubble bursting should result in those bubble profits disappearing as quickly as they came into existence. But in the current money system banks are systemically important and too big to fail as they alone provide money/credit and the payment infrastructure for the real economy. If banks are not bailed out, the payment infrastructure would break down, quickly freezing the whole economy and further, the inherent risk of bank runs could materialize and lead to a total system-break down as well. Therefore, banks (and subsequently “the have’s” assets) are usually bailed out by the government and supported by central banks “whatever it takes” (i.e. through acquisition of bad loans, emergency liquidity provision etc.). Additionally, the central bank’s typical attempts to push up consumer inflation by lowering interest rates to incentivize banks to lend more, results mostly in raising asset prices (and therefore in asset and not consumer inflation), allowing even more wealth gains for “the haves”. This means that when the house of cards collapses, those illusionary bubble gains don’t implode. Instead, the losses can be dumped on the government. These expenses for bank bailouts increase public debt and therefore increase future debt interest payments, which in turn usually mean budget cuts for public infrastructure and for public services.
Meanwhile, the asset boom (especially in the housing market) eventually results in increasing rental costs for all those who cannot afford to own their own home.
In short, the rich get much richer at the expense of the rest of society.

  • Competitive advantage for big corporations

Besides the above depicted boom/bust or respectively profit/bailout dynamics, the current money system also gives a general competitive advantage to big business in comparison to smaller-sized companies and therefore supports a general concentration of market power and wealth.
Firstly, this is because the implicit and explicit “too big to fail” subventions greatly favor a big bank infrastructure in which big loans for big businesses are preferred over comparatively costly mini-loans for smaller companies. In other words, in this environment it seems more likely that Bayer will get a mega loan to take over Monsanto than that a small or medium enterprise will get the bucks for some useful investment. The existing low interest environment and financial market microregulation only aggravate this dynamic, putting much pressure on smaller banks (which are often the backbone of the real economy) to merge or die.
Secondly, only big corporates have the means to set up their own corporate in-house banks, which provide them with a huge funding and liquidity advantage in comparison to smaller companies relying on external funding.
Thirdly, in the last years as part of its Quantitative Easing program, the European Central Bank even started to buy bonds from big multinationals like Shell, BMW or Repsol, thus driving down their financing costs and giving them another unfair competitive advantage. Such an indirect and ineffective channel as Quantitative Easing is only conceivable, because the central bank currently lacks more direct means and therefore depends on banks to increase the money supply.
Fourthly, the current cheap interest environment together with these factors provide the perfect environment for huge takeovers and mergers, leading to even more market concentration.
So all in all, the system supports extractive oligopoly structures and the concentration of market share, wealth and power in the hands of few big businesses at the expense of the public.

  • Whoever has will be given more

Additionally, the current money system generally benefits the wealthy because “whoever has will be given more (credit)”. Those who are creditworthy by already owning assets, get cheaper credit and often swim in liquidity (allowing even more profitable investments) while it is much more difficult and costly to receive a loan by the “not-haves”. In this regard the so called “Cantillon-effect” should be mentioned, which describes how an increase of the money supply benefits those parts of the economy where this money is created (financial markets, rich funds/investors) at the expense of all other sectors of the economy whose real value of monetary wealth is decreasing due to the corresponding inflation.

  • Growth imperative and underemployment

And lastly, the creation of money as debt results in systemic scarcity of money in circulation, a growth imperative and typically structural unemployment. This is because unless the money supply is growing constantly, there is systemically simply never enough money to pay back the debt PLUS interest, especially when some of the savings are hoarded and thereby removed from circulation in the real economy. So either the money supply and correspondingly the stock of debt is continually growing or there are defaults, economic depression and unemployment. In other words, the systemic scarcity of money in circulation in the real economy typically results in structural unemployment. The shortage of jobs leaves employees in a chronically bad bargaining position with relatively low wages and weak unions.

To sum up, money being created as bank credit systemically results in a multitude of direct and indirect factors that concentrate the distribution of power, wealth and income in the hands of few.

More fairness and equality in a sovereign money system

In comparison, a sovereign money system creates a much fairer economic playground compatible with the ideals of a free market economy and a thriving democracy.

