In this article, I argue for a policy of free money creation. This involves the creation of durable money without backing assets, or what is popularly known as ‘helicopter money’. I then propose policies for managing inflation under a regime of free money creation. The ideas presented are a condensed version of the Money Circuit Theory of Capitalism, a series of articles I have previously written.
My argument consists of five parts:
- All newly created money in the modern economy is debt.
- Capitalist economies require money growth to grow.
- Modern economic growth is unsustainable because it is inherently debt-driven.
- Existing economic tools cannot address the unsustainability of debt.
- Free money creation can enable sustainable economic growth.
The policies I propose to manage free money creation are:
- Curtailment of mortgages and credit card debt.
- Public financing of production.
- Management of labour supply.
- Public transparency regarding economic and fiscal policy.
All Modern Money is Debt Money
There are three forms of money in the modern economy. These are deposits, reserves and cash. Let us consider how each is merely debt, in the sense that they are temporary and destroyed when they are repaid.
It is well understood that most deposits are backed by bank loans rather than cash. When a bank grants a loan, it provides the borrower with a deposit. This deposit represents a promise of the bank to deliver cash to the borrower. It also represents an expansion of buying power in the economy, as deposits can be used for transactions, without needing to redeem them for cash. Balancing this liability is the acquisition of the loan as an asset. In the long term, this cancels out the increase in spending power through loan repayment. Hence, most deposits in the economy exist as temporary money, committed to destruction through loan repayment.
In the modern economy, reserves are backed by asset purchases. To supply the private banking system with reserves, the central bank buys securities such as mortgages and government bonds. Because such securities are debt, the process of reserve creation merely transfers debt from the private banking system to the central bank. Instead of the banking system destroying money, it is now the central bank that destroys money, when it receives payments on the assets it owns. For this reason, to engage in quantitative tightening, the central bank does not need to sell off its securities. It only needs to merely let the security roll off its balance sheet, as securities generally return more money than what was paid for them. Therefore, reserves are also a form of debt money, in that they are temporarily usable before they are destroyed by the debt issuer.
Cash appears as something physical and durable. To understand how it is also temporary, we must trace the process of cash creation. Under current limitations, the central bank cannot engage in free money creation. Therefore, cash is only created when reserves are redeemed for cash by the private banking system. To honour this, the central bank sends an order to the mint to create cash, before delivering it to the banking system in armoured vans. Because cash creation is entirely determined by reserve creation, it is also a form of debt. While it tends not to be destroyed itself, this is only possible through displacement to deposit and reserve destruction. In other words, when the private banking system facilitates payments to the central bank, it tends to run down its reserves at the central bank instead of delivering cash. Therefore, cash also represents a commitment to reducing spending power in the future, making it debt.
The Necessity of Money Growth
Capitalism requires money growth to avoid the spectre of deflation. This is because capitalist competition compels innovation and mechanisation. Such processes increase real production over time, threatening deflation unless money circulation catches up.
One might suppose that deflation can be sustained, as what matters is the real economy. However, the real economy is the product of non-real, psychological behaviour. The main driver of psychological behaviour in the economy is the pursuit of money and the perception of its scarcity. Therefore, deflation matters, because it decreases economic confidence and encourages the hoarding of money. It follows that money growth is required for economic growth under capitalism.
Modern Economic Growth is Unsustainable
We now combine our first two points to derive the third. Capitalism requires money growth, but modern capitalism can only achieve this through debt creation. To our intuitions, modern economic growth is unsustainable because it is entirely dependent on debt. The precise process of this money growth occurs through the loans of the private bank system, which creates deposits. Such loans can then be converted into reserves and cash when they are bought by the central bank. Another novel form of money growth occurs when the central bank uses reserves to fund the borrowing of the government.
One might suppose that debt does not necessitate unsustainability. So long as more debt can be issued, the economy encounters no problems. Herein lies the origin of unsustainability. Prior debt must always be honoured, but new debts are conditional on economic confidence. If the modern economy experienced no loans for a year, the economy would immediately contract from the money destruction of loan repayment. Nor is it realistic to hope that economic growth can shrink the size of the debt burden, because all economic growth is funded by debt. Therefore, as the economy grows, the factors favouring contraction, in the form of debt repayment, must grow as well.
