Banking and money creation process

March 2024 Forums General discussion Banking and money creation process

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  • #82039
    Anonymous
    Inactive

    Why do banks compete with each other to attract people’s savings (i.e., money people don’t want to spend for the time being)? What is the difference between a bank and a moneylender? Do moneylenders, pawnbrokers and loan sharks also create money out of thin air when they make a loan? If not, why not? 

    You mention this on one of your web pages about banks and money lending. Why do banks compete for savings if they can create money ? (Your question) –  Because it replenishes their account at the Bank of England when they receive deposits or loan repayments (see description of this further down). Banks do create money when they make a loan, which ends up as a deposit elsewhere in the banking system, or even at the same bank. The money supply more than doubled between 1997 and 2007, mainly caused by extra bank lending. All the banks increased their lending together, which generated new deposits elsewhere, and helped to push up house prices in this period by 200%., then they can expect new deposits to return to them. In other words, the lending came before the deposit. There is a difference between accounts you and I have at the bank (where a bank can make a loan to me and my account increases, and the loan ends up in a deposit or current account elsewhere in the system and becomes new money), and the accounts all the main banks have at the Bank of England to settle up between themselves each day. The act of lending reduces this account for Barclays for example (at the B of E), and loan repayments and new deposits will increase it. Northern Rock got into trouble because their account at the Bank of England got depleted. They were making new loans too quickly, to many bad borrowers, and they borrowed short from other banks. They did not get enough new deposits and loan repayments back, so they were heading for bankruptcy. Money lenders cannot create money, in the sense that they are genuine intermediaries – they have to have deposits to lend on, for example "Bank on Dave" in Burnley. I think about 16 to 20 big banks have money creation privileges with accounts at the Bank of England, and are part of what used to be known as the APACS clearing system. The money supply reduces when loans are repaid faster than new ones are created. This is why we have had a recession after the boom years, and the Bank of England has resorted to Quantitative Easing, so keep the money supply up, because there is a shortage of money as people and government try to repay debt after the huge credit expansion of recent years. The only restriction on bank lending in recent times was the banks confidence to lend, and borrowers willingness to borrow. Interest rates and the reserve requirement were, and still are, very weak regulators of the lending and money creation process. The multiplier model does not really apply in the UK any more (where banks keep a fraction of a deposit and lend the rest on). Banks are not confident now, so there is less lending, less money and a flat lining economy. I am happy to review any evidence you have which disagrees with my analysis.

    I am also surprised that the Socialist Party of Great Britain is in favour of a private banking cartel creating nearly all of our money as a debt, and requiring more people and government to take on yet more debt for the economy to function as it does at the moment. I presume this may be because you are not fully aware of how the money and banking system works now. The book "Where does money come from" produced by the New Economics Foundation and Positive Money explains in detail how the system works, and further material is available on the Positive Money web site and http://www.legalforgery.com Positive Money have studied the system for several years, and reviewed thousands of pages of evidence supplied by the Bank of England and elsewhere. Unfortunately many mainstream economic text books do not describe the current system in an accurate sense and persist with the outdated multiplier model, although some do say that banks create money when they make a loan. Many are silent, or suggest banks are just intermediaries.

    There are plenty of people in the mainstream including Mervyn King and Paul Tucker at the Bank of England who say that banks do create money when they make a loan, as does Adair Turner, ex head of the FSA.

    #94338
    ALB
    Keymaster

    There's actually already a long-running thread on this here on this forum:http://www.worldsocialism.org/spgb/forum/general-discussion/100-reserve-bankingand the New Economics Foundation book you mention was reviewed in the Socialist Standard in February last year:http://www.socialism.org/spgb/socialist-standard/2010s/2012/no-1290-february-2012/where-money-comes-reply-new-economics-foundationYou will see that this is partly a question of the definition of money: If you include bank loans as money then of course by definition banks create money, but the question that then arises is: where does what they lend come from? Thin air (as some claim) or money they have borrowed from elsewhere, eg the public or other banks via the money market (and including, as you seem to be admitting, the Bank of England).As you say some textbooks say:

    Quote:
    banks are just intermediaries

    Sometimes they get it right!You are right on one point. The amount banks lend depends on the state of the economy, as much on what businesses want to borrow as on what the banks have or can borrow, and that there's not much that the government or the Bank of England can do about it. But this statement of yours is ridiculous:

    Quote:
    I am also surprised that the Socialist Party of Great Britain is in favour of a private banking cartel creating nearly all of our money as a debt, and requiring more people and government to take on yet more debt for the economy to function as it does at the moment.

