The Debt Pyramid

by Anne Belsey
(Leader of the Money Reform Party)

One way to get a sense of the historical significance of the present financial crisis is to visualise society as a triangle with a pointy top and a broad base. It is the picture of a side of a pyramid.

The rich people are those at the small pointed top of the pyramid, which broadens to encompass the 'comfortable' middle-classes and broadens further to include those less well off with the wide base of the very poor.

At the beginning of the 20th Century, that part of society which had bank loans consisted solely of those at the very top of this pyramid. The aristocracy, people with 'private incomes', were the only individuals who borrowed from banks. They were joined by large companies seeking short term loans and the government seeking much longer term loans.

As the century progressed, after the First World War, so bank-lending began to slide down the social scale, absorbing more and more of the population. A step down from the aristocracy, the upper-middle classes, professionals such as doctors and lawyers, began borrowing to buy the suburban villas they had previously rented, and smaller limited companies began to borrow to finance expansion or to cover cash-flow shortages.

After the Second World War, the lower middle classes, clerks, middle managers, teachers and other salaried workers, also started to take out mortgages to buy their three-bedroom-semis, whilst even very small family firms began to rely on an overdraft facility. This expansion of new lending was important for the economy because successive governments began to pay down the National Debt as a proportion of GDP (even though it kept rising in real terms), from 250% in 1945 to 40% in 2007.

So the burden of borrowing into existence the money supply that the economy needed (and paying it back with interest) shifted from the government to private individuals.

Into the 1980s and borrowing increasingly became a way of life for the 'skilled working classes' and anyone in secure employment, as council houses were sold, house-ownership became the realisable dream for almost everyone and credit cards became popular.

Then in the 1990s, students were brought in to carry their share of the nation's debt burden, as were the elderly in the form of equity release schemes. Meanwhile in business, a great many companies were the subject of highly-leveraged buyouts, leaving those companies heavily indebted.

By the early 21st Century, anyone who was willing to borrow and able to afford the repayments on such borrowing was in debt up to the hilt, but further borrowers were needed. With money coming into existence in the form of debt, not as an expression of positive value as many people suppose, the amount of borrowing has to rise year on year simply to keep the whole system from collapsing.

With the money supply being the collective principal of all outstanding bank loans, the amount of money needed to pay back these loans (with interest) is greater than the money supply. So more new money has to be borrowed each year in order to pay back both the principal and the interest on the borrowings of previous years. In effect, the amount borrowed each year has to meet the amount borrowed the previous year plus the interest on that debt.

It is an exponentially growing debt and one that is not repayable. It can be likened to a pyramid selling scam, wherein each successive intake of gullible participants has to be double the previous intake until the whole scheme collapses due to a lack of gullible participants.

In the real economy, over the past century, we have expanded the proportion of the population that is heavily in debt to the banks until we have reached exhaustion. We have run out of credit-worthy borrowers. Therein lies the simple reason for the credit crunch.

For those of us who advocate a reformed money supply, the solution to this problem is obvious. It is also very simple, and could be applied very quickly and easily. We should have a money supply that exists as a positive, permanent medium of exchange, the existence of which is not dependent upon anyone being in debt.

Unfortunately, mainstream economic thinking is tied to the existing system of money being based upon an ever increasing level of debt. Those economists and politicians who adhere to this viewpoint have to answer this question: 'With debt at saturation point, who is going to borrow into existence the extra money that the economy needs?'

Why money reformers are cranks

by Anne Belsey
(Leader of the Money Reform Party)

I write this blog as something of a belated response to a comment posted on guardian.co.uk by Chris Colvin on 29th December 2008. This was brought to my attention by Mark Braund's article of 5th April 2009 via James Robertson.

The theme of Mr Colvin's article is that 'many whacky fixes for our broken financial system are currently floating around cyberspace' and they are not to be considered as serious alternatives to the excellent system that currently prevails.. He mentions the Money Reform Party by name and derides its performance at the Bromley by-election in 2006, trailing in even behind the Official Monster Raving Loony Party. As the leader of the MRP and the candidate in Bromley, I feel it appropriate to respond.

Firstly, I should correct a serious mistake made by Mr Colvin about the policy of the Money Reform Party. He asserts that the policy of the party is to adopt the gold standard. That is not so, and never has been.

