The note has been written by regular commentator Clive Parry, who has been a bond trader for 35 years, as a response to the discussion on government and bank money creation on this blog over the last few days.
I will be writing a response addressing issues I think needing discussion. That should come out late today if all goes well. My points will address mattes arising from paras 3 (3) to 5. The rest I have no issue with at all, and I am not disputing the descriptions in the paras I refer to, but will instead discuss their consequences.
1 - Money creation
Pieces by Richard about money creation have attracted a lot of comment and quite a bit of trolling, too. Let me be clear, Richard is right – as supported by a string of Central Banks around the world (and every government bond trader I have ever known). However, this is just the start of the story and it is what happens next that seems to have muddied the waters. I thought it might be illuminating to explore this.
First, let's understand what a Central Bank Reserve Account is. The Bank of England (BoE) is “the bankers' bank”; every UK clearing bank will have a Reserve Account with the BoE – you can think of it as the Commercial Bank's current account with its bank.
2 - Money creation by the Government
Let's look at the creation/destruction of money by the government…. and then put it to one side. When the government spends money (eg. pays me my £1) the Central Bank Reserve Account of my bank will be credited with £1 and my bank will credit my current account with them with £1. Assets for the bank will have increased by £1 (the £1 in their account with the BoE); liabilities will have increased by £1 (my pound held with them). Total Central Bank Reserves for the banking system will have risen by £1. £1 has been created.
Equally, when I pay £1 in tax the reverse process happens. My current account is reduced by £1, my bank's CBRA is reduced by £1 and £1 is destroyed.
Also, government activity in the gilt market creates and destroys money. If I buy £1 of a gilt sold at auction by the DMO my bank account is debited by £1 as is my bank's CBRA and £1 is destroyed. Equally, this is true if the gilt is sold from the BoE portfolio of gilts.
And, of course, the converse is true; if the BoE buys a gilt money is credited to my account and my bank's CBRA.
It is also true that open market operations conducted by the BoE via the Rep market add or drain Reserves from the system.
In short, any transaction where the government (in all its guises – BoE, DMO etc.) is on one side, money is created or destroyed and it shows up in the aggregate CBRA balances of all clearing banks.
So far, so good. I don't think anyone would disagree with this. What about money created by commercial banks?
3 - Money creation by banks
If I borrow £1o,000 from my bank to buy a car…
- My bank will credit my current account with £10,000 and record (in a loan account) the fact that I owe the bank £10,000. There is NO movement in any CBRA. £10,000 has been created by the commercial bank. (Note that there is no change in aggregate CBRA balances when this £10,000 is created – it is a different type of money to government-created money but to us in our day-to-day lives we do not distinguish between them. Government-created money is base money. Commercial bank-created money is commercial bank-created money. In use, it's hard to spot the difference).
- I will instruct my bank to pay the car dealer £10,000;
- If the car dealer banks with the same bank as me, my current account will be reduced by £10,000, the dealer's increased by £10,000, the loan account unchanged. No movement in any CBRA account, no money is created or destroyed by this payment.
- If the car dealer banks with a different bank, my current account will be reduced by £10,000, my bank's CBRA will be reduced by £10,000, the dealer's bank's CBRA will be increased by £10,000, the dealer's current account will be increased by £10,000 (my loan account is unchanged). There is a £10,000 movement between the two banks' CBRAs but no change in aggregate CBRA account balances. No money is created or destroyed by this payment. It is a transfer if existing money.
- Banks must maintain a positive balance in their CBRA. So, all other things being equal if the car dealer banks elsewhere my bank will have to attract £10,000 back into its CBRA. It has three choices:
-
- Encourage someone to make a deposit (which will entail a transfer into my bank's CBRA).
- Borrow from another bank (handily, the car dealers bank may want to lend out the £10,000 it received).
- Borrow from the BoE. If my bank can't get the money elsewhere the BoE (as “lender of last resort”) will lend to my bank as long as it can post collateral against that loan – and, no, the car loan is not eligible collateral with the BoE it has to be gilts.
So, let's be clear the act of lending me money does NOT require my bank to borrow. However, if money starts to leave a bank's CBRA for any reason (e.g. the car dealer banking elsewhere) then the bank must borrow to keep its CBRA in good order with the BoE.
Now, if my bank can borrow at (say) 4% and lend to me at (say) 6% they will make 2p a year (as long as I pay them back). Now 2p is slim pickings for a banker…… so can I scale it up? In short, no.
