Some heat has been expended in the comments section of this blog concerning the ability of banks to create money of thin air, which despite the evidence some would seem to claim is not true. So let me offer a reference to this journal paper by Richard Werner, the creator of the quantitative easing concept:
As Richard says in the abstract:
This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing' and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust' produced by the banks individually, "out of thin air".
This, of course, only confirms what the Bank of England has recently admitted. And because, as the Bank of England also admits, it can use the quantitative easing process to create money - and this process is not restricted solely to the purchase of gilts gilts but could also be used to purchase bonds issued by a Green Investment Bank, local authorities, housing authorities and others to fund a Green New Deal - a process I call Green Quantitative Easing - this ability to create money out of nothing can, when an economy is working at less than full capacity, be used to deliver prosperity costlessly and without obligation for the loans to be repaid.
The costless element comes from the fact that if money can be created out of nothing there is no obligation to pay interest on it: such sums can be advanced as if share capital to those authorities able to use them for public good. And the absence of a need to repay comes from the fact that if the money was created out of nothing then there is no need to repay it because no one provided it.
The question then arises as to why this is not being done? Isn't that obvious? To do this would challenge the commercial banks' ability to make money from lending and their chance to extract what in economic terms is called a rent from doing so which is the foundation of the excess returns that the City of London makes at cost to all the rest of us. Green quantitative easing is a direct challenge to the City's right to extract that worth from all of us to benefit a few when it is possible for that worth to instead be used for social good. And that's precisely why it has not happened to date. And precisely why it must be used in future.
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Richard Werner’s paper is about the “credit creation theory of banking”.
I have no specific problem with that theory – banks can and do extend credit (though there are limiting factors). What you have done here is equate “credit” with “money” on a balance sheet.
If someone borrows money, their net financial position hasn’t changed. If they started with zero on either side of their balance sheet, with a loan they now have an asset (cash/money) and a liability (to repay the loan). They aren’t any richer because of the loan, but they do have money now which they can spend and repay over time. Broad money supply has increased, as has the velocity of money.
The Bank of England agrees that this is also the case. Banks create credit “from thin air” as you call it, which the BoE call “broad money” or the M4 money supply. This is distinct from the M0 money supply – which they go to great pains to point out.
Where you go dramatically wrong though, is that you only look at one side of the balance sheet in this credit creation. You see new “money” which can then be used to purchase assets. In reality, this credit creation doesn’t make us inherently any richer as there is an offsetting liability. That as an accountant and self-professed economist you ignore this is hard to fathom. You can see this very clearly on page 16 of the full BoE report you link to.
You then take this erroneous approach and apply it to QE.
“a process I call Green Quantitative Easing — this ability to create money out of nothing can, when an economy is working at less than full capacity, be used to deliver prosperity costlessly and without obligation for the loans to be repaid.”
The BoE dispute this. On page 24 of the report, you can see that QE doesn’t affect the balance of asset/liability statements (figure 3) and they specifically state that QE is not free money.
I’ve asked this before, and haven’t been given a straight answer. If you could create “free money” with no need to repay it, why hasn’t it been done?
You give an answer based on a corporate capture conspiracy theory, but seem to forget that many countries in the world have majority owned banking systems. Yet those countries still need to borrow and issue debt. A policy from a government which could remove all national debt, and at the same time enable almost unlimited government spending on its people would surely prove an enormously popular policy for the party which enacts it. Are you really saying that every government in the world has been captured by some nefarious banking cabal?
Or is this (as I am confident it is) simply a way of trying to deflect attention from the reality – that creating money out of thin air devalues that money and creates no new wealth which can be used to buy all the infrastructure you promise.
Green QE as you term it is not QE by the BoE or even Richard Werner’s definition. It is monetarism – printing of new money Weimar Republic style. I have no problem with you arguing for that – as long as you acknowledge the risks involved and stop arguing that there are no consequences to such actions. Why will you simply not acknowledge this fact?
Of course creating money dies not make us wealthier
It’s what you do with it that counts!
The last round of QE made a few richer at cost to the rest of us
But that does not mean the money could not be used as I say
And by being used in that way it will create wealth
Or do you deny money by its existence can aid that process?
And I do not argue this can be done without limit – so yet again you are simply creating straw men
Your arguments are those of a man clinging to a life raft of failed belief
Ed comment:
Comment deleted for being repetitive and time wasting
I see you have resorted to simply deleting comments when they show you up. Truly the cowards response – though you could always prove me wrong by posting the response you deleted.
