The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending.
— Martin Wolf, Financial Times, November 9, 201016
There is a natural immature human inclination to find a way around the rules if a tangible, immediate reward is at hand. History shows us we need our collective grownup selves in the form of governance to set limits and curtail bad behavior – especially in the face of enormous temptation. What greater temptation than the privilege of creating money?
Over the past century, the banks of the world with the privilege of creating our money, have managed a steady deregulation of the banking sector that in practice removed deposit reserve requirements and nearly any meaningful capital-equity requirements. Great Britain removed reserve requirements in 1888. The US still has some reserve requirements in place, but they are readily, routinely and legally circumvented. For at least the past 50 years in the US, the multiplier model of reserve banking has hardly applied to US banking and money creation, although it is still taught in economics classes, and we still call our banking system, The Federal Reserve System. So, once the reserve requirements are gone, and the capital requirements are almost nonexistent, what determines how much new money is created?
The bankers’ moods
The moods of private bankers become the only limit on their creation of new money through the issuance of credit-debt. When bankers are confident the economy is perking along and they think they are likely to be repaid, they create new money by freely handing out new loans. When considering just how freely, think of the NINJA loans of the early 2000s (No INcome, Job or Assets); banks were making $500,000 house loans without requiring proof of income, employment or assets.17 When the inevitable bubble pops, the bankers are doom and gloomy and money is tight. People suffer.
Bankers have convinced academics and Congress that this cycle of boom and bust, exuberance and restraint is a normal economic- business cycle. It is not. There is a natural business cycle from new, to we-must-all-have-this, to ho-hum, to gone and forgotten, to the next new thing. Think of the businesses that boomed and collapsed as we innovated from phonograph records to the cloud: the manufacturers of record players, magnetic tape decks, 8-track and then cassette players. Think of the video stores, and the manufacturers of all the products supporting these technologies.
There is also the business cycle of a successful bandwagon. Selling Christmas trees is a ready example of this common business cycle. If only a few people are selling, they can demand full price and sell out, making a nice profit. Interested people notice and the next year more people decide to sell Christmas trees. If in the next year there are too many sellers, no one will sell their entire inventory, and many will lose money. Then the year after, there will be only the few who survived. Of course, this pattern repeats.
Money force not market force
Our money system inflates the entire economy like a giant balloon until it pops. The idea that this is a natural economic cycle of boom and bust is part of the con. An entire economy that cycles from boom to bust every 7–12 years is only natural in a private money creation system such as ours; a fractional reserve money creation system is prone to asset bubbles and market crashes. They are part and parcel of this system.
Boom and bust can happen in any business, but it only happens in an entire economy when the money supply itself is ballooning and bursting.
This is our system now.