Prof Steve Keen of Kingston University drew my attention to an article by Nobel Laureate Prof Jospeh Stiglitz in which he writes about the current malaise in the world economy.
Much of what Stiglitz writes in that commentary is sound, appropriate and to be agreed with. Unfortunately, this but is staggeringly wrong:
While our banks are back to a reasonable state of health, they have demonstrated that they are not fit to fulfill their purpose. They excel in exploitation and market manipulation; but they have failed in their essential function of intermediation. Between long-term savers (for example, sovereign wealth funds and those saving for retirement) and long-term investment in infrastructure stands our short-sighted and dysfunctional financial sector.
Former US Federal Reserve Board Chairman Ben Bernanke once said that the world is suffering from a “savings glut.” That might have been the case had the best use of the world's savings been investing in shoddy homes in the Nevada desert. But in the real world, there is a shortage of funds; even projects with high social returns often can't get financing.
The only cure for the world's malaise is an increase in aggregate demand. Far-reaching redistribution of income would help, as would deep reform of our financial system — not just to prevent it from imposing harm on the rest of us, but also to get banks and other financial institutions to do what they are supposed to do: match long-term savings to long-term investment needs.
As the Bank of England conceded in April 2014, the idea that banks act as intermediaries between savers and investors is just wrong. The fact that economics textbooks and economists still say they do does not, they argue, make that true: it just means that the textbooks and economists in question are wrong, they say. Which makes it all the more surprising and even shocking that here is one of the world's leading economists making what should now be seen as an elementary error.
The reality is that banks technically do not need any deposits to make a loan: all money is created out of thin air through the process of money creation that occurs in the lending process. And money is cancelled by the repayment process. In that case banks do not allocate savers money to investment when they make loans: they create new money to provide to investors, and they have not been willing to do that.
The relationship between deposits and investment is much more remote and complex in that case. Effectively deposit taking is a service utterly distinct from lending although historically undertaken by the same institutions. What the deposit taking does provide is capital to underpin risk at very low cost. That is because money deposited in banks ceases to be the property of the depositor: it becomes the property of the bank. What the depositor is left with is a loan to a bank that may, or may not be repaid (hence the bank deposit protection schemes that would not, otherwise, be needed). So the cash deposited then becomes the bank's risk capital in the event that they make poor lending decisions (as was seen in the case of Northern Rock). But that capital is a buffer to the bank, and not a source of funds for lending.
It is vital that these distinctions are understood now because if not serious policy errors and blame result, and we cannot afford to do that again.
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This is just another example of the failure to confront the lies and misinfomation being peddled by centre-right governing politicians and compliant policy-makers who are ably assisted by much of the media and the commentariat with both groups in thrall to the corporate capitalist elites and high wealth individuals. (It might also be that Prof. Stiglitz, despite his undoubted competence and knowledge, feels compelled to pronounce on matters that are quite a bit removed from the specific area in which he won his Nobel.) But it is dismaying when those whose pronouncements have some impact on the public policy debate treat post hoc accounting identities as being causal relationships. This gives centre-right politicians free rein to further distort and manipulate the public policy debate.
It would also be interesting to know how many of the other six members of Labour’s economic advisory cttee share Prof. Stiglitz’s erroneous views. This probably doesn’t matter hugely, because I doubt they will have much impact on the policies formulated and advanced by the shadow chancellor and his team. The irony, of course, is that his ideological predispositions are likely to lead him to accept the advice they offer which is based on erroneous assumptions and analysis (such as the above) and to ignore more soundly-based advice. But, again, this probably doesn’t matter hugely because Labour is unelectable for the foreseeable future.
What most people on the left-wing side of the house seem to forget or ignore is that the Tories and UKIP together received 50% of the votes case in May’s general election. While UKIP drew support from all parties there can be no doubt that many UKIP voters in May were former Tory voters. There is now a ‘conservative’ majority. Vague hopes of a currently disenfranchised mass that would vote for Labour if they were registered to vote are just that – vague hopes.
The only hope for Labour is that it might secure popular consent to govern by default in the event of the Tories’ false, but popularly preceived, governance competence being shredded by a vicious internal split over the EU referendum, a popular majority in favour of an EU exit and a major economic downturn. But these are outcomes I would not wish for.
In the meantime all that can be done is to continue chipping away at the false and damaging premises of current economic policy and to hope that Labour will eventually return from this period outside.
The claim that Labour is unelectable is another of those lies
Are you part of the solution or just another part of the problem?
Richard-I think Paul is right to point out that there has hardly yet been any significant challenging of the language framework of Austerity/book balancing nonsense fromm Labour-on the contrary more ‘Tory-Lite’ confirmations of it from McDonell. And theyu are doing zilch to get the public educated about the realities of bank money creation-as I’ve said before, either they are keeping their powder dry or they are, as yet, too consumed by internal nonsense which could take years to clear up.
