What is overlooked is that one sector did a gargantuan amount of manufacturing during this period. The big international banks manufactured money, using very simple raw materials. All they needed were computers and borrowers. Every time they made a loan, the banks simply typed the amount they were lending into their computer system, transferred it to their victim\’s account, and charged interest for the privilege.
No, no, it doesn\’t work this way, it really doesn\’t.
How did this outrageous scam ever get started? The pressure group, Positive Money, explains it well. The Bank Charter Act, of 1844, removed from banks their licence to print money. The Bank of England printed the money, and the banks bought it. The state retained the seigniorage – the difference between the cost of creating the physical currency and its face value.
That is true, that is what seigniorage is, the difference between the value of a £5 note and the paper and ink that went into making it.
Now, only 3% of the \”money\” in Britain is cash from the Bank of England. The rest is electronic, created by the banks, simply by virtue of the fact that the Bank Charter Act didn\’t foretell the advent of computer-screen credit, and no one stepped in to arrest its development. Positive Money campaigns for the establishment of electronic seigniorage, which would establish a nice little earner for the state. Obviously, this responsibility could not be placed in the hands of politicians. Positive Money suggests that the Monetary Policy Committee could take on this function, gauging the release of currency to the rate of inflation – including house-price inflation. Frankly, the fact that the banks had been gifted with the closest thing to alchemy that humanity has ever contrived, and still managed to screw it up, suggests that a state institution could do no worse than they on this matter.
No, banks do not create money. The banking system as a whole creates credit. But individual banks do not create money. They just don\’t.
BTW, this idea of creating money at just the right rate for the economy: Milton Friedman would be proud. This is the essence of monetarism after all.
Now, how to show that banks do not in fact just create money?
Well, if they did then Northern Rock would not have gone bust, would it?
Recall what they were doing. Lending out money as mortgages. John and Sue (yes, terribly heterosexist of me) wanted that little ex-council in Newcastle. Rock lends them the money to buy it. Where does Rock get that money from? Just print it on their own little computer system? Well, if they did, then Rock wouldn\’t, couldn\’t have gone bust.
What Rock actually did was write that cheque, make that transfer, which bought the house for John and Sue. Then, by the end of the day (and yes, all banks balance their books every day) Rock would go and borrow that money from somewhere else. Maybe someone had deposited money in their account at Rock. But more often than not they would go and borrow it from another bank. On the interbank markets. Rock\’s books balance, they\’ve an asset, that mortgage that John and Sue owe them, they\’ve a liability, that same amount owed out to the interbank market.
Rock would then save up some thousands of these mortgages and when they had enough would issue a bond. This would replace the liability to the interbank market with the bond itself as a liability. The advantage being that the bond would be for 10-15 years, Rock has now matched the maturity of its assets and liabilities (sure, the mortgage might be for 25 years, but the average life of the pool will be shorter, refinancings, people moving etc).
So, what happened to Rock? Well, they were issuing mortgages, piling them up to issue more bonds, when the interbank markets decided no more money for you you Northern Twats. Can\’t have country boys making it in The City type stuff. At which point they went bust. Because at the end of the day they could not balance their books. They could not renew that interbank lending which was financing the mortgages they had already issued.
Think through this for a moment. If Northern Rock could just print money on its own computers then could they have gone bust in this manner?
No, clearly not.
Did Northern Rock go bust in this manner?
Yes, clearly so.
Therefore, Northern Rock could not print money on its own computers.
Death of the Positive Money thesis.
We can take this further but I wouldn\’t want to tire the loons\’ brains too much. The very existence of the interbank market shows that banks cannot just print money. The existence of bank bonds, of bank borrowings, shows that they have to go and get the money they are lending from somewhere else.
Thus it cannot be true that banks just print the money they lend.
Repeat after me: the banking system creates credit, yes. Banks do not print money, no.
Tim I have made this point ad nauseam all round the blogosphere – there was a positive money rant in the Independent the other day.
The problem is that there is a subtle issue here. It is that individually a bank cannot lend out more than it has on deposit (or borrowed in the cap markets). However the redepositing of the borrowed money in another bank and the use of this cash to fund another loan which creates credit and grows the amount of money in the economy. It is often difficult to explain this without reverting to a detailed example which is often too much for the dumbos who like the idea of positive money.
One thing I am not sure about is this issue about paper money versus the more general definition of money. If only 3% of money is cash, then are the PM people correct to assume that the other 97% was created via the fractional reserve banking credit expansion mechanism ?
Tim adds: Money is money, credit is credit. They are not the same thing.
I’d have to delve around to get the precise descriptions but think of the monetary aggregates. M0. M1 etc.
Roughly, M0 is money. M4 is total credit. BoE (or the Mint) produces M0. Banking system as a whole produces M4.
And something else the PM people ignore. The BoE regulates (to an extent) M4…..that’s what all the playing around with interest rates, deposit requirements, open market operations etc is.
It’s all to do with the way we measure money. Lending creates deposits, which are indistinguishable from any other kind of deposit – obviously, because otherwise people couldn’t spend the money they borrow. Those deposits go into current accounts or sometimes into other sorts of deposit account. Here’s the definition of sterling M1:
“notes and coins in circulation plus sterling sight deposits by the UK private sector in banks and building societies in the UK”
And M2 (retail M4) is the same plus deposits in interest-bearing accounts in UK financial institutions.
So when a loan is granted, it creates a deposit which immediately inflates the measure of M2 and usually M1 as well (as a current account is a sight deposit). The fact that the bank then has to borrow to fund drawdown of that deposit does not feature in these measures.
The Positive Money loons have got completely hung up on these measures of money. As you say, Tim, effectively they are advocating a return to 1980s monetarism – direct government control of the money supply. Various countries including the UK tried this and quickly abandoned it. It’s fair to say that they abandoned it because in a fractional reserve banking environment it doesn’t work. But Positive Money want to end fractional reserve banking, force all banks only to lend money they already have, and rely on the MPC to control the money supply directly. The MPC’s record on inflation control is dismal, so why should we believe that they would be any better at projecting money supply requirements?
I had a discussion with a Positive Money representative about this. He kept insisting that forecasting money supply requirements would be EASIER than forecasting inflation. How, since accurately predicting inflationary trends is essential for money supply forecasting?
I look forward to the generation of prospective homeowners and small businesses who approach their banks for loans only to be told, “Sorry, we can’t lend you any money because we haven’t got any”……
There’s a plague of halfiwts who have read “banks can print money” and off they go spupouting rubbish
Tim and Frances:
I agree with what you both say. I have had to contend with a positive money fruitcake who lives nearby and one of the issues he raises is this money thing.
Let me just explain where I think “money” comes from and then you can tell me where I am wrong if I am wrong or missing something.
Physical cash: printed by BoE and kept at a level to sustain an economy which requires physical money for basic transactions. I would imagine that this has declined with the increasing use of electronic transactions but maybe not.
Electronic deposits: Money which has been deposited in a bank either physically or via electronic transfer. This money could have been based on the FRB expansion of an initial physical loan. Given a reserve ratio R, the upper bound on the deposit money created is a multiplier of 1/R.
BoE open market operations: The Bank of England decides to expand money a little bit every year. They do this by buying back government debt – a sort of mini QE. This is done electronic by adjusting cash balances at the central bank. They can also do the reverse if the economy is overheating.
