figures stood on stacks of coins

Money creation, debt, and justice

 

Money plays an essential social role, and its distribution is linked to that of justice. Unfortunately, bias has corroded the mechanisms that govern money creation, resulting in injustices that benefit the wealthy at the expense of the poor.

 

Peter Dietsch, a philosophy professor at the University of Victoria, British Columbia, Canada, says it’s time to re-evaluate the system and consider alternatives.

 

Read their original article: https://doi.org/10.1177/1470594X21999736

 

Read more in Research Outreach

 

Image credit: Shutterstock/Hyejin Kang

 

 

Transcript:

 

Hello and welcome to Research Pod. Thank you for listening and joining us today.

 

In this episode we’ll be looking at biases in the current monetary system, how people who need credit are least likely to be able to get it, and what a more equitable money-creation system could look like.

 

Money is an essential social good – ask any family without it. So its distribution is highly relevant from the perspective of justice. Printing more physical notes and coins, as any first-year economics student will know, is not the solution. Money creation and its just distribution relies instead on equitable access to credit, which represents the bulk of money in a modern economy. Unfortunately, bias has corroded the mechanisms that govern money creation today, and the result is an entrenched injustice that benefits the wealthy at the expense of the poor.

 

This should worry anyone, but it’s of particular concern to Peter Dietsch, a philosophy professor at the University of Victoria, British Columbia, Canada.

 

He sums up the current money-creation system in the words of singer and poet Leonard Cohen: ‘Everybody knows the fight was fixed, the poor stay poor, the rich get rich’.

 

Dietsch says it’s time to re-evaluate the system and consider alternatives. He starts from the observation that money confers freedom – but the system that creates money has unintended and undesired consequences. The way credit is allocated leads to some people enjoying less freedom than others through no fault of their own. It’s neither ethical nor meritocratic and is prejudiced against those without collateral. It is also unstable.

 

Let’s take a step back and look at how money works. The money powering the global economy is essentially an IOU system. In its most basic form – cash – it’s a promise from a central bank to pay the bearer the sum displayed on the note. The most common IOUs are commercial bank deposits issued as loans to individuals and non-financial entities, and loans between commercial banks, known as inter-bank lending. A third form of IOU are central bank reserves – just as individuals have deposits with commercial banks, those banks have deposits with central banks. This entire system relies on certified trust.

 

Here’s a simple example. A bank will issue an individual a mortgage or a loan to invest in, say, a business, if the applicant shows they can service the loan, or have collateral that the bank could secure should things go south. The creditor’s capacity to contribute to a broader societal good is not a viable measurement of their ‘worth’ to the lender. Meritocratic reasoning doesn’t come into it.

 

Inter-bank lending follows the same rules. Credit markets provide commercial banks with leverage to pursue profit. The assets sitting on their balance sheets – government bonds, credit card debt and student loans – are used as collateral to get credit from other banks. They then invest this credit to maximise profits for shareholders and pay bonuses to executive teams. The claim that these benefits eventually ‘trickle down’ to the more needy, is overshadowed by the looming reality that the newly created money often ends up in asset markets, such as stocks or real estate. It doesn’t incentivise commercial banks to issue more loans to those who need them. The result is further bias within the system that benefits the wealthy.

 

Where do central banks fit into this unjust money creation system? Their footprints are in the chaos after the 2008 financial collapse. When commercial banks, especially in the US, saw their assets suddenly become worthless, central banks injected new money onto their balance sheets in the form of central bank reserves. By essentially buying useless assets from commercial banks and other private institutions, thus creating money – a process called quantitative easing – the prime beneficiaries were again financial institutions. They were given a hand up – or more correctly, a handout – and returned to business. One reason they had access to such credit was because they were considered ‘too big to fail’. Contrary to the intention of the central banks in launching quantitative easing, such benefits rarely trickled down, and the bias remained.

 

Dietsch does point to one positive from the 2008 financial crisis: the fallout, and the monetary policy response, reignited interest in the normative dimensions of money and its creation.

