Hitch-hiker’s guide to monetary infrastructure - FT.



March 5, 2013 10:30 pm

Hitch-hiker’s guide to monetary infrastructure
From Prof Richard A. Werner. Sir, Good to know from your report “BoE eyes ‘radical’ spur to growth” (February 27) that the deputy governor is familiar with The Hitch-Hiker’s Guide to the Galaxy, and so knows that negative interest rates on banks’ reserves at the Bank of England cannot be “the answer to the universe” (the answer is 42). Instead of decision-makers well versed in fiction, we need a bit of non-fiction know-how about how our monetary infrastructure works. Paul Tucker’s suggestion that negative interest rates on reserves might encourage banks to lend more is likely based on textbook descriptions of “fractional reserve” banking and the notion that banks can withdraw the reserves to lend them to the economy. These belong to the world of fiction. There are different types of money. The first is legal tender paper money. This is mainly used by the public for petty transactions and amounts to only about 3 per cent of the total money supply. Another type of money also created by the central bank is solely for the use of its clients, the banks. This is reserve money. It stays in the banks’ accounts at the BoE to settle their claims against each other. If one bank reduces its reserves, this raises those of another bank, leaving the total amount of this closed-loop money unchanged. It normally also amounts to about 3 per cent of the money supply, but it never circulates in the economy and as such is not really money. So what about the money that is used for most transactions and accounts for the bulk of the actual money supply? As Martin Wolf has pointed out, it is created by profit-oriented companies, the banks, when they do what is commonly referred to as “lending money”. But they don’t lend existing money. Instead, they newly invent the money that they lend, by pretending that the borrowers have deposited it and thus crediting their accounts without transferring any money there, by simply inputting the desired number. Since people do not know about this, and would have trouble distinguishing the fictitious deposits from actual deposits, this bank credit money is accepted for payments. This is how the bulk of the money supply is invented into existence. While we have this peculiar monetary system, it is high time for leaders to realise that they need to kick-start the bank credit money supply, and can do so immediately by stopping the issuance of government bonds and instead funding the public sector borrowing requirement by having the Treasury enter into loan contracts with the money creators – the banks. That would constitute true quantitative easing of the kind I called for in Japan in the 1990s, and it would create a full-blown recovery within six months. These and related issues will be discussed at the European Conference on Banking and the Economy this Wednesday in Winchester Guildhall – sponsored by the Bank of England.

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19/03/2013 9:46 PM

Hitch-hiker’s guide to monetary infrastructure - FT.com


Richard A. Werner, Chair in International Banking, School of Management, University of Southampton, UK

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