Conundrum – the illusion of wealth

I am often asked: “How does printing money work and where does it come from?” And so, I thought I would try to answer this tricky question.

There is no beginning or end to money, and here is the dilemma we face as we print money out of nowhere and run zero interest rates: Money is created from nothing! Confidence in the recipient’s ability to repay the money is how value is created and controlled. So money is manufactured, and those who attended the Roger Martin-Fagg lectures at our autumn seminar a few years back may recall Roger saying, “banks manufacture money from thin air”.

How do banks do this? And why?


The Bank of England (BoE), the European Central Bank (ECB) or any commercial bank has permission from government to manufacture money. The manufacture, minting or printing of money has been going on for thousands of years.


It all started with humans bartering for goods and services. For instance, I might plough your field using my horse and, in return, you would give me a dozen eggs from your chickens. As you might imagine, society became more sophisticated and this system of bartering became rather complicated. A medium was required and so began money.

For many centuries money was minted rather than printed, i.e. coins were made and they were minted from precious metals which had a perceived value which meant that people were able to attach a price to goods and services based on the perceived value of the metal coins. I might have then realised that the amount I could charge to plough your field was, in fact, worth 24 eggs, or maybe even a whole chicken! Gradually, from the 16th century onwards, notes were issued, hand written at first in return for gold deposits and then, from the 17th century notes were issued with a ‘promise to pay’ and with no direct link to valuable metals. This is when money became detached from reality.

As time went by institutions sprung up which only dealt in money, they became banks. These banks lent money to governments. The BoE was founded in 1694, as a privately owned bank, in order to lend money to William IV’s government in order to pursue war against the French. It was only nationalised in 1946.

The government then gives the manufactured money to the people either in wages, loans or through capital spending (e.g. on infrastructure). The government agrees to repay the bank the manufactured money, or debt, using the following means: where money was given as wages the government either collects some of it back through direct taxation (Income Tax), or through indirect taxation on the spending of the wage (Value Added Tax), or taxation on profit (Capital Gains Tax or Corporation Tax).

Thus the basis of any economy has always been based on the ability of a government to repay its debt. The value of any currency and economy is based on the ability to tax the economy and repay, one day, the debt. The national debt accrued during the Napoleonic Wars (the largest ever as a proportion of GDP) was never really paid back; it just inflated away over many decades. Britain’s war debt to the USA from the Second World War was only paid off last year having also been massively reduced by inflation.

A commercial bank which is allowed to manufacture money can also pass this to companies, and individuals, and get them to repay the amount lent. Even companies can manufacture money and lend it to other companies or people so that they can buy the companies goods. Ever wondered where your car financing comes from?

So, in the end, manufactured money, now called debt, is eventually repaid and the amount the manufacturer gets should be greater than the amount they manufactured in the first place. Thus they have more money in their account than when they started because they charged you interest and the car cost them rather less to make than they sold it to you for. Then what happens? This money is deemed profit, and so the government comes along and says “Hey company, I will tax that profit”, and then the government has some of the profit as well!

So, we now have a rule; no government, be it communist, capitalist, terrorist or dictator can survive without a bank, and no bank can survive without some form of government, however brutal it may be. This is the basis of most developed governments, and is enshrined in the Magna Carta.

Why manufacture money?

Take a simple example: William the Conqueror defeats Harold in 1066 and becomes King. He arrives in London with no money because waging war and paying thousands of troops is an expensive business. Rather than destroy London he does the reverse: he asks for a loan to pay his victorious troops. (And by the way, as we celebrate Shakespeare’s birthday, Venice is a great city-state to survive on this basis, hence “Merchant of Venice”). The banks, who don’t mind who the borrower is so long as they can get a profit on lending manufactured money, lend William the money because they decide he is good for the debt and will raise the required taxation to repay their manufactured debt, and thus give them a profit.

Or how about car-financing? The price of the car is an illusion of what the company can get away with and has little to do with what it cost to build the car. Houses are the same, the insurance value to re-build your house is very much less than the current market value. So the car company puts a high price on the car but then says you can pay £1,000 now, and then pay £250 per month and the car is yours for two years. Gosh that’s a good deal! Or is it? A new car with a price tag of £40,000, which loses a big chunk of its value the moment you drive it out of the showroom, and the cost over two years of £7,000 to ‘borrow’ the car is really a high price to pay.

The point of these examples is that manufacturing money is all about the future and about growing the economy; it’s about making us all better off and getting us to buy things we need, and don’t need. This creates employment which creates wages which creates taxation which expands the sum of the parts and so it goes round and round and always gets bigger and bigger and bigger! UNTIL IT STOPS.

