ON THE CRISIS OF GLOBAL CAPITALISM by Dr. Ellen Brown
THE GLOBAL FINANCIAL MELTDOWN:
CAUSES AND CURES
Ellen Hodgson Brown, J.D.
IBON Europe Conference, January 30, 2009
The global financial system is in crisis, but the problem is not with the earth or its resources. The problem is in the banking system itself. The banking system is collapsing because it can no longer cover up the shell game it has played for three centuries with other people’s money. Controlled collapse, however, is not necessarily a bad thing. The old corrupt system must come down before it can be replaced with something new. The good news is that violent revolution has not been necessary to bring it down. The old is collapsing of its own weight. Violent revolution has not been necessary to bring it down, but violent revolution may well be the result if the old system is not quickly replaced with something better; and that is why conferences like this one are so important. There is a better solution to our monetary ills than throwing billions of taxpayer dollars at the banks.
Politicians and bankers are frantically scrambling to bail out the private banking system, because they believe that without the bankers’ credit, the wheels of the economy would stop turning. But credit is just an accounting system, a means of drawing against future productivity. We don’t need the credit of private banks. Sovereign governments can create their own.
To understand the real cause of the credit crisis and how it can be reversed, we first need to understand credit itself – what it is, where it comes from, and what the real tourniquet is that has limited its flow. Banks actually create credit; and if private banks can do it, so could public banks or public treasuries. The current crisis is not one of “liquidity” but of “solvency.” It has been caused, not by the banks’ inability to get credit (something they can create with accounting entries), but by their inability to meet the capital requirement imposed by the Bank for International Settlements, the private foreign head of the international banking system. That inability, in turn, has been caused by the derivatives virus; and only a few big banks are seriously infected with it. By bailing out these banks, governments are actually spreading the virus, by furnishing the funds for them to take over smaller regional banks.
A more effective alternative than trying to patch up the hopelessly imperiled derivatives positions of these few big banks would be to simply create another credit system with a pristine set of books. We don’t need to fix the bankers’ disease; we can bypass the whole problem and create a new, healthy, parallel system. A network of public banks could create “credit” just as private banks do now. This credit could be extended at low interest rates to consumers and at very low interest to local governments, drastically reducing the cost of public projects by reducing the cost of funding them.
Today in the United States, as in most other countries, the only money issued by the government consists of coins. Federal Reserve Notes (or dollar bills) are issued by the Federal Reserve (or “Fed”) – the nation’s central bank. The Fed then lends these dollars to the government and to commercial banks. Coins and Federal Reserve Notes together, however, compose less than 3 percent of the U.S. money supply. The rest is created by commercial banks as loans. They do this by something called double-entry bookkeeping: the borrower’s promissory note is simply credited as a deposit to the borrower’s account and offset with a matching liability on the bank’s side of its books.
The notion that virtually all of our money has been created by private banks is so foreign to what we have been taught that it can be difficult to grasp, but many reputable authorities have attested to it, including the Federal Reserve itself. The Chicago Federal Reserve wrote in a publication called Modern Money Mechanics:
“Of course, [commercial banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.”
Graham Towers was Governor of the Bank of Canada from 1935 to 1955. He acknowledged:
“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created -- brand new money.”
Sir Josiah Stamp was governor of the Bank of England and the second richest man in Britain in the 1920s. He declared in 1927:
“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in inequity and born in sin . . . . Bankers own the earth. Take it away from them but leave them the power to create money, and, with a flick of a pen, they will create enough money to buy it back again. . . . Take this great power away from them and all great fortunes like mine will disappear, for then this would be a better and happier world to live in. . . . But, if you want to continue to be the slaves of bankers and pay the cost of your own slavery, then let bankers continue to create money and control credit.”
