It would be hard to overstate the importance of an article in the latest edition of the Bank of England's Quarterly Bulletin. Entitled 'Money creation in the modern economy' it is hard to know where to start quoting from the piece, so I will start with its conclusion:
This article has discussed how money is created in the modern economy. Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves: banks create money whenever they lend to someone in the economy or buy an asset from consumers. And in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money. The Bank of England is nevertheless still able to influence the amount of money in the economy. It does so in normal times by setting monetary policy – through the interest rate that it pays on reserves held by commercial banks with the Bank of England. More recently, though, with Bank Rate constrained by the effective lower bound, the Bank of England's asset purchase programme has sought to raise the quantity of broad money in circulation. This in turn affects the prices and quantities of a range of assets in the economy, including money.
I have been arguing that this is the case for many years. So have people like Ann Pettifor and Frances Coppola. And to be candid, we've been treated as little short of mad for saying so. The reason for that is obvious: we had the temerity to challenge the standard economics text books on this issue and say that money does not work in the way they say it does. Now the Bank of England has confirmed that we were right to do so.
We were right to say that money is created out of thin air when banks lend to their customers.
We were right to say that it is lending that creates deposits, and not saving that does.
We were right to say that saving is not a pre-condition of lending, or as a result of growth.
We were right to say that quantitative easing was an exercise in money creation and that there is, as a result, no reason to unwind it.
And we were right to say that 97% of all money is a confidence trick - it is as good as your bank's ability to repay it to you because it only exists as a liability on their balance sheet.
That, I admit is a pretty staggering list of things to say that a group of economists, largely working outside the mainstream, were right about when the mainstream - including almost all those teaching undergraduate economics, and many of those who took that teaching into their work - were wrong.
But, being right is one thing, satisfying as it is. Working out the implications of this admission - which are potentially huge - is another thing altogether. That's something I will return to, hopefully later this morning.
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One possibly fruitful aspect is consideration of whether the banks are guilty of fraud, gaining pecuniary advantage by deception. They suggest they’re lending us existing money (loans, mortgages, credit cards) and demand interest on it when in fact they’re making such sums up out of thin air. They cannot, I should point out, create these sums without the participation of the public through their signature on a loan, mortgage or credit card application. Interest on a loan is usually considered perfectly fair as, while I’m lending my money to you, say, I’m denied the use of it myself and so I should be compensated in some way, otherwise I’ve no ‘interest’ in making the loan. This is why it’s called interest. Nothing comparable happens when banks make, ahem, ‘loans’ though, as they aren’t being denied use of any existing money. Why should they get any interest then? They could argue that since they’re exercising their right to money creation in your favour then they should be able to charge a fee of some kind, and arguably indeed they should be, but this then provokes the awkward query, why are they and only they allowed to create money from nothing in the first place? How fair is this on the rest of us who don’t have this privilege? One feels the sun may be setting on the banking empire…
Positive MOney has been also campaigning on this issue for the last four years-their website has videos linked to this issue and the recent acknowledgements of the BoE:
http://www.positivemoney.org/2014/03/bank-england-money-money-creation-modern-economy/
Not sure it is totally correct to say that QE is an exercise in money creation for the whole economy although it created extra liquidity for banks which contributed to asset bubbles. Economically QE has been a failure other than stopping the banks collapsing -which some argue would have been a sharper learning curve.
Even the BoE is being loose about their terminology now.
Banks don’t create money, they create credit. M4 money supply, not M0/M1.
And no, that CREDIT is not created out of thin air, it is a maturity transformation and the balance sheet of the lender still needs to be made whole, normally via short term lending/money markets.
If nothing else, if the above was not true, asset/liablity accounting would simply not be necessary, and capital adequacy ratios would not matter.
The Bank explains completely, and appropriately why the double entry of the credit creation that it talks about does work. Please go and read the paper, and please stop pretending that the world is not as it really is
The bank loan is BOTH an asset and a liability to the bank. Banks simultaneously create a loan (asset) and a deposit (liability). Er….that’s it….isn’t it?
As for the CAR…did it make any difference in the end? (Basel 1,2,3…..)
One wonders if there are different factions within the bank itself at odds with each other given that Carney was recently asked in an interview how money was created and he hemmed and hawed about it, yet from within the lower ranks and files comes this composed revelation.
You have to wonder why we don’t remove the private banks ability to create money.
Make that a central bank government function subject to some rules on matching the money supply with purchasing power and the real economic growth. The funds could then be to handed to government to spent into existence on infrastructure developments or given away to pay down debt(mandatory) or spend/invest in the an approved scheme. (Ref Steve Keen)
Move the banks to full reserve banking and reduce the regulation and let them compete with new entrants on a level field.
QE isnt going to be reversed so they have had to acknowledge that money can be created out of nothing- subject to confidence in the currency.
The next thing to admit is that inflation is really a tax, that they control.
My preference would be for a nationawide chain of money creators similar to the old bank managers. They’d know their patch, who could and couldn’t be trusted, and would dispense interest-free credit not on the assurance that it wouldn’t not be paid back and so nudging the issueing bank to insolvency but rather that it would be put to appropriate use and so not devaluing the currency. The process of money creation needs to come out into the open and be understood for what it is. There’s no need for a sovereign nation (or its agents) issuing credit/money to demand interest on that credit as it benefits by the wealth duly created, there, if you will, is the ‘interest’.
What the quote did not say though should have, is that a government with an unpegged sovereign currency, such as the UK, creates money out of nothing as well. When the Government spends money it is at the same time creating it and can afford anything priced in its own currency. There is something very special about a sovereign government’s ability to create money. When it spends itself into a deficit it increases the financial assets in the private sector (ignoring the foreign sector for now) without creating an offsetting liability in the private sector. So when the private sector spends less than it earns because it saves or when investment creates capacity greater than it creates demand, the state can make up the demand deficiency just by its ever affordable deficit spending. The most important pressing economic problems of the day (other than the ecological ones)are on the demand side. With a sovereign currency the state has a ready answer.