Why does it stop?

Simply because we lose confidence in the value of things and in governments.

The world lost confidence in Argentina in 1998 and Zimbabwe has been a basket case (as opposed to a bread-basket) for many decades. In Germany, in the 1920s, hyperinflation led to the rise of National Socialism and thence the Second World War. Northern Rock manufactured and lent too much too recklessly and then confidence failed them. Lehman Brothers: The same thing.

Car manufacturers who have falsified emissions are in danger of breaking the confidence trick – and that’s why they have to buy back all their stock before the illusion manifests itself as worthless assets. (It’s nothing to do with emissions and moral embarrassment; it’s just commercial common sense after fraud came un-stuck).

Companies and individuals go bankrupt because the financiers decide they won’t or can’t pay their debts. You don’t have to have a manufactured debt to go bust because just living and paying for your right to walk on a pavement is a debt (i.e. council tax).


The cost of debt is almost zero thus we can print as much as we like, can’t we?

Because the cost of debt is nearly zero we don’t need to raise any tax to pay the interest and we don’t need to re-pay the debt because, after all, it was manufactured out of nowhere. So what’s the problem?

The problem is that the bankers and the world are ruled by a small number in America, Russia, Europe, China, India and the IMF. They are not making any money and they are getting worried that the politicians won’t pay them back what they printed. And what they have printed has ended up not growing the economy as expected, but has inflated the value of assets such as house prices in certain hotspots, and works of art and old cars and so on. The manufacturing process isn’t working; the future is not getting any bigger, in fact it’s getting smaller.

The fault lies in the following conundrum: should we have let the banks go bust in 2008 so that the debt would go away and we could start again? But because politicians ducked the moral hazard issue we have now created a genie which is getting ever further from the bottle.


We are all enjoying technology, and using it to increase our wealth, our health, our life expectancy and our travel. We are all doing more and more and more for less and less money. If we are spending less we paying less tax and we are employing fewer people and we are using less material. (Steel is a good example in the news right now, or BHS).

The Productivity Conundrum

Disruptive technology combined with human behaviour or human fallibility is up-ending all our basic understanding of economic evolution. We all know that humans avoid paying as much tax as possible, extract as much social welfare as possible, and some manipulate the system to work as little as possible whilst trying to get high wages for little work. So technology is creating wealth for us all whilst also supporting those who want to do very little. Thus banks and governments are flying blind and don’t really know how our economies are changing, or how they are creating wealth and are certainly struggling to collect taxes and interest because technology is allowing us all to manipulate the system quite legitimately to our own benefit.

If you are a government do you tax and spend: Corbynomics; or save and shrink: Osbornomics? Neither is right because the fundamental flaw in all economic theory which will never be resolved is human behaviour! No-one knows at what point enough of us will collectively take fright and panic about the value of the illusion …..e.g. OUR MONEY!


Remember there is no end to humanity and its ingenuity. Humankind won’t stop because the banks go bust. After all, it is just an illusion and in the end THINGS still exist: food, energy, transport, buildings, infrastructure, schools, hospitals, sports venues etc. In other words stuff we can’t do without or won’t live without.

What has to happen is as follows:

If you can manufacture money out of nowhere you can do the same in reverse and none other than the last head of the Financial Conduct Authority told everyone this should be considered, but he didn’t say when!

How? There could be a great agreement between all governments to just wipe debt out but the complications would be fantastic. (We did a bit with third world debt recently so we know it’s possible). There could be global inflation and we all lose confidence in paper money. We could just knock off a zero of every currency. (The Italians were very good at this pre joining the EU, and Argentina did it in the 1990s). A massive war tends to sort things out, but the human cost is deplorable, although that’s how most of these crises have been resolved in the past, intentionally or other-wise. The fact is that the world has been here many times before. All we have to do is not invest in things that may have to be destroyed eg banks, cash, or debt (although borrowing personally is fine).

Politicians create bankers; bankers feed politicians to buy voters.
Politicians feed voters with debt created by bankers.
Humans are emotional, spend most of their time living in an illusion and try to ignore basic facts for as long as they can and until the facts become unavoidable.

A final thought:
What is the time line for one or more of the above happening? Japan has been in stasis for 20 years and so too could we be. It might not happen for a 100 years but it could happen in 100 days.

Whatever happens, KMG will continue to read the fault lines and interpret the signals.


Patrick McIntosh

May 2016