Enough Is Enough

by Rob Dietz

  BILL MCKIBBEN1

  WHAT ARE WE DOING?

  In the early 1990s when financial derivatives were taking off in the world of securities trading, one of Wall Street’s rising stars, John Fullerton, was taking off on a flight bound for Tokyo. It was his inaugural trip as the manager of J. P. Morgan’s commodities investment business in Asia, and it was a heady time. He was young—in fact, he was the second-youngest person ever to have become a manager at the renowned bank—and, as he remembers it, he was “running with the big dogs.”2

  When the flight got under way, he smiled to himself as he unfolded a copy of the New York Times. In addition to the demands of his rising career, he faced the demands of having a two-year-old and an infant at home. The first-class seat seemed like a luxury, but it was nothing compared to the luxury of being able to relax in peace with a newspaper. He should have felt like a million dollars, but instead he had an uneasy sense that he was in the wrong place. The fact that it was Father’s Day weekend undoubtedly played a role. As they might say in the financial industry, leaving his family behind on that particular weekend had a “deflationary effect” on his excitement about his new job. But something else also troubled him.

  As he browsed the business section of the Times, two articles caught his attention. The first was about a struggling federal housing program. He wasn’t particularly interested in housing issues, but the article reminded him that there were plenty of problems in the world in need of attention besides a portfolio of bank investments. The second article was about media business icon Walter Annenberg, who had donated huge sums of money to several schools near the end of his life. The article quoted the head of one of the schools as not knowing what to do with the massive cash infusion. Fullerton thought, “What was the point of accumulating so much money—enough to become a philanthropist—if you couldn’t make intelligent decisions about how to invest it?” It seemed that even the financial success of someone like Walter Annenberg came with a downside. Contemplating these news stories reinforced Fullerton’s emerging doubt about spending his whole career in the high-flying world of investment banking. These thoughts contributed significantly to what he calls his “rolling epiphany”—a growing awareness of fundamental flaws in the way the financial system works.

  A number of people around the world are rolling along with Fullerton toward the same epiphany. Protests in the United States have showcased public outrage about the way Wall Street operates, and in Greece and other European countries, people have expressed anger over the austerity programs proposed to deal with high levels of debt. The problem is that both the financial system and its lifeblood—money—are becoming increasingly unhinged from real assets.

  Fullerton has some ideas about how to reform the financial system based on his years as a banking industry insider, but when considering the basics of money, he’s refreshingly open about what he doesn’t know. He says, “I frankly don’t understand money. It’s way more complicated than any of us realize.” And he’s not alone. In their textbook Ecological Economics, Herman Daly and Joshua Farley write, “Anyone who is not confused by money probably hasn’t thought about it very much.”3

  Money serves three key functions in modern society. First, it’s a medium of exchange, an intermediary used in trade to avoid the inconveniences of a barter system. Second, it’s a unit of account, as things are sometimes assigned money values even if they are not being bought or sold (e.g., unsold inventories in warehouses). And third, it’s a store of value, in that it can be saved and used in the future to purchase goods and services.4 These three functions of money make it a very useful tool for helping people get what they need. But even with these well-defined functions, three key misconceptions about money and finance cause us to use them in unsustainable ways.

  Misconception Number 1: Money Is Wealth

  Wealthy characters in comic books, such as Scrooge McDuck and Richie Rich, often make a sport of diving into vast piles of gold. In calmer moments, they might take a stroll through a personal vault that contains bags of money stacked from floor to ceiling. The gold and cash are proof of their “wealth,” but money is not real wealth—it’s a claim on wealth.5 Real wealth takes the form of housing, land, fertile soil, medical care, dinner, and computers—actual resources, goods, and services that have value. Money itself has no intrinsic value. Its value is derived from the fact that we accept it in exchange for real wealth. The only reason anyone wants money is to be able to trade it for a bundle of goods and services (or, more cynically, to have the status and power that accrue to someone who can make many such trades).

  The fact that money serves as a claim on wealth poses a problem when its supply surpasses the supply of real wealth. When there are too many claims on real wealth, prices go up (i.e., inflation occurs) as more and more money chases the same volume of goods and services.6 Unfortunately the system is rigged for this to happen because of the mathematics of compound interest. Take, for example, a simple investment in which a millionaire deposits a million dollars in a savings account at 5 percent interest per year. His interest earnings in that first year total $50,000. With compound interest, that $50,000 payment is added to the principal, and the next interest payment is calculated based on the new total. So the following year’s earnings come to $52,500. And then it’s off to the races. No physical law prevents the claim on wealth in this savings account from expanding indefinitely—it could increase as high as we can count. However, the supply of goods and services that this money can buy can grow only according to the laws of physics and ecology that govern the real world.

