Dr. JŠnos Plenter






The last three decades of the 20th century have been distinct by series of monetary crises, posing a gradually increasing threat to the world economy both in scope and content.

Financial disturbances are nothing new in the modern market economy, enough to remember the world financial collapse of 1929/33, or the endless currency crises in Western Europe in the 50's through the 70's, but the more recent turmoils of the past 20 - 30 years have one very significant special feature in common: they all came about in a global monetary framework where gold holds no restraining role any more and the monetary affairs of the world are without any built -in, automatic control; a man -made control function has been assumed by the leaders of the central banks and money has become almost like a commodity which can be produced or reduced at the discretion of human beings. This is a distinctly new era in the world monetary affairs. It began in 1968, when the earlier U.S. law requiring 25 percent gold backing of the dollar was repealed, and came to a total end in 1973, when even the U.S. dollar was forced to abandon any relation to gold and it - too - has become a paper currency, a fiat money.

That was the end of the Gold Standard Era, which came into being way back in human history, at the dawn of the ancient civilizations.

Economists and monetary analysts so far have failed to describe the new siruation in real depth. A sort of theoretical astigmatism has developed around this issue, as if the most recent and current monetary crises were just like the many others before in the history of market economy.

To recognize the vital differences of the two systems, let us point out just two areas of the many contrasting features.

1. In the now defunct Gold Standard System money creation was automatically regulated by the amount of gold reserves, thus it provided built - in safeguards against inflation. But there was no protection against recession and unemployment.

2. In the current system which could be described as an infinitive one, there is no specific, built -in guidance mechanism to regulate the supply of money. Decisions about the amount of money supply are left to human discretion, in practice upon the individual judgement of the people in charge of this momentous task, namely the leaders of the central banks. A more flexible - and a more fragile ! - system could not have been invented. If the economy is percieved to need more liquidity, there is no formal barrier to create more money, any amount the Central Bank deems necessary. And there is a way to reduce the supply of money if inflation is assumed looming.

The system of discretionaly money creation has evolved over the earlier decades when the gold standard was still officially in place ( at least in one country, the United States ) and therefore when its final and complete demise occured, the transition from the one system to the other was smooth.

The disappearance of gold from the monetary system, and its replacement by human will and decision making resulted in at least two fundamental changes in the monetary process of the market economy. We should review these two changes first, and then their inevitable consequence for the economy.


1. Unlimited intermingling of politics and monetary affairs

Politics is about riches and wealth and their distribution amongst the members of the society. Wealth is ultimately expressed in terms of money, therefore politics has always had a strong bias to influance money in one way or another or vice versa. Throughout the milennia gold was the ultimate embodiment of power and wealth, so much so that even the New Deal legislation of 1933/34 - fairly recent by historical standard - found it necessary to prohibit private ownership of gold in the United States, and the government was given the monopoly of owning gold, with the intention of maintaining the overall economic power of the United States. This is a glaring example of how politics interfered with monetary matters even in the era of gold standard, where - in theory - money was supposed to be neutral with regard to the economy and politics was supposed to be neutral with regard to money.

Gold had to make an exit of the monetary system for a number of compelling economic reasons, and the vacuum it left behind was filled - inevitably - by human decision making. The change is extremely significant. Whereas previously - in the era of gold standard - politics could use their monetary influence only through the manipulation of gold, from now on the way has become open for politics to influence money and monetary matters directly. In the hierarchy of power governments have the decisive say in appointing leaders of the central banks and this legal mechanism provides them with a subtle but extremely strong power to influence central bank monetary policy,

On the face of it central banks are independent from the governments in their policymaking, but this is true only within limits. Examples abound - ( Canada, Germany, U.S.A., etc. ) - that whenever in a major policy matter the government and the central bank happen to be on a collision course, the looser is the central bank.

The theoretical and practical consequence of this situation is immense.

The amount of money in the economy, i. e. its liquidity and its ability to facilitate the exchange of goods and services, could be determined - in the final analysis - not by the actual needs of the overall economy ( assuming it can be calculated ) but by the economic and political powers behind the government. In other words: in the era of fiat money there is a possibility - and a strong bias - to adjust the supply of money in accordance with the perceived needs of the major forces in the economy ( and politics ) and not necessarily accordaning to the needs of the economy as a whole. Thus, for instance, governments can deliberatly implement a monetary policy which reduces the income of the salaried population and making them de facto poorer. ( It actually happened in Hungary in 1995 ) There is no theoretical formula to exactly determine the amount of money the economy requires at any given point in time. This only increases the tendency at the central banks to accomodate the monetary demands of pressure groups with the strongest influence on government policy in general and monetary policy in particular.


2. Direct and decisive influence of the banking system over the money supply

Simultaneously with the declining role of gold and its final disappearance from the money equation a powerful new source of money supply has been emerging: the banking system. Quite logically, if there were no more legal barriers to regulate and restrain the supply of money by the central banks, then the banking system as a whole should also have the right to create its own money - credit - according to the needs of the markets or the needs of the banks ( the two notions are not the same ), free from any restrain. Accordingly, a strong and persistent push began to achieve financial deregulation, first in the United States, then in Europe.

By now, by the end of this century, the banks - or in more general terms: the financial institutions - basically have achieved their objective.

Creating money by lending is the activity that makes the banks thrive, and this activity has been so much liberalized since the mid 80's and made free of restrictions as never before in the history of banking. As a result, a tremendously large and powerful source of money supply has emerged, parallel to the central banks, and its money creating ability almost dwarfs that of the latters. And all this happened in about two decades only!