  • Full seigniorage income for the public

Firstly, when transitioning to a sovereign money system, there would be a considerable one-time debt relief as credit money would be replaced by debt-free sovereign money. Depending on a country’s level of debt and the amount of bank money in circulation, this would typically allow a huge reduction of government debt just due to the transition. Less government debt means less interest expenses for the public, allowing lower taxes and better public services and better infrastructure.
Additionally, an expansion of the money supply would typically flow as seigniorage income to the government and would imply an additional regular income. The amount of this seigniorage would depend on the growth of the economy and the inflation target. Even though full price stability in a zero-inflation environment seems much more feasible in a sovereign money system, it is also thinkable to have a modest inflation target (2-3%) as this would allow more money creation equaling more government seigniorage. This would practically imply a form of circulation safeguarding a la Silvio Gesell as money hoarding would be penalized through real devaluation. This way, the Cantillon-effect would affect a constant redistribution from money-holders to the rest of society instead of the other way around as it is now.

  • Prevention of boom/bust dynamics and bank bailouts

Secondly, as the banking system as a whole could not any longer fuel asset bubbles through newly created credit money and as the government/central bank could counter booms and busts much more directly, the current for banks highly profitable boom/bust dynamic seems less feasible. In this regard, it seems generally much less likely that politicians should decide to bail-out banks as the payment infrastructure would be safe from bank failure, the bank run dilemma would be resolved and as the money supply would be independent from bank’s lending activities. This means that even if there was a boom that busts, those who invested and profited in the first place would have to pay the bill afterwards (as it would probably happen with the bitcoin bubble). Preventing an economic depression would no longer require saving banks and “the haves”, but instead the economy could be boosted directly through additional government spending or helicopter money benefitting all and not only “the 1%”.

  • Fair competition with big corporates

Thirdly, a sovereign money system brings about a generally fairer business environment. Given the alignment of potential profit and risk-taking in a more coherent and stable economic framework, there are no more implicit too big to fail subventions and no argument left for microregulation in the banking sector. This means smaller banking entities serving the real economy have it much easier to compete with their bigger brothers. Also, the competitive advantage of corporate inhouse banks with the former power of money/liquidity creation would be removed. Similarly, it would be more difficult to set up gigantic loans as these can’t be created out of thin air, but rather would have to be fully financed through savings beforehand. This removes the funding advantage for big corporate and the basis for huge takeovers and acquisitions/mergers resulting in a fairer environment for relatively smaller businesses.

  • Full employment without a growth imperative

Lastly, as underemployment could be tackled directly through money creation by additional government spending into the real economy (and not mostly into the financial sphere as it is now), the growth imperative would be diminished and full employment seems much more feasible. This should improve employees bargaining power and increase the wage share in relation to financial income.

Therefore, all in all, a sovereign money reform should result in less concentration of market power, wealth and income and could improve the income distribution considerably.

Concluding remarks

Even though the current money systems effect on rising inequality is neglected in public debate so far, it can hardly be questioned that banks power to create deposit money has a huge impact on the distribution of power and wealth and amplifies inequality through various direct and indirect mechanisms. In comparison, a sovereign money reform could mend many of these negative distributive effects and would provide the chance to redistribute much more fairly. Of course, there are also various other factors that are causing increasing inequality worldwide and numerous other reforms could bring more equality besides a monetary reform, but it seems politically much more difficult to have a system with unfair chances to begin with and then redistribute afterwards (i.e. through taxation) than already starting with a just system where everyone only gains his or her fair share. However, a sovereign money is obviously not a cure-it-all and cannot solve everything. Several other reforms are needed to fix our economic system. But still most of these seem much more feasible in the framework of a sovereign money system, where the financial sector is back in its proper role as a servant of the real economy.

Given the massive amount of activism and political energy around fixing inequality in recent years, the money reform community should see the monetary systems´ effect on the distribution of income and wealth as a promising entry point to get our issue of sovereign money reform into the mainstream and reach a wider audience. However, this topic is still underexposed in our external communication and therefore deserves more attention and more research.

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