Should we change the way money is created?
The so-called ‘magic money tree’ was a hot topic of discussion in the build-up to June’s General Election. If politics isn’t for you, then the expression ‘money doesn’t grow on trees’ may have more resonance. Either way, it implies that money cannot simply be created from thin air.
Yet while this may be true at individual or household level, in reality money is created every day. And lots of it, too.
How is money created?
Banks issue loans to consumers and businesses, but are not actually required to have the specified amount in cash. If they determine that you are creditworthy, they simply punch a few numbers into your account, and, with the help of the central bank, the money is created! And it’s all yours too – at a cost.
The key is that the level of savings deposits in a bank have little bearing on the level of money which is actually out on loan, provided the bank operates within seemingly lenient capital ratios. This type of money creation is also known as fractional-reserve banking, and the degree to which it occurs is starkly illustrated by estimates from the not-for-profit organisation Positive Money that approximately 97 per cent of money circulating in the UK economy is created by banks issuing loans.
In a recent article in This is Money, the organisation explains why they think this is a deeply flawed system, which needs radical change. With money creation as their primary tool, it is very much in the interests of banks (and their shareholders) for the amount lent to exceed deposits within their institution by as big a margin as possible, as it allows them to maximise interest earnings. On the face of it, it seems to be a good result for the debtor too: they receive a loan or a mortgage to complete their relevant purchase.
However, excessive money creation, by definition, also increases debt, and often, as history has shown, unsustainably so. An excellent example of this is the 2008 financial crisis; the biggest underlying cause of which was reckless lending and over-leveraging on the part of banks. Taxpayers paid a hefty price with the resultant bailout, and many continue to suffer the ramifications of the recession today.
Bringing money creation 'in-house'
Positive Money's proposed solution? Quite simply, to take the power of money creation away from the banks (and the central bank), and instead hand it over to the State. The consensus among participants in the organisation is that, instead of channelling money towards banks and financial markets, such an approach could instead see money injected into the system to help people pay down their debts, rather than fuel them.
At a wider level, State-controlled, or 'sovereign' money creation could also help to right many other wrongs in society. For example, it is not in the interests of banks to create money for things like preservation of the environment, or assisting with mental health. However, sovereign money could allow investment in initiatives which aren't profitable, thus benefiting society as a whole.
Added to that, sovereign money could also address issues such as inequality (by providing a steady income to the poorest individuals in the UK), be invested in the housing market, bring stability to the banking system, and potentially even end the cycle of boom and bust.
Is sovereign money creation viable?
While such a 'panacea' to society's ills is enticing, there would undoubtedly be counter arguments and ramifications of implementing such an approach to money creation - far beyond the scope of a single blog post. Within the confines of Westminster, Positive Money's brainchild hasn't achieved any real traction as of yet. And the prospect of such an overhaul of the financial system happening in the UK anytime soon appears fanciful, to say the least.
So, is this concept simply one for the waste bin then? Some intelligent economists think not, and with inequality on the rise, wages being squeezed, and frustration brewing among a generation struggling to get onto the housing ladder, there is growing unrest with the status quo. It may thus not take much more than another recession to move the needle of public opinion, and thrust ideas such as State money creation into the spotlight.
‘Money is a manmade construct,' observed Rachel Oliver of Positive Money. 'So it doesn’t make sense that it doesn’t work for so many people. Surely there is another way?’
Whatever your musings on the concept, it certainly provides some interesting food for thought.
Is money created in peer-to-peer lending?
One of the many virtues of peer-to-peer lending is that there is no money creation involved. Every pound lent and borrowed is 100 per cent real, and matched on a one-to-one basis. While this naturally applies a bit of a handbrake on the potential profitability of an individual peer-to-peer lending platform, it provides peace of mind to the public that our sector, by definition, does not contribute to the so-called boom and bust cycle.
Of course, that’s not to say that peer-to-peer lending can’t be affected by economic ups and downs. But the industry itself doesn’t add any fuel to the fire, and instead allows consumers to invest money or take out a loan in an efficient, sustainable way. A model for a stable, secure economic future? We’ll leave that to you to decide…
The 2019 ISA season is now in full swing, and it's as good a time as any to focus on financial planning - and, within that, looking ahead to your retirement years to ensure financial security.
The Lifetime ISA (LISA), announced in 2016, would prove to be one of George Osborne’s last flagship gestures to UK savers and investors as Chancellor, eventually launching against a backdrop of anti-climax a year later in April 2017.
Over the last decade, there can be little dispute that the reputation of mainstream banks – and particularly the so-called ‘Big Four’ (HSBC, Barclays, Lloyds and RBS) – is at its lowest ebb.
The peer-to-peer (P2P) lending industry is now regulated by the Financial Conduct Authority (FCA). The regulatory framework has been designed to protect customers and promote effective competition.
Loan underwriting is the process that we undertake to analyse all of the information provided by each loan applicant and their credit file to assess whether or not that applicant meets our minimum loan criteria. As part of that process all data is verified, analysed and summarised to paint a picture of each applicant.
When you earn interest from a regular bank savings account, for example, the bank automatically deducts basic rate tax (currently 20%) before paying your interest. With interest earned from peer-to-peer lending, tax is not deducted automatically so lenders will need to declare their income to HMRC.
As 2018 draws to a close, with our bellies full of Christmas turkey, it's only natural to look back on the past 12 months and reflect. No doubt, it's been a turbulent one economically and politically, and not everyone has had it all their own way.