Investigating_Money_Mechanics_for_Sustai.pdf - Investigating Money Mechanics for Sustainable Economic Development EXECUTIVE SUMMARY The economic crisis

Investigating_Money_Mechanics_for_Sustai.pdf -...

This preview shows page 1 out of 205 pages.

You've reached the end of your free preview.

Want to read all 205 pages?

Unformatted text preview: Investigating Money Mechanics for Sustainable Economic Development EXECUTIVE SUMMARY The economic crisis that started in 2007 draws new attention to the financialization of the economy and in particular to the concept of debt. Simultaneously, rising energy and commodity prices are yet another indication for concern about a growing population, emissions and resource exploitation that is burdening the Earth. Those researchers that bring these two trends together claim that it is in particular the nature of the money system that hinders or even prevents sustainable development by causing an inherent tendency towards inequality, a growth imperative, and an unsustainable debt burden. This thesis aims to evaluate these claims. It provides an extensive overview and analysis of the relevant literature, followed by the application of economist Steve Keen’s model of the role of money in a simple credit economy. It is used to test whether the money system is viable and/or has inherent mechanisms that hinder sustainable development. Both methods aim to be a springboard from which further research can be undertaken as this remains a topic alive with uncertainty. Part I considers the concept of ‘sustainable development’. A clear definition is needed before analyzing the effects that the money system has on it. Three pillars are outlined: human, environmental, and economic sustainability. Empirical evidence reveals negative trends in each of the pillars – a cause for concern. Economic inequality is found to be a reasonable indicator of human sustainability, the existence of a growth imperative is shown to reflect a lack of environmental sustainability, and economic sustainability is defined as an efficient and resilient economy. Part II introduces money and the money system. Again, a definition is formed, followed by a literature review on the origins of money. Money has always been somebody’s debt. Debt incurred by various parties: individuals, religious institutions, and the State has circulated and been saved as money. Economic thought however has allocated changing roles to money: from money neutrality (no effect on the economy) to the view that it has significant economic effects because of its flipside – credit. Debt and credit are sides of the same coin, enabling investment and economic growth as well as inflation and asset price bubbles. There remains a controversy between the ‘new’ school of thought concerning money that explicitly judges money as endogenously created commercial bank debt, and the ‘old’ school that adheres to the traditional fractional reserve multiplier model of money (creation). The ‘new’ view, adhered to by Post-Keynesians amongst others, is found to explain the economic events of the past decades better. It implies, however, that there is less public control over the money supply than traditionally thought, that the entire money supply is interest-bearing bank debt which is associated with short-termism, and, that it is in the interest of individual banks to concentrate, thus reducing the level of competition in the sector. Part III applies the mentioned model, which incorporates the ‘new’ view with a simple model economy. It reveals that the money system is viable and does not impose a growth imperative. However, it does have inherent tendencies towards a growing debt burden and the associated economic growth or inflation because it facilitates private incentives to borrow in expectation of higher future capital income more easily. While the resulting economic growth has negative effects on the environment (Part I), the model also reveals that this is not economically sustainable as in the long-run the growing debt burden becomes unserviceable. This collapse is associated with rising unemployment and a growing share of income allocated to banks arguably making it socially unsustainable as well. In the model, it can be avoided if a portion of the money supply does not originate from bank loans (‘bank debt free’ money), if there is more competition in the banking sector (lower interest margins), lower levels of investment (investment is partly debt financed), or if a steady-state economy is imposed (no population or labor productivity growth). In sum, whilst I find no mechanical tendencies in the money system that hinder sustainable development, it is a system that, given individual incentives and lack of appropriate government intervention, favors short-term private interests over long-term society-wide progress. This stimulates a concentration of economic control, that sits uncomfortably with most definitions of sustainable development. 3 TABLE OF CONTENTS INTRODUCTION CHAPTER I – INTRODUCTION ........................................................................................................................... 