Ritchie doesn’t even understand his own arguments

At the same time as this situation has developed some long known, but disputed economic understandings have received recent endorsement as key planks for economic development. The first is that cash is, as has long been denied by many economists, is literally made out of thin air by banks, and that was how QE funding was created.


Thirdly, the IMF has confirmed inequality imposes real cost on a society, and fourthly has suggested both tax revenues and government spending play a vital role in the redistribution that provides the foundation for sustainable growth.

Good grief, the BoE did not say that cash is created by banks out of thin air. It said that broad money, or credit to give it its other name, is created by the banks. It also said that the BoE creates base money, or cash to give its other name, and that’s what QE is, the creation of base money, not broad.

And the IMF also said that modest redistribution is a good thing and that excessive is not. The dividing line between the two being, apparently, at changing market gini by more than 13 points. Given that the UK currently changes market gini by just over 13 points we’re already at the limit.

Can’t he even get his own arguments right?

98 thoughts on “Ritchie doesn’t even understand his own arguments”

  1. But I thought the IMF were part of the Global NeoCon Conspiracy(c). Or at least they were last time I looked and I distinctly remember Trickie agreeing with me once.

  2. So the banks create all the credit/ loans out of thin air (and charge interest on it) but not the very much smaller ,practically insignificant amount of hard cash.And we’re supposed to think Murphy’s an idiot and you’re not?

  3. A Ritchie comment:

    “Nile’s suggestion that I admire the chancellor is laughable

    I ignorfed it

    Spellings and all”


  4. DBC Reed: but not the very much smaller ,practically insignificant amount of hard cash

    Specie? Are you attracting the spotlight of idiocy onto yourself?

  5. DBC Reed, you can be our stand-in for Richard Murphy:

    “So the banks create all the credit/ loans out of thin air (and charge interest on it)”

    Do you actually know the difference between “the banks”, as used by Tim here and “banks” as you’re using it?

  6. Richtie writes

    “At this point I admit I wrote a proposal last year that reflected much of the thinking that would deliver the budget we need now and so much of what follows is based on the thinking from then, not least because George Osborne was churlish enough to ignore it then…”

    Just who do these chancellors think they are, ignoring the great man’s work like that? ‘Churlish’ is indeed the only word for it.

  7. I’ve had numerous arguments with the Ritchie over these sort of topics.

    In short, he doesn’t understand the difference between base money and broad money, he doesn’t understand that QE isn’t simply money printing and you can’t write QE off, and he certainly hasn’t read the IMF papers which specifically state that the UK tax system is already highly redistributive, and that any more redistribution would likely damage growth. Instead he takes the general point that redistribution might improve growth (in less redistributive economies) and simply assumes the same for the UK.

  8. ‘not least because George Osborne was churlish enough to ignore it’

    Now I fucking *know* he’s a spoofer.

  9. @ GlenDorran

    I’ve seen that little bundle of nonsense as well.

    It’s simple really, if these people bothered to think about it.

    BoE controls base money/M0.

    Banks can extend credit, which then the Guardian and Co. immediately call “money”. A bank extending this credit still needs to borrow from money markets etc to make up this shortfall, and they can’t extend credit past their capital adequacy ratios etc….as a very simple rule of thumb, about 10 times leverage. Another simple rule of thumb is that a bank will have roughly 10x liabilities in comparison to its market cap when normally capitalised.

    It’s much easier though to solve all problems via the magic money tree, and suggesting the banks somehow have free access to it.

  10. So, are we still in denial about the banking system creating money ex nihilo then?

    Hopefully Frances Coppola will turn up ánd sort this thread out.

  11. I think Tyler is wrong on two counts

    “money printing” in modern economies refers to the purchase of government bonds by the central bank using newly created high powered money. QE is money printing.

    a debt can be cancelled by being rolled over in perpetuity. The monetary base has a corresponding quantity of government bonds being held by the central bank. Permanent monetary expansion would entail permanently increase the quantity of government debt held and rolled over in perpetuity by the bank. If the BoE decided to roll QE over in perpetuity, that would amount to permanent monetary expansion and could be described as writing off the government debt purchased via QE

  12. @ Luis

    QE is often described as money printing, but in reality it isn’t. It’s an asset swap, putting cash into the system in exchange for bonds. It has it’s easing effect by lowering long term yields.

    When those bonds mature, either the cash has to leave the system once again or as you correctly say, you can roll the debt over. However, that provides it’s own problems as long as you are issuing new debt on top of the rolled QE debt, and it acts as a once off expansion of the monetary base.
    The flip side of this is that once that debt is rolled, those bonds still need to be financed somehow. The effect of this is to constrain M4 (someone still needs to put up the cash to hold the new debt).

    In either case, the debt is not written off though.

    Rolling the debt also introduces an existential risk. You can keep doing it as long as debt is low, but once the markets lose faith in the ability to repay you are either going to see much higher rates or much more inflation. QE is essentially faith based – one day it will be unwound. If it becomes clear that you are simply monetising debt (as Ritchie is keen to do) then you may as well jsut cut out the middle man and print money.

  13. What definition of “cash” are we using here? I think Ritchie just means, “the money we spend” in a general way; which is not precise, but probably adequate for a polemical piece. I’m not sure what use of “cash” Tim means, but I’ve checked around the interwebs before posting this comment and as I thought, nobody seems to think it is a synonym for base money.

    In general, cash is either physical note and coin (which isn’t specie by the way, is it? Specie is commodity currency like gold or silver, not token currency) or the money we spend. And the money we spend is broad money, not base money. I popped into the BoE and asked for some base money to buy a burger, and they told me to fuck off and get some broad money from my bank account. Bastards).

    So I’m a bit lost as to what the argument is.

    What it really comes down to is whether “the banking system” creates money, which it does. Arguing about which part of the banking system generates it is like arguing what component of your car engine makes the car go forward. The answer being, “all of it”; the system in general.

