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comment by wasoxygen

My earlier remarks were mostly speculation and intuition. I drafted another indignant reply before coming to my senses and doing more reading and thinking.

Graeber's breathless article about the Bank of England's "radical" "new position" is a lot of nonsense. I haven't looked carefully at the "Money Creation" paper, but it mentions a companion paper, Money in the modern economy: an introduction, which led me to believe that my disagreement was mostly semantic.

It says that "Money today is a type of IOU." Saying that banks can create money, by this definition, is equivalent to saying that lenders can create loans. This has been going on for thousands of years.

As Graeber has it:

    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.

The Bank of England is rather more sedate:

    Banks can create new money because bank deposits are just IOUs of the bank; banks’ ability to create IOUs is no different to anyone else in the economy.

When I borrow lunch money from a coworker, she is also creating money in this sense. My promise to repay is a financial liability to me and a financial asset to her. The main difference between my IOU and a federal reserve note is that she can't exchange my IOU for a cup of coffee at Starbucks. Uncle Sam is widely recognized as a reliable debtor, and I am not.

The Bank of England:

    Because financial assets are claims on someone else in the economy, they are also financial liabilities — one person’s financial asset is always someone else’s debt.

These financial instruments always balance out: credits and debts cancel, so the act of making a loan does not change the number of dollars in circulation, what a casual reader thinks of as "money." The Bank of England is careful to show this equivalence:

Interestingly, the Bank of England depicts all of the central bank's liabilities as backed by non-money assets.





wasoxygen  ·  3332 days ago  ·  link  ·  

I would like to add, mk, that I am still fuzzy on a lot of the Bank of England information on modern banking. There are many mysterious and complicated phenomena in the world. We are told that matter and antimatter particles are constantly coming into existence out of nowhere and then annihilating each other. This is very interesting and confusing.

I am dismissive of Graeber because he reminds me of someone who distorts the science to sell books about crystal power or UFOs. He uses the financial world’s unfamiliar definition of “money” to support the Occupy movement’s portrayal of banks as predatory schemers deceiving customers and getting rich (he convinced the headline writer: the banks are “rolling in it”).

There is a sense in which the bank’s fountain pen brings money into existence ex nihilo. Before I bought a house, I spent a good while with a bank officer watching the fountain pen do its thing. At the end, indeed, the largest chunk of money I had ever seen appeared. This new money was a credit in my name. Of course it was, that’s what I traded to get the house! The bank got a couple hundred bucks in service fees.

At the same time, the magic fountain pen created a debt, of equal magnitude and opposite direction to the credit, also in my name. I solemnly promised to spend thirty years annihilating this debt. As I return the bank’s federal reserve notes, I pay a kind of rent for the ones I am still using to keep the house’s former owner happy, this is the interest that the conventional view tells us the bank counts as income.

It is hard for me to remember that currency is not intrinsically valuable. I call it “money” which I use interchangeably with “wealth.” We should remind ourselves that banknotes are just notes, like Post-It notes, with a promise written on them, complete with a formal signature.

When I reread your excerpt from page 15 and mentally substitute “IOU” for “money,” it makes more sense. But not perfect sense. This sentence in particular is hard for me to understand:

    Saving does not by itself increase the deposits or ‘funds available’ for banks to lend.

In the conventional view, if I transfer my savings from Wells Fargo to First Union, First Union can then approve more car loans. I thought that was the whole purpose of the fractional reserve system. Banks are required to keep 10% on hand for people who might demand cash that day, the balance of the cash can be extended as credit. “Extended as credit” means the cash — the Federal Reserve’s IOUs — is given to home sellers and car dealers who can then trade them for gold bars immediately if they choose. The IOUs, and their power to obtain gold bars, must be in the bank's hands before they can be given away.

Perhaps _refugee_ can give us a professional opinion.

_refugee_  ·  3332 days ago  ·  link  ·  

    In fact, when households choose to save more money in bank accounts, those deposits come simply at the expense of deposits that would have otherwise gone to companies in payment for goods and services.

This is an extremely macro view. "All the money is in the system and can be assumed to be in the bank; the account doesn't matter; the bank is the institution through which all money flows, so regardless of where the money is, the money is in the bank."

