Isn’t this just absolutely gorgeous?

Jack C “I’d be interested to know exactly how this money creation works. ”

When you go to a Bank and ask for a loan (to buy a house for example), the Bank can simply type some numbers in a computer (£500,000 for example). In exchange, you sign an agreement to pay back the sum with interest over say 25 years. In the UK the Banks don’t even fix the interest rates in advance – after a couple of years, you have agreed to pay whatever amount they ask. If you don’t pay, they can repossess your house. The only limit on the banks ability to create money in this way is the fact that the Basel Banking regulations put limits on the amount of capital they have to have to back up loans. Normally, they need to have capital equivalent to around 10% of their assets. However, for mortage lending, the risk-weighting is only about 30%, meaning that they can lend out around 30 times more.

The remarkable exception is lending to governments. In that case, the risk-weighting is fixed at 0%, which means that the bank can create literally infinite amounts of debt, if they can find some complicit or ignorant politicians prepared to take on more debt. This is what I was denouncing in my post – what Tim describes as Flatulant Tospottery.

Please allow me to disagree. I sincerely believe that if Europe’s taxpayers knew that they had handed over more that €6.6 trillion in interest payments on public sector debt over the last 20 years, there might just be a little bit of disbelief.

And maybe a slight sense that we have all been robbed by the 1% at the top who control the money creation process, and who are so ably defended by Tim on his blog.

The bank just invents the money for your house purchase! Banks only ever have assets, no liabilities!

They do not, for example, have to balance their books once a day. The interbank market does not exist, deposits do not matter. Banks just invent money!

Remember, this guy is a scientist!


Directeur de Recherche CNRS

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Perception and Recognition of Objects and Scenes (PROS)

Research Interests

My current interests are centred on understanding the phenomenal processing speed achieved by the visual system. For a number of years we have been running experiments that attempt to measure just how fast visual processing is using briefly flashed natural scenes using a combination of electrophysiological and behavioural methods. With Holle Kirchner, we recently found that when two images aresimultaneously flashed to the left and right of the fixation point, humans can initiate saccades to the side where the scene contains an animal in only 130 ms. Such severe temporal constraints pose majorproblems for virtually all current theories of visual processing. In an attempt to explain this sort of ultra-rapid processing I proposed a novel coding scheme that uses the order in which cells fire spikes,rather than firing rates to encode information. It turns out that using such a code may allow us recognise objects when as few as 1% of the neurons in the visual pathways have fired a spike. In 1999, I setup a company (SpikeNet Technology) that has developed image processing software based on these principles. A demo of the software can be downloaded from the company web site (

I have recently become interested in questions of the economy and tax reform. You can find out more about my radical ideas here.

81 thoughts on “Isn’t this just absolutely gorgeous?”

  1. So, let’s get this straight.

    Guy I bought my house from owned it outright.

    I’ve a mortgage from Barclays, for about half its value.

    For sake of argument, my house cost £100k.

    So, when I bought my house, the following could have happened:

    I go and look under the bed, find my £50k in used fivers, pop round to my solicitors with it, and the pass it on to the ex-owner. So far so straight forward.

    Now, Barclays dial up some money electronicly and do a bank transfer to the ex-owner (who for the sake of argument banks with Barclays too).

    He pops round to a cash machine and withdraws this £50k because he wants to spend his £100k on coke and hookers at the weekend.

    All straight forward apart from: where did the banks £50k come from that they gave to the ex-owner to spend? Did they just congure it up at the touch of a button?

    I’ve a feeling that there is more to this than the bank just inventing money when I take out a mortgage.

  2. One further question arises.

    If banks can just create money to buy government debt, then get rewarded with massive interest payments – why are governments so stupid as to let them.

    If the government cut the middle man out, and just created money for their current spending, they would save a fortune in interest payments.
    But for some reason when governments try it, it’s never worked out terribly well.

    How come it works so well* when the banks do it?

    *or at least not nearly as badly

  3. Do keep up, theProle.
    It’s only the top 1% who can do this.
    You need Jewish lizard DNA to magic up money: muggles like us can’t do it.

  4. “he wants to spend his £100k on coke and hookers at the weekend.”

    Isn’t it here where people like this get money wrong? They persist in seeing money as having value in itself. But the bank holding the £100k has the liability of providing the hundred grand’s worth of coke & hookers. And coke dealers & hookers want real things in exchange for they’re offering. Possibly hookers & coke. So all the way round, money touches down in the real world of being exchanged for tangible goods or services. And these have to balance. Because their providers want real things in exchange. Not bits of paper or electronic numbers.

  5. So now that the government owns RBS or Lloyds or whoever, they’re paying all that wonderful interest to themselves? Problem sorted.

