Creation of Money
Edited by David Soori
and John Courtneidge, from an article by Richard Greaves
loaned by banks is created by them out of nothing ì the
idea that all a bank does is to lend out money deposited
by other people is very misleading.
MONEY IS CREATED AS A DEBT
At the moment
we don¯t distinguish between the £25 billion in circulation
as notes and coins (issued by the government) and £680 billion
in the form of loan accounts, overdrafts etc. (created by
the banks). The
failure to distinguish is a big mistake. The notes and coins
are debt-free money, i.e. when it is printed/coined,
the government does not go into debt. But the loan accounts and
overdrafts are interest-bearing [credit]money i.e.,
you have to repay it and pay interest on top as well. Even money earned,
which does not have to be repaid, is mostly available only
because someone has borrowed it into existence.
between debt-free money and interest-bearing [credit]money
has radically changed over time. In 1948 we had £1.1
billion of notes and coins (i.e. debt-free money) and £1.2
billion of loans etc. (i.e., interest-bearing money) created
by banks. By
1963 the figures were £3 billion and £14 billion respectively.
over 95% of the new money supply comes from the banks as
interest-bearing [credit]money ì around £680 billion. Even allowing for inflation,
that¯s an enormous relative and absolute increase.
this vast amount of bank-created money come into existence?
process by which banks create money is so simple that the
mind is repelled.î
J. K. Galbraith
how it¯s done!
(This is a simplified example).
of a small bank with ten depositors/savers who have just
deposited £500 each.
The bank therefore owes them £5,000 and it has £5,000
with which to pay out what it owes.
(It will keep that £5,000 in an account at the Bank
of England ìthe contents of this account are called the
bank¯s liquid assets).
comes Sid, an entrepreneur.
He asks the bank for a £5,000 loan to set up a business.
The bank agrees the loan -
repayment in 12 months time @ 10% interest. A new bank account is
opened in Sid¯s name and, although Sid has put in no money,
he is nevertheless being allowed to withdraw and spend a
should be noted that the original depositors have not been
consulted about the loan to Sid and the reason is that their
money has not been lent to Sid.
you will say, in granting Sid his loan, the bank
has increased its obligations to £10,000 -
Sid is entitled to £5,000, and the depositors can still
claim their £5,000.
If the bank now has obligations of £10,000, then
isn¯t it insolvent because it only had £5,000 of deposits
in the first place?
answer is -
not exactly! The
bank treats the loan to Sid as an asset, not a liability,
on the basis that Sid now owes the bank £5,000. The bank¯s balance sheet
will show that it owes its depositors £5,000, and it is
now owed £5,000 by Sid.
Thus the bank has created for itself a new asset
of £5,000 in the form of a debt owed by Sid where nothing
existed before -
and this is on
top of any of the original deposits still in its
account at the Bank of England.
least for accounting purposes-
the bank is solvent!
NB. At this stage the bank
is gambling that as Sid spends his loan, the depositors
won¯t all want to withdraw their deposits! One thing, however,
is very clear -
the bank has created the [credit]money for the
£5,000 loan out of nothing.
It is new (interest-bearing, repayable) money where
none existed before.
The creation was done by the pressing of a computer
isn¯t that extraordinary?
The banks create money out of nothing (and then charge
interest on it). Yet
if you or I created money out of nothing (let alone charged
interest on it) we would be guilty of fraud, or counterfeiting
into the economy...
effectively becomes new úmoneyî as it is spent by him to
pay for equipment, rent and wages etc. in connection with
his new business.
This new úmoneyî is thus distributed to other people,
who will in turn use it to pay for goods and services. Very soon, the new money
is circulating throughout the economy and, as it circulates,
it inevitably ends up in other people¯s bank accounts.
note something - when the
new money is paid into someone¯s account which is not overdrawn,
it is a further deposit. So when Sid pays his
secretary £100 and she pays it into her account at our small
bank, the bank now has £5,100 of deposits. Moreover, if we assume
for a moment that the remaining £4,900 ends up in the accounts
of the original depositors of our hypothetical small bank,
it now has another £4,900 in deposits - £10,000
in total if the depositors have not touched their original
course, in practice much of the new £5,000 will end up in
depositors accounts at other banks, but, either way, there
is now £5,000 of new úmoneyî in circulation.
reality, all deposits with banks
and elsewhere actually come from úmoneyî originally created
out of nothing as loans ì (except where the deposits
are made in cash ì more on cash very shortly).