4 - Equity Capital
There is a risk that loans will default and the bank will not get its money back. Banks must have a cushion of (equity) capital to absorb losses that occur from bad loans so that depositors can always be paid on a timely basis in full. How much capital? Well, it depends on who you lend to but the numbers are all laid out in the Basel Accords that apply globally to all banks. Regulators have continually tightened these rules and now, as a rough estimate, a bank requires 3 or 4 times as much capital for a given level of credit risk than it did in 2008. There is a limited amount of capital and that constrains lending.
Banks have had to shut down since 2008 but they have done so without recourse to financial support from governments (although the jury is still out on SVB and Credit Suisse, but it looks reasonably encouraging). You can't make stupidity illegal but having enough capital insulates the rest of us from banker's poor lending decisions.
Lending decisions are dominated by the amount of capital required to make the loan versus the interest earned over and above a bank's cost of funds. Nobody asks “do we have anything in our account to lend out?” – but it should be noted that the ability to raise deposits will factor into the “cost of funds” for a bank and therefore, obliquely into the lending decision.
5 - Liquidity
So, let's look at “cost of funds”. We currently live in a world of “excess reserves”. This means that the aggregate balances held by commercial banks exceed the levels required by the BoE. They came into being because the Government spent money without draining it out of the system by issuing gilts. (Well, they did go through the charade of issuing with one hand and then buying back with the other under the QE programme but the rise in CBRA balances is clear proof that it was a charade). That money was spent as (say) furlough payments that went into people's bank accounts and had a corresponding increase in their banks CBRA account. Whatever they did with it (except pay tax or buy gilts) it remained in the CBRA of one or other commercial bank. These reserve balances peaked at almost £1,000bn and are currently £800bn and the banks receive interest on them at the Base Rate and there are not enough borrowers who want to borrow these reserves so, going back to my car loan, if my bank pays the car dealer (who banks elsewhere) all they need to do is bid Base Rate plus a smidgen and other banks will be happy to lend their reserves to earn that smidgen over and above the alternative they have with the BoE. So, a simple view would maintain that the cost of funds is Base Rate plus a smidgen…. But it is not so simple. This set up of lending to me for 5 years and funding it in the overnight interbank market is not permitted. Not permitted because it makes my bank very vulnerable to a bank run. Banks need stable funding and this comes at a price. For Barclays this price is almost 1% above Base Rate for locking in funding for 5 years. Now, it is pretty certain that Barclays will be able to borrow overnight at Base Rate every day for the next 5 years – so why pay so much more to lock in money for 5 years? It is because regulators require it to protect banks from bank runs. So, “cost of funds” for their lending business is certainly not zero or even Base Rate.
What we should probably do is think about commercial banks in two parts; running current account banking/payment services and lending.
The lending side is where money is created. To meet LCR regulations they must finance their business by borrowing from (selling bonds to) the non-bank sector (borrowing from other banks just passes the problem round) and that costs. (I would say that a retail deposit base of insured deposits is handy, too, but meeting liquidity requirements is tough). Increased capital requirements and tighter liquidity rules make this a much tougher business than it was 15 years ago. The license to create money by lending is not “free money”.
- So where is the free money?
The current account bit is where the “free money” is. Whenever a customer receives £1 into their account it is mirrored by receipt of £1 in the bank's CBRA. The CBRA pays interest at Base Rate; my bank pays me considerably less (zero). Yes, there are costs associated with running a branch network, ATMs and Internet banking systems, and the interest margin earned was the quid pro quo for free current account banking. This was fine when Reserve balances were small (about £30bn prior to 2008) but now they are at £800bn the sums are huge £40bn at 5%, or £8bn for each percentage point Interest Margin earned. Not bad for doing very little. It does not have to be this way. You can't walk off with Reserves, they are “trapped” in the system so paying banks £40bn seems a bit unnecessary. This is “free money” for banks and should be tackled.
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I am going to read this a few times. Like all things economic, they take a while to stick!
The reply is well under way….
A spreadsheet would help to illustrate and explain
How?
I know someone who works in a special school for children with profound difficulties. They are short of Teachers’ assistants because the pay is so low. Teachers therefore have to take on some of the TA’s duties which detracts form their teaching role.
We can find similar in the mainstream education system , the NHS and much else.
Yet the govt. send billions to bank shareholders.
In 1958 J K Galbraith wrote a book I came across later -The Affluent Society’ where he wrote of private opulence and public squalor. We are back there now.
Oh yes
Galbraith got a great deal right
Thank you Clive, always noted your comments, and RM for establishing such discussions you can’t get elsewhere.
I didn’t understand the ‘£1′ value in section 3.2 “my current account will be reduced by £10,000, the dealer’s increased by £1, the loan account unchanged.”
Also questions I had:
1. I thought that banks had to cover a loan by a certain % of savings, by law? I guess CBRA (auto) transactions covers that.
