Why is money important to society


Hans Christoph Binswanger

Hans Christoph Binswanger

To person

Dr. oec., born 1929; emerit. Professor of Economics at the University of St. Gallen; 1967 to 1992 director of the Research Association for Economics (FGN-HSG); 1992 to 1995 director of the Institute for Economics and Ecology (IWÖ-HSG), Tigerbergstrasse 2, 9000 St. Gallen / Switzerland.
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The inflation of the money supply into a speculative bubble should be prevented and the growth tendency kept within limits so that an ecological qualification of the growth is possible. Reforms of the monetary system are essential.


The development of modern society is shaped by the constant tendency towards economic growth. It has become the general line of development. The growth is based to a large extent on the endless creation of money and the use of money for capital formation. To understand the resulting dynamics, it is necessary to take a closer look at how money works.

First you have to know what money is, what is money today. Money is everything you can pay with: banknotes, i.e. paper money, as well as sight deposits at the banks, i.e. balances that are booked on the checking accounts at the banks; one therefore also speaks of book money. It can be redeemed in banknotes, but the banknotes can no longer be exchanged for gold coins as they used to be. The last remnants of such an obligation to redeem fell by the beginning of the 1970s. Since then, the central bank has been able to provide the banks with paper money in any amount regardless of any gold reserves. In this way, the amount of money - book money and central bank money - can be increased from year to year. One speaks of money creation. This can go on indefinitely without encountering limits that were previously given by the limited gold reserves. - Today around 95 percent of the money supply is book money and 5 percent banknotes including coins.

Money is created by the banks granting loans to companies, the state and households - mainly to companies. The banks are producers of money. You create money - book money - by granting credit. This is done by the banks crediting the borrowers with an amount corresponding to the loan on a checking account. This credit is book money. It is 100 percent new money because it does not reduce any amount in another account. Only a small part of it - about 5 percent - is redeemed in banknotes. The banks must therefore keep this part ready in sufficient quantities. The central banks can always deliver them to the banks by taking over loans from the banks that they have given, and possibly also other bank assets, and providing the banks with the banknotes, the paper money, in the desired amount.

Because the money supply increases through the increase in credit, and the companies invest the money they receive as credit from the banks, i.e. the book money: spend it in order to buy production services - labor, energy, raw materials - and with these Increasing production increases the production of goods. In this way, the newly created money can be redeemed, but no longer in gold, but - even if only afterwards - in additionally produced goods. The money creation that occurs through credit creation therefore leads to real value creation. This is the way in which gross domestic product, GDP, grows.

Growth has evolved into a perpetual motion machine, a process that keeps itself going by creating the conditions that enable it to continue. How does this happen?

In order to explain this, it is necessary in a first step to show the necessity of capital formation in order to found and expand companies and to achieve the profits that justify capital formation. It should be noted that the companies cannot sell the goods - the products - until they have been produced. Production takes time. However, the companies have to pay for the production services at the time they are used. You therefore need an advance of money. This advance is the company's capital. It is made up of borrowed capital - these are the loans that the banks in particular give - and equity. It is made available to businesses by households, today mainly through the purchase of stocks; it is either money saved or that part of the profit that is reinvested.

The capital claims a profit. Why? Because the use of capital carries a risk that has to be compensated. The risk arises from the fact that the capital providers - the banks and the households - cannot know in the moment when they provide the capital, i.e. the cash advance, to enable the companies to buy the required production services the extent to which this money flows back through the sale of the products. Because the return flow will only take place in the future. In order for investors to take the corresponding risk, they must - legitimately - be able to expect a profit from which both the interest on the debt can be paid and a sufficiently large net profit remains for the equity.

On average, this must apply to all businesses if the economy is to function. That means: the chance of a profit must always be greater than the risk of a loss. The expected value of the profit in the overall economy must therefore be positive. This is only the case if the overall frequency of the profit was always greater and is still greater than the frequency of the loss, i.e. if the companies have always made and are making profits on balance, i.e. from the sum of the profits and losses of all companies Profit surplus results.