    We are just trying to explain how the capitalist economic system works not with proposing how we think it ought to work (not that it does work, anyway, in the way you are suggesting).  As a matter of fact we are in favour of a society in which money and banks would be redundant. 

    #94339
    Anonymous
    Inactive

    You do not describe the economic system correctly in terms of banks and money creation for your readers, even though you say I describe it incorrectly. I do not say banks have to borrow money from the Bank of England, although they have done in these extreme times to help repair their balance sheets, and try and get "funding for lending" going.  Where do you think all the money came from between 1997 and 2007, when the money supply more than doubled ? Where has all the money come from between 1960 and 2008 when it increased by 100 times ? When banks are confident, they lend and create money, the economy grows and house prices increase. When they are not confident and people cannot take on any more debt, there is less money and a recession as loans are repaid and the money is not lent out again.  I describe a process where new loans by private banks generate new deposits and money. In other words, the loans come before the new deposits. The money supply reduces when loans are repaid faster than new ones are created, which is where we are now, and why the Bank of England is doing Quantitative Easing, so there is not a "money shortage", and a severe recession. Only banks which are members of what used to becalled APACS have the privilege of money creation, because they have accounts at the Bank of England which they use to settle up with each other each day. A Credit Union or Savings and Loan institution does not have the same privilege. A bank cannot go very large on lending without getting deposits and repayments back, as in the case of Northern Rock, (because it's account at the Bank of England will get depleted)  but if they all keep in step, then new loans, deposits and money will be created. Your view is different from people at the Bank of England like Mervyn King and Paul Tucker, and the ex head of the FSA Adair Turner, who do say that banks create money when they make loans. It is unfortunate that many economic text books are out of date, or wrongly regard banks as just intermediaries.I agree with you about the nature of society, and I would very much like to see a situation where money is much less important, and the basic needs for everyone are met properly, without some people falling into debt and poverty, and where the benefits of technical progress and the world's resources are shared more equally, rather than being concentrated in fewer hands as at present. There are many things wrong with Capitalism, and I like it less as time goes on. Unfortunately we have a warped version of capitalism, where mega corporations and large banks rule the world, to the detriment of everyone else. I am in favour of re-nationalising many parts of our economy like power supply, water and public transport, and building much more public housing. The main political parties are in thrall to big business and banks and do not serve the interests of ordinary people.

    #94340
    Anonymous
    Inactive

    For those in London this coming Sunday (June 16th) there's a talk being given at the Party's premises in Clapham with the title "An Introduction to Marxian Economics".http://www.worldsocialism.org/spgb/event/marxian-economics-clapham-300pmAnd the following Wednesday (June 19th) a talk will be given in Glasgow on "Quantitative Easing"http://www.worldsocialism.org/spgb/event/quantitative-easing-glasgow-830pmFull audience participation at both meetings.

    #94341
    ALB
    Keymaster

    Our main concern re banking is to refute the view that a single bank can create money/credit (purchasing power which didn't exist before) by a mere stroke of a pen or, these days, a keyboard stroke. You don't think that either so what we are arguing about is the best way to describe how the banking system works.You say that the theory that the whole banking system (as opposed to a single bank on its own) can lend many times more than an amount initially deposited with one bank in the system is out of date. Maybe but we never thought much of this theory anyway, but at least it didn't accept the view that a single bank can create money to lend out of thin air and in any event assumed repeated deposits as well as repeated loans and so didn't refute the view that "deposits create loans".You say that a better description now is one which says that the banks together with the central bank can create purchasing power that didn't exist before. This is true, but only because the central bank does have the power to create new purchasing power by a keyboard stroke. We have never denied this, but of course this isn't an increase in actual wealth (which can only happen through work) and, if it does not correspond to an increase in wealth, will lead to a depreciation of the currency and so a rise in the general price level, aka inflation. I think that inflation (which has gone on continuously since 1940 and which it is current government policy should be about 2% a year) will be a big part of the reason why the "money supply" has increased 100 times since 1960. Another reason will be the expansion of production and trade in the period but, as you yourself note, this and bank lending with it sometimes goes down as well as up.

    simondav wrote:
    The money supply reduces when loans are repaid faster than new ones are created, which is where we are now, and why the Bank of England is doing Quantitative Easing, so there is not a "money shortage", and a severe recession.