  14. Ritchie said cash is literally made out of thin air by “banks”. Does he know what he means by “banks”? Does DBC Reed? What impact does he think this has on the idea of fiscal stimulus? In short, as Tim asks, does he understand his own argument? Does he even know which argument he is employing today?

  15. “not least because George Osborne was churlish enough to ignore it”

    Ha ha. I think you meant ‘sensible’ not ‘churlish’, Richie dear.

  16. Does anyone want to explain what they think Ritchie has got wrong, rather than just saying he doesn’t know what he’s talking about?

    What do you think he means by “banks” and what has he not understood of what “banks” are?

    What is the actual criticism here?

  17. Ian B take this bit

    “The first is that cash is, as has long been denied by many economists, is literally made out of thin air by banks, and that was how QE funding was created.”

    first there is a distinction between cash (notes and coins, reserve balances held with BoE – high powered money in economic jargon) and broad money (includes the balance of your current account etc.) which he may not be aware of, but when using those terms correctly, private bank lending does not create cash (high powered money) it creates broad money “out of thin air”. Although if you ask me that phrase is very misleading because for the banking system to create broad money, individual banks must find somebody to lend them the money the finance the loans and cannot use thin air.

    If you are kind and interpret him as meaning broad money when he writes cash, then the fashion in which broad money is created (fractional reserve lending by private banks) is not “denied by many economists”, it’s in every first-year undergrad text book, plus it has nothing to do with how QE funding was created. QE involves purchasing bonds using newly minted high powered money, quite distinct from how private bank lending creates broad money.

    he packs a lot of wrong into a couple of lines

  18. @ Ian B

    Ritchie uses the terms credit and money interchangeably.

    The BoE can only create base money, M0. That is to say, cash, in simple terms.

    Banks can extend credit, which can become money, but is normally asset back (mortgages etc). Again in simple terms, what a bank does is a maturity transformation of cash.

    Let’s look at a mortgage as an example. You buy a house for 1m, and put down a 100k deposit. The banks lends you 900k over 25 years, secured against the house. That 900k is credit, extending the M4 money supply.

    However, the bank still needs to find that 900k from somewhere, as at the end of the day it still needs it’s assets to add up to it’s liabilities on it’s balance sheet. it does this by borrowing short term via money markets. The primary sources for this cash are other banks, pension funds and potentially the central bank, often secured against other liquid assets (like government bonds). Rehypothecation of these liquid assets, with fractioanl reserve banking, allows the M4 money supply to grow faster than M0.

    So what the bank has done is borrow short to lend long, extending credit. Being pedantic (as you have to be) this DOESN’T create new money out of thin air, it creates credit.

    Another way of looking at it is that creation of credit involves an asset and an equal liability on the other side, whilst “money” is a more simple store of value without a directly offsetting liability.

  19. @ Luis

    Only saw your post after I posted my own, but I think we are basically singing from the same hymm sheet.

  20. Luis-

    All well and good. We may accuse him of terminological inexactitude. But much as I hate to defend Ritchie, it is I think understandable that he’s using “cash” to mean “money in general” and in that loose language he’s close enough.

    But then we get to Tim, apparently wanting to be terminologically precise, saying Ritchie doesn’t know what he’s talking about because-

    ” It also said that the BoE creates base money, or cash to give its other name,”

    -and I’m a bit baffled by this since, whatever you want to call base money, it sure as shit isn’t “cash”.

  21. @ Luis Enrique
    There is a *very* major difference between cancelling a debt and rolling it over in perpetuity.
    It is called the coupon – the interest actually paid over in cash or cash substitute every year. That is, in many cases, worth more than the eventual repayment of the capital.

  22. Half the problem is that Tim Worstall is attacking Murphy for what the Bank of England is saying, or finally admitting at long last, in “Money Creation in the Modern Economy” which begins
    “. This article explains how the majority of money in the modern economy is created by commercial banks making loans.
    . Money creation in practice differs from some popular misconceptions – banks do not act simply as intermediaries lending out deposits that savers place with them ,and nor do they ‘multiply up’ central bank money to create new loans and deposits.
    . The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times ,this is carried out by setting interest rates .The central bank can also affect the money directly through purchasing assets or ‘quantitative easing’.”
    A bit of a game changer this article.Still, it won’t penetrate the Matrix pods of most of you lot.

  23. Ian B,

    nope, base money *is* cash, plus reserves held at central bank.


    and even if you allow for his loose language, he’s then flat out wrong about QE and what economists supposedly think


    OK yes that would matter in most cases, but not when the Treasury pays the interest to the BoE and the BoE remits the interest to the Treasury.

  24. DBC Reed,

    no it is not a game changer but is being interpreted as such by people with a very weak grasp on what the standard account of money creation already is

  25. @ Luis

    “no it is not a game changer but is being interpreted as such by people with a very weak grasp on what the standard account of money creation already is”

    This is the crux of the problem really. Loonies like Ritchie with a very poor grasp of how finance actually works take this notion that banks can create money out of thin air as fact. Then they say that it should be illegal for a private enterprise to do that, but its perfectly OK for the government to do it, not least as it helps their second argument: we can spend as much as we want on benefits/infrastructure etc with no need for austerity, with no potential downside risks, and it’s only ansty neoliberal capitalists which are preventing it.

  26. Tyler/Luis/IanB

    Just so you know: when Tim explained to Ritchie on his blog that a bank’s assets must balance its liabilities at the end of the day, Ritchie quite expressly told him he didn’t know what he was talking about.

    DBC Reed (or ‘Ritchie’s Stand-In)

    Why did you tag on your comment about banks charging interest? Now that we all accept that individual banks cannot create money ‘out of thin air’ or otherwise (well, those of us that can read all the way to Page 5 of that BoE paper can) we can see that this is just how it attempts to make a profit, yes?

  27. Tyler

    well it *is* a fact that the banking system creates money (“out of thin air”) by lending and holding reserves that are a fraction of its liabilities.

