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Taking the debt out of money creation

By Kevin Cox - posted Tuesday, 25 August 2009


What is the solution?

There are many solutions to the problem. One way is to attempt to regulate banks and restrict how they create loans and hence create money. Unfortunately this has not worked very well to date and to improve the regulations requires the agreement of all countries.

A different solution is to create money that we are assured will be used to create an asset that will back the money created. There are various ways to do this. One simple way is for banks to issue zero interest loans that may only be used for the creation of new assets. Banks would be repaid - potentially more than was originally loaned - over the life of the asset providing the asset earns enough money. Such an approach would gradually remove the need to create extra credit money by having enough money already in existence to act as a store of value and to be used for trade.

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Will banks do it?

Under existing banking regulations banks may not be allowed to do this because there may be no asset backing the loan when it is first issued. However, if it is highly likely that the money would create a productive asset or an asset that is of value to the general public, then the banking regulator could allow it.

So, will the banks be interested? Banks are only likely to support such an approach if they are guaranteed not to have to make up the money from any failed loans from their own reserves. A simple way to ensure this is for the money created for zero interest loans and then used for the creation of new assets is backed by the government. We have this already with the recent bank guarantee of deposits which is far more onerous as the government is guaranteeing the money created for all loans created by banks and not just money created for new assets.

And there is a way for banks to cover their risks. They create loans but only if the borrower deposits a sum of money at zero interest that reverts to the bank if the loan defaults. The other way is to build systems that make it highly probable that the money will create a new productive asset. It is the ability of modern information systems to ensure this occurs that makes this approach viable.

Will depositors deposit money at zero interest to get a loan at zero interest?

They will, provided the deposit is much smaller than the loan given and if the asset created can earn enough money to return the loan to the bank.

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Should governments be involved?

If governments are going to guarantee the money created for zero interest loans then they must be involved. Banks can still issue zero interest loans without the guarantee provided they are confident most loans will be repaid and if the system works as expected and the default rate on loans is small. However, in the first instance it is expected that governments will use the approach so that they can direct investment - via zero interest loans - to areas of the economy where new investment is needed but cannot compete for funds currently being used to purchase existing assets.

For example the Australian government could guarantee the money created for zero interest loans for investments in new assets that would reduce the level of greenhouse gas concentrations in the atmosphere. If the government did this then the cost to the government would be a permanent increase in the money supply equal to the value of the new assets created. Provided the value of the new assets created was in total greater than the money invested then there would be no net loss to the economy.

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About the Author

Dr Kevin Cox is an entrepreneur. Previously he has taught Information Systems in Canberra and Hong Kong and worked with computers for various multinationals in Australia, the USA and Indonesia.

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Creative Commons LicenseThis work is licensed under a Creative Commons License.

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