So outside of banking, money comes from physical cash created by central banks and electronic cash created by central banks. So it is possible that if we restrict our definition of money to physical cash and electronic deposits, that if 3% of this money is physical cash, it is possible that say 50% was created via government open market operations over time and 47% by FRB, i.e. to argue that 97% of money is due to FRB is to ignore open market money injections.
Can someone help explain ? I have found it difficult to get a full explanation elsewhere.
@Fred: Most of the money comes from the magic money tree. Unfortunately bankers sit closer to it and so peoplelikeme don’t get any, and it’s so unfair, and so that’s why they should be punished by punitive taxes or flogged or something…
We need Britmouse….but I will quote him:
“Repeat after me: only central banks can create money”
The rest is leverage.
Fred, I would agree that the 97% ignores BoE open market operations. I don’t think the loons know about them.
The total money supply (M4) does increase as a consequence of bank lending. This is because of 1) the way loan accounting works 2) the way we measure money. And despite what Positive Money say, it has ALWAYS worked like this. Even when there was no electronic settlement, banks still recorded loans in advance of obtaining the money for drawdown. And even now, on bank computer systems, loan agreement dates are separate from settlement dates (even if the loan is drawn the same day). The accounting for those loans creates a deposit, which is then counted in measures of money supply. All that has happened is instead of those loans and associated deposits being painstakingly recorded in dusty ledgers with quill pens, we now record them by typing numbers into a computer. The accounting has not changed and – broadly – neither have the measures of money. Positive Money are simply wrong.
@Frances – yep agree – the whole computer argument is dumb as you say. Nothing has really changed it is just a different information storage device.
I also think Ms Orr is your standard idiotic guardianista who thinks that if money is not created and stored in organic papyrus then it must be bad. She writes this on her macbook I presume.
Fred
further to my last…..central bank created money, including open market operations, is the liabilities side of the Bank of England’s balance sheet, which is now consolidated with the Government accounts. Worth a look at the Whole Government Accounts for 2o10-2011:
http://www.hm-treasury.gov.uk/d/whole_government_accounts201011.pdf
Figures for sterling M4 can be obtained from the Bank of England’s website:
http://www.bankofengland.co.uk/boeapps/iadb/FromShowColumns.asp?Travel=NIxAZxI3x&FromCategoryList=Yes&NewMeaningId=LM4L,LM4&CategId=6&HighlightCatValueDisplay=M4
The difference between central bank liabilities and sterling M4 is the leverage created by the UK financial sector.
@Rub
No-one has ever seen the magic money tree except Polly Toynbee. Not even bankers.
This looks interesting. I will read it later.
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb070302.pdf
Fred,
Huh, WGA doesn’t give sufficient detail. Here’s the Bank of England report & accounts for the year ended 29 Feb 2012:
http://www.bankofengland.co.uk/publications/Documents/annualreport/2012/2012account.pdf
Before the advent of computerised banking and electronic money, what was the % of all money that was physical cash? I’m thinking back in the 50s and 60s say, when your wages were paid weekly in cash in a little envelopes. There were no credit/debit cards, pretty much all transactions were cash. Physical money changing hands. That to me seems like a more stable system than what we have today.
Have we not just spent 40 years leveraging ourselves up with debt, and have reached the end on that road? Can credit expand ad infinitum? Mathematically I assume not, nature tends to destroy anything based on exponential growth.
I did read the last chapter of Samuelson, but I can’t pretend I understood it.
Here’s a thought experiment. If a loan goes bad and the asset turns out to be worthless, both the bank and the borrower have lost money. In fact money has quite literally disappeared. Credit contracts (or should do if the bank sticks to its capital ratios) by more, thanks to FRB leverage.
If that’s true backwards (is it?) then it might also be true forwards, with credit expansion. If not, why not?
(Do feel free to be derisive, it’s the weekend.)
Jim, I’m trying to follow the argument but I think all that cash in the 50s and 60s was both physical and virtual (in a ledger). Exactly the same as all the physical and virtual (electronic) cash now. All thats changed is that instead of cheques for the virtual cash we use debit cards.
Jim
We do seem to have become addicted to debt. Largely, that is because debt creates wealth. I mean that literally: we have a worldwide savings glut which exists BECAUSE we also have high levels of debt, both private and sovereign. Debt doesn’t exist by itself: the other side of debt is capital. Deleveraging inevitably involves capital destruction.
Those people who are desperately trying to find safe havens for their money AND at the same time calling for debt reduction are fundamentally illogical. As sovereigns, corporates and individuals reduce their debts, capital – including ordinary people’s savings -reduces in parallel. They call this “financial repression”, which is a sanitised way of saying “lose your money”. It happens principally through interest rates below the rate of inflation, either because inflation is high (as happened after WWII) or because interest rates are low or even negative (as they are at the moment). It can also happen through falling asset prices, though at the moment many “safe” assets are highly-priced because investors are so desperate for safe havens.
The conundrum is that we all agree debt is too high – generally – but we don’t want capital destruction, because that destroys economic investment. Sovereigns at the moment are slowing the deleveraging process down, mainly through central bank interventions, and trying to encourage more bank lending. Meanwhile businesses and households are avoiding bank credit (though that doesn’t mean they aren’t borrowing, see my post here: http://coppolacomment.blogspot.co.uk/2012/07/i-am-bank.html). Deadlock, I think.
Frances, I think that quote must be from somebody else!
I have tried reading the Positive Money stuff before but it is a total mess. They have started from a false assumption that “debt is bad”, and “caused” the recession, and it goes downhill from there.
We do not have a “debt crisis”. We have an income crisis. When people take out loans, they assume a path for future income. Total national income for the UK, nominal GDP, was on a very stable path up to 2008, growing at around 5% a year.
Nominal income has since fallen a long way below the previous path. This makes maintaining the existing debt burden much more difficult than was expected for debtors. This is true for the government, for corporations, and for households.
I’d recommend reading some David Eagle or George Selgin.
http://marketmonetarist.com/2012/01/20/guest-blog-the-two-fundamental-welfare-principles-of-monetary-economics-by-david-eagle/
@blokeinfrance
Yes. A defaulting loan (without security) is a destruction of credit and capital as the bank still has to pay back the money it borrowed to finance the loan. So it reduces the amount of money in the system.
Repaying a loan destroys credit but not capital.
Actually secured or unsecured it should be the same. With adequate security the asset becomes the banks’ so the borrower loses while the bank is protected. Without security the bank takes the loss. The borrower gets a bad credit rating.
@Tim – I think it might be worth going to town on the positive money loons. With a recent piece in the Indy and yet another in the Guardian, perhaps it is time to do a DT column on it. At least so we have something to link to which will help counter the positive money propaganda.
Fred etc.
FTAlphaville’s Izabella Kaminska took Positive Money apart some time ago, particularly with regard to their “debt is bad” attitude that Britmouse notes. Well worth a read – and the (extensive) comments too:
http://ftalphaville.ft.com/blog/2011/11/15/747991/on-the-demonisation-of-debt/
Steve Keen claims private banks create money, inasmuch as loans determine deposits and reserves follow relatively passively afterwards.
http://www.debtdeflation.com/blogs/
Jahn
Yes, that’s what I was saying. Loans create deposits, then banks look for reserves for settlement. The reason why I say FRB money creation is LEVERAGE and that only central banks can actually create money is that in the last resort, if banks cannot fund themselves, the central bank will create money “out of thin air” and lend it to banks against collateral. Positive Money completely ignore the funding issues and the role of the “lender of last resort”.
