Sunday Mail discovers how banks work
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The classical saving banks were absorbed by the big commercial banks. The American Institute of Banking ( AIB ) which provided classes for peoples working for banks and financial institutions ( specially bank officers ) did not teach the theory of the thin air, they explained that banks needed depositors, They used to teach about Metropolitan Banking ( Savings, Checking and Loans ) and International Banking. The major in Finance does not teach that theory either, the theory was created outside of the banking industry and the academia
Despite regular evidence from the financial pages showing that banks do need deposits, whether from individuals or from other financial institutions, to be able to lend, the myth persists — and not only amongst open currency cranks — that banks can create the money they lend from thin air.
Yesterday. Close Brothers, which is a financial institution specialising in financing loans to buy a car, reported half yearly results:
One factor in the loss was a reduction in its net interest margin (the difference between the rate of interest paid to those who lend it money and the rate it charges borrowers). This is the source of a lending institutions’ income and, after paying running costs, of their profits.
“The group’s net interest margin reduced by 30 basis points to 7.2 per cent from 7.5 per cent.”
It is forecast to fall further this year to 7 per cent, so reducing its income.
Another reason is a fall in deposits from other financial institutions:
“Corporate and council treasurers are already voting with their feet. They pulled a net £700 million of their deposits from Close last year, reducing its non-retail deposits by 22 per cent.” (Today’s Times).
The obvious question to put to those who claim that banks don’t need deposits to make loans is: why would this matter?
“You Know Nothing About Economics” is the title of this article….
https://vocal.media/education/you-know-nothing-about-economics
That article has an appropriate title as the author does indeed know nothing about economics, at least not about monetary economics. He is a supporter of Modern Monetary Theory, or MMT. Which also stands, appropriately, for Magic Money Tree.
This theory claims that the government doesn’t need to impose taxes or borrow in order to finance its spending. It can simply create the money and spend it. True, the government could do this but it wouldn’t be creating new wealth only new money-tokens that could be used to buy existing wealth. The result of course would be Zimbabwe-style roaring inflation.
But to give them their due, they don’t claim that banks can create money out of thin air but only that the government can. In a sense this is true. Only the government can create money-tokens but if it wants to avoid debasing the monetary unit/inflating the currency then it needs to be careful how much it issues and try to guess how much the economy needs to maintain a stable (or slowly increasing) price level.
Here’s another item to add to the pile of evidence refuting the theory that banks create credit from thin air and not from resources they have or acquire. It’s from today’s Times about Metro Bank, quoting chief executive Daniel Frumkin:
“We have continued to deliver the strategic repositioning of Metro Bank’s business, maintaining strong cost control while driving higher net interest margin by changing the mix of assets and remaining disciplined about deposits”.
As followers of this thread will know, “net interest margin” is the difference between the rate of interest a bank charges those they lend to and the rate they pay those they themselves borrow from. If banks really could create credit from thin air this concept would be meaningless as there would be no deduction from gross income.
More details here:
Even more, School of Finance and Banking do not support that conspiracy theory. Metropolitan banking officers were encouraged to obtain new customers and new depositors all the time. There is a new financial scandal on cryptocurrency
I have replied to the SPGB criticisms of my book ‘Time to get rid of Money’ and ALB asked me to continue my response on this thread. I want to respond to some specific points of criticism made about the so called magic money theory in the recent review and editorial
Firstly, that the idea of banks creating money contradicts the labour theory of value. I do not understand this argument at all as the labour theory of value relates the value of a commodity to the labour hours in its production and the monetary value ascribed to it relates to the current cost of labour, wage increases/decreases inflation, currency used, supply and demand and possibly other factors too. The monetary value therefore can vary and money is there as an exchange token to be able to the equate labour value of differing products.
In the early days of capitalism, money would have its own value from the gold, silver and copper content but this type of money has been replaced over the years so we now all money is either fiat money as cash or electronic money ( bitcoins are a different creature and not part of banking system as yet) and these 2 forms of money are pure tokens of exchange with no intrinsic value so i do not see how they can subvert the labour theory of value.
Amongst others, ALB suggests incorrectly in my view that : The thin-air theory posits that banks can create money — and so what it reflects and measures (value) — other than by labour being applied in a capitalist context to materials that originally came from nature. At most, all that banks would create would be extra tokens for money, which would only have the effect of devaluing the money unit as a standard of price (inflation). But they can’t even to do that. Only the state can.