Among other problems with this system of money creation is that banks create the principal but not the interest necessary to pay back their loans; and that is where the pyramid scheme comes in. Since loans from the Federal Reserve or commercial banks are the only source of new money in the economy, additional borrowers must continually be found to take out new loans to expand the money supply, in order to pay the interest skimmed off the top by the bankers. New debt-based money fans rising asset prices called “bubbles,” which expand until they “pop.” New bubbles are then devised, until no more borrowers can be found and the pyramid finally collapses.
In effect, our private international banking system is a pyramid scheme; and it is collapsing of its own weight for the simple reason that it has reached its mathematical limits. Economic collapse has been the predictable end of all pyramid schemes ever since the Mississippi bubble of the eighteenth century.
A pyramid scheme is an investment scheme in which earlier players are paid with the money of later players, until no more unwary investors are available to be sucked in at the bottom and the pyramid collapses, leaving the last investors holding the bag. Our economic pyramid scheme is called “fractional reserve” lending, and it dates back to Oliver Cromwell’s revolt in seventeenth century England. Before that, the power to issue money was the sovereign right of the King, and for anyone else to do it was considered treason. But Cromwell did not have access to this money-creating power. He had to borrow from foreign moneylenders to fund his revolt; and they agreed to lend only on condition that they be allowed to return to England, from where they had been driven centuries earlier.
In 1694, the Bank of England was chartered to a group of private moneylenders, who were allowed to print banknotes and lend them to the government at interest; and these private banknotes became the national money supply. They were ostensibly backed by gold; but under the fractional-reserve lending scheme, the amount of gold kept in “reserve” was only a fraction of the value of the notes actually printed and lent. This practice grew out of the goldsmiths’ discovery that customers who left their gold and silver for safekeeping would come for it only about 10 percent of the time. Thus ten paper banknotes “backed” by a pound of silver could safely be printed and lent for every pound of silver the goldsmiths held in reserve. Nine of the notes were essentially counterfeits.
The Bank of England became the pattern for the system known today as “central banking.” A single bank, usually privately owned, is given a monopoly over issuing the nation’s currency, which is then lent to the government, usurping the government’s sovereign power to create money itself. In the United States, formal adoption of this system dates to the Federal Reserve Act of 1913; but private banks have created the money supply in the United States ever since the country was founded. Before 1913, multiple private banks issued banknotes with their own names on them; and as in England, the banks issued notes for much more gold than was in their vaults. The scheme worked until the customers got suspicious and all demanded their gold at once, when there would be a “run” on the banks and they would have to close their doors. The Federal Reserve was instituted to rescue the banks from these crises by creating and lending money on demand. The banks themselves were already creating money out of nothing, but the Fed served as a backup source, generating the customer confidence necessary to carry on the fractional-reserve lending scheme.
This private banking scheme spread around the globe, locking most of the world into debt to the global bankers. The global debt trap was set in 1974, when OPEC was induced to trade its oil only in U.S. dollars. The price of oil then suddenly quadrupled, and countries with insufficient dollars for their oil needs had to borrow them from international lenders. The debt trap snapped shut for these countries in 1980, when international interest rates shot up to 20 percent. At 20 percent interest compounded annually, $100 doubles in under 4 years; and in 20 years, it becomes a breathtaking $3,834.
By 2001, enough money had flowed back to First World banks from Third World debtors to pay the principal due on their original loans six times over; but interest had consumed so much of those payments that the total debt had actually quadrupled. In 1980, median income in the richest 10 percent of countries was 77 times greater than in the poorest 10 percent. By 1999, that gap had grown to 122 times greater. In December 2006, the United Nations released a reported titled “World Distribution of Household Wealth,” which concluded that 50 percent of the world’s population now owns only 1 percent of its wealth, while the richest 10 percent of adults owns 85 percent. At interest compounded annually, the debts of the poorer nations can never be repaid but will just continue to grow.
Compound interest is the secret weapon that has allowed a small clique of financiers to control the people and resources of the world. What bankers call the “miracle” of compound interest is called “usury” under Islamic law and is considered a crime. It was also a crime under Old English law until the sixteenth century, when Martin Luther redefined the offense of “usury” to mean the taking of “excess” interest. This debt scheme, with its lethal weapon of interest compounded annually, is what has allowed a small clique of financiers to dominate the international business scene through its control of credit, which it has provided on favorable terms to those large corporations it also controls.
