The monetary system and the productive system are two distinct factors in an economy. Therefore; we must inquire how the money system and the productive system are linked? What is the purpose of a productive system? And how does the productive system satisfy our needs?
"It must be borne steadily in mind in considering this question that the object of industry is not work for its own sake; the industrial system exists firstly because society has need of goods and services." (C.H. Douglas, "Credit-Power and Democracy")
The goal of the productive system is to create goods and services. The production of goods is the transformation of matter, and its movement to where it is demanded. Services enhance the value we attribute to goods. Work is merely a bye-product of this system. Therefore, the purpose of the industrial system is not to provide work; although, some work is necessary to provide the goods and services that we desire. The amount of labour required for production is constantly decreasing through advances in technology. Man organizes himself for productive purposes because we are capable of producing far more when we work together than if we were to attempt to produce individually. The increased output achieved by working together is known as the increment of association. This increment is dependent on available physical capital (raw materials, machines, buildings etc. ), technology and processes; most of which were built, invented, and developed, by people who are long since dead. The invention of the wheel, or the harnessing of fire, have both brought great benefit to mankind, but the people who developed these technologies are long since gone. These technologies, or processes, belong to every man by birthright, and form a part of our cultural heritage. Production is mostly a function of our cultural heritage. Direct labour is constantly becoming a less important factor in production.
"The modern producer-not so much of course, the agricultural producer, although to some extent that is true by the use of harvesters, and gang plows and many other things, application of transportation and so forth--but taken over the whole world, the actual producer so called is more and more the delegate of the general community, delegated as you might say, to press the keys of an enormous productive machine which is over-whelmingly effective as a result of inherited knowledge and technique. You can prove that to yourselves if you consider the effectiveness as producers of ten men, let us say in Detroit, and ten men on a desert island. What ten men on a desert island can do, is what they can do as producers; what ten men can produce in a year in the way of wealth in Detroit is due to their value as producers plus their application of the heritage of civilization, and I suppose ten men in Detroit could probably produce ten thousand times as much real wealth in a year as the same ten men on a desert island. The difference between that productivity is due not to their own virtues but to their inheritance of this technique of civilization." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)
The cultural inheritance of the technique of civilization is primarily responsible for the wealth that we are capable of producing today. The current generation of men who "press the keys" of this enormous productive machine add very little to its productivity, and as Douglas said, if someone is sceptical of this fact, they should compare the productivity of ten men on a deserted island who do not have access to the cultural heritage, as opposed to ten men in Detroit who do. Of course, the machine would not produce at all without those who "press the keys", but the productivity of those who press the keys is mostly a function of our cultural heritage.
"The industrial machine is a lever, continuously being lengthened by progress, which enables the burden of Atlas to be lifted with ever-increasing ease. As the number of men required to work the lever decreases, so the number set free to lengthen it increases." ( C.H. Douglas, "Credit-Power and Democracy")
The industrial machine acts as a lever, which allows man to free himself from the burden of Adam, by substituting solar power for human power. Progress, or advances in technology, decrease the amount of labour it takes to produce goods or services. As the amount of men freed from production increases, via advances in technology, so the amount of men available to devise technology that is labour saving, is increased. As an example, the productivity of farmers has increased dramatically since the advent of the industrial revolution, and this has led to a drastic decrease in the amount of people engaged in agricultural production.
"A factory or other productive organization has, besides its economic function as a producer of goods, a financial aspect - it may be regarded, on the one hand as a device for the distribution of purchasing-power to individuals through the media of wages, salaries, and dividends; and on the other hand as a manufactory of prices-financial values" ( C.H. Douglas, "Credit-Power and Democracy")
Companies have a dual role in the economy, because the modern economy is dependent on money for the distribution of goods and services. Firms not only create goods and services, but distribute incomes, at the same time creating price values. Income is distributed when a company pays wages and salaries to its employees, or distributes dividends to its owners, and that income is "repaid" when a consumer pays a price, thus acquiring a good or service in exchange for his money. We are now in a position to apprehend the accounting cycle of money. Money is created by banks through loans or overdrafts to businesses (excluding for the moment consumer debt), it is then distributed as income to workers, and owners, through the media of wages, salaries and dividends. It is eventually taken back in the form prices or taxes in exchange for a good or service,making its way back to the bank where the loan is repaid and, consequently, the money destroyed. Money operates in accounting cycle: it does not circulate. It is either creating costs or cancelling them. It has direction: it is either flowing from the bank and being distributed as income, or it is taken back as prices and flowing back to the bank (taxes being the government equivalent of prices) .