But the creation of electronic money by the banks is clearly not the creation of value but precisely that creation of exchange tokens that is the whole point. No money today has any value in itself. This does not devalue money unless far too many loans is created which is not the norm as this is overseen by the banks and government. Even The Magic Money Myth is forced to admit: If you define bank loans … as money, then, by definition, banks “create money” whenever they make a loan; they are one and the same thing. but that is all I am arguing even if the book suggests that creating a bank loan instead ‘means creating fiat money’ – which it of course does not. Normal practice is that bank loans are of course electronic money and as ALB says: cash is only marginally used for this today. Most payments to and from banks are made electronically.
So secondly we must accept that today’s money is 3% fiat money and 97% electronic money and all bank accounts all transaction by banks eg government and bank, loans accounts, bank transfers, interbank settlements are made using electronic money. In all these accounts in which money is stored and from which these transactions are conducted all records are electronic too. Electronic accounts mean that the accounts records can only created by computer, stored on a computer and transferred by computer. There is no ‘real money’ in the system outside of fiat money and electronic money. Notes and Coins are only held in the commercial bank as stocks for the cash points and as reserves in case of runs on the bank and to support the needs of individuals for withdrawals but also as stocks.
In my book i underestimated the extent to which banks cover loans but even so when they do cover loans it is only going to by by an account containing electronic money therefore any suggestions made about loans being covered by accounts with some form of actual money or cash is completely wrong.
Thirdly here are various points to consider regarding the actual double entries of a loan onto a bank’s accounts. Even if the banks have to cover the amount they loans they make by funds contained in other accounts, they have to keep these 2 accounts separate. It is argued that deposits are used to make loans with but on the banks balance sheet these have to be kept separate. Indeed it is the case that deposits are normally used to earn interest from short term investments like the money market rather than be utilised for loans despite what is suggested by the SPGB book, the Magic Money Myth.
One important way the bank has to analyse its loan making is the Loan to Deposit Ratio which may vary between about 130% and 80% so it is not always the case that loans are less or equal to deposits. This ratio means that loans made and deposits received by the bank must be kept in separate accounts for recording purposes, they do not pay for one another. This need to keep accounts separate is why the Bank of England argues that banks create money as the loans they create are recorded in additional accounts recording whoever is the borrowing the loan and not deducted from the deposit accounts. Loans made by the bank therefore exists in addition to consumer and business deposits in banks.
When a loan is created by a bank, one side of the double entry is an asset ie a loan to be repaid, and the other is a liability account, a ‘Customer Demand Deposit’ account, from which the borrower is paid. This payment of this amount to the borrower is not made in cash, but is normally transferred electronically to the customer and also posted to the interbank settlement system which settles electronically at the end of the day. The loan remains as an asset for the bank until the loan is repaid and at that point both sides of the double entry are cancelled out and all that remains in circulation s the interest received by the bank.
So electronic money is created when a loan is made but importantly it is also deleted when the loan is repaid. This means that talk of devaluation of money is not relevant
Lastly a technical issue regarding the process involved in transferring money from one account to another. I have asked 2 computer specialists on this and both were in agreement that the transfer on computers is conducted by deleting the original amounts of money in an account and creating the same figures in a new account. It is not that a package of money is handed from one account to another as though they are some form bitcoins, it is a new creation in the new account. In the end the same process of money creation by loan is repeating with a transfer to a new accounts.
It seems to me these points are fundamental to an accurate understanding of money creation not the confused arguments used by SPGB and others about money being transferred from account to account and somehow being covered by accounts that contain ‘real money’. This is something that just does not exist today.
1. The point of whether banks’ creating money out of thin air undermines the labour theory of value is easily cleared up. New wealth (use-values) can only be created by the application of human labour power to materials that originally came from nature. Under capitalism wealth takes the form of value and is the result of the application of socially-necessary labour to materials that originally came from nature. If banks could create money from thin air (as your book endorsed) then this would be tantamount to saying that value could be created other than by the exercise of human labour power. It is not incompatible with your revised position that banks create additional money tokens (in the same way that the state can). In fact, that creating an excess of money-tokens would lead to a depreciation of the money-unit and so to a general rise in prices is based on the labour theory of value. Banks don’t create any additional value. I think we are agreed on that point (even if not that banks create additional money-tokens when they make a loan).
2. Opponents of the intermediary theory of banks (that they borrow at one rate of interest and lend at a higher) claim that its supporters argue that what banks lend has to come from “deposits” ,ie money deposited in the bank from outside. But that is not the argument. Such deposits are not the sole source of what banks have to lend. Banks can also borrow from other financial institutions or use their own capital (reserves).