2. Building Societies. Is there a higher requirement of savings to cover loans. I recently asked my building society manager. He said they had to be covered by savers’ deposits (no mention if the % of savings was offered when I enquired further).
3. I changed banking from The Halifax to Nationwide after the 2008 crash, as the former was privatised. I always suspected mutual building societies were less protected, by Govt, than banks? Is that so?
I added the £1 / £10,000 confusion, as I did not think a car loan of £1 realistic, which is what Clive used. So the editing errors were mine alone.
The requirement to cover loans is in regulation and relates to capital, not saving.
Real building socities are intermediaries. Those registered as banks (as most are) are not. Building socities are as protected for the consumer as banks are.
At some point, without wishing to be a nuisance, could that be cleaned up; for future readers?
Cleaned up in what way?
£1/£10,000 confusion.
I think that has gone now?
It occurs to me that when a bank charges a customer interest (such as on a loan/credit card), it is not creating money, as the customer has to find this money to pay it back; It must come from the economy, so it is a way for banks to accumulate money. Since a bank does not have to rely on savings to lend, this money earned from interest must end up going into a small number of private hands: shareholders and executive pay.
Since every penny of bank loan must be repaid (with interest), the only financial benefit to society is to rely on “trickle-down” economics from those who have earnt this interest, but at best, it can only be recycled, and the economy has no net gain in wealth.
Only government spending and paid interest can increase the net wealth of the country, as accounted for by the government debt, and inequality shows that this money is distributed unfairly in the economy.
Interest is a transfer of existing money to the bank for its gain as you note
Forget “trickle down” economics, what the UK needs is middle-out economics:
https://www.theguardian.com/politics/2022/sep/25/forget-trickle-down-what-the-uk-needs-is-middle-out-economics
Many thanks Clive Parry and Richard for this post.
It’s pretty clear. 🙂
I think it answers an earlier question about why banks still want our money. I think I’d (eventually) got there myself, but it’s good to have it spelt out. A look at bank savings rates shows “easy access”, i.e. zero notice, pays about 1.5%. So clearly if someone deposits money in such an account then the bank makes base rate minus 1.5%, or a nice little earner of 3.75%. And their marginal costs for doing this are very low since they are running their branch network etc anyway.
Clive says that, for loans, the bank must find the reserves so that their CBRA doesn’t fall below zero, even though they don’t worry about having the reserves before they make the loan. I can understand this pre 2008 when, as Clive says, “Reserve balances were small (about £30bn prior to 2008)”. But, now, Reserve balances are £800 billion. At least some, and probably many, of the banks must, individually, have quite large balances. They can’t get rid of these balances except by making loans which are then deposited in other banks. Overall, the total level of reserves remains the same. So, it seems to me, that, at the moment, with large excess reserves, banks often may not have to find more reserves once they have made a loan because they already have a lot. This means that from Reserves perspective they are unconstrained in their lending. The only constraint appears to be capital adequacy.
The Reserve balance for a bank is the total of its deposits (it is currently high because the government created a lot of money). If the bank isn’t constrained by finding reserves when it makes a loan it looks (emphasis “looks”) a lot like it is lending out deposits. This looks a lot like the old, discredited, incorrect, model of lending out deposits. If reserves were lower it wouldn’t look like this, it would be as Clive explains but, at the moment, it does LOOK (to me at least) a lot like the old model.
Furthermore one might interpret bank reserves as lending to the government. The government doesn’t need these “loans” because it can create as much money as it wishes. But, the BoE currently insists on paying interest on all reserves, so it looks a lot like a loan. An unwanted loan, forced on the BoE by its own crazy rule of paying interest on the whole reserves balance, but a loan none the less.
None of this invalidates what Clive and Richard (on many occasions) have been saying. And I don’t say this simply to be difficult or pedantic. But what looking at it this way does is to give neoliberals an excuse to maintain that it is the old, lending out deposits, model, even though it is not. It is certainly possible to make a, wrong but superficially, convincing, case to that effect. And that’s all neoliberals need to espouse their pernicious ideology.
What is needed is a clear narrative to discredit this line of thought. But I don’t know of one.
Any thoughts?
Tim
I am working io. this – as I signalled I would
Wait a bit….
Richard
Thank you Richard. 🙂
I don’t mean to nag.
With regard to interest on CBRA (point 6), the Bank of England does this in order to maintain its control of interest rates. If it didn’t do this and paid nothing on the reserves as appears to be proposed, interest rates would tend towards zero as banks competed to lend their excess reserves to other banks. As the banks are all stuck with their CBRA balances and in aggregate there are ultimately excess reserves in the system, the supply of reserves available for lending would outstrip demand for them and thus the interest rate would tend towards zero.