As far as ordinary people are concerned, though, the leverage created by FR banks IS money. I can buy you a pint using money I’ve borrowed from the bank just as easily as I can with money I’ve earned. (In fact more easily, as I have an overdraft most of the time….). On that, Positive Money, Steve Keen and the Bank of England (see Fred’s link) are in agreement. The only central-bank-created money that ordinary people use is notes & coins: all electronic money used by ordinary people is FR bank-created leverage. Therefore 97% of the money used by ordinary people is indeed created by bank lending. But that’s not the same as the money supply.
Britmouse
You’ve touched on one of my bugbears – the illogicality of comparing debt to GDP, or indeed debt to income (for private sector borrowers). It’s not the amount of debt that’s the problem. It’s whether you can afford the payments.
@Frances – I read that at the time but thanks for the reminder. I found it okish. She did not get into the technicals too much which was a shame as you need to see an example balance sheet to see what happens in one bank and then see how this percolates through the system as the deposit is reloaned and redeposited. And you need to see the bank business model of
profit per $ loaned = loan rate – depositor rate – costs – default risk reserves
to see that the bank does have to pay interest on its liability side, i.e. the bank does not get the money for nothing (unless it is part of the LTRO 😉 when it is not far off)
Also, the DT has a broader impact and Tim is a snappier writer than Izabella.
Fred
Interbank lending rates are pretty low too. But it’s definitely wrong to assert, as Positive Money and others do, that there is no cost to FR bank leverage.
Andrew Lainton is currently doing some detailed accounting models of the lending process, including the impact on capital, on his blog. I’ll post the links later. Hard going and seriously wonkish, but well worth the effort.
@Frances Coppola: yes credit creates capital, but is it real capital, or is it just an illusion? The capital only exists if the debt is serviced and repaid. And you have to repay more than the initial loan, the interest has to be found from somewhere. I lend you £100 at 5% interest for one year you have to repay £105. So the extra £5 has to come from elsewhere within the system.
So it seems to me that you either expand the credit system for ever so there is enough money to pay the interest as well as the capital, or you stop expanding credit and the whole system collapses inward (as we are kind of seeing now).
Which brings me back to my point – can a credit money system expand for ever or is there a mathematical/pyschological limit to that expansion?
@Jim – this £5 is not correct. As a borrower you pay the bank £5 which is used to pay the depositor who provided the initial £100. If he gets a 3% rate then I pay him £3. So that is only £2 that is needed. But then I pay £1 to my share holders who then put this back in the bank. So that means that only £1 is needed. And then there is a 1% risk of a default with zero recovery. The risk of this means that I will lose £1 out of every £100 I lend. This wipes out my remaining £1. So actually no extra money was needed to create the interest.
Jim,
Since loans are used to buy stuff (generally), lending generates wealth for the sellers of stuff. This wealth is not an illusion and it is not dependent on the loan being serviced and repaid.
The additional money for interest comes from income. Borrowing is a way of bringing forward future income, and the interest on that borrowing (in a perfect world) represents the difference between the present and future value of income. Yes, it may be that the borrower’s income itself is generated through his/her employer’s borrowing, though it might equally be generated through his/her sales of “stuff”, perhaps to other people who borrow…..but however you look at it, interest is simply a reduction in future income. No further money creation is needed. I can only assume that those who think that additional money is needed for interest payments don’t understand the time value of money or the way in which economic activity itself creates wealth.
Fred,
As promised, Andrew Lainton’s models. They aren’t complete. I’ve added a comment about the value of risk, and I’m sure he’d appreciate any suggestions you have too.
http://andrewlainton.wordpress.com/2012/07/08/the-transmission-of-lending-power-between-banks-in-monetary-circuit-theory-part-i/
http://andrewlainton.wordpress.com/2012/07/11/the-transition-of-lending-power-between-banks-in-endogenous-monetary-theory/
@Frances Coppola: if interest is a reduction in future income, when does the future arrive? When do you have to pay the piper? Or can you put off that day for ever by constant credit expansion?
Which what I’m getting at when I ask if there is any limit to credit money expansion, and no-one seems to want to give me an answer.
@FC&LE
Please provide a reasoned refutation of libertarian hardnut Murray Rothbard’s case against Fractional Reserve Banking (on Net)which includes such gems of statements as “Banks make money by literally creating money out of thin air…This sort of swindling…is dignified by the term fractional reserve banking.”
As I have been clouted over the head by Rothbard’s opinions on Land Value Tax as wielded/quoted by anti-LVT idealisers of the the UK property market, it is nice to use Rothbard against somebody else for a change.
Jim,
The interest on a loan represents the difference between its present value and its future value at maturity, of course. If you then roll that loan over you have more interest to pay, because you have brought forward more income from the future. Rolling over a maturing loan is not further credit expansion – it is repaying one loan and taking out a new one, so there is no net effect on credit. It is NEW lending that expands credit, not rollover of existing lending.
The question you should be asking is not how much credit money can be expanded, but how its value is maintained. The more money there is in circulation, the less it is worth unless there is sufficient productive activity to use it. When the economy is growing you want the money supply to increase – usually that is done by increasing bank lending to productive enterprises, enabling them to sell stuff, create wealth and grow. The total amount of money in circulation should be no more than the amount needed to maintain the economy at full capacity. If there is more money in circulation than the amount needed to maintain full capacity, you get inflation. So credit money can’t be expanded infinitely unless economic growth also expands infinitely. If the production of credit money exceeds the productive capacity of the economy, you get inflation in asset prices and most likely a large trade deficit as imports are sucked in – as we saw in the run-up to the 2007 crash. Expansion of credit money at a faster rate than economic growth is unsustainable in the longer run, because there isn’t sufficient future income to support it.
Does that help?
Tim, you might want to contribute to this – you are more “up” on the Quantity Theory of Money than I am!
DBC
Nice to know there are nutjobs on the Right as well as the Left!
This thread is getting ridiculously long, though. I will have to write a post on the subject, evidently! Luis – joint effort, maybe?
DBC
I wrote this a while ago. It was debunking Positive Money, but it should do a reasonable job with Rothbard too. It describes how loan accounting and settlement works from a balance sheet and reserve perspective, with accounting entries. And there is an excellent discussion of LVT in the comments!
http://coppolacomment.blogspot.co.uk/2011/11/other-side-of-debt.html
The conversation with a Positive Money fruitcake that I mentioned further up this thread is at the end of the comments. I think what he means by “reserves” is money directly created by the central bank, not whatever is in bank reserve accounts on any given day.
Request for advice (from a non banker and non-economist) – what phrases/concepts/assertions about banking should make me think “Nutter” and move on?
“Bring back the gold standard”
“Banks create money”
“I’m an Austrian” (I have no idea what that means unless the speaker lives in Vienna.)
“It’s the Rothschilds/Jews”
Any others?
Also watch out for those who discuss “hard money”
This is my favourite explanation of monetary policy
http://www.youtube.com/watch?v=32779CpfymI
Luke
General rules:
– If they’re calling for the Gold Standard they are definitely nuts.
– If they claim that banks create money they MAY be ok, but if they claim banks create money out of nothing at zero cost they are fruitcakes (and probably signed-up Positive Money supporters).