Our policy is that bank loans should be backed 100% by holdings of legal tender. We do not advocate gold or other single commodity as the backing of the money supply. Rather we believe that Britain's money supply should be backed by the productivity of the British economy as a whole. This would done by the simple process of maintaining the money supply at a level that gives us a zero inflation rate.

I shall say no more about the other mistakes made by Mr Colvin in his analysis of money reform, they were more than adequately dealt with in Mr Braund's article.

For the record, in the 2006 Bromley & Chislehurst by-election, I received just 33 votes and came in 11th out of 11 candidates. It was an embarrassing result, but not for myself nor the Money Reform Party. No one who is clearly on record of having attempted to alert the British people, their politicians and media commentators to the problems building up within the money supply in the years before the credit crunch storm broke has any cause for embarrassment. That sentiment properly lies elsewhere.

I am pleased to use this opportunity to bring Mr Colvin's article and his views to wider public attention, for it is the purpose of the Money Reform Party to alert people to the nature and origin of our money supply. Were Mr Colvin's views to be more publicly known, discussed not merely on some obscure website column but in the leader columns of our major newspapers and by reporters on our major television and radio stations, there would be no need for the Money Reform Party.

An example of why this is occurred during the night of the count of the Bromley by-election itself. Myself and two or three of my supporters found ourselves in discussion with someone, presumably a supporter of a rival candidate, I know not which, who was curious to know what money reform was all about.

We explained how the present money system works and he frankly denied that it could be so. Put simply, he denied the existence of the present money system which Mr Colvin so assiduously defends. It could not be the case, he asserted, that banks are 'able to issue credit in excess of the government-backed notes and coins deposited in their vaults' (to use Mr Colvin's phrase).

I do not criticise this individual's ignorance. It is all too common. It is quite understandable. Indeed, the great difficulty of the Money Reform Party and of the money reform movement lies not with convincing people of the justice and desirability of the country having a money supply consisting 100% of publicly-created legal tender, with banks limited to lending out deposits. That is what most people assume to be the case! The great difficulty lies in convincing them that it not so. Although, in truth, as the credit crunch and recession rumble on, the difficulty lessens by the month.

Needless to say, when the penny does drop and people do accept the facts of the current money system, their reaction is usually one of outrage. To secure their support for the sort of simple, honest and stable money supply advocated by the Money Reform Party, which coincides with what they had hitherto supposed existed, is then the easiest thing in the world.

To repeat, the great difficulty confronting money reform is getting people to understand and accept that what presently exists is what presently exists. Without that, our message of reform falls on deaf ears. Unfortunately, there are far too few of the likes of Mr Colvin, trumpeting the cause of debt-based money created by commercial banks, for awareness to have spread very far.

Hitherto, money reformers have found themselves regarded as cranks by two quite distinct groups of people for two quite distinct and mutually incompatible reasons. Economists, politicians and commentators like Mr Colvin condemn us as cranks for suggesting abolishing credit creation by commercial banks, whilst many ordinary, less 'financially-literate', members of the public condemn us as cranks for suggesting that such a credit creation process could actually possibly exist in the first place.

Please, Mr Colvin, get out onto the streets of Britain, or at least onto the pages of the Guardian newspaper itself, with your message of how the nation's money supply comes into being, it will save me a fortune in future election expenses.

We need nationalised money, not nationalised banks

The recent loss of £24 billion by RBS, together with the £11 billion loss declared by HBOS, almost wiping out the profits of its parent company, LloydsTSB, has brought the idea of total nationalisation of most or all of the British commercial banking sector once more into the arena of political commentary.

The reason why so many British banks (like many others around the world) have had to go cap in hand to government to buy up some, or all, of their shares, is that UK banks, like those of all the major industrial countries, are bound by the Basel Capital Accord which, since 1988, has determined how much a bank can lend.

Many people are under the misguided apprehension that banks lend out their savers' deposits and therefore they can only lend out as much as their savers have deposited. This has not been the way that most commercial banks have operated for more than three hundred years.

Banks used to operate under a concept called 'fractional reserve banking', which effectively meant that banks only needed to have in their vaults a fraction of the money that they lent out. When money meant gold or silver, then banks created loans to many multiples of their holdings of bullion. Since legal tender came to mean bank-notes, then a bank could create credit to the the value of many times its stock of 'real' money.