"It is a widely spread delusion that price is simply a question of supply and demand, whereas, of course, only the upper limit of price is thus governed, the lower limit, which under free competition would be the ruling limit, being fixed by cost plus the minimum profit which will provide a financial inducement to produce." (C.H. Douglas, "Economic Democracy")
Companies will not produce for any length of time below cost. Profit is the incentive to produce. Obviously, any price below cost results in a negative profit and a disincentive to produce. Retailers may sell some items below cost (known as "loss leaders") in the hope that they can sell other products above cost in order to compensate for that loss, but no company can produce below the total cost of production for any length of time. Hence; cost is the lower limit of price. The upper limit of price is what people are willing to pay, and the more they are willing to pay, the more profit. Often, firms will engage in "economic sabotage", or the artificial restriction of output, in order to sell at a higher price; thus maximizing their profit. This restriction is made easier when there is differentiation between products. For example, an individual farmer has no affect on the price of wheat by restricting his output, because wheat is a homogeneous product. Consequently; the price of wheat is often at or below the cost of production. However; a Mazzerati can be sold well above the cost of production by merely limiting the amount of Mazzeratis produced: creating an artificial scarcity. If effective demand is well above the ability of all producers to supply consumer goods, then the price of all goods will eventually rise regardless of the ability to create artificial scarcity. This situation is also known as inflation.
"The essential point to notice, however, is not the profit, but that he cannot and will not produce unless his expenses on the average are not more than covered. These expenses may be of various descriptions, but they can all be resolved ultimately into labour charges of some sort (a fact which incidentally is responsible for the fallacy that labour, by which is meant the labour of the present population of the world, produces all wealth). Consider what this means. All past labour, represented by money charges, goes into cost and so into price. But a great part of the product of his labour -that part which represents consumption and depreciation - has become useless, and disappeared." (C.H. Douglas, "The Control and Distribution of Production")
All costs go into price, and represent the lower limit of price. And all costs can ultimately be resolved into labour charges of some sort. However; the portion of the labour that represents past consumption and depreciation is no longer income. The problem is clear: cost forms the lower limit of price, and all costs go into prices: these prices are paid by incomes, but the portion of cost represented by consumption and depreciation does not exist as income. Therefore, total incomes are less than total costs. If every firm sold their product at cost (i.e. without profit), total incomes would be incapable of purchasing all the products that are produced. This fundamental flaw would have been exposed a long time ago if it were not for an intervening factor - credit from an extraneous source. An obvious extraneous source of credit is consumer credit, which is really a mortgage on future incomes, and only goes to exacerbate the problem as future incomes are decreased by an equivalent amount. However; the gap is mainly hidden by capital production and exportation of product. There are two types of goods: 1) Consumer goods, and 2) Capital goods. Consumer goods are purchased by consumers and their cost is defrayed upon purchase. Capital goods are purchased by businesses in order to produce consumer goods. Capital goods are raw materials, buildings, equipment etc., and their cost is not defrayed upon purchase, but transferred, and the cost ultimately ends up in the cost of a consumer good, where it is eventually defrayed upon purchase by a consumer.
"In consequence, the production which is stimulated - the production which we are asked to increase - is that which is required by the industrial machine, intermediate products or semi-manufactures, not that required by humanity." (C.H. Douglas, "The Control and Distribution of Production")
The cost of capital production showing up in the cost of consumer goods is delayed, because it takes time for a capital good to make its way through productive system in order to be consumed. This fact allows the income from capital production to cover the gap between income and prices on consumer goods. In fact, massive amounts of capital production can lead to inflation in prices of consumer goods, if the effective demand created through capital production is in excess of this gap. Alberta is experiencing this situation currently, as capital production in heavy oil upgraders is dispersing massive amounts of income leading to the inflation of prices - especially for consumer goods whose supply increases slowly (i.e. housing). However; the cost of these capital projects eventually make their way into the cost of a consumer goods (i.e. the cost of the upgraders will eventually be included in the cost of gasoline), and if the money disbursed as income for these capital goods is used on current consumption (which it most likely the case), then it will not be available to meet the price of the consumer good created at a future date. By attempting to close the gap between income and prices of consumer goods through capital production, we are exacerbating the problem, as the gap between income and prices of consumer goods only widens at a future date. When there is a lack of capital production (i.e. investment), firms find their margins decreasing, and we experience a business "slump".
"In other words, it is quite immaterial how many commodities there are in the world, the general public cannot touch them without doing more work and producing more commodities." (C.H. Douglas, "The Control and Distribution of Production")
Regardless of how many consumer goods are in existence, we are unable to purchase them unless we engage in capital production (i.e. there has to be sufficient investment to cover the gap between prices and income), or we engage in a policy of a "favorable balance of trade" (i.e. exports exceed imports) with other nations, disposing of production (i.e. doing more work than is necessary) in order to close the gap between income and prices . The more we engage in capital production, the more we are forced to seek a favorable balance of trade with other nations. This is a vicious cycle, because if we don't engage in excess capital production, or dispose of production by sending it to another country, companies find their margins decreasing, which in turn leads to layoffs, and a recession. However; it is impossible to keep following this path, because increasing investment ultimately leads to inflation as capital production makes its way into the cost of consumer goods, and all industrialized countries are seeking to continuously export their surplus production to foreign nations, which leads to ever increasing third world debt, and friction between industrialized nations, ultimately leading to war. Capitalism is plagued by periods of heavy investment, followed by rising prices, increasing interest rates in order to control prices, decreasing profit margins to businesses, unemployment, and finally a recession. In fact, some people have come to believe that this is a naturally occurring phenomenon like the rising of the sun or the law of gravity: what goes up must come down.