– Austrians are good in parts. Especially if their surname is Trapp.
– Rothschild/Rockefeller/Zionist/Vatican conspiracy theorists – send for the men in white coats.
Here are a few more phrases beloved of nutjobs:
“We need flat taxes”
“We’re bankrupt”
“Nationalise the banks”
Question for people so i don’t get this wrong.
A bank takes in 100. It has to put 10 aside for capital requirements, and lends out 90. Borrower deposits 90. The bank can only lend out 81. So far, total credit extended, 171, capital reserved, 17.1. That should give you a kind of pyramid, with a finite limit to e amount of credit creation a bank can do off any amount of deposit. That make sense? It should be the next step to the line that only central banks create money, ordinary banks only create credit,cand even that has a limit. Or am i off?
Ambrose
That’s the classic money multiplier as explained in economics text books, and it is the wrong way round. Loans come first and they create deposits, which when spent recycle back into the banking system to fund (note funding is AFTER loan agreement) more lending. The deposit created when a loan is agreed inflates broad money. Provided banks can obtain cash or reserves for deposit drawdowns, therefore, there is no limit to credit money creation. In the event of a bank being unable to fund itself, the central bank provides reserves – which is what happened with Northern Rock on an emergency basis and is now happening daily in the Eurozone because no-one wants to lend to southern banks.
Only central banks can create money without there being an associated asset (a loan), and in economic thinking we tend to distinguish between central bank created money (reserves) and bank credit money. But as far as ordinary people are concerned it’s all the same.
@FC
Don’t see that the above is much different from what the thin airists are saying.Tim of course tries to claim that the banks are only creating credit not money.And the difference is?As long as you get it in your bank account and can spend it ,nobody’s bothered by any academic or pettyfogging distinctions.
It is not called Fractional Reserve Banking for nothing(And thin airism is the Economic Orthodoxy; it is the naysayers who are unorthodox) .As the money supply is increasing the anti thin airists have a job to say where its all coming from:it can’t be loaned from existing bank deposits or the volume of money would remain the same.
As to the LVT debate on your blog: very good IMO.However LVT does n’t have to be 100% which Rothbard assumed ( I think: I am not going to check).The original-ish English version by J.S. Mill ,which I support, only came into operation when land values increased and would only scalp a small percentage whereupon prices would go back down again.It would now serve as an anti land price inflation device and ,as such, cannot really be argued against IMO.
As regards the supply of money I think even the present fundamentally dishonest system would work if new credit was not diverted from increasing goods and services into the inelastic supply of land, which is bound to bubble in value.One reason I don’t support bank nationalisation which is the easy way out of the money supply problem (you can retain fractional reserve banking but put the proceeds to public use and replace other taxes with a tax on credit creation aka interest rates)is that the Homeownerist political parties(all of them) would bribe voters directly with promises of unearned wealth from owner occupation (as a way of keeping wages down) instaed of as now indirectly via the servant banks.
If you think it desirable to control the money supply strictly, then it would seem to be a good idea to abolish fractional reserve banking. Have any politicians within reach of actual power ever proposed doing that?
Paul,
Abolishing fractional reserve banking is essential if governments wish to control the money supply directly. The problem is keeping it abolished when demand for lending exceeds available money. I don’t know of anyone who ever seriously attempted it.
DBC
The thin airists are to a degree correct about deposits being created in the absence of reserves and therefore inflating the money supply. What they leave out is funding of deposit drawdowns. They think that loans are self-funding from the created deposits. Within the banking system as a whole that is more-or-less true – and the multiplier does show that, even though it has the precedence of loans and deposits the wrong way round – but for individual banks it is not. It’s a classic fallacy of composition.
I think I argued that 100% LVT was neither achievable nor desirable, didn’t I?
Oh, of course, the same old story: “Banks don’t create money, they just create credit.”
What is credit? It’s the numbers that appear in your bank account when you take out a loan from a bank. You can pay everything with these numbers, can’t you? …even taxes!
Ask people on the street if they don’t consider the numbers in their bank account to be money! Really, do it!
The Bank of England itself confirms what Positive Money is saying:
http://www.positivemoney.org.uk/how-banks-create-money/proof-that-banks-create-money/
And regarding Northern Rock:
When you transfer money from your bank account your bank settles this transaction by using something called central bank reserves. Only the central bank can create this type of money, and therefore it is entirely possible for private banks to run out of it.
When depositors spend their money central bank reserves flow from their bank to the bank of the business they are buying from. If all banks expand their lending at the same rate, the outflows of reserves will broadly match the inflows from other banks. However, if one bank is increasing its lending faster than the others, then it will have a constant outflow of reserves to the other banks. Banks may borrow reserves from other banks; however in times of financial stress other banks may be unwilling to lend their reserves in case the bank they are lending to goes bust. This is essentially what happened to Northern Rock.
More details on this here:
http://www.positivemoney.org.uk/how-banks-create-money/balance-sheets/#insolvent
Fred,
you write: “And something else the PM people ignore. The BoE regulates (to an extent) M4…..that’s what all the playing around with interest rates, deposit requirements, open market operations etc is.”
No, it’s not ignored, it was explored, an extensive research has been done (with New Economics Foundation) that showed that the Bank of England has very little control over the money supply.
http://www.youtube.com/watch?v=Qf_DxbWVaak
Frances,
you say: “The MPC’s record on inflation control is dismal, so why should we believe that they would be any better at projecting money supply requirements?”
Of course is dismal, because the tools they have and use in their desperate attempt to control inflation are not working. They don’t have really much control over it.
You have probably not read the proposals of Positive Money. Otherwise you wouldn’t suggest that it would come to this situation: “Sorry, we can’t lend you any money because we haven’t got any”
Here is the Positive Money proposal in plain English, on page 31 you can read more about this common concern:
http://www.positivemoney.org.uk/wp-content/uploads/2012/02/Full-Reserve-Banking-in-Plain-English1.pdf
Frances,
“FTAlphaville’s Izabella Kaminska took Positive Money apart …”
Unfortunately, what Izabella Kaminska misunderstands is that Positive Money wasn’t demonising debt. They were questioning a system in which the monopoly on creating the numbers that we use as money is given to the same banks that caused the crisis. They were questioning a system that forces the population into debt to the banking sector simply in order to have a means of exchange so that trade can take place.
It’s a simple question, and repeating the textbook fairytale of banking doesn’t count as an answer.
You can read the response of PM to Isabella’s article here:
http://www.positivemoney.org.uk/2011/11/ft-alphaville-touched-nerve/
@FC That was my impression of what you said :that 100% LVt was neither achievable desirable.This is surely sensible but it leaves open the question whether you think anything less than 100% was achievable or desirable.I nailed my colours to the mast by sayingthat the land tax takeshould be at any percentage that stopped land values inflating (JS Mill’s original proposal before Henry George took over as the Land Tax guru and got more fierce.)The most successful Land Tax venture was at Tsing Tao (where the very good lager comes from, not entirely coincidentally)where bizarrely the German Imperial Navy introduced a 6% p.a. lvt with 9% on deliberately undeveloped land,all with the full support of von Tirpitz, no less.
Bobidlo,
I have read Positive Money’s proposals, in detail. Many times, actually – because every time I point out the flaws in their arguments someone does exactly what you have just done, which is to send me their proposal YET again, and I read it again just to make sure I haven’t got it wrong. I really haven’t. Positive Money’s proposals would create the mother of all credit crunches.