In a system dependent on debt, a recession is not merely a deviation from long-term growth. It represents an existential threat to the economy if left unchecked. Notably, a contraction in GDP worsens economic confidence, which decreases loan creation and contracts GDP even more. This vicious cycle threatens to reinforce itself until defaults occur, threatening a financial crisis. At the endpoint, all of the debt money within the private banking system is wiped out, producing a catastrophic contraction in spending power. In this sense, the modern economy has been on the same credit cycle since the conversion to fiat money in the 1970s. There has never been a true contraction of this credit cycle.
Modern Economic Tools are Insufficient
The modern economic system possesses numerous tools to avert recessions and financial crises. This toolkit has enabled the modern economy to respond to recessions and financial crises which might have otherwise threatened economic collapse if they were left unchecked.
Firstly, the central bank can increase asset purchases, to provide liquidity to the financial system and to reduce losses. This transfers asset risk to the central bank, which can easily bear it through its monopoly on reserve creation. Secondly, where a particular financial firm threatens to become bankrupt, its losses can be absorbed by the central bank or government. This reduces the concentration of losses that could trigger a financial crisis. Thirdly, the debt burden can be alleviated through a reduction in interest rates by the central bank. Fourthly, the government can promote the circulation of money to restore GDP and economic confidence. This occurs through government spending funded by borrowing, which converts savings into spending, increasing the velocity of money.
None of the above tools are sustainable. They merely defer the crisis of debt for another time. As the modern economy can only grow through debt, the size of the crisis next time is necessarily larger, straining the ability of such tools to resolve them. We see this in growing government debts, the growing size of central bank balance sheets, increasing central bank losses and the secular downtrend in interest rates. Increasingly, the modern economy is dependent on tools historically deemed extraordinary.
Classical economists also recognise the problem of growing debt, and how conventional tools are increasingly stretched. Like us, they argue that conventional tools have merely deferred the problem, such that subsequent crises are of increasing severity. The difference is that they argue that the financial crisis should be allowed to run its course. This captures the intuition that the contractionary effects of debt can be removed if the debt is allowed to collapse. Yet all of our analysis so far has shown that this would entail a catastrophic contraction of the economy. This is because the debt itself is the spending power of the economy. Specifically, a bank collapse threatens a wipeout of deposit money, which accounts for over 90% of transactions. No amount of deposit insurance can cover this amount.
The Ideological Limits of Capitalism
If we carefully interrogate why conventional tools are not sustainable, we realise that they arise from purely ideological limitations. There is nothing physically preventing the central bank from running permanent losses, or the government from running large deficits. Nor is there any preventing the central bank from creating reserves to replenish the losses of the private banking system, or from using those reserves to forgive debt. The problem is that such activities deviate from orthodox economic ideology, such that they decrease psychological confidence in the economy, which then causes real economic effects. Therefore, we might say that modern capitalist growth is ideologically unsustainable.
That capitalism is ideologically limited is an important point to emphasise. So much of the common discourse treats debt as if it were a real limit on economic growth. As a result, during the situation of an economic crisis, the problem of debt and default is treated as a real problem, as if an earthquake had destroyed half of the factories. Yet debt repayment is merely a legal arrangement; its only economic role is to act as a deflationary check on the inflationary effects of loan creation. It is entirely possible to forgive debt while replacing its economic effects debt through deflationary policies. What ultimately brings about recession and financial crisis is an acquiescence to conventional ideological limitations.
Consider that on the day of a financial crisis, all of the machinery, natural resources and labour exists as it was on the previous day. There is nothing physically preventing output from remaining as it was before. What produces the depression is the collapse in the psychological behaviour that brings these ingredients together to produce economic output, due to the crisis in conventional ideology. Therefore, what is required to overcome a financial crisis is an ambitious break in capitalist ideology. In the Great Depression, this amounted to an increase in government spending through the welfare state and military spending. In the GFC, this took the form of QE and banking bailouts. In the coming financial crisis, it must take the form of free money creation that funds debt forgiveness.
Free Money Creation is the Solution to Sustainable Growth
The fundamental problem of the modern economy is that all growth is dependent on debt. This is because it is the only method of money creation. The solution is simple. Debt-free money creation must be allowed to occur.
