The process by which banks create money is inherently inflationary, because they lend only the principal, not the interest necessary to pay their loans off. To come up with the interest, new loans must be taken out, continually inflating the money supply with new loan-money. And since the money is going to the creditors rather than into producing new goods and services, demand (money) is increasing without increasing supply, producing price inflation. If credit were extended by governments interest-free, inflation might actually be reduced, by reducing the need to continually take out new loans to find the elusive interest to service old loans.
Historical Precedents
Government-issued money to fund public projects is not a new idea but has a long and successful history. Among other notable examples:
In the early eighteenth century, the colony of Pennsylvania issued money that was both lent and spent by the local government into the economy, producing an unprecedented period of prosperity. This was done not without producing price inflation and without taxing the people.8
When Abraham Lincoln needed money to fund the American Civil War, rather than paying 25 to 36 percent interest charges, he avoided going into debt by printing Greenback dollars that were "legal tender" in themselves. Again, historians of the period attest that this issue of Greenbacks was not responsible for price inflation.9
The island state of Guernsey, located in the Channel Islands, has been funding infrastructure with government-issued money for over 200 years, without price inflation and without government debt.10
During the First World War, when private banks were demanding 6 percent interest, Australia’s publicly-owned Commonwealth Bank financed the Australian government’s war effort at an interest rate of a fraction of 1 percent, saving Australians some $12 million in bank charges. After the First World War, the bank’s governor used the bank’s credit power to save
Australians from the depression conditions prevailing in other countries, by financing production and home-building and lending funds to local governments for the construction of roads, tramways, harbors, gasworks, and electric power plants. The bank’s profits were paid back to the national government.11
A successful infrastructure program funded with interest-free "national credit" was also instituted in New Zealand after it elected its first Labor government in the 1930s. Credit issued by its nationalized central bank allowed New Zealand to thrive at a time when the rest of the world was struggling with poverty and lack of productivity. According to a book titled State Housing in New Zealand published by the Ministry of Works in 1949:
"To finance its comprehensive proposals, the Government adopted the somewhat unusual course of using Reserve Bank credit, thus recognizing that the most important factor in housing costs is the price of money – interest is the heaviest portion in the composition of rent. . . . This action showed . . . it was possible for the State to use the country’s credit in creating new assets for the country."12
Stan Fitchett, writing in the New Zealand Guardian Political Review in 2004, explored whether this approach would create price inflation today. He confirmed with bank officials that
97 percent of the New Zealand money supply is now created by commercial banks when they make loans. The year he was writing, the money supply increased by 18,527 million New Zealand dollars, or 16.8 percent; and 97 percent of this increase came from commercial bank lending. Fitchett confirmed with banking experts that if the Reserve Bank had created 100 million New Zealand dollars for new houses in New Zealand, the sum would have had no noticeable impact on inflation, since it was only one-half of one percent of what was already being added to the money supply annually by private commercial banks.13 Similar figures apply in the United States and other countries.14
Implications for the Current Climate Crisis
Development loans have become debt traps for many Third World countries, as interest has compounded annually on loans of money created by commercial banks with accounting entries. If governments or the United Nations would take over that function and advance credit created with accounting entries themselves, the crippling expense of compound interest could be eliminated. Interest-free loans could help ease the current crises not only of climate change but of housing, energy, infrastructure, food, and health care.
Funds for public development could be advanced as "contingent grants." If the projects were profitable, the money would be returned to the government from profits. Private contractors could be hired to do the work, but the projects would remain public assets that continued to produce profits for the benefit of the government and the people. To prevent abuse, the money would not simply be given away but would have to be repaid on a regular payment schedule, just as private loans are now. The only difference would be that the credits would be advanced by the government or the United Nations rather than by private commercial banks, and they would not be burdened with interest.
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