Do Banks Create Money? or No Big Deal

 

 

To get a real insight into whether banks do indeed create money, we must first sharpen the focus of our enquiry:

 

If banks do create money, what kind of money do banks create?

 

For instance, do banks print foreign money?

 

It has been rumoured that in the past North Korea has printed North American dollars, but for the most part this practice is frowned upon and we can say that generally banks and governments refrain from printing each others currencies.(Although that might change in the Eurozone quite soon).

 

Do banks create their own private money? Is there such a thing as Lehman dollars?

Banks printing money in this form is not generally held to be the case, (at least not yet), but we can come back to that later.

 

Since it is clear that private banks don’t create money in general we have refined the question to:

 

Do banks create the national money used by you and I? Or to phrase it using democratised money theory language: Do private banks issue Government Issued Money?

 

And of course, when you put it in these terms, the answer has to be ‘no’.

 

Problem solved to my satisfaction at least.

 

But maybe not quite to yours.

 

In my last post I commented on a quarterly bulletin of the Bank of England that seems to suggest that banks do indeed create the majority money in circulation in the form of debt. This capitulation to the radical interpretation of economics piqued my interest. Putting aside the question as to whether banks do or don’t create money, why would the Central Bank retreat from earlier positions and just as importantly, why would it do so after all this time?

One plausible reason for a tactical concession to the insurgents is to better position the Monetarists for the next assault in their ongoing campaign to control the future of money.

 

It could be that central banks are positioning themselves so that it is not such a big shock when they come clean about derivatives being money. The message will be; Sure, private banks and financial institutions print money of one kind or another; they always have. So what’s the big deal? Perhaps the arrival of this political concession actually means that the time is approaching when the shadow economy will be coming out of the shadows.

 

This would be a reasonable assumption if there is a need for some kind of normalisation of interest rate policy. It will be impossible to significantly and permanently raise global interest rates without some corresponding amendment of national and international banking and exchange rules. These rules would need the justification of a new worldwide orthodoxy on money and banking. This might be the actual truth behind all those predictions of a world currency.

 

If orthodoxy were to concede that derivatives were to be regarded as a form of money it would confirm what I have been arguing for more than five years. But I don’t think I will be celebrating my intellectual success. Any successful attempt to conflate bank credit or anything else with Government Issued Money can only serve one purpose: to discredit and denigrate cash money. And that is nothing short of a disaster for you and for me.

 

There is a horrible synchronicity here between both orthodox and unorthodox wings of the monetary conflict; Monetarists and radical Bitcoiners. The message from Bitcoiners and Monetarists alike is leave government cash behind, the battle has moved on.

 

Bitcoiners argue that their cryptocurrencies are democratic and free from central bank oligarchy control and therefore better than cash. Monetarists argue for a technocratic ‘non politicised’ control of money issuance; effectively privatisation of money control in a credit card world. Both result in the end of cash money guaranteed by the state, under political control. Both result in the privatisation of the issuance of money.

 

In the light of these developments the strategic imperative for us is to ague for the sole primacy of Government Issued Money as the only form of currency. Let me explain why.

 

There has been a constant attack on the use of cash for at least two decades and this attack has been centred around the point of contact between cash and banking. The introduction of numerous legal requirements on bank reporting of activity as well as private petty restrictions on how much cash you can depots and withdraw have had a chilling effect on cash based banking.

 

At the same time cash has been increasingly frozen out of commercial activity- many utilities are virtually impossible to purchase with cash unless you use prepaid cards and are extorted by the utility provider for the privilege.

 

For the past six years or so this attack on cash has been masked by the attack on savings deposits expressed through negative interest rates. Not only do deposits not pay interest, but bank accounts and their supposed contents are rapidly losing their legal status.

 

The end game in all this is bail ins where banks simply convert deposits into shares, which you are not even allowed to freely trade! If bank credits really are money as the Bank of England paper argues, on what basis is this being done? Follow the actions not the words and you will at least begin to question any supposed conversion of monetary orthodoxy to radicalism.

 

It is possible to cut through the confusion between cash and credits illustrated by comparing the decision to hold goods, cash or credit.