If you would care to read the link to my blog I posted further up this thread, you will find a debate with a Positive Money representative on exactly this subject at the end of the comments. His reaction to my remark that Positive Money’s proposal would seriously restrict the availability of credit in the economy (which was also what the Vickers Committee said about it) was to say that having far less lending would be a good thing. I would suggest to you that Positive Money has not thought through the implications of serious restriction of credit in the economy – although a cursory glance around at the moment should inform you!
You don’t understand reserve accounting. Because bank created “credit” money and central bank created money are indistinguishable, what passes through a bank’s reserve accounts may or may not be money actually created by the central bank. Money is fully fungible, after all. What we do know is that banks have to fund their reserve accounts to prevent balances dipping below the reserve requirement if more deposits (in the widest sense, including created ones) are drawn than are received. In the UK at the moment the reserve requirement is zero (though that hasn’t always been the case), but in most other countries it is above zero. Balances above the reserve requirement are known as “excess reserves” and these days central banks usually pay interest on them, although that is a fairely recent development. No way is the central bank going to create excess reserves if it has to pay interest on them, is it? In fact, why would it provide any bank with more money than it needs to meet its reserve requirement? No, those are excess commercial deposits parked at the central bank for safe keeping and a few basis points. However, most reserve account funding is done by borrowing those excess reserves from other banks. In effect, therefore, banks FIRST borrow commercial deposits from each other to fund deposit drawdowns. The central bank only “tops up” the reserve account if for some reason the other banks can’t or won’t lend their excess reserves (commercial deposits) – and it charges a penalty rate for doing that. Normally this excess reserve circulation process works well, since the central bank pays below LIBOR on excess reserves so there is an incentive for banks to lend their excess reserves to other banks at LIBOR or above. In this way banks DO “lend out” deposits – but not directly to customers. However, at times of market stress banks are reluctant to lend to each other, interest rates on interbank lending rise and the market can seize up completely.
Northern Rock’s initial request for emergency funding was because it could not meet its reserve requirement due to freezing of the interbank markets after the collapse of Bear Sterns. At the time the Bank of England did not have a discount window facility and emergency lending to banks required Treasury approval. Some idiot leaked that to the press, spooked depositors and the result was a run on the bank.
In the Eurozone the whole banking system is completely dependent on the ECB. Banks don’t trust each other, so they park their excess commercial deposits at the central bank which lends them on to other Eurozone banks that are short of funds. The ECB is acting as a clearing house. It isn’t terribly happy about this – it would rather the banks lent directly to each other through the interbank market – so it has just stopped paying interest on excess reserves. In the ECB banks have two reserve accounts – current accounts (required reserves), on which the ECB pays zero, and the deposit facility (excess reserves) – on which it now also pays zero. So Eurozone banks are now leaving excess reserves in their current accounts, because it isn’t worth their while to move them to the deposit facility. They still aren’t lending them directly to each other. And central bank created money and commercial bank credit money are all mixed up together in the same accounts.
Regarding Positive Money’s notion that direct control of the money supply would give it better control of inflation: I would seriously suggest you read Fred’s link further up this thread. The Bank of England discusses the many factors that make it difficult to forecast and control the DEMAND for money. I do not agree that direct control of the money supply would give the Bank of England better control over the demand for money, which is what drives inflation. The factors governing money demand are far more complex.
Bobidlo
Re Positive Money’s response to Izabella’s post:
Clearly you haven’t read your own link. If you had you would note that I was very involved in the discussion in the comments.
Can I suggest you read something other than Positive Money? They are wrong about so many things…..
There’s an excellent explanation from Steve Keen of how our credit money system works on the link posted by Jahn, above. Or there is also a very readable paper by Cullen Roche – American, but our system works similarly:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625
DBC Reed
Yes, I think I would agree with you – some level of LVT short of 100% but sufficient to keep land value inflation low is probably reasonable. We do have a sort of LVT in business rates, of course – anyone know what the current business rates level is (it is uniform across the country, I believe)?
Bobidlo,
By the way, Izabella isn’t the only person who sees Positive Money as “demonising debt”. See Britmouse’s comment further up this thread.
Should I add “positive money” to my list?
Top of the list, Luke!
Happy to do so…but don’t get me down as an apologist for bankers. Their idiocy on a particular level (let’s leave out complex abstractions) has kept me in business for years..let me take that back, keep up the food work.
The MPC’s record of providing low and stable inflation is the most successful in history (as in last 100 years), if judged on the basis of providing price stability.
Even the last few years – notable for oil and indirect tax shocks in both directions, have delivered far lower inflation and lower volatility than most other times in UK history.
On house prices: in the six years to Q2 2012, house prices on the Nationwide index were almost exactly flat. No inflation at all. In the previous six years, we had 100% inflation in house prices; prices doubled. Which of these periods correlated with a period of economic prosperity?
In England the business rate for 2012-3 is 45.8p in the pound, or 45p for small businesses. That’s levied on the assessed rental value as of 1st April 2008. The numbers are closely similar in Scotland and Wales.
The business rate is not an LVT, in that it’s based on property value not land value.
I have written on the “can banks create money?” debate here: http://mickanomics.blogspot.co.uk/2012/02/money-paradox.html
Frances says “Since loans are used to buy stuff (generally), lending generates wealth for the sellers of stuff. ” But surely, it’s the stuff itself that’s the wealth, not the money?
Frances,
ok, you think Steve Keen’s explanation is excellent?
I agree. So please listen carefully to his first few words in this presentation:
https://www.youtube.com/watch?feature=endscreen&v=I4Cm9HLJZwE&NR=1
Frances,
btw, the Richard’s talk that Steve Keens is referring to is here:
Prof Richard Werner at the Just Banking conference:
http://www.youtube.com/watch?v=O0wA6SbsHg8
“Empirically, it had been found that banks are special. Their function cannot be easily replaced by other financial players or markets. Banks must have a kind of monopoly power compared to other financial institutions.
But economic theory could not explain why.
Here is why.
Banks are special, because they can create new money ‘out of nothing’ = credit creation.
This explains why banks are special: They are not (just) financial intermediaries. They have a license to ‘print money’ by creating credit. There is no such thing as a ‘bank loan’. Banks do not lend money, they create it.”
Prof. Richard Werner
“…it proved extraordinarily difficult for economists to recognise that bank loans … create deposits. In fact, throughout the period under survey they refused with practical unanimity to do so”
Schumpeter (1954)
Bobidlo
What exactly are you trying to prove to me? You are simply repeating points I’ve already made. I know loans create deposits and that those deposits inflate the money supply. I’ve said it again and again both on this thread and elsewhere. I’ve written an entire post, to which I linked further up this thread, explaining exactly how bank “money” creation through lending works – including the accounting entries. If you got off your high horse and bothered to read this thread properly, including the links, you might realise that I do actually know what I’m talking about. But I don’t think you are going to do that, are you? You’re too busy trying to convert me to your cause.
Kay Fabe
I would only regard “stuff” as wealth if you perceive value in hanging on to it. If you perceive higher value in what you can buy with the money you get in exchange for your stuff, then wealth comes through selling stuff. There is no “intrinsic” value in stuff.