    This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits

    Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.

I think this is silly.

At the end of the day, the bank has a balance sheet. The sheet must be balanced. If banks simply created loan after loan after loan without deposits and other income (fees) they would show marginal income on year-end reports based solely off of the interest made on the loans, assuming all borrowers repay. Deposits are necessary.

I think this article may be making the point that because banks act on such a macro level, they can afford to lend out more money on say, Tuesday, than they actually have in deposits - because they can count on the fact that by Friday, everyone gets paid by direct deposit, it'll even out.

A bank could not fountain pen money into existence if it did not have deposits. A bank can only seemingly "fountain pen" money into existence because these days they are so huge. If I am a small bank or a credit union and I really only have $10,000 of money - let's say some is start-up capital or whatever, but most is deposits - if that is all I have on my balance sheet, sure I can "lend out" $12,000 by simply fiddling numbers in the system, but then I am factually $2k in the hole, and either I have to make that money up somehow or I'm going to be in the red when I report my earnings for the year. I'm not ENRON and we'll assume I'm not ENRON-izing my report.

Sure, at the end of the day, I can lend way more money than I have - if I am a major bank with systems, ATMs, networks, and all the systems that would enable it to appear that that money is actually there. But that money has to come back to me. I can't count on a 100% rate of return on my loans so the interest on the good loans isn't going to be enough to turn a profit, plus not to mention all the people I have to pay in order to service these loans and run my Collections department. It'd be unwise to depend on investments to return that money because basically that's not reliable.

If we have a closed system and there is $100 in the system and Alice has $50 and Bob has $50, sure, Carol can go to the Bank of Ted and ask for $100. The Bank of Ted can even say "Sure! Here, have $100!" but unless Alice and Bob actually believe the Bank of Ted has $100 already, Carol doesn't have $100. Alice and Bob will not believe that the Bank of Ted has money simply because BoT says it has money; it needs to be an accepted fact that BoT is "the place where all the money is." If Alice and Bob know BoT has no money they will not accept BoT's notes.

I feel like I'm missing some sort of point here or something.

Yeah, rereading it, and just not getting it. They're basically saying that because banks use systems and not real money, banks can fudge the numbers and just make it look like there's money somewhere even when nothing happened to make that money appear wrt "real money" or physical money.

mk  ·  3332 days ago  ·  link  ·  

Yes, I don't think it's fair to hold the Bank of England to Graeber's interpretation.

From a few readings, my take away is that the lending of banks is limited not by availability of notes printed by the Reserve (and thus a proportion of savings deposits), but instead by the cost of a bank's deposits, and the return on its assets. From page 20:

    Banks receive interest payments on their assets, such as loans, but they also generally have to pay interest on their liabilities, such as savings accounts. A bank’s business model relies on receiving a higher interest rate on the loans (or other assets) than the rate it pays out on its deposits (or other liabilities). Interest rates on both banks’ assets and liabilities depend on the policy rate set by the Bank of England, which acts as the ultimate constraint on money creation.

Thus, the bank can lend when they feel the loan will perform well enough to cover their liabilities, and this lending creates more money as it increases their balance sheet (to be reduced as the lender pays it back).

From page 20:

    The supply of both reserves and currency (which together make up base money) is determined by banks’ demand for reserves both for the settlement of payments and to meet demand for currency from their customers — demand that the central bank typically accommodates.

    This demand for base money is therefore more likely to be a consequence rather than a cause of banks making loans and creating broad money. This is because banks’ decisions to extend credit are based on the availability of profitable lending opportunities at any given point in time. The profitability of making a loan will depend on a number of factors, as discussed earlier. One of these is the cost of funds that banks face, which is closely related to the interest rate paid on reserves, the policy rate.

That demand that the central bank typically accommodates part is where I think a potato/potato argument can be made. What I think the Bank of London is saying here, is that the Reserve isn't making the decision of whether or not there needs to be more money in circulation, but it is the banks that are making that determination. In fact, the Reserve adjusts the costs of lending, and that alters the math when a bank is deciding whether or not to create a new loan, and this bring more money into the system.

It's very interesting stuff.