Reflections on finance as credit and credit as a public good

by Johnna Montgomerie

Finance as credit

This week we begin to unpack the world of global finance by looking through the lens of finance as ‘credit’ – or trust – as a commodity not just a ‘medium of exchange’. The 2 chapters of readings from Pettifor highlight some very important aspects of credit that are largely overlooked by economists and economic policy makers. 

This post focuses on two key questions:

1.  What is a monetary system? How is it national and global, public and private at the same time?
2.  What does it mean for credit to become like a public good/resource? How is that made possible?

Monetary system – how nationally dominated credit-money flows through the global economy

One of the most interesting aspects of contemporary global finance is to understand what parts are old and which are new. In practice, human’s use of money is centuries old but the use of credit is even older (see David Graeber’s book Debt: the first 5,0000 years). Central banks have been around since the 1700s, corporate entities since the late 1800s; therefore it is useful to think about the monetary system has evolving over centuries – as private source of wealth but also as a public infrastructural resource – fuelling the development of banking as a social technology and as ICT.

What is significant is that most Economists treat money as if it were 'neutral' or simply a 'veil' over economic transactions. 

This means that credit is neutral – not a transformative force. The result of this overly simplistic view is that it neutralises any political question of how to control the monetary system and in whose interests it should be managed.

Two quotes from the text really bring home the state of play of the contemporary monetary system:

The first is from finance-guru Frances Coppola:

Bank reserves never leave the banking system. They are not "lent out'/ as is often claimed. When a bank lends, it creates a deposit "from nothing',' which is placed in the customer's demand deposit account. When that loan is drawn down, the bank must obtain reserves to settle that payment - but the payment simply goes to another bank (or even the same one), either directly through an interbank settlement process, or indirectly via cash withdrawal and subsequent deposit. The total amount of reserves in the system DOES NOT CHANGE as a consequence of bank lending. Only the central bank can change the total amount of reserves in the system. This is usually done by means of "open market operations" buying and selling securities in return for cash. Money's quality, its acceptability and validity is simply due to being able to facilitate transactions.

The other is from the prominent economists Andy Haldane (Executive Director of Financial Stability at the Bank of England) who explained recently that by fixating on inflation targeting, central bankers had turned a blind eye to what was really going on in the credit-fuelled financial system:

"Inflation targeting assumed primacy as a monetary policy framework, with little role for commercial banks' balance sheets...what happened next was extraordinary. Commercial banks' balance sheets grew by the largest amount in human history. For example, having flatlined for a century, bank assets-to-GDP in the UK rose by an order of magnitude from 1970 onwards."

Therefore, a key overlooked element of the monetary system is that how it exists as part of socio-political relationships from regulation because money and credit are based on norms of Trust – which exists as legal relationships of English Common Law. Credit and debt is a ‘promise’ to pay, in other words, how this promise is recognised and enforced is crucial to how the monetary system operations.

Finance and Credit as a Public Good?

Understanding finance as a public good, entails unpacking what it means for the monetary system to be managed as a public resource, but Pettifor argues that what is crucial is greater public understanding of money, and how the system works.

I want to force into the open a subject that is taboo: the role of private, commercial banks in the creation of money 'out of thin air. For too long orthodox economists have misled politicians and others, and focussed only on central bank money creation. They have deliberately down played the role of the private sector: in credit creation or 'printing' money; in providing or denying finance to productive sectors; and in generating inflation.

This is an important element of the Just Money book is that while it paints a picture of a highly dysfunctional finance sector that controls, and arguably hugely distorts the global monetary system, the system itself is also potentially a great public good.

A key problem to understanding what finance as a public good means is the ways in which the enforced distinction between the public and the private sphere muddies the conceptual waters. This text for example emphasizes that banks engage in ‘private credit creation’ – this is true, but it is not historically unique. Fractional reserve banking is precisely lending on multiples of deposit reserves (back when people actually deposited valuables in banks), this is also ‘private’ credit creation.

Governments also create credit/debt/money when they issue government bonds (T-bills or Gilts), this is public credit creation. However, since the 2008 financial crisis governments have created more and more debt to bail out the banks. Importantly, global regulation says that government debt is a source of collateral for banks (because it is guaranteed to be paid). Therefore, private banks use public debt to secure their financial stability.

As side note, a key aspect of why private banks are lending more is because of their ‘originate and distribute’ business model. This came to prominence as many banks abandon being private firms to becoming public firms (traded on the stock market), making them subject to the shareholder value revolution in the late 1990s.

Therefore, private banks are actually public companies creating private credit based on their access to public debt as a source of collateral.

Pettifor, suggests we understand what is wrong with this practice in terms of what Keynes called capitalism's "elastic production of money", to indicate how monetary reform can restore oversight of the finance sector to democratic institutions.

The preliminary argument is that by focusing regulation on establishing a fair rate of interest, and on the basis of trust credit/debt can be better used to invest and generate jobs/income, to create and to innovate based on sound democratic principles and stable long term planning for the monetary system.

Conclusion

The legacy of the 2008 financial crisis is still unfolding because there was a fundamental lack of engagement with the causes of crisis in order to learn from these grave errors. What initially appeared as the 'magic' of credit-creation by the corporate banking system must be managed better and more carefully regulated if lending is to be affordable, sound and sustainable. Importantly, we need to consider how society as a whole is to benefit from a publically subsidised credit system.