Tim and Francis, if you’re interested, here’s a full explanation of why Northern Rock can go bust whilst having the ability to create money:
http://www.positivemoney.org.uk/2012/07/if-banks-can-create-money-how-come-northern-rock-went-bust/
Positive money are not loons, at least not by academic standards. I reccommend this book, published by respected think-tank, New Economics Foundation and based on months of research including inside the bank of England. http://neweconomics.org/publications/where-does-money-come-from
Ben Dyson
I know perfectly well how that can happen. As I explained further up this thread. Isn’t it time you you and your acolyte stopped pimping your beliefs? How many MORE times do I have to say “loans create deposits which inflate the money supply” before you realise that I agree with you on this? What I fundamentally disagree with is your notion that this arrangement needs to change.
Jeebus, they’re out in force now. How many more times do I have to say it? WE KNOW THAT LENDING CREATES DEPOSITS WHICH INFLATE BROAD MONEY. We do not agree that this needs to change.
Tim’s idea that central banks create money, commercial banks create credit is exactly the same as Positive Money’s idea that central banks create reserves, commercial banks create money. There is no significant difference between these two concepts – it is simply a question of terminology. Both recognise that central bank money creation is qualitatively different from commercial bank money creation. In practice – speaking as someone who has actually worked in the industry and knows how banking systems work – you can’t tell the difference between central bank money (“high powered money”) and any other sort of money.
@Frances – excellent. Let’s agree to disagree then.
@Frances – you don’t think that banks ability to inflate broad money at will needs to change?
Is everything OK with global economics then?
Or is there something else that you think needs to change? I’m just trying to understand if you have alternative proposals or if you are defending the current situation.
It’s incorrect of you to say that PM is advocating a return to a system which has been tried previously. You must know that their suggestions are novel.
At least you’re not as lazy or rude as Tim Worstall.
Eoin
Just because I don’t happen to think that properly regulated fractional reserve banking is a bad thing doesn’t mean I think everything is hunky-dory with global economics. Far from it, actually.
And you’ve misread me. I didn’t say that PM was advocating returning to a system which has been previously tried. If you look at my reply to Paul B in comment 42 you will see that I actually said the opposite.
The Fed did experiment with direct money supply targeting in 1979-82. But they did that while retaining fractional reserve banking. As I said in comment 2 (my first comment on this thread), targeting the money supply does not work in a fractional reserve banking environment. Not surprisingly, the Fed abandoned this experiment and turned initially to reserve requirement targeting then, from 1990, to direct interest rate management.
What Positive Money are suggesting amounts to returning to reserve requirement targeting, but with the requirement set at 100%. There’s an interesting paper from the IMF on the subject of reserve requirement policy:
http://www.imf.org/external/pubs/ft/wp/2011/wp1136.pdf
Note that the use of reserves as prudential regulation is a hang-over from the Gold Standard. We still have not fully appreciated the implications of the change to a worldwide fiat system in 1971. Too much of finance and economic thinking is still stuck in a Gold Standard mindset.
Frances, it’s the stuff that’s the wealth. Money is just something you trade for what makes you wealthy. Can you eat money, wear it etc? Nope. But, you can trade it for stuff that you can eat and wear and that’s its value. Wisely used it’s your passport to wealth, but it’s not the wealth itself.
Frances “… the Gold Standard. We still have not fully appreciated the implications of the change to a worldwide fiat system in 1971. Too much of finance and economic thinking is still stuck in a Gold Standard mindset.”
Agree with you there bigtime. My thought though is that we can create as much money as we need, I’ll stress need, so long as it’s used to create proportionate wealth so there won’t be any (perceived) inflation. I know we disagree about what’s wealth though… I’m thinking, train a surgeon, that’s wealth. Build a school or a hospital, that’s wealth. Create money from nowhere to pay teachers… well, is that wealth, or is that inflationary? I’m not sure.
Kay,
No, we don’t disagree about what is wealth. You’ve misread my comment. I did not say that money was wealth. I said that if you perceive higher value in WHAT YOU CAN BUY with the money you receive from selling your stuff, then your stuff is only of value to you to the extent that you can sell it. If you can’t sell it, it is worthless. Even if you can sell it, it is of less value to you than it is to the person who buys it. Value is not in the stuff itself, it is in how you perceive it.
I now know why it seems impossible to reform thr world’s banking and monetary system. After reading, for the first and last time this blog, I have become aware of something I never really appreciated. The world is full of ostriches, the vast majority of the posters to this blog, who are quite content to bury their heads in the sand. There are none so blind as those who willnot see.
Without going into vast detail, Postive Money and their ilk – COMER, NEW ECONOMICS FOUNDATION, ETC – are completely correct. Perhaps you bloggers should take some lessons in basic banking through history.
Alan D’Arcy
Are you an expert on banking through history, then? If not, what is your qualification for such a strong statement as “Positive Money and their ilk are completely correct”?
I do know something about banking through history, actually, and from my perspective Positive Money are NOT correct in their view that electronic money has fundamentally changed the nature of banking. Eoin, above, is more accurate – he claims that Positive Money are proposing something completely new. I think they are, too, since as far as I can see full reserve banking plus 100% reserve banking (they are proposing both) on the scale that they wish to implement it has never been done before.
I would recommend a read of David Graeber’s “Debt: the first 5,000 years” for a sensible discussion of credit money systems throughout history.
The banal bluster of the tabloid hack. Yawn.
Tim your ramblings are unpleasant and ignorant.
No evidence offered, just assertions, playground insults and a simply laughable analysis.
Your (ahem) assertion about Northern Rock is so childishly simplistic and so lacking in any of the basic knowledge and detail required that I am astonished you would put it in the public domain.
The people you banally smear as ‘loons’ include:
Mervyn King, Paul Tucker, Charles Goodhart, Martin Wolf, Steve Keen, the Bank of England, the New Economics Foundation and pretty much any heterodox economist.
I’m not worried. The nature of our monetary system is emerging very quickly now.
It will take more than the ill informed squeals of a hack from The Telegraph to stop it.
In fact, keep it up. With you on the side of the banking lobby how can reform fail!
@ Francis
You said:
“What Positive Money are suggesting amounts to returning to reserve requirement targeting, but with the requirement set at 100%.”
This sentence shows that you misunderstand the nature of the PM reforms. You are suggesting that the PM proposal is that banks operate as they do now, with customer deposits appearing on the liabilities side of their balance sheet, with the only difference being that banks are required to hold central bank reserves to back these deposits (which appear as an asset on their balance sheet) 1 for 1.
This is incorrect. It would also be a stupid reform, so perhaps it is not surprising you don’t think much of it. Besides anything else it would be difficult to enforce, and would not stop banks increasing the money supply by making loans, they would just have to get reserves off the central bank first (or later).
As we both know, the central bank is forced to accommodate requests for reserves to prevent liquidity crisis (this is the reason the central bank has no over the level of reserves in the current system control – unless you count interest rate policy as control). It makes no difference if the ratio is set at 1%, 10% or 100%. For example, in America it is set at 10% (for certain deposits) and this has in no way slowed down the rate at which American banks can lend.
However this is not what PM are proposing. As they state in their joint submission (with nef and Prof. Richard Werner of Southampton Uni):
“Transaction Accounts are held separately from the balance sheet of the commercial banks, and are not recorded as liabilities of the commercial bank; they are merely held in custody.” They go onto say they these accounts are to be held in an account at the Bank of England.