    I do not understand arguments from Richie that this ability to create money is the source of bank profits. Suppose banks only lent their equity and did not create money, they’d still make profits if the returns on their loans is high enough. And they can still lose money, having the ability to create money, if the returns on loans are low enough. Their ability to make money has to do with competition and interest differentials, not the extent to which they can “create money”

  28. Luis,

    the only reference to “cash” I can see in the Wiki article is “vault cash” which is clearly a banking jargon term and not the same as “cash”; in the same way as “planet” and “dwarf planet” are different.

    This still comes down to the basic point that what Ritchie has said is that the banks create money, which they do. And why there is a small cottage industry in denying this basic reality is the thing that remains baffling.

  29. Sorry, to correct; “vault cash” is just cash that happens to be physically in a vault. It’s not base money.

  30. Ian B

    nope, in first para the words “the total currency circulating in the public” refers to cash held in wallets, cash registers, behind cushions in sofas and so forth

  31. Yes Luis, that works if you deliberately edit off the first half of the sentence. Which is dishonest, but it does make your argument appear to work.

  32. Ian B

    nope, cash that happens to be physically in a value is base money.

    base money is cash in vaults, cash in circulation, reserve balances held at central bank.

    perhaps you need to revisit your understanding of the term “base money”

    also: who denies bank lending creates money? Not Tim W, nor mainstream economics

  33. what are you on about?

    here is the full sentence

    In economics, the monetary base (also base money, money base, high-powered money, reserve money, or, in the UK, narrow money) in a country is defined as the portion of the commercial banks’ reserves that are maintained in accounts with their central bank plus the total currency circulating in the public

    so that’s base money = reserves in accounts at CB plus cash.

    which is what I have been saying all along.

    please do not accuse others of dishonesty when your own inability to read is at fault

  34. IanB

    No, he did not say that”the banks” create money; he said that “banks” create money. The difference being that he thinks individual banks can create moneyJ they can’t!

    ‘Out of thin air’ is also a very poor way of describing what happens as it doesn’t give any hint of the very real restrictions facing banks looking to lend.

    Again, I would urge everyone (well no, a lot of us have already read into this) to read the BoE paper, all of it. It sets out the operation and those restrictions.

  35. What it’s saying in that sentence is, the base money is reserves plus note and coin. That doesn’t mean you can use “cash” (note and coin) as a synonym for “base money”.

    In the same way that the term “humanity” includes some proportion of “Venezuelans”, but it does not follow that one can use the word “Venezuelan” to refer to humanity in general.

  36. and cash held in vaults is part of “currency circulating in public” as the rest of the sentence says .

  37. Ironman, with all due respect, this is all nitpicking vernacular (written) speech. Banks and “the banks” are reasonably interchangeable in that context.

    Honestly, I wonder if the world has gone mad that I’m sitting here defending Ritchie. But this really isn’t substantive criticism. It’s just having a go at him for the sake of it. The basic point in his rant; that banks, or the banks, or the banking system, or banking, or bankers, or banksters, or bankocrats, or the bankocracy, or whatever, create money, is sound.

  38. Ian B my very first comment on this topic was

    Luis Enrique
    March 18, 2014 at 3:51 pm
    Ian B,

    nope, base money *is* cash, plus reserves held at central bank.

    now you are telling me base money is cash, plus reserves held at central bank.

    whereas you wrote

    whatever you want to call base money, it sure as shit isn’t “cash”.

    that’s a bit like saying, “whatever you want to call lunch, it sure as shit isn’t a sandwich” because lunch was actually a sandwich plus and apple

  39. Ian B

    you are also yet to acknowledge the simple point that when you wrote “the only reference to “cash” I can see in the Wiki article is “vault cash”” you missed the reference to “currency in circulation” but instead prefer to accuse me of dishonesty when I point out those words refer to cash

  40. Ian B

    and remember this all started from the Tim pointing out that “banks create cash out of thin air” is wrong because cash is base money, and banks do not create base money. That’s why we started looking at definitions of base money.

    But as we have established, cash is base money. So Tim’s criticism is correct.

    Cash is base money does not mean that base money consists only of cash.

    Chicken is food, but food is more than just chicken.

  41. No, cash isn’t synonymous with base money. Base money includes note and coin. Which is a small percentage. It depends what you mean by cash, and Tim is wrong, and Ritchie is wrong, but Ritchie was writing vernacularly whereas Tim was affecting precision, so TIm has less justification for being wrong.

    I’m interested here in what Tim said, not what you said, and what Tim said was-

    “It also said that the BoE creates base money, or cash to give its other name, ”

    He is clearly saying that base money and cash are synonymous. They are not. “Cash” is not another name for base money. Cash as note and coin are a component of base money (a small one). Not the same thing. Base money is not cash, but cash is base money. Humanity is not Venezuelans, but Venezuelans are humans.

  42. Ian B

    take a look at this


    “The published M0 series comprises notes and coin in circulation and bankers’ operational balances at
    the Bank of England, with the latter accounting for a very small part of the whole.”

    so notes and coins in circulation account for the lion’s share of base money, not a “small percentage” [*]

    it would help if you didn’t make stuff up.

    but yes if you want to salvage a triumph after failing to acknowledge when you get things wrong all down the thread, then strictly speaking Tim should have written

    “It also said that the BoE creates base money, or cash plus reserves, the latter accounting for a very small part of the whole, to give its other name”

    have a biscuit

    * that’s in normal times, not after what QE has done to reserves

  43. Tyler/Luis

    Just stop!

    Richard Murphy, DBC Reed, IanB, they simply will not have it, so stop trying.

  44. The central bank creates M0 (notes, coins and reserves). Other banks do not.

    Commercial banks create M4 (credit), but they do not do it out of thin air, as Ritchie tries to claim. The fact that they pay interest to depositors shows this to be an false notion.

  45. The banking system creates the credit; an individual bank cannot. The combination of the bank, the person borrowing from it and person depositing the sum that the original borrower gives him for whatever it is he’s borrowed the original amount has created the money.

