Manufacturing Money
by Australian Mark Mansfield B.Ec.

A 1998 explanation of how money is created in Australia and problems resulting.

When One Nation National Director, David Ettridge, stated government could print the money to provide the $150m start up capital for a people's bank lending at 2% interest to farmers, small businesses and homeowners, he was ridiculed. Treasurer Costello claimed inflation would explode and savings would be destroyed if government was to start printing money. Howard, Beazley, the establishment, and the media applied the political blowtorch. Suffering from the usual One Nation foot in mouth disease, Ettridge quickly recanted his heresy.

David Ettridge should be thanked though for putting the whole question of money and banking back on the political stage. Not since the 'loans affair' in 1975 has money and banking been the subject of public debate in Australia.

Now it is obvious to everyone that money is a man made symbol. It does not occur in nature. It must be manufactured or created, (i.e. made out of nothing), before it can serve as a convenient medium of exchange in the trading of goods and services. Someone must make the money we use, whether it is printed, or just the numbers in a computer which are a record of deposits in accounts. If it seems I am stating the obvious, I make no apologies for this. People get confused very quickly when it comes to money and banking. The obvious things need to be said to keep in mind that money is only an abstract symbol which should represent reality.

It does not matter though who creates the money we use. What does matter is what gives money value? How is it put into the economy? Who controls on what terms we get access to money? What is the cost of money? What economic policy implications exist as a result of all these factors regarding money?

Information about money is not a state secret. The following statistics are readily available from the Reserve Bank of Australia's monthly Bulletin.

When the Federal Coalition was elected in March 1996, Australia's money supply was $345,479m. By March this year, it had grown by $55,968m to $401,447m or $22,302 per Australian. In other words, there is now $3,110 more money per Australian in the economy than there was two years ago. I guess Treasurer Costello has been a pretty good treasurer if we are all now $3100 each richer, than we were under Keating? But as Treasurer Costello says it would be lunacy for the government to print money, where did all this new money come from?

Well, some of the money was printed. In March 1996 there was $18,691m in notes and coins in circulation. By March this year it had grown by $2,140m or $120 per Australian to $20831m. Notes and coin in circulation though represent only 5.2% of the total money supply or $1,157 per Australian.

The vast bulk of the money supply is held as deposits in accounts with banks and other financial institutions. Ninety-six per cent of the growth in the money supply in the two years from March 1996 occurred in financial institution deposits as a result of the financial institutions themselves growing the money supply.

Banks grow the money supply every time they claim to lend money. I say claim to lend money, because banks do not really lend money. When money is borrowed from a bank, the bank actually creates new money or credit out of nothing. It credits a loan account it has set up on its books with a deposit which can be drawn upon by the borrower. As banks must pay out deposits on demand this is a liability for the bank which is entered in the debit side of its ledger. On the credit side of the ledger, because the bank charges interest on this created money, this is an asset for the bank earning it income.

Everyone sub-consciously knows banks do not lend money. When you draw on your savings account, the bank doesn't tell you you can't do this because it has lent the money to somebody else. You would be pretty irate if this happened because it would amount to theft. You do not have to rely on my word about banks having a credit creation power. I'll let the experts speak for themselves in describing how banks create money on their terms.

Ralph Hawtrey Assistant Under Secretary to the British Treasury in the 1930s wrote in 'Trade Depression and the Way Out', "When a bank lends, it creates money out of nothing." In his book the 'Art of Central Banking', Hawtrey went on to make it very clear what the implications of creating credit out of nothing meant, when he wrote, "When a bank lends, it creates credit. Against the advance which it enters amongst its assets, there is a deposit entered in its liabilities. But other lenders have not the mystical power of creating the means of payment out of nothing. What they lend must be money that they have acquired through their economic activities."

The Rt Hon Reginald McKenna, former Chancellor of the Exchequer addressing a meeting of the shareholders of the Midland Bank, 25 Jan 1924, as recorded in his book 'Post-War Banking', "I am afraid the ordinary citizen will not like to be told that the banks can, and do, create and destroy money. The amount of money in existence varies only with the action of the banks in increasing or decreasing deposits and bank purchases. We know how this is effected. Every loan, overdraft or bank purchase creates a deposit, and every repayment of a loan, overdraft or bank sale destroys a deposit."

