Thursday, April 24, 2014

the truth is out: money is an iou and banks are rolling in it...,

guardian | Back in the 1930s, Henry Ford is supposed to have remarked that it was a good thing that most Americans didn't know how banking really works, because if they did, "there'd be a revolution before tomorrow morning".

Last week, something remarkable happened. The Bank of England let the cat out of the bag. In a paper called "Money Creation in the Modern Economy", co-authored by three economists from the Bank's Monetary Analysis Directorate, they stated outright that most common assumptions of how banking works are simply wrong, and that the kind of populist, heterodox positions more ordinarily associated with groups such as Occupy Wall Street are correct. In doing so, they have effectively thrown the entire theoretical basis for austerity out of the window.

To get a sense of how radical the Bank's new position is, consider the conventional view, which continues to be the basis of all respectable debate on public policy. People put their money in banks. Banks then lend that money out at interest – either to consumers, or to entrepreneurs willing to invest it in some profitable enterprise. True, the fractional reserve system does allow banks to lend out considerably more than they hold in reserve, and true, if savings don't suffice, private banks can seek to borrow more from the central bank.

The central bank can print as much money as it wishes. But it is also careful not to print too much. In fact, we are often told this is why independent central banks exist in the first place. If governments could print money themselves, they would surely put out too much of it, and the resulting inflation would throw the economy into chaos. Institutions such as the Bank of England or US Federal Reserve were created to carefully regulate the money supply to prevent inflation. This is why they are forbidden to directly fund the government, say, by buying treasury bonds, but instead fund private economic activity that the government merely taxes.

It's this understanding that allows us to continue to talk about money as if it were a limited resource like bauxite or petroleum, to say "there's just not enough money" to fund social programmes, to speak of the immorality of government debt or of public spending "crowding out" the private sector. What the Bank of England admitted this week is that none of this is really true. To quote from its own initial summary: "Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits" … "In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money 'multiplied up' into more loans and deposits."

In other words, everything we know is not just wrong – it's backwards. When banks make loans, they create money. This is because money is really just an IOU. The role of the central bank is to preside over a legal order that effectively grants banks the exclusive right to create IOUs of a certain kind, ones that the government will recognise as legal tender by its willingness to accept them in payment of taxes. There's really no limit on how much banks could create, provided they can find someone willing to borrow it. They will never get caught short, for the simple reason that borrowers do not, generally speaking, take the cash and put it under their mattresses; ultimately, any money a bank loans out will just end up back in some bank again. So for the banking system as a whole, every loan just becomes another deposit. What's more, insofar as banks do need to acquire funds from the central bank, they can borrow as much as they like; all the latter really does is set the rate of interest, the cost of money, not its quantity. Since the beginning of the recession, the US and British central banks have reduced that cost to almost nothing. In fact, with "quantitative easing" they've been effectively pumping as much money as they can into the banks, without producing any inflationary effects.

What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow. Government spending is the main driver in all this (and the paper does admit, if you read it carefully, that the central bank does fund the government after all). So there's no question of public spending "crowding out" private investment. It's exactly the opposite.

Why did the Bank of England suddenly admit all this? Well, one reason is because it's obviously true. The Bank's job is to actually run the system, and of late, the system has not been running especially well. It's possible that it decided that maintaining the fantasy-land version of economics that has proved so convenient to the rich is simply a luxury it can no longer afford.

But politically, this is taking an enormous risk. Just consider what might happen if mortgage holders realised the money the bank lent them is not, really, the life savings of some thrifty pensioner, but something the bank just whisked into existence through its possession of a magic wand which we, the public, handed over to it.

Historically, the Bank of England has tended to be a bellwether, staking out seeming radical positions that ultimately become new orthodoxies. If that's what's happening here, we might soon be in a position to learn if Henry Ford was right.


umbrarchist said...

And Henry Ford did not start the creation of debt from the planned obsolescence of automobiles. Some say he almost wrecked his company by not changing the Model-T Ford.

But now economists do not talk about what the world and countries lose on the depreciation of that junk every year.

umbrarchist said...

Money propelled us into space?

Part of the problem is the worship of money. If we wanted more people to be objective about it why not make accounting mandatory?

BigDonOne said...

@" and water should be removed." Rather, a better homicide-free way to do it would be to make unlimited opiate painkillers available to those over some arbitrary age, e.g. 70...then the useless-geezer problem would (very pleasantly) take care of itself.

John Kurman said...

Well, duh! Even I knew that! Try this:

CNu said...

No arguing with that. The entire thrust of posting this article was the fact that it had appeared in the Guardian. This is all....,

John Kurman said...

What a surprise!

CNu said...

old order lds, out in the nevada hinterlands since 1947, i'm guessing old cliven pans out on the ignorant side of life, with scant little interpersonal interaction that might have set him straight. so, not only no surprise, no reason for victoria's secret to get wedged deeply where the sun don't shine like my name was Chauncey or Tahnussy...,

John Kurman said...

No. Funny to watch all the small government types scamper away, like Rand Paul, and puff out their cheeks in outrage. Speaking of outrage, RE: your Cathedral reference, you might be interested in a book "I Wear The Black Hat" by Chuck Klosterman.

Chuck muses that perhaps it was around 1990, with maximum coarsening of culture (presumably hitting some floor level cultural equivalent of the Planck Length of Depravity) when the Left took over the Right's former duty of outrage and jowel shaking and sussing and shaming and shunning. I have to assume, since conservatives always fight a rearguard action, seeing as the Future always wins, that they tried to do a jujitsu move, and let the Left take on the role of Nanny Plumpkin. Problem is they still have to go along with it.

John Kurman said...

I personally would like to see that video of the militia boys redone so that, just as the guy finishes with "we are ready to use our weapons against tyranny" or some such, his head explodes like in Scanners. That would be kind of funny.

Makheru Bradley said...

Considering all of the unarmed people who are killed annually by law enforcement officers, how is it that this person aiming his rifle at federal officers is not arrested?

CNu said...

Same as when I answered Tom two days ago and unintentionally got BD excited:Very simple actually;
1. They had the police outnumbered and outgunned
2. The local constabulary is comprised of their kith and kin
3. They brought their women and children with them to the firing line.

This was a complete and total no-win situation for the feds...,

(lol, already starting to sound a little like it was some kinda friggin Yemeni goatherd wedding and the bearded towel heads were waving around
AK-47's and RPG's or some shit and you just called in a Hellfire missile strike from a Predator drone)

Makheru Bradley said...

In other words, under those conditions, aiming a sniper rifle at federal officers is not a crime. But driving erratically around DC is a capital offense.

The reality is the big bad Drone Ranger, like all bullies, was a scared punk, in the face of cowboys who have never proven they have the courage to fight their government as a group.

BigDonOne said...

@CNu "and unintentionally got BD excited:" We expected you to respond that "towelhead" was actually a 'term of endearment' when Yemenis use it in reference to each other....(ROTFLMAO)

CNu said...

You may return to your hijinks BD...., grown folks talking out here in the study.

Do What I Do - ENJOY THE CHASE - And Stay Amused....,

  "Many years ago I was convinced the Heisenberg uncertainty principle was incomplete, and people shouldn't just believe it becaus...