The Truth Is Out: Money Is Just An IOU, And The Banks Are Rolling In It
The charge that private banks create money in the form of debt and that debt money creation caused the credit crunch is a major charge against the financialised world economy and orthodox economics. This charge targets the Federal Reserve and central banks across the developed world as authors of the problem.
If this is an accurate understanding of the way the economy works then the solution to the credit crunch and its aftermath is relatively straightforward: ‘End the Fed’ and effectively nationalise it (and all central banks), and money making powers for socially desirable projects (such as reconstructing capitalism along traditional lines!). Proponents of this type of approach action include Ellen Brown on her ‘Web of Debt’ blog and Professor Steve Keen.
This argument does have a number of positive aspects to recommend it. It is underpinned by the desire to reconstitute a commons – money which serves everyone. It is a political solution that emphasises the need to have a political confrontation with the Monetarists that have hijacked the monetary system.
And all of this becomes ever more relevant in the light of a recent discussion paper by Frosti Sigurjonsson commissioned by the prime minister of Iceland* exploring the possibility of nationalising the money creation process. Iceland is noted for adopting a non mainstream approach to the credit Crunch and its consequences, nationalisation would be more of the same non orthodox approach. The most significant thing is that this approach again argues that a political solution to the Credit Crunch and financialisation is possible.
But it is not just the ‘unorthodox’ that are offering new ways of looking at money philosophy. A discussion paper by the Band of England ‘Monetary Analysis Directorate’# makes the admission that banks do in fact, print their own money, just like the insurgents claim. This document is startling for a number of reasons and well worth reading.
In a Guardian opinion piece by David Graeber more or less gets the tone of the insurgent ‘victory’:
‘Last week, something remarkable happened. The Bank of England let the cat out of the bag. In a paper called “Money Creation in the Modern Economy“, co-authored by three economists from the Bank’s Monetary Analysis Directorate, they stated outright that most common assumptions of how banking works are simply wrong, and that the kind of populist, heterodox (‘insurgent’- AP), positions more ordinarily associated with groups such as Occupy Wall Street are correct’
Surely, the first question that arises from this development has got to be: Why now? The Orthodoxy after decades if not centuries of standard monetary theory is now suddenly throwing in the towel and telling us the great unwashed occupy insurgents were right all along!
As David Graeber puts it:
‘Why did the Bank of England suddenly admit all this? ‘
And the answer?
‘Well, one reason is because it’s obviously true.
Hang on a minute, its obviously what you want to hear, but does that mean it is necessarily true?…and even if that is so, truth did not seem to be a consideration before…To be fair, David Graeber senses that this is not really an adequate explanation so he offers the following elaboration:
‘The Bank’s job is to actually run the system, and of late, the system has not been running especially well. It’s possible that it decided that maintaining the fantasy-land version of economics that has proved so convenient to the rich is simply a luxury it can no longer afford.’
Which itself leads to many more questions than it answers; Why has the Bank of England decided to deep six the elite it served so faithfully now? Better to turn to the paper itself, which after a first reading the text turns out to be a little more subtle and nuanced than might be supposed from reading the Guardian opinion piece about it.
In fact the paper itself turns out to be essentially a semi-orthodox defence of QE that smuggles a number of unorthodox ideas in the body of the argument, a kind of intellectual Quantitive Easing if you will. Nevertheless, the concessions it makes appear to be remarkable.
Still it would be good to keep this question in your mind as we proceed:
Why would the keepers of monetary orthodoxy need to make concessions to opposing points of view and why now?
Lets have a look at the concessions themselves. First of all the concession that private banks make money:
‘The reality of how money is created today differs from the description found in some economics textbooks:’
- Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
- In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.
The paper goes on to say that ‘lending’ out and ‘multiplying up’ of existing deposits in banks is little more than a childs bedtime story:
‘While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality’
So bank lending is not related to deposited money from the public in any way; the money is created from scratch. However, the paper repeatedly and forcefully argues this is not carte blanche to print:
‘Banks themselves face limits on how much they can lend. In particular:
- Market forces constrain lending because individual banks have to be able to lend profitably in a competitive market.
- Lending is also constrained because banks have to take steps to mitigate the risks associated with making additional loans.
- Regulatory policy acts as a constraint on banks’ activities in order to mitigate a build-up of risks that could pose a threat to the stability of the financial system.’