The Basel Capital Accord (known as Basel II since 2004) has taken this money creation process one step further. A bank's lending is now determined by a set ratio of its capital value on the stock market. The minimum capital ratio is 8%. Meaning that for each £8 of its capital value, a bank can create £100 of new credit.

What this means, of course, is that as a bank's share price rises so its capacity to create more credit rises and conversely, when its share price falls, so its lending capacity also falls. The banks that took up the offer of extra capital from HM Government did so because their falling share price meant that they were in danger of breaching their agreed capital ratios.

The whole basis of the Basel Capital Accord is further proof that bankers have simply lost touch with reality. Its fundamental weakness is that is a pro-cyclical or positive feed-back system. It creates dangerous excesses for the banks operating under its rules, both in good times and bad. It is a wholly flawed concept which has contributed greatly to the global credit crunch.

We do not need to base banks' lending capacity upon capital ratios, nor upon a fractional reserve. Instead, for simplicity, stability, honesty and sustainability, we need a 100% reserve banking system, which operates in the manner that most people think that banks do operate, by lending out such money as they have, and not by creating credit based on money they have not got.

The commercial banks currently create our money supply as an initially matching asset and liability on their books. These assets and liabilities do not remain matching for long, of course, as the interest charged on assets (loans) soon outstrips the interest paid on liabilities (deposits). Out of nothing, a commercial bank can create for itself a myriad of profitable income streams against a very much lower level of costs.

This arrangement currently constitutes 97% of the UK money supply. If the commercial banks were limited to lending out only such legal tender as they have on their books, our nation's money supply would shrink to 3% of its present size. More money would be needed to fill the gap.

The 3% of the money supply that consists of bank notes issued by the Bank of England would have to be expanded to 100% to meet the need for money within the banking system. The profit from the money creation process would then go to the public purse. This would give us a nationalised money supply.

With a money supply entirely and directly controlled by a single public agency, inflation could be eliminated from the economy through the simple process of creating no more money at any given moment than is required to maintain inflation at 0% (or between +0.5% and -0.5%).

A nationalised money supply should constitute one of the basic services provided by government in even the most free-market orientated of societies. Few, if any, would advocate that Britain should be defended by privatised armed services, or that our streets be protected by privatised police-forces, or our courts run by a privately-owned judiciary, or that every road and street in the land should be privately-owned with no public rights of way. A publicly-provided money supply is as essential as these services.

By requiring banks to operate in the manner that most people actually believe they do – lending out only so much legal tender as they hold in their vaults – bank regulation could be made very simple and very possible. The capacity for banks to lend would not depend upon the rise and fall of the stock market, but upon their customers' capacity to save.

This would be counter-cyclical. If people spent more and saved less, so increasing the demand for goods and services, thereby 'overheating' the economy and creating inflationary pressures, so the capacity for borrowing would diminish, automatically curbing such pressures.

In such an environment, banks could not get themselves into the mess that they recently have, requiring government bail-out plans. They could be left to get on and operate as privately-owned commercial businesses, just like building societies, credit unions and like most of the rest of the economy. They would no longer be massively profitable, as they would no longer create the money supply, but then why should they be massively profitable, when such profitability occurs at the expense of the productive part of the economy?

For a genuine free-market, both in the financial and the productive sectors of the economy, free from the cumbersome bureaucracy of excessive regulation, a nationalised money supply is a must.

We need Money Reform, not Quantitative Easing

With the Bank of England base rate fallen now to 1%, the Bank and the Government are fast running out of ways of stimulating lending in order to get more money into the economy.

This has been recognised for some time, indeed, if base rate reductions were going to work at all, they would have worked when the rate was 2% or 1.5%. So it is that the frightful phrase 'quantitative easing' has entered the vocabulary of economic commentators.

This has been explained by some as 'printing money', but in fact it might not involve any increase on the Royal Mint's normal annual increase of one to two billion pounds-worth of extra legal tender. Instead, it might just involve the Bank of England issuing bonds in exchange for some of the commercial banks' rather more dubious assets – their toxic sludge.

With some nice AAA rated Bank of England bonds as assets on their books rather than the loans and mortgages of their more insolvent customers, so the theory goes, the commercial banks will be more willing to lend to each other and so facilitate their lending to their retail customers. There is a widespread belief that the commercial banks are currently unwilling to lend.

