Most people do not realise that banks have been giving the privilege to literally “make money”. The major banks in Australia can lend money to people even though the bank does not have matching funds on deposit. In fact for every $100 in real deposit the banks can lend $900 in “new money”. This is an enormous privilege but with the privilege there is a responsibility. The current credit crisis is a result of the banks not fulfilling their responsibilities and it is time for our society to think of a better way to “make money”. To put the figure in context last year $170 billion dollars in new money was created out of thin air. This was up by 12% from the previous year and is about $8,000 for every person in Australia.
Banks only lend money to people who have money or who have assets. When you borrow money to buy a new house the bank is not concerned too much about the house value but about your future earnings. That is, the main criteria that banks use for deciding whether to lend money is whether you are likely to pay it back. They really do not care too much about what you do with the money as long as they will get their loan back and they make no distinction between loaning “old money” or “new money”. This leads to them lending money to the likes of ABC Learning.

This system has several inherent flaws and leads to instabilities. Perhaps the major flaw is that “new money” immediately attracts interest. This leads to inflation because we should not pay interest on money that is not backed by an asset. The idea of interest is a payment on the use of an asset. With new money there is no asset earning money. What happens is that as a society we create more new money to pay the interest which then causes us to create more money to pay interest …
The second flaw is that the system leads to asset inflation bubbles. Remember banks will loan you money if you have an existing asset. If you already own a house the bank will lend you money for a second house if you use the first house as collateral for the loan. The bank does not really care if the underlying value of the first house is less as long as they will get their money if you default on the loan of the second house. You do not care that the first or second house is overvalued because you expect both houses to increase in value and pay the interest on the loans. The government does not care if the prices inflate because they collect more taxes and can charge more taxes and more for change in land use.
The only people who suffer are those not in the house market or those who are the last people to get a loan before the bubble bursts and they have little voice in the matter. The house price bubble has to stop sooner or later because it is a form of pyramid selling or Ponzi scheme.
When the bubble bursts or starts to leak slowly we then get a credit crisis with governments rushing around in a panic. The reason governments panic is that the banks reduce lending because asset prices have dropped and so banks are unwilling to lend because there are less asset values against which to lend. This then leads to recessions or depressions because no one wants to loan anyone any money even though it will produce productive assets. The problem is not a lack of money. The problem is one of lack of assets and the government adding more money without thinking about how it will be spent will cause the problem to get worse. In particular the current approach of “handouts” is almost certain to lead to inflation because we have more money chasing fewer assets.
There is a solution and that is to stop the banks creating new money. Let new money be treated differently from old money. Let the Reserve Bank create all new money and let it lend it to the citizens but require the citizens to invest the money in productive community infrastructure. Let the money be paid back from taxation on the income that derives directly or indirectly from the use of the community facilities.
To give an example. Gungahlin needs say $240,000,000 dollars in community infrastructure expenditure this coming year. Give each Gungahlin resident $8,000 loan of new money at zero interest but require them to spend the loan on different infrastructure proposals. Let the Reserve Bank print the new money and issue the loans through a community group responsible to the community.
The result would be infrastructure for Gungahlin, the residents getting the infrastructure they as a group want, no inflation because the money is spent creating an asset, and lower prices because the government would not have to charge high prices for the land to cover infrastructure costs.

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