“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.” Guarding against inflation
- Further safeguards against inflation
- The difference between bank created debt money and State created Positive Money
How well has the current system prevented inflation?
Over the last 20 years, the banks have been inflating the money supply by an average of 9% per year, through creating endless amounts of new debt. This has led to inflation over that time of hundreds of percent, especially in the housing market.
In fact, between 1980 and 2010, total general inflation (the increase in the Consumer Price Index) was 429%, while house price inflation has been much higher at 1,310%!
From this we know that an annual increase in the money supply of 7-10% will cause inflation, so we already know our upper-limit on how much new money should be created. As long as the MPC keeps the annual increase under 9% per annum (the average growth rate since 1990) then inflation should be less than it has been under the old system.
In other words, inflation is significantly less likely under the modernised system than under the existing one.
Further safeguards against inflation
If further safeguards are needed to reassure people that hyper-inflation is not a risk, the following safeguards could be put in place (but note that they are not included in our proposal at this stage):
- The absolute amount of the increase in any one month must be no more than x% greater than the previous month. This prevents any wild fluctuations in the amount of money created from month to month, and depending on the level of ‘x’, ensures that it would take decades before they could create sufficient levels of money to cause hyperinflation.
- The total annual increase in the money supply should not exceed x% of the current total money supply. If you doubled the money supply in the space of one year, you would cause asset bubbles and very high inflation. If you cut the money supply by 50%, in one year, you would cause an economic collapse. Common sense suggests that the ‘safe’ rate of growth in the money supply should closely match the rate of growth of the economy in order to keep inflation as close as possible to zero.
The difference between bank created debt money and State created Positive Money
A 10% rate of growth in money supply is a very different thing when that additional money comes from the state, rather than from commercial banks.
When commercial banks increase the money supply, they do so by creating an equivalent amount of debt. The new money acts as a stimulus to the economy, but the new debt acts as an immediate drag on the economy. (If you accept and spend a personal loan in August, you will start repayments in September.
In September you are immediately poorer than you were before you took the loan (even though you may have more 'stuff') as your disposable income is reduced by the amount of the repayments. You spend less in the shops and the real economy loses your regular spending).
Allowing banks to create money is therefore akin to pressing both the accelerator and the brake at the same time – and the results are equally painful to watch!
In contrast, the debt-free injection of money from the Reserve Bank is free from the immediate sedative of an equivalent amount of debt. This is akin to pressing the accelerator with your foot clear off the brake. Which system would you expect to have the greatest stimulating effect on the economy?
For that reason, we can assume that a 10% increase in the money supply, when created as debt-free money by the Reserve Bank, would be far more of a stimulus to the economy than the same rate of increase when caused by commercial banks issuing debt. Whether we should therefore aim for 5% instead (to avoid any risk of inflation) or stay at 10% (to pull ourselves out of this recession with a quick stimulus) needs further analysis.
In short, however, inflation is much less of a threat under the modernised system, whereby the state creates all new money, than under the existing system (whereby new money is created as debt by private commercial banks).