  6. The most annoying part of this tribe has to be when he thinks that governments only take on debt because they want to pay interests to banks or are tricked into doing so by the evil bankers. meanwhile, in the real world, governments run deficits because the leftists tell them to and then (after deciding how mich to spend and finding out that it’s more than the raise) go out and try to find someone to lend them money…

    Oh and yes, this is just the old national socialist confusions rents and time value of money

  7. The Prole, it is very simple. I will not bore you with accountancy stuff so to sum up, the bank “splits the zero” into a mortgage and an equal and opposite deposit.

    In the morning, your vendor owns a house worth £100k.

    In the afternoon, you own a house worth £100k but owe the bank £100k and the vendor has a deposit with the bank of £100k instead of a house.

  8. @Mark Wadsworth
    I understand all that perfectly.

    My sightly sarcastic point was that this isn’t cost free for the bank – they have to have some cash available in case the person they now owe £100k to wants to spend it.

    This means they can’t just “create money” from thin air indefinitely – they have to have reserves to match a certain percentage of their liabilities or else you tend to get a queue outside the door of people wanting their money ASAP.

  9. If banks can invent money – how do we get bank runs?
    It is possible to prove anything in theory but it must be the same as reality.

  10. This situation where post the BoE’s “Money creation in the Modern Economy,” the old argument was finally settled with a no ifs, no buts verdict= Banks create money, is somewhat similar to the experience of the Great Randi, the debunking magician who proved that a faith healer was being told what was wrong with very ill audience members and where they lived through a radio/ ear piece by his wife reading the information his customers had provided beforehand. In no time at all the faith healer was back making more money than ever, probably because the audiences were so full of shit they thought they couldn’t be taken for mugs.

  11. “You can find out more about my radical ideas here.”

    When did “radical” come to mean a bodge up of discredited ideas from the past? 1960s? 70s? 80s?

    “I have recently become interested in questions of the economy and tax reform.” He would have found more beauty in stamp-collecting.

  12. Banks create money, true.

    BUT, what that means is that they expand the (broad) money supply. It does NOT mean they create money for themselves.

    Broad money includes all the money in bank accounts. For the broad money calculation, credit and debit accounts sum.

    The banks net position is all its assets minus all its liabilities. For this calculation, credit and debit accounts offset.

    (We’re not going to create a just society by talking nonsense about how the banking system works.)

  13. I sneeze in threes

    If the bank can’t pay out the £100k don’t they have to borrow. It on the overnight market? If the can’t access funds from the overnight market do they not go to the central bank as lender of last resort? As long as there is a margin between what they charge the chap with the mortgage and what the bank pay to either their depositor (or money market or BoE) then all is well, no?

    Where does the central bank get the funds from?

    So if the BoE wishes money is created. However as clearing is just accounting entries and not the movement or gold or coin what, other than the rules, necessitates that a bank must settle its debts each day. As long as each counterparty can record its debit or credit position all balances and all is well.

    Does an existential crises occurs by putting a number in a ledger in brackets. The problem would of course be rampant money creation (inflation in the Austrian sense) . And inflation is a toy only for the government to play with.

  14. I was taught that when the bank hands you a check (cheque?), they have created money. You hand the cheque to the homeowner, and he gives you the house.

  15. “Creating money ‘out of thin air'” is a passable analogy as long as you realise that the supply of thin air is limited. As a proper scientist would.

  16. “my day-job is as the Director of the Brain and Cognition Research Center (CerCo) in Toulouse, France. It’s a lab with about 85 people, many of whom are keen young scientists working for a Masters, a PhD thesis or as a postdoc. Many of them are highly motivated, very dedicated to science, and hoping that at some point, they may able to make a living from doing science.

    The problem is that, tragically, there are simply not enough jobs to go round. Many will be forced to give up science at some point.”

    Does he have no qualms of conscience about exploiting these naive young things? Could he not at least job-share, and take a large pay-cut, to spread the jam around? I think we should be told.

  17. Haven’t we been here before every time some conspiracy nut thinks he’s discovered the secret to free money?

    The banking system, when taken as a whole, creates money, but any individual bank can’t just magic up cash at the push of a button. Because if they could, why did they go bust in 2008?

  18. I sneeze in threes

    So why theoretically can’t you just have only a central bank that all of us use, which does create thin air money. I suppose then that the interest paid by those borrowing from the central bank should be paid to the depositors with the central bank to offset their loss of relative value they experience due to the inflationary nature of money creation.

  19. Sneeze in trees has again discovered the comunist efficiency by avoiding duplication theory. Pity that it has been proven wrong empirically n. times as it
    a) ignores dynamic efficiency (aka innovation and competition which there is quite a bit off in banking – anyone thinks that a monopolist bank would have invented ATMs or on-line banking, etc ?)
    b) increases systemic risk by putting more power in the hands of fewer people

  20. Jebus. The money you pay in to the bank doesn’t stay in the bank: it’s re-lent (less a bit held back in case people want their money back).

    Crucially, you think you still have money (you deposited it but you consider it yours, right?) AND the person borrowing the money has money. Thus is money created.