 

Let us say that due to deflation you decided to put off purchases, that is to say to hold cash or bank credits. Are the risks and benefits the same in each case?

Holding and using cash offers the benefits of anonymity and privacy. Does bank credit offer this?

Cash money offers the benefit of dealing with no ratification, in other words no-one oversees and confirms any deal you might choose to make. Does bank credit offer this?

Cash money is legal tender, it has to be accepted in settlement of debt. Does bank credit offer this?

Cash money offers complete liquidity. Does bank credit offer this?

Bank credit is subject to seizure, forfeiture and conversion (as in bail ins). Does cash money suffer from this?

Cash money clearly offers a number of benefits and guarantees that bank credit cannot. Bank credit suffers in the comparison with cash money.

 

It should be clear from this that as bank credits become denigrated by the state it increasingly becomes necessary for central banks to delegitimise cash to at least a corresponding amount. Because if only a very small minority of the general population decided cash was the better option that would cause a lot of problems.

 

Only around 3-5% transactions are cash and this proportion will significantly diminish further if Monetarists have their way. But if usage of cash was to increase significantly, the plans of Monetarists would start to run into serious trouble in short order.

 

Firstly, cash is hard to take back in a way that credit is not. Paying off bank created debt ‘dissolves’ credit money but cash money has to physically be withdrawn from the economy which is much more difficult to do- this means hard inflation. The kind that central banks cannot control except by raising interest rates.

 

But even more important is the relationship between cash money and banking reserves. Cash money is directly created by central banks and obviously bank deposit credits are not (this is the essential complaint of unorthodox economics). The creation of cash money directly affects the amount of reserves required to be held by each private bank and by the central bank.

 

Bank credits can be created forever without necessarily altering the requirement for reserves. If people take their physical money out of the banking system for use they are effectively calling it into physical existence– forcing the banks to actually print and therefore again forcing them to raise interest rates.

 

These two reasons why bank credits are not Government Issued Money are still within the bounds of standard economics but there is a further more fundamental reason within Democratised Money theory.

 

I have argued previously that money makes a proclamation as part of a general contract between issuer and user.

This proclamation takes the form of the Base Interest Rate which determines the nature and scale of the economy. It is something that is universally applicable to the same extent. It affects everyone equally.

It is inextricably bound up with the specific contract of the money itself. Once this printed money proclamation goes out the door of the central bank it cannot be undone.

 

The cumulative effect of these non- undoable operations is the recorded element of the currency. You can’t undo a money issue interest rate or the effects it has on the economy but you can use the next money issuance to offset the effect. In other words vary the interest rate from issuance to issuance.

 

In contrast, bank credit is a specific, not a general contract. Credit is offered on an individual basis. The ‘proclamation’ from the lender is concerned with what the individual borrower must do, not the general economy. Because of this the issuance of bank credit requires a separate individual contract, unlike money where the contract is part of the money. This ‘money’ creation through debt is subject to ratification by the legal system; it can be undone if deemed onerous or illegal, unlike cash money.

 

The cumulative effect of credit creation by private banks does have a massive effect on the economy. But it is not a general effect like money, it is a cumulative private effect. When you borrow from a bank you have to deal with the economic power structure as a lone individual instead of as a citizen member of society dealing with a central bank. In other words it is the ultimate codified example of divide and rule.

 

If as I argue, Monetarists want to create a Permanent Credit Economy, (that is a decentralised planned economy, with banks deciding who gets credit to do what),

Then deceiving propaganda giving bank credit the status of money can only be to their advantage.

 

We should oppose it.

 

 

The Truth Is Out- Or Is It? or Do Banks Print Their Own Money? Part 1

dosh

 

The Truth Is Out: Money Is Just An IOU, And The Banks Are Rolling In It

David Graeber

http://www.theguardian.com/commentisfree/2014/mar/18/truth-money-iou-bank-of-england-austerity

 

https://s3.amazonaws.com/s3.documentcloud.org/documents/1698915/monetary-reform.pdf *

 

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf #

 

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.

