Examining the Foundations of Modern Money Creation

The structure and functioning of the current monetary system have long been subjects of scholarly discussion, with particular attention given to the mechanisms of money creation and its broader social and economic implications. Recent lectures at the Frankfurt Institute for Social Research have brought renewed focus to the legal and institutional frameworks that underpin the generation and distribution of money in capitalist societies.

At the heart of the debate is the distinction between the general perception of money and its actual creation process. Contrary to popular belief, the majority of money in circulation is not directly issued by central banks. Instead, private commercial banks are the primary agents responsible for the creation of new money through the process of lending. When a commercial bank approves a loan, it does not simply redistribute existing funds; rather, it credits the borrower's account with a deposit, thereby generating new money in the form of 'book money' or bank deposits. This process is based on the bank's ability to create liabilities that serve as money within the economy.

The legal foundation of this system is significant. The right to create money is not an inherent characteristic of banks but is conferred upon them through regulatory frameworks and state-issued licenses. This delegation of monetary authority allows private institutions to generate profit from interest and related financial activities, while simultaneously relying on state backing to maintain trust and stability within the financial system. For example, central banks act as guarantors, ensuring that the liabilities created by private banks can be converted into legal tender if required.

This system has notable implications for economic inequality and systemic risk. As private banks profit from lending, the accumulation of interest-bearing debt becomes a defining feature of economic relationships. Each unit of money created through lending is accompanied by a corresponding obligation to repay, typically with interest, embedding the pursuit of profit and growth into the very structure of the monetary system. Critics argue that this arrangement can deepen financial dependency and reinforce hierarchical power dynamics within society, where access to money is mediated by private financial institutions.

Moreover, the reliance on private banks for money creation has periodically contributed to financial instability. The incentive for banks to maximize lending can lead to excessive credit expansion, increasing the risk of financial crises. During such crises, it is often the state and, by extension, the general public that bears the burden of stabilizing the system, as seen in various historical episodes of bank bailouts and state intervention.

Alternative models of money creation have been discussed by experts and scholars. These include proposals for state-led or community-based systems where the creation and allocation of money are determined by democratic processes rather than profit motives. For instance, some have suggested systems in which money is issued as grants rather than as loans, thereby removing the inherent requirement for repayment with interest and potentially reducing the cyclical build-up of debt and instability.

Debate continues as to the compatibility of these alternatives with the existing capitalist economic structure. While money is often regarded as a neutral medium of exchange, it also functions as a gatekeeper to resources, goods, and services, shaping social relations and economic outcomes. The question of who controls the creation and distribution of money is therefore central to discussions about economic democracy and social equity.

Banking professionals and regulators acknowledge the complexities involved in managing money creation, recognizing the balance between facilitating economic activity and ensuring financial stability. While the current system emphasizes the central role of private banks, there is growing interest in exploring new frameworks that might better align monetary policy with broader societal goals.

In summary, the current monetary order is characterized by a hierarchical structure in which private banks hold significant authority over money creation, supported by legal and institutional arrangements. This structure shapes economic behavior, distribution of wealth, and the resilience of the financial system, prompting ongoing reflection on possible reforms and alternative models for a more equitable and stable economic future.