Dr Coombs, former Governor of the Reserve Bank of Australia said in the ES & A Research Address at Queensland University on 15 September 1954, "Any given piece of expenditure can be financed from one of four sources:

This last source differs from the first three because when money is lent by a bank it passes into the hands of the person who borrows it without anybody having less. Whenever a bank lends money there is therefore, an increase in the total amount of money available."

There is however a limit to the amount of credit banks create. This is governed not so much by the demand for money to facilitate commerce but what the banking system considers is necessary to maintain a stable financial system. As English economist Hartley Withers in his book 'International Finance' wrote: "A credit in the Bank of England's books is regarded by the financial community as 'cash' and this pleasant fiction has given the Bank the power of creating cash by the stroke of a pen and to any extent that it pleases, subject only to its own view as to what is prudent and sound business."

Any standard economics text explains the credit creation mechanism which banks perform. What they don't explain however, are the policy implications of what this means.

When Treasurer Costello ridiculed David Ettridge for saying the government could print money, he was speaking up for the status quo where banks have a monopoly on the creation of credit. Prime Minister Howard also blasted the One Nation proposal to lend $150m at 2% interest by a people's bank, saying "...you will have to find some mugs who will lend to the bank at 1% and I don't know many Australians who will do that."

But as Dr Coombs said, money can be made available by a bank to a borrower without anybody having any less. Because banks actually create new money when they lend it, depositors are not required to start the process.

I would have thought One Nation's proposal for a people's bank was an excellent beginning for breathing life back into Australian industry, farming and small business. Australia is deindustrialising. In 1961 27.5% of the work force was employed in manufacturing. By 1996, employment in manufacturing had more than halved to 12.9% of the work force. From 1965 to 1985, the share of manufacturing in national income fell by a massive 40%. This decline has occurred because interest rates in Australia have been comparatively higher than most of the Western world for a generation. It is not a level playing field when industry in developing countries operates at lower cost, not because of cheaper labour, but because it can get access to finance, the life blood of the economy, at 2-3% interest rates, compared to the 8% to 28% interest rates Australian firms have endured for the last 30 years.

From 1965 to 1985 the manufacturing share of national income grew by 75% in Indonesia, 80% in Taiwan, and 111% in Malaysia. These countries along with Thailand, the Philippines and China now have a proportionately larger manufacturing sector than Australia. Common sense tells us Australia's manufacturing sector should be way in front of these countries because of the abundance of raw materials which we possess.

Now either Howard & Costello are completely ignorant of the most basic banking function of credit creation, in which case they do not deserve to hold their offices for this reason alone, or for political reasons they are suppressing policies which could be used to strengthen Australia economically be utilising the power of creating credit on the right terms.

When money or financial credit is created, it is a symbol which monetises what could be called real credit. This is the ability of individuals, companies, governments or nations to use raw materials, technology and skilled labour to produce goods and services needed and demanded by the community.

This was ably stated by Sir Denison Miller, Governor of the Commonwealth Bank of Australia from its creation in 1912, to 1923, when he was quoted in the Australian Press on 7 July 1921 as saying,"The whole of the resources of Australia are at the back of this bank, and so strong as this continent is, so strong is the Commonwealth Bank. Whatever the Australian people can intelligently conceive in their minds and will loyally support, that can be done."

The Commonwealth Bank began in 1912 as a people's bank with a 10,000 (probably $1m in today's money) from the Commonwealth government. By the end of World War One in 1918, it had financed what in today's money would be $35,000m for Australia's war effort alone, the purchase of the Commonwealth Fleet of Steamers, the forerunner to the Australian National Shipping Line, the trans-Australia railway and growth in Australian industry when British banks and their Australian subsidiaries were running a deflationary policy.