    So ‘out of thin air’ is a very poor expalantion.

  46. Ironic that in the week that Tony Benn died his late 1970s plan for a siege economy was reworked and put into the public sphere by the LHTD. To critique the entire piece would be akin to shooting fish in a barrel, and probably take about 50 posts.

    The examples of Much of Southern Europe and or/Japan illustrate the idiocy of the ‘Banks create all the money’ position, if they don’t have sufficient assets to cover their liabilities. By his own admission on frequent occasions (Quote of the Day:’ It’s always possible I’m wrong – I know of noone of whom that is not true’ which might explain Osborne’s ‘churlish’ relutance to take any of his lunacy on board) he has ‘no idea’ about Japan, which is in many ways the ultimate guide as to why the approach he outlines cannot work,has never worked, and is doomed to failure.

    To echo the excellent Luis Enrique:

    ‘Oh god he is awful, please make him go away!’

    As to DBC Reed (surely Arnald’s nice brother?) – the article you refer to doesn’t change the game for me – it’s an opinion, nothing more….

  47. I don’t want to get involved in this argument (I know what’s correct).

    I do wonder however, if maybe a brief Venn Diagram from R Murphy showing money creation by BoE and commercial banks might help understanding here?

    I can’t ask him as I don’t post there anymore, but maybe someone else could?

  48. And today Richard Murphy tweeted “If the bank created your mortgage out of thin air, then why does it charge you so much interest on it?”

    Altogether now, slap your palm very hard onto your face.

  49. I wonder why he’s never applied for a banking license then he can create all the money he wants to help all those good causes he says he supports?

    Maybe one of the readers here who does go over to his place could ask him?

  50. Crikey, where do I start with this heap of conflicting opinions?

    First, Murphy is technically incorrect to say that banks create “cash”. Cash is notes & coins in circulation and is one component of base money or M0. In England and Wales these are created only by (respectively) the Bank of England and the Royal Mint. In Scotland and Northern Ireland some banks can create cash but only if it is 100% backed with sterling cash reserves.

    Secondly, Murphy is incorrect to suggest that QE is funded by creation of cash out of thin air by commercial banks. It is actually funded by the central bank creating reserves out of thin air – which as Luis has correctly explained, are the other component of base money or M0. Only the central bank can create the components of base money.

    Thirdly, Tim is incorrect that QE only creates new base money. It’s a little more complicated than that. When assets are purchased from investors – which is most purchases in the UK, the US and I think also Japan – both M0 and M1 rise, because the new money goes into customer deposit accounts. M4 may also rise, depending on the extent to which the increase in M1 due to new customer deposits offsets the reduction in M4 caused by private sector deleveraging (which is of course what QE is intended to counteract).

    Fourthly, you are all missing the point. I’ve explained ad nauseam both here and elsewhere how banks create money ex nihilo. But at the risk of being REALLY tedious, here it is again.

    Loans are created as a double entry pair: DR loan account (asset), CR deposit account (liability). It is the deposit liability that the borrower is really interested in, because that is the money she will spend. At the point that the new deposit is created – and BEFORE it is drawn (i.e. spent by the borrower) – M1 increases by the amount of the deposit. Yes, the bank then has to obtain funding to enable the deposit to be drawn. But the money already exists.

    It is frankly ridiculous to argue that the money put in a customer deposit account by a bank when it lends is somehow different from the cash the same customer put in that account the day before, or the wages that were electronically paid in last week. Once they are in that account they are indistinguishable. Trying to distinguish between “money” and “credit” in a customer deposit account is like trying to unscramble an omelette. Money is fungible.

    The exception to the above is something like a credit card, where there is a credit limit but no actual money advanced until the card is used. In this case, when the implied “loan” is drawn, the new deposit goes straight to the payee rather than to the borrower. This is similar to the way the classic “money multiplier” works.

    Exactly how the mechanism works is not as important as the fact that commercial banks create money when they lend, money which for all practical purposes is indistinguishable from money created by the central bank. Banks are not pure intermediaries.

    This does NOT mean that funding is not important. But it is deposit withdrawals (payments) in general that have to be funded, not just loan drawdowns. The way loan funding works should be seen as part of payments funding, not as a separate matter. Having said that, though, most banks do pre-position funding for large loan commitments – understandably, because they want to know they can fund a loan before they will agree to it.


    rolling over government debt is not a constraint on M4. Paying off debt reduces M4, but rolling it over maintains it.

    If the debt being rolled over is held by the central bank, then what we have is maturity of the central bank’s holding, which reduces M0, followed by a QE purchase of replacement assets, which raises M0 again. The Bank of England already does this.

  51. Frances:

    Up to a point (and for the system as a whole) that makes sense, but surely for a single bank making a loan, the (net) double entry is

    debit loan account (asset), credit cash (liability)

    because the loan will be drawn (why else would it be made), so it has to be funded

    as Ironman says, isnt it different for a single bank (rather than the system as a whole) from me paying my wages into the bank the week before because some of my wages are still there a week later

    I fully acknowledge that im speaking as an accountant here – my a level economics were a long time ago

  52. h

    The accounting entries I gave are correct. Cash on a bank’s balance sheet is an asset not a liability.

    Banks do not have to fund loans in advance of lending. They have to fund the drawing of the loan – which is a payment. Payment accounting entries are as follows:

    Sending bank
    DR customer deposit (transaction) account
    CR reserve account

    Receiving bank
    CR customer deposit (transaction) account
    DR reserve account

    Central bank (RTGS)
    DR Sending bank reserve account
    CR Receiving bank reserve account

    These entries would be the same whether the customer was paying his mortgage at a different bank from his wages or buying a car with a previously agreed loan.

    Even with lending, some of the money may still be there a week later. How long is it between a mortgage being granted and completion of the house purchase? And some loans are never settled – they simply refinance existing borrowings. You can’t assume that money lent is spent immediately, or at all.