5 CHAPTER II – METHODOLOGY .........................................................................................................................14 REFERENCES....................................................................................................................................................16 PART I - A SUSTAINABLE WORLD? CHAPTER III – PILLAR 1 : HUMAN SUSTAINABILITY ..........................................................................................21 CHAPTER IV – PILLAR 2 : ENVIRONMENTAL SUSTAINABILITY ..........................................................................29 CHAPTER V – PILLAR 3 : ECONOMIC SUSTAINABILITY......................................................................................40 REFERENCES ....................................................................................................................................................51 PART II - MONEY AND ITS CREATION CHAPTER VI – DEFINING MONEY.....................................................................................................................57 CHAPTER VII – THE HISTORICAL ORIGINS OF MONEY ......................................................................................61 CHAPTER VIII – DEVELOPMENT OF ECONOMIC THEORY, THOUGHT, AND MODELS OF MONEY ......................77 CHAPTER IX – THE CURRENT MONEY SYSTEM ...............................................................................................100 REFERENCES ..................................................................................................................................................138 PART III - MONEY AND SUSTAINABILITY: A MODEL CHAPTER X – THE ‘VAULT’ MODEL ................................................................................................................149 CHAPTER XI – A CYCLICAL MODEL OF THE ECONOMY ...................................................................................162 REFERENCES ..................................................................................................................................................189 SUMMARY, CONCLUSIONS AND DISCUSSION SUMMARY, CONCLUSIONS AND DISCUSSION ……………………………………………………………………………………….…. 191 REFERENCES ..................................................................................................................................................202 GLOSSARY .....................................................................................................................................................203 RECOMMENDED READING ............................................................................................................................206 4 CHA PTE R I – I NTRODUCTI ON Global society is facing three very distinct but closely related crises: a financial crisis, an environmental crisis, and an energy crisis. Despite the popularity of threatening books such as The Limits to Growth (Meadows, 1972) and Our Common Future (WCED, 1987), advocates of sustainability over the past century have not succeeded in developing a sustainable society. A quick look at historical statistics reveals a still growing stock of debt in the UK, and a growing global population, carbon dioxide emissions, and (non-renewable) energy use (Figure 1). 1000 UK Public Net Debt (£ billion 2005) 500 10000 6 5000 3 0 1820 1900 1980 Chantrill (2012) Global energy use Global CO2 Emissions (million tons of C) Global Population (millions) 0 1820 1900 1980 Maddison (2008) 0 1820 1900 1980 CDIAC (2011) The Oil Drum (2012) Figure 1. Unsustainable Trends in Society. This introduction commences with a definition of sustainable development, followed by empirical evidence that reveals a lack of a sustainable economy and society. From this broad perspective, I delve into the money system, to be interpreted as what money is in our current economy, and how it is brought into circulation. An overview of research investigating the relationship between our money system and sustainability presents the research context within which this thesis finds itself. Finally, an outline of the chapters to come, together with the basic approach applied provides more detail on the basic structure of the thesis: 1. Sustainable development; 2. The money system; 3. The relationship between the money system and sustainable development. 1.1. Sustainable development. Roosevelt in 1910 already stated that “the nation behaves well if it treats the natural resources which it must turn over to the next generation increased, and not impaired, in value” (Roosevelt, 1910). This requires keeping the total value of capital intact, similar to the definition of income by Hicks (1939) where income is what you can spend this month if you keep the same amount of spending next month. Sustainability is most commonly defined as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs” (WCED, 1987). In this thesis, I will adhere to this definition of sustainable development. It implies equity, fairness, and social coherence in the form of a just distribution of resources and opportunities across space and time. However, in