This is not quite the full picture. In truth, the commercial banks are more than willing to lend, but only to people and businesses with good-credit ratings and little risk of default. This is nothing more than we should expect of our banks. They should only lend to good risks. Indeed, the phrase 'to bank on it' rather implies that a total lack of risk should be the foundation of banking practices. The commercial banks have been roundly, and rightly, condemned for lending to risky borrowers over recent decades.

Unfortunately, both in this country and around the world, the supply of credit-worthy, low-risk borrowers has almost totally run dry. Never mind about an oil shortage crippling the economy at some point in the future, a world-wide shortage of solvent, prudent and obedient borrowers is crippling our economy now.

So quantitative easing in the form of Bank of England bonds is unlikely to get things going. It will doubtless be tried, as the powers-that-be run through their diminishing range of options, but it will fail. So the next step could indeed be the rolling of the printing presses.

This will get the economy functioning again, but the cost will be high. The cost will be high levels of inflation with all the insecurity and industrial action that we experienced during the 1970s and 80s.

The cause of this inflation will not be the extra bank notes themselves, but the fact that for every £1 of legal tender issued, the commercial banks will be able to conjure into existence £30 of bank credit. In other words, with the banking system unchecked, the commercial banks will be able to cause massive inflation through their current standard banking practices.

The current money supply serves to illustrate this. The total amount of sterling legal tender in circulation within the economy (including Scottish and Northern Irish notes) is about £50 billion pounds. However, the total UK money supply (M4), as reckoned by most economists and the Bank of England's own statistics, is in the region of £1,700 billion, over 30 times as much.

Without the capacity of the commercial banks to create credit, our money supply, along with prices, wages and savings deposits would be 3% of what they presently are. In other words, we would not have had the inflation of the past 40 years.

The Money Reform Party advocates that our money supply should be created solely by a public agency as legal tender and that commercial banks should be limited to lending only the legal tender in their possession. This is called 100% reserve banking to distinguish it from fractional reserve banking. (Although, for the 10 countries of the Basel Capital Accord, fractional reserve banking has been replaced by capital ratios.)

To cover all the existing debts, this would indeed involve creating a lot more legal tender, although it might only need be in the form of billion-pound bank notes, or it could probably be done electronically. This extra money would not flow into the wider economy, because only so much would be created as would have to be borrowed by the commercial banks to cover their existing loans. So it could not be used for further lending. Thus a cap and control would be placed on the money supply. There would be no risk of inflation.

Indeed, it is the view of the Money Reform Party that the public agency that is charged with creating and issuing the nation's money supply should be charged with maintaining inflation at 0%. Inflation is a necessary feature of a money supply consisting of bank credit, hence the current Government target of 2% and not 0%. It would not be necessary with a debt-free money supply, and only a 0% inflation rate is fair to both savers and borrowers.

The economy would be revived not through increasing the money supply, but through stripping out hundreds of billions of pounds worth of debt, both public and private, together with increasing Government spending, notably through investment in environmental protection measures, and reductions in taxation on low and medium incomes.

This is totally different to quantitative easing which is designed to keep the debt-based system largely in place and is deliberately intended to increase inflation. A low level of inflation is regarded as an essential aspect of a dynamic economy by conventional monetary theorists.

The current, debt-based money supply has been described as a form of slavery, debt-slavery. Quantitative easing is akin to a slave owner who, having flogged his slave nearly to death, decides to lay off the lash for a while to enable his property to recover sufficiently to be set to work again. Money reform is akin to abolishing slavery and giving each former slave a trade with which to support themselves in freedom and prosperity.

Both of these actions are intended to ease the lot of the slave, but their difference is quantitative.

Base rates are a broken lever

The Bank of England's reduction of its base lending rate to 1% is proof of the utter irrelevance of the economic theories under which it and the prevailing academic consensus is working. By reducing the base rate to 1%, it is announcing that a rate of 1.5% will not work.

1.5% was itself a record low. If reducing the base rate was going to work at all, then 1.5% should have been quite low enough. It was less than half the current level of inflation and meant that anyone with a tracker mortgage set at 1% above base would have been paid to borrow, in real terms.

The drop to 1% is akin to the tragi-comic situation whereby a character discovers that a particular control for a runaway machine no longer works but, instead of reassessing the situation in order to establish control by some other means, continues to pull on the broken lever in the vain hope that somehow it might spontaneously repair itself.