  53. h

    The bit I left out, of course, is Tyler’s favourite – the funding transaction. Exactly what the entries are depends on the source of funds. But if we assume it is interbank lending, then the bank will pledge some of its quality assets in return for a short-term loan (repo). The pledge is off balance sheet (contingent liaibility), but the funding entries are:

    CR wholesale funds (liability)
    DR reserves (asset)

    Note that there is a reserve movement associated with the funding transaction, since it is of course an inward payment. The reserve movement is equal and opposite to the reserve movement associated with the customer payment.

    This transaction must take place at some point between the loan being granted and close of business on the day that the borrower pays out the lent funds. The Bank of England will allow banks to run daylight overdrafts in their reserve accounts, which they cover with collateral pledges (intraday repo). Funding has to be provided by the end of the day, however, to avoid penalty interest. It’s much like the way in which a bank operates a customer current account.

    In practice, of course, banks self-fund as far as possible using stable funding sources such as time deposits and bonds. It’s only funding shortfalls that leave reserve accounts in overdraft (or in the US, below the reserve requirement) that have to be met with short-term borrowings.

  54. Frances:

    Sorry, I dont think i was being clear – I’m an accountant so I know cash is an asset on a banks balance sheet. What I meant that asset is reduced by the cash outflow, hence the accounting credit

    I also agree/know that some loans aren’t drawn immediately, fully drawn or drawn at all

    Equally though, I see a lot of loans (eg acquisition finance and refinancings) that typically get “made” and drawn almost simultaneously. The drawdown mechanics in my experience are such that the cash actually flows (often to an intermediary holding to order) before a liability nominally exists

    The point I was trying to make (badly) is that cash, for an individual bankx loans, needs to be funded, even if only pro tem.

    I’m not close enough to central bank settlement accounts to know how a bank treasurer will look at that – I can see that on average that the flows should net for the system, but if I’m a bank advancing (ie actually funding) a very large above average loan tomorrow, I need to flow the funds or make up some last minute nonsense about why the cps aren’t satisfied, don’t I?

    Or are you saying that the central bank wont look (on average) to see reserve accounts net to zero over a period? If that’s the case, I can see how an individual bank can create money temporarily, but they not how they can create money in the sense that people are suggesting, ie out of thin air and for more than the time between banks opening and closing for a day

  55. frances:

    sorry, comments crossed – your last one was what I was trying to get at, the point being (I think) that an individual bank cant just magic money out of thin air (absent bad/no regulation).

    At best, it can fund via a daylight overdraft, and absent some actual/perceived collateral for that (or a lender of last resort), its northern rock isn’t it?

  56. Even Frances Coppola is wrong.
    Banks cannot create money out of nothing – what they can do in an era of fractional reserve banking is to multiply the amount of money entrusted to them by shareholders and depositors. They are notionally limited by leverage ratios (which are far too high) and effectively by capital adequacy ratios – hence the squeeze on lending after Darling decided to increase those ratios. If they could create money out of nothing their leverage ratios would be infinite and their capital adequacy ratios zero.
    Even the unused balance on my credit cards (and my unused overdraft limit) are part of the “asset base” of the guaranteeing bank against which it is required to hold capital. Two or three years ago some bureaucrat (or maybe a computer programme) wanted to reduce my overdraft facility because it generated a capital requirement (after receiving the computer-generated letter I walked into my local branch and told the manager I wanted to keep a £1,000 facility and, as I had been a customer longer than she had been an employee, she told the bureaucrat/programme to shut up).

  57. h

    What I’m trying to get at is that the granting of the loan ITSELF creates money (in the sense that it increases M1) because of the new customer deposit entry, which is not “moved” from anywhere else on the balance sheet but simply created “ex nihilo”.

    Funding the drawdown of the loan is a separate activity with a different set of accounting entries, even if it happens on the same day. But deposits of course fund payments – in fact current account balances are rather a large proportion of clearing bank funding. So when our borrower pays out the money she has borrowed, the payee’s bank uses that money (which remember was created “ex nihilo” by the sending bank when it made the loan) to fund other payments such as drawdown of loans it has made. So loans create deposits, but deposits fund loans. I hope that makes sense.

    The vast majority of the money in circulation is created by bank lending in the way that I have described.

  58. PS DBC Reed sounds as much of an idiot on this subject as Murphy, so he should heed the phrase about people in glass houses.

  59. john77,

    I am not wrong. Banks create money in exactly the manner I have described, and theoretically their money creation powers are limitless. They do not “multiply money entrusted to them by shareholders and depositors”. The multiplier is simply an accounting identity, not a determinant of behaviour.

    Banks are indeed constrained by capital and leverage ratios. This is because both limit the size of the asset base in relation to equity. When banks create money through commercial lending, the size and risk of their asset base increases, and their equity cushion diminishes (because the new deposit created is debt not equity). Therefore capital and leverage ratios, properly applied, act as a brake on lending and associated money creation.

    Banks are also constrained by the cost of funding – which is influenced by the rate that the central bank charges for reserves borrowings and deposits. They are additionally constrained by the willingness of households, businesses and governments to borrow. And finally, they are constrained by their own assessment of risk versus return. Put bluntly, if the return on lending does not in their view justify the risk, they will not lend.

    Risk-weighted capital measures include off-balance sheet (contingent) assets – that’s why your undrawn credit card and unused overdraft facility are included.

  60. @ Frances

    I should have been clearer. Rolling over debt held for QE will not affect M0. It will over time affect M4 growth via substiution. In essence banks are forced to leverage to hold government debt rather than extending credit. It’s certainly not a linear relationship though.

    I used to work at a large international bank doing most of their short term funding. Unless Goldman Sachs are getting something horribly wrong, it’s not just the reserve account which needs to be made whole at the end of every day. It’s the total asset/liability of the balance sheet. pretty much every liquid asset held above the reserve requirements is out on repo, and the next biggest source of funding tends to be money market funds.