    It all goes into reverse when everyone simultaneously says “I want my money back” and the bank can’t give it back (cf Wonderful Life). And thus money is destroyed.

    You’d think they’d teach this in schools instead of making kids draw posters about recycling.

  21. I sneeze in threes

    I’m saying what, with respect only to the operation of money as a medium of exchange, is incorrect in my analysis. I’m not taking about any other function of a “bank” and it’s ability to innovate in other business areas.

    Ultimately the central bank is controlling the game, the other banks provide a smokescreen to it’s activity. I don’t recommend any bank, including a central bank being able to create any money, so I’m not saying let only the central bank create money do so we don’t have to pay those “joos”.

    I’m with Rothbard and Schlicter in that “Any quantity of money is “optimal.” Once a money is established, an increase in its supply confers no social benefit.”

    Of course, a government and it’s acolytes may see a great social benefit in creating money but I don’t.

  22. @dearieme, he has an answer to that which is that we establish a universal basic income so that frustrated postdocs with no hope of tenure can, once their salary runs out, continue to tinker around in the lab (presumably to the eternal glorification of the gracious tenured lab head to whom they should be ever so grateful) while the taxpayer pays them a few hundred euro a month.

    As one of those frustrated postdocs who didn’t make tenure, I added a comment on this to his blog. Quite apart from the fact that most of those frustrated postdocs then go to industry and earn far more than the professor ever will (so aren’t going to stick around to wash glassware on sub-minimum wage), it illustrates that this individual has a severe narcissistic personality disorder which is disturbingly common in those who succeed in academia.

  23. @ISIT,

    Yes the central bank is in control. Yes that has disadvantages (it can overstock the money supply and cause inflation). It also has advantages in that we need never again have a US depression-style bank run. Until we have Zimbabweans in charge, the latter is the bigger threat in the west, so on balance I’d rather keep the central bank for the moment.

    Do I hear someone mention “Greece”? Special problem there, because Greeks borrow almost exclusively from Greek banks. If their assets there are going to get turned into ND, or if their liabilities to those banks get converted (doesn’t really matter which) then Greece’s banks are in the shit and the ECB is unlikely (though not impossible) to continue keeping banks that are no longer in the euro on life-support.

    That, IMVHO, that we still have 95% national banking systems rather than a more integrated pan-European market, is a bigger flaw in the construction of the euro than the state borrowing moral hazard issue (and the euro has already proven it can survive a state default – hasn’t yet proven that it can survive an enforced redenomination).

  24. Flobble demonstrates why to have a central bank – if all deposits are called in the central bank can provide the liquidity (and even the physical readies) to cope with that. Private banks can’t.

  25. DBC Reed has today replayed the Richard Murphy game of pointing to the BoE paper and shouting “That proves it. No ifs; no buts”. And I’m sure they have both read it.

    Which makes me wonder: what is it about those plain words in plain English that they find so hard to assimilate in their brains. Perhaps Simon Thorpe and his under-employed young scientists should conduct research into Simon’s head.

    Because the BoE paper set it out for us; ALL OF IT! However, when I challenged Murphy to show us the accounting for ‘money creation out of thin air’ he offered this:

    Cr current a/c
    Db loan a/c

    “Are you going to finish it off, add the other transactions?” I asked
    “What else is there?” he replied.

    So thank you SJW, Meissen Bison, Glendorran et al for trying; now give up lads.

  26. Good lord, is this the first time you lot have run across these very old conspiracy theories about ‘The Jhooz’? Don’t bother even giving this idiot the time of day. Just like Ralphy, he’s not interested in truth, he’s interested in telling lies which (he hopes) will lead to genocide.

    For those who haven’t run across this propaganda before, the trick is quite simple: take a very small part of the process out of context, and pretend that’s all there is. It’s akin to claiming that light switches create electricity because the first step in turning on the light is to flick the switch.

  27. BinG

    To be fair ‘half baked’ i.e. national banking systems and national fiscal policies with a superimposed supranational currency, was always going to be that currency’s terminal flaw. Those of us on this blog who have always been against it have been proved right. Sorry to sound gloating, but we have been.
    However, I don’t think we should necessarily be critical of any currency that struggles to survive ‘an enforced redenomination’.

  28. @”Does he have no qualms of conscience about exploiting these naive young things? Could he not at least job-share, and take a large pay-cut, to spread the jam around? I think we should be told.”
    I doubt it very much

  29. Surprised that this is so controversial-don’t small govt/libertarian people see in fractional reserve banking, bank licenses, and fiat money a pernicious system of arbitrary power?
    It seems to me that this system creates a twin headed monster:.govt and the banking cartel, and the body will die if either head is severed-hence their mutual aid.
    That’s my conclusion after reading Rothbard (the Mystery of Banking for example) who explains the consequences of treating deposits as debt and not as warehouse receipts;

  30. Look , I used to write monetary reform pieces back in in the 70’s and 80’s when it was very hard work because the things the BoE says now about “Money creation in the Modern economy” were considered unorthodox or even Economic Heresy. Now the boot is on the other foot.The old reforms are now the new orthodoxy.You have no alternative, if you disagree with the BoE ,but to prove it wrong by taking, say, the Overview of the Bank Bulletin in question and subjecting it to line- by- line close criticism bringing to bear your superior knowledge of banking.

