finance

Column by Adrian Kuzminski on May 11, 2018

Money Made Out Of Thin Air,
But Be Sure To Repay Lenders

You’ve got to have money to make money, the saying goes. If you have money, you can invest (or speculate) in something you hope will produce a profitable return. If you don’t have money, you’ll need to figure out where you can get some.
There are two basic options for most people: work and debt, and they usually go together. Earning money by working, by selling your manual or intellectual labor, is what most people do. But it’s usually not enough.
Most people also need to borrow money. You have to repay with interest as time goes on, but you can use the borrowed money right off the bat to invest in something you need or want, like a house, a car, an education, or a business.
The ability to borrow money is fundamental to modern societies, and is part of what makes them modern.
Until the invention of modern finance in early 18th century Britain, it was hard to borrow money. Banks were few and far between, and most loans were private affairs between individuals.

Money in circulation was largely limited to inelastic precious metals. What happened in England was the creation of a set of interlocking institutions: a central bank, national debt, stock and bond markets, and institutionalized lending. Since then, the precious metals industry has expanded and is now regarded as an investment opportunity, being involved in trading operations and much more as you can see by reading this article on an Australian company ABC Refinery. And as it started to develop, together these institutions made it far easier for private banks to issue loans to the public. These loans, which circulated as banknotes, or currency, pumped money into the economy. This was no small thing. It started the industrial revolution. The “English System” of credit, as Alexander Hamilton later called it, made it possible for English landowners and manufacturers to borrow large sums to improve their estates and industries. The British economy exploded.

The hitch was that borrowers still had to pay interest on their loans – a kind of private tax – even though the money which the private banks lent was created out of thin air.
When you borrow money, even today, say for a mortgage, the bank isn’t giving you money that it already has on deposit. Rather it’s giving you a line of credit backed almost entirely by the likelihood that you’ll repay it with interest.

The effect is to concentrate wealth in the hands of creditors. It’s tolerable for debtors as long as they remain productive enough to cover their loans and interest, and still leave a profit for themselves. A loan provides a way, not otherwise available, to appropriate new assets and put them to use.
That works as long as the economy is growing as fast as the interest rate. When loans get too far ahead of productivity, however, and can’t be repaid, we have a crash.
Up to now, crashes have weeded out the less efficient investors, and allowed the rest to restart the process. That was possible as long as opportunities for economic growth remained.
For better or worse, after a long run of 250 years, the credit-based industrial revolution may be coming to an end. We have a finite planet with finite resources, weighed down by pollution and environmental degradation, struggling to support over seven billion people.
As the rate of production decreases, it gets harder and harder individuals and governments to pay off their debts. The federal government – with its $20+ trillion debt – isn’t even trying anymore. There is increasing concern that the overall debt burden is getting too big for the economy to absorb.
In the old days, not paying debts led to insolvency and bankruptcy. More recently, government bailouts have replaced bankruptcy – provided you’re too big to fail.
In 2008, only one major company – Lehman Brothers – was allowed to go under. The other big players, from AIG to General Motors to the big banks, were bailed out. Since it was politically impossible to raise taxes, this was done by increasing the federal debt.
However the debt crisis may be resolved, the need for credit will remain.
One alternative is public banking. The idea is to lend money not for profit, as private banks do, but at little or no interest, as a public service. We need to transition to a steady-state as opposed to a growth economy, and no-interest loans might help get us there while still meeting the need to invest in our future.
But that’s another column.

Adrian Kuzminski, former Hartwick College philosopher-in-residence and Sustainable Otsego moderator, resides in Fly Creek.