I thought Quakers were meant to listen to other peoples views. Instead you seem to resort to censorship, rhetoric and abuse.
As I said, the only one clinging to a life raft here is you – you’ve directly contradicted yourself in your very own arguments.
Editorial freedom is a fundamental right
And I have listened to you repeatedly – and repetition does not change what you are saying, to which I have fully responded
You disagree with me. I have heard that loud and clear
And I am very comfortable with the position I have taken and its validity and that many people who I think wiser than me agree with it
In which case I think your rather cowardly trolling behind anonymity is something I can now quite appropriately dismiss
No further comments from you will be posted. I have even provided you with the chance to be rude – which is what you all resort to
“corporate capture conspiracy theory”. It’s a pretty open conspiracy. Parts of the state structures are transferred to private operation almost every week.
In the eurozone, a system designed by bankers with the Delors committee including our own Mr. Leigh Pemberton, governments who wish to borrow had to go to the bond market. Belatedly the ECB has stepped up to the mark. Governments do seem to be directed by financial interests rather than by considerations of full employment or other social objectives.
PPC,
Re your claim that commercial banks do not create money I suggest to look up the definition of “money” in a dictionary of economics. You’ll find it defined as something like “anything widely accepted in payment for goods and services or in settlement of debts”.
If I get a loan from a bank and the bank credits my account, I can then run out with my cheque book or plastic card and buy goods and services, no problem. Ergo commercial banks create money when the grant loans.
End of argument.
Ralph
Think you have missed what PPC has been saying all along – and are doing exactly what Murphy has been.
That money you get in a loan is really credit. You can buy things with it but have an offsetting liability against it, because you have to pay the bank back. You have money to spend but are no richer. In Bank of England terminology it is broad money supply.
If someone gifted you cash, which the Bank of England calls base money, you have no liability and are simply a little bit richer.
PPC might be pedantic, but he is correct. There is a real difference between “money” and “credit” in accounting and finance terms. The “money” created by QE has a liability on the other side, so can’t be used in the way Richard suggests.
The double entry of QE is entirely within HM Treasury control
It is money, not credit
It is accepted as money because people trust the BoE
The main point is being missed.Money is the oil that enables economies to function and the fuel that allows them to expand.Serious problems arise when the major source of money is as debt created by commercial banks. At least 50% needs to be created debt-free by sovereign states – which is where we were in 1970 before “Big Bang”; prior to QE we were in an unsustainable situation where 97% of M3 – £1,700bn – had been created by commercial banks out of thin air; against a mere £100bn debt free BOE money. QE attempted to address two problems: [1] Bailout dysfunctional insolvent banks and restore liquidity to the banking system [2] Inject money into the economy to fend off recession. Unfortunately QE failed in the second aim since nearly all of the money beyond that needed to bolster banks’ capital reserves cascaded into increased asset prices; stocks and commodities creating bubbles, most of which have yet to burst – oil is just the first! QE will not be reversed and further QE must be directed towards sound functions in the economy – eg. capital and infrastructure projects – certainly for the unexpired duration of the repurchased bonds. Of course, at the same time, the dissipation of the repurchased bond coupons alleviates pressure on taxation.
Money is the oil that allows economies to function. Too little gives rise to recession, depression, stagnation and deflation; too much creates inflation. Increased wealth cannot be created without an increase in the money supply – preferably not as debt. Creating the necessary monetary expansion as debt tends to just flow into the hands of the wealthy, especially bankers, thereby “justifying” obscene salaries and bonuses. You can have shed-fulls of goods but if the customer is skint so are you! If too much of the money supply is created by commercial banks as debt then eventually the debt compounds exponentially giving rise initially to stagnation and ultimately collapse. It’s very simple really!
The main point is being missed.Money is the oil that enables economies to function and the fuel that allows them to expand.Serious problems arise when the major source of money is as debt created by commercial banks. At least 50% needs to be created debt-free by sovereign states — which is where we were in 1970 before “Big Bang”; prior to QE we were in an unsustainable situation where 97% of M3 — £1,700bn — had been created by commercial banks out of thin air; against a mere £100bn debt free BOE money. QE attempted to address two problems: [1] Bailout dysfunctional insolvent banks and restore liquidity to the banking system [2] Inject money into the economy to fend off recession. Unfortunately QE failed in the second aim since nearly all of the money beyond that needed to bolster banks’ capital reserves cascaded into increased asset prices; stocks and commodities creating bubbles, most of which have yet to burst — oil is just the first! QE will not be reversed and further QE must be directed towards sound functions in the economy — eg. capital and infrastructure projects — certainly for the unexpired duration of the repurchased bonds. Of course, at the same time, the dissipation of the repurchased bond coupons alleviates pressure on taxation.