 

  1. 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.

 

  1. 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?…

Using Democratised Money Theory to Understand Bitcoin

imagesPoints from previous posts on Democratised Money Theory can be taken and applied to Bitcoin and other Cryptocurrencies. This can give an interesting insight into all forms of money.

 

Democratised Money Theory:

 

Money is a contract – a set of words and images that embodies a decree. (This is the decree gold and silver bugs get confused about when they refer to fiat money). This decree element is a vital component of a money contract. It decrees the economic environment for the life of the money contract. This decree is expressed in form of the central bank interest rate in respect of that specific contract.

 

Applied to Bitcoin:

 

Bitcoin is a set of words and images that embodies a contract. This is what Bitcoin is in its totality that and nothing else. In its form, Bitcoin differs from government money in how and where that contract is recorded. In the case of Bitcoin the contract is recorded in programming code form. This is the decree that Bitcoin embodies, which is intended to function exactly the same as the decree embodied by government issued money. Programming code embodies the method and thence the rate at which Bitcoins can be ‘mined’ or Bitcoin ‘decrees’ made. It effectively decrees the rate of creation of decrees!

 

But this is really no more than a marketing device. By making the issuing of Bitcoin decrees ‘automatic’, the creators of Bitcoin are seeking to obscure their role as the Authority which delineates the terms and form of Bitcoin. They do this precisely because the people who might adopt Bitcoin don’t like the idea of conforming to a given authority. The ‘anonymity’ of ‘Satoshi’ is more of the same marketing…. a personification of the commons; ‘Everyman’ and ‘No One’

 

Bitcoin is a commercial contract as opposed to a state sponsored contract in the case of Government Issued Money.. Despite the best efforts of Bitcoin advocates to obscure the fact, Bitcoin is at its core a business proposition and in this it differs fundamentally from state issued money which is at its core a political proposition.

 

This points to a fundamental difference. State issued money is derived from the commons, crypto currencies are not. Crytocurrencies, like all ‘democratised’ currencies, represent an exact inversion of the developmental dynamic of state issued currencies.

 

State issued currencies began their existence in the commons operated for the benefit of all, and were appropriated for the benefit of a minority. This process culminates in the creation of specific forms of privately issued Democratised Money.

 

Democratised currencies such as derivatives and Bitcoin were created and developed by a minority supposedly for the benefit of all. Democratised money and Government Issued Money begin at opposite ends of the money spectrum and move in opposite directions.

 

There is no point in simply describing the differences between state issued money and democratised money as they are now. At best this will offer you a blurred snapshot of the development of money in the 21st century. You have to describe the trajectory of development of both democratised privately issued money and state issued money simultaneously and how they will affect each other as they develop.

 

Democratised Money Theory:

This money contract is mounted on a transferable medium. Something that can be securely transferred from one owner to another. The contract is issued by the relevant legal authority which is the body authorized to mount that specific proclamation upon that specific transferable medium.

Applied to Bitcoin:

 

The Bitcoin contract is recorded as code which can be transferred from one processor to another. The proprietary name that is given to the contract and its mode of transference is the ‘Blockchain’. The blockchain in its totality serves as both decree and record of Bitcoin whereas individual notes serve as decree or record of government issued money. But the blockchain cannot be owned by any one person; unlike a money note (or all money notes), which can be transferred, stored and even destroyed by its owner. (Although interestingly it is a crime to modify and deface modern banknotes. Now why would that be?…)

 

(As a secondary point of interest, bank credits are not money despite what many insurgents argue. Bank credit transactions require a separate and autonomous mode of record, disqualifying them as money.)

 

There may be some confusion over the designation of the ‘relevant legal authority’. In this case it is the creators of the blockchain code and the issuers of Bitcoin. The authority to do this is vested in private property which is a totem of capitalist states. Satoshis have legal authorization to issue Bitcoin, although final rights are reserved by national governments.

 

Democratised Money Theory:

 

The validity of a money contract depends on the extent to which it decrees the nature of the real economy. The ‘value’ of that money contract is an expression of its validity. In other words: The money contract is valid to the extent that it decrees the nature of the real economy. Not ‘reflects’ the nature of the economy, decrees it. It is valuable to the extent it is valid. This comprehensively defines the value of money.