  31. @Ironman,

    An anti-anything needs only be right once, and probably will be right once. I don’t understand why so many economic liberals oppose it, given that it provides a much-needed straitjacket for governments and dramatically cuts the cost of cross-border trade.

    Those that don’t play by the rules lose their sovereignty very easily – as Greece is finding out. Debtors who cannot pay do have to do what their creditors ask of them (less sovereignty). If you or the Greeks think there is an alternative to this look at how Newfoundland ended up being absorbed by Canada.

  32. I seem to remember a lot time ago when Tim sneered at the fools who think that banks create money, asking, “well, where does it come from then?”. I didn’t get an answer.

  33. BiG,
    I think you’re missing the point.

    “Those that don’t play by the rules”

    You’re quite right. A set of rules governing entry to the Eurozone, and subsequent behaviour within it, could have allowed the Eurozone to succeed without supra-national government.

    Two flaws however:

    1) The rule book was binned long before the Euro was introduced. You’re aware of that, right?

    2) What rules remained were always going to be optional for all. Germany, don’t forget, was the first country to break them.

  34. You’re quite right that Germany is not in any position to lecture other countries on their debt addiction. Yet it’s not Germany’s debt problem that has broken the euro. It’s not even Greece’s debt addiction that has broken the euro, rather than that it’s going to prove impossible in the little time remaining to break Greek commercial banks into “good” bits, that should be merged with other European commercial banks, and “bad” bits that need winding up. This is exactly the same thing we have seen in many other countries (indeed, notably the UK and Germany), but it isn’t likely to happen in Greece.

  35. @social justice warrior,

    I’ve just looked at your irregularly-updated blog. Since you don’t label your axes, whatever the merits of your other points you should go to the back of the class now. What the fuck are we looking at on your “tax” article (still on your front page)? In fact you have graphs with two ordinates, neither of which are labelled, and we can’t tell which ordinate applies to which series.

    If you could get at Z- at GCSE maths, that’s what you’d get.

  36. Are we really still arguing about this one?

    Money is created whenever an exchange of goods/services between people is split into transfers occurring at different times. “Money” is simply the representation of the obligation to repay during the time interval between the two transfers.

    Alice does a job for Bob, in return for a promise to do Bob a favour in return. The obligation is the “money” and is created as part of the deal. When Bob later asks for that favour, the obligation is cancelled and the money disappears.

    “Money” is any credible promise to repay a past service. Anyone can create it, not just banks.

    When you go to the bank for that £100k mortgage, the bank gets a bit of paper in which you promise to repay. That piece of paper sat in the bank vault is therefore worth £100k, and the bank is simply buying it. They pay out £100k of cash and receive a £100k piece of paper in exchange for it – a net zero. The only person who actually *creates* money in this transaction is the customer who signed the piece of paper, promising to repay, and backed by the promised value of their future labour. All the bank is doing is acting as a guarantor to provide credibility and liquidity, converting the customer’s money to a more widely-accepted form.

    Money is not quite the same thing as currency, which is the “medium of exchange” thing. This is just a commodity that enough people want (and will continue to want) to make it universally acceptable in exchange. Fiat currency is a currency backed by remission of future taxes (i.e. you can pay your taxes with it), which since everyone is subject to taxation, everybody wants. Currencies that consist of a promise to pay a good rather than the good itself (i.e. a paper promise to pay a pound of gold rather than the chunk of gold itself) are a variety of money. Ironically, the gold itself isn’t – at least under this definition.

    Anyone can create a currency, too. Book tokens, store vouchers, money-off vouchers, IOUs, etc. All you need is credibility.

  37. Ian B
    You are being unfair on Tim W who said “No, banks don’t create money” on here 14.vii 2012 then after the publication by the BoE of “Money creation in the Modern Economy” the complete opposite”The short explanation is that banks do indeed just create money out of thin air” on 19.iii.14.So he must have been right once and he has never claimed to be qualified as an Economist.

  38. Alice promises to do Bob a favour? This just proves that neoliberal capitalism is a phallocentric ideology underpinned by the patriarcho-hegemonistic mindset and designed to ensure misogynists get favours by means of enslaving those they opress by forcing them to accept their debt tokens and then repay them by providing future “favours”.

  39. “They pay out £100k of cash ” Isn’t this the important aspect (from JT’s viewpoint)? Is it 1.a transfer to the seller of 100k already deposited. Or 2.a creation in the bank’s books under fractional reserve banking.
    In 1.,assuming for the purposes of illustration,on demand deposits only, then the bank wld be in default if every depositor simultaneously asked for delivery of their deposit.
    2. is the procreant cradle of f the zombie banks which feast on taxpayer’s labour..