The Bank of England needs to have an effective means of transmitting its interest rate policies into the market, so it has no alternative but to pay its current interest rate on the reserves so that a floor is put on the interest rate at which reserves are available to be lent out. If it didn’t do so, it would no longer be setting the interest rate in the market as banks could borrow reserves from other banks at close to 0%.
Your comment makes no sense when the ECB and BoJ pay tiered rates on CBRAs
Unless you can explain how that works your claim does not stack
Richard,
The ECB only pays zero interest on the MINIMUM Euro reserves that banks have to hold at the central bank. The banks cannot, by definition, lend out their minimum reserves, so there is no need for the ECB to remunerate them. Back in 2019, the ECB’s said it introduced the two tier system of payments on reserves “with the aim of supporting the bank-based transmission of monetary policy”.
See https://www.ecb.europa.eu/press/pr/date/2023/html/ecb.pr230727~7206e9aa48.en.html and https://www.ecb.europa.eu/mopo/two-tier/html/index.en.html
Oh dear Rupert
Have you not realsied that banks never lend reserves?
Have you really not twigged as yet tht banks are not intermediaries?
Richard,
Technically, you are right, but banks do lend each other assets (typically gilts and other HQLA (High Quality Liquid Assets)) in the repo market and through the system of settlement via the central bank (already well described) that has the effect of moving their cash (and associated CBRA) to the bank on the other side of the repo trade.
See my discussion of this issue discussed this afternoon.
Yes, this is an issue and I have raised it when it has been suggested that no interest be paid on Reserves. I don’t think it is quite as simple as Richard suggests but there are several “low risk” ways that the interest bill can be reduced. Eg. the Reserves required to collateralise the payments system should be unremunerated. What that number is is not clear but could be in excess of £100bn. (There was some research on this by the Fed… but I can’t recall the details (or how it applies in the UK)).
The tricky bit is to create a system that decides at a bank by bank level what the correct level of unremunerated Reserves is…. but can, I think, be done.
I do not deny the need for work on the practicalities of this. But I also think it possible.
… also, the aim is not to eliminate ALL remuneration of reserves. Just because you “can’t pay zero on everything” does not mean you should “pay Base Rate on everything”.
So, we start with the easy bits and go from there.
Agreed, totally
I entirely agree some reserves will be remunerated
Clive, you quite often, rightly refer to “unintended consequences”; which are a fundamental insecurity and instability, that provide a troubling problem, that will not go away; for both monetary economics and banking, and indeed for practical business. The problem here is that it is a great deal easier to worry about setting a level for interest free reserves (when a lot of banks will be exercised by it) than it is to worry about ‘unintended consequences’ (unknown unknowns – Rumsfeld); but this whole post-2008 system is in reality not a deeply thought through and configured master plan, but I suggest the final refinement of what is, at base a hastily rigged, spatchcock device that is the product of a hasty rationalised panic response to an overwhelming crisis that devoured the credibility of the whole system; and that has, in monetary/banking terms, at best a short – and not wholly convincing in all respects – history*, and virtually no sense of the unintended consequences. What are the “unintended consequences” of paying for reserves? Effectively the banks are being lavishly subsidised for providing what is an essential service. Is this really the best answer, the only way?
I do not wish to sound apocalyptic, but what is the point of commercial banks if they have to be subsidised simply to provide a secure market place that will not collapse and destroy the system? Whatever that is; if that is the best solution, someone is asking the wrong question.
* I offer the real surprise of Truss; collateral calls from Liability-Driven Investment (LDI) pension funds: an unknown unknown? So what is the next one likely to be, and could it arise from some unforeseen/unforeseeable consequence of interest on reserves?
I think you recognise that Clive and I are struggling to find answers in what is an uncertain mess where there are no definite answers but very clearly something wrong.
Another fantastic post/thread: thanks to Clive, Richard and others.
WRT high rates earned on CBR by banks:
1. Why does it matter? It seems to me that what it does is make bank owners relatively wealthier ie increasing wealth disparity. I’m not saying I think doesn’t matter, just trying to get at the fundamentals.
2. Isn’t it another form of money creation by government?
3. One means of tackling it could of course be taxation.
Thanks to all for an interesting and stimulating thread 🙂
Perhaps, as someone completely outside the world of finance, accounting, and economics, I can offer a different perspective.
Why does the government need to pay interest on ANY reserves. Pre 2008 it didn’t really matter, but now with vastly greater reserves it clearly does.
One argument I have heard is that it is the mechanism by which monetary policy is transferred to the real economy. I can appreciate that though, as discussed, there is no need to pay interest on all reserves.
