A case for credit based Monetary System

Debt based monetary system

A debt-based monetary system is one where money is primarily created through debt, usually when banks (mainly private) make loans. When a bank lends money, it doesn't typically draw from existing deposits. Instead, it creates a new deposit (money) in the borrower's account. This process creates both money (the loan amount deposited in the borrower's account) and debt (the borrower's obligation to repay the loan) simultaneously.

This system is closely tied to fractional reserve banking, where banks are only required to hold a fraction of their deposits as reserves, allowing them to lend out the remaining amount.

The "Debt Trap": The inherent nature of debt means that the system relies on continuous economic growth to allow debts to be repaid. If the economy stagnates or shrinks, it can become increasingly difficult for individuals, businesses, and governments to repay their debts, potentially leading to financial crises.

Central banks play a role in this system by influencing interest rates and lending practices, which can affect the amount of money created and the level of debt in the economy.

For individuals everyday transactions like borrowing for a house, a car, or a credit card are all part of this debt-based system. Companies can raise debt in several ways, including by borrowing from lenders (like banks) or by issuing debt instruments like bonds to investors. This is known as debt financing. Governments borrow money primarily by selling bonds to investors, essentially creating IOUs that promise repayment with interest. These bonds are then traded on secondary markets and.these are often purchased by financial institutions like pension funds, insurance companies, and banks. 

The Indian government borrows money by issuing securities to fund expenses when tax revenues fall short. This borrowing, a part of the fiscal deficit, is managed by the Finance Ministry and RBI. 

The US government borrows money by issuing securities like Treasury bonds, bills, and notes, which are purchased by individuals, institutions, and even foreign governments. These securities represent loans to the US government, and the government uses the borrowed money to cover budget deficits and fund federal programs.

The UK government borrows money primarily by issuing government bonds, known as called a "gilt". 

Government bonds are generally considered safe investments because the government has the ability to collect taxes to repay its debts. Further, the Governments sell various types of bonds, including short-term and long-term, and those with varying interest rates.

Perils of Debt based monetary system

Here are some big disadvantages of this system:

Need for Constant Growth: A debt-based system requires constant economic expansion to generate enough income to cover interest payments on debt. Without this growth, the system can become unsustainable, as the accumulated debt burden becomes too large to manage.

Instability and Financial Crises: The system can be vulnerable to financial crises due to fluctuations in interest rates, which can make it more difficult for borrowers to repay their debts. Additionally, the concentration of wealth in the hands of lenders can create a system where the majority of the population is reliant on debt, potentially leading to instability.

Increased Inequality: A debt-based system can exacerbate existing inequalities by concentrating wealth in the hands of lenders and financial institutions. This can lead to a widening gap between the rich and the poor, as the latter are more likely to rely on debt to finance their lives.

Potential for Economic Stagnation: The focus on debt can divert resources away from productive sectors of the economy, leading to potential stagnation and hindering overall economic growth.

Inflationary pressures: The creation of money through debt can contribute to inflation, as the money supply increases without a corresponding increase in the amount of goods and services available.

In addition, I had always believed that the current debt based global monetary system has its roots in the bygone eras that were pre-dominated by the wars - especially the two World Wars. Hence the system emerged from the warfare is oriented for crisis and wars and has no welfare objectives.

Global History of debt based monetary system

Early Forms of Debt and Money:

Adam Smith (1723 - 1790), a Scottish Economist and a Philosopher, who is generally regarded as 'father of Capitalism', in his classic book 'Wealth of Nations' had written along the following lines:

 David Graeber, an American and British anthropologist, in his book 'Debt: the First 5,000 years', had narrated:

"the historical development of the idea of debt, starting from the first recorded debt systems in the Sumer civilization around 3500 BCE. In this early form of borrowing and lending, farmers would often become so mired in debt that their children would be forced into debt peonage. Because of the social tension that came with this enslavement of large parts of the population, kings periodically canceled all debts. In ancient Israel, the resulting amnesty came to be known as the Law of Jubilee." 

Later, in early 16th century, 

I won't go back to the eras of barter trade but would like to summarize the history of the Economic / Monetary system since the introduction of the coinage system.

With the introduction of the coinage system, the global trade got a big boost and the merchants across the globe; engaged in the trade (national and international) created competition amongst themselves and in this race the traders felt the need for competitive edge and to expand / grow their share in the market supply of the goods. Now, in order to expand their mercantile, they obviously felt the need for funding. And this funding was provided by the citizens who had surplus money in their coffers. As the demand for the funding grew, the risk of default by the borrower also grew. Enter the system of interest rates when the lenders began to apply on the money they would lend. And soon, the world had the system of 'Usury', though despised as unethical and labelled as a sin by almost all religions of the world, but still it flourished because that was much needed.