 

Applied to Bitcoin:

 

Trade and creation are ubiquitous in human society. Human beings purposefully alter the environment around themselves continually and without exception. This is the real economy. The control of this alteration is the purpose of politics and economics. Money is one method of implementing this control. A piece of money is a decree of who will do what where and when. It is specific to the extent that this serves the purpose of the issuer. It is generalised to the extent that this serves the interest of the issuer.

Bitcoin contract is specific in that it serves the interests of ‘Satoshi’ to create a privately issued digital currency through ‘mining’ and recording transactions on the Blockchain.

The Bitcoin contract is generalised to the extent that it operates as a store of wealth and to a much more limited extent as a means of exchange and transfer.

 

I have previously used the example of a train ticket to illustrate another aspect of money but the metaphor can be useful in this context too:

 

  • All train tickets are contracts.

All pieces of money are contracts.

 

  • All train tickets are the same in function and distinct from other contracts.

All money is the same in function and distinct from other forms of contract.

 

  • You need a valid train ticket to access the rail system.

You need a valid piece of money to access the economy.

 

  • Train tickets are specifically valid in terms of the journey you are permitted to undertake

Money is specifically valid in terms of the economic activity you are permitted to undertake

 

  • A specific train ticket contract decrees a type of journey will take place

A specific piece of money contract decrees a type of economic activity will take place

 

  • A train ticket is valid to the extent that the journey it decrees will take place, does take place

A piece of money is valid to the extent that the economic activity it decrees will take place, does take place

 

  • A train ticket is valuable to the extent it is valid

A piece of money is valuable to the extent it is valid.

 

(NB. Claiming gold is naturally money is like getting on a train with a piece of Stephenson’s Rocket in your hand and claiming it gives you a right to ride!)

 

The decree aspect of Bitcoin is well illustrated by the apocryphal ‘10,000 Bitcoin For A Pizza’ story.

 

Bitcoin, like any form of money, does not reflect reality or the economy. If it did, then the first Bitcoin would be designated as worth the totality of the economy, the first and second would each be worth half the economy, the first, second and third would each be worth one third of the economy and so on… This is obviously nonsense

Since money does not reflect the economy as it is or was, it must instead decree the economy as it is going to be.

 

In the case of the Bitcoin Pizza, 10,000 Bitcoin didn’t call the pizzeria that made the pizza into existence.

It didn’t call the flour purchase for the pizza into existence.

It didn’t bring the pizza man into work to make the pizza. All this stuff was already there.

But what it did, was to call this specific pizza into existence.

Bitcoin like all other money, decrees how the world will be from now on.

 

Once the Bitcoin Pizza transaction was successfully completed, the Bitcoin became both decree and record and its value was accordingly modified.

 

Democratised Money Theory:

 

A money contract is valid to the extent that everyone complies with the terms of the decree it embodies. A money decree is complied with to the extent that the amount and terms of money contracts issued compare with the amount and terms of economic activity undertaken for the same territory and time span.

 

Applied to Bitcoin:

 

Here is a ‘sketch’ graph which roughly illustrates the dollar value of Bitcoin since its beginning. The graph is useful in illustrating the decree function of Bitcoin. I have marked five significant points on the graph:

NEWGRAPH

1.Bitcoin the beginning has no recording function, so no value added there. The mining protocol decrees Bitcoin is virtually valueless.

 

2.Bitcoin records some few transactions; ‘wealth store’ value increases. This leads to an increase in mining which decrees Bitcoin is again virtually valueless.

 

3,4.The number of Bitcoin records begins to accumulate rapidly, especially in relation to the number of fresh decrees issued because it is becoming harder and more specialised to ‘mine’. The increased cost of ‘mining’ is effectively a decree of greater value.

 

5.The validity of recent decrees increasingly comes under question. Bitcoin is having trouble making the real world conform to what it proclaims. This is reflected in the recording function. Bitcoin falls in ‘value’