    “At the point that the new deposit is created – and BEFORE it is drawn (i.e. spent by the borrower) – M1 increases by the amount of the deposit. Yes, the bank then has to obtain funding to enable the deposit to be drawn. But the money already exists.”

    This isn’t technically true for the reasons above, though I do see a lot of economists argue this. In practice the money only exists if the bank can finance it – which means borrowing from someone else. Funding is *everything* in banking, as Lehmans can attest to.

  61. Tyler,

    Banks holding safe assets such as govt debt does restrict M4 growth if a leverage ratio is the primary microprudential regulatory tool, because it doesn’t weight capital allocation by risk. If risk-weighted capital ratio is the only or the main policy tool, safe assets make no difference to banks’ ability to lend. It’s worth reading Peter Stella on this – he was talking about reserves but the same applies to government debt.

    I used to work in asset & liability management for a large bank. Yes, asset/liability gaps have to be plugged daily. But that does not mean that M1 does not increase as a consequence of lending.

    I don’t know when you were at GS, but money market funds certainly aren’t the second largest source of funds these days – short-term funding use has reduced considerably. And they never have been in retail banks, which even before the crisis relied far more on customer deposits. Most UK banks now have loan/deposit ratios of 100% or less. The exception is Santander, which has a loan/deposit ratio of 130%, but they prefer to use covered bonds for funding rather than relying too much on deposits – understandable, given what happened to Cyprus.

    The truth is that banks are no longer funding large parts of their balance sheet with short-term funds: regulations and tax policies are driving them towards making far greater use of longer-term stable funding. I think this is a very significant reason for their unwillingness to take on new loans, which isn’t often discussed. These days, balance sheet expansion is expensive.

  62. Frances/All

    Thank you for your contributions. One of the reasons I like this blog is sometimes learning new things and sometimes being shown something that is staring me in the face that I haven’t seen!
    Such as: the deposit created with the loan facility is as much money in the borrower’s account as wages he’s depisited etc. And yes, the accounting entry of crediting the borrower’s account expands M1.
    However, this brings me to the substance of my points – repeated ad nauseum; I’m sorry: double entry accounting can, in the wrong hands, be meaningless or even fraudulent. Early on in my careey I came across any number of ‘proviaions’ being created to supress profits. It is all very well making the entries, but without the funding nothing of economic substance takes place. I know this is obvious and I know the loan comes before the funding, but it clearly isn’t obvious to some (hence Murphy’s tweet)m
    So please, do not ‘leave it out’ for any reason; not to explain the accounting, not to demonstrate the ex nihilo mechanism. And can we all agree that the banks, meaning the system creates money; the simple entry of debiting a loan account doesn’t do it.

    Oh yes: and NOBODY need ever ask why a bank charges interest!!!

  63. The Meissen Bison

    Of course one reason that short term funding has reduced is that the interbank market depends on borrower bank risk being acceptable to the lending bank.

    A few decades ago and in a market some way away, we wouldn’t even accept money market deposits from the local BCCI.

  64. @ Frances

    I was there for 5 years till 2006. Indeed things have changed as you mention – in no small part thanks to Basel III. Short term funding is still incredibly important to banks though, primarily as the cash component of repo lending. Where I primarily disagree with you is that M1 will increase *only* if a bank has access to suitable funding on the other side. Normally it will, which seems to be why economists tend to simplify the situation, but when that funding isn’t forthcoming that simplification breaks down.

    The M4 point is twofold. Firstly, even “safe” assets take a smalll haricut in collateral terms, so there is a small, compounding restriction on lending even when holding what are generally termed risk free assets.

    Secondly, issuing more debt can cause a feedback effect in M4. more issuance tends to force yields higher, and the main buyers of bonds (pension funds) only have a certain capacity to buy (especially with LDI strategies becoming more common) and some might even become net sellers given CPI benchmarks. This tends to leave the GEMMs holding more stock on balance sheet, with the associated costs and reduction in the ability to extend credit. It’s not the easiest relationship to unpick (let alone that higher yields make it more expensive to borrow), but anecdotally seems to hold. UK M4 hasn’t really budged since QE began, and there is a similar phenomonen in the US – indeed, US M4 money supply growth has accelerated snice the announcement of FED QE tapering.

  65. The basics here is that Frances is technically correct, but what she is saying is not what the common meme is.

    In reasonably accepted English, I suggest:

    Banks do indeed create credit* ex-nihilo, but when people wish to turn that in to actual spending**, the banks need, in order to ensure their books balance, to obtain funding for that credit (by the end of the relevant accounting period.)***

    * This counts as “money” for some technical and most practical definitions.
    ** This is “money”, by pretty much any definition and as it can actually be withdrawn in specie in most cases, can be money by any definition.
    *** This is completely invisible to the customer, therefore, as far as most people are concerned, doesn’t actually happen.

  66. Oh, and:

    *** And because that doesn’t actually need to happen until after the credit is spent, you can argue that banks create “virtual cash”, which will collapse “at the close of the next working day” unless “real money” is injected to support it.

  67. I agree totally with the comment above about this blog (especially he comments) being a good place to broaden knowledge.

    The key point I’ve taken from this thread is that we have (at least) two experts with deep market experience here who are debating this at length (highlighting that the precise and accurate use of terminology is vital).

    The idea that someone like Ritchie or that Guardian sociology lecturer are going to be able to add anything of value is….well…..challenging.

    Later this evening I plan to retreat to a quiet room with a cold towel on my head to try to understand the subtleties of the debate between Frances and Tyler. I have to confess that I find all of this fascinating.

  68. @ Frances
    Banks *cannot* create money out of nothing.
    If the Bank of Coppola, based in the self-declared autonomous republic of Rockall, which has nil shareholders funds and nil deposits issues a loan of 1 million “Puffins”, that is *not* money because the borrower cannot spend it since the bank has no specie and no creditor will accept a Bank of Coppola draft in exchange for goods and services since it is obvious that the bank cannot honour the draft.
    Your example demonstrates that banks multiply money but not that they create money out of nothing.