In the meantime our citizens get let down again and start moving to to utterly bogus parties like UKIP
Thank you, Simon. Unfortunately in May, a majority of voters succumbed either to the playing on fears and concerns and encouragement of loathing of ‘people not like us’ propagated by UKIP or to the more subtle variation of these perfected by the newly enobled Lynton Crosbie accompanied by a naked appeal to personal greed. Unsurprisingly, not enough voters were convinced by the senior representatives of Labour’s Spadocracy (the principal governance legacy of the Blair/Brown years). And, again, it is not surprising that the Spadocracy is bitterly opposing the Corbynista reverse takeover and that the Corbyn faction is seeking to seize control of the party machine to neutralise the Spadocracy. However much those involved may seek to conceal it, there is a civil war within the party. And while this remains unresolved most voters when considering the party as an alternative government will rightly conclude that if it can’t govern its own affairs effectively it is not fit to govern the country.
The galling thing is that there is a compelling economic policy narrative to which both sides should be able to subscribe – and which could be developed from the so-called Corbynomics advanced during the leadership election campaign. But each side has become entrenched in pre-existing largely non-economic positions and there has been no real effort to tackle Osborne’s economic policy lunacy – apart from the u-turn on supporting Osborne’s fiscal charter and the flinging of Mao’s little red book across the despatch box.
Richard, the Labour Party is currently unelectable. This doesn’t imply that many of its policies are unpopular with a large swathe of the voting public – but it does mean that its ability to communicate them to enough people to win an election within the available 4+ years against one of the most politically astute cabals since Tony Blair won his first election, is against all reasonable odds at this stage of the game.
Aside from ‘image’ (a factor not to be underestimated with the English voter)the almost insurmountable hurdle is to persuade enough people to ‘unlearn’ the household budget analogy. I spent several hours trying to get my head around – unsuccessfully – a recent post by Prof. L Randall Wray (for anyone interested: http://neweconomicperspectives.org/2015/12/debt-free-money-banana-republics-part-two.html#more-9844). Phew! It was hard work. The responses are as interesting as the article itself. It seems I’m not alone in my confusion.
My background is not in finance or economics but in consumer marketing. Hence I’m confident in repeating that to communicate successfully to an increasingly ‘dumbed-down’ audience even the basics of fiat money creation and debt is a Herculean task of depressing proportions that no professional communicator would willingly undertake. Even Stiglitz makes basic errors! And a well-intentioned popularist attempt by Positive Money has scarcely caused a ripple in the so-called ‘real world’.
Within the available time-scale, the only chance for the LP to increase its popular influence significantly is on the back of a catastrophic failure by the incumbent neo-cons. We know they can’t deliver what they have promised but they will conjure up enough (expensive) BandAid to prolong the impending crash and, with the invaluable help of the MSM, will still get away with their Crosby-inspired mantra that however bad it is in 2020 it will be worse under Labour.
The problem facing progressives is that we don’t wish any additional pain on the electorate in order to win – but it may just be necessary. As I have suggested previously, it is going to be a long, arduous campaign with many unforseen set-backs. Of course, pessimism isn’t an option but realism is. Like you I’m not a member of the LP and have never voted for it. It would seem that the only feasible strategy is somehow or other to bring progressive forces together with a simple, realistic agenda to be shaped into a more preferable and digestible alternative that can be ‘understood’ by enough of the 2/3rds of the voters who are up for grabs.
Personally I’m not too impressed by the leadership qualities of the opposition cabinet but, unlike you, have never had the opportunity of meeting them personally. Hopefully they are better than I assume. But however competent they may be, the economic education task is a massive problem. Which is why they may shy away from it and we’ll end up yet again with another Tory-lite alternative. It’s worth repeating Antonio Gramsci’s famous quote: “I’m a pessimist because of intelligence, but an optimist because of will.”
Thanks for your time. A Happy New Year to you and all your readers!
The first para suggests that “sovereign wealth funds and those saving for retirement” (a euphemism for pension funds?) need banks as intermediaries when making investments. My contact with companies in the infrastructure business suggests that pension funds (amongst others) invest directly in projects & certainly do not need banks as intermediaries (although they may also be investing in the same project).
It does make you wonder how this fundamental error may have affected Stiglitz’ thinking in other, related areas.
It is truly a sad state of affairs when (some of) the world’s so called economic experts seem not to understand the basics of money creation, fractional reserve banking and debt.
How on earth is the general public supposed to believe anything from any economists without firstly asking them to pass a basic test in reality? And these so called experts are teaching our children and get airtime in the national press and TV!
This is like Steven Hawking writing that the sun is a giant ball of burning coal (as per mainstream Physics text books read by students) whilst other ‘Post-Einsteinians’ (who never get listened to) have shown for decades that its actually powered by something else altogether – nuclear fusion.
Of course that could only happen if physicists tore up the very essence of all science – observation & reasoning.
Economics is a disgrace.
