2020s >> 2022 >> no-1417-september-2022

Cooking the Books 2 – Can banks create wealth?

Those who believe that a bank’s business model is to create money out of thin air, lend it at interest, and make a profit as the difference between the interest they receive and their running costs, must have been mystified by an article in the Times (6 July) which reported:

‘The Bank of England has warned the City against making ‘excessive’ cuts in lending to households and businesses as the economy slows because of the risks of exacerbating a downturn.’

If banks make loans out of thin air, why would they cut back on lending? One reason, compatible with this belief, might be an absence of credit-worthy borrowers; although it wouldn’t cost the banks anything to conjure up the money to make a loan, it would be pretty pointless if the loan wasn’t to bring in any interest.

This already shows that bank lending (whatever the source of the money to lend) depends on the state of the economy. If this is contracting there is less opportunity to make loans (even out of thin air). On the other hand, if it is expanding there is an incentive to make more loans. This suggests that theories that a boom is caused by banks lending too much put the cart before the horse. Bank lending depends on the state of the economy, not the other way round.

Ignoring for the moment where the money for a bank loan comes from, what is the source of the interest? With big loans to capitalist enterprises to invest in expanding their business, the interest comes out of their profits. As these profits come from the unpaid labour of workers, the source of the interest is human work. Smaller loans are given to individuals, such as to buy a house. Here the interest is paid out of their wages but, since wages are a share (the paid share) of what workers produce, in this case too the source of the interest is human work.

The belief that banks create money out of thin air assumes that banks can create wealth by a few keyboard strokes. If that were true it would indeed be amazing, on a par with alchemy let alone magic. It might be said that what banks create from nothing is a claim on wealth. But that doesn’t hold water either. That claim would be transferred to the borrower. As soon as the borrower uses the claim to actually acquire wealth by buying something, the bank has to honour it; it has to produce a corresponding amount to transfer to the person or business that the borrower used the loan to buy something from. These won’t be satisfied with thin air. They will want the real thing. The bank will either have to have the money already or get it fairly quickly. In other words, it is already existing money that is the source of what banks lend, which will be the monetary representation of actual wealth produced by human work in the past.

Banks are not financial alchemists but intermediaries between those with money they don’t want to spend for the time being and those without money who want to spend some. This is why the banks are wary of lending when the economy is contracting. If they lend to people or businesses that may not be able to pay it back, they risk losing not just the interest but also the money they lent.

The Bank of England can no more cajole banks into lending money when the economy is contracting than they can to lend less when it is expanding. Not that that stops them trying.


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