"By an accounting method of analysis, the conclusion is reached that the value, at the current retail price-level, of goods produced far exceeds the flow of purchasing-power from permanent sources. In other words, recurring periods of business depression are shown to be the result of present financial and business policies." (C.H. Douglas, "Social Credit")
Business cycles are simply caused by financial and business policy, and unless there is a change in our policy towards incomes and prices, this will be a recurring problem with our economic system. Attempts to close the gap between income and prices by increasing income through investment simply results in inflation: attempts to close the gap by giving surplus production to foreign nations leads to the struggle for markets, resulting in third world debt, friction between industrialized nations, and ultimately war. Attempts to reduce prices by restricting credit through increasing interest rates is also doomed to failure, because the upper limit of price is governed by the law of supply and demand, but the lower limit is governed by cost of production. It is the rising cost of production that is the primary culprit for inflation, not too much income. If effective demand is insufficient to cover the cost of production, plus the profit margin just large enough to provide incentive to produce, businesses will simply stop producing. This policy leads to bankruptcies and economic hardship.
"Now any attempt, by current financial methods, to reduce prices (or even to stabilise them, as the phrase goes) is a mathematical absurdity unless the cost of this stabilisation, or lowering of prices, is met from some extraneous source. Or to put the matter another way, the margin of profit which makes it possible for a producer to go on producing, disappears unless the financial cost, and consequently the price of production, is allowed to rise steadily in relation to direct labour cost." (C.H. Douglas, "Social Credit")
Central Banks attempts to arrest inflation through the use of interest rates to restrict the supply of money is futile, since it does not deal with the root cause of inflation, making the cure worse than the disease. The artificial restriction of credit causes margins to decrease leading to decreased production, which explains the common fallacy that there is a natural trade-off between inflation and decreased production. In reality, there is no trade-off. Prices can decrease, and production can increase, if part of the cost of production is defrayed with money that did not come from the productive system. Every debt created in the aid of production creates an equivalent cost, because the debt must be repaid. Debt is recovered in prices.
"the consumer cannot possibly obtain the advantage of improved process in the form of correspondingly lower prices, nor can he expect stable prices under stationary processes of production, nor can he obtain any control over the programme of production, unless he is provided with a supply of purchasing-power which is not included in the price of the goods produced. If the producer or distributor sells at a loss, this loss forms such a supply of purchasing-power to the consumer; but if the producer and distributor are not to sell at a loss, this supply of purchasing-power must be derived from some other source. There is only one source from which it can be derived, and that is the same source which enables a bank to lend more money than it originally received. That is to say, the general credit." (C.H. Douglas, "Social Credit")
Mankind will never have control over production, or stable prices, unless we are provided with a steady supply of purchasing power not included in the cost of goods sold. This purchasing power must be created debt free, and given to individuals in such a way that it's not derived from work, for all debt servicing charges, and labour costs, go into the cost of goods sold, and consequently, into price. In this way, improvement in processes, which decrease the real cost of production (i.e. the amount of energy used), will also reduce the financial cost of production, resulting in falling prices. By providing debt free credit to consumers in reduction of prices, and by virtue of a dividend not associated with work, not only will prices fall, but consumers will finally have control over production, and no longer will the productive system have control over mankind.
Sunday, May 20, 2007
Sunday, April 29, 2007
Money and Banking
If the public is unfamiliar with the techniques of money and banking, then they will never understand how the current monetary system governs them. Further,if a monetary system governs individuals, then we have a system controlling men, and since men are above all systems, it is essential that we, as individuals, control the monetary system. In order to control a system, we must understand its techniques. Before trying to understand the techniques of money creation, we must first ask ourselves what is money, and what is its purpose?
"It is absolutely vital to realize that the essential part of money is the belief that through its agency you can satisfy your demands. (C.H. Douglas, "The Control and Distribution of Production")
Money is essentially effective demand. We place our money down in the faith that another will depart with a good or service in exchange for it. It allows us to carry on trade without barter. Money makes it possible for men to associate together in a manner which is beneficial to everyone. Therefore; money is essential to our economy. But, our demands can only be satisfied if money delivers goods and services. Therefore; the basis for the quantity of money, or the limit to our demand, is the ability of the productive system to deliver goods and services when and where they are needed. What does this mean? For one, it means that the basis upon which the quantity of money is determined has nothing to do with any of the physical properties of money itself.
