Debt, Credit and Value: Could we Pay for a New Economy?

In my last article on the topic of use-value, exchange value and the carbon tax, we considered the idea of money as a form of social credit. While last week’s paper focused on the creation of value through the production of commodities, money —as a token of credit —is ultimately created outside of the process of commodity production. If money is a token of social credit, and how it is spent is a sign of what is valued, how are these tokens created, and who has control over their creation? The answers to the questions are important because they help us to understand Canada’s economy and some of the pressures that lead us to act imprudently in regards to climate change.

Canada is a “monetary sovereign,” able to issue its own currency (compare this to the situation in Europe, where the European central bank controls the currency for most member countries in the EU). As such, it can legally print (or create digitally without printing) its own money, just as a public transit commission can issue as many tokens for rides as it wants. To put this another way, the amount of social credit that is available is (in principle) controlled by the Bank of Canada vis a vis the government, vis a vis the voting public.

When the Bank of Canada (by order of the government) “deficit” spends money into circulation, it amounts to saying that there is work that needs to be done that deserves to be paid for, but which there is not currently available credit (in public hands) to do so. When the government taxes and spends, they are not actually spending the money collected (which is all virtual anyway), but rather controlling the amount of money (or credit) in circulation by first destroying some of it (through taxation).

While spending more money into circulation means each unit of credit has less value (inflation), if the additional credit is paid out in exchange for work that improves the quality of life for Canadians in an enduring way, inflation should not be a problem, even for those who save, since they will also benefit from the results of the spending.

There is also a second, much more common —but much less well known —way in which money is created (though not printed) within our economic system, which is by private (or chartered) banks. In this case, credit is given (loaned) prior to the work being done to earn it. To understand this, let’s take an example.

Mary has been working as a doctor. One day she makes a deposit in her savings account of $10,000. John is an aeroplane mechanic and he wants to invest in some new equipment. He goes to the bank and takes out a loan of $10,000. The bank takes the $10,000 from Mary’s account and gives it to John. John agrees to pay the money back with interest.

Most people —including economists —imagine the above model when they think of how banking works. They see banks as “intermediaries of loanable funds” moving money from one hand into another so that Mary’s savings fund John’s investment.

A much smaller percentage of people will tell you that bank lending works according to the “fractional reserve model.”That model states that when Mary makes a deposit at her bank, the bank keeps a fraction in reserve, and the rest can be loaned to John. When John deposits his loan (or whoever ends up with John’s money makes the deposit), that money can be loaned out again. This process gets repeated over and over, with only a fraction of each deposit kept by the banks. In this way, banks are seen as creating money through loans. This model is also known as the“money multiplier” model, as a single deposit gets multiplied through the process of issuing loans and depositing them.

Even though most economists assume the banks as intermediaries model, neither it nor the fractional reserve model are correct. Over the last few years several papers have come out from central banks (including the German Bundesbank (, and the Bank of England ( stating as much. There have also been peer-reviewed papers, which have considered each model empirically and have come to the same conclusions (for example, Richard A Werner, “A lost century in economics”).

So what does happen when a bank issues a loan? The answer is that the money loaned out is not taken from existing deposits at all, but is created through a bookkeeping entry. The bank grows the amount of money on its accounts by adding to both the liability and asset side of the ledger. To return to our example, Mary’s deposit plays no role at all in John’s loan. The money for John’s loan is created by keystroke.

Since the Brian Mulroney government, private banks in Canada are not required to keep a reserve (, but even in countries with reserve requirements, there is a time delay on meeting the requirement. If a bank creates a large number of loans (beyond what currently held reserves allow for), they can top up their reserves by making a request to the central bank within the allotted time period. The central bank cannot say no without sending the economic system into chaos. In that way the central bank serves a supporting role in the credit creation practices of the private banks.

So irregardless of reserve requirements, private banks are the predominant creators of money, and they do this through double-entry bookkeeping: i.e. by adding numbers in a computer.

If you are interested to learn more, I encourage you to follow some of the links given above. For the sake of this article what is important to note is that a) the amount of money in circulation is increased by bank loans, and so private banks have the ability to create (but not print) money; b) when debts are paid back the amount of money in circulation shrinks; and c) it is private banks, and not central banks, that have the most control over where money is being spent, i.e. on the distribution of social credit, and the determination of what is valued.

It is beyond me to say whether a better model exists or not. But one thing is clear, —as three mid-level bankers from one of Canada’s largest banks once conceded to me after an hour-long discussion —if private banks are to continue having control over where social credit flows, then they need to be more tightly regulated than they have been in recent decades. If they are not carefully regulated in accordance with values conducive to longevity, they will create money in order to inflate asset bubbles with short term returns. We will get housing bubbles, share buybacks, and other forms of market manipulation that divert investment from things like research and development, and which function nearly identically to any Ponzi scheme.

Canada has a reputation for having a very stable, well-managed banking system. However, Canadians are currently burdened with very high levels of household debt compared to their incomes ( A lot of this has to do with the price of housing, since most houses are purchased with a mortgage, and housing prices can only increase if larger and larger mortgages are issued. Since housing prices in many areas of the country have been increasing faster than wages in most sectors, debt to income levels must go up.

Is it any wonder that making the changes to our energy systems that are required to avoid catastrophe —catastrophe meaning that, as one of the fathers of climate science Dr. James Hansen recently stated, the earth becomes ungovernable in the next several decades —is met with so much trepidation and opposition? Far from the indigenous teaching that we should think in terms of seven generations, far too many of us are living precariously and thinking (and voting) only in terms of our day to day survival.

The unfortunate thing about debts —even for lenders —is that eventually, they become too large to service. This has always been the case, and many past societies regularly forgave debts in order to reset the system. In order to reset the system during the recent Great Recession, banks in the United States were bailed out instead of citizens. While a huge amount of money was created by the Federal Reserve (the U.S. central bank), very little of it was spent into the real economy. That has led to asset bubbles being re-inflated, and the economy rebounding on paper, while signs of despondence, such as drug overdoses, continue to increase dramatically. The political consequences are also currently on display.

Without pretending to have all of the answers, or all of the details made clear, I hope this article at least makes us rethink whether we have enough money to accomplish necessary, life-improving work, such as is required for Canada to lead the world in response to a changing climate. The required credit can be made to exist. During World War Two, Canada became one of the world’s largest navies, building ships rapidly; in the past, using the Bank of Canada, we have built canals, universities, highways, railroads, and other infrastructure that is now approaching the end of its life. The federal government, by properly regulating lending by private banks, removing incentives (and creating disincentives) for short term gains in the housing and other markets, and by spending effectively, could transform our economy rapidly. It is possible that Canadians could be the ones helping to build new infrastructure in other nations, where changes are also required over the coming decades.

The difference between asset price inflation, or inflation generally, is whether the return on investment is lasting and can be built upon, or whether it only results in short term gain. Whether the credit issued goes towards buying imported toys, or whether it leads to the creation of new sectors, healthier and smarter citizens, and a more just society.

Instead of a system that focuses mostly on the growth of capital, usually at the expense of the earth’s systems and the poorest people, we could refocus on the growth of minds. We could attach more credit to long term investments in the kinds of technology and public institutions that greatly improve quality of life without threatening the longevity of our civilization.

Many of these necessary changes could be brought about through relatively minor tweaks in the system. We are not talking about a political revolution, but the revolution that follows from the revaluation of values.

Leo Lepiano