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April 24, 2014 1:32 pm

Strip private banks of their power to create money
By Martin Wolf
The giant hole at the heart of our market economies needs to be plugged
rinting counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the
businesses that can do this is the source of much of the instability of our economies. t could and should be terminated.
I explained how this works two weeks ago. Banks create deposits as a byproduct of their lending. In the UK, such deposits make up
about 97 per cent of the money supply. Some people object that deposits are not money but only transferable private debts. Yet the
public views the banks imitation money as electronic cash a safe source of purchasing power.
Banking is therefore not a normal market activity, because it provides two linked public goods: money and the payments network. On
one side of banks balance sheets lie risky assets on the other lie liabilities the public thinks safe. This is why central banks act as
lenders of last resort and governments provide deposit insurance and equity injections. It is also why banking is heavily regulated. Yet
credit cycles are still hugely destabilising.
What is to be done? A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger
proportion of the balance sheet be financed with equity or credibly loss-absorbing debt. I discussed this approach last week. Higher
capital is the recommendation made by Anat Admati of Stanford and Martin Hellwig of the Max Planck Institute in The cnlers' Neu
A maximum response would be to give the state a monopoly on money creation. One of the most important such proposals was in the
Chicago Plan, advanced in the 1930s by, among others, a great economist, Irving Fisher. Its core was the requirement for 100 per cent
reserves against deposits. Fisher argued that this would greatly reduce business cycles, end bank runs and drastically reduce public
debt. A 2012 study by International Monetary Fund staff suggests this plan could work well.
Similar ideas have come from Laurence Kotlikoff of Boston University in 1immSteucrtisDecd, and Andrew Jackson and Ben Dyson
in ModernisinMone. Here is the outline of the latter system.
First, the state, not banks, would create all transactions money, just as it creates cash today. Customers would own the money in
transaction accounts, and would pay the banks a fee for managing them.
Second, banks could offer investment accounts, which would provide loans. But they could only loan money actually invested by
customers. They would be stopped from creating such accounts out of thin air and so would become the intermediaries that many
wrongly believe they now are. Holdings in such accounts could not be reassigned as a means of payment. Holders of investment
accounts would be vulnerable to losses. Regulators might impose equity requirements and other prudential rules against such accounts.
Third, the central bank would create new money as needed to promote non-inflationary growth. Decisions on money creation would, as
now, be taken by a committee independent of government.
Finally, the new money would be injected into the economy in four possible ways: to finance government spending, in place of taxes or
borrowing; to make direct payments to citizens; to redeem outstanding debts, public or private; or to make new loans through banks or
other intermediaries. All such mechanisms could (and should) be made as transparent as one might wish.
The transition to a system in which money creation is separated from financial intermediation would be feasible, albeit complex. But it
would bring huge advantages. It would be possible to increase the money supply without encouraging people to borrow to the hilt. It
would end too big to fail in banking. t would also transfer seignorage the benefits from creating money to the public. n 2013, for
example, sterling M1 (transactions money) was 80 per cent of gross domestic product. If the central bank decided this could grow at 5
per cent a year, the government could run a fiscal deficit of 4 per cent of GDP without borrowing or taxing. The right might decide to
cut taxes, the left to raise spending. The choice would be political, as it should be.
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RELATED TOPICS Central Banks, United Kingdom, UK banks, US banks
Opponents will argue that the economy would die for lack of credit. I was once sympathetic to that argument. But only about 10 per
cent of UK bank lending has financed business investment in sectors other than commercial property. We could find other ways of
funding this.
Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced
to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating
the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.
This will not happen now. But remember the possibility. When the next crisis comes and it surely will we need to be ready.
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When the next shortage of money rolls around, we need to have local currencies in place ready for it so the absence of state money, UK pounds, won't
affect communities so badly. A nationwide network of community-run farms would be useful too!
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Please tell me the rational reason why every man, every company and every country on the planet NEEDS to be in debt.? And who are we all in debt to? I'm
afraid most people, including politician in power, don't bother about the contradiction herein, ie that all (>95%) money originates from debt, and reducing
the debt (avoiding its growth due interests) in order to save the economy will make the money vanish and thereby hurt the economy. he rst step must
be to skip the Fractional Reserve system, so the banks can only lend out the money they have/own or have lend in the Central Banks, CB. BTW: CBs
around the world are mostly independent/private banks run outside direct control from the power of goverments - and in most democratic countries their
prots are paid back to the state.