"The best definition of money with which I am acquainted is that of Professor Walker, which is that "money is any medium which has reached such a degree of acceptablility that, no matter what it is made of, and no matter why people want it, no one will refuse it in exchange for his product." You will see that this definition rules out any physical properties in respect of money. The properties that are left, therefore, are not physical. They can be summed up in the word "credit," which is, of course, derived from "credere," to believe. The essential quality of money, therefore, is that a man shall believe that he can get what he wants by the aid of it. This is absolutely the only quality that it is required to possess, although, of course, certain minor attributes, such as convenience, have a bearing on the decision as to what particular description of money, if it fulfils the major requirements, is likely to come into the most general use. The cheque, no doubt, owes its popularity to this latter attribute." (C.H. Douglas, "Warning Democracy")
Money's value does not derive from its composition, but by the capacity of the economy to produce goods and services. This automatically rules out gold as an appropriate determination for the quantity of money. There is no real resemblance between the quantity of gold in existence, and the economy's ability to produce. Reality must reign supreme lest an abstraction have precedence over it, and money is an abstraction. Money should be a measure of wealth, and should never control our creation of it. Whatever is physically possible is financially possible.
"Money is nothing whatever but a ticket system which has nothing whatever to do with all these abstract descriptions of it such as a medium of exchange, or a storehouse of values or any of these other things. It is a ticket system and nothing else." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)
Douglas compared money to a ticketing system, because it is a means of distributing production. The only real limit to the amount of railway tickets issued is the number of seats on the train. The number of railway tickets should never be a limit on the number of people who board the train, for the latter is an inversion of reality. In other words, money should never be a limiting factor on production: production should be a limiting factor on money.
"There is also a nebulous idea involved, I think, to the effect that the man who grows, e.g. a ton of potatoes, also grows the purchasing-power of a ton of potatoes. The facts are far otherwise, as no doubt large numbers of potato-growers could testify. Given a fixed amount of legal tender, and assuming legal tender to be the only purchasing-power, no amount of production would increase it. Probably a minimum of nine-tenths of the immediately available purchasing-power in the world arises out of bank loans or their equivalent in bills discounted. These loans and the purchasing-power which they create have no automatic relation to either production or consumption. " (C.H. Douglas, "Social Credit")
Many people have a vague conception that the production system somehow manufactures money, and in so doing, create enough money to liquidate all costs of production. This idea is perpetuated by the belief that firms "make money" when they earn a profit. Of course, if companies literally "made money", they would be engaged in counterfeiting. The truth is money is not created by production, but is created by the banking system. Central banks are responsible for creating cash, and commercial banks create the majority of the assets used as money. The amount of cash in existence is determined by people's desire to hold cash. As Douglas states above, probably 90% of the money supply is created by commercial banks in the forms of loans to businesses and individuals. This money is called bank credit. Below are some quotes about banks and their ability to create money:
"In the normal course of their operations, banks create money" (Blomqvist, Wonnacott, and Wonnacott, "Economics First Canadian Edition"pge. 201)
"The actual process of money creation takes place primarily in banks." (Federal Reserve, "Modern Money Mechanics")
"Commercial banks and other financial institutions provide the greater part of assets used as money through loans made to individuals and businesses. In that sense, financial institutions are creating money. " (Bank of Canada, "Bank in Brief")
"The process by which banks create money is so simple that the mind is repelled." (John Kenneth Galbraith)
This idea may be novel to some, so it is important to understand exactly how banks create deposits. The process is known as deposit expansion. Many mistakenly believe that banks loan deposits. They believe that when they deposit their money in a bank, the bank somehow loans all, or part, of their deposit to another. This would only be true if a bank debited the depositor's account when they made a loan. Sceptics should ask themselves if they have ever had their bank account debited by any bank because the bank loaned their deposit to someone else. In reality, banks do not loan deposits but create them. Or, as Mr. McKenna, Chairman of the Midland bank, said, "every bank loan and every purchase of securities by a bank creates a deposit, and the withdrawal of every bank loan, and the sale of securities by a bank, destroys a deposit (AGM Midland Bank, January 25, 1924.) The process is explained by the Federal Reserve below assuming that the Fed's open market operations create $10,000 in cash reserves:
"How the Multiple Expansion Process Works
If the process ended here, there would be no "multiple" expansion, i.e., deposits and bank reserves would have changed by the same amount. However, banks are required to maintain reserves equal to only a fraction of their deposits. Reserves in excess of this amount may be used to increase earning assets - loans and investments. Unused or excess reserves earn no interest. Under current regulations, the reserve requirement against most transaction accounts is 10 percent.(5) Assuming, for simplicity, a uniform 10 percent reserve requirement against all transaction deposits, and further assuming that all banks attempt to remain fully invested, we can now trace the process of expansion in deposits which can take place on the basis of the additional reserves provided by the Federal Reserve System's purchase of U. S. government securities.
The expansion process may or may not begin with Bank A, depending on what the dealer does with the money received from the sale of securities. If the dealer immediately writes checks for $10,000 and all of them are deposited in other banks, Bank A loses both deposits and reserves and shows no net change as a result of the System's open market purchase. However, other banks have received them. Most likely, a part of the initial deposit will remain with Bank A, and a part will be shifted to other banks as the dealer's checks clear.
It does not really matter where this money is at any given time. The important fact is that these deposits do not disappear. They are in some deposit accounts at all times. All banks together have $10,000 of deposits and reserves that they did not have before. However, they are not required to keep $10,000 of reserves against the $10,000 of deposits. All they need to retain, under a 10 percent reserve requirement, is $1000. The remaining $9,000 is "excess reserves." This amount can be loaned or invested. See illustration 2.
