Less than 100 years ago you could walk into the Bank of England with a pound note and exchange it for a fixed amount of gold. But not any more.
These days money has no inherent value. In fact, most money has no physical existence at all. Less than 5% of money consists of notes and coins. The rest is “electronic” money, which means it only exists as numbers in a computer.
In the old days, if you wanted to create new money you had to get hold of some gold. And even notes and coins have to be designed, printed or minted. With electronic money you just have to decide that you want it to exist.
Banks do this all the time. When they decide to make a loan, they create new money to cover it. When the loan is paid off, they take the money out of the system again and they pocket the interest.
That’s good business for the bank – charging interest on money it didn’t previously have – and if the money went where it is needed that would be OK.
New money can set off a chain reaction of working, producing, earning and spending that spreads wealth throughout the economy and society, improving the lives of everyone involved.
But that’s not where it goes. The vast majority of bank lending goes to buying and trading property, stocks and shares, and financial speculation, where it’s feeding Britain’s chronic case of the Money Disease.
Low interest rates are not the answer
The Bank of England uses interest rates to control the amount of new money that banks create. Lower rates are supposed to mean that the banks lend more.
With the British economy in such a bad way since 2008, the official interest rate has been less that 1% for most of that time.
But this is not much good to ordinary workers and consumers. Credit card rates are 20% or more, and overdrafts are 30-40%, while the income paid on their savings accounts is next to nothing.
The people who can borrow money at low rates are people who have money and assets already. They can borrow money cheaply to buy more assets, because the value of their existing assets is rising.
Why are they rising? Because when interest rates are low, buyers of assets are happy to accept a lower return on their investment.
If a building with a rent of £10,000 is worth £200,000, the return is 5%. If interest rates fall so that 2% seems like a good return, the building is suddenly worth £500,000.
Share prices are the same. When shareholders are happy to accept a lower return, the price of the share shoots up. It’s a win-win for people who own investment assets.