    This is not what QE is really about (see the discussion on the thread about this) and in any event has not led to an increase in the "money supply" in your sense, i.e an increase in actual bank lending. What it has led to is an increase in the commercial banks reserves with the Bank of England which may be included in your definition of the money supply (but is not the same as bank lending or an increase in currency in circulation). Its affect and aim has been to sustain the shares market (and disrupt the bond market).

    simondav wrote:
    Only banks which are members of what used to becalled APACS have the privilege of money creation, because they have accounts at the Bank of England which they use to settle up with each other each day. A Credit Union or Savings and Loan institution does not have the same privilege.

    Actually all banks have access to this clearing facility (those that don't have accounts with the Bank of England have to have accounts with a bank which does; it's a condition for getting a licence to be a bank). And, as just pointed out, it's the Bank of England that's doing the actual "money creation". Incidentally, the New Economics Foundation booklet Where Does Money Come From? that you mentioned earlier does try to argue that credit unions too can create some money.

    simondav wrote:
    Your view is different from people at the Bank of England like Mervyn King and Paul Tucker, and the ex head of the FSA Adair Turner, who do say that banks create money when they make loans. It is unfortunate that many economic text books are out of date, or wrongly regard banks as just intermediaries.

    Yes, these people do include bank loans as part of the "money supply" (which we say is confusing but can live with as long as it is always made clear than "bank money" is not the same as money issued by the central bank). I'm not sure, though, that they would deny that banks are financial intermediaries. Certainly Sir John Vickers who chaired the recent Independent Commission on Banking doesn't; in fact he takes this for granted. See: http://www.worldsocialism.org/spgb/socialist-standard/2010s/2011/no-1286-october-2011/banking-reform-it-relevant

    simondav wrote:
    There are many things wrong with Capitalism, and I like it less as time goes on. Unfortunately we have a warped version of capitalism, where mega corporations and large banks rule the world, to the detriment of everyone else. I am in favour of re-nationalising many parts of our economy like power supply, water and public transport, and building much more public housing. The main political parties are in thrall to big business and banks and do not serve the interests of ordinary people.

    We are not in favour of trying to reform capitalism to make it work better. We don't think it can be. That's why we want to replace it with socialism as a society based on common ownership, democratic control, production directly for use not profit, and distribution in accordance with the principle of "from each according to their ability, to each according to their needs".

    #94342
    Anonymous
    Inactive

    Hi ALBI cannot get into a long discourse as I am not on my usual computer. The money supply has grown over the years primarily as a result of bank lending, and the government borrowing more by issuing gilts. The interest charged on all the debt has a cumulative and inflationary effect. The Central bank creates very little money, apart from the recent £375billion QE, and a small amount with the funding for lending scheme which is lent to the private banks. They also create the 3% of physical cash in the economy. This QE has increased bank reserves, and has balanced the loss of money through debt repayment by individuals and business, after the recent massive credit/ money expansion. An example of more money being created is someone paying £200,000 for a house which would have cost £30,000 25 years ago. The banks were recently lending a higher amount and greater multiple of salary (up to 8 times), which increased the money supply and had an inflationary effect, although they are now more restrictive and may revert back to say 3 times salary. They are having to do this because of tighter regulation, and the debt burden was becoming too high in society. I do not deny that wages and salaries usually go up as well, but usually this is because there is more money in the economy, and the cost of housing and rents have gone up. When the government borrows more, it usually raises taxes and this also has an inflationary effect as people ask for higher pay to compensate.I disagree with Positive Money and the New Economics Foundation that credit unions create money in the same way as big banks which are part of the B of E clearing system, as does my father Bill Davies on his web site http://www.legalforgery.com  I say they are genuine intermediaries. I do not say that banks are not intermediaries also, but they have money creation powers as well. One of the main functions of a bank is to match short term deposits with long term borrowers (maturity transformation).Positive Money want the Central Bank to issue money debt and interest  free, not have the private banking system create it with debt and interest.We may have to disagree on some pointsSome competitive elements of Capitalism are good in the sense that it can drive innovation and efficiency. However, taken to it's logical conclusion in a very automated world, it tends to lead to wealth in fewer hands, and workers being forced to take ever lower wages, or thrown out of work. It leads to millions being economically idle and not able to play a useful role in society. Cost savings, extra profit and efficiency have been the watchwords every where I have worked since the 1970s, usually to the detriment of the workers, suppliers and customers. We need some elements of Capitalism to drive innovation and growth, but the good elements of Communism too. I will make this my last post, I hope it has provided an interesting discussion, and it has been good conversing with you.

