• Economic Policies for an Incoming Labour Government – Part 3

    Economic Policies for an Incoming Labour Government

    By Bryan Gould and George Tait Edwards


    Part 3 of 9 – The Different Uses of Credit Creation


    Credit creation when properly deployed can serve five main purposes, each

    having major and differential effects on the real economy. We cannot

    expect, and nor can an incoming Labour government, to produce better

    economic outcomes unless we understand the differences between them.

    First, credit creation may be undertaken (and usually is) for purely

    speculative purposes. Its principal purpose and effect is to fund housing

    purchase and speculative financial transactions; it is often the main factor

    in the development of housing, land and asset bubbles. It is this aspect of

    credit creation that attracts most attention in today’s economy and which is

    the main focus of the banks’ activities, since it is the easiest business to

    attract, the most secure (since mortgages guarantee the value of the credit

    in most cases) and the most profitable.

    It is also the principal factor in stimulating inflation; housing values, in

    particular, rise sharply as large volumes of credit-created money flow into

    the housing market, and the consequent asset inflation is inevitably

    followed by consumer led inflation as home-owners use the increased value

    of their equity to increase consumption. This is, of course, of great

    significance, given that the control of inflation is the prime and virtually

    only focus of macro-economic policy; it suggests that the use of interest

    rates to tighten monetary conditions, impacting as it does on the whole

    economy, fails to address effectively and accurately the real cause of

    inflationary pressures and is an unnecessarily broad and badly focused

    instrument that does great damage to the wider economy at the same time.

    The overwhelming dominance of credit creation for speculative purposes –

    for both housing and other financial transactions – has other adverse

    features. It distorts the desired operation of the economy by diverting

    investment capital away from productive purposes, and by creating asset

    bubbles in both residential housing and financial assets, not least in western

    stock exchanges; and the resultant constant inflationary impetus then has

    to be restrained by measures such as higher interest rates, so that the

    chances of greater innovation and productivity are further prejudiced.

    Despite all of these downsides, credit creation for speculative purposes as a

    major economic factor impacting on the real economy is virtually ignored

    by our policy-makers, except to the extent that it is seen as perfectly

    normal and relatively benign.

    The second kind of credit creation operates as an important element in

    demand management. It is used to raise purchasing power by putting more

    money in people’s pockets, and thereby can help to resolve the problem of

    deficient demand that Keynes identified as the key element in the Great

    Depression and that continues to characterise recessionary conditions today.

    It would normally be undertaken by the banks, under direction from the

    central bank or the Treasury, though it could also be undertaken directly by

    the central bank or the government. It is little used in today’s Britain, not

    surprisingly, when the Coalition government does not recognise a deficiency

    of demand as the feature of a recessionary situation that needs correction.

    It has, however, returned to favour as a counter-recessionary instrument in

    the thinking of some of our leading monetary economists. Keynes had

    suggested in the 1930s – half-jokingly but so as to make a serious point –

    that a valuable counter-recessionary outcome could be obtained by burying

    money in the ground and then paying firms to employ people to dig it up.

    Their increased income would represent a significant increase in purchasing

    power and therefore demand.

    Such a policy today is often pejoratively characterised as “helicopter

    money” – the notion that demand could be raised if pound notes were

    scattered from the air – but has been seriously analysed by economists such

    as Adair Turner and Michael Woodford who have reached the point of

    debating whether it would best be delivered by fiscal measures (such as tax

    cuts) or by monetary policy (essentially printing money).1

    Credit creation undertaken to raise demand does not mean that it cannot

    serve other purposes at the same time; or, to put it in another way, credit

    creation undertake for other purposes, such as funding the purchase of

    assets or providing capital for investment, may well also have the additional

    effect of lifting the level of demand. As we shall see, the crucial question

    is then as to whether the increased demand is merely inflationary or is

    matched by increased output.

    Thirdly, credit creation can also be undertaken for the purpose of stabilising

    the financial system; this technique, which has been called Quantitative

    Easing over recent times, has been implemented by governments in both

    the UK and the US, and was meant to remedy – in the wake of the Global

    Financial Crisis – the precarious situation of an otherwise bankrupt financial

    system. In the case of the UK, the policy took the form of the Bank of

    England’s £375bn of financial credit to stabilise the UK Clearing Banks but it

    did nothing to benefit the wider economy. The greater proportion of that

    sum was used by the banks to strengthen their balance sheets (and to

    resume paying large bonuses); very little found its way into lending to the

    Small and Medium-Sized Enterprises that desperately needed help in

    maintaining adequate liquidity (and for plant and equipment investment).

    Credit creation for the purpose of funding major innovative programmes –

    sometimes called Government Credit Creation (GCC) – is the fourth kind of

    credit creation and is designed to enable major innovative structural

    economic change, such as the invention of the atomic bomb, the mass production

    of synthetic rubber in the US in 1940-44, and President Obama’s

    Energy Initiative; it is often resorted to in wartime. The intention is to

    stimulate innovation in the public sector or infrastructure area of the

    economy and to undertake large-scale projects that are vitally important to

    the economy but are too large or not commercially rewarding enough to

    attract private capital.