Having disposed of deposit and money multiplier orthodoxy, the Bank of England goes on to attack the Monetarist quantity of money theory as another bedtime story:
‘In no way does the aggregate quantity of reserves directly constrain the amount of bank lending or deposit creation…..
Rather than controlling the quantity of reserves, central banks today typically implement monetary policy by setting the price of reserves — that is, interest rates’.
Cutting through the circumspect language, the core message is clear: The quantity of money is not a concern for the Bank of England. Targeting money quantity is voodoo economics; in other words the amount of money in the economy does not directly lead to inflation or anything else. The right wing shibboleth of hyperinflation through excessive printing is dismissed as a childish preoccupation, just like deposits and money multipliers.
Now we have got all that out of the way we can have a look at how things really work:
‘Banks first decide how much to lend depending on the profitable lending opportunities available to them — which will, crucially, depend on the interest rate set by the Bank of England’.
Let us be absolutely clear; this means the end of ‘risk’ as a supposed factor in the activities of banking. The ‘risk’ that lenders undertake in return for the ‘reward’ of interest is the risk of not making a profit – NOT the risk of losing their money. If a money lending institution makes no profit it will cease to exist just as surely as if it had lost all the ‘money’ it had ‘bet’ on various business enterprises.
And the paper freely admits that profitability is the province of the central bank. The Bank decides what will be profitable and what will not be profitable through the medium of interest rates. It must logically follow that the amount of ‘risk’ in the economy is entirely the creation of the central bank. (If you doubt this for even a second, just consider that this is exactly what ‘Too Big To Fail’ actually means…).
David Graeber makes this point quite elegantly in his Guardian piece:
There’s really no limit on how much banks could create, provided they can find someone willing to borrow it. They will never get caught short, for the simple reason that borrowers do not, generally speaking, take the cash and put it under their mattresses; ultimately, any money a bank loans out will just end up back in some bank again. So for the banking system as a whole, every loan just becomes another deposit.
And here is the Bank of England making the point ever more clearly:
‘The ultimate constraint on money creation is monetary policy.
By influencing the level of interest rates in the economy, the Bank of England’s monetary policy affects how much households and companies want to borrow. This occurs both directly, through influencing the loan rates charged by banks, but also indirectly through the overall effect of monetary policy on economic activity in the economy. (my emphasis). As a result, the Bank of England is able to ensure that money growth is consistent with its objective of low and stable inflation.’
Leaving the last bit aside for a moment, this again makes explicit the proclamation function of interest rates that I have discussed before. Bank money loans are made and bank deposits called into existence on the basis of the central bank proclamation of what will be profitable. Risk is not a factor. Amounts are not a factor. The only significant factor is the proclamation of profitability as expressed through interest rates. This is precisely democratised money theory as applied to credit.
Lets apply this radical orthodox/unorthodox anlaysis to the historical devleopment of democratised money and see what we come up with.
The economy is divided into two spheres; state and private.
- High interest rates are a central bank proclamation.
They proclaim the extent tow which the economy will be profitable by decree; i.e they say you should be able to make at least this much (base interest rate plus bank mark up) on any investment you undertake.
Profitablility expressly and explicitly means efficiency.Too many low productivity workers is inefficient- rationalise them. Government lending for social services is inefficient- cut back on it and so on…
This rationale describes the intent and effect of the famous Volcker interest rate rise that kicked off the Monetarist project in earnest. High interest rates served the Monetarist objective of diminishing the state and all ‘indulgent’ inefficient capitalist business.
- Low interest rates are a central bank proclamation.
They proclaim that the economy will be not be profitable by decree. i.e. they say you should be able to make little or nothing (base interest rate plus bank mark up) on any investment you undertake.
Lack of profitablility expressly and explicitly means inefficiency- many low productivity workers employed in low wage, low value added service sector jobs. Government lending for Quantitive Easing and TARP supported by low interest rates
This describes the intent and effect of the famous Bernanke interest rate slashing that kicked off the Q.E. project in earnest. Low interest rates served the Monetarist objective of making the state the entire guarantor of the post credit crunch economy, protecting all ‘indulgent’ inefficient financialised business.
High interest rates in the 80’s signalled shrinking the state, the end of ‘socialism’ and the consumer society post war settlement.
Low interest rates in the ‘00’s signalled an UNPRECEDENTED EXPANSION of the state in order to usher in an age of socialism for the rich….
Next time, Q.E.
But bear this in mind;
If banks really do print money, how come you never hear of anyone caught trying to get through airport customs with bunches of bank statements hidden in their underpants?…