So you have
£500 in your bank account, the fact is someone else like
Sid went into debt to provide it!
key to the whole thing is the fact that: -
Cash withdrawals account
for only a tiny percentage of a bank¯s business.
Bank customers today make almost all payments between
themselves by cheque, switchcard, direct debit or
electronic transfer etc. Their individual accounts
are adjusted accordingly by changing a few figures
in computer databases ì just book-keeping
entries. No actual money/cash changes
hands. The whole thing is basically an accounting
process that takes place within the banking system.
ROLE OF CASH
is responsible for the production of cash in the form of
notes and coins. These are then issued by the Bank
of England to the high street banks - the banks buy them
at face value from the government to meet their customers¯
demands for cash. The banks must pay for this
cash and they do so out of what they have in the accounts
which they hold at the Bank of England ì their liquid assets.
Their accounts are debited accordingly.
(through the Treasury) also keeps an account at the Bank
of England which is credited with the face value of the
notes and coins as they are paid for by the banks.
(This is now money in the public purse available for spending
on public services etc.)
how all banks acquire their stocks of notes and coins, but the cash a bank can
buy is limited to the amount it holds in its account at
the Bank of England ì its liquid assets.
cash is withdrawn by banks¯ customers, it enters circulation
in the economy. Unlike bank created loans etc, cash
is interest-free and debt-free and can circulate indefinitely.
CASH PAYMENTS - Book keeping entries
little cash being withdrawn, and from experience knowing
that large amounts of deposits remain untouched by depositors
for reasonable periods of time, banks just hope that their
liquid assets will be sufficient to enable them to buy up
the cash necessary to meet the relatively very small amounts
of cash that are normally withdrawn.
A bank has
serious problems if demands for cash withdrawals by depositors
(and, indeed, borrowers who want to draw some of their loans
in cash) exceed what the bank holds in its account at the
Bank of England.
it would probably try to get a loan itself from the Bank
of England or another bank, to tide itself over. Failing
that, it would have to call in some loans and seize the
property of borrowers unable to pay.
CLAIMS AGAINST BANKS ò
have made a deposit at the bank (in cash or by cheque),
all you then have is a claim against the
bank for the amount in your account. You are simply
an unsecured creditor. Your bank statement is a record
of how much the bank owes you. (If you are overdrawn,
it is a record of what you owe the bank). The bank
will pay you what it owes you by allowing you to withdraw
cash, provided it has sufficient cash to do so.
are trying to withdraw too much cash, there is a run on
the bank, which will soon refuse further withdrawals.
So it¯s a case of First Come, First Served!
want to make a payment by cheque, this is less likely to
be a problem ì you are simply transferring part of your
claim against the bank to someone else ì the person to whom
your cheque is payable - just a book-keeping entry.
If the person
to whom your cheque is payable has an account at the same
bank as you do, the deposit stays with that bank ì overall
the bank is in exactly the same position as it was before.
If I give
you a cheque for £50 ì and we both have accounts in credit
at Barclays ì what Barclays owes me is reduced by £50, and
what Barclays owes you increases by £50. But nothing
has left Barclays ì the total deposits or claims against
Barclays remain the sameò
BANKS¯ CLAIMS AGAINST EACH OTHER
.BUT if you keep your
account at Lloyds, deposits at Barclays are reduced by £50,
whilst deposits at Lloyds increase by £50.
of transactions like this take place every day between customers
of the various banks, using switch cards, direct debits,
electronic transfers as well as cheques ì deposits are therefore
constantly moving between the banks.
cheques and electronic transfers pass through a central
clearing house (which is why we refer to a cheque being
úclearedî). The transactions are set off against one
another, but at the end of each day, a relatively small
balance will always be owed by one bank to another.
A bank must
always be ready to settle such debts. To do this,
it makes a payment from its account at the Bank of England
to the creditor bank¯s account at the Bank of England.