If business is active, the banks with excess reserves probably will have opportunities to loan the $9,000. Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system. See illustration 3.
Expansion - Stage 1
3.Expansion takes place only if the banks that hold these excess reserves (Stage 1 banks) increase their loans or investments. Loans are made by crediting the borrower's account, i.e., by creating additional deposit money. back
STAGE 1 BANKS
Assets Liabilities
Loans....... +9,000 Borrower deposits.... +9,000
This is the beginning of the deposit expansion process. In the first stage of the process, total loans and deposits of the banks rise by an amount equal to the excess reserves existing before any loans were made (90 percent of the initial deposit increase). At the end of Stage 1, deposits have risen a total of $19,000 (the initial $10,000 provided by the Federal Reserve's action plus the $9,000 in deposits created by Stage 1 banks). See illustration 4. However, only $900 (10 percent of $9000) of excess reserves have been absorbed by the additional deposit growth at Stage 1 banks. See illustration 5.
The lending banks, however, do not expect to retain the deposits they create through their loan operations. Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks. See illustration 6.
Whether Stage 1 banks actually do lose the deposits to other banks or whether any or all of the borrowers' checks are redeposited in these same banks makes no difference in the expansion process. If the lending banks expect to lose these deposits - and an equal amount of reserves - as the borrowers' checks are paid, they will not lend more than their excess reserves. Like the original $10,000 deposit, the loan-credited deposits may be transferred to other banks, but they remain somewhere in the banking system. Whichever banks receive them also acquire equal amounts of reserves, of which all but 10 percent will be "excess."
Assuming that the banks holding the $9,000 of deposits created in Stage 1 in turn make loans equal to their excess reserves, then loans and deposits will rise by a further $8,100 in the second stage of expansion. This process can continue until deposits have risen to the point where all the reserves provided by the initial purchase of government securities by the Federal Reserve System are just sufficient to satisfy reserve requirements against the newly created deposits.(See pages10 and 11.)
The individual bank, of course, is not concerned as to the stages of expansion in which it may be participating. Inflows and outflows of deposits occur continuously. Any deposit received is new money, regardless of its ultimate source. But if bank policy is to make loans and investments equal to whatever reserves are in excess of legal requirements, the expansion process will be carried on." (Modern Money Mechanics, U.S. Federal Reserve)
Any individual bank is not concerned with what stage in the process of deposit expansion they exist when making loans, because the inflows and outflows of deposits occur continuously. The important point to note is that bank loans create deposits/money. The loan is an asset to the bank because the borrower owes the bank the amount of the loan, plus interest. The deposit is a liability to the bank because the bank must now be able to supply cash for the deposit upon demand. Commercial banks cannot create cash, but have to borrow it from the Central Bank, so there is a limit to how much money, or how many deposits, a commercial bank can create, and that limit is based upon the ratio of reserves to deposits. As to the banking system as a whole, including Central Banks, there is absolutely no limit to the amount of money, or credit, that can be created. Cash is an asset to the bank, and along with its securities, forms the banks reserves. In most nations, the government mandates, through law, the amount of reserves a bank must keep in ratio to its deposits. In Canada, changes to the Bank Act in 1992 did away with any legal obligation of Chartered Banks to hold reserves in ratio to their deposits. However; all banks keep a certain amount of reserves in ratio to their deposits for liquidity purposes. When banks are unable to meet their clients' demand for cash, this is known as a "bank run". Because of the possibility of bank runs, the Canadian Deposit Insurance Corporation, and the Federal Deposit Insurance Corporation in the United States, insure deposits up to a certain limit. In order to understand how banks obtained the power to create money, we must understand the history of fractional reserve banking.
"It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.
Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.
Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could "spend" by writing checks, thereby "printing" their own money." (Modern Money Mechanics, U.S. Federal Reserve)
The goldsmiths realized they could issue more notes than the amount of gold coin they had on deposit, because only a portion of the notes they had outstanding would be redeemed for gold coins at any point in time. This is also true with cash today. The banks realize that only a portion of the money that people have on deposit with the bank will be redeemed for cash at any point in time, so they create more deposits than they have cash. This works so long as everyone does not demand cash for their deposit.
We see from above that the productive system, and the banking system, are two distinct factors in the economy. The productive system is responsible for producing goods and services, and the banking system is responsible for creating the money necessary to act as effective demand to mobilize those goods and services. The banking system is the distributive system, and far from money originating from the productive system, like the scent from a rose; money originates from a completely separate system; as such, there is often no correspondence between these two systems. Therefore, " it is necessary to transform the basis of the credit-system entirely away from currency on which it now rests, to useful productive capacity." (C.H. Douglas, "The Control and Distribution of Production")
Money's role is to distribute the goods and services that people demand. It's an order system. Since there is no limit to the ability of banks to create money, the only limitation that should be imposed on the amount of money in existence should be the ability of the economy to deliver goods and services when and where they are required - i.e. the real credit of the community. Our ability to produce is based on the physical assets of our nation. Money's role is the monetization of those assets in order that they can be mobilized for production. Douglas created a hypothetical balance sheet for Great Britain in the "Monopoly of Credit", which is reproduced below:
Great Britain Limited
Assets:
(Population. Education Morale) i.e. Human potential
Policy
Organization
Natural Resources
Developed Power
Plant (Railways, Buildings, Tools, etc.)