Therefore, rather than there being a distinction between broad money (which are liabilities of private banks) and base money (which is a liability of the central bank) as there is in the current system, all money would only exist on the central bank’s balance sheet – all money would be base money, as it were. Because private banks would merely be administering these accounts (i.e. they would only be able to send instructions to the BoE requesting money be moved between accounts on the BoE’s books) they would not be able to change the money supply.
Furthermore, and again because the money would only exist on the BoE’s balance sheet, only the central bank would be able to alter the money supply – none of the problems that current apply to trying to use reserves to alter the level of broad money would apply (because, again all money would be base money and only exist on the BoE’s balance sheet).
PMs submission, for anyone that hasn’t read it, can be found here:
http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf
Although there reform deals with bank accounting in rather a novel way (that is, using custodial accounts), the reform can also be explained using standard double entry bookkeeping techniques.
Stephen
It’s not me who has misunderstood PM’s proposal – it’s you. You are confusing transaction accounts (current accounts) with deposit accounts. PM’s proposal treats these separately:
1) PM proposes to segregate transaction accounts (current accounts), so that they are no longer commercial bank liabilities but liabilities of the central bank. Since these balances would be unavailable to commercial banks to support lending, this would to all intents and purposes be full reserve banking (safe custody) for transaction accounts.
2) PM also proposes to restrict the lending of commercial banks to balances in time deposit accounts (“investment accounts”) that the customer had specifically agreed could be lent out. In other words, banks could only lend money they already have available to lend – they could not lend “ahead of reserves” as they do at the moment. This is 100% reserve banking.
My comment refers to the second part of PM’s proposal. In fact all my comments on this thread refer to that second part, which I think is simply unworkable, not the first (which I think is quite a sensible idea).
Stephen
Oh, and the central bank doesn’t use reserves to try to influence broad money, as you suggest. It stopped doing that in 1990. These days the main tool for managing broad money is interest rate policy. The unconventional tools such as QE that central banks are using at the moment are simply extensions of interest rate policy.
However, you should also be aware that, as Britmouse pointed out a hundred miles further up this thread, the Bank of England’s primary objective in interest rate policy is inflation control, not money supply control. It is only interested in money supply control to the extent that the money supply influences inflation.
PM propose that the Bank of England should control the money supply directly rather than indirectly via interest rates. But if the primary objective of the Bank of England is to control inflation, there seems little benefit to this change. After all, we have just had the longest period of price stability (as measured by CPI) since the second world war.
Personally I am concerned that the Bank of England’s narrow interpretation of its inflation control mandate led it to ignore hyperinflation in the housing market. But fixing that problem is simply a question of changing the target measure from CPI to something broader – Britmouse and others suggest targeting NGDP. Changing the means by which inflation control is achieved wouldn’t fix the main problem, which is that the Bank of England simply wasn’t looking.
Did you know that three days after the collapse of Lehman, the Bank of England seriously considered RAISING interest rates? They were more worried about inflation than financial system meltdown. Terrifying.
I agree, I meant that the central bank can’t control the money supply using reserves (it is impossible unless one wants to accept massive interest rate fluctuations and liquidity crisis.), and even then as the experience of the 80s showed the BoE still overshot. And I am agreed about the problem of asset bubbles, the problem is the interest rate is an inefficient tool for popping them (because you have to raise it so high which has the side effect of bankrupting businesses).
Onto the PM proposals:
Once all money exists as liabilities of the central bank, for money to be lent by a bank (using a time deposit) , they would have to get someone to agree to move their money from a transaction account to said time deposit.
Perhaps an example will make what I am trying to say clear. Say Jake wants to put his money in a time deposit. This involves money being transferred from his transaction account (a liability of the central bank) to his bank’s account at the central bank (called the investment pool, also a liability of the central bank).
This money is then lent to a borrower, say Mary, which involves a transfer from the banks investment pool account (still a liability of the central bank) to Mary’s transaction account (which is a liability of the central bank).
Repayment is the same process in reverse.
Therefore the whole process of borrowing and lending is nothing more than the central bank moving numbers between accounts on its own books (specifically across its liabilities). There is no money that exists anywhere else.
This process is analogous to a private bank settling a payment between two of its own customers now – by simply adjusting the values of two accounts on the liabilities side of its balance sheet (one up one down). The liabilities don’t change in aggregate (or the assets).
Lending therefore does not affect the aggregate money supply, it merely increases the value of one account at the BoE while decreasing the value of another.
I can’t see what is unworkable about this?
Stephen,
You really don’t need to explain this. I do understand the process!
The problem, as I have now been trying to explain for hours, is that only allowing banks to lend money that has been specifically placed “at risk” would cause the mother of all credit crunches – especially when combined with money supply control by an MPC that is only interested in controlling a very narrow measure of inflation. Hence my Lehman comment. Didn’t you “get” it?
The question of whether “money” resides at the central bank or the commercial bank is in my view completely irrelevant and I see no point at all in that change as far as lending is concerned. What concerns me is the huge restriction on lending that would ensue if banks were only able to lend against 100% “at risk” reserve balances. No-one at PM has yet given me an adequate explanation as to why they think that would not be an issue.
And one further point. If all “at risk” money is liabilities of the central bank, where are the associated assets when loans are made? Are those assets of the central bank? If so, then you effectively have government guaranteeing all lending. After all, the central bank cannot be allowed to fail.
I lovve the fact that Worstall can’t be bothered to answer the critcisms.
That’s worse than Richard Murphy’s intelligent censorship. It shows that Worstall is a total lightweight with nothing to offer, but getting paid for shitty advertising space.
What a sad man.
Yep. Making waves in political discourse, just like the rest of the drunk swivel eyes.
Frances
The guys at PM and nef havve got more ideas stuck in the gaps of their teeth than any of the misguided fools on here. You obviously have a firm grasp on things. You should contribute more to their cause than trying substantiate a nutter like Worstall.
Arnald
Good evening. You’re up late!
I’m not substantiating anyone. I comment on here because Tim doesn’t censor, unlike some other people I could mention, which means I can have a good debate.
I agree with PM about some things – as you’ve no doubt realised – and massively disagree with them about others. Same with NEF (actually I probably disagree with NEF more). And I do so on the basis of my own knowledge of the way our financial and economic system works and my own opinions about how I think it SHOULD work, not out of any desire to back up Tim. Didn’t you notice that I actually disagreed with him about commercial bank money creation? Not for the first time, either. I did it fairly diplomatically, as this is his site and I am his guest here. As are you. And I pointed out that actually he and PM were using different terms for the same things, and that was causing some of the disagreement. I am hoping that both sides will take that on board and realise that they are not as far apart as they think.
I don’t find it remotely helpful when people slag each other off and score political points. I would rather that people engaged with the issues and avoided ad hominem attacks.
Frances
Fair. Which is good:)
@ Francis
Re: PMs proposals would cause the mother of all credit crunches.
It is my understanding that PMs are well aware of the effect of their proposals on the availability of lending. They propose that to mitigate these that the central bank provides funds to banks to on lend into the economy. Presumably these would be supplied at a level in order so that banks could continue their current levels of lending. Over a period of several years this facility would be slowly wound down, either to zero or a permanent lower level. Furthermore, at the same time the MPC would be creating and granting money to the government to spend into the economy debt free, and this would reduce the need for as much debt.
“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.” – Graham Towers, Governor of the Bank of Canada from 1935 to 1955.