But why do we want to transmit interest rates to the real economy? There has been a lot said about how inappropriate the current high interest rates are. Is there significant evidence that interest rate policy has ever been an appropriate tool, other than to cause recession? So why should the government facilitate it’s application to the real economy at huge cost in subsidies to the banks?
Are there not better ways to manage the economy? What about taxation? And, if there is a need to control interest rates, why not the Japanese approach of defining the yield curve on government bonds (gilts).
Is there a risk of missing the wood for the trees, or am I failing to understand?
Low interest rates are a pre-condition of a successful economy now, I suggest
But base money does need to be transmitted to the economy. Our money supply cannot be met by commercial banks alone.
Bless you Clive, bless you – as well as our host.
Most useful.
Richard, Clive many thanks. I shall reflect on these two posts, rather than rush to comment. May I suggest you make them both easily accessible, Richard for those who may wish to return to read them, or merely come later. An easy access entry on the Home Page would be helpful (I am thinking of new readers and returning readers for a second look).
Let me think about that…..
Great thread,
Clive,
You make this statement.
“Now, if my bank can borrow at (say) 4% and lend to me at (say) 6% they will make 2p a year (as long as I pay them back). Now 2p is slim pickings for a banker…… so can I scale it up? In short, no.”
Just a few ideas for perusal.
I actually would argue here that the bank creates the credit(or money if you prefer, which I tend to) at very little cost, and so the actual bank profit is way higher than you say. Some checks have to made on the loanees for example but other than that there are no costs.
Most netting out of transactions by banks does not vary much day to day. In fact over a few weeks I’d be surprised if any net difference occurs at all. For all the many daily payment transactions the eventual amount that gets netted out by the banks would therefore be neutral. (unless you have a turbulent market where vast sums are leaving the country or coming in or being withdrawn as cash and stored under mattresses or used to buy other assets, but those would be crisis situations).
So in normal times, if we now say that the bank does not have to really go and find £10K to lend £10K we can now say what actually happens is that the bank creates the £10k and just gets to keep the whole 6% profit in total because it hasn’t actually had to borrow anything at all,….or it may have had to borrow a very small fraction to compensate for some odd anomaly in bank settlements. At any rate the banks do not worry too much about finding reserves when considering their lending, if someone looks a good bet they will lend regardless and worry about the reserves later if they indeed worry at all.
It is very hard to see this at a macro level and also apply micro level analysis. So the banks get away with avoiding scrutiny on the profit they make on this. It would be interesting to get figures showing actually how much banks pay on deposited money, my guess is that it is quite small compared to all the money on deposit. I would hazard a guess most deposits sit in idle current accounts earning no interest whatsoever for the depositor.
You get to the cure of the issue
Bank regulations mane it seem like banks have to borrow the funds they lend
They don’t. The lending arrangements are net zero sum, I think, and disguise the reality of what is happening.
You can’t both create out of nothing and have to borrow. That is not possible, and we know they crate out of nothing. So the rest needs to be unpacked as it is a sham. But I need to do more on that.
For every loan made there IS a deposit raised. The very act of lending creates that deposit…. whether or not it has to enter the interbank market or not to borrow.
The profit for the bank is the Net Interest Margin (NIM) – the rate earned on the loan minus the rate paid on the deposit – less any credit losses.
Now, we just don’t know what a bank has to pay to attract/keep deposits. Big clearers can get away paying zero on current accounts; small specialist lenders might have to pay Base Rate plus 0.25%.
In many ways, the whole point of my piece is to say “money/credit creation is not free money for banks BUT taking our deposits at zero interest and keeping it at the Central Bank and earning Base Rate IS free money”.
Re your conclusion, I have to disagree
The second part is right
The first part is not. Money creation is free. And deposits are the same in both cases. So it is only regulation that makes money creation look to not be free. That is the issue.
Clive
Re NIM…I am not a trader like you but it seems to me that it is using an inaccurate model of how the banks actrually work there. It is indeed the big lenders we need to be concerned about here not the smaller specialists.
When a loan is made the bank does not raise any new deposits on which it has to pay interest. It just creates the loan which then becomes a deposit in its ledger(set against some real asset for larger loans). What happens after that depends on the holder of the deposit. They may move it all by spending it with someone with a different bank or they may just leave some or all of it at in their account, no one knows, we just see a cummulative effect of many singular decisions.
End result though, is that the bank pays no interest at all on that new loan/deposit they just created. The only cost then to make any loan is the loan officers time. But the receiver of the loan is going to have to pay it back with his own hard earned cash, plus find the money to pay the interest on top of that…. and that is the magic of commercial bank lending. Yes there are also defaults but they tend to be small and these will be factored into the margins, such that they are.