Public Services
Goodwill (Tradition, reputation etc.)
Work in Progress
Consumable Goods
Liabilities:
National Debt
Bankers (Potential creators of effective demand)
Insurance Companies (Mortgage and Bondholders)
Cash at Call
Taxation for Public Services
Notice that cash is a liability, so the amount of credit created by the current banking system is based on a liability, not on the assets of the nation. However; the amount of credit created should be based on the real credit of the community, which is reflected in the nation's assets.
"We know quite well that the core of this problem is in the disparity between the real wealth available and the monetization of that wealth; that it is within the power of monetization of real wealth that this power of credit lies." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)
The power of credit creation, or the monetization or wealth, has been appropriated by a monopoly of credit - the banking system - which is a body of unelected people responsible solely to their shareholders, and who have been centralizing their power since the creation of the Bank of England in 1694. This centralization process continued with the creation of Central banks around the world including the Federal Reserve Bank in 1913, the Bank of Canada in 1934, and culminating with supranational banks like the IMF and World Bank, which were created in 1944. Not only is the basis of our current money system fundamentally flawed because it is not based on the real credit of the community, but the system itself has become a form of government which has been centralizing its power to the point of being above any national power. Therefore; the real government is not the one that is elected by ballot box every few years, but is a centralized body of unelected officials which dictate monetary policy from organizations which are beyond any national law.
"It is absolutely vital to realize that the essential part of money is the belief that through its agency you can satisfy your demands. (C.H. Douglas, "The Control and Distribution of Production")
Money is essentially effective demand. We place our money down in the faith that another will depart with a good or service in exchange for it. It allows us to carry on trade without barter. Money makes it possible for men to associate together in a manner which is beneficial to everyone. Therefore; money is essential to our economy. But, our demands can only be satisfied if money delivers goods and services. Therefore; the basis for the quantity of money, or the limit to our demand, is the ability of the productive system to deliver goods and services when and where they are needed. What does this mean? For one, it means that the basis upon which the quantity of money is determined has nothing to do with any of the physical properties of money itself.
"The best definition of money with which I am acquainted is that of Professor Walker, which is that "money is any medium which has reached such a degree of acceptablility that, no matter what it is made of, and no matter why people want it, no one will refuse it in exchange for his product." You will see that this definition rules out any physical properties in respect of money. The properties that are left, therefore, are not physical. They can be summed up in the word "credit," which is, of course, derived from "credere," to believe. The essential quality of money, therefore, is that a man shall believe that he can get what he wants by the aid of it. This is absolutely the only quality that it is required to possess, although, of course, certain minor attributes, such as convenience, have a bearing on the decision as to what particular description of money, if it fulfils the major requirements, is likely to come into the most general use. The cheque, no doubt, owes its popularity to this latter attribute." (C.H. Douglas, "Warning Democracy")
Money's value does not derive from its composition, but by the capacity of the economy to produce goods and services. This automatically rules out gold as an appropriate determination for the quantity of money. There is no real resemblance between the quantity of gold in existence, and the economy's ability to produce. Reality must reign supreme lest an abstraction have precedence over it, and money is an abstraction. Money should be a measure of wealth, and should never control our creation of it. Whatever is physically possible is financially possible.
"Money is nothing whatever but a ticket system which has nothing whatever to do with all these abstract descriptions of it such as a medium of exchange, or a storehouse of values or any of these other things. It is a ticket system and nothing else." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)
Douglas compared money to a ticketing system, because it is a means of distributing production. The only real limit to the amount of railway tickets issued is the number of seats on the train. The number of railway tickets should never be a limit on the number of people who board the train, for the latter is an inversion of reality. In other words, money should never be a limiting factor on production: production should be a limiting factor on money.