So a high loan to deposit ratio (of a 100 or more) does not mean that some of what banks loan is from thin air (not that you are claiming it does). It simply means that a higher proportion comes from sources other than deposits.
The Investopedia entry on this is quite helpful in understanding this :
“ a 100% LDR means the bank is lending out as much money as it’s taking in—an aggressive strategy carrying a lot of risk. The bank lacks liquid funds to cover withdrawals or unexpected expenses. Plus, when the LDR exceeds 100%, the bank may need to borrow money to fund its lending activities, adding interest costs that cut into its profit margins.”
“As a result, a bank that borrows money to lend to its customers will typically have lower profit margins and more debt. A bank would rather use deposits to lend since the interest rates paid to depositors are far lower than the rates it would be charged for borrowing money”.https://www.investopedia.com/terms/l/loan-to-deposit-ratio.asp
3. I don’t think that banks’ accounting methods prove anything either way. In any event, as explained above, the intermediary theory does not claim that the same money deposited with a bank is directly transferred to the deposit of the person the bank is making a loan to. The claim is only that a bank cannot lend more (mainly electronic) money than it has (or can get quickly).
If we can agree on these three points then we can move on to discuss the real point at issue — when a bank makes a loan, is it creating purchasing power (in the form of electronic token money) that didn’t exist before or is it recycling already existing purchasing power? Or, if you like, can excessive bank lending cause a depreciation of the currency leading to a rise in general price level?
1. I think ALB confuses money and value. If all money is token as ALB agrees, then there is no value in it, it is just an exchange token. If money is just a token then when banks create money, as i argue, they do not create value they only create exchange tokens, as you indeed say only labour power can create value. This must surely be the same for your interpretation of money. I think this is an important point to be clarified as i do not think you are applying the labour theory of value correctly which is probably why you argue for the intermediary theory.
2. Also i accept that banks borrow money at lower interest rates than they lend money. This is clear and i am not arguing otherwise. Remember also that generally speaking deposits do not receive an interest payment. I do not see this an significant element of either theory, it is just one way banks make profits.
LDR simply suggests the loans make do not always equal deposits received and i note yr quote only says ‘the bank may need to borrow money’ suggesting it is not essential as you imply however.
3. As you say it is only a claim that ‘the bank cannot lend more money than it already has or can get quickly’. This is confusing statement as if it needs to ‘get it quickly’, then it clearly must have loaned out more than it has. It de facto created electronic money, an electronic exchange token. I use evidence in my book that the Federal Reserve in America lent out money to bailout a firm and had not source for it. There are other examples which is did not use where people working in banks admit they lend out money without making checks on what is available. If the bank does cover it by taking in loans, then it is done in arrears.
I think this point is precisely the point that when banks make loans they create purchasing power. I agree that there is oversight of this process by the banks themselves and governments and I agree it would be disruptive if too many loans were created relative to the overall economy. Isnt this in essence what happened in 2008 where debts were trading on insufficient basis
I would like to add that although i agree this discussion is not the most critical issue and certainly not a discussion between a marxist and a mon-marxist viewpoint, I do think that money and the way it is used today is an important, everyday feature of the capitalist system and when the working class takes power it will need to attack and remove quite systemically the whole financial system. The focus of my book was therefore the absurdity and unreliability of how money is used in today’s capitalist economy where the whole system is based on a belief that the state generates and maintains, and not on any real value.
“If we can agree on these three points then we can move on to discuss the real point at issue — when a bank makes a loan, is it creating purchasing power (in the form of electronic token money) that didn’t exist before or is it recycling already existing purchasing power? Or, if you like, can excessive bank lending cause a depreciation of the currency leading to a rise in general price level?”
As i say i dont disagree that excessive lending can cause problems for the economy but is that the real issue.
The point i made in my first contribution here is more important i think. When 97% of all money is electronic, then how else can it all have been created but by computer. It must have been created by the computers of the banking system whether by commercial banks or the Bank of England and each ‘creation’ means more electronic money exists than previously
Simple question, Link.
So if banks can create money at the stroke of a pen, or in modern parlance a stroke on a keyboard, did the following US banks (there are many more outside the US, but this a a sample) that went bankrupt between 2015 and 2023, not know they could create money to save themselves by the use of a computer, decided not to create money to save themselves due to incompetence or did they think for some moral or ethical reason it was “wrong” to create money with a computer to save themselves?