The 1930s Depression focused people's minds as never before on money and banking. Financial poverty consigned millions of people around the world to material misery amidst the material plenty of the age. In many countries around the world enquiries into the financial system were set up to find solutions. In Australia the Commonwealth Royal Commission into Money and Banking reported in 1937. In section 504 of its report, which dealt with the creation of credit, the Commissioners wrote,"Because of this power, (i.e. credit creation) the Commonwealth Bank is able to increase the cash of the trading banks in the ways we have pointed out above.(The Commonwealth Bank at the time was Australia's central bank, like the Reserve Bank is today). Because of this power too, the Commonwealth Bank can increase the cash reserves of the trading banks; for example it can buy securities and other property, it can lend to governments or to others in a variety of ways, and it can even make money available to the Governments free of any charge."

When asked to explain the exact meaning of what making money available to government free of any charge meant, the Chairman of the Royal Commissioners, Justice Napier of the South Australian Supreme Court, issued a statement through Mr Harris of the Commonwealth Treasury, who was the Secretary of the Royal Commission, which read,"This statement means that the Commonwealth Bank can make money available to Governments or to others on such terms as it chooses - even by way of a loan without interest, or even without requiring either interest or repayment of the principal."

This long forgotten advice given by the Royal Commissioners is staggering when we think how the economy functions today. We are told by the financial establishment, the media and politicians that deregulation, rationalisation, and privatisation is necessary if Australia is to remain internationally competitive and service the huge burdens of personal, corporate and government debt.

The fundamental problem in the world's financial system is that all money is created as a debt to the banking system. Banks claim to own money which does not exist and lend it against the real credit of society as an interest bearing debt, permitting activities of the banks' choosing to be undertaken. This would be akin to the Electoral Commission, who print all the ballot papers for Australians to decide who we want to elect to govern us, said, because they print all the symbols with which Australia makes this decision, they own the symbols and can fill out all the ballot papers themselves. There would be uproar!

The trouble with interest is that it can never be paid off. If the banks demanded repayment of say the roughly $405,000m in Australia at the end of the financial year, at say an average interest rate of 5%, we would have to repay $425,000m. You can't do this if there is only $405,000m. Consequently, interest is continually compounded as a debt. This is a mathematical certainty. Money is a stock. It does not matter how many times it changes hands generating a flow of income as goods and services are exchanged. At any point in time, the capitalised value of debt and interest will always exceed the money supply. At the end of May 1998, the total value of lending by banks was $518,498m, while the money supply was $404,109m.

The whole economy then slaves away at the impossible task of trying to repay the ever increasing debt to the banking system. Prices and taxes must be continually inflated to pay an escalating interest burden. Family life, human personality and the environment are sacrificed for production, while production and consumption in their turn are sacrificed for monetary profit to pay debt.

When the government borrows money, it issues interest paying securities such as Commonwealth Bonds which it sells to the financial market and Treasury Notes which are bought by Reserve Bank. Treasury Notes in turn are purchased by the private banks from the Reserve Bank using credit they have created. The private banks then exchange Treasury Notes with the Reserve Bank whenever they require currency. Hence, even that fraction of the money supply which is currency is ultimately an interest bearing debt to the banking system.

The Reserve Bank is not so much the government's bank, but the banking industry's bank. Despite the window dressing of public ownership, it runs its own policy independent of government. Australian politicians of whatever party, like most of their counterparts around the world, pride themselves on saying the Reserve Bank is independent of government. What they are really saying, is that despite whatever rhetoric about the Reserve Bank serving the people of Australia, it is not accountable to its supposed shareholders, the Australian people.

Government could print money or create the necessary credit through the Reserve Bank at no interest cost for worthwhile public works. Instead it goes cap in hand to the banks issuing IOUs by Treasury Notes, Commonwealth Bonds and other securities to borrow money created by the banks out of nothing at interest, for which the long suffering taxpayer has to pay.

US President Abraham Lincoln was acutely aware of this dilemma facing government. When seeking finance for the North during the US Civil war, Lincoln rejected the usury of the banks who were prepared to finance the North at 24% to 36% interest. Instead Lincoln began printing 'greenbacks' which the US currency design has followed ever since. As quoted in Appleton Cyclopaedia Lincoln was moved to remark, "I have two enemies; the Southern army in front of me and the financial institutions in the rear. Of the two the one in the rear is my greatest foe." He also noted that, "The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of government and the buying power of consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government's greatest creative opportunity."