    #94343
    ALB
    Keymaster
    simondav wrote:
    as does my father Bill Davies on his web site http://www.legalforgery.com

    This site illustrates the confusion that arises if you define bank loans as money and then assume that it is the same as money issued by a central bank. You end up proposing that "bank money" should be replaced by "government money"; which would mean, on the one hand, restricting the supply of funds to industry and, on the other, causing raging inflation. If implemented it would make things werse not better. Which is why it never will be. Those in charge of running capitalism may not understand completely how capitalism works, but they are not that stupid.

    #94344
    Anonymous
    Inactive

    These videos provide a brief explanation of how the money and banking system works, and are based on extensive research which was used to produce the book "Where does money come from" ? The book is for the more technically able. The recent research by the Positive Money team is an accurate description of how the system works, as is the work done by my father. Unfortunately you may be looking at some economic texts that are out of date or flawed in their analysis. Many economists do not understand how the system works, and it has taken an independent team including ex engineers, systems analysists and ex bankers to give an accurate view. There should be no doubt these days as to where money comes from, in the same way as there is no doubt as to how and why an aircraft flies.http://www.positivemoney.org/how-money-works/banking-101-video-course/The central bank issues very little of our money, (we would like them to do this, rather than government and people borrowing money into existence), apart from physical cash, recent QE, and a bit of lending to the private banks for the funding for lending scheme, who then lend it on at great profit. I assume you are thinking  the accounts that the big banks have at the Bank of England is "Central bank money", which are the accounts the banks use to settle between themselves. The videos show how loans, deposits and repayments that the private banks make/receive ultimately affect their accounts at the Bank of England. We do not propose the government creates money, we say the Bank of England should do it, free from political influence. It is not necessarily true that issuing debt free money would cause inflation if done properly (anyway the private banks certainly managed to cause plenty of inflation by tripling house prices in 10 years up to 2007). As debts are repaid, this takes money out of the economy. The key is to get less debt money, and more money (in other words electronic money is like physical cash), so as to reduce the private and public debt burden, and as debt free money is issued, to get something for it like improved infrastructure and more people in work. The ideal would be to keep the money supply fairly constant, or growing slightly, not doubling in less than 10 years which it did recently, obviously then causing a massive boom, then bust. Hitler issued debt free money in the 1930s in Germany which improved their infrastructure (and helped to prepare for World War 2 unfortunately). This was not the earlier Weimar inflation of the 1920s, much of which was caused because Germany was trying to pay back World War 1 reparations, a massive debt burden.Positive Money are suggesting £50 billion QE for infrastructure which is a reasonable aim, before we try and get all of our money supply issued debt and interest free, I will concede that the private banks decide at the moment what they will give a loan for (in recent times much went on asset speculation), so having the Bank of England issue debt free money, and then deciding where it is to be spent is not easy. The money could be used to give everyone a tax credit for example, so they can spend it into the wider economy. I also concede that changing the present system is very difficult, because there are powerful vested interests (banks, and pension funds who get interest income on gilts) that want to continue to rent our money to us, in the same way that people like to receive rental income on private and commercial property. We have a "rentier" economy in other words, where an elite group want to live off the hard work of the majority.

    #94345
    Anonymous
    Inactive
    simondav wrote:
    We have a "rentier" economy in other words, where an elite group want to live off the hard work of the majority.

    Actually we have a capitalist economy where an elite group already lives off the hard work of the majority.  Rent (or ground rent, more precisely) is but one sub-division of the surplus value produced by wage labour. Workers are constrained to selling their labour power for a wage or a salary, but during their time in employment they can produce a value greater than their wages and salaries. Because the capitalist class owns the means of life and their products, they appropriate this unpaid surplus when the commodities are sold on the market.No amount of tampering with capitalism will change this fundamental state of affairs. As John Spritzler, in this critique of the Bank of North Dakota advocates,

    Quote:
    …an egalitarian society with an economy based on sharing according to need instead of buying and selling for profit, and a vision of genuine democracy…It is not possible to abolish a social and economic system based on inequality by "sneaking" in a different system without confronting and defeating the plutocracy whose wealth, power and privileges depend on keeping the present system.
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