Ideologies of credit creation

The money-system thinking of those in Feasta’s extended network has mainly involved examining and exploring the benefits of debt-free money – that is money that is spent rather than lent-at-interest into circulation. This line of thinking has been and is inspired and informed by the work of Feasta’s co-founder the late Richard Douthwaite. At some point a proper retrospective on debt-free money is probably due – notably why loan-credit seems still to have the relative moral high ground despite all we know, historically and personally, viscerally, about usury. But this article isn’t it.

Money enters circulation in one of three ways, two direct, one arcane and indirect – it can be spent directly into circulation by government; or it can be lent at interest (a function governments have largely devolved as a right to commercial banks). The money supply can also be indirectly influenced via asset purchases by the central bank (varieties of Quantitative Easing) which boost the reserve accounts of the banks and thereby facilitate more lending. All of these methods can be ‘unwound’ – the orthodox thinking is that if they are not, too much money in circulation will cause excessive inflation. The first is unwound by taxing back the money spent (to some degree [1]); the second through the repayment of loans; the third by selling back the assets purchased thereby tightening reserves.

For the purposes of this article, we will leave aside the primary toxicity of credit-at-interest – it is after all understandable if entities wish to borrow against their future ability-to-earn in order to expedite their plans. And credit creation isn’t going to go away any time soon. So this piece is about sources of credit-creation and their associated ideologies.

We can identify five sources of credit creation: i) the government or central bank (or fiat currency ‘owner’ to permit EU entry to the category). ii) commercial banks (an extraordinary privilege granted under a non-documented ‘confidence and supply’ agreement from governments) iii) other for-profit entities iv) the community – in the guise of mutual credit v) the individual

It is widely accepted that commercial bank lending is the source of most money in circulation [2].

Government controlled fiat money has the great advantage that it is widely acceptable as a means of payment, thanks to its historic position as (until recently) the only game in town and to its necessary accumulation for the purpose of paying tax. Bank-created credit-money – since it is indistinguishable from government created money once issued – shares this advantage. The other credit creators have to bootstrap in a network-of-acceptance and thus only make sense in the medium term within a more diverse monetary ecosystem. Government/bank fiat currency therefore has a built-in tendency to favour status-quo monetary monoculture rather than an ecosystem within which it is forced to compete with other monetary offerings.

Lets look at the associated ideologies in reverse order:

The Individual

Anyone can create their own credit notes – it’s getting them accepted that is the problem. As individuals we can only back credit issued with our own personal capabilities to create. So a note from an artisan baker who lives nearby is probably a good bet. But in late stage capitalism most of our personal contributions to value-added are selected/ combined/ subsumed into the capitalist value-creation function. In fact this selection and combination is the core rationale for capitalism – the ability to create something bigger than the sum of its parts and cash in the resulting surplus value.

The appeal of this person-as-primary-credit-creator ideology derives to a large extent from the cult of the heroic individual. It represents an atomistic view of society informed by the rampant competition/ evolutionary school of economic thought. It is interesting only in the sense that all value creation is grounded in individual contributions and that recognising those contributions in some way is important.

Community/ Mutual Credit

Here the ideology is one of communal support. No man is an island ; we all need support at different stages of our lives and careers. So the community manages in some way its collective resources in order to smooth the path. Note that this may be more or less socialist in its nature; and the community may be of individuals or of businesses or both.

We can characterise this approach as a credit commons [3]. And for a sustainable commons a key success factor is to specify boundaries – who is in and who is out (and thus under what circumstances a party can join or be asked to leave). This turns out to be a non-trivial governance task and leads into consideration of wider ‘digital democracy’ issues.

Much of the thinking behind mutual credit dates back centuries but more recent instantiations have been reinvigorated by emerging seductive digital ‘solutions’. At their best they can facilitate information and experience sharing; at their worst they relegate decision making to algorithms with no room for flexibility or judgement as circumstances change.

Mutual credit however remains the purest form of credit creation because it satisfies the core test set out by Douthwaite in The Ecology of Money – that a currency should be controlled by its users [4]

For-profit non-banking entities

When Hayek wrote about ‘Denationalising Money‘[5], he was clearly thinking about banks – what we might perhaps today call challenger banks – creating their own credit money. For Hayek competition was the answer to everything, so we can imagine that if he revisited his thoughts today he would happily include the potential for Amazon / Apple / Google to create their own money-as-credit and direct it where they will. When Hayek wrote, the idea of fractional reserve was already understood – that is the practice of issuing more loan-credit than you have assets to back.

Hayek’s take on the risk involved was to let failing banks go bust and the shareholders and account holders lose their money. So the ideology here is that rare (arguably untried) beast Proper Capitalism.

Non-banking entities are worth noting as a category because while the likes of Amazon do not have the deposit taking functionality of banks to base their proposition narrative on, they do have enormous network effects at their disposal, and their ability (based on data) to direct incentives to procure certain behaviours may be a more than adequate replacement. They have already proven their ability to capture governments, so assuming to themselves the role of credit creators may not be that much of a leap.

Commercial Banks

As mentioned there appears to be no clear description of the mandate that governments have given to the commercial banks to create money-as-credit ex-nihilo and direct that credit where they will. For such a wholesale outsourcing of strategic power this seems strange.

The rationale for the approach might perhaps be justified as a combination of: a) the belief that bank-directed market demand for credit is a good proxy for national strategic priorities and b) the desire for governments to avoid the temptation of printing money for party political reasons.

If you are quietly laughing to yourself at this point, you can be forgiven I think. The ideology here is the pursuit of profit.