addition to this internal sustainability, the definition also requires external sustainability: we must live within ecological bounds and at the same time build up an efficient and resilient society to be able to remain within these natural limits. It requires a stabilization of the natural and human system, as opposed to an overshoot and collapse. One can 5 characterize such a societal lifestyle as one in which there is ‘human dignity’ (van Egmond and de Vries, 2011). History, however, reveals society is characterized by great instability with yearly economic or financial crises across the world (Reinhart and Rogoff, 2008). The recent events of the 2007-200? financial crisis have exposed the related exorbitant gains for some, and vast losses for others – across geographic boundaries, population groups, and generations. One can fairly say that even current needs cannot be met as homes are foreclosed and unemployment rises. Figure 2 gives an indication of the increase in unemployment associated with a variety of past crises. Figure 2. Increase in Unemployment During Selected Crises (Lietaer et al., 2012). Unemployment increases on average by about 7% during a financial or economic crisis. Some crises will be more severe than others, and some localities will be hit harder than others. For comparison, the current crisis has increased the unemployment rate in the UK from about 5.5% to about 8.5%, a rise of 3% (ONS, 2012). In the United States (US), the rate increased by about five percentage points from 2007 to the peak of the crisis in 2009 (BLS, 2013). Compared to Figure 2 this is below average, and yet it has caused political turmoil and uncertainty. Crises also increase poverty levels, result in a loss of output, and increase public debt as well as taxpayer costs (Lietaer et al., 2012). Currently, Europe and the US are experiencing increased poverty, a drop in bank lending, falling house prices, and stagnating economic growth (European Commission, 2009). 6 Table 1 shows the output losses, public debt increase, and fiscal costs associated with past financial/ economic crises. Direct Fiscal Cost Increase in Public Debt Output Losses Medians (% of GDP) Old Crises (1970-2006) Advanced economies Emerging markets All 3.7 11.5 10.0 36.2 12.7 16.3 32.9 29.4 19.5 New Crises* (2007-2009) Advanced economies 5.9 25.1 24.8 Other economies 4.8 23.9 4.7 All 4.9 23.9 24.5 * Includes Austria, Belgium, Denmark, Germany, Iceland, Ireland, Latvia, Luxembourg, Mongolia, Netherlands, Ukraine, United Kingdom and United States. Table 1. Direct Fiscal Costs, Increase in Public Debt, and Output Losses Due to Selected Crises (Laeven and Valencia, 2010). Note that the ‘new crises’ denoted in the table do not yet consider the latest data, and therefore the direct fiscal costs, increase in public debt and output losses will be different than presented here. Also, ‘All’ includes more than the advanced and emerging market economies, these are there for individual illustration. We already see higher direct fiscal costs for advanced economies in the recent crisis than past crises. The increase in public debt given here for the new crises in advanced economies is lower than the old crisis, but a better judgment of this requires newer data that considers the full costs of the public interventions in the financial sector that have occurred recently. Furthermore, as also revealed in the unemployment statistics above, output losses until 2009 were not as dramatic as in previous crises. Ultimately, a full analysis of this however can only be done once the crisis is over. Nevertheless, there are clear negative effects of financial and economic crises. In terms of the state of the planet, we see the crisis has resulted in greater investments in natural resource based commodities (Buiter, 2007; Buscher, 2011) such as oil and grain, as investors shy away from traditional financial products when a recession hits and rather invest in commodities (Gorton and Rouwenhorst, 2006). The buildup of debt indicated optimism that future economic growth could continue unchecked despite various natural resource ‘peaks’ being reached. The economy did indeed continue to prosper for the largest portion of recent decades. Economists such as Romer (1986) applied endogenous growth models to try to explain the rising growth rates of developed countries and lack of convergence to a steady-state growth rate that Solow (1956) had predicted. However, in a finite world with imperfect substitutability between natural, human and physical capital, a belief that this material growth can continue forever is not sustainable (Daly, 1977). And in a credit economy, such as the one that exists today, it is uncertain whether debt buildups are avoidable, and whether an economy with controlled growth is possible. Meanwhile, the International Energy Agency (2011) has estimated that globally about US$1 trillion is estimated to be needed per year until 2035 to make the transition to a more renewable and secure energy system. This global change will involve high-risk projects with much uncertainty and of which the benefits often only