  40. Okay, I’m finding this all quite hard to follow.

    Am I right in concluding:

    1) When banks agree to lend they do indeed “create money out of thin air”. Ie, without a corresponding deposit. The bank, at this early stage, electronically creates a sum in the borrower’s account, which the borrower can see waiting for them when they go online and check their bank balance.
    [This is what the BoE document seems to be saying. It calls it “fountain pen money”].

    2) When the borrower wants to use the money and makes a withdrawal, then the bank suddenly needs to raid its deposits, or borrow using the interbank scheme, to cover the cash withdrawal.
    – At this moment the “thin air money/fountain pen money” turns solid. Meaning, cash needs to be found via deposits, reserves, or interbank loans, to cover the loan.

    For example, a bank could promise to lend a punter a trillion quid (1), despite having no deposits. And even put the trillion in his account. But because of (2) they’d go bust the moment he tried to withdraw it.

    Am I even close?

  41. “the consequences of treating deposits as debt and not as warehouse receipts”: that’s the difference between a bank and a vault, isn’t it? There was a useful compromise when I was young – the Savings Bank. I gather they’ve all gone now except the one in Airdrie. Does anyone know of any others?

  42. So far as I can tell the official position of this blog is that money is created by invisible money elves.

  43. So far as I can tell, no one here disagrees that bank lending creates new (broad) money supply.

    The disagreement is about whether banks, as Simon Thorpe claims, “have a licence to create infinite amounts of ‘money’ that they can lend to governments”. If someone wants to defend that proposition, would they please explain how it’s done, and how banks can get into financial difficulties despite their access to this inexhaustible well of free money.

    BiG: thank you for the feedback. I thought it would be obvious to my few readers that an income tax chart would plot tax against income. I apologize for not having been more inclusive.

  44. So Much for Subtlety

    Ian B – “So far as I can tell the official position of this blog is that money is created by invisible money elves.”

    Yep. So don’t upset them by talking of international Lizard conspiracies. Or they may stop.

  45. Curious

    I’m not adding anything new here to most of the comments / explanations above, but don’t forget that all electronic loans and assets in this context (mortgages versus household savings and deposits etc) do all net off.

    Everything balances off on a daily basis, nothing new is created by closing time. Forget actual pound notes and coins for a moment, they are a small percentage of all of this.

    Think through this, and assume nothing else happened in the world on this particular day. Everything (to do with money, not the house) is electronic:

    Imagine A sells his house to B for £100K.

    B borrows £100K from Barclays, and pays the money to A. A deposits the money at Abbey (or whoever they are nowadays).

    At the end of the day, Barclays has an asset (due from B), and Abbey has a liability (due to A) but neither Barclays nor Abbey are balanced off; their books do not balance. They are both out of kilter by £100K.

    To solve that, at the end of day (daily interbank clearing) Barclays and Abbey create a new balance between them – Barclays now owes Abbey £100K, and all is back in equilibrium.

    Say Barclays charged B 5% (on the mortgage), and A gets 3% from Abbey (deposit saving). Assume Barclays is paying Abbey 4%. Both Barclays and Abbey earn 1% on the deal. Now, if A and B could cut out the middle men, that would be even more efficient..:) But then we introduce risk.

    Yes money was apparently created, because Barclays “lent” the money to B, before any new savings deposits were placed at Abbey. But this was temporary. No real new money has been created; the loans and assets all matched off at the end of the day.

    Hence, this so called creating money in effect just creates liquidity.


    So… To your point: 1) is just a promise, nothing more, no actual loans are created at that point, in effect, it’s just a “facility”.

    Your point 2) is the reality, see what happened above. Hence, no bank would promise to lend a punter £1 trill – under 1) above – in case they were asked to deliver on it (and must have x% reserves and all that)!

  46. NiV

    “Alice does a job for Bob, in return for a promise to do Bob a favour in return.”

    OK, I’ve read it again – and Bob’s definitely up on this deal!

  47. Just an aside: house purchases are usually settled through CHAPS, which is a real-time system – funds are transferred between the banks’ settlement accounts before the receiving account is credited.

  48. >Debtors who cannot pay do have to do what their creditors ask of them

    That hasn’t historically been the case with Greece. Traditionally, when they couldn’t cough up, they told their luckless bond holders to do one. (And/or printed some cash, which had a similar effect)

    This was why they had to offer pretty massive inducements to get people to buy Greek government debt – otherwise it wasn’t worth the risk.

  49. @IanB
    >So far as I can tell the official position of this blog is that money is created by invisible money elves

    And there was me thinking it was done buy men in squirrel suits…

  50. Bloke in Costa Rica

    Whatever the ins and outs of all this turn out to be, I think we can all agree that sufficiently close scrutiny will reveal the Yid in the woodpile. Stands to reason, dunnit?

