Cooking the Books: More Hot Air About Banks

‘Shock data shows that most MPs do not know how money is created’ Guardian columnist Zoe Williams began her article (29 October). She was publicising the results of a survey of MPs by the banking reform group Positive Money which claimed that it showed that ‘85% were unaware that new money was created every time a commercial bank extended a loan, while 70% thought that only the government had the power to create new money.’

This reflects not the assumed ignorance of MPs, who actually got it right, but the confused use of the word money. This is now used to describe two different monetary phenomena. First, what in America is called ‘fiat money’, money issued by administrative decision by the state as notes and coins and electronically. Second, what used to be called ‘bank credit’, loans banks make to businesses and individuals. This is now called ‘bank money’, so banks are regarded as ‘creating money’ every time they make a loan.

This confusion misleads some into thinking that banks can create money in the same way that the state can, by a mere ‘stroke of the pen’. Williams herself wrote that ‘all money comes from a magic tree, in the sense that money is spirited from thin air’. But not all money (in the contemporary usage of the word) does, only fiat money – and that doesn’t create any new wealth, just more claims on wealth. What commercial banks lend is not ‘spirited out of thin air’. It is already existing money that they lend on from what they themselves borrow from depositors and the money market.

Bank lending certainly has the economic effect of increasing spending. It is this that gives rise to the illusion that they are ‘creating new money’. But what they are doing is making available, to those who want money to spend, the money of those who don’t want to spend theirs for the time being. This is not creating new money, only activating existing money. That’s precisely the economic role of banks and their usefulness to capitalism.

As the article (which currency cranks are always citing, though not this passage) in the March 2014 Bank of England Quarterly Bulletin puts it:

‘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). (…) The commercial bank uses the difference, or spread, between the expected return on their assets and liabilities to cover its operating costs and to make profits’.

Their business model is not based on spiriting money up from thin air and charging interest for the loan of it. That would be too good to be true. They have to have the money – or at least have to obtain it fairly quickly, as the German central bank, the Bundesbank explains:

‘The banks also keep a constant eye on the costs that may incur by granting loans and creating book money. For example, if the customer uses the new credit balance to transfer money to an account at another bank, from the bank’s point of view money will be flowing out. The bank then often has to recover this money, for example by taking out a loan from another bank, or by “refinancing” itself with a loan from the central bank. Alternatively, it can persuade savers to invest cash or credit balances at the bank in the form of savings or fixed-term deposits.’ (

In other words, in the end (if not immediately) they have to pay for what they pick from the ‘money tree’.

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