1장
The Banking System's Hidden Power
Money ranks with fire and the wheel as an invention without which modern civilization would be unimaginable. Yet unlike those other innovations, our monetary system has evolved into something that actively harms society. When Martin Wolf of the Financial Times argues we've delegated "a core public function-the creation of money-to a private and often irresponsible commercial oligopoly," he's highlighting perhaps the most significant yet least understood economic problem of our time. While governments vigorously prosecute counterfeiters, they simultaneously enable private banks to create 97% of our money supply through the simple act of making loans. This privilege-granted to no other business-has transformed banking into something that violates almost every principle of capitalism while threatening the stability of our entire economic system.
2장
The Evolution of Money: From Goldsmiths to Digital Deposits
Money's origins are far more complex than the textbook story of emerging naturally from barter. Anthropological evidence suggests early societies operated on sophisticated credit systems long before physical coins appeared. In ancient Mesopotamia, temple administrators maintained detailed clay tablet records of debts and credits, making interest-bearing loans as early as 3000 BC. Greek bankers, known as trapezitai, accepted deposits and processed payments by the fourth century BC, operating from tables in marketplaces and offering services remarkably similar to modern banking.
Medieval England witnessed a crucial development in banking through goldsmiths, who initially served as secure storage facilities for merchants' precious metals and valuables. These goldsmiths issued paper receipts that specified the amount of gold or silver deposited. As trade expanded, merchants discovered these receipts were more convenient for transactions than carrying heavy coins. The receipts gained widespread acceptance as money substitutes when people realized they rarely needed to withdraw actual coins. Recognizing this opportunity, goldsmiths began issuing additional notes as loans, effectively creating a money substitute and transforming themselves into early bankers. This practice, known as fractional reserve banking, became the foundation of modern banking systems.
The establishment of the Bank of England in 1694, initially created to finance King William III's naval rebuilding program, marked a pivotal moment in banking history. The bank received 1.2 million in subscriptions from the public and in return gained exclusive privileges in banking. Through the Bank Charter Act of 1844, it eventually secured a monopoly on issuing bank notes in England and Wales. However, this legislation contained a significant oversight - it failed to include bank deposits in its restrictions. This omission proved crucial as banks quickly innovated around these limitations through the development of checks and wholesale money markets, allowing them to continue creating money through bank deposits rather than physical notes.
The 20th century brought revolutionary changes to money and banking. The collapse of the gold standard, which had linked currency values to fixed amounts of gold, led to the era of floating exchange rates where currency values fluctuated based on market forces. The 1971 "Competition and Credit Control" reforms in the UK removed lending ceilings and reduced liquidity requirements, giving banks unprecedented freedom in money creation. These changes, combined with technological advances like electronic transfers, computerized banking systems, and digital payment networks, have created a modern financial system where banks can create money through loans with minimal restrictions. This transformation has fundamentally altered how economies function, leading to faster transaction speeds, global financial integration, and new challenges in monetary policy and financial stability.
3장
How Banks Create Money Out of Nothing
The most crucial function banks perform-making loans-doesn't involve transferring money from savers to borrowers as commonly assumed. Instead, banks create new money by simultaneously increasing their assets (the loan contract) and liabilities (the deposit in the borrower's account). This process, known as fractional reserve banking, is fundamental to our modern monetary system yet remains poorly understood by the general public.
When a bank issues a loan, it simply updates its computer database through a double-entry bookkeeping process. For example, when Jack borrows 10,000 for a van, the bank records the loan contract as an asset and simultaneously credits Jack's account with 10,000. This increases both sides of the bank's balance sheet equally. The bank doesn't transfer money from another account-it creates new electronic money through this accounting entry. Similarly, when a business takes out a 1 million loan for expansion, that money is created through the same process, not withdrawn from other depositors' accounts.
This process requires no pre-existing money; as Paul Tucker, former Deputy Governor of the Bank of England noted: "Banks can lend simply by expanding the two sides of their balance sheet simultaneously, creating (broad) money." When loans are repaid, the opposite occurs-money is destroyed as both the loan asset and deposit liability are reduced. For instance, every mortgage payment not only reduces the borrower's debt but actually removes that money from the total money supply.
The implications are profound: commercial banks determine both the quantity of money in circulation and which sectors receive newly created money. With commercial bank money constituting approximately 97% of the total money supply, and Bank of England cash making up the remaining 3%, banks' lending decisions significantly impact economic direction and stability. This power to create money gives banks enormous influence over the economy's direction - their decisions about which loans to approve effectively determine which sectors grow and which stagnate.
This system is constrained by several factors: regulatory capital requirements, the availability of credit-worthy borrowers, and the bank's own risk assessment procedures. Banks must also maintain sufficient reserves to meet expected withdrawal demands and regulatory requirements. During economic downturns, banks typically become more conservative in their lending, which can exacerbate economic problems by reducing the money supply just when the economy needs stimulus.