Citizens Bank, Sac City, Iowa 11/03/2023
Heartland Tri-State Bank, Elkhart, Kansas 07/28/2023
First Republic Bank, San Francisco 05/01/2023
Signature Bank, New York 03/12/2023
Silicon Valley Bank, Santa Clara, Calif. 03/10/2023
Almena State Bank, Almena, Kan. 1 04/23/2020
First City Bank of Florida, Fort Walton Beach, Fla. 10/16/2020
The First State Bank, Barboursville, W.Va. 04/03/2020
Ericson State Bank, Ericson, Neb. 02/14/2020
City National Bank of New Jersey, Newark 11/1/2019
Resolute Bank, Maumee, Ohio 10/25/2019
Louisa Community Bank, Louisa, Ky. 10/25/2019
The Enloe State Bank, Cooper, Texas 05/31/2019
Washington Federal Bank for Savings, Chicago 12/15/2017
The Farmers and Merchants State Bank of Argonia, 10/13/2017
Fayette County Bank, Saint Elmo, Ill. 05/26/2017
Guaranty Bank, Milwaukee 05/05/2017
First NBC Bank, New Orleans 04/28/2017
Proficio Bank, Cottonwood Heights, Utah 03/03/2017
Seaway Bank & Trust Co., Chicago 01/27/2017
Harvest Community Bank, Pennsville, N.J. 01/13/2017
Allied Bank, Mulberry, Ark. 09/23/2016
The Woodbury Banking Company, Woodbury, Ga. 08/19/2016
First CornerStone Bank, King of Prussia, Pa. 05/06/2016
Trust Company Bank, Memphis, Tenn. 04/29/2016
North Milwaukee State Bank, Milwaukee 03/11/2016Also if Banks can create money at the stroke of a key board, why do they charge interest at all. If they could create money, they could create a £1,000 then offer a loan of £1,000 to a lender who was only required the lender to repay £500, which would mean the lender got a total £500 (very nice little earner), the bank would make an initial £500 profit and end up with an eventual £1,000?
All created from nowhere, what’s not to like?
Link, before dealing with the main point at issue, of who creates new electronic money, let’s clear up the minor points.
1. Some currency cranks give the impression that banks can create new wealth out of thin air. If this were true then the labour theory of value would be invalid as that would be another source of wealth production to applying human labour to materials that originally came from nature. Your revised theory that banks create new token money though mistaken is not incompatible with the LTV any more than is the (correct) theory that states can create new money tokens. I think we are both agreed that banks can’t create any new wealth or any new value.
2. The quote from investopedia, that a bank running a loan to deposit ratio of over 100% “may” mean that it would have to borrow some of the money to lend, was not saying that such a bank would not have to cover its loans. It might also cover them by using its reserves (of accumulated capital). In practice most of the excess of loans over deposits will be covered by the bank itself borrowing money.
3. When I wrote that a bank had to have assets to cover its loans or acquire some “very quickly” I was referring to the fact that this has to be done by the end of the working day when what one bank owes another is “cleared”. If a bank is in real trouble through over-lending, to prevent collapse it will have to be “bailed out” by other banks or the central bank. That takes longer than the end of the trading day. Of course, as Bijou points out, if this doesn’t happen the bank collapses as has happened in the numerous cases he lists despite them supposedly having the power to conjure up money out of thin air.
On money as a token. That token is a claim to wealth: when a government issue a token, it has the force of violence behind it. “Use this money, or face the consequences”, hence why taxation is an essential part of issuing money.
Anyone can issue an IOU, and that IOU might circulate (if people trust you sufficiently), but for it not to be fraud, you have to be capable of making good the promise on the IOU if it ever gets called in. Of course, it is not fraud if you don’t have the goods to redeem the IOU in your pocket at the moment of its creation, if you have a reasonable expectation that you will be able to pay when the note gets called. An IOU does not transfer money from one person to the next, it transfers a claim to money.
Whilst a good solid IOU is written on paper, properly notarised, signed, counter signed and stamped, there is nothing to stop an IOU being electronic, so long as the eIOU can be validated and verified.
When a bank issues a loan they (should) carefully check that the borrower is capable of paying it back, they are creating a sort of IOU for their customer saying ‘they are capable of paying for an asset worth £X thousand.’ depending on the nature of the loan, they’re also certifying that the borrower has sufficient wherewithal to cover the loan in the event of default through cash flow issues. If anything, it would be the borrower (and their work) that creates the money, not the lending bank.
But the borrower hasn’t created the wealth yet, and needs time to realise that, which is where the bank comes in, the bank covers the IOU, to prevent it being fraudulent. But, in turn, the bank has to be good for that over the counter demand, or it is committing fraud. Only the state, which gets to define fraud, can issue money without needing to back it from elsewhere: but, of course, when a state issues unbacked currency to appropriate resources, that is a form of taxation, so even then, it is only taking from wealth already created elsewhere.