The second step is to explain how such a macroeconomic profit surplus can arise. The profits of the enterprises are basically equal to the difference between the income and the expenditure of the enterprises - more precisely: between the income and the expenditure of the enterprises for the production of the products from which the enterprises obtain the income, i.e. equal to the difference between income and costs . So that the enterprises together can always achieve profits on balance, the income of the enterprises must therefore always be greater than the expenditure of the enterprises. How is this supposed to happen? Obviously it is not possible to achieve this goal if the money just goes in circles, i.e. if the money that companies pay households for their production services is simply used again by households to buy the products, which the enterprises have established with their help. Because then the company's income and expenses would only balance each other out. So the sum of profits and losses would not result in a positive profit balance. This can only arise for the economy as a whole if there is constant flow of money.

But how does money flow into the modern economy? We already know: in that the companies take out loans from the banks, which the banks provide at least in part by creating money, i.e. by increasing the amount of money on the credit route. Enterprises need the credits - let it be repeated - in order to invest, in order to use the borrowed money, together with the reinvested net profit, to purchase additional production output: in order to grow. The incomes of households as providers of these labor and production services, as workers, thus rise with the growth of GDP, and the profits of enterprises with the growth of the incomes of households, since they spend the income on the purchase of the products that the ventures established with their help.

The "trick" here is: the households immediately spend their income on buying the products that the companies manufacture with their help, because the households have to survive. They therefore immediately become income for the company. At this point, however, the companies can only sell the products that have already been produced, i.e. those that they manufactured before the new investment. This means that companies' income increases before they spend on the products they sell, so the returns outweigh the costs. In the economy as a whole, the balance of profits and losses always results in a profit if the economy continues to grow.

In this way, the economic cycle develops into a growth spiral, into a perpetual motion machine, in that the growth of production with the help of money creation creates the prerequisite for profits to arise, and with the profits again the prerequisite for money to be used as capital and so on further growth becomes possible. The prerequisite for the functioning of the perpetual motion machine is, however, that it does not face any obstacles. This is not guaranteed. It is endangered by crises that become more acute the stronger the dynamics of growth develop.

The focus is on the risk of financial crises. [2] They are the result of excessive money creation, which is not used to finance real growth in production, but to speculatively buy assets - in the expectation that their prices will rise precisely because of the constant increase in money. If the expected future price increase is higher than the interest rate, one also takes out loans in order to buy the assets and thus to be able to enrich oneself virtually for free. However, speculation is endangered by the fact that interest rates can rise. This occurs when the central banks fear an inflationary development because of the money supply inflated by speculative credit and, to prevent this, raise interest rates. Then, because interest rates are too high to justify speculative credit, the financial crisis occurs.

But what if there were no financial crises? Would everything be all right then? No, because the growth trend can only be enforced if there are sufficient natural resources from which the raw materials and energy are obtained, which form the basis for increased production. More and more economic growth is confronted with the long-term scarcity of nature. Their use can therefore not be expanded indefinitely. An increasingly acute environmental crisis arises. Humans should therefore treat nature economically, i.e. manage nature sustainably. However, this imperative is opposed by the growth trend anchored in the monetary system.

What needs to be done in view of our economy's double susceptibility to crises? The urge to grow cannot be eliminated as long as there are good reasons why we want to maintain an economy that is based on independent companies that invest in the market on their own initiative, but are also exposed to risk. Nobody will make money available as capital, i.e. as an advance, if they can only expect to get back the same amount as they have invested. Then he'd rather keep the money in hand than expose it to risk!

However, we should be able to control the creation of money and credit through appropriate reforms to such an extent that the inflation of the money supply into a speculative bubble is prevented and the growth trend is kept within limits so that an ecological qualification of growth is possible. The creation of appropriate reforms of the monetary system will be the great task of our society in the future.