Dr. Carroll Quigley was a professor of history at Georgetown University, where he was Bill Clinton’s mentor. Dr. Quigley wrote from personal knowledge of the financial clique he called “the international bankers.” He said their aim was “nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole,” a system “to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements.” The key to the bankers' success was that they would control and manipulate the money systems of the world while letting them appear to be controlled by governments.
The alternative to the independent “central bank” system is something called “national banking.” A central bank owned by the government issues the national currency, which the government then spends or lends into the economy for internal development and public needs. The government gets the money debt- and interest-free. The goal of the international bankers was to privatize this system and bring it under their control. The central bank would still create the national money supply, but it would lend the money to the government, leaving the government with a massive debt on which it owed interest. Once caught in the debt web, the government could then be induced to privatize other assets, making them available for purchase and control by international finance capital.
Before World War II, the head of this private global banking system was in England; but it moved to Wall Street with the economic ascendancy of the United States. Under the Bretton Woods Agreements, the U.S. dollar became the world’s “reserve currency.” Like the British pound that preceded it in that role, the dollar was backed by the right – at least for foreign central banks – to exchange it for U.S. Treasury gold. In 1971, President Nixon took the dollar off the gold standard, and the dollar became the world's reserve currency without that tether. U.S. lenders could create and lend dollars to whatever extent the world could be induced to borrow them. To insure that the lenders got their interest, in the late 1970s the World Bank and International Monetary Fund began imposing “conditionalities” on loans to Third World debtors, requiring them to open up their capital markets, slash spending on social programs, and privatize their industries. Meanwhile, speculative attacks on local currencies that had been left to “float” in foreign exchange markets without the tether of gold caused radical currency devaluations, allowing foreign investors to pick up these privatized assets at bargain basement prices.
When the developing world’s potential for incurring debt had been exhausted, the financial sector turned to the American people themselves, hooking them into a stock market bubble that collapsed in 2000, then a real estate bubble that reached unprecedented heights before it collapsed in 2007. When lenders ran out of “prime” borrowers, lending standards were relaxed in order to qualify “subprime” borrowers – those who would not have qualified under the older, tougher standards. The risks of these loans were then transferred to unsuspecting investors. The loans were sliced up, bundled with less risky mortgages, and sold as mortgage-backed securities called “collateralized debt obligations” (CDOs). To induce rating agencies to give CDOs triple-A ratings, “derivatives” were thrown into the mix, ostensibly protecting investors from loss.
Derivatives are basically side bets that some investment (a stock, commodity, etc.) will go up or down in value. “Credit default swaps” are a form of derivative in which the risk of default is sold to speculators gambling that they can sit back and collect the premiums without ever having to pay out on claims. Derivatives became such a popular form of gambling that by December 2006, the derivatives trade had grown to $415 trillion. This is a pyramid scheme on its face, since the sum is nearly nine times the size of the entire world economy. A thing is worth only what it will fetch in the market, and there is no market anywhere on the planet that can afford to pay up on these speculative bets. The catch in the scheme is that derivatives bets are private: there is no regulator checking to make sure that the parties actually have the money to pay out on claims.
The implosion of the giant derivatives bubble began when investment bank Bear Stearns, which had been buying CDOs through its hedge funds, closed two of those funds in June 2007. When the creditors tried to get their money back, the CDOs were put up for sale, and there were no takers at anywhere near their stated valuations. Panic spread, as increasing numbers of investment banks had to prevent “runs” on their hedge funds by refusing withdrawals by concerned investors. When the problem became too big for the investment banks to handle, the central banks stepped in. In the fall of 2007, the central banks injected $300 billion into the banking system; but the derivatives bubble continued to implode. By the fall of 2008, some of the largest derivatives players had collapsed, including not only Bear Stearns but Fannie Mae, Freddie Mac, AIG, and Lehman Brothers.