"There is also a nebulous idea involved, I think, to the effect that the man who grows, e.g. a ton of potatoes, also grows the purchasing-power of a ton of potatoes. The facts are far otherwise, as no doubt large numbers of potato-growers could testify. Given a fixed amount of legal tender, and assuming legal tender to be the only purchasing-power, no amount of production would increase it. Probably a minimum of nine-tenths of the immediately available purchasing-power in the world arises out of bank loans or their equivalent in bills discounted. These loans and the purchasing-power which they create have no automatic relation to either production or consumption. " (C.H. Douglas, "Social Credit")
Many people have a vague conception that the production system somehow manufactures money, and in so doing, create enough money to liquidate all costs of production. This idea is perpetuated by the belief that firms "make money" when they earn a profit. Of course, if companies literally "made money", they would be engaged in counterfeiting. The truth is money is not created by production, but is created by the banking system. Central banks are responsible for creating cash, and commercial banks create the majority of the assets used as money. The amount of cash in existence is determined by people's desire to hold cash. As Douglas states above, probably 90% of the money supply is created by commercial banks in the forms of loans to businesses and individuals. This money is called bank credit. Below are some quotes about banks and their ability to create money:
"In the normal course of their operations, banks create money" (Blomqvist, Wonnacott, and Wonnacott, "Economics First Canadian Edition"pge. 201)
"The actual process of money creation takes place primarily in banks." (Federal Reserve, "Modern Money Mechanics")
"Commercial banks and other financial institutions provide the greater part of assets used as money through loans made to individuals and businesses. In that sense, financial institutions are creating money. " (Bank of Canada, "Bank in Brief")
"The process by which banks create money is so simple that the mind is repelled." (John Kenneth Galbraith)
This idea may be novel to some, so it is important to understand exactly how banks create deposits. The process is known as deposit expansion. Many mistakenly believe that banks loan deposits. They believe that when they deposit their money in a bank, the bank somehow loans all, or part, of their deposit to another. This would only be true if a bank debited the depositor's account when they made a loan. Sceptics should ask themselves if they have ever had their bank account debited by any bank because the bank loaned their deposit to someone else. In reality, banks do not loan deposits but create them. Or, as Mr. McKenna, Chairman of the Midland bank, said, "every bank loan and every purchase of securities by a bank creates a deposit, and the withdrawal of every bank loan, and the sale of securities by a bank, destroys a deposit (AGM Midland Bank, January 25, 1924.) The process is explained by the Federal Reserve below assuming that the Fed's open market operations create $10,000 in cash reserves:
"How the Multiple Expansion Process Works
If the process ended here, there would be no "multiple" expansion, i.e., deposits and bank reserves would have changed by the same amount. However, banks are required to maintain reserves equal to only a fraction of their deposits. Reserves in excess of this amount may be used to increase earning assets - loans and investments. Unused or excess reserves earn no interest. Under current regulations, the reserve requirement against most transaction accounts is 10 percent.(5) Assuming, for simplicity, a uniform 10 percent reserve requirement against all transaction deposits, and further assuming that all banks attempt to remain fully invested, we can now trace the process of expansion in deposits which can take place on the basis of the additional reserves provided by the Federal Reserve System's purchase of U. S. government securities.
The expansion process may or may not begin with Bank A, depending on what the dealer does with the money received from the sale of securities. If the dealer immediately writes checks for $10,000 and all of them are deposited in other banks, Bank A loses both deposits and reserves and shows no net change as a result of the System's open market purchase. However, other banks have received them. Most likely, a part of the initial deposit will remain with Bank A, and a part will be shifted to other banks as the dealer's checks clear.
It does not really matter where this money is at any given time. The important fact is that these deposits do not disappear. They are in some deposit accounts at all times. All banks together have $10,000 of deposits and reserves that they did not have before. However, they are not required to keep $10,000 of reserves against the $10,000 of deposits. All they need to retain, under a 10 percent reserve requirement, is $1000. The remaining $9,000 is "excess reserves." This amount can be loaned or invested. See illustration 2.
If business is active, the banks with excess reserves probably will have opportunities to loan the $9,000. Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system. See illustration 3.
Expansion - Stage 1
3.Expansion takes place only if the banks that hold these excess reserves (Stage 1 banks) increase their loans or investments. Loans are made by crediting the borrower's account, i.e., by creating additional deposit money. back
STAGE 1 BANKS
Assets Liabilities
Loans....... +9,000 Borrower deposits.... +9,000
This is the beginning of the deposit expansion process. In the first stage of the process, total loans and deposits of the banks rise by an amount equal to the excess reserves existing before any loans were made (90 percent of the initial deposit increase). At the end of Stage 1, deposits have risen a total of $19,000 (the initial $10,000 provided by the Federal Reserve's action plus the $9,000 in deposits created by Stage 1 banks). See illustration 4. However, only $900 (10 percent of $9000) of excess reserves have been absorbed by the additional deposit growth at Stage 1 banks. See illustration 5.
The lending banks, however, do not expect to retain the deposits they create through their loan operations. Borrowers write checks that probably will be deposited in other banks. As these checks move through the collection process, the Federal Reserve Banks debit the reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks. See illustration 6.
Whether Stage 1 banks actually do lose the deposits to other banks or whether any or all of the borrowers' checks are redeposited in these same banks makes no difference in the expansion process. If the lending banks expect to lose these deposits - and an equal amount of reserves - as the borrowers' checks are paid, they will not lend more than their excess reserves. Like the original $10,000 deposit, the loan-credited deposits may be transferred to other banks, but they remain somewhere in the banking system. Whichever banks receive them also acquire equal amounts of reserves, of which all but 10 percent will be "excess."