    This kind of credit creation for public purpose is being supplanted

    increasingly in Britain today by Public/Private Partnerships, on the specious

    ground that they offer better value to the taxpayer; the reality is that they

    are much more expensive than publicly funded projects, but they have the

    great merit in the eyes of right-wing governments of offering fat profits to

    their friends in private industry.

    The fifth and, for our purposes, most interesting and important form of

    credit creation is usually called Investment Credit Creation (ICC). This form

    of credit is targeted at increasing investment in the plant and equipment

    level in private industry, with the goal of encouraging productivity

    improvement, accelerating the rate of economic growth and providing full

    employment. Investment Credit Creation is usually delivered through the

    local banks (if you have any) at the behest of the central bank and the

    government. It is this aspect of credit creation that has been virtually

    ignored in western economies over recent decades but which offers by far

    the best prospect of breaking out of our seemingly irreversible economic


    There is today virtually no understanding in Britain and other western

    countries of how Investment Credit Creation functions and of the benefits it

    can bring to economic development. The provision of credit – that is, bank

    lending – is seen almost exclusively in terms of its capacity to stimulate

    inflation and is seen therefore as a potential threat rather than as an

    essential element in producing a better economic performance.

    This is notwithstanding Keynes’ perceptive assertion that there is no reason

    why the provision of credit for the purpose of productive investment should

    not precede the increase in output that it is intended to produce, provided

    that the increase occurs over an appropriate time frame. Other economies

    have understood and benefited from this insight and have used Investment

    Credit Creation to stimulate growth, without being inhibited by the

    conviction that any increase in the money supply must necessarily be


    There are, in fact, many persuasive instances from both recent history and

    from other countries of the successful deployment of Investment Credit

    Creation. One of the most striking examples of the use of credit creation,

    not to inflate the property market for private profit as is done in the West

    at present, but to stimulate rapid industrial growth, was provided by the

    United States at the outbreak of the Second World War, when Roosevelt

    used the two years before Pearl Harbour to provide virtually unlimited

    capital to American industry – simply by printing money – so that the

    country could rapidly increase its military capability.

    Roosevelt encountered the usual objections from conventional economists

    but the exigencies of war and his own political strength and will prevailed.

    The results were spectacular and hugely significant. American industrial

    output grew on average by an unprecedented 12.2% per annum from 1938

    to 1944 – an outcome that went a long way towards enabling the US, and

    the Allies more generally, to win the Second World War.

    An equally impressive instance is provided by Japan in the 1960s and 1970s,

    when Japanese industry was enabled by similar means to grow at a rapid

    rate so as to dominate the world market for mass-produced manufactured

    goods. Western economists have typically shown no interest in how this was

    done and are almost totally ignorant of the work of leading growth expert

    economists such as the Japanese Osamu Shimomura and the American-

    Japanese Kenneth Kurihara. We shall look in more detail 2 later at exactly

    how Investment Credit Creation was specifically implemented by the Bank

    of Japan, at the behest of the government and following the advice of

    Shimomura and his colleagues, and accordingly brought about the Japanese

    economic miracle.

    More recently, China has used similar techniques to finance the rapid

    expansion of Chinese manufacturing. The Chinese central bank, and their

    provincial counterparts, under instructions from the government, makes

    credit available to Chinese enterprises that can demonstrate their ability to

    comply with the government’s economic priorities. Enterprises that wish to

    build or buy new capacity in compliance with the overall industrial strategy

    are provided with the required investment capital, obtained through cost-free

    credit creation; Chinese manufacturing capacity in particular has

    largely been funded by such government-authorised new credit, as has the

    huge purchasing programme of strategic assets from around the world that

    is currently being undertaken by Chinese enterprises. This is admittedly, in

    principle at least, easier to bring about in a totalitarian regime than in the

    UK, but in practice there is nothing to stop a British government from

    requiring the central bank, as the Chinese have done, to create cost-free

    credit for specific (and productive) purposes.

    Other Asian countries, such as Korea and Taiwan, have applied similar

    policies in order to produce rapid industrial growth. Typically, however,

    Western economists have arrogantly assumed that these successful

    economies have nothing to teach us, and are easily dismissed as

    undeveloped economies relying for competitive advantage on cheap labour;

    the reality is, of course, that these economies are, as a consequence of the

    rapid economic growth and industrial development made possible by

    Investment Credit Creation, delivering incomes and living standards to their

    populations that are approaching and in some cases surpassing those in the


    1 See www.voxeu.org/article/helicopter-money-policy-option

    2   http://londonprogressivejournal.com/article/view/1565/the-key-relevance-of-the-writings-of-professor-kenneth-kenkichi-kurihara

    © Bryan Gould and George Tait Edwards 2015