  Around the globe, claims on wealth (in the form of debt) have been ballooning. An example from the United Kingdom demonstrates the trend (Figure 8.1).7 Between 1965 and 1985, the money supply and GDP grew at a similar rate, but following deregulation of the finance industry in 1986, the money supply began to grow much faster than GDP. In recent years, the money supply has become almost completely detached from the real economy, as new financial instruments have allowed banks to pump more and more money into the economy. The disconnect has caused much of the economic and financial instability in the world today.

  As long as our claims on wealth are growing, there’s a strong incentive to produce enough real wealth to keep pace. Imagine the potential for social chaos if people suddenly found that their money couldn’t buy what they thought it could—that there was too much money and not enough real wealth. (Actually, you don’t have to imagine it; you can study historical instances of hyperinflation or the effects of the sub-prime mortgage crisis.) Growing the economy has been the strategy for preventing the financial system from collapsing, but this is a case of the tail wagging the dog. Money should serve the economy, not govern it.

  FIG. 8.1. The money supply (claims on wealth) is becoming increasingly detached from economic output (as measured by GDP) in the United Kingdom. Quantities for the money supply and GDP are expressed as multiples of their values in 1965. SOURCE: see note 7.

  Misconception Number 2: Governments Are the Primary Money Creators

  Another common belief holds that money originates from the printing presses and coin mints of governments. Some of it does, but only a small fraction. In the United Kingdom, for example, the Bank of England and the Royal Mint create about 3 percent of the money in circulation as banknotes and coins. Private banks create most of the money in the form of interest-bearing loans.8 Banks do this by a simple trick of bookkeeping. An example helps explain the process.

  Suppose you want to buy something expensive like a car, but you don’t have the money to pay for it up front, so you go to the bank for a loan. Assuming we’re not in the subprime mortgage era, the bank might do a little research on your financial health. After judging you to be creditworthy, it grants you a loan. In one column of its books, the bank enters a liability, the money loaned to you. In the other column, it enters an asset, the money owed by you. Everything balances out because the two numbers are equal.9 With a few keystrokes on the c
omputer, the bank simply transfers money into your account. The money didn’t come from the bank’s vault. It didn’t come from a central bank like the Federal Reserve. It came from nowhere.

  How can banks operate in this way? Banks are able to create money out of thin air because they can legally issue loans far in excess of the money they hold on deposit. In the United States, the Board of Governors of the Federal Reserve Bank sets reserve requirements, which specify how much money a bank must have on deposit in comparison to its liabilities.10 Over time reserve requirements have become more and more lenient.11 In fact, the reserve requirement for some types of accounts is zero.12 The result is that banks have very few restrictions on how much money they can create.

  But the story doesn’t end there. Money that is created by a bank in the form of a loan must be paid back by the borrower. The borrower has to go out and earn this money by engaging in economic activity (e.g., doing a job). In addition to the principal, the borrower has to pay interest, which generates even more economic activity. Debt-based money creation, therefore, drives economic growth, the primary reason why a steady-state economy requires a different sort of monetary system.

  Another reason is that the current money system also fuels an upward spiral of debt. Since loan recipients must pay back more money than they borrow, the total money supply must expand over time to avoid defaults. This additional money can only come from one place: more loans. As a consequence, the total amount of debt must increase over time for the financial system to continue functioning under its current conventions. It’s a bit like using your Visa to pay off your Mastercard—except applied to the whole economy.

  This method of money creation is inherently risky. If banks stop lending, the whole system collapses. That risk became clear in the meltdown of 2008. The flow of credit from banks slowed and threatened to topple a number of financial institutions. National governments intervened with taxpayer-funded bailouts to keep the system running, at least in the short term. In the aftermath, many taxpayers felt they had been fleeced, and rightfully so. Money that could have been spent on salaries for school teachers, vaccinations for children, repairs to crumbling infrastructure, or other worthy public projects went, instead, to big banks.

  The meltdown and bailouts eroded some of the trust people have in the system of finance. For money to work, people must trust it. After all, who would be willing to accept money as payment if no one believed in its value? Trust in money largely exists because the government guarantees the currency and is willing to back it up in times of crisis. Yet control of this necessary public resource, and the profit made from producing it, is given to a small number of private banks. The ability to create money and lend it at interest provides banks with huge profits, while taxpayers receive only a small amount of revenue from the issue of banknotes and coins.13 Moreover, this right to create money gives the banking sector incredible power to decide where to direct investments in society.14

  Misconception Number 3: The Current Financial System Needs to Be Maintained for Economic Health

  Financial institutions have a legitimate role to play in the economy—to facilitate investment of scarce resources in enterprises that will make the best use of them. For providing this service, financial institutions should earn a modest return. However, instead of allocating capital efficiently, financial institutions are using a variety of convoluted financial instruments to create and redistribute money to themselves, at great cost to the rest of society. The financial sector is capturing vast sums of money through speculation, as banks buy and sell securities and profit from fluctuations in their prices. In these transactions, the underlying value of the assets is not important—it may not even change. What matters is the perceived value and whether the assets can be sold for more than their original purchase price. Money is being created and shuffled about in a shell game where nothing tangible is produced, and where, at the end of the game, the banks have all of the money. In fact, a third of the money created by banks in recent years was simply loaned to other banks.15 In a phenomenon called “financialization,” the U.S. financial sector has accounted for more and more of the nation’s total economic activity (Figure 8.2),16 but it is questionable whether this activity has produced anything useful.