materialize in the long-term. The financial sector plays a critical role in these decisions, and before one can attempt to steer society in a more sustainable direction, it is important to ensure the foundation is strong, efficient, and neutral. Otherwise, we may be trying to ‘row 7 upstream’. So far, the current crisis has revealed that when the financial sector is in bad shape, and not geared towards sustainability, society follows. This motivates the investigation into what influence our financial system has on the (im)possibility to develop sustainably. In this thesis I focus this one step further, from the financial system to a very specific and fundamental part of it: its role in creating our money supply. Although we will see in later chapters that the sector’s role in money creation influences their capability to do the following, this is distinct from an analysis of the nature of the investment decisions and credit allocation function of the financial sector. 1.2. The money system. I interpret ‘the money system’ as the form that money takes, and the way it is brought in to circulation. The standard approach to this system, as discussed in almost all economic textbooks, is that central banks control the money supply by means of their base money, which banks can expand by means of the money multiplier model (Mishkin, 2009). However, new arguments claim money is based on credit, created by commercial banks and brought into the economy endogenously at the demand of the market (Wray, 1998). A greater demand for money hereby increases credit, of which debt is the flip-side. This strand of thought judges the money we utilize on a day to day basis, as bank debt, and thus for almost every Pound, Euro, or Dollar in existence someone has to go into debt with a bank. We will see that money as debt is nothing new, but that in the evolution of this form of money, the banking system has gained an increasingly important role in our payments system as compared to the State. In this process, it has also become more relevant for sustainability because of its role in deciding where new money (purchasing power) enters the current economic system first. 1.3. Transmission mechanisms linking our money system to sustainable development. A number of different negative effects that our money system may have on society and sustainable development exist. These are considered as transmission mechanisms between the nature of money and (un)sustainable development. The number of transmission mechanisms has not been established beforehand; the goal of this research is to determine these. I present here some initial channels of influence that have been proposed by other researchers to provide an initial context for this thesis. These will be organized and consolidated afterwards, and investigated in Part III of this thesis. Understanding what money is today and its effects on society is not straightforward. There are various debates occurring at the moment surrounding this subject: politically, academically, in the media, and also in more popular or unorthodox circles (see for example the documentaries Money as Debt, the Money Masters, and Zeitgeist). This has historically also been the case, especially in the US where the struggle over who controls the money supply has been an ongoing affair since the nation’s inception (see Zarlenga, 2002 for more). Today, think-tanks across the world such as the British New Economics Foundation and Positive Money, the Dutch Economy Transformers, and American Monetary Institute, attempt to illustrate how the modern money system is fraught with mechanisms which prevent sustainable development. Individuals from a broad spectrum of disciplines have similarly presented their conviction that our money system hinders sustainability: Lietaer (2001) in The Future of Money, Creutz (2010) in The Money Syndrome, Martenson (2011) in his crash course on the subject, and Robertson (2012) in Future Money. The importance of money in our society makes this a natural result, especially during times of crisis. The role of the financial sector in the recent crisis has turned the spotlight on the workings of this industry, and their main medium – money. The lack of agreement and clarity in the academic literature on the various elements of the money 8 system has also enhanced public suspicions. When people started asking questions and bankers, politicians and academic could not answer, protestors took to the streets. The main theory upon which most of the following arguments are based is that the current money supply is created for the largest part by commercial banks, as bank debt. This will be considered in depth in Part II. Research in this direction has been strongly influenced by Post-Keynesian theory (Moore, 1979; Wray, 1998; Godley, 1999; Keen, 19...
View Full Document

  • Summer '20
  • Dr joseph
  • Economics, Monetary economics

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

Stuck? We have tutors online 24/7 who can help you get unstuck.
A+ icon
Ask Expert Tutors You can ask You can ask You can ask (will expire )
Answers in as fast as 15 minutes