  51. So Much for Subtlety

    theProle – “And there was me thinking it was done buy men in squirrel suits…”

    We are a sex-friendly blog but I think we can all agree paying some bit of rough to dress up as a squirrel for carnal purposes is liberalism gone too far.

    What is perfectly normal in a loving, committed relationship is simply sordid when done on a commercial basis. Everyone knows that.

  52. Social Justice Warrior “The disagreement is about whether banks, as Simon Thorpe claims, “have a licence to create infinite amounts of ‘money’ that they can lend to governments”. If someone wants to defend that proposition, would they please explain how it’s done, and how banks can get into financial difficulties despite their access to this inexhaustible well of free money.”

    Can you have a look at my discussion of the contents of the 192 page document published by the Bank for International Settlements on Minimum Capital Requirements.

    Or preferably, the original BIS document. It really is very clear. I quote:

    ” Claims on sovereigns and their central banks will be risk weighted as follows
    AAA to AA- 0%
    A+ to A- 20%
    BBB+ to BBB- 50%
    BB+ to B- 100%
    Below B- 150%”

    Now, until someone explains to be why I’m wrong, this seems clear. If a bank buys bonds from an AAA to AA- rated government (eg the UK and Germany,) this is considered to have zero risk, and doesn’t count. It needs no capital banking, and is therefore unlimited. The only limit seems to be the problem of finding Politicians sufficiently complicit or ignorant to play the game. Clearly, with Osbone and Cameron the banks have struck gold – since they have happily borrowed no less than €625 billion between the end of 2009 and the end of 2014 – around £10,000 for every man woman and child in the UK. Brilliant George.

    Now, UK taxpayers are used to paying interest on the “money” that their governments have borrowed from the Banks. It’s averaged 4.4% of GDP per year since the creation of the Bank of England in 1694.

    But the day that the interest rates go up on the £1600 billion now owed by the UK government, the cost of Welfare, Pensions, and Public Sector workers will be nothing by comparison with the cost of the interest charges.

  53. “It needs no capital banking”

    It need not keep *reserves*.

    I don’t think you understand how money actually works. I think it stems from misunderstanding the difference between the money base and other types of money and a confusion between this and accounting.

    Banks do not create money individually: they are constrained by what deposits they attract. The creation of money occurs collectively when money lent is re-deposited in another bank. They most definitely have not magicked up their own money in their own name – simple accountancy means all liabilities and assets from transactions are matched.

  54. theProle :”If banks can just create money to buy government debt, then get rewarded with massive interest payments – why are governments so stupid as to let them.
    If the government cut the middle man out, and just created money for their current spending, they would save a fortune in interest payments.”

    Spot on! That would indeed be infinitely more intelligent than the current system. And it would have saved European Taxpayers over €6.6 trillion in interest payments since 1995.

    Unfortunatley, the Maastrict and then the Lisbon treaty made it impossible for Central Banks to fund Governments directly – It’s in Article 123.

    This is a simply brilliant piece of treaty writing, that means that all the European Union’s governments are obliged to borrow from the Commercial Banking system, rather than creating their own money. Is it conceivable that the Banking lobby may have had something to do with getting that gem into the treaty?

    Recently, the ECB has tweaked the rules a bit by buying bonds on the secondary markets. But the original bonds were probably all purchased by Banks, before being sold on to Pension Funds, Insurance Companies etc.

  55. Simon

    Try reading the Basel 3 documents. They are not very difficult. You will see that, in addition to the Capital requirement ratio, which is based on risk-weighting, baks also have to preserve a leverage ratio 0f 3% or more, which is NOT based on risk-wighted liabilities. So please stop writing the nonsense.

  56. Increasing the Money Supply =/= creating money.

    The Money Supply calculation counts current account balances twice, once when they are deposited and again when they are lent out.

    This is why economics is an Art, not a Science.

  57. Simon: Re. your post you linked to:

    Banks create money out of thin air when they make loans – they lend money that they don’t have…

    As you’ve now agreed on another thread, that’s not true. Banks have to pay out the money they’ve lent.

    You have probably heard the story that Commercial Banks are supposed to have a certain amount of capital to back up their loans. You often hear that Banks can only generate about 10 times as much in loans as they have deposits.

    In Fractional-Reserve Banking, banks retain a proportional of their deposits (not their loans), so that they can meet withdrawals.

    Take a look at the 192 page document published by the Bank for International Settlements on “Minimum Capital Requirments”

    Those Capital Requirements are nothing to do with fractional reserves. They’re a credit reserve, to make it unlikely that the bank will fail because its assets default. Those countries coloured green on your map – Germany for example – are the ones whose governments are almost certain to meet the payments on their bonds. So there’s no need for a credit reserve to protect against their defaulting. Other counties – Greece is a pertinent example – might not pay, so banks counting Greek government bonds among their assets are required to hold some capital to protect them from the hole which would appear in their balance sheets if Greece defaulted.