 

To begin to fix the bias we need a clearer idea of what justice in a monetary system looks like. If, as Dietsch claims, bias is ingrained in the system, we need a normative benchmark against which we can evaluate biases. This would guide us towards a more equitable framework of credit distribution. Unfortunately, the voice of economists and philosophers is patchy on questions of justice around money creation.

 

One of the rare exceptions is the late political philosopher GA Cohen, who believed money and freedom were intertwined. According to Cohen, given that money is a necessary condition to acquire most goods and services, a lack of money makes one ‘liable to interference’, as he put it. At its most basic, if someone simply takes something they cannot afford, this will invite strict retribution. Hence Cohen believed that money confers freedom. No one is entirely free from interference, and freedom is relative, not absolute. But while differentiated freedom is not unjust in itself, if it is tied to access to money and the structures that determine bias, then the resulting inequality is undeserved.

 

Dietsch admits there is a flipside to credit when it comes to issues of freedom, which is debt. Those accorded credit are indebted to the creditor, as anyone who starts a career in the shadow of a student loan knows. Similarly, having to enter into debt to acquire other fundamental rights, such as healthcare, hardly enhances an individual’s freedom. But when we’re talking about extra cash to satisfy secondary needs, rather than fundamental ones, having access to extra money through credit arguably outweighs any constraining aspects of debt in most cases.

 

A key point here is to distinguish inequalities in wealth from the question of justice in money creation through credit. Even if a rich person deserves the underlying wealth differential that gives them collateral, it does not follow that they should have privileged access to another social advantage in the form of money created through credit, and to the additional freedom this bestows. In essence, equality in access to credit should be our normative default position.

 

So how might we achieve a fairer system? It’s clear some fundamental things need to change. Dietsch has a proposal – not so much because he believes it’s the best way forward, but to demonstrate that a less biased system of money creation is possible.

 

Today, central banks pursue the objective of price stability – the stable level of prices in an economy, which sustains the value of money over time. They do this by using the credit market as a transmission mechanism. Put simply, they open or close the valve of money creation. But commercial banks play an important role in deciding where the extra credit actually goes. If a lot of the biases in money creation can be traced to the role of commercial banks, what if we separated money creation from private bank credit?

 

To understand what this means, note that the idea of commercial banks safely holding their customers’ money is a little simplistic. A country’s financial stability relies on the fractional reserve banking system, where only a fraction of bank deposits is supported by actual cash on hand. The result is a system woven together by credit upon credit, and the hope that customers don’t suddenly all demand to have their money. It’s not difficult to comprehend why commercial banks prefer issuing credit based on minimal risk instead of maximum need.

 

So, what’s the alternative? Dietsch suggest it’s an economy with ‘full reserve banking’, in the sense that commercial banks cannot lend more than they receive in deposits. Meanwhile, central banks would make monetary policy, not via the transmission mechanism of the credit market, but by directly injecting or withdrawing money from consumers – for instance through an instrument that Milton Friedman coined ‘helicopter money’.

 

The concept of full reserve banking has a long pedigree. It was proposed by Irving Fisher in the 1930s and has been regularly defended by a minority of economists since. It is controversial and is yet to find favour with any country’s primary credit institutions. But that certainly doesn’t mean we should dismiss it out of hand. It has considerable virtues for eliminating bias in the issuing of credit. It would reduce the enormous privileges accorded to commercial banks, and the bias in favour of financial asset holders, thereby throttling the fuel that feeds asset price bubbles. Thanks to increased stability, bailouts would – theoretically – be unnecessary.

 

Of course, there are concerns with full reserve banking. Increased interest rates are a likely outcome, and while this might squeeze the level of relative freedom between rich and poor, the system might also become more risk-averse, potentially reducing overall growth.

 

But as Dietsch points out, even though full reserve banking may not be the last word on the issue, it is a vital starting point to discussing distributive justice, and devising a more equitable system of money creation.

 

That’s all for this episode – thanks for listening, and stay subscribed to Research Pod for more of the latest science. See you again soon.

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