Foreign debt crisis: The role of IMF, World Bank
October 21, 2023: In the first part of this special report, we discussed how banks create money out of thin air. We had a close look at this mysterious role of high-street banks. We saw that the moment a bank decides to give you a loan, it manufactures new money by simply clicking a few buttons on a computer – and your loan is ready. We covered that in the first part. We suggest you have a quick look at it before coming back to this second and concluding part of the report.
In this concluding part, which goes deep into the agenda behind the foreign debt crisis, we will dive deeper into this unusual subject. We will discuss why people are never told about this incredible role of banks. Let’s find out the hidden agenda behind this 100-year-old banking mystery.
First, a quick recap, so that we can move ahead with clarity. So, by now, we know that banks are tasked by some higher authority to manufacture money out of thin air. But the banking theory that explains this mysterious role of banks was brushed under the carpet almost 100 years ago.
Since then, it has only been talked about in hush-hush tones. It is called the ‘credit creation theory of banking’. This theory clearly shows that banks don’t just take deposits and lend out loans. They play a far bigger role in the economy. Their purpose is to create new money and release it into the economy to keep society running.
Take note here that we are talking about non-cash money, which comprises 95-97% of the total money supply. The 3-5% cash money supply is produced by central banks and governments – in the form of paper currency and metal coins.
You must be wondering why this credit creation theory was sidelined, right? We will go into it. But before that, we first need to quickly look at a timeline of events. Let’s go back to the time when the credit creation theory was in vogue.
This theory has been around in various forms throughout 5,000 years of banking history. But it jumped into prominence towards the end of the 19th century. From then, until the 1930s, the credit creation theory was the accepted idea.
It means, at that time, the banking industry and economic circles, especially in the West, accepted the fact that banks create money out of nothing, like magic. The theory has been supported by many high-profile economists, such as Irving Fisher, Henry McLeod, Joseph Schumpeter, and most recently, Richard Werner.
Strangely, during the 1930s, it was decided to dump the credit creation theory and replace it with a whole new theory. It’s called the ‘fractional reserve theory of banking’. The fractional reserve theory says banks individually don’t create new money. They are just financial intermediaries, taking deposits and lending out loans. However, all the banks together, through their collective actions, play the larger role of creating new money in society. The banks do this collectively through what is called the ‘money multiplier process’.
Now, what is this money multiplier process? Let’s try to understand this in a simple way. According to the process, money supply in society multiplies as a result of connected financial activities of all the banks. Still confusing, right? Let’s understand the money multiplier process with a simplified example.
Let’s say, bank No.1 gives you a loan of Rs 10,000. You take it and straightaway deposit that Rs 10,000 into bank No.2. Later that day, bank No.2, which received Rs 10,000 from you, gives a loan of Rs 10,000 to an individual loan-seeker called ABC. Now, ABC takes that Rs 10,000 loan from bank No.2 and deposits it into bank No.3. Later that day, bank No.3, which received Rs 10,000 from ABC, gives a loan of Rs 10,000 to an individual loan-seeker called XYZ.
Now, according to the money multiplier process, the total money supply in society is not Rs 10,000, which is circulating. Instead, it says, the total money supply is Rs 30,000. Why? Because Rs 10,000 was loaned out by different banks to different people three times.
Therefore, Rs 10,000 loaned out and deposited three times means the money supply in society has multiplied three times – therefore, the total supply is Rs 30,000.
Well, we know very well that is actually not true. All that is there is just Rs 10,000. It’s the original Rs 10,000 that you took as a loan from bank No.1. It’s just that it circulated and exchanged hands three times. New money did not get created.
It’s a strange theory. Some of you are even wondering that it is ridiculous! But this is what the money multiplier process is. It is, unfortunately, the backbone of the fractional reserve theory. Many banking industry insiders say the money multiplier process is, in fact, dangerous for the economy because it causes banks to collapse from time to time because of the illusory bubble of money multiplication.
Now, this fractional reserve theory was in vogue from the 1930s until the 1960s. Many reputed economists supported this theory, such as Friedrich Hayek and Joseph Stiglitz. But during the 1960s, it was decided to drop this theory and bring in a new one.