This new and unanticipated development raised a host of new questions about the nature and role of money in contemporary economy, raised new and serious doubts about the assumed neutrality of money versus the real economy. Contemporary economic thinking is helpless to interprete this new monetary phenomenon. Recent works and macroeconomic models formulated in the traditional sense mostly treat the production of money as a stochastic process, the money stock changes randomly, regardless of the institutional struckture of the monetary sphere or the economic process. Some researchers even say that in view of the new phenomenon money cannot be reliably defined, others claim that money has no systematic relation to any real economic variable at any time.

In the midst of the theoretical uncertainty financial institutions enthusiastically took advantage of their newly acquired opportunities, and the last two decades of the 20th century witnessed a virtual explosion of credit which - in the process - has become the dominating form of money. Example: 1980 through 1996 the M3 money supply ( which includes credit ) has increased from 1,992 billion dollars to 4,933 billion dollars in the United States. In the meantime, currency and demand deposits grew from 409 billion dollars to 1,081 billion dollars only. The trend has been similar throughout the industrialized world.

The unfettered credit expansion is a major coup by the financial system and by the financial institutions in particular.

However, where there is a credit, there must be a debit, too. Looking at the flip side of the credit explosion we see an unprecedented - indeed frightening - indebtedness within the economic fabric of the industrialized world, with ominous consequences not unlikely to happen.





Credit, based on paper money, i. e. without gold backing, is an economic and monetary change of enormous significance and consequences. For the first time in the economic activity of many thousand years of mankind a situation - a chance - has emerged, where certain participants of the economy - the banks - are in a position to provide credit to the other participants of the economy, without first they themselves having had the credited amount or its monetary backing. In other words: in the current monetary framework - the paper money system - the banks have the means and the legal power to bring the other participants of the economy ( society ) into a dependent position of a debtor, without the banks' own monetary wealth or equity being decreased whatsoever in the lending process. What the banks lend is not real money in a literally sens but a fictiv amount, created for the purpuse of lending. The banks use these fictiv amounts to create a very real legal financial obligation of the borrower, the debtor.

This ability of practically unlimited credit creation ( within the rather flexible framework of regulations ) provides the explanation for the astronomical indebtedness of the industrialized civilization in the last quarter of the 20th century, totally undermining the earlier economic modus operandi and the social fabric of the global world.

The size of global indebtedness is shocking. The combined GDP of the European Union is about 8 trillion dollars ( 1997 ), this is accompanied by a combined EU-government indebtedness of approx. 5 trillion dollars. The annual GDP of the United States was approx. 6,6 trillion dollars in 1997, at the same time the American state debt was about 6 trillion dollars. Furthermore, the total personal debt of the American public is of a similar magnitude, without mortgage debt. The Japanese GDP was about 3,2 trillion dollars in 1997, the total state indebtedness was estimated about the same, 3,2 trillion dollars. At the same time - in 1997 - the aggregate indebtedness of the so called developing world ( stagnating world would be a more appropriate name ) was about 2 trillion dollars.

All in all, the global world is moldering under the burden of approx. 20 trillion dollars debt, and almost all of it accumulated during the last 15 - 20 years. The real final debt figure is probably much higher, if corporate debt and private mortgages could be added.

By servicing a 20 trillion dollar debt the interest charge itself amounts to about 160 billion dollars annually, if we assume an average 8 percent rate of interest. A considerable part of that amount is financed by taxation, to service government debt, but in the end all that 160 billion dollars is financed by the consumer - either directly or through taxation - which means a corresponding reduction in overall consumption every year. Of course, part of the personal debt originally may have been incurred by the consumers in order to enhance consumption beyond their own purchasing power at that time, but here we are discussing the long term consequence of indebtedness, which is the inevitable reduction of consuption later on, with an effect of decreasing demand in the economy. An ever increasing debt service charge is an invisible yet very real burden on the economy, with ravaging long term effect. Furthermore, in the present structure of financial obligations money has a tendency of moving in its own closed circle, money flows representing interest payment tend to remain in the monetary orbit, mostly lost for consumption and growth in the real economy. Since total debt already constitutes a hardly managable problem world wide, debt servicing and interest payment are becoming a major preoccupation of economic policy on both sides of the Atlantic, almost the central policy issue itself. Ironocally, at the end of this much celebrated century and millennium it is not the growing welfare of the nations, nor increased consumption of the people that is the main objectiv of economic and monetary policy. It is the ability of the society to service its debt that matters. A sad reflection on the economic state of the world at the end of the 20th century.

In the quest for monetary efficiency global monetary policy went astray, economic values have been reduced to mere monetary categories, the social function of economic activity have been reduced to mere money creation. The driving force of world economy and world politics centers around debt creation and debt servicing, as the quintessential means of acquiring wealth.

The conclusion of this analysis should be clear for everybody.

In our times, at the turn of the millennium, it is no more the paper money as such which poses a major threat to the present and the future of the industrialized civilization, but the gigantic global debt burden built as a superstructure on top of the paper currency system. The economic and political consequences of this enormous debt obligation determines the main direction of changes in the contemporary world. Therefore, the most appropriate economic description of the present economic era is the word " debitocracy " , since it expresses most succinctly the substance of the dominating economic and social force of our times: the rule of money through the intermediary instrument of debt. The expression - debitocracy - comes from the combination of the Latin word "debitum" ( debt) and the Greek word "cracy" (power).

It is a major challenge to contemporary economic thinking to analyze and explain the nature of debitocracy and provide eventual theoretical solutions, before debitocracy brings down the whole world economy and the Western civilization with it.