In Icelandic banks refused extensions on loans, Tom Bawden reports that:

ICELAND’S three biggest banks had their finances called into question last night, after US institutions refused to extend some of their loans to the banks. A group of US insurers and mutual funds yesterday decided not to roll over $600 million of so-called short-term extendable notes they had made to Kaupthing, the icelandic bank.

Just a bank with a few cash flow problems you might say. Right. But there are some messages for all of us in this about how money is created and circulates and who holds real power in the world as a result. For example:

Richard Thomas, an analyst at Merrill Lynch, said: “We are seeing the classic signs of an overleveraged banking system and this has flashed a red alarm signal. The banks are extremely vulnerable and it is clear that the sentiment is shifting against them.”
Iceland’s biggest banks have grown so fast in the past three years that the loans they have made are now three times as great as their deposits, Mr Thomas said. A solid European bank would typically have a loan value of between one and 1½ times its deposits, he said.

Well, he would say that, wouldn't he. He wants to give the common impression that the banking system is balanced. We are always told that banks don't create money, they just move it around, balancing people with spare money with those in need of it to make investments. I hesitate to give anyone from the "great" Merrill Lynch a lesson in banking but he ought to know how banking started and how the system continues today to hide a massive fraud that affects every single one of us, indebted or not.

The original banks in the western financial system were goldsmiths. Our cash was in the form of precious metals, primarily gold and silver. But it's pretty inconvenient stuff. People wanted a way of spending what they had without having to lug around gold and silver. So the goldsmiths used to store the gold for their customers and give them a slip of paper (a bank note, if you will) that told someone they were going to trade with that they could collect the gold when they wanted from such and such a goldsmith.

The goldsmiths found that these bits of paper themselves were traded without anyone ever coming to redeem the notes for the underlying gold. So they worked out that they could make some money themselves on this by lending another customer the rights to the gold already in their coffers and charge them a little, interest, for doing so. But the notes were no different. You wouldn't know by accepting such a note in payment whether the person paying you had actually deposited any gold at the bank concerned or whether they were just borrowing the "right" to use it - from the goldsmith of course, not the person who actually had deposited the gold in the first place.

This system did occasionally get out of hand and runs on banks occurred when people thought that the bank concerned had "inflated" the amount of paper in circulation beyond what their gold deposits could really stand.

So, you might ask, how is this relevant today when Mr Thomas tells us that normally a bank will only lend one to one and a half times what it has in deposits? And moreover, our money is no longer backed with gold, or anything else. The fiver in your hand may say "I promise to pay the bearer on demand the sum of five pounds Sterling" but what would you expect to get if you demanded it? Gold? No. You'd get another fiver. Our monetary base is no longer based on gold but on the economic activity, the credit, of the nation and its citizens. That fiver is the "gold" of today. The entire basis of our money supply is just a quantity of paper worked out by the Bank of England.

On Mr Thomas's claim then, we know that just the mortgage sector of personal lending accounts for £974.6bn as of January 2006 (source, Credit Action). So all of that has real deposits backing it up does it? Far, far from it. How much "real cash" is there in the system? It turns out that there is just £43.5bn as of December 2005 (source Bank of England Statistical Release Dec 2005).

So, whilst Mr Thomas might rightly claim that banks' balance sheets do nearly balance (of course they should being BALANCE sheets), it's nearly all "money" they have themselves created in the commercial banking system that actually has no backing in hard cash.

So what, you may ask? Well, as we have been told for at least two decades now and known in the back of our minds for much longer, too much money creates inflation. So what are we doing allowing the banking system to take £44bn and turn it into the £1.5 trillion of debt that lubricates our ability to trade? That £44bn created by the Bank of England costs only the cost of production to create - the ink, the paper, the coin dies, the non-precious metal, the distribution costs. But think what it costs to borrow money. 5% ANNUALLY of the outstanding balance, and often far more - the unsecured personal lending outstanding of £193.2bn is mostly credit cards, and averages 15% ANNUALLY.

If you buy something from a firm that borrowed money to manufacture it, not only are you paying for the wages and materials and other "hard" inputs that went into creating it for you, but that firm also has to cover its borrowing costs. If you borrow to buy something now and pay later you have to earn that much more in coming years to pay it back, and often as not you're going to have to replace it before you finish paying for it!

So, it is the process of creating most of our money by the commercial banks and lending it out at interest that increases the money supply, causing inflation and making it necessary to chase economic growth to suck in more money in order to pay off the interest on the whole money supply.

Is there an answer? It hasn't always been this way has it? Well, no, it hasn't. In terms of the proportions of free money against interest bearing artificial money at least. In the sixties about 20% of our total money supply in the UK was created by the Bank of England, free of interest, against the credit of the nation and its citizens. Now it is less than 3%. The annual interest bill born by the citizens now in all forms exceeds the government's capital spending plans per year.

There's no need for any legislation. Just the political balls to start restricting the banks' ability to create new money through increased operational deposits (all that is left of the old "fractional reserve" system) and introduce appropriate amounts of new, interest free money, into the system, probably by capital investment in state provided supply side projects - schools, hospitals, transport networks and even "good causes". At the same time we could massively cut taxation and completely eliminate the national debt.

Whether you are an economist or not, I would urge you to go do some reading:

James Robertson and Joseph Huber's "Creating New Money" is available online from the New Economics Foundation.
Michael Rowbotham's "Grip of Death: A study of modern money, debt slavery and destructive economics" is a very readable primer, and
Bernard Lietaer's "The Future of Money" gives a more detailed look at the implementation of different solutions.
And if you don't believe me about how money is created and want to hear it from a real economist, John Kenneth Galbraith wrote a good book on the subject in which he debunks lots of the myths that economists and bankers continue to promulgate in order to confuse right-thinking people into believing that they do not perpetrate the most egregious fraud and counterfeit called "Money, Whence it Came, Where it Went"

And in the meantime, all this monetary revolutionary can hope is that for the sake of all of mankind, and the future of the planet in general, a reasonably well thought of, western, sophisticated economy can have a banking crisis that brings these issues more to the fore. Iceland has the wherewithal to deal with it I am sure. They could even create credit on the basis of the natural energy wealth they have bubbling up through their streets and hillsides.

The alternative is more unsustainable growth, more pain for indebted individuals unwittingly participating in the greatest fraud in history because it is literally the only way to survive in this screwed up monetary system. And continued unaccountable unrepresentative power going to the owners of the commercial banking system.