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Our nancial system is unstable because it is run by the state. iving the state a larger monopoly on banking than it already has will only make things
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a OA remains a OA even if reported by one of the world's most inuential writers on economics. Creation of money must be kept independent from
political power because otherwise it could be used for electoral purpouses instead of regulating ination. hink about what could have happened if Mr.
Berlusconi had this kind of power in his hands. Fractional reserve is simply useful to have money circulating and not blocked into banks' deposits, and
seignorage benets in most countries already go to the public. It is a pity and a shame to see such an economist spread those conspiracy theories, but
nevertheless it is happening about almost every subject of human knowledge.
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Strip private banks of their power to create money -
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May 10, 2014
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Apr 29, 2014
Apr 29, 2014
Anthony C
Alex Erskine
Olaf von Rein
This is the simplest and best explanation I have come across:
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I think this is absolutely stop on. The basic tenent of a free market economy is that all actors in the economy have equal access to act in the economy,
except where the action is illegal.
From this basic concept, we determine that all people and companies can paint houses, however no one can steal someone's bike.
So it should be with electronic money. Either we can all create money, electronically, as a newly created debt, and then lend it out at interest or we say that
no-one can create money, electronically. I would even argue that allowing the central bank or government to create the money is not that great as a
The way to think about this, is a simple thought experiment.
Lets assume on Monday, 60bn was the sum total of all deposits in the UK and that was currenty nominally worth 60m loaves of bread in monday money.
Assume there are 60m people in the UK, every person has 1000 each in there account, so everyone nominally has 1000 loaves of bread. I.e. bread costs
Then, on Tuesday, the bank creates a really lovely new loan of 3bn to one person. Now there is 63bn of deposits in the UK. There is still 60m loaves of
bread in nominal terms, as ination will automatically revalue bread, so that bread now costs 1.05. So now you see what has happened, everyone that did
not get a loan now has 952 loaves of break in purchasing power. I.e. the legalized forgery of deposit funds, means that the bank and lender have
successfully redistributed 48 loaves of bread from everyone else in society to themselves.
It is obvious, that this is neither socially just, nor a correct application of the free market economy.
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Seems to me most commentators have forgotten how important cross-border trade, investments and ows are in the modern economy. he
ackson/Dyson proposal would likely lead to such business collapsing, as governments would have to approve such ows of money. he other
conjectured benets of the proposal would have to be massive to outweigh that cost. Surely it is preferable to retain the current system, but require banks
to raise the requisite increase in capital and impose tight prudential supervision, as Admati and Hellwig propose.
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@ Olaf
Fair point.
I think the present problem is more a lack of business condence than lack of cash.ou may be correct about investing in weak businesses,no one should
throw money at risky ventures particularly in poor economic climates.The real trouble occurs when the recession hits and businesses cut back and sit
tight waiting for the recovery,if and when that ever appears.
It is not that the money is not there to borrow, just no one wants to take a chance.During the boom years the banks were lending too much to the wrong
sector. I do agree plenty have a had a good whinge about bank lending recently when it as not been really justied.
However it is the private banks irresponsible lending that got us where we are.
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@vincentjohn: "Thus real wealth generating businesses get starved of funds while the majority are created to chase the same stock of property,creating
one huge property bubble." I agree with the latter but I am seriously sick of the former assertion. Is there any evidence of this "starvation"? Of all the
Strip private banks of their power to create money -
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Olaf von Rein
sopping news coverage I saw on the evening news during the recession about this or that company not getting any bank nance - well, know what, I would
not invest a penny of my money either. Oh, and what there is positive evidence of is corporate balance sheets awash with cash.
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Great article and one I never expected to become mainstream.I have been actively supporting Positive Money for a few years now and I can fully
understand most peoples' shock and disbelief when they rst encounter proposals that would abolish fractional reserve banking and nationalise the
money supply.
Once one get ones head around the idea it certainly seems very appealing.I do like to keep an open mind however,but as yet have not seen a major aw in
the proposals.
It is not a universal panacea for any society's problems but it would be remove one major strife we all suffer from, rich and poor alike,namely boom and
bust economic cycles.
