Paper money and coins are for the general public – the ‘little’ people, who don’t earn enough to warrant bank accounts, needing mostly fives, tens, and hundreds. The broader middle class also need 500 and 1000-rupee notes. After all, billions of transactions daily buy groceries, medicines, fuel, umpteen consumer items, and pay employees and services like utility bills, skilled workers, street vendors, etc.

The State Bank may be printing paper money and minting coins, but thereafter banks create several times more money—mainly serving business and industry. How does this happen?

People believe banks lend out customers’ money for a profit which they share with them – which is only partly true. Instead, every time someone makes a deposit, a string of banks lend it out in turn as additional new money. It isn’t converted into new paper money and coins, but appears only as numbers in account books recording bank-to-bank transfers by cheque or electronic transfer. The government and State Bank have authorized them to do so. It’s all legal, but it does not necessarily make it fair.

It all began in Europe and England when it was found that people who kept their gold in goldsmiths’ vaults for safekeeping for a fee, seldom visited to collect it. Instead they used goldsmiths’ receipts as money, and which other tradesmen trusted and accepted and used similarly. The receipt was convenient and reduced the risk of robbers.

That’s how the use of paper money began. Goldsmiths charged interest without informing the customer or sharing the profit — which was the dishonest part — making fortune after fortune.

Depositors only needed to exchange the receipt for their gold. But because this happened only at great intervals – some didn’t turn up for years – the goldsmith calculated how much gold he could safely lend out in short-term loans. He kept only a fraction of the gold in reserve in case they did.

Once in a while the goldsmith would miscalculate and lend out too much or a customer returned unexpectedly early, and he would get into serious trouble. But this didn’t happen most of the time.

This was the origin of modern banking with a twist: today there’s no gold involved; the banks retain a fraction of the deposits (between 1% and 30%, depending on the country; about 5% in Pakistan) and loan the rest as new money. When their next borrower deposits it in his bank, the same thing happens all over again. It’s known as ‘fractional reserve banking’ – multiplying purchasing power by about ten times as it moves through the lending system from bank to bank.

Critics have throughout objected to this ‘creation of money out of thin air’. Yet, used with discretion, ‘fractional reserve banking’ has its advantages. It saves the trouble of producing vast, unmanageable amounts of notes and coins when most large transactions can be conducted by non-cash means. It creates credit and stimulates the economy – up to a point. The central bank of every country lays down the minimum reserves a bank must retain before lending out (like the cautious goldsmith did), but American banks have ignored limits and lent up to fifty times more. Some countries place no limits.

There are other valid objections. Only the privileged class benefit when banks manufacture money. With such a powerful tool, public banks could easily serve the majority who are unable to obtain credit, lacking collateral, and who find microcredit inadequate. The question is: if banks can make massive profits for themselves with fictitious money, why should borrowers be forced to provide collateral of real substance such as their cars or houses?

The state has failed to balance this huge privilege with conditions to benefit the wider citizenry. This has a direct bearing on democracy and people’s right to money and credit. Why should one class be served, and the other not at all? With gold and other precious metals no longer backing up money, its ultimate value comes from the country’s combined assets. Economic activities require use of natural resources (known as public goods) that belong collectively to the people, such as land, water, fossil fuels and other public assets.

Unfortunately, ‘democracy’ started on an uneven keel by failing to first determine the value of each citizen’s rightful share of the commons, as public natural resources and public services are known. (Some countries are said to be doing or updating this exercise; at least one US state – Alaska — redistributes the annual profits from its oil wealth after expenses, to each citizen of the state which come to several thousand dollars a year.) That way – total worth of public goods divided by population — each adult citizen could receive an equal share of the country’s collective wealth, if not in cash, then in the form of interest-free and tax-free credit to start off or supplement his own enterprise. As an annual entitlement, it would also take care of the retired, the elderly, and the disabled. 

Such possibilities are already being discussed by monetary reformists, catalyzed by the abuse of the ‘fractional reserve’, compound interest and the diverse, complex and risky forms of speculation (which caused the global financial crash of 2008). But taking on the global banking cartel bent on maintaining their monopoly over money-creation, is difficult, and therefore suppressed by the corporate media, academia and governments.

It was therefore an encouraging surprise when a year ago, the IMF, perhaps the world’s most predatory financial institution, came out with a working paper recommending putting an end to fractional reserve liberties. To quote: “The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business.”

The IMF was responding to the mess and collapse that western, especially American big banks, have landed in through reckless and dubious speculation, ignoring the fact that all resources being finite, unlimited growth was simply not possible. And therefore growth of money had to have a cut-off point too when it could no longer produce more. The central banks need to determine and directly limit the money supply.

Although the IMF was not thinking of the developing countries it preys on, it realized that if profitable banking was to survive globally, it had to be prudent. And banking being intertwined worldwide, all banks would have to conform. But the IMF needs to look itself in the mirror as well.

 The writer is a former journalist and currently director of The Green Economic Initiative at Shirkat Gah, a rights and advocacy group.