This post is part of a blogging series by economics students at the Presidio Graduate School’s MBA program. You can follow along here.
By Elze van Hamelen
….”[earth] has, or had, a problem which was this: Most of the people living on it were unhappy for pretty much all of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movements of small green pieces of paper… which is odd, because on the whole, it wasn’t the small green pieces of paper that were unhappy…”
— Douglas Adams
The recent financial crisis has been a credit crisis, and in response the government and the Federal Reserve have taken an active role in increasing the money supply to manipulate business cycles. The surges and contractions of the business cycles cause fluctuations in the economy, and thus in employment. In this way these fluctuations are felt in every aspect of society. We take these cycles as a given. However, in Ecological Economics Daly and Farley (2008) put forward an interesting idea: the fluctuations in the economy are caused by the design of the monetary system, and not by law of necessity. By decoupling business cycles from the circulation of money these ups and downs can be avoided.
Currently the worldwide money supply is tightly linked to investment cycles. Business has its natural cycles, but the linkage of these cycles to the money supply by means of lending and borrowing causes a self-reinforcing feedback loop: when investment goes down, spending goes down, causing a decrease in the money supply, which will further decrease investments, and so on. Daly and Farley have a novel proposition: ‘there is no reason why the monetary system must be linked with the private commercial activity of lending and borrowing’.
Let’s imagine a world where the monetary system is decoupled from the activity of lending and borrowing. Money will be treated as a public good that facilitates exchanges within the economy. The government can match the supply based on for instance, consumer price indexes. A beneficial side effect is that inflation will be easier to control. The reserve requirements of banks will be 100%. Banks will make money by charging for services they provide and by borrowing and lending real money instead of by creating it.
What effects will such a decoupling have? Currently, the financial sector has a disproportionate size compared to the real sector: the size of the real sector is roughly $30 trillion per year, whereas the trade in money, with no intervening commodity is almost $2 trillion per day (Daly & Farley 2008, p.257). The financial sector should be in service of the real economy, and a decoupling of the money supply from investments will support this.
With investments recoupled to the real economy – making rents based on increased production capacity by means of investments- the focus on how to make economic rents will shift. Currently profits are made by moving paper around. With the financial sector recoupled to the economic sector it will become more important to make profits in the real economy. Introduction of a 100% reserve requirement will bring investors closer to their investments. It is only make-believe, but it is interesting to think of what implications this will have for business. With rents primarily to be made in the real sector instead of the financial, how will this affect the organization and management of business?
The current design of the economy and its institutions, banks and business, make up a system that is unstable, unpredictable and uncontrollable. After the crisis in 2008 most agreed that things needed to change. Yet most has returned to business as usual. This necessity for change has not eroded. Exploring this possibility of decoupling the monetary system from private lending may be a perfect solution to many of our economic problems.
Daly, H., & Farley, J. (2007). Ecological Economics. Principles and Applications. Dehli: Island Press.