I would not say the economics is a disgrace, but it is certainly not physics! Physics is relatively straightforward by comparison. Physics has laws that remain the same whereas in economics even things that we thought we understood can morph into something new. I have read quite a bit on money, on how it is created and destroyed, but I am still not sure that I could decide what is the right thing to do next because as soon as we start to do something different the rules change again and the outcome is unpredictable.
Agree that being a man-made abstraction, the ‘laws’ of economics can change unlike the physical world, which, in the main, are immutable – I’ll leave out what goes at the centre of black holes for now! 🙂
But a Nobel Prize winner not knowing that his understanding of how banks work is at the ‘noddy’ story level? And the whole profession (well the orthodox bit) similarly being believing a ‘noddy’ story about how and why money arose in ancient societies?
In both cases it takes only a teeny bit of credulity and introspection to go and double check by, I don’t know, asking experts who might actually have a LITTLE practical knowledge of those things (accountants for the former, anthropologists for the latter). There are many, many other examples of economists ignoring the real world. Why do they do it?
If I may quote heterodox economist Steven Hail here…
OK, so point taken on money creation versus financial intermediation in commercial banking — as the Bank of England spelt out in its 2014 article.
But Stiglitz says (here I paraphrase rather than directly quote):
– The only cure for the world’s malaise is an increase in aggregate demand. Redistribution of income would help as would financial reform…to get banks and other financial institutions to do what they are supposed to do, match savings to long-term investment needs. –
So he may be mistaken in saying that the (commercial) banks’ role is one of intermediation, but he adds “other financial institutions” and here I think he is correct. I’m open to correction / debate, but in my opinion the financial system spectacularly fails to match savings with long-term productive investment.
Too much capital is allocated to short-term or speculative projects / trades and towards unproductive assets such as existing real estate. At least Stiglitz acknowledges the role of the financial system in matching savings and investment, and the likes of Keynes (regardless of whether he was right or wrong on the role of banks) were right to criticise Classical Economics for attributing virtually no importance to this. Irrationality, herding, momentum etc. all drive financial behaviour, and current bank regulations, indexation and benchmarks in asset management, offers of illusory liquidity by asset managers, bonus arrangements etc. all exacerbate these problems. I worry that Solvency II will do the same to insurers.
Isn’t it really nitpicking to highlight Stiglitz’s comment on banks as intermediaries? It doesn’t change the thrust of his argument.
On other institutions e.g. Pension funds and life assurance etc he is correct
But getting banks wrong was a massive error and cannot go unnoticed
Richard
I would be very grateful if could clarify one or two questions I have; I cannot find satisfactory answers in the literature anywhere:
It is often stated that Commercial Bank Deposits make up 97% of money in circulation and that this money is created as result of the bank lending process and cancelled by the repayment process. The remaining 3% is made up of Central Bank Reserves in the form of notes and coins. It is also stated that when the Government spends it creates money and that when it taxes money is cancelled.
Thus, if we were to take a snap shot of the money in the economy, would it be accurate to assert that the 97% of Commercial Bank Deposits comprises money created via the Commercial Bank lending process and via Government spending? If this is not a correct assertion, then what is the result of Government spending? Where does the money go and what form does it take?
(I assume that when the Government spends it does so by creating Central Bank Reserves at The Bank of England that wend their way on to the balance sheets of Commercial Banks. The Commercial Bank then creates a deposit in the payees account. Conversely, when taxes are owed the Commercial Bank deposit is cancelled and the Commercial Bank transfers Central Bank Reserves to the Government’s account at the BOE, where they are then cancelled.)
Gratefully,
Richard Tye
Richard
I would love to have the time to do that right now but haven’;t
Anyone else?
Richard
When govts spend in excess of tax revenues they will issue govt bonds, which are sometimes referred to as pseudo-money because they perform a monetary function in the wholesale cash markets.
Actually it is hard to define how much “money” is in circulation at any moment because there are many different things that are classified ad money but are all slightly different. Eg notes and coins, commercial bank call deposits, term deposits, central bank settlement funds, government bonds, etc.
Gov’t bonds are not pseudo money: as they perform a monetary function (and repo would not exist without them and markets would just about collapse as a consequence) it is wise to consider them money itself
They underpin ‘bank money’ which is why George Osborne is also so unwise to try to restrict their creation
Richard,
I had exactly the same issue with the ‘97%/3%’ figure.
Firstly, as you say, it doesn’t make sense that government-created money has exactly zero impact on our bank accounts (after all what would be the point of spending it in the first place if it didn’t show up in the one place where employee’s/contractor’s get their income?). Secondly the 97% figure is pushed incessantly by the Positive Money campaign (as it suits their thesis that money-creation by private banks is a bad thing). PM are wrong, but that’s a discussion for another day.
Anyway my one nagging concern was that the BoE itself validated PM’s 97% assertion, which they’ve been pushing for years, in a BoE quarterly Bulletin in 2014.
