Banks Create Billions Out Of Thin Air Every Day

For Their Own Profit-Making Purposes

- Bryan Gould

The role played in our economy by the banks – and, in our case, our Australian-owned banks – is still shrouded in mystery and contention, even though their impact on our lives is huge and growing. Most people remain confused at best or totally mistaken at worst – believing as they do that the banks are simply intermediaries between savers and borrowers, and that they render a public service, for which they charge a small percentage, by lending to those wishing to buy a house money deposited with them by savers.

My own efforts to clear up the confusion concluded with the New Zealand Herald’s disappointing decision to decline to publish my rebuttal of Don Brash’s repeated attempts to deny the truth about money creation, with the consequence that he was left with the last word and that, yet again, the Establishment was able to obfuscate on a subject of huge importance to all of us. And, sadly, the Herald’s readers were left with the erroneous impression that the matter is not settled but is still one of contention.

It is little comfort that the Herald’s decision succeeded only in further damaging Don Brash’s reputation by giving him a further chance to air the errors and misapprehensions under which he seems to labour. In his various contributions, Don Brash chose repeatedly, on the central issue as to how money is created, to deny (without any evidence or countervailing argument) what is now almost universally accepted – that an individual bank, in the act of placing a credit entry in a borrower’s account, creates new money.

Failure To Understand Process Of Money Creation

This simply betrays a failure to understand the process of money creation described authoritatively in the Bank of England paper published in 2014.  As that paper says: “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”.

“For this reason,” says the Bank of England, “some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans”. The paper goes on to say that “in reality in the modern economy, commercial banks are the creators of deposit money… Rather than banks lending out deposits that are placed with them, the act of lending creates deposits -  the reverse of the sequence typically described in textbooks. Bank deposits make up the vast majority – 97% of the amount (of money) currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themselves”.

The paper’s conclusions are accepted by almost all leading economists, including Lord Adair Turner (former Chair of the Financial Services Authority in London­­­) and Professor Richard Werner of Southampton University, and by top economics journalists such as Martin Wolff of the Financial Times, and were foreshadowed (in a 2008 paper) by the Reserve Bank of New Zealand itself.

Brash sought to undermine the clarity of these statements by asking why, if the banks create money, would they bother to do anything other than write cheques to themselves? But this simply underscores his failure, or refusal, or inability, to grasp the point. The banks cannot of course write cheques to themselves - they create money by advancing credit to borrowers.

The banks do need to have capital reserves for prudential purposes, but they have no capacity to create money for this purpose. As the Bank of England explains: “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 (central) Bank”.

I had, at one point, thought that Brash’s denial that commercial banks were responsible for creating most of the money in circulation had to be either a deliberate attempt to mislead or the consequence of simple ignorance. But, since he states that he “is aware” of the Bank of England paper (and has therefore presumably read it), I can only assume that his continued denial of what that paper tells us is either a deliberate misstatement or the consequence of his intellectual limitations.

It is very frustrating that what is now a virtually undisputed truth has been continually confused by palpable errors in Brash’s contributions and that they have been lent some unjustified credibility by their publication in the Herald. It is surely time that our own Reserve Bank should come clean and say whether or not they accept and agree with the conclusions of the Bank of England.

Properly Informed Debate Needed

We could then have a properly informed debate about the policy implications of the banks’ virtually unconstrained power to create new money. For a start, here was one of our most high-profile public figures revealing that he was woefully ill-informed on a subject on which he was widely regarded as expert. He had, after all, been the country’s top banker, and that is to say nothing of his eventual emergence as a “hard Right” politician – leading first the National Party and then ACT, and only narrowly failing to become our Prime Minister in 2005.

As Governor of the Reserve Bank, he had been the principal champion and practitioner of the neo-liberal economic policies which became known as “Rogernomics”. Are we happy that our economic fortunes were entrusted to a single individual who understood so little of his subject, and that Ministers applauded themselves for their disclaimer of any responsibility for the decisions he made?

His woeful attempt to deny what is now widely accepted must cast huge doubt on the continuing legacy of “Rogernomics” in our economic policies. The whole myth of prudent economic management under neo-liberal policies must be reconsidered in the light of what we now know is the banks’ self-interested creation (or “printing”), without any let or hindrance, of billions of new money. 

The frequent condemnations from neo-liberal quarters of any suggestion that governments might “print money” (unless it is “quantitative easing”, with the purpose of bailing out the banks) must now be viewed in light of the relaxed attitude towards the banks doing precisely that – day in, day out, and on a massive scale – for their own profit-making purposes. An acknowledgment of the true role of the banks should lead us to reconsider many of the hitherto accepted nostrums in tackling economic problems. Inflation? No, not created by greedy workers claiming higher wages but by banks printing more and more money to boost their profits.

Housing Unaffordability?

No, not attributable primarily to a shortage of supply but fuelled by the bellows applied to inflating house prices by billions in new money being created out of nothing by the banks to spend on house purchase. Those many well-intentioned people attempting to explain why house prices go on rising need look no further.

And what of the constant drag on our balance of payments as a result of the transfer every year back to Australia of the billions of dollars in profits made in New Zealand by our Australian-owned banks – profits made from the interest we pay on money created out of nothing by those banks? Why do we allow such a huge transfer of wealth generated in New Zealand back across the Tasman? How did we allow this situation to develop? And should we let it continue?

Perhaps the most fundamental questions arise in respect of how long it has taken to bring the true state of affairs to public attention. Why have the media not blown the whistle long before now? Why is the revelation of the truth even now largely ignored, and even denied, by media outlets? And what of our politicians? It is perhaps to be expected that politicians on the Right might see it as in their interests to conceal and obfuscate. 

But What Of The Left?

Why do they sub-contract the supervision of the banks, with the huge impact they have on our economic circumstances, to the Reserve Bank – itself a bank whose loyalty is to the banking system - and then pat themselves on the back for ensuring that monetary policy, unlike any other area of policy, is immune from democratic control?

Are they too timid or lacking in confidence or too imbued with neo-liberal convictions themselves to challenge an orthodoxy they profess to criticise and oppose? Are they really so frightened of losing the argument that they dare not take it on? And are they so focused on winning approval from the guardians of neo-liberal orthodoxy that they are prepared, for the sake of staying in the good books of bankers and their ilk, to ignore the truth, and to fail thereby those who have no one else to defend their interests.


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