Thus it is that the Governor of the Bank of England, the members of the Monetary Policy Committee, the Prime Minister, the Government's Treasury team, most economic commentators and everyone else who takes base rate reductions as a serious solution to the present economic crisis can number themselves amongst a cast of notables that includes Dick Dastardly, Wile E. Coyote and the Keystone Cops.

To understand why this is, let us consider the theory behind the raising and lowering of interest rates.

Very simply, the theory is that when base rates are low, people borrow more and because people borrow to spend, so more spending takes place and the money moves around the economy faster. When saving rates are low, there is less incentive to save, because savings rates are low.
The implication of this is that there is only so much money within the economy, and people are either spending it or saving it. They cannot do both. What is not addressed is the question, if people are saving less and borrowing more, from whom are the borrowers borrowing?

The unspoken truth, of course, is that borrowers do not borrow from savers. Their borrowings are entirely new money created as debt by the clearing banks.

Even so, the lowering of interest rates at the retail level should stimulate economic activity, because through increased borrowing, more new money is created, enabling businesses to sell more, employees to earn more, people to spend more, and so on. It has always worked like this before.
The trouble is that we have never before had the levels of debt within the economy that we have now. People with tracker mortgages, who are finding themselves with hundreds of pounds extra money to spend each month are not spending it. They are using it to pay off even more of their mortgages, worried that in a few month's time, they might be unemployed.

Everyone with even the slightest amount of fiscal awareness, obviously excluding Dick Dastardly et al, listed above, is doing the supremely sensible thing for themselves and their families of paying off their mortgages and other debts, and building up their savings, no matter how low the interest rate they might earn, against the possibility of their own domestic financial difficulties.

This sensible course of action is disastrous for the economy. What is good for individuals is bad for the economy. What is good for the economy, indeed, what is essential for the economy is for individuals to borrow massively, even against their own long term best interests. This is a perversity within our current monetary system that rarely gets mentioned.

This peculiar and perturbing fact is due to our high dependence upon debt to provide the money supply. Without large numbers of solvent borrowers taking out mortgages for homes, loans to start businesses or credit cards to consume, our money supply would almost totally disappear.

This explains the Government's obsession with getting banks lending, 'to get credit flowing once again'. The trouble is that for the banks to lend, someone else has to borrow. The Government itself is doing its bit, but Government borrowing has fallen over recent decades as a proportion of overall national borrowing, and there is a political limit on future increases, especially if the Conservatives win the next election. They have so vilified Government borrowing, that whilst they might find it expedient to increase it slightly themselves should they come to power, they cannot do so by much without becoming a laughing stock.

So the burden of borrowing the increasing amounts necessary, a need that rises exponentially year-on-year, to fund both day-to-day economic activities and the high level of residual interest on past borrowing, will fall on the private sector, both households and businesses.

The question is how much increased borrowing are we, as a nation, collectively able and willing to undertake?

Even with base rates at 1%, with mortgages fallen to an all time low, the desire to borrow (and ability to repay) is modest. Even if people were not worried about possible unemployment or other insecurities, their borrowing might be expected to decline, for the very simple fact is that there is a limit to the amount that anyone can borrow.

Micro-economic factors feature rarely, if at all, in the macro theorising of most monetary economists, but real people, unlike lines on graphs have their limits.

With average unsecured debt for households that have such debt standing at £21,000 and average outstanding mortgages for the 11.7 million households who have mortgages standing at £104,000, there is a very real possibility that we have maxed out on debt. We have gorged ourselves and can borrow no more. There must be a limit somewhere.

If the limit has been reached, then cheap loans will not aid us. In that case, if we adhere to the economic orthodoxy that us got us into this mess, the only solution is to take the pain of our indigestion for the next decade or so as our level of indebtedness declines through house-repossessions, bankruptcies and high levels of unemployment.

With the current Bank of England base rate at the lowest point it has ever been in the Bank's 315 year history, firstly as a private company, then since 1946 as an agency of the state, we are clearly living in historic times. Few man-made processes last forever. We might well have reached the end of the Era of Debt.

There is, of course, an alternative to a money supply consisting of debt. We could quite easily switch to a debt-free money supply of the sort that currently exists in the minds of most ordinary people, who are baffled by the concept of money as debt. It does not make sense. Indeed, it does not, and we can expect to see the end of it during the next decade.

Welcome to the Money Reform Party Blog.

The Money Reform Party exists to educate the British people and their politicians about the money system and to campaign against the creation of the money supply by the private banks.

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