As the Federal Reserve and the Treasury ran out of money, they turned to Congress and the taxpayers. Congress was coerced into passing a bailout bill for $700 billion, a figure that quickly became $800 billion. By the end of November 2008, the reported total commitments taken on by the Treasury and the Federal Reserve had reached $8.5 trillion – over half the gross domestic product of the United States. Where is this money coming from? We got a glimpse in January 2009, when the Federal Reserve produced its balance sheet. Its assets and its liabilities had both risen by a whopping $1.2 trillion in the past year. That means the Fed is doing what all banks do – simply creating “credit” on its books by double-entry bookkeeping.
If money can be created in this way to bail out the banks, it can be created to jumpstart flagging economies. Governments have the sovereign right to create and lend the national money supply. Internationally, the United Nations could also assume that right. Precedent can be found in the “Special Drawing Rights” issued as credits convertible into national currencies by the International Monetary Fund. Government-issued money or U.N.-issued money could be used for sustainable energy projects, and this could be profitably done even by impoverished governments with weak legal structures and immature government accountability mechanisms. A government exercising its sovereign right to issue money could pay workers to build power plants using “clean” energy, high-speed trains, low-cost housing, and other needed infrastructure. The government could then charge users a fee for these services. Inflation would be avoided because the money would be recycled from the government to the economy and back again.
Credit created by governments or the United Nations would have the advantage that it could be issued interest-free. This could cut production costs dramatically. On average, the cost of interest has been estimated to be about half of everything we buy; and it composes as much as 77% of the cost of capital-intensive goods and services such as public housing. Interest-free credit could turn alternative energy proposals that would have been priced out of the private credit market into profitable ventures, even for poor countries lacking financial and other resources.
The argument against governments issuing and lending their own money is that it would be inflationary, but this need not be the case. Price inflation results when “demand” (money) increases faster than “supply” (goods and services). When the national currency is expanded to fund productive projects, supply goes up along with demand, leaving consumer prices unaffected.
There are many cases historically of government-issued money being used to fund public projects without creating inflation. Among other notable examples:
* In the early eighteenth century, the colony of Pennsylvania issued money that was both lent and spent by the local government into the economy, producing an unprecedented period of prosperity. This was done not only without producing price inflation but without taxing the people.
* When Abraham Lincoln needed money to fund the American Civil War, rather than paying 25 to 36 percent interest charges, he avoided going into debt by printing Greenback dollars that were "legal tender" in themselves. Again, historians of the period attest that this issue of Greenbacks was not responsible for price inflation.
* The island state of Guernsey, located in the Channel Islands, has been funding infrastructure with government-issued money for over 200 years, without price inflation and without government debt.
* During the First World War, when private banks were demanding 6 percent interest, Australia’s publicly-owned Commonwealth Bank financed the Australian government’s war effort at an interest rate of a fraction of 1 percent, saving Australians some $12 million in bank charges. After the First World War, the bank’s governor used the bank’s credit power to save Australians from the depression conditions prevailing in other countries, by financing production and home-building and lending funds to local governments for the construction of roads, tramways, harbors, gasworks, and electric power plants. The bank’s profits were paid back to the national government.
* The government of New Zealand also responded to the Great Depression with a successful infrastructure program funded with interest-free “national credit.” This program was instituted after the country’s first Labor government was elected in the 1930s. Credit issued by the government’s nationalized central bank allowed New Zealand to thrive at a time when the rest of the world was struggling with poverty and lack of productivity.
Development loans have become debt traps for many Third World countries, as interest has compounded on loans of money created with accounting entries by commercial banks. If governments or the United Nations would take over the credit-issuing function, the crippling expense of compound interest could be eliminated. Projects previously considered unsustainable because of the burden of interest could become not only self-sustaining but highly profitable for their funding governments. “Credit” can and should be a national utility, a public service provided by governments to the people they serve.