If government harnessed credit creation as it should, the phoney argument for privatising public assets like Telstra because government does not have the money to develop these assets disappears. Selling Telstra and other government business enterprises to redeem public debt is also nonsense. Privatising assets only transfers the burden of debt from government to another sector of the economy. Investors either borrow money or use savings which have ultimately been created as an interest bearing debt by the banking system. Importantly, no net reduction in debt occurs in the economy, unless foreigners purchase these assets, in which case the debt burden is transferred offshore.

We do not need foreign investment to develop Australia. We may need to buy technology and skilled labour from overseas, but we do not need foreign investment. Foreign investors cannot spend their $US, Japanese , German DM or Sterling, in Australia, they can only spend $AUD. When foreign investors purchase assets in Australia, they need to buy $AUD. They purchase these dollars from Australian banks, or from banks in their own nation holding reserves of $AUD. In effect the banking system releases counterpart $AUD into the economy, on the signal of the foreigner investor. This is totally unnecessary. Why allow an Australian bank to introduce $100m into the economy to start a mine or factory for a foreign company, when $100m of new money could be created for an Australian company to do so.

Now after relating to you how banking operates in the economy, we should not be bitter about banks, nor toward the people who work in them. However, unless reform of our financial system is made, Australia will end up in the same strife as Africa, Latin America, Indonesia, Thailand, Korea, and Russia. The social fabric in these countries has been torn asunder by debt.

The prescriptions imposed on these countries by the International Monetary Fund and are criminal. It has lent more money, just so these countries can try and pay the interest bill on their debt. Note there is no talk of trying to repay the debt itself. This is like giving an alcoholic more drink to cure his drunkenness. The only solution is a complete write off, in an orderly manner of the international debts of these countries.

In Australia, growth in the money supply each year should be related to the total productive capacity of capital and consumer goods and services. There should be a scientific approach to creating and distributing money in the economy based on what is needed, rather than the arbitrary policies of the banking system. We need a national supply and demand account listing productive capacity against anticipated demand. This will indicate whether the money supply needs to be expanded or contracted. We need a national balance sheet listing assets and liabilities, which would include the money supply since it is a claim upon assets.

As we have significant numbers of unemployed and a huge proportion of the population living below the poverty line it is obvious our productive capacity exceeds demand at the moment. The Reserve Bank could be directed to costlessly expand the money supply according to what is indicated by the national accounts, at no inflationary cost by paying price subsidies to producers.

Before the establishment scream this distorts the market and makes producers inefficient, it is far less market distorting than sales taxes, which make the pockets of businesses and consumers inefficient by draining them of money. It also ignores the fact that this has been successfully done in Australia before. A universal price subsidy scheme to control inflation operated in Australia from 1943 to 1946. Businesses supplied evidence of their prices to government, and then discounted their prices in return for compensation from consolidated revenue. In effect, this was a sales tax in reverse.

The Reserve Bank could provide Federal State and local governments with their monetary for capital development, free of debt or interest. The debts of all government business enterprises could be refinanced by the Reserve Bank at an interest rate of 1% or less to cover the cost of administration. Governments would then be in a position to significantly cut taxes and charges across the board as the interest servicing costs funded by the taxpayer would dramatically decline.

In the tax election at the moment, the politicians are only offering various versions of ever increasing taxes. Whether or not we get a GST, there is bracket creep which slugs wage earners as they are pushed into higher income tax brackets when their pay increases, automatic inflation linked increases in petrol, tobacco and alcohol excise, and increases in sales tax and stamp duties as prices and asset values rise. The various tax packages are not aimed at reducing the level of taxation, but only at shifting the burden between groups of taxpayers.

Money is a symbol which determines how resources are mobilised and consumed. At the moment the whole of the real economy is held to ransom by those who create and distribute the symbols. Australia needs policies which grasp the reality that the economy exists to sustain individuals and families in a dignity befitting their development. Production should be subservient to this. Money and banking should be subservient to production. Anything else is arranging deck chairs on the Titanic.