I agree that this is on top of the profit they are making from the interest on CBRA’s held at the central bank,which is scandalous right now,but that is totally unaffected by the loans/deposits they are holding/creating. What matters there is that they do not leak deposits to other banks on a consistent basis ,which no doubt affects the interest thay have to offer to tie their deposits down.
In effect the banks are making double profits in this way, its a double edged sword for them.
You are heading in the nright direction by standing back and looking at the big picture
My point is that it free money all boils down to NIM and size.
The size is focussing the mind because CBRA balance are £800bn not £30bn.
The NIM has come into view as the Base rate is now 5.25% not 0.25%….. with many depositors only being paid zero or a pittance.
Now this money is coming to banks WHATEVER banks do in providing credit to the real economy – lending does not alter aggregate reserve balances.
The solutions are
1) stop paying base rate on some of the Reserves
2) force banks to pay base rate less a sensible margin
3) taking back the money via tax
4) offer savers a competitive rate at NS&I
Credit creation does enrich banks at the State’s expense in the same way… because Reserve Balances do not change.
ERROR
Last sentence should read….
Credit creation does NOT enrich banks at the State’s expense in the same way… because Reserve Balances do not change.
“I am quite sure the state will not want to be in the market of providing commercial bank style credit.”
No, But I am sure it wants to ensure there is freely circulating money accessible easily to all for the benefit of the transactions that make life possible; and the sovereign issuer should wish to ensure that the money supplied for this purpose circulates without a commercial bank acting as credit gatekeeper over every transaction (which we are quietly moving toward, without anyone noticing – except that recently there has been a blowback uptick in the use of cash, apparently).
So, do they really want to issue cash?
Clive you wrote about this complex topic and the charade very clearly. But Reserves/settlement balances are very confusing. This passage by academic and former Fed VP David Andolfatto was helpful for me and it leads me to a different conlcusion – that we need CBDC to simplify the system; that currently the CB can only bail out the banks!
“All the money we use today consists of bank liabilities, either private or central. Let me label this private bank digital currency (PBDC). I’ve also mentioned that CBDC exists in the form of reserves held in accounts with the central bank. Reserves are counted as a liability of the Federal Reserve. The third type of money takes the form of small‐denomination paper bills issued by the Federal Reserve. Let me label this central bank paper currency (CBPC). These too are counted as liabilities of the Fed.
The way things presently stand, everyone in the world is permitted access to CBPC, the paper component of the Fed’s balance sheet. However, only banks (and a few other agencies) are permitted access to CBDC, the digital component of the Fed’s balance sheet. Why is this the case?”
https://www.cato.org/cato-journal/spring/summer-2021/some-thoughts-central-bank-digital-currency
Why is this the case? In short, history and (then existing) technology….
With modern technology it IS possible for us to all have Central Bank money… a lot of people are excited by this.
I am unsure for two main reasons.
First, who will and how will they provide credit to the real economy?
Second, current proposals will still leave CB money “administered” by existing banks as the CB does not want the bother of this (IT, money laundering checks, ATMs etc.). So, to most folk it will appear the same so, with their PBDC guaranteed, why change?
Agreed
But the scandal of the CBRAs has to go in that case
Although the central bank does not want the bother of having a myriad of small accounts the is no reason why it can’t contract this out to a wholly owned subsidiary.
The model would be to have a not for profit bank competing with the for profit banks. The neo-liberal claim is that private organisations are always more efficient than public organisations. If that’s so they have nothing to fear from a public not for profit rival.
An example of this model is the BBC. Whatever you think of them, this model has worked for decades in maintaining standards INCLUDING in the for profit broadcasters. This is something that those who complain about the licence fee conveniently forget (or never realised); the licence fee maintains standard even if you never watch the BBC. I might also mention that TV advertising revenue costs the average household more than the licence fee, but that’s another discussion.
A state owned bank would be much better
But digital currency is a total distraction
Clive,
“With modern technology it IS possible for us to all have Central Bank money… a lot of people are excited by this.
I am unsure for two main reasons.
First, who will and how will they provide credit to the real economy?”.
There is so much flying around that (with other matters), I can scarcely keep up.
Well, this is interesting. I understand your caution; but do the commercial banks really do a good job of providing credit to the real economy? I do not think QE demonstrated a success, across the board. It provided a huge buffer, but didn’t do much to stimulate the real economy. The scale of excess reserves …. long after QE stopped? Legal tender always worked in the real economy, long ago in a pre-digital, primitive (but economically more effective) age. Now, with the near collapse of legal tender the Government what effective contact does the sovereign Government have with the real economy, and more important, the people it represents; except through commercial banks with a prime objective of their profit?
I understand your caution; but not if you imply scepticism of the objective. My problem is understanding the virtue or utility (for anyone) of commercial banks to the public or real economy; based not on theory, but the real, evidenced commercial banks we have, and the history they offer as a CV.