    So, suppose a bank buys a UK government bond. We’ll pick one expiring in September. Currently the bond will yield about 0.46%. It has to put the money to pay for the bond in its BoE settlement account, whence it will be transferred to the seller’s bank (in the case of buying new bonds from the government, the money goes to a Dept Management Office account). No problem, the bank can borrow the funds cheaply in the inter-bank market – three-month LIBOR is about 0.57%.

    Did you get that? The bank pays 0.57% to receive 0.46%. The bank is not getting the bond interest for nothing.

    Now that the bank has bought the bond, it recalculates its capital-reserve requirements. This is not too taxing, because the risk weighting for a UK government bond is zero. And rightly so: there’s almost no doubt that the UK government will meet its bond payments.

  58. Interesting though isn’t it how leftists can agree.with each.other whilst trumpeting diametrically opposed paradigms. So we have people like Howard Reed on the one hand claiming that the UK has no need at all to reduce its public sector debt and this Simon Thorpe character on the other claiming that debt is a swindle carried out on imbecilic politicians.
    Oh and you have Richard Murphy making both of these claims on alternate days.

  59. @ Simon Thorpe

    I’m sorry but you are simply a bit ignorant.

    Banks can’t exceed their Tier 1 capital ratios, regardless of risk weighting. In real terms this is normally around the 9% level. Which means their leverage never tends to exceed x10 until derivatives are taken into account, which can increase their leverage. So they can’t buy infinite amounts of government bonds regardless of how risky they are.

    Nor do banks create money out of thin air, a you suggest. They can extend credit – so they can loan you money (which is what you call money creation) but they then have to go and borrow that money from elsewhere to make their balance sheet whole (assets matching liabilities).

    They borrow this from money markets, short term, to lend to you long term – banks are in the maturity transformation game.

    Another immediate problem with your idea is that banks have worse credit ratings than governments on the whole, so borrowing for them is more expensive than the underlying government. Which means that the cost of capital needed to buy government bonds is higher than the return on those bonds. Which means banks hold absolutely the lowest amount of government bonds needed to meet Basel 3/Tier 1 capital requirements.

    The real end buyer of most government bonds are the long only asset managers and pension funds – which deal in real money and absolute return. And by law these guys are not allowed to leverage at all.

  60. @ Ironman

    No problem. Banking is really a bunch of fairly simple concepts which interact in complex ways.

    The simplest concept though is one Murphy and this Simon Thorpe chap seem to forget all too easily.

    Basically it’s this: there’s no such thing as a free lunch.

  61. BIS,

    > Isn’t it here where people like this get money wrong? They persist in seeing money as having value in itself.

    Exactly. As I said the other day, of course some money is created out of thin air: all money is created out of thin air. What the hell do these people think money is?

    But value isn’t created out of thin air. Value requires that someone somewhere do some sort of work. The whole point of inflation is that money decreases in value when the increase in the amount of money is greater than the increase in the amount of value. This should tell all non-dullards all they need to know about whether you can create money out of thin air in order to buy actual stuff with.

    the Bank can simply type some numbers in a computer (£500,000 for example).

    Yes, and the Royal Mint can simply stamp some numbers onto a metal disc. And?

  62. Squander Two

    Why should we not insult and ridicule Jew – haters?

    Because they take licence from this blog’s belief in liberty to respond endlessly with their stupid, stupid crap.

    Oh sorry, that was last week’s thread.

  63. I’m ignorant about banking; have I got this right (ignoring the money squirrels)?

    Simon Thorpe quoted BIS requirements for risk weighting:
    “Claims on sovereigns and their central banks will be risk weighted as follows
    AAA to AA- 0%
    A+ to A- 20%
    BBB+ to BBB- 50%
    BB+ to B- 100%
    Below B- 150%”

    But these seem to be risk weighting on a baseline capital requirement (which sort of fits with what Tyler & diogenes say above), rather than absolute capital requirements themselves.

    Let’s call that baseline capital reserves requirement X%, so for AAA debt banks need reserves of X%, for A debt they need 1.2X% (i.e. the baseline plus a 20% risk premium), for BBB they need 1.5X%, for the real junk they need 2.5X% (baseline plus a 150% risk premium).

    Is that correct?

    And what’s X? Or does X depend on other factors as well?

    (and I think I’ve over-simplified, in that the reserve requirements are a % of deposits, but calculated based on what you’re then investing / lending the money to, so it sort of works out as effectively a % of investments).

    Whereas Thorpe’s theory seems to be based on a misunderstanding that for AAA debt banks need zero reserves, for A debt they need reserves of 20%, etc., up to needing reserves of 150% for debt below B- (which would be daft; there wouldn’t be any need to hold reserves greater than your liabilities).

    Have I got that right, or am I still floundering around?

  64. @ Richard

    You are basically correct. Banks need a certain amount of Tier 1 capital in cash or near cash equivalents. Minimum is 4.5% but most run around the 9% mark.

