15 Mar 2014

Victory! The Bank of England admits that commerical banks create money out of thin air!

This is truly an event worth celebrating. The Bank of England has just published two articles in its Quarterly Bulletin that lay bare the truth of how the money system works. There's one called "Money in the modern economy: an introduction" which was written by Michael McLeay, Amar Radia and Ryland Thomas of the Bank's Monetary Analysis Directorate.

Try this for starters:
“Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves…  When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created…”
You can actually watch Ryland Thomas from the Bank of England, the author of the article, in a video on Youtube say the following (at 0m50s):
"Broad money... includes all the bank deposits of households and companies. And one of the key points of the article is that banks create additional broad money whenever they make a loan.  Now while this is nothing new, it is sometimes overlooked as the main way in which money is created. And it runs contrary to the view sometimes put forward that banks can only lend out deposits that they already have. In fact loans create deposits - not the other way round. "
Here's the bit where he reveals all:
video

The other paper, also by the same three authors is called "Money creation in the modern economy".
There you can find the following statements:
"Whenever a bank mades a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money.
 The reality of how money is created today differs from the description found in some economics textbooks:
  • Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits
 Later on in the article you can read:
"Broad money is made up of bank deposits - which are essentially IOUs from commercial banks and companies - and currency - mostly IOUs from the central banks. Of the two types of broad money, bank deposits make up the vast majority  - 97% of the amount currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themsleves."
 And how about this?
"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. "
 Not bad eh? Anyone out there still doubting that commercial banks can create money out of thin air?

They also make it very clear how money can be destroyed.
"Just as taking out a new loan creates new money, the repayment of bank loans destroys money.  For example, suppose a consumer has spent money in the supermarket throughout the month using a credit card. Each purchase made using the credit card will have increased the outstanding loans on the consumer's balance sheet and the deposits on the supermarket's balance sheet... If the consumer were then to pay their credit card bill in full at the end of the month, its banks bank woudl reduce the amount of deposits in the consumer's account by the value of the credit card bill, thus destroying all of the newly created money."
The Bank of England also lays to rest another long standing myth - that Central Banks can control the money supply by the so-called Money Multiplier mechanism.

“…the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks. Banks first decide how much to lend depending on the profitable lending opportunities available to them…It is these lending decisions that determine how many bank deposits are created by the banking system. The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England.”

All this is really a remarkably victory for the people at Positive Money - and they are rightly claiming some credit for progress in this area. When they started out in 2010 arguing that the vast majority of the money in the economy is created out of thin air by commercial banks, many people ignored them, saying that it couldn't possibly work that way. But they published the book "Where does Money come from?" which has now become a standard text at some universities.

And now, the Bank of England has essentially said that, yes, they were right.

Congratulations Positive Money!

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