There are two ways to create debt-free money. The first is to make money exchangeable with a durable asset whose production naturally increases with economic growth. Historically, this occurred with the gold standard. In modern times, it could occur with money backed by carbon credits. Because such assets are durable, the money becomes durable, without any threat of future economic drag. This is in contrast to the current system of debt, where future spending power is perpetually threatened with contraction. The second is free money creation, where there is no backing asset at all. This corresponds to the popular picture of ‘printing money’. Free money creation is the ideal solution to the modern economy’s problems because of its flexibility.
Free money creation is not so outlandish when one considers that debt-free money creation has occurred for the majority of human history. Notably, consider the operation of the gold standard. One might suppose that the increase in money supply was backed up by ‘real output’ in the form of gold production. However, once gold was exchanged for cash, it was locked up at private banks and the central bank, separate from the real economy. It was entirely analogous to free money creation, only more ideologically tolerable, such that it was easier to maintain faith in currency.
Beyond being historically possible, the more important point about debt-free money creation was that it was able to generate durable economic growth in the very long term. Importantly, while financial crises occurred because private banking also existed during the gold standard, they were not as crippling to the economy. This was because gold mining had increased the money base in a lasting way. Therefore, when financial crises collapsed the system of deposit money, there was a durable and increasing spending base to fall back on. In the same way, free money creation promises economic growth without the prospect of deep recessions or financial crises. We contrast this with the present, where a true contraction of the credit cycle threatens to send the economy back decades.
Free Money Creation Must Seriously Consider Inflationary Concerns
In previous societies, any government with a monopoly on money creation would inevitably debase its currency, so long as it was not tied to precious metals or debt. Conventional economic thinking was rightfully constructed as a guard against this threat. Yet for the first time in human history, governments and institutions are sufficiently enlightened to understand the importance of managing inflation. Advances in data collection and communication also provide the tools for achieving this prudently.
With the above in mind, free money creation must seriously consider inflationary concerns through an equally ambitious set of deflationary policies. These tools must go beyond the existing framework of interest rate rises or government deficits, to tame the inflationary effects of free money creation and to maintain the value of the currency. Together, they offer a paradigm of achieving stable economic growth.
Policy #1 — Curb Private Banking and Unproductive Loans
If we contemplate the deflationary nature of capitalist production, it must be the case that a significant amount of money growth is money growth for the sake of money growth. This is because if all loans were financing production, this would only exacerbate deflationary tendencies. Therefore, the existing banking system must possess a surfeit of unproductive loans which do nothing except create money. The real economic effects of such unproductive loans are entirely equivalent to free money creation, in that they increase consumption without any increase in production.
The main forms of unproductive loans in the modern economy are credit card debt and mortgages. It is easy to understand how credit card debt is unproductive. It is harder for the mortgage, as it sometimes funds the construction of housing. However, consider that the majority of home loans are for already existing houses and land. It merely funds a change of seating, without any change in the productive economy, as is the case for any asset transaction. The only real economic effect is that the process of loan creation generates money for the home seller, who then spends it to boost economic growth. In this way, one of the key engines of modern capitalist growth is the consumption of retirees who fund their retirement through asset sales.
The rationale behind our first policy proposal is clear. Modern capitalism already has a money-printing machine. The problem is that it only runs for the benefit of asset owners. This money-printing machine has been indispensable for capitalist growth due to the deflationary pressures of mechanisation and offshoring. Free money creation can easily achieve the same thing, without the instability that is generated by debt. Specifically, credit card loans are replaceable through increased welfare payments, while mortgages are replaceable through increased pensions. To the extent that the bloated housing market funds housing construction, this is replaceable through public housing. Finally, to account for the deflationary effects of unproductive loan repayment, such government programmes would pay less than what was being provided by such loans. In this way, the unproductive aspect of modern finance would be replaced through government transfers funded by free money creation.
Of course, even with a more generous welfare state, there will be people who want to increase their consumption at the present. In that situation, the central bank can provide unproductive loans itself, under the same principles of repayment as the existing private banking system. The difference is that being freed from profit constraints, it would be able to tailor repayments to maximise economic welfare. For example, in the vast majority of cases, it makes no sense to make people homeless as a consequence of recovering debt repayment. The long-term economic costs of drug addiction and crime vastly outweigh any funds recovered. Instead, the central bank might force them to move into lower-quality public housing as punishment for failure to repay debt.