I am quite sure the state will not want to be in the market of providing commercial bank style credit.
Clive,
Forgive the rather garbled prose, but I have commented in considerable haste today, when I can.
This may be a minor quibble amongst all the other complexities of how the economy and money system works, but I’ve come to the view that banks do NOT create money, they ALLOW US to create money from nothing. The process is exactly the same whether we describe it as bank created money or not, but it seems there’s blame attached to banks for doing something that is legitimate and a cornerstone of the economy. That doesn’t mean to say the banks can’t be guilty of irresponsible lending …
I’ve never studied economics but I have been grappling with the concept of money from time to time beginning with Positive Money meetings maybe 10 years ago.
As I recall at that time there was a view that money was NOT debt, but I’m sure I’ve read a reversal of that position since then. Their website doesn’t seem to address anything so simple any more – maybe there’s a definition in one of their books.
The point here is that IF money IS DEBT, then when we borrow money from the bank or building society to buy a car or a house, WE are entering into an agreement that creates the debt. The bank alone can’t create the debt, it requires a borrower to sign the loan agreement or mortgage, and it’s that agreement, the signed bit of paper that is the IOU, the debt, or money that was created out of nothing.
The bank’s job is to ensure the borrower is credit worthy and will be able to repay the loan, but both parties, the bank and the borrower jointly create the money “from nothing”.
When the bank doesn’t do their job and enters into agreements with “sub-prime” borrowers and THEN sells on those “dodgy” loans as triple A rated mortgage backed securities, that’s when the whole system gets into trouble. The system based on honour, trust and “promises to pay” breaks down. We’ve allowed worthless promises to enter the system, or “dodgy” money.
It’s not the bank’s creation of money from nothing that’s the problem, it’s when the “promise to pay” is not properly assessed and then passed on to others with the approval of credit ratings agencies.
So my quibble is about something you may not have said or even implied. But we mustn’t blame banks for creating money from nothing, but somehow they should be held accountable for irresponsible lending and creating “dodgy” money before selling on those sub-prime loans to trusting buyers with the approval of regulators.
Your arguments are all essentially true, and yes, money is debt – and Postive Money got that wrong for a long time
I read this and find it extremely enlightening, particularly the concept that taxation is recovering money created. However, this has led me to wonder what happens here in Scotland where the devolved government has introduced an increase in income tax which, it is claimed, will be used to spend on public services. Could it be that the Westminster level of taxation woks as described in this post and any surplace really is spending money? Can the same be said of national insurance?
Scotland is not a money creating government
It is money user
See the Scottish Currency Group for explanation, and many others
I agree with Tim’s comment on mine.
I agree with Richard’s comment on a public bank – China is the chief shareholder of China’s major banks
I disagree with Richard’s view of CBDC being a distraction and my answer to him is the same as to Clive’s response of two concerns to my initial comment:
The first stage would be digital cash and coins. The CB would not be involved in accounts or retail banking at that point. They would just issue a digital version of what they already issue – banknotes and coins. They could use those coins to buy government debt from the government directly or even the banks in QE. It would be like driving an armoured car over with a load of cash. The government could write checks on that. In QE the banks would receive money that would shrink their balance sheet, rather than accumulate reserves. No interest – it solves the absurd interest on CBRAs.
Tell me why?
I can see no question that CBDC answers
Richard
A number of great minds have repeated the comment by Chicago Plan advocating congressman Wright Patman “I have never yet had anyone who could, through the use of logic and reason, justify the Federal Government borrowing the use of its own money.” The creation of national bank notes a long time ago was done in that spirit. Since most money became digital the banks have reacquired that free banking world. Digital dollars would have the same effect of regaining control over the money system and stoppong interest paid on CBRAs. We could do that now and print all the bank notes we need for government to spend into the system, but that would be supremely impractical.
Andolfatto makes that caveat to the MMT statement about being a money issuer,”When the interest comes due, it can be paid in legal tender—that is, by printing additional U.S. or Federal Reserve Notes. It follows that a technical default can only occur if the government permits it.”
https://www.stlouisfed.org/publications/regional-economist/fourth-quarter-2020/does-national-debt-matter
Banks never borrow their own money. They provide places of safe deposit from those who hold it.
Now I have answered Patman.
The rest of your comment is, as far as I can see meaningless – or at least is incomprehensible as to the mean8hg you think it imparts, not least because you acknowledge its own implausibility.
Sorry
Ahhh, I fear I may have been misunderstood.
For clarity –
I do advocate a public bank.
I do not support a “digital currency”, except in the sense that we already have digital currency (what else are debit/credit cards, Apple pay etc?).
