Bryan Gould: New monetary policy could revolutionise New Zealand

The majority of money in circulation is not notes and coins but is created by commercial banks through the credit they advance and using bank entries rather than cash, Bryan Gould says.

As a new government emerges, why is it likely that so little will change?

Why have so few of our political leaders kept abreast of recent developments in monetary policy that could revolutionise our prospects?

The story starts, at least in its most recent form, with the now almost universal recognition that the vast majority of money in circulation is not - as most people once believed - notes and coins issued on behalf of the Government by the Reserve Bank, but is actually created by the commercial banks through the credit they advance, usually on mortgage, and using bank entries rather than cash.

The truth of this proposition, so long denied, is now explicitly accepted by the Bank of England, and was - as long ago as 1994 - explained in a letter written by our own Reserve Bank to an enquirer, and stating in terms that 97 per cent of the money included in the usually used definition of money known as M3 is created by the commercial banks.

This explanation is endorsed by the world's leading monetary economists - Lord Adair Turner, the former chairman of the UK's Financial Services Authority and Professor Richard Werner of Southampton University, to name but two, and they are joined by leading financial journalists, such as Martin Wolf of the Financial Times.

The second development was the use by Western governments around the world of "quantitative easing" in the aftermath of the Global Financial Crisis.

"Quantitative easing" - often pejoratively termed "printing money" - was new money created at the behest of the Government to bail out the banks by adding it to their balance sheets.

These two developments, not surprisingly, generated a number of obvious questions - except, it seems, in the minds of our leading politicians. If banks could create billions in new money for their own profit-making purposes, (through charging interest on the money they create), why could governments not do the same for public purposes, such as investment in new infrastructure and productive capacity?

And if governments do indeed create new money through "quantitative easing", why could that new money not be applied to purposes other than shoring up the banks?

The conventional answer to such questions (and invariably given in New Zealand by supposed experts) is that "printing money" will be inflationary - though it is never explained why it is miraculously not inflationary when the new money is created by bank loans on mortgages or is applied to bail out the banks.

But, in any case, the master economist John Maynard Keynes had long ago explained that new money could not be inflationary if it is applied to productive purposes so that new output matches the increased money supply. Nor is there any reason why the new money should not precede the increased output, provided that the increased output materialises in due course.

These arguments are borne out by practical experience. President Roosevelt used exactly this technique, in the face of conventional opposition, to boost investment in American industry in the period before the US entered World War II. The substantial increase in American industrial output as a result was the decisive factor in allowing the Allies to win the war.

The great Japanese economist Osamu Shimomura (virtually unknown in the West) then took the same approach in setting out to rebuild a post-war Japanese industry devastated by defeat and nuclear bombs.

Today's Japanese Prime Minister, Shinzo Abe, is a follower of Shimomura. His policies, re-applied today, have Japan growing after years of stagnation at 4 per cent per annum and with minimal inflation.

Our leaders, however, including luminaries of both right and left, some having held senior roles in managing our economy, not only dismiss the views of experts and the experience of braver and more open-minded leaders in other countries and earlier times, but - surprisingly enough - seem to deny even our own home-grown New Zealand experience.

Many today will have forgotten or be unaware of the successful initiative taken in the late 1930s by Michael Joseph Savage. He created new money with which he built thousands of state houses, thereby helping to bring an end to the Great Depression in New Zealand and providing decent houses for young families (including the one I grew up in).

Why would our current leaders disown the lessons of that hugely valuable legacy?