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Diamid – The Production of Money: How to Break the Power of Bankers – by Ann Pettifor

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An interesting article on Ann Pettifor's book, The Production of Money: How to Break the Power of the Bankers  Ann Pettifor is a director of Prime Economics, which advocates for a more Keynesian view of macroeconomics, and has been involved in development and environmental economics for many years. In The Production of Money: How to Break the Power of the Bankers (Verso, 2017) she correctly identifies that ‘money enables us to do what we can within our limited natural and human resources’, and so ‘creates economic activity’ rather than being a result of it. It does this by creating the finance needed for productive employment and investment. Bank finance ensures that there is never a ‘shortage of money’ and so we are only limited by humanity’s capacity and the physical ecosystem. Yet

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An interesting article on Ann Pettifor's book, The Production of Money: How to Break the Power of the Bankers 
Ann Pettifor is a director of Prime Economics, which advocates for a more Keynesian view of macroeconomics, and has been involved in development and environmental economics for many years. In The Production of Money: How to Break the Power of the Bankers (Verso, 2017) she correctly identifies that ‘money enables us to do what we can within our limited natural and human resources’, and so ‘creates economic activity’ rather than being a result of it. It does this by creating the finance needed for productive employment and investment. Bank finance ensures that there is never a ‘shortage of money’ and so we are only limited by humanity’s capacity and the physical ecosystem. Yet when 95% of the money in existence has been created by the commercial banking system, whose aim (quoting Michael Hudson) ‘is not to minimise the cost of roads, electric power, transportation, water or education, but to maximise what can be charged as monopoly rent’, this power must be rigorously regulated. So much should be uncontroversial today and I have written about this here.

The second main part of Pettifor’s argument is that because money is a social construct, then so are interest rates. ‘Savings are not necessary to fund purchases or investment’ because banks can create money along with debt. Saving in the sense of obtaining a financial claim, whether a banknote, deposit, bond or share, always requires the prior issue of a debt from a process that involves time – an investment. The saving flow is a consequence of the investment flow rather than the reverse. This financial sense of saving is contrasted with the physical sense of saving a commodity for later use rather than consuming it now. If saving follows automatically from investment, interest rates do not derive from a supply and demand nexus for savings and investment but from the costs of issuing the debt that sets the whole process off.
But Diamid has some criticisms of Ann Pettifor's book -
I find some issue with her discussion of interest rates. Since ‘credit is essentially a free good’ if prior savings are not required, then interest rates charged to borrowers are ‘socially constructed’ just as money is, she argues. Yet this seems incorrect – banks may not be providing a scarce commodity when they create money, but they are providing a service for which the required resources such as monitoring attention, the capacity to make good the losses of debt default and the infrastructure required to attract deposits are all limited. Even if access to central bank reserves is cheap, the cost of acquiring these and other resources needs to be set off against the interest rate revenue received. The puzzle then becomes why banks have so often miscalculated the default risk element of their lending costs – an element which has no direct connection to the level of the bank rate. Interestingly the critique of the free-market Austrian school of economists, while ignorant of the workings of the finance system and mistakenly clinging to the idea that there is a ‘natural’ rate of interest that matches supply and demand for savings, also blame interest rates for the Great Financial Crisis. In their case, however, they believe that central banks set rates too low in the run-up – creating a demand for investment that exceeded the savings available. But the same critique applies – the cost of reserves alters the potential gains on a risky loan, but should not make the calculation of that risk more prone to error.
Another doubtful issue raised by Pettifor is the apparent exponential nature of debt growth linked to the compounding of interest. Interest only compounds if it is unpaid. If it is paid as it comes due it is recirculated as purchasing power by the recipient bank. A loan created where compounding is anticipated is recklessly risky for both parties – why should it be contemplated under normal business incentives? A productive loan (and this may mean various things, including the welfare benefit of time-shifted consumption) creates an income flow that exceeds outlay, allowing profit for the borrower and interest revenue for the lender along with debt repayment. There is no inevitability of the exponential rise in debt – it is not driven intrinsically by the way money and credit are created by banks.



Mike Norman
Mike Norman is an economist and veteran trader whose career has spanned over 30 years on Wall Street. He is a former member and trader on the CME, NYMEX, COMEX and NYFE and he managed money for one of the largest hedge funds and ran a prop trading desk for Credit Suisse.

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