'Our Crazy Money System'

In this thought-provoking, accessible book Dr Michael Reiss doesn't attempt to take on the entire edifice of neo-classical economics, instead he focuses on key shortcomings in prevailing economic theory and the consequences for the real world. As he addresses inflation, unemployment, savings and the business cycle among other topics, one thing quickly becomes clear: the single biggest culprit for our failure to address most economics problems is instability in the money supply. Either there's too much money in circulation, giving the (often false) impression of economic success, when in fact, another bust is just around the corner; or too little, after the bubble inevitably bursts and the extent of our collective self-delusion becomes painfully apparent. As Reiss says, 'it is the ballooning and shrinking of the money supply that has dominated all the major financial crises.'

He traces this back to what he calls 'Our Crazy Money System', referring to the way money is created, as debt, by privately owned banks, when they make loans to their customers. No government has had the courage to face down the bankers and tackle the problem of money supply instability by removing from them the right to create money. The recent Vickers Report into the UK banking system dodged the issue once again.

Lobbying and Leverage

There was a time, however, when governments did understand the need for bank regulation, and imposed of statutory reserve requirements. But these controls have been steadily eroded, largely at the behest of the banking lobby, so that today, as Reiss says, 'The conclusion from looking at the way reserve ratios and capital adequacy work in practice is that there is no limit at all on the amount of money that banks can create, other than their ability to find people they can lend to and make a profit from.'

And this is the crux of the matter: The objective of privately owned banks is to maximise shareholder value. That means profits, and the more money they can lend/create, the more profit they make. Reiss's solution is to move to a system of full reserve banking, the efficacy of which he describes with admirably clarity.

Perhaps the most original contribution of this book concerns the subject of investment: In some detail, but without ever becoming opaque, Reiss contrasts true investments with what he terms pseudo-investments. The former include loans to existing business for new plant and machinery, or to entrepreneurs to start a new business, or to firms needing to carry out research and development to bring new and innovative products to the marketplace. Each of these activities promises to generate additional real wealth. From this new wealth, among many other social benefits, a return is paid on the original investment.

Such investments are productive, and they include the initial purchase of shares, where by an investor hands over cash to a business in return for an ownership stake and a promise of future dividends.

In terms of both the volume of transactions and the total value, true investments make up a tiny fraction of overall investment. Most supposed investment is in pseudo-investments which generate no new wealth. Secondary dealing in company shares, much of which is speculative, is one such. The arbitrage trading of currencies, corporate and government bonds and other, less transparent, financial devices, are also pseudo-investments.

What is real?

Reiss points out that neither politicians nor bankers bother to distinguish between true investments and pseudo-investments. When deciding whom to lend money to, or which sectors of the economy to incentivise, they are considered equally valuable in economic terms. He goes onto explain how non-productive loans (ie credit extended for pseudo-investments) reduce the amount of credit available for productive purposes, and rightly laments the fact that politicians and economists, apparently in ignorance of this fact, do nothing to suppress non-productive lending.

Reiss also casts his common-sense eye over the looming pensions crisis. It's hardly surprising that we can't generate a collective pension pot sufficient to cover the retirement needs of an ageing population, especially as the conventional means for doing this is either to raise money through a tax system where the burden falls increasingly on those who earn the least; or by investing private savings in non-productive pseudo-investments. It doesn't take Reiss long to conclude that the only sensible way to provide pensions is through a system that obliges us all to save a basic amount for retirement, and to top this up by a levy on those currently in work.

Immense Common Sense

In his chapter on land ownership and housing, Reiss offers some powerful insights into the relationship between land values (and therefore house prices), the money supply, and the means – fractional reserve banking – by which money is created. These insights are so important that I can't do them justice in this review, but I hope to return to the subject in a subsequent post.

'What went wrong with economics' answers it's own question with clarity, reason and immense common sense. It reminds us that as a tool to guide decisions about how society should be arranged, economics is useless without a moral dimension. This book is required reading for anyone who would like to see a radically different economic system replace the current, confused mess. Michael Reiss has made a great contribution the debate about economic renewal, and his timing could not have been better.

You can purchase the book here via Amazon What Went Wrong with Economics - The flawed assumptions that led economists astray >>

Michael Reiss will be a guest Renegade Economist correspondent in the coming weeks.