Our banking and monetary system is toxic
The country’s economic structure needs major surgery if we are to build a socially cohesive, inclusive, harmonious society and a sustainable economy, argues Dr Yaj Chetty, a civil society activist and one of the early members of the former economics think-tank SANE (South African New Economics Network).
The FeesMustFall campaign has focused the attention of the nation on the economic plight of the majority of people in this country. Quite clearly, the transition of 1994, while delivering political freedom has not brought us economic freedom or reduced unemployment and inequality.
At the root of the problem is a financial system based on debt, fractional reserve banking and compound interest. This system essentially means that 97% of our money supply is created as debt by private banks when they issue loans. It is created out of thin air by the banks using the fractional reserve banking system. The other 3% of our money in circulation is the cash component (coins and notes) which is printed and minted by the Reserve Bank.
Under this system, essentially all new money is borrowed into existence and created from nothing. Fractional reserve banking means the Reserve Bank sets a reserve requirement ratio for the private banks which limits their capacity to create credit out of thin air. For example, if the reserve requirement is set at 4%, then the private commercial banks can lend out 25 times the reserves. This literally means that they can lend out R2 500 million for every R100 million they borrow from the Reserve Bank at the repo rate which is the interest rate set by the Reserve Bank. This is sometimes referred to as leverage.
Simply put, you or I as individuals cannot lend out R2 500 if we only have R100 or lend out the same R100 twenty five times over. However this exorbitant privilege and extraordinary power to create money out of nothing is vested in private banks for their own profit! Under double- entry accounting any new loan issued by private banks is entered as both an asset and liability on the balance sheets of the banks.
The effect of this monetary system is that it creates scarcity of money in circulation because only the principal is created but no money created for the payment of the interest on the loan. There is, therefore, never enough money in circulation for every borrower to pay back both interest and principal, hence the fierce competition in the world for survival just to keep the wolf from the door. The money system works well during booms when the economy is growing and credit is expanding with more and more people going into debt, with inflation of the money supply. However, the system is prone to busts when economic growth slows down, when interest rates rise and credit extension contracts, demand drops and recessions ensue with rising levels of bankruptcies, retrenchments and business closures.
This system works on the basis of survival of the fittest, the bigger companies out-competing the smaller ones through mergers and acquisitions for example. There is also a tendency to formation of monopolies and corrupt practices like collusion and price-fixing. For the private banks the main risk is the ability of their customers to pay back the loans and to hope that there is never a run on the banks through loss of confidence. This money system is prone to excessive and reckless lending with misallocation of capital to consumption, asset price inflation, speculation in derivatives, securitisation and fraudulent rigging of rates by the banks.
The global financial crisis of 2008 which brought the global financial system to the brink of collapse was a perfect illustration of this phenomenon. While South African Banks claim to be uninvolved in the kind of reckless subprime lending that occurred in the USA with the bursting of the housing bubble there, they are just as implicated in the securitisation of loans which means the bundling , slicing , dicing and selling-on the risk to other investors as mortgage-backed securities and other structured investment vehicles.
This banking/monetary system therefore creates financial instability and insecurity as well as concentrating wealth in the hands of the big private banks and big companies. It must be remembered that the rich get richer and the poor get poorer from this system because money in the form of interest flows from the poor who are net payers of interest to the rich who are the net receivers of interest from their interest-bearing assets.
Because 97% of our money supply is created as debt/credit and interest- bearing loans, we as the public are left with little choice but to go into debt and borrow. Ironically, if all debts/ loans were paid back all at once and nobody borrowed any more loans into existence, then our money supply would disappear and the system would crash. It is therefore even futile and nonsensical to constantly exhort the public to save and pay down debt when it literally becomes impossible for the majority of people to do so.
To exacerbate this problem national governments like ours are also forced to go into debt borrowing interest from the private banks , (the creators of money out of nothing) either by incurring loans or the issuing of government bonds to meet their fiscal obligations. The public is subjected to taxation large proportion of which is used to pay back these loans with interest. In effect governments also become over-indebted at our expense and sometimes for corrupt expenditures like arms deals.
Ecologically, this monetary system is also very destructive because it only works with continuous economic growth at whatever costs to the environment or public health as more money must be continually borrowed into existence against future economic growth. However, compound or exponential growth is not possible or even desirable in perpetuity on a finite planet without disastrous environmental consequences.
In essence, we have a banking and monetary system that is toxic, iniquitous and exacerbates the inequalities inherited from our colonial and apartheid past. So, the question is what can be done differently to transform this system so that it works for everybody, reducing inequality , fostering social cohesion, solidarity and a sustainable economy ?
Simply, a full reserve (100% reserve) system should and ought to replace the current fractional reserve banking system. The reserve requirements of private banks can be progressively raised until 100%. This simply means that private banks can no longer create new money from nothing. They will either lend money that they have or they can borrow money in full from the Reserve Bank before they can issue loans. Thus all new money would be created exclusively by a Reserve Bank that is mandated to do so debt-free and interest-free. In this way such a Reserve Bank would have more direct control of the money supply and therefore inflation. Furthermore, governments would be able to access interest-free credit directly from the Reserve Bank for investment in essential infrastructure like renewable energy, housing, public transport, and financing public health, education and a basic income.
This is precisely how Canada funded their infrastructure and highly acclaimed national health service between the years 1939 and 1974, when the government of Canada was able to access interest-free loans from the Bank of Canada, its own Reserve Bank. This period in their history was characterised by stability, prosperity and low levels of national debt. However, this window was shut down by the Bank of International Settlements, the central banks of all the central banks with the passing of the Basel Accord in 1975, effectively coercing governments to borrow at interest from the private financial sector ostensibly for reasons of managing fixed exchange rates at the time. There are currently legal challenges under way to restore the constitutional obligations of the Bank of Canada once again.
Ellen Brown a US litigation attorney , author of the “Web of Debt” and president of the Public Banking Institute advocates a Public Bank system along the lines of the state-owned Bank of North Dakota functioning successfully to this day since its inception in 1919. North Dakota owes much of its economic resilience to this fact, being only one of two states in the USA which is solvent with a budget surplus, low unemployment and availability of low-cost loans for farmers, businesses and students.
The whole issue of full reserve banking and debt-free public credit creation is supported by numerous eminent economists around the globe including : Prof. Laurent Kotlikoff, University of Boston USA, Prof .Richard Werner, University of Southampton , UK, Prof.Steve Keen from the University of Sydney West, Australia, Prof .Herman Daly former chief economist of the World Bank, Lord Adair Turner, recently the chairperson of the FSA Financial Services Agency (UK) to name a few.
Quite notably an IMF Working Paper by Jaromir Benes and Michael Kumhof of August 2012 entitled “The Chicago Plan Revisited” fully supported full reserve banking as a comprehensive solution to the global and national economic problems and vindicated the findings of renowned economist Irving Fisher who advocated a 100% money system.
Positive Money in the UK is a civil society advocacy group that is dedicated to raising awareness on this issue of monetary and banking reform. It is doing some sterling work in this regard providing workable pragmatic solutions. Locally, Redge Nkosi has set up a website www.firstsourcemoney.org.za to enlighten the public about the issue of money creation and full reserve banking.
It is imperative for all of us to learn more about this vitally important issue if we want to provide any hope of addressing our challenges of poverty, inequality and unemployment in any meaningful way.
We need the most effective tools with which to build a socially cohesive, inclusive, harmonious society and a sustainable economy. This will be the greatest tribute to our struggle for real freedom and build on the legacy of Nelson Mandela , Robert Sobukwe and all those fallen and unsung heroes and heroines from our proud history of struggle for human dignity.