In my opinion digital coins make no sense, because they are not backed by tax raising
powers (which does require some centralisation). Certainly some people believe in digital coins such as Bitcoin. But then some people also believed in non fungible tokens, which were equally nonsense. You don’t hear of those much anymore. Bitcoin and it’s ilk, including “stable” coin, seem to me to be a Ponzi scheme. As such they should be illegal. But, anyway, there essentially a fad based on a misunderstanding and they will eventually disappear.
Tim I agree on a public bank.
Also maybe I have been misunderstood. I am talking about government digital bank notes . They would have the same function as cash. They are backed by taxing power. They would avoid paying interest on reserves which is money only banks can use. CBs can only bail out banks, because non banks and citizens can not use CB money other than cash. Digital bank notes would change that.
And I think we can say say they are not going to happen, nit least because you are not answering the question as to why they should (or, even, what you think they are).
Mr Kent,
I agree with you, both on a public bank and on digital currency.
The problem, however remains. The commercial banks were so catastrophically untrustworthy following the 2007-8 Crash, we now have effectively a different central banking and regulatory regime that is at best a work in progress, and in the rapidly changing dynamics of the digital age, not adequately tested. On the other hand, the Post Office scandal runs deep and has huge undercurrents of implications for British Government, Law and Parliament. It shakes us to our foundations; if we actually begin to think it through. It isn’t just the Post Office; Government, politicians, Parliament… everything needs investigated.
In short, who can we trust?
I respect Richard’s efforts because he sticks his head above the parapet, and takes risks. How else do you advance knowledge, save by making errors on the way. This is what he says (today),
“As I often explain about my writing of this blog, much of my motivation for doing so is to work out what I think about an issue. This is why I will, for example, put half-formed ideas on here to test reaction to them, and why I am, on many occasions, willing to change my mind about things that I have said because others have presented me with better ideas.”
I know that is why I am here. I have no objection to Richard’s critics commenting on his Blog; through it they can make a case, and further a debate. They do, however have an obligation, in my opinion to stand up their argument under their own full name; and if they are going to make personal or abusive comments; stand publicly behind them. The anonymous critics who criticise Richard most vehemently, and defend the banking conventional wisdom most determinedly, often claim the greatest authority in banking, but also often abuse the platform they are offered, and wish to join and depart the debate with their anonymity intact; which means that they wish to join and depart in guaranteed anonymity even where they may have advanced an argument that is in error. It seems they are so overwhelmed by their own ‘amour propre’, by entitlement to privileged, exceptional treatment, that they cannot take the risk of being in error, and being exposed.
Thanks John
Government owned competitor bank for current accounts achieves (virtually) everything wanted without wholesale changes to financial infrastructure. We could create Girobank MkII quite easily.
I was going to say let the Post Office do it but then again…….
🙂
Richard – you keep saying – “you are not answering the question as to why they should (or, even, what you think they are).”
To which I say – I’m trying, I’m trying 🙂
1. I suggest CBDC should start with digital bank notes equal to cash, because the other option is CB accounts – vastly more complex.
2. I agree with a host of economists who say the banks have captured the money creation process and extract wealth as a result. Your point on the interest on CBRAs is a case in point
3. For the public good the simplest approach is a part of Friedman’s proposal – just use the digital bank notes for government shortfalls – “Under the proposal, government expenditures would be financed entirely by either tax revenues
or the creation of money, that is, the issue of non-interest-bearing securities. Government would
not issue interest-bearing securities to the public; the Federal Reserve System would not operate
in the open market. ”
https://miltonfriedman.hoover.org/internal/media/dispatcher/214916/full
4. IMF/BOE economist Kumhof most recent article on CBDC proposes 30% of GDP would be CBDC and his model shows a better economy:
https://www.bis.org/publ/work1086.pdf
I reiterate, I think this all a meaningless waste of time. Unless anyone else can explain what point I am missing I will not be allowing further posts on this idea.
Fair enough Richard – it is your blog 🙂 And an excellent one to follow!
Thanks
From a technical perspective, as a Chartered Engineer, I can assure you Joe, that digital cash is not a simpler option.
I would have thought, in the wake of the Horizon Post Office scandal, that it would be obvious that to put trust in complicated software systems is naive at best. This is all the more so with something as important and fundamental as currency.
Thanks
Isn’t already happening here – gift cards, crypto, google and apple pay, …
“Countries like Kenya have successfully experimented with mobile payments, making transferring money as simple as sending a text message”
https://www.salon.com/2014/02/26/the_post_office_can_save_america_10_ways_postal_banking_can_fix_some_of_societys_worst_problems/#.WkZLtMvzcUc.twitter
The relevance of this is?