  A contributing cause of financialization is that financiers fail to understand how the financial system relates to three broader systems. The financial system is a subsystem of the economy, the economy is a subsystem of human society, and human society is a subsystem of the biosphere. Without recognizing these relationships, financiers and their institutions are driving global processes that negatively impact the biosphere.

  Unlike most of his colleagues, John Fullerton understands the financial system’s modest position within these other systems, but he’s not a typical financier. After studying the bigger picture and realizing that the financial system was having a negative influence on the three broader systems, his “rolling epiphany” was complete, and he knew he had to reinvent his career. In a striking transformation from Wall Street insider to Wall Street reformer, he founded the Capital Institute in 2009.

  FIG. 8.2. The finance and insurance industry has accounted for an increasing percentage of total economic output in the United States over the last few decades. SOURCE: see note 16.

  The Institute approaches finance with a worldview grounded in the science of the biosphere rather than unrealistic economic theories. This worldview demands an overhaul of monetary and financial systems. As Fullerton says, “If there are limits to economic growth, then there are also limits to debt and limits to investment.” The challenge is to design a monetary and financial system that respects these limits—a system that promotes stability instead of growth.

  WHAT COULD WE DO INSTEAD?

  To achieve a steady-state economy, we need to eliminate the growth imperative that is built into the current monetary and financial system. Such a change means overhauling the process of money creation and accepting a more modest role for financial institutions. We need a monetary system and financial institutions that are commensurate with a nongrowing economy, and that serve the interests of society and the biosphere.

  The economists Molly Scott Cato and Mary Mellor have proposed sweeping changes to the structure of the monetary system to make it consistent with steady-state principles. They recommend the establishment of (1) a debt-free national currency created by a public authority, (2) local currencies that are created by communities to support local production and trade, and (3) an international currency to support sustainable and equitable international trade.17 This three-currency approach, in combination with a restructuring of financial institutions, would provide a way to support economic transactions without breaching ecological limits.

  Debt-Free National Currency

  The most important change needed in the monetary system is to prohibit private banks from issuing money as debt. To accomplish this, the reserve requirement should gradually be raised to 100 percent, so that banks are no longer able to create money out of thin air.18 The practice of creating money as debt should be made illegal, just as counterfeiting is. At the same time, the power to create money should be transferred to a public authority such as a central bank. The central bank would decide how much money is necessary to facilitate exchange in the economy, create this money debt-free, and transfer it to the government to spend into existence.19

  Under this system, savings and investment would be separated. A customer could choose to save money by depositing it in a bank, where it would remain without being loaned or invested. No interest would be paid on such a deposit, and the bank might charge the customer a fee for this safe-keeping service. Alternatively, the customer could invest the money through a bank or other financial intermediary, and potentially earn interest. In this case, the customer would have no access to the money until the loan was repaid.

  As the public reclaims the power of money creation, the priorities for investing newly created money should be determined
democratically. The money could, for example, be used to build the infrastructure for a low-carbon economy (public transport, insulation for homes, improved electricity transmission grids, and so on) or to finance social programs, such as public education.

  To prevent inflation, taxation and government spending would need to be linked to the system of money creation. If prices started to rise, money could be removed from circulation using taxes. Conversely, if prices started to fall, additional money could be created and spent into existence. This system would allow the size of the money supply, and hence inflation, to be controlled more directly than is possible with the current debt-based banking system.

  Local Currency

  A local currency is money that is issued by a community and valid for transactions only within that community. It can serve as a substitute for the national currency in local transactions, as long as businesses agree to accept it, citizens are willing to use it, and a bank or local exchange provides a service to swap the local currency for units of the national currency. This rather modest idea can produce far-reaching social and environmental benefits.

  Since a local currency is accepted only within a small area, its use encourages the purchase and production of local goods and services. As the currency circulates to people and businesses within the community, more benefits accrue to the community, and less money drains out to other parts of the country or world—a recipe for enhancing the local economy. In addition to the economic benefit, the use of a local currency can improve community trust by encouraging neighbors to rely on one another to meet their economic needs. As residents become accustomed to spending and receiving a local currency, they also build community security. In an age of financial uncertainty, it’s reassuring for a community to know that it can rely on a local currency in the event of a breakdown in the broader monetary system. And as the currency encourages more consumption of locally produced goods, the community can reduce its dependence on products that are transported long distances.