The textbook explanation of how economic activity is financed is based on a simplified conception of the function of banks and the stock market. Banks theoretically use their depositors’ money to make loans to businesses, and the stock market enables businesses to raise money by selling “shares” to individual investors. Each of these ideas glosses over important aspects of the process. 

When a bank extends credit to a business, it is not actually using its depositors’ money; it is creating new money which will circulate through the economy without having any impact on the amount of money each depositor has at its disposal. [ see Banks ] 

More importantly, the main function of the stock market is primarily to provide liquidity to investors who buy shares and to enable speculators to gamble. Only with an initial public offering or when a company issues additional shares does the money an investor pays for shares of stock go to the actual business in which he is acquiring the shares. Normally it goes to another investor who owns the shares. The justification for the stock market is that it provides liquidity to owners of shares. If investors could not easily sell shares in a market, they would be much less inclined to buy them in the first place. [see Liquidity ]

Both these methods of financing imply that money must come from savings and that growth of an economy depends on the willingness of some to forego current consumption in the hope of accumulating “wealth” in the future. Mainstream economics even defines “saving” and “investment” so that they are equal in the accounting of national income, although this definition is complicated by the fact government surplus or deficit is classified as “public saving” (which is negative if there is a deficit). Nonetheless if investment is funded by the creation of money, there is no need for anyone to forego consumption. In fact, the additional money injected into the economy as an investment in production of capital goods could enable more consumption as it circulates through the economy.  This would be equally true of government money creation and the extension of credit by banks. 

If this is hard to believe or seems like a have-your-cake-and-eat-it-too fantasy, it is because of the ideas we have about money.  Given the current system we know that personally we cannot “invest” without foregoing “consumption,” and the textbook explanation uses the same frame of reference: “Increasing capital requires the sacrifice of current consumption to increase future consumption. Instead of eating more pizza now, people build new pizza ovens to make it possible to produce more pizza for future consumption.” [see Samuelson p.417 ] This may be true if you are the owner of a pizza parlor wanting to expand and unable to secure a line of credit to do so, but it need not apply to the economy as a whole. It only applies to a system where economic prosperity or growth is based purely on the efforts of autonomous individuals to better their own lives and where money is a commodity with a price set by a market. Thinking about economic relations and money in a different way can actually change the way things work.

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