Eventually I found the answer via a discussion with MMT economist Steven Hail on his blog. See here…
https://www.facebook.com/green.modernmoneytheoryandpractice/posts/931150753634735?comment_id=931247443625066
Basically what happens is that NET (i.e after tax) UK government spending is ‘soaked up’ out of UK private bank accounts by bond (aka gilt) sales to the non-banking sector (e.g. pension funds). With the associated reserves shifting out of commercial bank’s accounts at the BoE into the UK Treasury’s account at the BoE.
As a result of using net figures and not absolute ones, it LOOKS as if 0% of ‘bank money’ is due to government-money creation, even although every year many billions of ‘government’ money still pour into UK private bank accounts.
PM were right all along, but only in a technical final accounting sense as the ‘97%’ figure hides a mammoth amount of economic activity that would never happen if it weren’t for government spending.
As Steven said the important point about those bonds is they are still a ‘net financial asset’ to the non-government sector. Neither private banks nor anyone else can create net financial assets as, within the system, all private bank loans net to zero. Only the currency issuer – the government – can provide our actual ‘savings’. All 100% of it.
All money is ultimately government created
I have concerns about the PM analysis
But, I agree with them that 97% of all money is not notes and coins
Thanks Steven. I’m beginning to piece it together. It’s obvious to say it, but I think it is vitally important to formulate an accurate description of how the system operates; after all, it is a description of reality and should not be beyond us. Thereafter, we can move on to the political aspects, have a proper debate and undermine the rhetoric of the political, media and elite classes.
Apologies, I did of course mean: thanks Stephen.
Richard Tye @January 5 2016 at 4:57 pm
Absolutely!
I’d be interested to learn what your concerns with Positive Money’s analysis are.
When the Nationwide gave me a mortgage, they weren’t redeploying Mrs Brady’s savings – they created that money and that debt from nothing. So the bank is not an intermediary, agreed. But in what sense is my mortgage ‘money’ ultimately government created?
In response to Stephen – ”all private bank loans net to zero” – what about the interest?
Unless the Nationwide had credit with the BoE it’s promise would be worthless
So it’s promises are government backed
“Richard Murphy says: January 5 2016 at 2:58 pm
All money is ultimately government created”
Bitcoin was not government created.
Nor were the various ‘local’ currencies such as the Bristol pound.
Regards
Pardeep
Bitcoin is not money
The Bristol pound converts 1 for 1 with sterling
That’s the only reason it has value, like all things claiming to be sterling money
It is that promise to pay backed by central reserves at the BoE that makes bank money viable
Jim Green @January 6 2016 at 8:23 am,
That interest payments are a ‘Treadmill of Debt’ is a common misconception.
They don’t disappear into some black hole never to be seen again, but instead, like any other industry’s income stream, are spent back into the economy.
As one wag put it: interest is the wages of bankers, profit is the wages of capitalists.
By the way the Nationwide creating money for your mortgage is only half the story. You too simultaneously created money ‘from nothing’ to exactly the same amount and handed that over to the Nationwide (aka as the loan agreement). There’s nothing magical going on here. You and the Nationwide swapped IOUs, thats all. At that exact moment of the transaction both parties liabilities & assets net to zero. And, in aggregate, all such private money creation nets to zero.
Well put
Stephen et al:
Isn’t the nub of the matter:
1) All Government spending IS a net asset therefore real money creation
2) Bank loans create ‘horizontal’ (endogenous) money and are NOT net assets as there is a corresponding liability along with the asset.
3) MMT disagrees with Positive Money as a figure of 97% can’t be claimed as sovereign money creation as its happening every time the Government spends
4) Government spending is NOT transfers of TAX money therefore it is a net asset not the spending of ‘revenue’.
5) As Richard says, all money is Government created with the horizontal ‘bit’ recycling in the non-Government sector.
6) There is no restraint on the spending of a currency issuing Government other than resources and inflation.
Simon @January 6 2016 at 5:52 pm
1) Agree that government spending is indeed a net asset, however I’m not expert enough to judge if that money is ‘real’.
However, being High Powered Money (HPM), it is acceptable to one and all. Unlike ‘private bank’ money, which is only acceptable to the individual bank that created it.
2) Agree
3) It turns out that MMTers don’t disagree with the 97% figure, but they at least are honest enough to explain we only get that number by calculating NET money created (which, because the government’s net expenditure is ‘nulled out’ by bond sales, makes it look like 0% of the net increase in our bank accounts is due to government money creation). PM dishonestly never explain that, because it doesn’t fit their scare story that only banks create money.
4) Agree
5) Again, am not expert enough, but perhaps Richard’s point is that if all private sector money nets to zero and only government money (including bonds, which are just money that bear interest) net to a +ve number, then only government can truly create money?
6) Agree
Only the Treasury can increase or decrease the “financial assets” in the private sector economy, by deficit spending and taxation respectively, not the central bank. The Treasury can spend its own currency whenever it wants, it is the currency ISSUER. The trick is not to allow too much spending that pushes the private sector beyond its capacity to supply; creating inflation.