Abhorred by current Debt based monetary system an eminent UK based political and economic writer, Michael Rownotham, in his book 'The Grip of Death: A Study of Modern Money, Debt Slavery, and Destructive Economics', had stated:

"[Abraham] Lincoln instructed the Treasury to draw up government-issued money, the notes that came to be known as 'greenbacks'. During the [US Civil] war (April 12, 1861 - May 26, 1865), some $300,000 of this currency was created by the government, and spent into the economy as part of its war expenditure. The issue was secured against the credit of the United States, not registered as a debt. Not only was the war financed without debt being incurred, but the issue of notes helped the economy at a time when the banking system was under threat, and contracting its credit."

Credit based monetary system

In a credit based monetary system, the government issues debt-free money that either fiat money or simply interest-free credit money. The money thus released is directly proportional to the assets of the government and is injected in the economy by undertaking large projects such a infrastructure building (roads, IT infrastructure, Space programmes etc) of the nation or in social sectors (education, health, environment restoration etc). Needless to say, the government delegates the actual implementation of the projects to the private sector, only retaining the process of creating money and guaranteeing the supply with assets it holds.  

When this system was first applied in the USA soon after its war on Indepence, the President Benjamin FranklinIn had remarked - "this manner, creating for ourselves our own paper money, we control its purchasing power, and we have no interest to pay to no one. A legitimate government can both spend and lend money into circulation, while banks can only lend significant amounts of their promissory bank notes, for they can neither give away nor spend but a tiny fraction of the money people need"

This statement is in stark contrast to the current debt based system where money is created by the private banks through borrowing and lending, and exists as a promise to repay a debt. This system is widely used today and involves the creation of money by banks through the lending process.The only limit is the 'fractional reserve system', in which the bank is obligated to maintain a small fraction of the money it lends as deposits.

The global warfare that we are witnessing all around us has the regressive economic system that is based on Financial Debt accumulated by almost all countries of the world and its disastrous effect can be seen across all of the emerging nations, especially the small ones in Latin America, Africa and Asia. Or let us put it another way - all countries that had globalisation pushed down their throats by the financial infrastructure and institutions established by the western nations since the end of the WW2. Not only the wars that are being fought by the nations (think Ukraine-Russia conflict that began in February 2014 and still going on after a decade in the spring of 2025 as I write this blog), but all the global financial crisis that the world has witnessed in past 80 years since the inception of IMF International Monetary Fund) in year 1944 are the legacy of this debt based financial system.

History

 I won't go back to the eras of barter trade but would like to summarize the history of the Economic / Monetary system since the introduction of the coinage system.

With the introduction of the coinage system, the global trade got a big boost and the merchants engaged in the trade (national and international) created competition amongst themselves and in this race the traders felt the need for competitive edge and to expand / grow their share of produce in the market(s). Now, in order to expand their mercantile, they obviously felt the need for funding. And this funding was provided by the citizens who had surplus money in their coffers.

As the demand for the funding grew, the risk of default by the borrower also grew. Enter the system of interest rates when the lenders began to apply on the money they would lend. And soon, the world had the system of Usury, though dispised as unethical and labelled as a sin by almost all religions of the world, but still it flourished because that was much needed.

Looking ahead

Looking ahead in the future, we know we need to rejuvenate our world that is in deep crisis as of early 2025. In order to build a better and brighter future for the whole of humanity across the globe and the revival of global flora and fauna and the revival of our lost environment. In a nutshell, we need to switch to the UN's Sustainable Development Goals (https://www.un.org/sustainabledevelopment/). Expert and 'caring' monetary economists can drive further models as how to convert the development index to the money supply equivalent. This way, the differentiations such as rich vs poor country could be made concepts of the past and any sincere government can engage its citizens to achieve the SDGs, would automatically become a 'truly' rich nation - in 'welfare'!

One of the biggest advantages of adopting SDGs is to give rest to the US Dollar, which is currently a global reserve for all other nations, is a tired currency now because of the gross debt that the USA is under (over $36.2 trillion as of January 2025), and still rising! Also, many poor and developing countries are struggling to pay-off their USD denominated debts.

Base Funds

Every country can provide a 'basic support' allowance to all the citizens (rich and poor) that can be identified by the country (on the basis of unique ID of a citizen such as Aadhar number in India, State-Issued Driver's Licenses and ID Cards in the USA and NHS [National Health Service] number in the UK). Such 'basic support' would be a credit money to all the receivers - and would help in alleviating poverty and unemployment in the country.

Asset Capitalisation of the Poor

Finally, as I have mentioned in my Blog 'Indian Economy - Post Corona scenario', an eminent Peruvian Economist - Hernando De Soto, in his seminal work had stated:

Poor people, especially in poor and developing countries, too have assets but they are not brought into the books because of lack of ownership documents [of the assets] - that apparently were never created. These people also fail to become active participants in the Country's Economy. Governments must drive Property Reforms to bring/release these 'Dark Assets'- as he called them - into the mainstream financial system of the country i.e. within the domains of the national economic worth.