Policy #2 — Public Financing of Production and Economic Coordination
Another function of private banking is the expansion of economic production through productive loans. This is another function which can be replaced through public policy. Just as a bank carries out market research to inform a loan, the central bank can do the same, both at a local level and national level. Having identified relevant needs, it can then provide finance to businesses which are capable of expanding production in such areas, funded through free money creation. Modern technology makes this readily achievable through surveys and modelling. At the same time, the government can also engage in infrastructure projects and trade deals to support the growth of industry in the particular area where deflation is desired.
For example, in response to increased free money spent on welfare, the central bank could do research on a basket of goods most likely bought by poorer people. It could then contact major firms in the production of those areas to offer them favourable financing, as well as to learn more about the production process of those goods. After identifying key bottlenecks, the government could then be directed to change laws or international agreements to alleviate such problems, in anticipation of increased production. This planned production would result in economic growth much smoother than the present, as firms could be more certain about their sales, while also being offered favourable financing.
Policy #3 — Management of Labour Supply
Ultimately, any expansion of production to offset free money creation must involve the mobilisation of more labour into the economy. Otherwise, the government financing one area of production may produce deficits and inflationary pressures in another area. Therefore, the economic coordination of production must be paired with broad macroeconomic policies that increase labour supply.
There are four general categories to increase the labour supply to encourage deflation. These are increasing the working-age population (such as through immigration or pro-natalist policy), increasing working-age participation in the labour market (such as by decreasing homelessness or training programs), increasing hours worked per person (such as through reducing income taxes or reducing pensions) and decreasing social problems that require economic activity (such as basic health improvements that reduce the need for doctors).
The implementation of labour-increasing policies is inevitably limited by political considerations. For example, immigration and retirement restrictions may be unpopular. Therefore, decisions may have to be made about which areas of production are to be sacrificed to minimise inflationary pressures. As a general principle, where the overall economic good is concerned, it is better to sacrifice the production of luxury goods than common goods, because more people benefit from the latter. This is unless a country is particularly dependent on luxury goods for its exports.
We should also note that there exists plenty of space in the existing economy for rationalising the labour supply. As previously analysed, a large portion of the private banking system does nothing productive for the economy, because its only role is to generate money for consumption. A similar thing applies to those working in the share market, except where the share market is used to raise money for capital. In any case, the allocation of capital to socially useful production can be accomplished through public financing of production. The people working in such jobs represent an immediately accessible labour pool in the initial stages of adopting free money creation, to offset deflation through productive policies.
Finally, we might make use of Marx’s concept of the reserve army of labour to propose an additional policy for managing labour supply. The government could create a pool of people who can be flexibly channelled into areas of economic production on demand. During inflationary pressures, this pool of people would be mobilised, while during deflationary pressures, this pool of people would be made inactive. Marx understood this pool of people as the unemployed. However, the state of being unemployed creates social stigma and alienation. Instead, the state should create a program of ‘registered artists and intellectuals’. These people would be supported in their creative output in periods of deflationary economic pressure. However, this would be conditional on them accepting employment in areas of needed economic production during periods of inflationary pressure.
Policy #4 — Public Messaging About Economic Policy
Previous emphasis has been placed on the psychology underpinning economic behaviour. Any implementation of free money creation must remain cognisant of this fact. To maintain public faith in their money, the government and central bank must engage in a type of double-entry bookkeeping. On one hand, it must record each instance of free money creation and where it is entering the economy. On the other hand, it must also record the deflationary measures taken to offset that instance of free money creation. Moreover, it must make such information publicly available. Only through these thoroughly transparent measures will public faith in currency be maintained. They also function to keep the government accountable, should it stray into the temptation of unchecked free money creation, as governments did in the past.
Conclusion
The foundations of modern capitalism are inherently unsustainable, having been built on debt. Yet while popular discourse tends to blame this on decadence or moral failing, we see how this has been the only way for the economy to grow. As a result, the economy is threatened with crises of increasing severity, while the tools to resolve them appear increasingly stretched. Such circumstances call for a paradigm shift in economic policy. The program I have proposed is one of free money creation, with fastidious diligence taken towards inflationary concerns. Such practices promise a path of harmonious growth, enabled by the advances in data collection and communication. It is time that economic policy matched the ambition of historical progress.
