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Women in Macro-economics

It is nice to see women taking their place in the world of finance and mocro-economics. Elinor Ostrom got the Nobel Prize and Cantwell and Collins leading the charge for sensible emissiosn control in the US. Here is another doughty female campaigner Ann Pettifor writing in her blog Debtonation, who never fails to gladden my heart. In interview she gives a simple straightforward explanation of how the money and banking systems really work.  Here is a snippet.

“People find it hard to get their heads around this concept, but we must…or else we will fail to understand the financial system.

Before western societies invented bank money and institutionalised banking systems – there were often shortages of money in the economy as a whole. This was because money was linked to a commodity – like gold – which was limited, and indeed was used as an anchor, precisely to limit the availability of money.

Then some geniuses (including one John Law) discovered that it was not necessary to have the same amount of ‘money’ or ‘credit’ in circulation, as there was gold in the bowels of the earth. One just needed to create enough money equal to the amount of economic activity in the economy.

If one created less money than the amount of economic activity, the result was depression and deflation. If one created more money than the amount of possible economic activity – the result was inflation… So central bank governors were given the task of carefully measuring economic activity and then supplying enough money to enable that activity to take place.
Money is not the thing for which we exchange goods and services.

Its the thing by which we exchange goods and services.

And bank money is not tangible. You cannot touch it or smell it. You cannot even see it – except perhaps as a statement on your monthly bank account. What you do touch and smell is cash – and these days only a tiny proportion of the money we use is issued as cash. The rest takes the form of cheques (declining in number now, and soon to be abolished in some stores in Britain); bank transfers; credit card and debit card payments. (Not so in many parts of Africa where they do not trust their banking system, where they may not have developed a system of bank money with credit and debit cards, and so, in some countries, carry cash around in large bags!)
Now intangible bank money is one of the most wonderful things humanity has ever invented. It enables us to engage in economic activity. That’s all. It’s effectively incidental to that activity – because without economic activity that money would be useless.

But it is potentially also one of the most dangerous of our inventions – which is why credit creation must be so carefully regulated.

Bank money comes into existence in the form of credit, issued by the central bank, and then distributed by the commercial banking system. Credit creates deposits, and in England it has done so since 1694 with the foundation of the Bank of England.

This is the very opposite of what most people think – that only once you have deposits can you obtain credit. No, credit creates deposits in the bank.

So when you are a youngster, fresh out of school, your employer has invariably obtained credit from the bank to finance her investment, and she uses part of that to pay you, and you promptly pay that into the bank as a deposit – using some of it as cash.

That credit has stimulated or generated the first month of your productive economic activity. The deposits that the young person places in her bank account are then exchanged and transferred as ‘bank money’ invisible and intangible – but very useful when she is shopping on Ebay, using her credit card, or paying by cheque.

Until recently, most people could not bring themselves to believe in something intangible and invisible called bank money. But now we have a new phenomenon to discuss over our dinner tables: quantitative easing, or ‘Queasing’ as we joke in English.

Last year on 13th March, 2009 the governor of the US Federal Reserve, Ben Bernanke gave an interview to CBS TV, in which he was asked: “where did you find $160 billion to bail out the insurance company AIG? Was that taxpayers money that the fed was spending?”. “That was not tax money” replied the Governer. He elaborated: “the banks have accounts with the Fed, much the same way that you have an account with a commercial bank. So to lend to a bank we simply use the computer to mark up the size of the account that they have with the Fed”. The Fed did what a commercial bank does when it provides you with a loan: they entered a number into a computer and charged it to AIG’s account (Watch CBS News Videos Online).

The fact is that the Federal Reserve did not even have to print 160 billion greenbacks – they simply entered a number into a computer.

And that is what the bank does when you apply for a mortgage, to buy a house for example. All the bank needs is a) your application for a loan b) the collateral of your property and c) your promise to repay at a certain rate of interest. Hey presto! The money is transferred – digitally – to your bank account and appears there as a deposit. You may spend 10% of that money on small purchases with cash (euros), but most of that will be paid by cheque or bank transfer.
Now the point of explaining this is as follows: the creation of credit is in fact an almost effortless activity. Different for example, from growing tomatoes. To grow tomatoes one has to depend on the weather, on the rain to fall; on the land and its fertility, and on labour, yours or that of another. All of these factors can disappoint or fail a farmer.

To create credit there is no need for our banking system to depend on the weather, on land, or even on labour. “Why then”, as John Maynard Keynes once argued in his ‘Treatise on Money’:
…if banks can create credit, should they refuse any reasonable request for it? And why should they charge a fee for what costs them little or nothing?
Keynes, 1930.

The ‘fee’ that Keynes is referring to here, is the rate of interest – the ‘price’ of a loan. And the point he is making is correct: the price of money should remain low – to enable people like entrepreneurs to borrow to invest; to enable governments to borrow to invest for example in de-carbonising the economy – something that requires major investment.

However, he also argued that while the rate of interest should be low – the creation of credit should be carefully regulated. In other words, bank money should be regulated so that it is lent to stimulate productive economic activity rather than speculative, inflationary activity.
We have just lived through three decades of financial de-regulation where economic policy makers have encouraged reckless, privatised credit creation. This in turn led to crazy speculation and gambling – in derivatives, collateralised debt obligations, and a range of other parcelled up, sliced-and-diced securities.

At the same time central bank governors and finance ministers succeeded very successfully in repressing the inflation of wages and prices – while allowing the prices of assets (property, race-horses, works of art, stocks and shares etc.) to rocket upward in an inflationary bubble.
However none of the economic gurus of the time – from US Federal Reserve Alan Greenspan, to European central bankers, to orthodox economists – while ferociously opposed to the inflation of prices and wages, ever complained about the inflation of assets.

Why? It is my belief that this is because it is the rich, on the whole, that own assets. The rest of us live by our wages, or by the prices we can obtain as farmers or small business women… The rich live on rent from their assets – be it property, stocks and shares or an number of assets. And orthodox economists allowed bankers and the rich to inflate the value of their assets with easy credit. This enabled the rich to enrich themselves over the period of financial liberalisation to an extent probably unknown in our history.  (link to full article)

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