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Current financial system at heart of global woes

Published May 17, 2010


We have seen the bailouts and nationalisation of banks in the US, UK and Europe. In addition, we have had the co-ordinated interest rate cuts by the central banks in these regions despite high rates of inflation. About $27 trillion (R202.5 trillion) of value has evaporated from the stock markets globally over the last year. Billions of dollars of liquidity has been pumped into the money markets to thaw the credit freeze and kickstart interbank lending.

Paul Krugman, the Nobel Prize-winning economist, says that a global collapse may have been averted. A recession, however, is almost certain while a deep and long depression is possible. The question now frequently asked is: has the market reached the bottom yet? It seems there is still much more downside to the markets, judging by the size of the derivatives bubble, a gargantuan $561 trillion or 10 times the global output of the real economy.

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But at the heart of our economic woes is a financial system that is based on endless economic growth driven by a debt-based money system of compound interest and fractional reserve banking. Unfortunately, exponential economic growth is not sustainable on a finite planet with finite resources. Our current money system whereby 95 percent of our money supply is issued in the form of loans from private banks, where only the principal is created but never the interest, leads to a scarcity of money in circulation. This system is fundamentally dependent on perpetual lending and new money creation for its own sustenance.

Commercial banks, endowed with this power of credit creation, through fractional reserve banking, can issue loans many more times the actual deposits that they hold dependent only on the reserve ratio set by the reserve bank. For example, if the reserve ratio is set at 4 percent, the commercial banks can issue R2.5 billion of new loans for every R100 million that they borrow from the reserve bank or 25 times their deposits. This power of seignorage and money creation is partially responsible for the current financial crisis and needs greater regulation and reform.

The interest money system as a whole favours the wealthy and the bigger, stronger companies and promotes predatory behaviour, monopolistic tendencies, corruption, creative accounting and fraud, as well as trade and resource wars between nations. It is a system that is both sick and unsustainable. What is needed is a benign, sustainable system that promotes co-operation rather than competition, peace rather than war and conservation of energy and the environment rather than depletion.

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This begs the question: what are the solutions? There are many good, innovative and democratic ideas that can achieve a more sustainable economy by intelligent re-structuring of the market through monetary reform.

A new financial architecture needs to be negotiated and a new Bretton Woods agreement needs to be put in place, based on fixed exchange rates. A neutral universal global reserve currency could be introduced, such as the terra, based on a basket of basic commodities as proposed by Professor Bernard Lietaer.

At the national level, a public institution should be responsible for the provision of credit to be spent directly into the economy through investment in essential infrastructure. This would mean direct control of the money supply and more direct control of inflation. Take, for example, Eskom and its need for capital. This could be provided by the SA Reserve Bank and paid back either without interest or at a low rate of interest.

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Clearly there would have to be oversight, regulations, checks and balances to prevent abuse or hyperinflation of money supply. But the first step needs to be the nationalisation of the central bank coupled with raising the reserve requirements of the commercial banks incrementally up to 100 percent. This has been strongly recommended by Professor Herman Daly, another Nobel Prize winner and a former World Bank chief economist.

The idea of a sustainable steady-state economy based on renewable energy and recycling has come from eminent scholars and academics and has already been successfully applied in the past. The currency experiments with stamp scrip in Worgl, Austria of the 1930s is a noteworthy example. Much of the recovery from the Great Depression in New Zealand - particularly in housing development - can also be attributed to social credit polices.

Monetary reforms will go a long way to help with the end of cheap oil and climate change but will not be sufficient.

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To deal with the effects of oil depletion, an international agreement to control and guide the reduction in consumption and production to match the natural rate of depletion has already been proposed. Successfully implemented, this will prevent economic collapse and wars.

Tax reform is also essential to redirect and reshape the market to encourage investment in higher energy efficiency measures. Indeed carbon taxes must be raised higher but only by simultaneously lowering income tax and value added tax (VAT) until they are eliminated.

A number of communities around the world have already organised themselves into "transition towns", where businesses trade with local interest-free currencies and multilateral barter exchange systems, building lifeboats in preparation for peak oil and financial meltdown. A good example of this is the Welsh town of Totnes, where the Totnes pound, is being successfully traded. In Cape Town there is a community exchange system using talents.

In the short or immediate term, policymakers need to be bold and implement economic policies that serve the needs of the broader community. A universal basic income grant is essential to deal with destitution and to act as an economic stimulus for recovery. We need a massive investment programme in labour-intensive, local and small-scale renewable energy and mass transit light rail infrastructure to create jobs, drive economic development and prepare for peak oil.

To fund these investments, we need to implement a small financial transactions tax that will replace VAT and income tax as they are phased out. Such a tax is efficient, progressive, reduces the cost of doing business, removes the need for tax avoidance, curbs speculation and reduces currency volatility. Perhaps Finance Minister Pravin Gordhan can apply his mind to this idea. After all, we are running out of time.

Yaj Chetty is the communications officer at the Association for the Study of Peak Oil SA and a member of SA New Economics

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