When the government spends, it always spends new “money” (ie units of accounting it calls “reserves”, not real money as you think of it), NOT recycled taxes. Think of it as the government spending twice. When it keyboards your pension into your current account, it keyboards the same amount into your banks “reserves” account at the BoE to keep your Banks balance sheet, balanced. All out of thin air, every time.
BTW. The government does not have to borrow its own money. Gilts are trad-able risk free savings certificates, they are not used to fund government spending. Likewise, taxes don’t pay for anything. Taxes disappear back into thin air, from whence they came, the moment they get back to the Treasury via HMRC etc.
Those two parts float around the economy going from bank to bank until the Treasury grabs both of them back as taxes. When the two parts are reunited on the screen, that was attached to the keyboard that created the two parts originally, they vaporise back into thin air, from whence they came. The only trace of there existence is in the “real” assets they created during there FIAT lifetime, transaction by transaction by transaction.
I can withdraw my pension as cash from an ATM and my banks current account at the BoE will drop by the cash amount during settlement. I take my cash to another bank and open a deposit account, for instance, and put my cash in. This new bank will have its reserve account at the BoE, topped up with that cash amount. The monetary base (MB), that is cash and reserves, has not changed through out the process.
I could have done the same with a cheque drawn on my bank and deposited in another bank. In that case when the cheque clears the exact equivalent “reserve” at the BoE will move from my bank to the new bank. Reserves are not spent, they are used to settle accounts between clearing Banks who may lend and borrow them as required, inside the central bank. They don’t exist outside of the central bank system, so commercial banks can’t lend them to retail borrowers. There is no “money multiplier” of reserves into “money supply M2 / M3”. There is no lending of retail deposits into money supply either banks hold it as bank capital.
If my bank is short (long) of reserves it will borrow (lend) them. The BoE likes that to happen around its target interest rate; which can be any rate it wants, positive or negative. It will drain or supply the reserves level by selling or buying government Bonds to keep that rate. Or, as it does now, pay interest on reserves because QE has created a lot of reserves, which would normally force the overnight interbank rate rate to zero; no clearing bank will want to borrow that much.
There is about £75 billion in cash and £325 billion in “reserves” at the moment. Private sector banks’ loans (credit, not cash or reserves) is about £2,300 billion. Have a look at Bankstats. http://www.bankofengland.co.uk/statistics/Pages/bankstats/current/default.aspx QE has messed up a lot of historic ratios.
Thanks acorn…
Currency is created when Parliament orders the Treasury to spend. The Treasury then, through the central bank, credits the reserge accounts of the appropriate banks which the credit the deposit accounts of the appropriate account holders. The 97% of money in circulation (this figure does not include the reserves) is thus created by a) public spending and b) me taking out a bank loan to finance a 2013 Avalanche.
It would be really useful if the opposition got itself educated in how our fiat money system actually works. It would be a lot easier to rebut “austerity” in the UK and the EU.
May I suggest a read of “A General Analytical Framework for the Analysis of Currencies and Other Commodities”. http://www.epicoalition.org/docs/general2.htm It was written at the time of the Asian crisis. It describes the basics of “money” systems. Particularly the difference between vertical money the sovereign currency issuer provides (Treasury), and horizontal money (Credit)that commercial banks provide. Both are created from thin air. The sovereign (Treasury) currency “issuer” is unconstrained in how much it creates in theory, the currency “using” commercial banks are constrained only by capital equity and how far it is allowed to leverage that capital to risky borrowers.
Richard, have there been any real world experiments to prove conclusively of how banking works apart from Prof. Richard Werner’s? –
1)From his 2014 paper, Can banks individually create money out of nothing? – The theories and the empirical evidence (http://www.sciencedirect.com/science/article/pii/S1057521914001070)- “The evidence is not as easily interpreted as may have been desired, since in practice it is not possible to stop all other bank transactions that may be initiated by bank customers (who are nowadays able to implement transactions via internet banking even on holidays). But the available accounting data cannot be reconciled with the fractional reserve and the financial intermediation hypotheses of banking.” This one only proves that fractional reserve and financial intermediation are incorrect. But doesn’t conclusively prove the endogenous money theory
2)His 2015 paper – Werner, R.A., A lost century in economics: Three theories of banking and the conclusive evidence,International Review of Financial Analysis (2015),http://dx.doi.org/10.1016/j.irfa.2015.08.014
No
But it is now accepted fact by central bankers
It would also be interesting to know whether any commercial bank (or central bank) has ever been audited in full including accounting correctly for any shadow banking/derivatives/securitised debt obligations?
I have a feeling that a full account of most large banks would show they are still deeply insolvent, but that is just a hunch as I doubt their own published accounts represent the true picture of their assets and liabilities.
The UK government should have done this with RBS and Lloyds, but if they did I am yet to be convinced the true story was ever made public. Does anyone have any other views/evidence on this?