Thus a bank
faces claims from two sources (which
it meets out of its liquid assets) ì its customers wanting
cash, and other banks when it has a clearing house debt
the banks are faced with big demands for cash at the same
time, the banking system as a whole is safe, although an
is vulnerable, should a large number of depositors for some
reason withdraw their deposits in cash or transfer their
deposits to other banks.
We now see
how today the whole system is basically a book-keeping exercise
where millions of claims pass between the banks and their
borrowers and depositors every day with relatively very
little real money or cash changing hands ì backed by tiny
reserves of liquid assets.
is known as FRACTIONAL RESERVE BANKING
and banks are sometimes accurately referred to as dealers
Bank¯s 1999 accounts illustrate the whole thing very well
- it had loans of £217 billion owing to it; and it owed
£191 billion to its depositors ì backed by just £2.2 billion
in liquid assets!
level of lending is geared to the amount of cash it has
or can buy up ì its liquid assets - rather than the amount
of its customers¯ deposits.
But if a bank can
attract customers deposits from other banks, it will add
to its liquid assets, as other banks settle the resulting
clearing house debts in its favour ì hence there is tremendous
competition between banks to attract deposits.
ò. = Big Profits for the bank...
return to Sid who has to pay our small bank 10% interest
on his loan i.e., 10% of £5,000 = £500. These interest
payments are money coming into the bank, they are profits
and they end up in its account at the Bank of England -
additional liquid assets for
now has an extra £500 to meet its
depositors¯ withdrawals. If Sid manages to repay the
original loan as well, it will have an extra £5,500!
So our bank
created for itself out of nothing an asset of £5,000 in
the form of a loan to Sid. It is no longer owed anything
by Sid, but in repaying his loan with interest, Sid turned
a mere debt into £5,500 of liquid assets for the bank ì
a tidy profit for the bankò. and the basis on
which more loans can be made!
therefore not be surprised to learn that banks today create
loans 100 times or more
in excess of their liquid assets ì see above Barclays
Bank¯s 1999 accounts
bank will soon be making many more loans. In this way, the
deposits it receives back will increase and so will interest
payments and therefore profits. With more loans and
more deposits, there will be a greater demand to withdraw
cash ì but increasing profits means more cash can
bought by the bank. (This is how the amount of cash
in circulation has been increasing to reach
£25 billion by 1997.)
it is a myth to think that when you borrow money from
a bank, you are borrowing money that other people have deposited.
You are not ì you are borrowing the bank¯s
money which it created out of
nothing and made available to you in the form of a loan.
More debt for the rest of us...
Sid¯s interest payments and any repayment of the loan itself
to the bank means that this úmoneyî is no longer circulating
in the economy. Indeed, any payment into an overdrawn
account reduces that overdraft but it also operates as a
repayment to the bank and the repaid úmoneyî is lost
to the economy.
more money must be lent out to keep the economy going!
If people don¯t borrow or banks don¯t lend, there will be
a fall in the amount of money circulating, resulting in
a reduction in buying and selling ì a recession, slump or
total collapse will follow depending on how severe the shortage
in bank created loans over the years is additional conclusive
proof that banks do create úmoneyî out of nothing ì £1.2
billion in 1948; up to £14 billion by 1963; and up to £680
billion by 1997.
supply of notes and coins, after taking inflation into account,
has similar buying power to the supply in 1948 (£1.1 billion)
but since then, there has been a ten fold plus increase
in real terms in money supply made up of credit created
have enabled the economy to expand enormously, and as a
result living standards for many people may have improved
substantially...ì but it has all been done on borrowed money!
What is credit to the bank, is debt to the rest of us.
banks are acquiring an ever increasing stake in our land,
housing and other assets through the indebtedness of individuals,
industry, agriculture, services and government ì to the
extent that Britain and the world are today effectively
owned by them.
The Cash Illusion
Borrowers think that when they
get a loan from the bank they can, if they wish, take
the loan in the form of cash (coins and bank notes).
This then leads them to think that, in borrowing,
they are really borrowing somebody else's money, when
they are not.
The truth is, of course, that if everyone took their
loan in cash, it would have to be rationed ì
only about three pounds out of every hundred
could be in the form of notes and coins.