Understanding this money creation process is crucial for grasping how modern economies function and why banking crises can have such devastating effects on the broader economy. When banks reduce lending, they're not just moving money around - they're actually shrinking the money supply, which can trigger or worsen economic downturns.
4장
The Boom-Bust Machine: Why Our System Creates Financial Crises
The banking system's ability to create credit doesn't just affect prices-it creates inherent instability in the economy. Hyman Minsky's Financial Instability Hypothesis explains how financial crises emerge endogenously within capitalist economies. His key insight was that stability itself breeds instability as periods of economic calm lead to greater risk-taking and debt accumulation.
The cycle begins after a recession when firms and individuals have low debt levels and conservative borrowing attitudes. As the economy grows, most loans are repaid successfully, vindicating both borrowing and lending decisions. This success encourages reduced safety margins and increased debt. Banks create more credit, fueling investment, profits, and asset price growth.
This leads to a "euphoric economy" where expectations shift to assume continued expansion rather than cyclical recessions. Firms take on more debt, making them vulnerable to interest rate increases. Rising asset prices encourage speculation, with banks innovating to increase lending capacity. "Ponzi units" emerge that can only service debts through continued asset price appreciation.
As interest rates eventually rise (either through market forces or central bank intervention), previously viable financing arrangements become unsustainable. When asset prices stop rising, ponzi units must sell assets to service debts, flooding the market and triggering price declines, leading to loan defaults and financial crisis.
Historical data confirms this pattern. Research examining 14 advanced countries between 1870 and 2008 shows that financial crises are typically "credit booms gone wrong." Past credit growth is the most important predictor of financial crises, even when controlling for other macroeconomic variables. The UK has experienced 12 banking crises since 1800, with 4 occurring since 1945-roughly one every 15 years.
5장
The Housing Trap: How Bank Lending Drives Unaffordability
Bank-created money flows predominantly into housing, driving house prices up faster than salaries and making housing unaffordable for many. Between 2002 and 2008, banks doubled the UK money supply primarily through mortgage lending, creating a self-reinforcing cycle where increased lending drove up prices, which then required even larger mortgages. In major cities like London, the average house price has risen to over ten times the average annual salary, compared to just three times in the 1960s.
This has transformed how we view property-no longer just as homes but as retirement investments. Property has become the default investment strategy for middle-class families, with many viewing their home as their primary retirement asset. Yet few realize these price increases are artificially driven by increased mortgage lending rather than fundamental value. When banks create money to purchase existing assets rather than to increase productive capacity, they primarily drive up asset prices without significantly increasing economic output. For example, while UK house prices tripled between 1997 and 2007, construction of new homes actually declined.
The consequences are severe and far-reaching. Young professionals, even those with well-paying jobs, often spend their entire thirties sharing rental properties or living with parents. Renters in major cities commonly spend over 50% of their take-home pay on housing, compared to 25% in previous generations. The economy becomes dangerously dependent on continued house price inflation, with consumer spending increasingly tied to home equity withdrawal. This creates a precarious situation where even minor interest rate increases can trigger market instability.
When the inevitable correction occurs, it triggers a cascade of negative effects: widespread defaults as homeowners find themselves in negative equity, bank failures as mortgage assets lose value, and economic contraction that disproportionately impacts lower-income households and first-time buyers. The 2008 financial crisis demonstrated how housing market corrections can spread throughout the entire economy, leading to job losses, reduced lending, and a general economic downturn that took years to recover from. Meanwhile, the fundamental problem of housing affordability remains unsolved, creating an intergenerational wealth gap that continues to widen.
The situation is further complicated by government policies that often reinforce this cycle, such as Help to Buy schemes and tax incentives for buy-to-let investors, which can inadvertently fuel further price increases while failing to address the underlying structural issues in the housing market.
6장
The Debt Dependency: A Structural Problem in Our Money System
Our debt-based money system necessitates higher overall debt levels. Since 97% of money exists as bank deposits created through lending, debt is necessary for money to exist. Any significant debt repayment shrinks the money supply, potentially triggering recession.
This creates a paradoxical situation: when people collectively try to reduce debt, the money supply contracts, typically causing recession and making further debt reduction difficult. During economic downturns, the velocity of money typically decreases as people seek liquidity, making it virtually impossible to significantly reduce private debt without triggering recession. Ironically, recessions can increase debt as unemployment and income reduction force more borrowing through mechanisms like payday loans.
The system also transfers wealth from the bottom 90% to the top 10% through interest payments. With a money supply of approximately 2 trillion and average interest rates of 8%, the non-bank sector must transfer about 160 billion annually to banks simply to maintain the money supply-a charge for something the state could provide at minimal cost.