Assuming that the banks holding the $9,000 of deposits created in Stage 1 in turn make loans equal to their excess reserves, then loans and deposits will rise by a further $8,100 in the second stage of expansion. This process can continue until deposits have risen to the point where all the reserves provided by the initial purchase of government securities by the Federal Reserve System are just sufficient to satisfy reserve requirements against the newly created deposits.(See pages10 and 11.)
The individual bank, of course, is not concerned as to the stages of expansion in which it may be participating. Inflows and outflows of deposits occur continuously. Any deposit received is new money, regardless of its ultimate source. But if bank policy is to make loans and investments equal to whatever reserves are in excess of legal requirements, the expansion process will be carried on." (Modern Money Mechanics, U.S. Federal Reserve)
Any individual bank is not concerned with what stage in the process of deposit expansion they exist when making loans, because the inflows and outflows of deposits occur continuously. The important point to note is that bank loans create deposits/money. The loan is an asset to the bank because the borrower owes the bank the amount of the loan, plus interest. The deposit is a liability to the bank because the bank must now be able to supply cash for the deposit upon demand. Commercial banks cannot create cash, but have to borrow it from the Central Bank, so there is a limit to how much money, or how many deposits, a commercial bank can create, and that limit is based upon the ratio of reserves to deposits. As to the banking system as a whole, including Central Banks, there is absolutely no limit to the amount of money, or credit, that can be created. Cash is an asset to the bank, and along with its securities, forms the banks reserves. In most nations, the government mandates, through law, the amount of reserves a bank must keep in ratio to its deposits. In Canada, changes to the Bank Act in 1992 did away with any legal obligation of Chartered Banks to hold reserves in ratio to their deposits. However; all banks keep a certain amount of reserves in ratio to their deposits for liquidity purposes. When banks are unable to meet their clients' demand for cash, this is known as a "bank run". Because of the possibility of bank runs, the Canadian Deposit Insurance Corporation, and the Federal Deposit Insurance Corporation in the United States, insure deposits up to a certain limit. In order to understand how banks obtained the power to create money, we must understand the history of fractional reserve banking.
"It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.
Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.
Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could "spend" by writing checks, thereby "printing" their own money." (Modern Money Mechanics, U.S. Federal Reserve)
The goldsmiths realized they could issue more notes than the amount of gold coin they had on deposit, because only a portion of the notes they had outstanding would be redeemed for gold coins at any point in time. This is also true with cash today. The banks realize that only a portion of the money that people have on deposit with the bank will be redeemed for cash at any point in time, so they create more deposits than they have cash. This works so long as everyone does not demand cash for their deposit.
We see from above that the productive system, and the banking system, are two distinct factors in the economy. The productive system is responsible for producing goods and services, and the banking system is responsible for creating the money necessary to act as effective demand to mobilize those goods and services. The banking system is the distributive system, and far from money originating from the productive system, like the scent from a rose; money originates from a completely separate system; as such, there is often no correspondence between these two systems. Therefore, " it is necessary to transform the basis of the credit-system entirely away from currency on which it now rests, to useful productive capacity." (C.H. Douglas, "The Control and Distribution of Production")
Money's role is to distribute the goods and services that people demand. It's an order system. Since there is no limit to the ability of banks to create money, the only limitation that should be imposed on the amount of money in existence should be the ability of the economy to deliver goods and services when and where they are required - i.e. the real credit of the community. Our ability to produce is based on the physical assets of our nation. Money's role is the monetization of those assets in order that they can be mobilized for production. Douglas created a hypothetical balance sheet for Great Britain in the "Monopoly of Credit", which is reproduced below:
Great Britain Limited
Assets:
(Population. Education Morale) i.e. Human potential
Policy
Organization
Natural Resources
Developed Power
Plant (Railways, Buildings, Tools, etc.)
Public Services
Goodwill (Tradition, reputation etc.)
Work in Progress
Consumable Goods
Liabilities:
National Debt
Bankers (Potential creators of effective demand)
Insurance Companies (Mortgage and Bondholders)
Cash at Call
Taxation for Public Services
Notice that cash is a liability, so the amount of credit created by the current banking system is based on a liability, not on the assets of the nation. However; the amount of credit created should be based on the real credit of the community, which is reflected in the nation's assets.
"We know quite well that the core of this problem is in the disparity between the real wealth available and the monetization of that wealth; that it is within the power of monetization of real wealth that this power of credit lies." (C.H. Douglas, Testimony before the Alberta Agricultural Commission)
The power of credit creation, or the monetization or wealth, has been appropriated by a monopoly of credit - the banking system - which is a body of unelected people responsible solely to their shareholders, and who have been centralizing their power since the creation of the Bank of England in 1694. This centralization process continued with the creation of Central banks around the world including the Federal Reserve Bank in 1913, the Bank of Canada in 1934, and culminating with supranational banks like the IMF and World Bank, which were created in 1944. Not only is the basis of our current money system fundamentally flawed because it is not based on the real credit of the community, but the system itself has become a form of government which has been centralizing its power to the point of being above any national power. Therefore; the real government is not the one that is elected by ballot box every few years, but is a centralized body of unelected officials which dictate monetary policy from organizations which are beyond any national law.
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