  69. John77

    They would accept the draft if they perceived that it was backed up by a bond of sufficient quality

  70. or they could agree to net it off in a contra account with one of there own future drafts, or there drafts might net off in clearing, or Coppola bank could open a loan account with the receiving bank. or failing that Coppola bank could borrow some reserves from the BOE and transfer them over.

  71. john77

    but I think the point is that people *do* accept bank IOUs as money, which is what makes them different from you and I, and is where the creating money out of thin air bit comes from.

    however, we accept bank IOUs as money *because* we are very confident they will be able to provide the hard cash on demand. And that’s where the “creating money out of thin air” thing is misleading, because their ability to do so relies on their ability to hand over hard cash on demand – most definitely not created out of thin air.

    however, my bank lends me £500, they can add £500 “out of thin air” to the balance of my current account. Then if I purchase something for £500 from somebody who has an account at the same bank, they can reduce my balance by £500 and increase the vendors by £500. The vendor will accept that. They don’t have to find hard cash. That £500 has been used as money to conduct a transaction.

    It’s only when I want to withdraw £500 cash, or I want to transfer £500 to another bank they need to find the money, and of course their are thousands of inward and outward transfers every day so they only ever really need to fund net transfers.

  72. The hard cash you refer to is not materially different from a commercial bank cheque. It is a cheque from the BOE.
    The phrase “out of nothing” is misleading as it suggests that the deposit is the source of value in the system , which it is not, the source of value is the bond, mortgage IOU etc.

  73. What Dinero said. The new deposit is a bank IOU which is backed by the loan asset that is created at the same time. This may in turn be backed by real physical assets – as in mortgage lending for example. Indeed I think it would be fair to say that in these days of repo funding, virtually all money creation is secured on existing assets one way or another. There is very little unsecured lending in interbank markets now. Tyler, would you agree?

  74. Hi Frances

    In your explanation and the BOE’s dexplanation reserves are shown to be required when a new deposit is drawn down. But is that completely true, is it the case that the deposit transfer going from one bank to another may be netted off with a simmilar deposit going to its own accounts originating from the receiving bank during the clearing process and thus reserves not neccassarily being required or changing hands.

  75. @ Dinero
    Only if it is backed by *something*
    *Not* if it is backed by nothing.
    @ Luis Enrique
    *Because* we are confident that they can provide hard cash on demand. So they *have* to have the hard cash to start with and they just multiply it up.

  76. Tyler,

    I really don’t agree. M1 rises even if a bank lends recklessly.
    Northern Rock’s reckless lending caused its balance sheet to expand (i.e. M1 to rise) during the six months prior to its failure even though it was having increasing difficulty funding its lending during that time.

    And the existence of a lender of last resort facility means that banks may continue to lend even when market funding is no longer available. Did you know that Northern Rock continued to lend for another five months after its emergency bailout by the Bank of England? And many Eurozone banks were in the same situation in 2011-12. They couldn’t get market funding at any price, but they continued to lend knowing that national central banks would fund them. Laiki Bank, which was actually insolvent, was funded by ELA for a year before its eventual collapse.

    On the M4 point, I agree that the haircut may act as a small constraint on repo funding. But rolling over debt doesn’t increase the stock of debt, it merely prevents the existing stock from reducing. Therefore why should it cause yields to increase?

    I’m not convinced that the US M4 growth (M3? M2?) is in any way caused by the Fed taper. In my view it is simply due to economic conditions improving, banks becoming more willing to lend and businesses/households becoming more willing to borrow.

  77. john77,

    First point – see my comment above on asset backing for money creation.

    Second point – no, they don’t have to have the “hard cash” to start with. They only have to be sufficiently creditworthy to get it when they need it. Creditworthiness is determined by things such as market capitalization and asset quality, not by the existence of cash reserves on bank balance sheets.

  78. john77

    no, I don’t think they *have* to have the hard cash to start with. Although having sufficient reserves in place is certainly one good reason to be confident they can provide hard cash on demand, they are also able to borrow from the central bank (and for all I know other sources) to obtain hard cash to settle net transfers, meet cash withdrawals etc.

    I really do think they can lend first and sort their funding out later as they go along

  79. Dinero,

    Absolutely yes. Funding is only required for a reserve shortfall (and associated asset/liability mismatch) after all intraday movements. If the intraday movements net out, no additional funding is required.

  80. > John77

    its not backed by nothing , its backed by the banks assets ie the borrowers bond and in turn ultimately the goods and services sold by the borrower in order to honour the bond.

  81. @ Frances

    M1 can rise while a bank can still access funding – you are correct. What I am saying is that the simplification economists typically use breaks down in the limit where funding is not available any more, suggesting an oversimplification of the problem.

    The central bank lender of last resort does solve one problem, at the cost of creating an asymetric risk for the taxpayer. It also assumes that a country can afford to bail it’s banks out – which in the case of Cyprus it simply couldn’t. i guess a country could simply print money (not QE) to prop up its lenders but at the cost of a devalued currency and inflation.

    You’ll also notice that during the Lehmans crisis funding became near imossible to get from the market as the bank’s credit worthiness was called into question – and the main sources of “real” money (pension funds etc) stopped lending it out.

    Rolling over debt will increase the debt stock – assuming a country’s budget deficit is static. You still need to issue enough paper to cover the deficit, as well as extra paper for the roll. You can think of QE as forward starting debt in some ways (think of the cash flows).

    As for M4, as I said it’s very difficult to unpick the various causes. Economic growth will also tend to increase M4 as people borrow to invest (though gross fixed capital formation has been pretty static). It is interesting to note though that the implementation of QE didn’t cause a real increase in M4, and that even though tapering has sent bond yields significantly higher M4 is now picking up.

    Again, it is hard if not impossible to pick out the individual effects of each input (and at a guess QE tapering is secondary to GDP grwoth), but this effect of QE is essentially the “crowding-out” in debt markets people were worried about.