I have worked with those who suggest that IFRS can never result in a bank producing accounts showing a true and fair view, which I am convinced is true
That’s worrying. Because isn’t it then the same as accepting the fractional reserve or intermediation theory?
In what way?
Argh darn! That comment got placed in the wrong place. It was supposed to be in reply to your comment – “No
But it is now accepted fact by central bankers”
“…the idea that banks act as intermediaries between savers and investors is just wrong.”
Stiglitz did not actually say this. He (correctly) said that banks intermediate between savers and borrowers. He used clumsy wording “long-term investment” to represent those who would borrow for such purposes.
It is true that banks do not need to source funds or deposits before they make loans, but that doesn’t mean they are not intermediating. It just means that the intermediation might flow the other way. They lend money first then find the “savers” afterwards. (Actually it is a continual process).
But overall it is still an intermediation between savers (who will then hold their savings in the form of financial assets issued by the bank (bonds, deposits, etc) and those who need to borrow money for a business opportunity in the real economy.
Why use a term used to incorrectly describe banking as a term to describe what banking actually does?
Sorry: I simply think you are using semantics to cover a very obvious error
Banks do not intermediate. Full stop
Intermediation is simply standing between two parties (or sets of parties) and co-ordinating an exchange. This is exactly what banks do. The fact that some academic economists developed incorrect theories about how this intermediation operates does not mean that it is not actually intermediation.
You’ve said in the post that Stiglitz was staggeringly wrong about something, and then above that there is an “obvious error”? What is this staggeringly wrong and obvious error? Simply the use of the term “intermediation”?
Yes, when a loan is made two accounts are created:
1) loan account (asset to the bank, liability to the borrower)
2) deposit account (asset to the borrower, liability to the bank)
But this doesn’t mean that the bank doesn’t have to worry about the liability side of their balance sheet at all. They MUST manage their liabilities by sourcing deposits or selling bonds.
Think it through:- the borrower is going to spend the money. Perhaps the borrower buys a car from someone and then transfers their borrowed funds to the seller who has an account at another bank. How does the borrower’s bank settle this transaction? They pay the second bank with central bank funds (or govt bonds). If they keep lending this way, by making loans and then “creating money out of thin air” they will soon run out of central bank funds and bonds. What do they do then? They have to entice depositors to transfer their deposits from other banks, or entice other investors (ie savers) to buy their bonds.
I’ve seen this theory before. That because banks can create money at the time a loan is made, it somehow means they do not have to worry about sourcing deposits or money from other savers at all. This is totally wrong, and it seems to be based on a flawed understanding of how the banking system actually works.
If not, why do banks bother offering interest to depositors or issuing term debt?
I do not dispute that any bank needs to maintain central reserves that permit payment to be made: that is an issue of solvency
But that is not intermediation and has nothing to do with it
Effectively it is about short term liquidity, or capital
I still do not get your point – not do you seem to get mine
Exactly. But the way that the bank “maintains” central bank reserves is by attracting deposits or the equivalent wholesale market transaction which is issuing debt (ie bank paper).
Where else could the bank get the needed reserves from? It can’t create them out of thin air.
So the net effect is that if they want to keep making loans, the bank must find people willing to lend them their savings, ie either deposit holders or institutional investors who are willing to buy their debt. This is the definition of intermediation.
This makes sense if you consider
That is not intermediation
That is, in effect, capitalisation
Very different indeed
Look at Northern Rock: it failed not because of a shortage of deposits but loans acting as capital
I think Ysaac’s links to Richard Werner’s analysis above offer the best understanding of our banking system and could be used as a source of reference for those who want to know more and for those who should know more.
Richard, is it entirely reasonable to expect an economist to understand what banks and bankers do?
Remember: the Bank of England’s economists only figured out the monetary role of banking in 2015.
OK….
I become more convinced by the day that The Wizard of Oz truly is a story about the mythical power of money and banking, which we are all trying to understand but never get to the truth because it is just an illusion created to confuse us about a simple reality – we are all being fooled!
Remember, also, that the proper role of latter-day economists is to be profitably wrong.
If you are shocked by my cyncism, I would point out that economists do know a thing or two about incentives, insofar as they apply to rational economic actors with perfect information in a frictionless free market, uniform spherical horses, and other economists.
You are right to be cynical Nile as what you describe is in essence the reality of reflexivity in all the so called social sciences. It’s a very interesting concept that applies to all “actors” in a social space, in that not only are we observers of the past and present we also can influence and change the future. In its simplest form the notion of a self-fulfilling prophecy is an example of reflexivity.
George Soros explains it quite well in terms of financial markets and clearly shows that you have to inherently mistrust what anyone says with regards to anything in the spheres of money, business and economics – because essentially self interest is always the driving force.
Just one empirical study that experimentally disproves financial intermediation and fractional reserve banking while proving endogenous money theory but in a controlled environment is not enough for me, as a layman trying to be a bit more scientific, to believe that either is what happens in the real world. If there are more empirical studies for endogenous money theory and against others, then I think Richard should highlight them in this blogpost than simply claiming that Joseph Stiglitz is incorrect. It can only be a good thing.