“When a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.”
– Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report
I agree with Frances Coppola that Positive Money does get some things wrong. However her suggestion that PM’s proposals would cause “the mother of all credit crunches” is not correct. Indeed, she makes the same mistake as the Vickers commission made when it criticised narrow banking, and more generally, when it worried about excessive restrictions on private bank activities.
It is perfectly true that restricting private bank activities will be deflationary ALL ELSE EQUAL. However, all else does not need to be equal. That is, if private banks’ activities are restricted, that can easily be compensated for by having the government / central bank machine create money and spend it into the economy: exactly what Positive Money advocates. The latter policy is also advocated, incidentally, by Modern Monetary Theory.
Pingback: Tim Worstall does not understand money or banking. « The Jefferson Tree
Ralph,
There are two quite separate issues here, which both you and Positive Money confuse. One is the structural reform of the banking system and the move to a mixture of full reserve banking with fractional reserve on a 100% basis (no “money creation”). The second is direct financing of government spending by central bank money creation. The second does not automatically follow from the first, and if it does not – which would be either due to misguided economists at the Bank of England trying to keep inflation too low (as is happening now) or misguided politicians terrified of hyperinflation (as is also happening now) – then the result would be the mother of all credit crunches.
Lively exchanges, but some things seem clear. Tim was mistaken in a) his cocky dismissal of Positive Money and b) his use of argumentation with Northern Rock (as Positive Money’s response explains http://www.positivemoney.org.uk/2012/07/if-banks-can-create-money-how-come-northern-rock-went-bust/ Also, from the comments afterwards, we see that those who dismiss the basic fact that private banks create around 97% of money in circulation do so on the basis of pedantic semantics i.e. “that’s credit not money” and dont want to address the real issues of relevance to society which is what this system of credit/money supply means for business, stability, fairness, equality, sustainability and democracy.
Frances Coppola and Ralph,
Positive Money proposes separating the trigger for the creation of money from the use to which the newly-created money is put. They would like the MPC to do the former, guided by specific economic metrics in which the government has no say, and leave the government to spend the money as it becomes available.
Ben Dyson is aware that this bit of their proposal is problematic, not least because the public (like Frances) will be very sceptical about the MPC’s competence in deciding how much money we need to keep the economy working sweetly and any government’s competence to spend the money wisely. In this scenario bank lending would be greatly reduced and even more finely targeted, and there’s little hope of government spending making enough of a difference across the whole economy – vested interests are too powerful and politicians too squashy. I share Frances’ concern that a credit crunch could ensue.
However, having done a lot of reading and thinking on the subject I’m sure that PM is heading in the right direction. They appear to have got to the nub of the problem – private commercial companies (banks) determining the amount of money available to the economy and where the money is spent.
What PM has yet to properly address is a better way of managing the amount of money in the economy and where any new money is spent.
But instead of shouting them down we should be thinking of ways to improve the PM proposals, finding a more elegant solution to the problem.
So narrow is your mind you will NEVER understand anything outside the frames of reference you have.
Ignorant does not do you justice and debate is worthless with you.
Pingback: If banks can create money, how come Northern Rock went bust? « NESARA AUSTRALIA
the quite deep conceptual confusions here are almost as bad as the positive money stuff… ‘if banks could print money northern rock wouldn’t have gone bust’: if you think that’s a killer point, you really need to think things through a little slower.
Banks extend credit by simply increasing the borrowing customer’s current account … That is, banks extend credit [i.e. make loans] by creating money
Paul Tucker, Deputy Governor for Financial Stability, Bank of England. Speech: ‘Money and Credit: Banking and the Macroeconomy’
Sure you guys are better schooled than this gentleman though
Pingback: Northern Rock and the Bank of England - Future Economics
Keep away from monetary theory Tim, or at least make sure you really research your stuff before you go ranting and raving on the subject…….frankly your article makes me feel embarrassed for you……too late now though.
http://www.positivemoney.org.uk/2012/07/if-banks-can-create-money-how-come-northern-rock-went-bust/
Pingback: Distributed Economics » Northern Rock
Sorry, the positive money guys are right. The ‘credit’ created by banks is, to all intents and purposes – ‘money’. It is the ‘money’ in your bank account. What banks can do is create as much of this as they desire – crucially while maintaining the confidence that the person who is given the credit (bank-created money) may change it up for central bank money on demand. As we know, there is some thirty times more private bank created money than central bank. And this is why banks are vulnerable to “the run” – if confidence i the bank goes, then it goes down because they can’t possibly change up their credits for central bank funds. Of course this is the real story behind northern rock too. It had a ‘run’. I’m amazed that Tim seems to think that everything was okay one day, then the next they made a few mortgages and some nasty city types wouldn’t cover them. That is piffle and betrays a false understanding. It is precisely because they are creating their own money that all banks are vulnerable to ‘the run’. The northern rock run lasted over a day, while the bankers kept saying the business was sound until it was all over. Had the run not occurred the bank would still be going.
Yes, it’s money in all senses – it became money as soon as the first cheque was written and deposits were transferred using it between banks. But it is incorrect to state that the banks can create as much money as they desire – and a significant and important distinction should also be made between money on the left hand side of the banking system facing the central bank, and the right hand side of customer deposits.
But let’s face it. The real issue is actually much simpler and can be observed in all these comments. In this 21st century, after 300 years of study, and a self-proclaimed status as a science – Economics is unable to provide us with a clear, and indisputable description of how the banking system actually works. And we trust these people to fix this mess?
I think the thing that is most fascinating about all these discussions/exchanges is that, of course, money does not actually exist. Money is only a medium of exchange for goods and services, if it is to be at all useful to the average human. And what is the point of it if it is not useful? Money can be represented by a cheque, cash, a credit card, a debit card, air miles, whatever. It still does not exist but it is still only one thing …….money. Of course, following the invention of computer we now represent money with varying electrical charges in a virtual World, but it still does not exist! And, in a virtual World there is little physical constraint on the size of the representation of the money, hence the massive ballooning of debt (yet another representation of money or rather anti-money).
Pingback: Inflationism: Economically Damaging
Pingback: [NEW SITE » Does Full Reserve Banking Equal Monetarism?
I’m afraid Mr Worstall you are, like many others who did not see the Credit Crunch coming, talking total and utter nonsense. How do I know that you may ask. Well, the Bank of England has confirmed that what Positive Money have been saying over the last 4 years is absolutely correct! So who is the ‘loon’ now? If you can be bothered to educate yourself out of your self-delusional ignorance, I can recommend these links to the Bank of England website:
http://www.youtube.com/watch?v=ziTE32hiWdk
Money creation in the modern economy: an introduction
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneyintro.pdf
Money creation in the modern economy
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
And of course Positive Money explain it all simply:
http://www.positivemoney.org/2014/03/bank-england-money-money-creation-modern-economy/
I trust that you will eat your words now? 😉
Tim, you are 100% wrong. The Bank of England published a report in 2014 title ‘Money Creation in the Modern Economy’ and it clearly states that banks create new money whenever they make a loan. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
You are distinguishing between currency and the electronic numbers in our bank accounts; the Bank of England calls both of those ‘money.’ Another Bank of England report form May 2015 states that banks are self-funding: http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf So, it seem the only loon here is you.
Pingback: If banks can create money, how come Northern Rock went bust? - Positive Money