Ann Pettifor writes in Prime Economics urging a Green Economic Transition. She sets out her arguments correctly, that savings are not needed a priori, to fund the investment in the Green Transition. Her conclusions are less clear. Is she suggesting that the private banks lend the needed money? Ann Pettifor must know surely, that the only possible and correct solution is that governments use their existing if underused powers, to simply spend the required money into existence?
Savings not needed to finance the Green Transition
In this short note I want to re-state facts known to economists down the ages, but most clearly explained by Keynes, and then subsequently lost to the field of macroeconomics.
The nature of money is highly peculiar. It is very different from the point of view of an individual and from the point of view of the system as a whole. Individuals cannot magic money from nothing. But the banking system as a whole can magic money from nothing.
This money can be used to bring economic activity into existence. Credit creates savings/deposits. Economic activity generates saving, it is not constrained by saving.
Keynes’s predecessors, the Classical economists saw things differently. According to Classical theory, saving was necessary prior to investment. Money – deposits or savings – existed only as the result of economic activity. These savings (or vaults of silver/gold) then created economic activity.
Keynes’s great contribution was to demonstrate the contrary: that saving, which is another word for non-consumption, or delayed consumption, is not necessary prior to investment. In other words, if a bank promises credit for an investment it really disposes of something belonging to the future: the coming saving. Credit creates deposits and savings. Credit creates economic activity.
Victorian constraints on finance
The economic theory that saving was necessary prior to investment came about, in part, because banks at that time were not adequate to the demands of rapid industrialisation, and firms could not easily raise funds for large-scale investment. Instead they relied on the savings of individuals. The saving habits of the time were therefore incorporated into Classical or Victorian economics and persist to this day in neo-classical economic theory – still dominant in our universities and think-tanks.
For the Victorians, banks were merely channels, passing money from lenders to borrowers; from individuals to firms and governments.[i] But as the banking system evolved, banks were able to create credit in excess of savings. With time it became clear that neither savings, nor prudent savers were necessary or essential for investment. Once society accepted banking systems and bank money, money was no longer a scarce resource. Economic activity was, and is, no longer bound up with, and dependent on the few with savings in excess of income.
Investment was, and is no longer constrained by saving.
Today, to make loans, banks (both central banks and private banks) do not have “savings” or “deposits” – either theirs, or those of others – to extend to others as credit, and on which they charge interest. The money for a bank loan does not exist, until the borrowers apply for credit. (The myth of ‘fractional reserve banking’ is just that: a myth.) Central banks do not need to tax the population, or to mobilise savings, before the creation of what is today known as ‘Quantitative Easing’, but was in the past known as ‘Money Market Operations’ etc.
At the height of the financial crisis, Governor Ben Bernanke was asked where he had found $160 billion to bail out an insurance company, AIG. Had he raised the funds from taxation? No, he replied:
“It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in 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.” (CBS 60 Minutes Show 15 March 2009).
In today’s economy, there is no tangible quantity corresponding to the aggregate of bank money in an economy at any point in time. Such a tangible quantity/quality is not a necessary characteristic of money. The acceptability and hence validity of bank money is due to its being able to facilitate transactions. [ii] To enable society, in Keynes’s terms, to ‘afford that which we can create’.
For investors that operate in today’s monetary economies, the relevant consideration is the availability of finance, not savings, and there need be no constraint on finance – because credit is not a commodity and there need be no limit to its creation.
This makes credit both a powerful resource for human development and protection of the ecosystem; but also a dangerous power if unchecked and governed by ‘light-touch regulation’. If more credit is created by the banking system than there is potential for economic activity, then the outcome is inflation. If less credit is created than there is potential for economic activity, then the outcome is deflation. Furthermore, if loans are made at rates of interest above a sustainable rate of return, the loans become unpayable.
Supply and the price of money
Fortunately, bank money has a second great advantage, the very thing that had motivated its invention: lower interest rates. Public banks could increase the supply of money, and thereby lower its price: the rate of interest. Entrepreneurs were no longer ‘in hock’ to those with savings in excess of income, who were often usurers.
For unlike gold or oil, credit is not subject to the laws of supply and demand. And because it is not subject to the laws of supply and demand, its price – or the rate of interest – should always be low, and is necessarily a social construct. In other words, the price of credit is influenced not by shortages or gluts, but above all by committees of men and women, based in central banks, and in the private banking system, who determine the most appropriate rates of interest for the economy, or for the private banking sector. (Consideration is not, so far, given to the ecological sustainability of rates.) The 2009 creation of extraordinary levels of ‘support’ – $16 trillion – for the banking system was accompanied by decisions by central bank committees to push base or policy rates to the lowest levels in history. While rates across the spectrum did fall, central banks have unfortunately lost control over rates set by the private sector, now determined overwhelmingly by the British Bankers Association’s determination of the London Interbank Offer Rate (LIBOR).
Bank money was a remarkable and very welcome development; a great public good. Indeed capitalism owes much of its advance to the development of sound banking systems.
Using the banking system to facilitate the Green Transition
By increasing the amount of credit in circulation, bank money facilitated what we have come to regard as progress. The development of modern technology (the light bulb and the steam engine) would not have taken place if entrepreneurs had not had their research and development funded by low-cost finance made available by bank money. Trade was made possible with bank money. The welfare state was made possible by bank money. And financial crises have been ameliorated by the issuance of bank money.
The 2009 financial crisis demonstrated to the public that the relevant consideration is the availability of finance, in the form of Quantitative Easing, not savings, and there need be no constraint on finance. Society now needs to argue that just as there was no constraint on the financing of the 2009 bailout, so there need be no constraint on the financing of the Green Transition. Instead there must be careful regulation of that financing, and of the rate of interest attached to loans for investment in the de-carbonisation of the economy.
The financing and investment of 2% of global GDP in the Green Economy Transition will in turn generate economic activity, and with it the deposits and savings needed to repay lending. There will be no need to resort to taxation, pension funds or other sources of ‘saving’. Indeed sound economic activity will generate additional savings for individuals, firms and governments.