Money is the oil that allows economies to function. Too little gives rise to recession, depression, stagnation and deflation; too much creates inflation. Increased wealth cannot be created without an increase in the money supply — preferably not as debt. Creating the necessary monetary expansion as debt tends to just flow into the hands of the wealthy, especially bankers, thereby “justifying” obscene salaries and bonuses. You can have shed-fulls of goods but if the customer is skint so are you! If too much of the money supply is created by commercial banks as debt then eventually the debt compounds exponentially giving rise initially to stagnation and ultimately collapse. It’s very simple really!
It is simple unless you are too blind to see
Or are a banker
I agree with Ian.
In fact let’s stop calling it ‘corporate capture conspiracy theory’ and call it ‘Observed Corporate Capture Practice’.
Any normal person can see that later rounds of QE just helped to keep the status quo going. It helped to fund asset acquisition and left the real economy to rot (or shall we say ‘adjust’) with lower wages, less hours etc.
There was a double lock of low demand (created by the Chancellor telling us how bad things were) which then made business reluctant to invest so that the QE released to banks sat in their accounts instead no doubt helping them to fill the holes in their accounts created by the 2008 crash and /or funding credit for asset purchases for the top 5%.
The whole thing seems very similar to what Richard Werner discussed in his book ‘Princes of the Yen’ concerning the Japanese economy in the 1980’s/90’s.
Printing money does create flows of real money into the real economy through transactions in that economy – it will provide turnover for business and wages for workers plus also tax revenue for government. By rights, politicians should do this.
The way in which central banks hold back the printing of money can only be explained by the fact that commanding heights of banking have indeed been captured by the very rich who see the growth in their earnings driven by debt – lending their cash out. This is the best way for them to preserve the value of their cash – which as we all know declines with time.
This is not a conspiracy; it’s a compelling factual account of practice.
After 2008 I spent a very long time puzzling over where the money that people lost went. Were other people enormously richer? There were a small number of hedge funds became incredibly rich, but I think most of the money just disappeared.
So that just as money can be created out of thin air, it can equally easily disappear into thin air.
The easiest way to look at it is to ask what happens if you buy an apartment in a block for £200,000. In a couple of years the identical apartment next door sells for £400,000. Are you really richer? You have the same number of pounds in your pocket and the same apartment. A few years later, another apartment sells for £100,000. Are you really poorer?
My suggestion is that most money is notional. Money is only real when it moves. If you take out a mortgage on the apartment, then money moves. But if the apartment falls in value and you can’t pay, then the bank finds that the money has still disappeared.
If you accept that most money is notional, then it helps explain how bubbles can be based on imaginary money and can so easily get out of control.
Richard, I notice that from time to time, generally on a Friday, you step into the cauldron of money creation and stir up the wrath of those who blindly accept the basic economics teaching of the past.
I think it is fair to say that Richard Werner invented the term “quantitative easing” but he used it to describe the money creation process which was already in existence and was used by central banks in the past.
I know you fully understand the process, Richard, but this link gives more detailed information for those who would like a deeper explanation.
http://www.positivemoney.org/how-money-works/advanced/how-quantitative-easing-works/
Printing money – which this suggestion is – is simply a means of transferring purchasing power from those who don’t receive it to those who do. It is therefore a form of taxation. But a very hidden one. Really it is no different from what banana republics do.
Do you realise 97% of money in the UK is printed by commercial banks
And that is why the 99% are stuffed by them?
Don’t you realise that this proposal corrects that?
But it’s not tax except to the extent it will create real income on which tax will be paid?
It has exactly the same effect as tax. Some people have less money, some people have more money spent on them. Inflation is a form if tax and this is inflation of the money supply. It’s not at all novel. Many if not all governments have used it to raise revenue.
I am sorry to say you really have no clue about the economics of tax
Inflation is emphatically not tax
It replaces the need to tax though doesnt it? Instead of taxing to get money, you just print it. So the question must be who pays the price for this free money? Someone must. And the answer is everyone who uses money because money is devalued. It is in fact very regressive, so I’m surprised you favour it. Why not just tax the rich to pay for things?