Please read what the Bank of England have to say
If you don’t believe me they happen to agree, even if I got there first
Wouldn’t the fact that bank reserves were so very low (sometimes 1% I understand) when the crash came, actually indicate that the experimental trial has in fact been conducted providing the proof that the only way bank reserves could be this low was because they had indeed created money out of thin air?
That is, essentially a solvency test
And they could not pass it
If I remember correctly, the BoE article in their quarterly journal did not do an actual experiment like werner. They just said it, pretty much the same way that many economists say about fractional reserve banking in their books. If they have done an experiment to find out if its empirically true, can you please cite the link?
Also, can you please cite the link to your study as well? Would be interesting to read.
My point here is that even before many people agreed on fractional reserve and loan intermediation and still do. Doesn’t make it right. As far as I understand these things, one’s got to do an empirical experiment to get to the truth eh?
There is an empirical study and a massive body of opinion that says it is true
There is no study I know if that says the opposite
And the simple double entry accounting shows it has to be true
Dr loan account
Cr current account
And the customer thinks money has been created and so spends it.
Of course their promise to pay, which is the bank asset
“There is an empirical study and a massive body of opinion that says it is true” – Can you please cite the study or post the link to it?
Regarding a massive body of opinion, the same was true of fractional reserve and intermediation. Consensus cant be taken for truth in this matter considering the very dubious history of academic economics.
It is Richard Werner’s work
Please Google it
It has been linked on this blog but I woukd have to google to find it so you are as able to do so now as me
I did cite Richard Werner’s work in my earlier comment as below –
“Richard, have there been any real world experiments to prove conclusively of how banking works apart from Prof. Richard Werner’s? —
1)From his 2014 paper, Can banks individually create money out of nothing? – The theories and the empirical evidence (http://www.sciencedirect.com/science/article/pii/S1057521914001070)- “The evidence is not as easily interpreted as may have been desired, since in practice it is not possible to stop all other bank transactions that may be initiated by bank customers (who are nowadays able to implement transactions via internet banking even on holidays). But the available accounting data cannot be reconciled with the fractional reserve and the financial intermediation hypotheses of banking.” This one only proves that fractional reserve and financial intermediation are incorrect. But doesn’t conclusively prove the endogenous money theory
2)His 2015 paper — Werner, R.A., A lost century in economics: Three theories of banking and the conclusive evidence,International Review of Financial Analysis (2015),http://dx.doi.org/10.1016/j.irfa.2015.08.014 ”
The problem I have is that its just one study by just one professor. Are there any others that you know of?
My other point was that saying that there is a consensus on credit creation is the same as what the previous economists did with fractional reserve or financial intermediation model. Considering the highly dubious nature of economics, a field in which even the basics such as the workings of a bank have not been agreed upon and empirically verified till flipping 2015,why should I believe in the Bank of England(or anyone else) if they cant even bother to substantiate their claim with empirical evidence? Professor Richard Werner’s work is an extremely important step in this direction and I think the group who supports endogenous money theory should gain credibility by empirical analyses, not just by consensus.
That is the study
By the guy who created QE
$6 trillion back Richard
Ysaac,
Go to a chartered bank and ask a loan officer if they check the bank’s reserve position before extending credit. They will tell you no, and this falsifies the notion of an exogenous money supply. By definition the money supply must therefore be endogenous. There is no other option.
You might also spend time thinking about the implications for exogenous theory in light of countries with no reserve requirements.
Sure. And Samuelson had a Nobel prize backing him up.
My point being that I think more empirical studies like this should be done to add credibility to the endogenous money theory. And those studies should be cited in documents like the BoE quarterly journal article on endogenous money otherwise its no better than Samuelson(or any other economist) writing about another theory of banking and money creation.
Richard, can this be projects worth exploring with students at your university?
That’s very definitely post grad stuff
Ysaac,
Sure. And Samuelson had a Nobel prize backing him up.
1) That isn’t an argument and it doesn’t address anything I wrote.
My point being that I think more empirical studies like this should be done to add credibility to the endogenous money theory.
Your point isn’t clear at all. It appears you’re only interested in empirical evidence of a highly specific yet undefined form presented as something called a “study”.
Go read Wray’s Theories on Banking. Once you’ve done that get back to us on this issue but don’t behave as if you have a magical ability to swat everything down by sticking your fingers in your ears.
@Ben Johannson – Firstly, that wasn’t a reply to your post, it was to Richard Murphy’s. The problem is that this site hasn’t been programmed to reply to specific posts so this problem occurs.
Secondly, I am surprised that you react like this. This is exactly the problem that this side of economics faces. The fact that they get into pitiful silly arguments about semantics, definitions and technicals without understanding the gist of what the layman might be saying or wanting to understand.This simply undermines their own efforts and gets them nowhere.
