How Money is Created: 3 articles

Also see:

Money as Debt (45 minute video)
Can Banks Create Money out of Nothing? – Richard Werner
Money Creation in the Modern Economy –Bank of England

David Graeber. March 18, 2014. The Truth Is Out: Money Is Just An IOU, And The Banks Are Rolling In It. The Guardian.

Back in the 1930s, Henry Ford remarked it was a good thing Americans didn’t know how banking worked, because if they did, “there’d be a revolution before tomorrow morning”.

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 3 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 positions more ordinarily associated with groups such as Occupy Wall Street are correct.

To get a sense of how radical the Bank’s position is, consider the conventional view: People put their money in banks, which lend that money out at interest to consumers or entrepreneurs willing to invest it in a profitable enterprise. The fractional reserve system allows banks to lend out considerably more than they hold in reserve, and if savings don’t suffice, private banks can seek to borrow more from the central bank.

The central bank can print as much money as it wishes. But it is also careful not to print too much. In fact, we are often told this is why independent central banks exist in the first place. If governments could print money themselves, they would surely put out too much of it, and the resulting inflation would throw the economy into chaos. Institutions such as the Bank of England or US Federal Reserve were created to carefully regulate the money supply to prevent inflation. This is why they are forbidden to directly fund the government, say, by buying treasury bonds, but instead fund private economic activity that the government merely taxes.

It’s this understanding that allows us to continue to talk about money as if it were a limited resource like bauxite or petroleum, to say “there’s just not enough money” to fund social programs, to speak of the immorality of government debt or of public spending “crowding out” the private sector.

What the Bank of England admitted this week is that none of this is really true.

To quote from its own summary: “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.

In other words, everything we know is not just wrong–it’s backwards:

When banks make loans, they create money.
This is because money is really just an IOU.
There’s really no limit on how much banks could create, provided they can find someone willing to borrow it.

The role of the central bank is to preside over a legal order that grants banks the exclusive right to create IOUs that the government will recognize as legal tender by its willingness to accept them in payment of taxes.

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. In the banking system, every loan just becomes another deposit. Even if banks need to acquire funds from the central bank, they can borrow as much as they like; all the latter really does is set the rate of interest, the cost of money, not its quantity. Since the beginning of the recession, the US and British central banks have reduced that cost to almost nothing. In fact, with “quantitative easing” they’ve been effectively pumping as much money as they can into the banks, without producing any inflationary effects.

What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow. Government spending is the main driver in all this (and the paper does admit, if you read it carefully, that the central bank does fund the government after all). So there’s no question of public spending “crowding out” private investment. It’s exactly the opposite.

Why did the Bank of England suddenly admit all this? Well, one reason is because it’s obviously true. 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.

Politically this is taking an enormous risk. Consider what might happen if mortgage holders realized the money the bank lent them is not, really, the life savings of some thrifty pensioner, but something the bank just whisked into existence through its possession of a magic wand which we, the public, handed over to it.

[My comment: this article doesn’t explain WHY this is such an “enormous risk”. So I’ve summarized some of the following video, which you really should watch to hear the parts I didn’t include and to fully understand how the system works so you can protect your wealth:]

The Biggest Scam In The History Of Mankind

Our financial system has kept the wealthiest at the top of the financial food chain for over a century. Never in history have so many been plundered by so few.

Most people don’t have a clue how currency is created: 92-96% of all currency in existence is created in the Banking system.

Our entire currency supply is a supply of numbers, little of it is printed. We work for this “currency”, trading years of our lives for numbers in a computer. We are what gives the currency its value.

Borrowing creates money and eventually far more debt than the “money/currency” itself.

We must keep going deeper and deeper into debt or the whole system goes into a deflationary collapse.

Of course, at some point the trillions of “currency” debt and quadrillions of derivative debt is impossible to pay back, but meanwhile, no one wants the system to crash on their watch, so more and more imaginary numbers are fed into the system to keep it going (i.e. the United States debt-ceiling). The can keeps getting kicked down the road.

It’s a fraud, a Ponzi scheme, a scam. It’s legalized theft. It has to crash eventually, [it always has in the bubbles of the past 200 years]. Here’s how it works:

Step 1. Banks swap I.O.U.s to create currency. The treasury sells the bonds to the banks.

Step 2. The banks then turn around and sell our national debt at a profit to the Federal Reserve, which they probably own (The federal reserve is not federal, it has stockholders). The Federal Reserve, then opens its checkbook, which doesn’t have a penny in it, and buys those I.O.U.s with I.O.U.s that it writes, gives those checks to the banks and currency springs into existence. This repeats relentlessly, which builds up bonds at the Federal Reseruve and currency at the treasury. All of it is just a bunch of numbers in a computer. The treasury then deposits these numbers into various branches of the government.

Step 3. Then the government spends the numbers on social programs, public works, and war. Government employees deposit their pay in banks.

Step 4. Banks multiply the numbers even more by inventing more I.O.U.S through fractional reserve lending where they steal a portion of everyone’s deposit and lend it out, and magnify the currency exponentially. The banks only have to keep a small part of your deposit. If you put $100 in, the bank can lend $90 out and keep $10 in case you want it back. It is legally allowed to replace your $90 with an I.O.U.