I agree if that is your argument: money can, as QE proved, help balance a budget
And of course QE has massively favoured the best off. That is regressive
Green QE is progressive
The reason it is progressive is because the money is used to benefit poorer people. That’s the spending part. But that doesn’t stop the printing part being regressive. So why not raise the money via progressive taxation and it would be even more progressive overall? There will be some poor people who will not benefit from the spending, but will suffer from the inflationary effect of printing. Pensioners on fixed income for instance. All things being equal the way the money is raised is regressive compared to a targeted tax. So why not raise it that way??
Inceasing Rac would take money out of the economy
We want to inject money into the economy
That’s what QE does
And printing us neutral
It’s the spending that makes the difference
As our 2009 paper for the Economics for Ecology conference put it:
“At this point, the simple fact is that regarding economic theory, no one knows what to do next. Possibly this has escaped immediate attention in Ukraine, but, economists in the US as of the end of 2008 openly confessed that they do not know what to do. So, we invented three trillion dollars, lent it to ourselves, and are trying to salvage a broken system so far by reestablishing the broken system with imaginary money.
What is not guesswork is that the broken — again — capitalist system, be it traditional economics theories in the West or hybrid communism/capitalism in China, is sitting in a world where the existence of human beings is at grave risk, and it’s no longer alarmist to say so.
The question at hand is what to do next, and how to do it. We all get to invent whatever new economics system that comes next, because we must.”
The following year, we presented the core argument from the 1996 paper which warned of the risk of uprisings as a consequence of this process allowing wealth to accumulate in the hands of a minority.
http://www.p-ced.com/1/node/325
Hyman Minsky was very clear that he didn’t consider banks extending credit to be loans at all, because there was nothing being loaned (as Richard Werner confirms).
Minsky famously said “everyone can create money; the problem is to get it accepted”, and this is the function that he considered banks to carry out when extending credit. He called it the “acceptance function”, and saw it as a development from discounting bills of exchange (the ‘traditional’ activity of commercial banks).
“Banking is not money lending; to lend, a money lender must have money. The fundamental banking activity is accepting, that is, guaranteeing that some party is creditworthy. A bank, by accepting a debt instrument, agrees to make specified payments if the debtor will not or cannot… A bank loan is equivalent to a bank’s buying a note that it has accepted”.
Viewed like this, a bank’s business is to create it’s own liabilities in exchange for the liabilities of someone whose credit it chooses to guarantee. Whether or not a bank carries out this acceptance is more often than not down to the presentation of adequate, quality collateral (e.g. a house).
I wanted to offer this alternative perspective as I find the phrase “creating money” to be so highly charged and value laden that it can hinder discussion more than help it. Much of the current debate, in my view, is a clash of semantics.
It is hard to ‘do’ economics, in the broadest classical tradition, with anything except commodities. As wikipedia puts it, “a commodity is a marketable item produced to satisfy wants or needs. Economic commodities comprise goods and services”. When they deal with money at all, economists tend to view it in this ‘commodity’ manner, which is an essential prerequisite for establishing a quantity theory of money (money must act like a commodity, i.e. always and only an asset, if its market value is to be established and adjusted by setting the amount of the stock of money available to the market). If you conceive of the value of money being established by the amount of it in circulation, you are operating in this mode of classical economic theory.
As Werner points out though, money isn’t currently being created with any concern for the size of any money stock. The closest we come today to the notion of ‘money creation’ is when banks create liabilities in acceptance of their customers’ credit (and most often with collateral backing). The Bank of England chooses to define broad money as the sum of various liabilities of the commercial banking sector, and some of its own (notes and coin), and it exerts control of how freely banks accept their customers’ credit by controlling their access to the reserves they use to settle in the payments system, and hence controlling banks’ available liquidity. In this ‘finance’ view, the value of ‘money’ liabilities are supported by the collateral assets that back them and are freely convertible with them.
These two views clash. The economics view doesn’t operate well without money being an easily defined commodity, so will seek to present money as if it were a commodity, and even propose policy to try to make it act like a commodity. As is typical with economic theory, much is abstracted from. In the theoretical story of money creation, what is the role of collateral for bank ‘loans’? It tends to be abstracted out of the picture in the ‘out of thin air’ view as do balance sheets and accounting. There’s usually some point in the ‘out of thin air’, economics led view, that a bank’s balance sheet (usually the central bank) is destroyed by the creation of liabilities unbacked by asset collateral. This is not problematic for a theory that suggests value derives from the quantity in circulation, but for a view where the value of liabilities depends on backing assets it’s the difference between QE expanding central banks’ liabilities in line with assets purchased, and the Reserve Bank of Zimbabwe expanding its liabilities with no worthwhile assets at all. Balance sheets don’t matter in economic theory, but there’s a slim chance they might count for something in the real world.