There is a school of thought that says the best guide as to a systems purpose is the outcomes it generates [6]. Thus inequality, planetary degradation and the primacy of finance over production can be seen as planned outcomes. Only a small part of bank credit creation finds its way into production – currently about 10% in the UK down from 35% in 1986 [7]. Most goes into ‘safer’ loans – primarily mortgages and financial speculation.

Occasionally governments have issued credit guidance (aka window guidance) to indicate their preference for the first-use of bank-created credit. The idea of ‘green quantitative credit guidance’ – directed lending to environmentally sustainable projects – has not been pursued.

Governments and Central Banks

Governments spend money into circulation and then tax it back. The prevailing ideology is to limit this spending to defined categories (health, education, benefits ) and to progressively reduce the spend in each of these categories by privatising and budget tightening. Again this derives from a competition-based framework and an aversion to ‘picking winners’. This despite the clear evidence that governments play an important role in managing market externalities and failures and in incubating innovation.

Government can also stimulate lending. But this is accomplished as discussed earlier via Quantitative Easing. Assets may be government bonds or ‘riskier’ assets [8]. The latter, so called Qualitative Easing, however is still largely concerned with financial assets (such as derivatives), presumably because the assets must be available from those organisations with reserve accounts at the central bank. A similar restriction would mitigate against green quantitative easing.

The ideology here, overall, is what might be called facilitating-via-finance. It seems important that governments do not get their hands dirty by trying to pick winners. There is a blind faith that the market will deliver what humanity needs.

The Ideological Battle

Ideologies do not in general yield to reasoned argument. We can hope that some of the heterodox thinking and radical approaches emerging around the money-system filter into the ideological bunkers and cause a degree of movement around the edges. We can not hope for much more, though this should not discourage us. It is likely that in the inevitable crises that await us there will be a thrashing around looking for solutions, so the existence, within reach, of a ‘shrink-wrapped’ alternative or two may be important.

It is patently obvious that commercial bank lending-at-interest is an unsatisfactory proxy for strategic planetary priorities. The capitalist model allows producers to ignore negative externalities that will in due course kill us all. Attempts to reinternalise those costs end up with complex markets-within-markets that are gamed-to-irrelevance. They serve the purpose of enabling producers to pretend they are addressing planetary issues while changing their models as little as possible.

It is equally obvious that government has no real appetite for addressing the wicked problems. They are too difficult – hard to think about, impossible to address without impossible international cooperation, and there is not enough time before the next election. It is much better to let the market’s invisible hand sort things out – it must at some point gravitate towards sustainable market solutions to existential problems. Techno-fixes will surely be found.

In parallel, governments are now in the business of pushing responsibility down to the individual. Of course consumer behaviour is an important factor but we are all constrained by the systems that surround us. The extent to which we have agency over our own situations is limited – and the poorer the individual the less agency they have. This is why it is important not to be judgemental about behaviours. Most of us are too busy dealing with the in-tray of life to contribute to changing the system. It can become a somewhat middle class glass bead game.

Pleasingly there is no shortage of innovative and inspirational ideas and approaches. There is however a shortage of working capital to develop those ideas. In order to access capital, projects have to demonstrate a profit potential. They almost have to hide any sustainability objectives to demonstrate serious commercial intent.

So against this background what directions of travel can we identify to facilitate?

Firstly national governments need to redevelop a sense of strategic direction, acting individually without waiting for international agreements even if economists tell them that will endanger their competitiveness. They have to re-exert directional control over bank credit via credit guidance. If they don’t start picking winners (in planetary sustainability terms) we will all be the losers. They need in particular to start to differentiate between the stuff we want and the stuff we need and to intervene in markets for the latter.

Secondly, if community/ mutual credit is indeed the purest form of money-system, we should be particularly sensitised to developments in this area. As progressively digital interactions push the boundaries and centuries-old governance ideas are given a digital boost, we should be open minded to the emergence of a more diverse monetary eco-system and participate in developments to the extent that our personal circumstances allow.

Thirdly we should push hard for the sort of enabling developments that will allow more people to spend more time working on things that matter rather than in bullshit jobs, for example Universal Basic Income and fair taxes including site value tax to address inequality.

Finally, if we do have any agency ourselves we should invest in ourselves and those close to us, and in investments we have direct control over, not in remote anonymous schemes managed by faceless third parties. So more self-invest pensions, productive land, self-generated electricity. And if you borrow against your capacity for future earnings do so from a source that shares your values not from one that gives the best deal.


[1]: The extent to which governments should be concerned with deficit financing has become a matter of exrreme controversy. Politicians present a nation’s finances as if they were a household budget, thereby implying deficits are bad housekeeping. Modern Monetary Theory and others point out that government deficit equates (pace exports) with private sector net income and that governments unlike households can create money ex-nihilo. Some now encourage us to see accumulated deficit as a sort of national equity – capital invested in a national future – rather than a debt to be repaid.

[2]: For example NEF’s 2017 report, Making Money out of Money: nt_E.pdf shows a breakdown of Money Supply in the UK 1969-2015, between money created by banks and cash.

[3]: see also: Money as a Commons

[4]: The Ecology of Money Richard Douthwaite Chapter 4

[5}: The Denationalisation of Money: Friedrich Hayek

[6]: “The purpose of a system is what it does. There is after all, no point in claiming that the purpose of a system is to do what it constantly fails to do.” ~ Anthony Stafford Beer. Diagnosing the system for organizations (p. 99), 1985.

[7] Credit where its due: Frank von Lerven September 2018

[8] Buiter, W. H. (2009a) Quantitative easing and qualitative easing: a terminological and taxonomic proposal.

Note: Feasta is a forum for exchanging ideas. By posting on its site Feasta agrees that the ideas expressed by authors are worthy of consideration. However, there is no one ‘Feasta line’. The views of the article do not necessarily represent the views of all Feasta members.