(Final wee point, in the UK many banks don’t pay interest on current accounts, but in lieu of interest they also don’t charge for services).
I suppose, as a generalisation, one can say that banks do not (and should not) loan out more money than they have in the form of deposits and what they can borrow on the money market. Exceptions may occur now and then but any exception to the rule really only work to prove the rule.
Banks that loan out more than what they have available to loan out are in danger of succumbing to a bank run – when depositors, fearful that the bank may not have the funds to cover or return their deposits, get into a panic and try to withdraw their money which then brings about the very crisis they feared. Bank runs have occurred throughout the financial history of capitalism. A recent and prominent example is the Silicon Valley Bank in 2023, the third-largest bank failure in US history which resulted from a $42 billion bank run.
It seems to me that the phenomenon of bank runs is further proof of the soundness of the view of banks as mere intermediaries in the mobilisation of capital. For banks to loan out more than they have means they face the risk of a bank run particularly today in the turbo-charged world of so called financial capitalism. The law of capitalist jungle in the form of natural selection works to ensure these aberrant forms of economic behaviour – banks loaning out more than they can loan out – are weeded out.
To be viable banks have to be sure, not only of the creditworthiness of their clients (whether the latter can pay back the principal plus interest) but also that they have the funds to cover themselves in case things go pear shaped
Conspiracy theory vs socialist logic. Conspiracy theories have been elaborated already, we do not have to do any personal elaborations
If the conspiracy theory which says that bank can make money from thin air is valid, why do most third world countries ( the south ) borrow money from the IMF ? If the central banks of those countries can issue money they can pay their loans, or they would not need to take loans, that theory goes along with the theory which says that US Reserve Bank is a private institution which is another false theory debunked by real economic conceptions
Money transfer, or money remittance make the same function as cashier check, money order, or officers check or certified check, to emit those instruments a customer deposit is required, the remittance companies that send money overseas the customer must give money to the clerk and a fee is also collected from the customer and the remittance can be delivered in different types of currencies. Real estate transactions the proceeds from both sides are made by electronic transfers, but a cash reserve is needed in order to make those transactions and the recording of both transactions is done immediately including the deed of trust, which would be the same as the old days when banks were issuing cashier checks
The US Postal Office also issues money order but the customer must first provide money or cash to the clerk in order to issue the instrument and a fee is also collected from the customer, and in some countries the Post Office had what it was called declared money value where a customer placed money inside an envelope and it was guaranteed by the post office and they collected a fee for the service, that type of service was replaced by electronically money transfer
The USA government in order to finance their operation is borrowing money from China and Japan, they do not issue money without any reserve, some countries accumulate dollars which are called divisas in order to finance their international operations, when the dollars was at par value with the currencies of several countries, banks customer used to obtain a cashier’s check in dollar by depositing their own currency or giving cash to a bank teller
In our time the labor theory of value is more actual than when Capital was written, and peoples who negate that theory are also negating the economical exploitation of the world working class, and the extraction of surplus value from the sweat of the working class, and negating that money is capital, and capital is unpaid labor, sadly some supporters of that theory, are called Marxists
The USA is losing its financial credibility because some countries and bank think that in the future they would not be able to pay their financial obligations due to the fact that they have a huge debt and would not have enough cash reserve, and part of the US budget is used in order to pay interests, why do they have to pay interests when they can emit money from thin air ?
When banks need to construct metropolitan branches, and towers for operations, or infrastructure they do not use their own cash reserve, they borrow money from others banks and they must submit a financial statement to the lenders in order to show that they are able to pay back the loans, and when a loan goes in bad debts banks create a contingency against those loans
If banks are able to produce money from the thin air, why do they fail and need state bail out ?
This is a list of most bank failures protected by the FDIC:https://www.fdic.gov/bank-failures/failed-bank-list?page=8–All these banks just need to issue money and comeback to their operations again. This is fairy tales vs reality . Anybody that does not know anything about economic, finance, business law or banking law will support that conspiracy theory .
Savings banks were separated institutions from commercial banks and they failed due to lack of depositors and money reserves and many customer withdrew their money from the savings banks and the commercial took over the savings banks, why they savings banks did not create money to recover their loss and financial insolvency ?
The pamphlet about money written by the SPGB is backed up by a very profound research and it was pretty well written and it debunks all the economic fairy tales
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