@ Mysterion,
Credit cards are a form money creation too, as are overdrafts and small consumer loans.However they made up only 10% of all bank loans in the 10 years
before the 2007 crash.Loans created for mortgages was about 40% and loans to nancial companies was another 37%.Non nancial business received a
mere 13%,so we can see exactly how the private banks create loans and where it goes.Thus real wealth generating businesses get starved of funds while
the majority are created to chase the same stock of property,creating one huge property bubble.This is no way to run an economy.
The government would have the power to create money to satisfy demand but could only do this after careful consideration of the amounts to be
created(or destroyed in times of boom)by the newly briefed Monetary Policy Committee.So credit would not be choked off.Which was the fundamental
idea behind the last round of QE .Though this has been a limited success,better ways of injecting money into the economy is outlined in Positive Money's
blog and its Sovereign Money policy proposals.
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Where do credit cards t into this system ? Presumably nowhere, if a bill isnt paid money is created.
As @Olaf seems to be suggesting, if this scheme led to a choke on credit banks activities would be replaced by loan sharks and new types of shadow bank.
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@Tim: "It occurs to me that there can be fractional reserve equity investment too!" Yes, I believe I pointed this out some weeks back in one of our
conversations. Equity as much as debt is simply a book-entry on the asset side of a lender / liability-side of a borrower. A bank could create money thru
equity just as easily as thru loans. They don't because they don't like the legal mismatch (duty to repay on the deposit, no corresponding claim on the
equity). MW tries to resolve this legal mismatch with his "investment account".
"I would not choose the term "preferred equity", but rather "... "preference shares"." You are right. My bad choice of lingo.
"[you] get all of your money back from equity if you have enough shares to vote for voluntary liquidation." I think we need not dwell on this situation. Such
a (liquid) borrower would not default on debt either. In the end, as we both know, the liability side is just a waterfall and different liabilities have different
attachment points. I just felt some months back when Wonga made the headlines that the best way to tackle the unsavoury enforcement actions of
Wonga would be to - in effect - ban "loans" and only allow "preference shares". That would put a stop to Wonga - and probably all other forms of consumer
loans, actually. (It would have negligible effect on business lending.)
Consumer loans is what the opponents of at-money should be most concerned about. he proposed "real money" plan here has as a side-effect that it
would stop all consumer loans. It might be helpful in this regard but I am with you that we don't have to turn the entire nancial system on its head just
because there is a tiny legal spanner in the works.
his might be a convenient moment to highlight the fact that this "tiny spanner" isn't so small at all: MOS of the problems in our nancial system arise
from a clash between private property law and central banking. And who should be surprised? ow can the law hope to protect property when the ination
brief of (the government to) the central bank effectively mandates robbery?
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Tim Young
Olaf von Rein
Tim Young
Put another way, our nancial world would be a whole lot more stable if loan amounts were expressed as %M4 and not in xed (notional) numbers.
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@Olaf, a thought-provoking comment! It occurs to me that there can be fractional reserve equity investment too! Which raises the confusion in the minds
of some of the money reform types. They object to the fractional reserve part on the grounds that it seems like fraud, whereas it is actually the maturity
transformation part that makes runs a destabilising problem. And you are right that there is a continuum between equity and debt, although I would not
choose the term "preferred equity", but rather "preferred stock" or "preference shares". To me "equity" should involve two properties: (1) some share in
the success of the enterprise and (2) some control rights, so I would not describe gilts as "equity". There is even a bit of a continuum between debt and
equity when it comes to getting your money back. I think you could get legally get less than your money back from an investment in debt with a collective
action clause, but get all of your money back from equity if you have enough shares to vote for voluntary liquidation. Often there are no clear cut answers,
which is one reason why I don't like dogmatic opinions on money.
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Don't worry Martin, Bitcoin will take care of this
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@Tim: I cannot see how in this world of central bank money there can be any maturity transformation / any loans. Unless you banned loans outright (*),
fractional reserve lending would always come back. hat genie is simply out of the bottle. Which then leaves only equity nance. Solves one of your gripes
about the preferential tax treatment of debt expenses ;-) For the whole thing to work, you would need a hyper-liquid equity market. This is hard to imagine
for SMEs. So banks would morph themselves into (closed-end) equity funds to provide the liquidity service you talk about.