Now there is $190 in the system.
Someone borrows your $90 to buy something, deposits the check in his bank, and that bank lends it out 90% of the $90 (or $81).
Now there’s $271 in existence ($190 + $81).
Eventually there’ll be $1000 created from your $100 deposit.

Step 5. We work hard for these numbers. And pay taxes to the IRS, who turn our numbers over to the treasury to pay principal plus interest to the federal reserve on bonds they created with zero collateral (such as gold, oil, etc).

Step 6 The system is built to require ever increasing amounts of debt that will eventually collapse under its own weight.

[My comment: the financial system has worked this long due to exponentially increasing amounts of fossil fuels. All goods, infrastructure, electricity, food, heating, etc., depend on fossil fuel energy at every step. Especially farming, transportation, etc., because 97% of billions of combustion engines run on oil, not electricity. Oil production has been flat since 2005, which drove oil prices up to $148 and caused the financial crash, which is why the economy hasn’t recovered, and never will. If the system doesn’t collapse under its own weight of debt, as shown in this video, then it will certainly collapse within the next 6 years as energy production leaves the plateau and declines exponentially. Oil production may already be declining, and isn’t apparent because demand has dropped since the majority of Americans are poorer and driving / consuming less since the crash].

Step 7 The secret owners – probably the largest banks — take their cut. They make a profit not just on your deposit (step 4) but also when:

They sell our national debt to the Fed.
When the Federal Reserve pays interest on the reserves
When the Federal Reserve pays them a 6% dividend on their ownership of the fed
Those who get the money first can spend it before prices inflate and get the most benefit.

This system is fundamentally evil

It funnels wealth to from the workers to the super-rich, causes booms and busts, and creates the great disparity of wealth.
It is a form of enslavement. Bond(age).
Nobody is asking our children if they want to work hard for the prosperity we’re enjoying now and be enslaved as well.
George Washington said “No generation has a right to contract debts greater than can be paid off during the course of its own existence”.
John maynard Keynes once said that “By this means, government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft”.

Strip private banks of their power to create money. Financial Times.

Printing counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and should – be terminated.

I explained how this works two weeks ago. Banks create deposits as a byproduct of their lending. In the UK, such deposits make up about 97 per cent of the money supply. Some people object that deposits are not money but only transferable private debts. Yet the public views the banks’ imitation money as electronic cash: a safe source of purchasing power.

Banking is therefore not a normal market activity, because it provides two linked public goods: money and the payments network. On one side of banks’ balance sheets lie risky assets; on the other lie liabilities the public thinks safe. This is why central banks act as lenders of last resort and governments provide deposit insurance and equity injections. It is also why banking is heavily regulated. Yet credit cycles are still hugely destabilising.

What is to be done? A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt. I discussed this approach last week. Higher capital is the recommendation made by Anat Admati of Stanford and Martin Hellwig of the Max Planck Institute in The Bankers’ New Clothes.

A maximum response would be to give the state a monopoly on money creation. One of the most important such proposals was in the Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher. Its core was the requirement for 100 per cent reserves against deposits. Fisher argued that this would greatly reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff suggests this plan could work well.

Similar ideas have come from Laurence Kotlikoff of Boston University in Jimmy Stewart is Dead, and Andrew Jackson and Ben Dyson in Modernising Money. Here is the outline of the latter system.

First, the state, not banks, would create all transactions money, just as it creates cash today. Customers would own the money in transaction accounts, and would pay the banks a fee for managing them.

Second, banks could offer investment accounts, which would provide loans. But they could only loan money actually invested by customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many wrongly believe they now are. Holdings in such accounts could not be reassigned as a means of payment. Holders of investment accounts would be vulnerable to losses. Regulators might impose equity requirements and other prudential rules against such accounts.

Third, the central bank would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as now, be taken by a committee independent of government.

Finally, the new money would be injected into the economy in four possible ways: to finance government spending, in place of taxes or borrowing; to make direct payments to citizens; to redeem outstanding debts, public or private; or to make new loans through banks or other intermediaries. All such mechanisms could (and should) be made as transparent as one might wish.

The transition to a system in which money creation is separated from financial intermediation would be feasible, albeit complex. But it would bring huge advantages. It would be possible to increase the money supply without encouraging people to borrow to the hilt. It would end “too big to fail” in banking. It would also transfer seignorage – the benefits from creating money – to the public. In 2013, for example, sterling M1 (transactions money) was 80 per cent of gross domestic product. If the central bank decided this could grow at 5 per cent a year, the government could run a fiscal deficit of 4 per cent of GDP without borrowing or taxing. The right might decide to cut taxes, the left to raise spending. The choice would be political, as it should be.

Opponents will argue that the economy would die for lack of credit. I was once sympathetic to that argument. But only about 10 per cent of UK bank lending has financed business investment in sectors other than commercial property. We could find other ways of funding this.

Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.

This will not happen now. But remember the possibility. When the next crisis comes – and it surely will – we need to be ready.