  82. To echo the sentiments of both Ironman and GlenDorran – this has been a fascinating thread, between two people who have an honest disagreement but who both appear (to my less than expert mind) to have considerable expertise – it is really very much a value add, as indeed is this blog, especially in comparison with Tax Research UK.

    I’d also echo his point that I’d question whether a man whose primary method of argument is to either delete comments with which he disagrees, liberally hurl out a lexicon of meaningless terms such as ‘NeoLiberal’ & ‘Troll’ or resort to quoting from Section 5 of his blog’s comments policy when he has been out argued by his interlocutors can contribute anything to the debate, let alone be taken seriously by economic policy makers.

  83. Frances Coppola has repeated Murphy’s lie that banks can create money out of nothing. So I point out that they cannot do so with a simple example. Dinero and Frances then “rebut” my claim by pretending that my notional bank has hard cash or a bond or “its backed by the banks assets” – which I have stated to be nil. Oh, the red herring that someone will accept a draft on a credit line of “a million Puffins” whose only backing is the creditworthiness of the borrower, less expenses, in preference to giving the borrower credit is just risible.
    Frances’ comments all start from the basis of the bank having capital (its own and/or deposits) not from nothing.
    I may seem a grumpy boring old pedant but this does matter.

  84. john77

    I really wouldn’t use the word ‘lie’ in the same sentence as Frances or Dinero, they deserve much better than that. It’s also just not your style.

    However, I do share your fundamental frustration: the term ‘out of thin air’ is unfortunate in the extreme and I would challenge anybody using it, be they called Worstall, Coppola, Dillow, Krugman… It just doesn’t describe the operation at all well and gives the impression that a bank has the ability to let rip with its lending.

  85. john77

    the borrower will be presenting the “1 million puffins at a later date”

    There’ no reason to be skeptical about the process. just think how credit cards work,
    There are no deposits in that system, no lender of last resort, no cash, no government, but it still works.

    Frances did mentioned bank Capital , but this includes and increases with assets to liabilaty ratio. An easy way of doing it is when they ask for a loan arrangment fee. Then the assets are immediately numerically greater than the liabilaty.

  86. Ironman

    I don’t like The often used phrase “out of nothing” either , it is misleading as it suggests that the deposit is the source of value in the system , which it is not, the source of value is the bond, mortgage IOU etc.

  87. John77
    in practice a brand new bank would probably have some seed money from shareholders, But there is nothing mandating that to be the case. And if it was all paid back in a buy back a week later the bank would still be operating and making loans so it is a mute point and doesn’t form part of the loan/deposit making process.

    The person can take the draft to the Bank and get the puffins in the present because the Bank can borrow the puffins from somwhere using its bonds as collateral.

  88. Well that’s alright then; back into your pods; that horrible glimpse of reality has all been explained away.Banks do create money ex nihilo but it only looks like a scam.Otherwise banks sending you loan cheques without any backing would be no better than Uncle Roger who got into trouble (no not that trouble,the other trouble) for writing unsupported cheques.That could never be.Or we might have a system where those government bogie men would n’t have to tax and borrow but could create the country’s money in the act of paying for public services.But we don’t use those do we ? Nothing so common .But we do have to do a bit of regime change from time to time .Which is SO expensive.But worth every penny .Look at Libya now.No, you’ll find they like the ruins. So everything’s for the best in the best of all possible worlds.Trust the bankers : they’ve got away with it so long they must know a thing or two!

  89. @ DBC Reed
    I am not banned from using the word lie in the same sentence as your name (I was not actually accusing Ms Coppola of lying, that was just poor wording that Ironman spotted could be misinterpreted).
    Until your apologise for your earlier lies, I can say what I like about you so just be grateful that I do not.

  90. john77

    And we’re certainly not banned from using the words ‘prat’, ‘arsehole’ or ‘dick’ in the same sentence as DBC. And yes, they are appropriate!

    I think the worst aspect of his latest comment is it comes after an extremely enlightening debate between genuine experts. How anyone can read Frances Coppola’s exchange with Dinero, Tyler, your good self, et al and not learn anything is beyond me. I hope for his sake he is an idiot, because the alternative is a determination NOT to learn.

    DBC, for the record: these people have worked at a high level in the field, they understand exactly how banks are financed and have been debating the minutiae of it. You would be well served by just shutting up, reading and feeling happy to learn something new.

  91. Wait a minute: Frances , Ian B , Dinero and the Bank of England are saying what I have been saying all along :that banks do not on-lend savers’ money but create entirely new sums out of nothing when making loans.To you this is a staggering proposition.I was writing about this in the 1980’s -a period of markedly greater personal courtesy,when you would not be called a liar for repeating something from an official B of E source.I have essayed a certain gentle satire :you have screamed like, well , a dick, arsehole or prat.
    (Keep going: we should get over the 100 e-mail landmark on this one)

  92. Well, sonny, you may have been using your skills at writing ‘A’ level history essays to write interesting fiction in the 1980s but I was studying mathematical logic in the 1960s and it is perfectly clear to ant anyone with the most basic elemental understanding of logic that banks cannot lend money if they have no money to start with.

  93. This is the kind of thing I was writing back then (in Vole Feb 14th 1980):
    ” In fact the responsibility for creating money is not within the power of parliament or government: the function has been assumed by the banking system .’Only banks create money’ is the claim of the system’s opponents, the truth of which is apt to disconcert those of settled opinion.”
    So I am surprised that the B of E has finally chosen to disconcert people as well.
    I also wrote of the ill effects of the inflation of land values in an earlier piece of November 1979 commemorating the centenary of Henry George’s “Progress and Poverty”.
    So it has ,speaking personally (your invariable mode of address) been a very strange experience watching the banking system create money and pump it into the property market over the intervening thirty-four years with results that were always predictable.
    I wish you would drop the patronising approach : I am by my rough estimate ,older than you.

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