My point was extremely simple. There is not much point in pushing for a theory if you cant say to the common person or politician “Look, we went to an actual bank, did an experiment and it actually confirmed our theory. Banks do work the way our theory said.” . And to do that, you need to actually do more experiments like Richard Werner’s. It will only add credibility and clarity to these rather endless blog posts about who’s right and who’s wrong.
Lastly, speaking of my magical abilities, I have loads! But I wish had one that would make you less impulsive and more constructive in front of the keyboard when making comments.
Ysaac
You clearly think economics is a science. Get over it
You clearly think peer reviewed papers are proof. Get over it
The Bank of England say it
That is good enough for 99% of people. Deal with it
The public have not a clue about experimental economics
Actually, since it is an almost unknown phenomena it is staggering Richard got the chance to do it
The problems are all yours
And you really are wasting our time
Richard
Ok.
Then why did Richard Werner bother doing the experiment,twice?
Ask Richard
I know he was pleased with the result: he told me all about it
I will. But my point was that if 99% percent of the people are ok with the BofE saying it, why did Richard Werner then bother to do the experiment? Clearly there’s some merit to it. I suppose it cant just be personal satisfaction.
Oh come on, have you no insight into the sort of curiosity that drives people like Richard?
Ysaac,
What you’ve done is behave churlishly, rejecting everything you claim to want no matter how many times it’s given to you.
No one has time to waste on such nonsense.
To be skeptical and ask for including empirical evidence in one’s blog post is to be churlish? To suggest to a group of people ,wanting societal change, to back up their arguments or blog posts with empirical evidence so that the credibility of their theories may improve is churlish? What the hell are you on about Ben Johannson?! Have you not read a single letter of what I have been writing?! I am seriously doubting whether you have anything constructive to add here apart from nitpicking and personal attacks. Go away!
@Richard Murphy – I am aware of the curiosity that drives such research. However, if the word of the BofE was enough, as you imply, it should have been enough to satiate his curiosity. But clearly not. There were competing theories of banking and he went ahead to actually confirm what actually happens in reality. So far, as far as I know,no one had done that and hence even if the likes of the BofE comes out saying this is how it happens, one cannot believe it unless they show some evidence for it. I request you that everytime you blog about competing theories, like how banks work, please include empirical evidence so that its clear to layman readers like me that we can trust you and are not wasting our time.
Two things
First, your response to NBen meaans that this is your last comment here: if you wish to be obnoxious (and as a matter of fact you quite clearly are) do it elsewhere
Secdond, if you think everything in life requires empirical evidence I suggest you start living in the real world for a year or two before opining again
Farewell
Ysaac you should read some of the recent work of Adair Turner on money creation and debt (or watch his lecture vids online). He is hardly left wing or radical (ex banker and chairman of the FSA), but has come to similar conclusions on the problem of excess credit creation by private banks and the way they create money through debt and primarily push it towards creating existing asset bubbles instead of investment in productive capability. His conclusions for the solution are also interesting and “non-standard”.
https://www.youtube.com/watch?v=OnB18YHA5AU
I do not agree with him on helicopter money though
I listened to that talk. Its good but very shocking that these people, who are paid thousands of pounds a year, have gone to the best universities in the uk and have significant influence and power in UK society, till after 2008 did not know the basic workings of one of the most basic institutions of current capitalism. Imagine if the state of medical science was like this at the moment, we would still be wondering why people get flu!
The fact that he and his colleagues in the regulatory bodies,along with the economists who taught and advise them, are still given such respect, should cast doubt in people’s minds to how bad the state of the governing class is.
Do you know if he has cited any studies which brought him to the conclusion that banks create credit money?
Ysaac there are many things that Bankers do no want the Public to know – which has been the same for a very long time!
“Give me control of a nation’s money and I care not who makes it’s laws”. Mayer Amschel Bauer Rothschild
“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” Henry Ford
“In our time, the curse is monetary illiteracy, just as inability to read plain print was the curse of earlier centuries.” Ezra Pound
“In 1977, when I started my first job at the Federal Reserve Board as a staff economist in the Division of International Finance, it was an article of faith in central banking that secrecy about monetary policy decisions was the best policy: Central banks, as a rule, did not discuss these decisions, let alone their future policy intentions.” Janet Yellen
A few more choice quotes from people who presumably had a good insight into how the national and international banking system worked in their lifetimes:
“Banking was conceived in iniquity and was born in sin. The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits.” – SIR JOSIAH STAMP, (President of the Bank of England in the 1920’s, the second richest man in Britain)
“Whoever controls the volume of money in any country is absolute master of all industry and commerce.” – James A. Garfield, President of the United States
“A great industrial nation is controlled by it’s system of credit. Our system of credit is concentrated in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the world–no longer a government of free opinion, no longer a government by conviction and vote of the majority, but a government by the opinion and duress of small groups of dominant men.” – President Woodrow Wilson
“I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power (of money) should be taken away from the banks and restored to the people to whom it properly belongs.” – Thomas Jefferson, U.S. President.