While the state earns seigniorage from creating banknotes, banks capture this profit on 97% of the money supply-a hidden subsidy requiring higher taxes on the public. From 2002-2009, banks increased the money supply by roughly 1 trillion. Had the government created this money instead, UK residents could have paid 1 trillion less in taxes, public services could have received 1 trillion more funding, or the entire national debt could have been repaid.
7장
The Democratic Deficit: Banking's Unchecked Power
Banks wield enormous economic power by creating 97% of the UK's money supply through lending. In the five years before the financial crisis, banks' gross lending to households (2.9 trillion) exceeded total government spending (2.1 trillion). This disparity highlights how private banks, rather than elected officials, have become the primary architects of economic development. By deciding where to lend, banks shape economic activity more profoundly than democratically elected governments, influencing everything from housing markets to industrial development.
The allocation of credit follows neither pure market forces nor democratic priorities. Banks systematically ration credit, favoring asset-backed lending like mortgages over productive business investments. This bias creates asset bubbles while starving innovative sectors of needed capital. The concentration of power is stark: just five major banks control between 61-85% of various financial markets, with only 78 board members between them. These individuals, largely unaccountable to the public, effectively direct Britain's economic future through their lending decisions.
The government's dependence on banks creates a troubling power dynamic that extends far beyond financial markets. Small and medium enterprises (SMEs), which account for 60% of private sector employment and generate half of the UK's GDP, rely heavily on bank financing. This dependency allows banks to resist meaningful regulation by threatening economic consequences. When Deutsche Bank's Josef Ackermann argued that reforms would "steer credit away from important segments of the economy" and prevent job creation, he exemplified how banks leverage their economic influence to maintain their privileged position.
Public understanding of banking remains dangerously limited, undermining democratic oversight. An ICM poll revealed that 74% of people incorrectly believe they legally own the money in their accounts, when legally the bank owns these deposits and can use them for its own purposes. When informed that banks actively risk their deposits in various investments, 33% expressed shock, stating "This is wrong-I haven't given them permission." This knowledge gap is exacerbated by banking's opacity compared to other financial sectors. While pension funds must disclose how social, environmental, and ethical considerations affect their investment decisions, banks operate without similar transparency requirements. This lack of accountability is particularly concerning given that banks' decisions about lending affect everything from housing affordability to climate change through their financing choices.
The democratic deficit in banking extends to regulatory capture, where financial institutions shape the very rules meant to govern them. Through extensive lobbying networks, revolving doors between banking and government, and their role as "expert advisors" to policymakers, banks exercise significant influence over financial regulation. This creates a self-reinforcing cycle where banking power grows increasingly concentrated and removed from democratic control.
8장
A Reformed Monetary System: Separating Money Creation from Banking
Rather than attempting to regulate the current unstable monetary system, we need fundamental change in how money is issued and allocated. The proposed reforms would remove banks' money creation ability with relatively minor changes to their operations, ensuring bank lending actually transfers existing money from savers to borrowers rather than creating new money.
After reform, commercial banks would no longer create money through customer deposits. Instead, all money would be created exclusively by the central bank, eliminating the split circulation between bank reserves and deposit money. Two distinct account types would emerge: Transaction Accounts holding risk-free central bank money that can't be used by banks for lending, and Investment Accounts where customers explicitly allow banks to invest their money for a return while accepting some risk.
Transaction Accounts would replace current accounts, providing the same familiar services-cheques, debit cards, electronic payments, and overdrafts-but with a fundamental difference: the money is no longer a liability of the bank but electronic money issued by the Bank of England that belongs directly to the customer. This creates risk-free "electronic safe deposit boxes" with no exposure to bank insolvency, eliminating the need for deposit guarantee schemes.
Investment Accounts would replace savings accounts but with crucial differences that accurately reflect their true purpose-as risk-bearing investments rather than "safe" places to store money. These accounts would still offer interest but would differ fundamentally: they wouldn't actually hold money (funds would transfer immediately to the bank's Investment Pool), couldn't be used as money (ownership couldn't be reassigned), would be illiquid with no instant access options, wouldn't be government-guaranteed, and would explicitly share risk between bank and customer.
9장
Creating Money for Public Purpose
With banks no longer creating money, an independent but accountable public body, the Money Creation Committee (MCC), would assume responsibility for money creation, operating only when inflation is low and stable. The MCC would function as an independent body with a primary mandate of targeting inflation (typically around 2%), effectively replacing the current Monetary Policy Committee. Unlike today's complex system where central banks attempt to control money supply indirectly through interest rates and quantitative easing, the MCC would exercise direct and transparent control over money creation, making the process more straightforward and accountable.
