Local Money as Solution to Capitalist Global Financial Crises

Abstract

Many people are virtually convinced that money is created by the Central Bank. But this is only true for a small amount of the total money supply in the so-called fractional reserve banking system. Most of our money is created by customers' banks by lending. To understand the problems inherent in our world financial system it is necessary to briefly explain how money creation works. If, for example, someone who possesses 100 € puts this money in a bank as a deposit, "First Bank," then the bank will lend this money to its customers, holding back just a fraction of the original amount as reserve. Banks cannot lend all of their obligations since they have to hold some cash because there are always customers who want to withdraw their money. Let us suppose the First Bank decides to hold a reverse ratio of 10 percent. It will lend 90 € to one of its customers, while the 100 € are still disposable in its cash account. The borrower of the 90 € will spend the money somewhere; maybe he or she will buy a new cell phone. The vendor of the cell phone takes the money and puts it in the cash account of his or her bank: the "Second Bank." The original amount of the 100 € has increased to 190 €. The Second Bank will do as bank A did: it will lend the money to its clients holding back just a small reserve, making the money supply grow further (see Figure 10.1). This well-known mechanism of money creation by fractional reserve banking is called money multiplier (e.g., Mankiw 1998, 600ff.; Larroulet 2003, 418ff.). Less known are the implications of this form of money creation. 1

Inside Barefoot Economics

“…The resultant set of economic theories could ultimately lead to an own school of economic thought, which Max-Neef once imagined being called "human scale economics" (Max-Neef 1985: 40, own italics, [1986 2005b: 43; see also Smith & Max-Neef 2011: 134;Max-Neef 2010b). Such a human scale economics could, among other things, involve a fundamentally different theorisation of entrepreneurship (see section 3.7.2) and the protection of local economies, including for example local currencies and sociocratic policies (see also Smith & Max-Neef 2011;Fuders & Max-Neef 2014). Ultimately, human scale economics could meet the desire for a substantial transformation of modern economic thought as articulated within the 21 st century sustainability discourse.…”