So, a third school of thought, called the ‘financial intermediation theory of banking’, was adopted. This theory further plays down the money-creation role of banks. Instead, it says banks are just financial intermediaries. They just deal with deposits and loans. Individually and collectively, banks have no role in adding to the money supply.
Many top economists have supported this theory, such as Raghuram Rajan, Anil Kashyap, John Maynard Keynes, Ben Bernanke, and Paul Krugman. This financial intermediation theory is now the widely accepted banking theory. The others almost don’t exist. The credit creation theory, in particular, is history. Almost no one remembers it, and therefore, almost no one knows that high-street banks magically create money out of thin air.
German economist Richard Werner, who invented the concept of Quantitative Easing (popularly known as QE) in 1994, supports the credit creation theory. He says banks are definitely tasked with manufacturing money out of nowhere. He conducted a real-world experiment at a bank and proved that all banks electronically create new money when they give loans.
Werner published his findings in the finance journal, International Review of Financial Analysis, in 2015. In that paper titled ‘A lost century in economics: Three theories of banking and the conclusive evidence’, he explored exactly why the credit creation theory has been hidden away.
Why is it that the most powerful people in the financial world don’t want the public and governments to realise that banks create money out of thin air? Banks create 95-97% of the money supply in society. Why is this vitally important role kept in the dark? It’s not there in textbooks and discussions. Why the secrecy?
Foreign debt crisis: What’s going on?
Here’s a possible explanation, and it has got to do with the largely misunderstood foreign debt crisis. Werner speculated in his paper a highly likely reason why the credit creation theory is ignored. He feels the whole mystery is connected to the questionable role of multilateral banks – such as the World Bank, the IMF (International Monetary Fund), the ADB (Asian Development Bank), the EBRD (European Bank for Reconstruction and Development), and similar politicised lending institutions.
Werner’s argument explains the agenda behind the foreign debt crisis with crystal clarity. The argument is that the credit creation theory questions or challenges why poor countries should take loans from multilateral banks based in rich countries. You see, if a country’s domestic banks can comfortably produce 95-97% of the money supply out of thin air, then there is no need for that country to take loans from the World Bank or the IMF, isn’t it?
If domestic banks are doing the job of money creation independently, then why go to foreign banks for help? They are not angels, after all. They charge very high interest rates on the loans they give, and therefore, they try to dictate policy. If poor countries realise that their own banks can take care of the domestic money supply, then they can simply stop borrowing from the outside world.
Once that happens, the poor countries’ economies will become decolonised or independent, with no need for external loans, and therefore, foreign interference. So, economist Werner, and many others like him, feel this is precisely why financial decision-makers in wealthy countries dislike the credit creation theory.
The moment poor countries realise the power of domestic banks, imperialist countries such as those belonging to the G7 cartel, and also China, won’t be able to dominate them through expensive loans. It’s vitally important for some countries to wake up to the reality shown by the credit creation theory, and stay away from foreign loans.
We are talking about countries such as Bharat, Bangladesh, Nepal, Sri Lanka, Pakistan, and also those in Southeast Asia, Africa, and South America, many of which are trapped in an inescapable foreign debt crisis. Real economic freedom lies in surviving on your own money, not on loans from imperial powers.
Werner explains it well in his 2015 paper: “A large number of developing countries… and emerging markets have accumulated large amounts of foreign debt. This debt was invariably denominated in foreign currency and needs to be serviced at interest. The large and rising amounts of payments to service their foreign debt may explain what otherwise is a puzzle in economic theory, namely why international financial flows seem to be directed from poor countries to rich countries… As a result, a transfer of net resources from the less well-off countries to the rich countries has been taking place, putting the former ever more at the mercy of the latter.”
So, now we know not just how banks create new money out of nowhere, but also why this role of banks is suppressed. So that rich countries can keep poor countries distracted and financially dominate them, through the tool of foreign debt crisis.
A country such as Bharat has a long history of taking big, fat loans from foreign banks. These loans come with strings attached, and servicing them is a costly affair.
Our question is: common people naturally are not supposed to know all this; but what about people in power, officials at the RBI (Reserve Bank of India), government advisers, and think tanks? Why can’t they take it up? Think about it. Till then, happy banking!
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