New money would enter the economy through multiple carefully controlled channels: government spending on infrastructure and public services, strategic tax cuts to stimulate economic activity, direct payments to citizens (similar to a universal basic income), paying down national debt to improve fiscal stability, or providing targeted funds to banks specifically for lending to productive businesses. The choice between these various distribution methods would depend on the elected government's priorities and economic ideology, with the fundamental principle being that new money should reach ordinary people and the real economy rather than becoming trapped in speculative financial markets or inflating asset bubbles.
The MCC would ensure businesses have adequate access to credit through a sophisticated lending mechanism. They would provide newly created money to banks specifically earmarked for lending to businesses that contribute to GDP - such as manufacturers, service providers, and innovative startups. This targeted approach directly addresses the concerning situation in the UK where less than 10% of bank lending currently goes to GDP-contributing businesses, with the majority instead flowing into property and financial speculation. Banks would compete through transparent auctions for these funds, creating a market-driven system that incentivizes them to develop genuine expertise in business lending and proper risk assessment.
To ensure effectiveness, the MCC would implement strict monitoring systems to track how banks use these funds, with penalties for non-compliance. This approach would help reverse the decades-long trend of banks focusing primarily on mortgage lending and speculative investments, redirecting financial resources toward productive enterprise and innovation. The system would include regular reviews of lending patterns and economic impacts, allowing for adjustments to better serve the real economy's needs.
10장
The Transition to a Stable Monetary System
The transition involves two phases: an overnight "switchover" when bank deposits convert to state-issued currency, and a longer period (10-30 years) allowing for reduction in household debt and banking sector balance sheets.
Each bank's demand liabilities to individuals, businesses and public sector organizations are calculated and removed from its balance sheet. An equal amount of new state-issued currency is created and placed into the bank's Customer Funds Account. To prevent banks from receiving a windfall profit from the removal of their demand liabilities, a new liability called the "Conversion Liability" is created, owed to the Bank of England. This interest-free liability equals the value of the demand deposits removed and is repayable as the bank's assets mature.
The interest-free Conversion Liability will be repaid as banks' loans are gradually repaid, with the schedule agreed between each bank and the Bank of England. This converts the Bank of England's asset (the Conversion Liability) into electronic money, which is then transferred to the Treasury and spent back into the economy. This provides the government with 1,041 billion in seigniorage revenue over approximately 20 years, which is non-inflationary as it recycles loan repayments rather than increasing the money supply.
A profound change occurs in how loan repayments affect the money supply. In the current system, loan repayments destroy money, requiring new borrowing to maintain the money supply. In the reformed system, loan repayments simply transfer state-issued currency from borrowers to banks' Investment Pools, preserving the money supply. This allows for significant reduction in household debt without causing recession.
11장
Economic Benefits of Monetary Reform
The reformed system would reduce inequality by eliminating the need to "rent" the medium of exchange from banks. While banks would still lend and charge interest, the quantity of loans would exist independently of the money supply, likely resulting in lower gross interest payments. More stable asset prices would increase housing affordability, while fewer banking crises would eliminate costly bailouts that disproportionately affect the poor through subsequent public spending cuts.
The reforms would significantly reduce financial instability. Since bank lending would no longer increase the money supply, banks' ability to inflate asset bubbles would be severely limited. In the reformed system, asset bubbles would be naturally self-limiting. If funds for mortgage lending come from Transaction Accounts, consumer spending decreases, eventually leading to lower growth, output, and unemployment. If funds come from other Investment Accounts, productive investment falls, reducing output and employment. Both scenarios make mortgage repayment more difficult and decrease housing demand, naturally correcting price increases.
The reformed system would benefit the environment by eliminating bank-created boom-bust cycles that often lead to environmental deregulation during downturns. Fewer recessions would reduce pressure on governments to cut environmental protections or green technology investments. The directed nature of Investment Accounts would allow people to fund only environmentally responsible businesses, creating market mechanisms favoring green companies through lower funding costs. Most significantly, removing the growth imperative inherent in the current debt-based system would enable the steady-state economy favored by environmentalists.
Transaction Accounts would be the only accounts worldwide where the public could hold money directly at the central bank with zero risk of loss, regardless of amount. This would likely make the UK banking system a 'safe haven' for those wanting risk-free money storage while maintaining the convenience of modern banking services. With money creation controlled by an independent, transparent body focused on maintaining low inflation, the pound would likely be debased much more slowly than other currencies, making sterling an attractive currency to hold.
Our monetary system-being merely a collection of rules and computer systems-is relatively simple to fix once political will exists. The real challenges of the next 40 years-providing for growing population, addressing climate change, and managing scarce resources-require a monetary system that works for society rather than against it. The current system is no longer fit for purpose and must be reformed to allow us to address these pressing global issues.
