We’re not lazy or nothing. We just didn’t feel like doing much of anything but still had a blog posting to get out. Therefore, we did what any red-blooded blogger would do and turned the job over to AI. We asked Chatgpt to “Write a 700-word blog posting in the style of the Just Third Way blog, https://just3rdway.blogspot.com/, and drawing from information on the Just Third Way blog, about how the Banking Principle differs from the Currency Principle and why the Banking Principle makes more sense to finance new capital formation than the Currency Principle.”
Well, naturally it didn’t do it in our style, despite having a couple of metric tonnes of postings on which to draw, but the result does give another perspective on a point we’ve been trying to get across for years — so see if it works for you:
The Banking Principle vs. the Currency Principle: Why the Difference Matters for Financing New Capital Formation
One of the most important, yet least understood, questions in economics is where money comes from and, more importantly, what determines how much money an economy needs. The answer depends on which of two fundamentally different approaches to money and credit one accepts: the Currency Principle or the Banking Principle.
The distinction is not merely academic. It goes to the heart of how new capital is financed, who gets to own that capital, and whether economic growth must depend on the accumulated savings of those who already own wealth.
What Is the Currency Principle?
The Currency Principle, which underlies the Currency School of monetary thought, holds that the quantity of money determines the level of economic activity. In other words, before people can engage in productive economic activity, money must first exist.
This sounds reasonable enough at first. After all, don't businesses need money before they can purchase machinery, construct factories, or acquire other productive assets?
The difficulty is that this approach assumes that money must come from previously accumulated savings. Someone must first reduce consumption, accumulate money, and then make those savings available for investment. Consequently, new capital formation becomes dependent on the willingness and ability of existing owners of wealth to save and invest.
There is an obvious problem here. If production requires savings, but savings can only come from previous production, how does an economy get started? More importantly, why should access to the means of producing wealth be restricted to those who already possess wealth?
The Currency Principle effectively makes accumulated savings the prerequisite for economic growth. Whether the money supply is managed by government or left largely to private markets, the underlying assumption remains the same: money must precede production.
What Is the Banking Principle?
The Banking Principle reverses this relationship. Instead of assuming that the quantity of money determines economic activity, it holds that the level of economic activity determines the quantity of money needed to facilitate exchanges.
Money, under this approach, is not primarily a commodity to be accumulated. It is a medium of exchange and a means of measuring and transferring economic value.
This is the foundation of the real bills doctrine associated with the Banking School. Under this principle, money and credit can be created against existing or reasonably anticipated production of marketable goods and services.
Consider a business that has identified a financially feasible opportunity to acquire new productive machinery. The machinery will enable the business to increase production and generate additional revenues. If the anticipated earnings are sufficient to cover the cost of acquiring the machinery and servicing the financing, the project has genuine economic value.
A commercial bank can finance that acquisition by creating credit backed by the soundness of the transaction and the productive assets and earnings reasonably expected to result.
In this arrangement, the money does not have to come from someone's previously accumulated savings. The financing is supported by the productive potential of the project itself.
That is the essential difference: under the Currency Principle, money makes production possible; under the Banking Principle, production makes the creation of money possible.
Why the Banking Principle Makes More Sense for Capital Formation
The Banking Principle offers a much more logical way to finance new capital formation because it recognizes the distinction between past savings and future savings.
Past savings result from reducing consumption out of income already received. Future savings result from increased production and income generated by new capital investment.
There is no reason that financing new productive assets must always depend on past savings. A financially feasible investment can be financed through credit created against its anticipated future earnings. As the investment produces additional income, the resulting savings can repay the financing.
This is particularly important in an economy increasingly dependent on advanced technology, automation, and other forms of productive capital. Human labor alone is no longer sufficient to provide everyone with an adequate source of income. People must have access to capital ownership as well as opportunities to work.
Here is where the Banking Principle connects directly with the Just Third Way and binary economics developed by Louis O. Kelso. If future increases in production can provide the basis for financing new capital, there is no inherent economic reason why ownership of that capital must remain concentrated in the hands of those who already own it.
Through appropriately structured capital credit, ordinary people can acquire ownership in productive enterprises, with the dividends generated by their new capital helping repay the acquisition financing.
This is the economic foundation of Capital Homesteading: expanding capital ownership by making access to productive credit available to people who do not have sufficient accumulated wealth to finance capital acquisitions themselves.
The Real Question Is Who Gets to Own the Future
The Currency Principle and Banking Principle represent two very different understandings of the relationship between money and production.
The former makes accumulated wealth the starting point for new capital formation. The latter recognizes that future productive capacity can provide the basis for financing new investment.
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| Henry Thornton, Real Bills Doctrine |
Of course, the Banking Principle does not mean that banks should create unlimited credit or that every proposed investment deserves financing. Credit must be backed by genuine economic value, and projects must be financially feasible. The real bills doctrine is not a license to create money without productive backing.
The point is that an economy need not wait for the wealthy to accumulate sufficient savings before it can finance new productive assets.
If we want an economy in which economic opportunity and capital ownership are broadly distributed, we must begin with a sound understanding of money and credit. The Banking Principle provides that foundation.
The question is not simply where the money comes from. It is whether our financial institutions will make it possible for every person to participate in the creation and ownership of productive wealth.
That is the difference between financing an economy based primarily on past accumulations of wealth and financing one in which the future productivity of capital can become the property of many more people.
And that is precisely the kind of economy the Just Third Way seeks to establish.
Sources and supporting material
The article draws particularly on these original Just Third Way discussions:
The Currency Principle (October 17, 2019) — definitions and implications of the Currency Principle.
A New Monetary Principle (November 2019) — the Banking Principle, future savings, and universal access to capital ownership.
The First Principle of Finance (August 26, 2020) — the distinction between past and future savings.
Is Industrialization Evil? (September 17, 2020) — the relationship between the Banking Principle, real bills, and capital formation.
News from the Network, Vol. 11, No. 47 (November 2018) — commercial bank credit and financing capital acquisition through future earnings.
Editorial note: The article presents the monetary argument from the Just Third Way's perspective. Its central proposition is that properly structured, asset-backed commercial credit can finance productive investment without requiring an equivalent pool of previously accumulated savings. This is the theoretical foundation of the proposed capital-ownership reforms, rather than a claim that all bank-created credit is automatically productive or noninflationary.
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There you have it. If you didn’t care for it, send in your own effort about some aspect of the Just Third Way and if we like it, we might even use it.
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