    So for example if a bank lends 100m it needs to hold (roughly) 10m in T1 capital. It can hold this in cash but on the whole it is more cost efficient to hold government bonds (cash yields zero at mom, 10y treasuries 2.35%).

    So looking at the bank’s balance sheet, it has an asset (100m loan), a liability (let’s say the loan is secured against a building) and it’s T1 capital, which is there to make sure the bank stays liquid in case of the loan v asset valuation going south. At the time of the loan the bank’s balance sheet is net unaffected though, as it gains an asset and a liability of offsetting value.

    The bank is however now long an illiquid asset (loan is only redeemable for cash in the future) and short cash, so to make it’s cash position healthy it has to go and borrow in the short term money markets.

    Now let’s say the asset it has bought is a bond. The bank can lend that bond out short term for cash in return (reverse repo) and thus square the circle. However, the credit rating implies a chance of default and this is taken into account when calculating *reserve* requirements (not the actual value of the bond) so depending on the credit rating of the bond the bank lends (borrowing cash in return) it might take a haircut on the book value of the bond when calculating the Tier 1 capital position of the bank.

    So with banks trying to minimise balance sheet costs (holding bonds is low return compared to other things that cash could be doing) banks also try and minimise the amount of bonds they hold. Having those bonds subject to a haircut means more need to be held, so on the whole banks will hold only the most highly rated bonds on their balance sheets for capital adequacy requirements.

    But as you say, Thorpe is wholly incorrect when he says banks need zero reserves. In practice, banks hold a little cash, lots of AAA/AA government debt and the rest is bonds/pref shares the bank itself issues as senior debt (the logic being you can’t have credit risk with yourself, so the bank gets cash and the buyer of the bank debt gets a return for holding onto the bank’s credit risk).

    This also explains why banks prefer to trade derivatives. A derivative with the same interest rate exposure (risk) as the 100m loan/bond above takes a fraction of the capital – the derivative is akin to a CFD and are usually margined. So same risk, lower capital requirements and much lower credit risk (thanks to the margin account).

  65. Thank you Tyler.

    – Bank raises £9m in capital (probably by issuing prefs);
    – It can then take £91m in deposits (ignoring the fact that 9/91 isn’t quite 9%).
    That’s the liability side.

    On the asset side, it’s got £100m in cash, so then:
    – It can then lend out £91m to businesses, mortgage borrowers, people buying fridges on tick, we feckless overdrawn or those who haven’t paid off their credit cards, etc. etc.
    – It keeps ~£1m as cash for when pesky depositors want to draw it out,
    – plus another £8m in AAA government bonds in case everything goes pear-shaped.

    If they want to hold riskier bonds, then they’d need more, so, for example if they want BBB bonds instead of AAA, with a 50% risk rating, they need £12m of them instead of £8m of AAA, which means they can only lend out £87m to non-government customers instead of £91m, giving them assets of:
    – £87m lent out to businesses, mortgage borrowers, the overdrawn, etc. etc.,
    – £1m cash,
    – £12m BBB government debt.
    That’s only worthwhile if the extra interest on the BBB debt (compared to AAA) makes up for having £4m less to lend out to customers.

    Is that right? So we’ve got 2 rules for their Tier 1 capital – it’s got to come from capital providers (equity, prefs, long-dated bonds) rather than depositors, and it’s got to be kept in cash or high-rated government debt. The more they want to lend out to customers (businesses, mortgage borrowers, etc), the more of that capital (long-term source and kept safe) they’ve got to have?

  66. Bloke in North Dorset


    Some great explanations, thanks. This blog at its best.

    As to this comment:
    “They [banks] borrow this from money markets, short term, to lend to you long term – banks are in the maturity transformation game.”

    And Northern Rock provide a classic example of what happens when they get it all wrong from my understanding..

  67. @ Richard

    You are basically correct. The only thing I would say is that the bank doesn’t have to raise the 91m from depositors before it starts lending. With the 9m cash raised from prefs in your example it can go straight out and lend 91m or so long term….BUT…it would have to find that 91m in short term money market borrowings.

    As for Tier 1 capital, the Basel 3 rules apply. So different assets have different weightings, and some assets don’t count at all. Cash deposits do count, to an extent. An added complication is that different B3 rules apply depending on the size of the bank in question….

    But in general terms your example is right. Holding riskier assets makes the haircut larger, and on the whole is less profitable (or higher cost of capital) than what the bank could otherwise use the money for. So in real terms banks hold as little capital as they can get away with – and will actively sell assets before quarter/year end to make their numbers look nicer – and they will hold those assets in the safest possible government bonds.

    @ BIND

    Thanks. The Rock is indeed an example, as is Lehmans. Nothing specifically wrong with their businesses, but they lent long and then ran out of short term liquidity in the money markets – making both technically bankrupt. The wind up of Lehmans actually returned more value than book when they went under, so in that case at least it was purely liquidity which killed them.

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