In fact, when Wolf writes that "banks could offer investment accounts, which would ... loan money actually invested by customers", he is painting an
institution that morphs a loan into preferred equity. I am not sure why he thinks this a desirable outcome. Better to ban the loan and have the SME issue
the preferred equity instead, such that the "bank" becomes simply an equity fund.
Preferred equity is practically indistinguishable to debt. Only difference is in the legal small-print: The lender loses the right to enforce the debt. Ironically,
this is no different to the biggest debt-stock there is: gilts. Yet just as the government continues to service its debt (absent any legal duty to do so), so
would every private borrower to assure access to future funds.
(*) Since loans cannot actually be banned, the legal reform required here is simply to say that no lender may insist on their capital back, ie an interesting
tweak to property rights.
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@dant, I am disappointed that you did not respond to my explanation of the useful role that banks play by being intermediaries (which can be separated
from the issue of maturity transformation, which was where my NHS bed example comes in).
By belittling money as merely some kind of electronic record, you are missing the useful liquidity service provided by banks. For the lender, a loan allows
consumption to be deferred, but uncertainty means that lenders generally prefer to keep the committed period short. For the borrower on the other hand,
the loan often nances some relatively long-lived real project, so borrowers typically prefer relatively long term loans. he banks' deposit and loan pooling
effectively allows both lenders and borrower to get what they want at the same time. The only way that I can see for this to be achieved if banks do not act
as principals but merely as agents which match individual lenders and borrowers, is by the lenders selling their loans when they want to cash them in, say
to nance consumption. I dare say that for idiosyncratic deposits and loans, held by non-experts, the transactions costs in such a market would be large.
So banks can provide a socially valuable liquidity service, in the same way that the NHS can use the law of large numbers to practically always provide care
on demand without notice (cf liquidity) using a number of beds that is much smaller than the number of people.
You are right that the central bank COULD provide as much transactions money as people wanted if the central bank offered that service, but in most
countries, the central bank chooses not to (there are some countries with many central bank branches, and even the BoE provides current accounts for
some individuals such as employees and traditional customers such as the Queen). In fact, in recent years, the BoE has actively sought to reduce its
involvement in banking, reducing its branch network and closing its cheque clearing operation at Eagle House. It is certainly not the case that private
Strip private banks of their power to create money -
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ted e. bear
Hans Mittendorf
sector banks "usurped" the power of money creation from the state as is sometimes alleged. Central banks believe that they can adequately control the
stock of money via reserves policy.
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Bravo Mr. Wolf! Economics today is a world of darkness but you just brought in some light.
Unfortunately many people here don't understand Martin Wolf's argument. Some are calling him a socialist and some are calling him an Austrian. This is
not a political argument. IT IS A MATTER OF JUSTICE. Let me explain:
US dollars are guaranteed by the government. Therefore all US dollar creation should originate with the US Treasury, or else the US govt is guaranteeing
something which they have no control over its issuance, which makes little sense. Private banks have no natural claim to create the government's
currency with fractional reserve loans. hey obtained this power centuries ago because it lled an oce easily when there wasn't enough gold in the world,
but we do not owe this tribute to the banks. he benet of money creation belongs to the ENIRE CIIENR through their own government, so we should
copy the banks' method of money creation in a manner that benets everyone, not just bankers.
Milton Friedman showed us the path for successful implementation of such a system by nationalizing deposits in a one-time operation, raising the reserve
requirement to 100%, and lling the gap in money supply lost with new reasury Notes. his would get us to a 100% reserve system with relative stability
and divorce private banks from the national monetary policy (the way it should be -let the private and public sector compete for the best money system).
As for future government spending, Friedman suggested a mechanical system which would keep the quantity of money going up at a steady rate. This is
the best way to do it. It MUS be based on rigid rules, not discretion. hat is how faith in maintained in any at system. Central bankers' poor discretion is
why so many are suffering today.
The big issue is how can anyone distribute the money "fairly"? Well this is where C.H. Douglas's idea of a national dividend would help. It would be the
most equitiable way of spurring economic activity. Perhaps allocate a certain percentage to infrastructure spending, some to social spending, but 50% to
a national dividend split evenly amongst all taxpayers (taxpayers being akin to a "shareholder" in the "corporation" that is the nation itself. This would be
the most fair way to go about monetary policy and would promote prosperity much better than any quantitative easing.
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yes, MARTIN, we are ready. It is unsustainable to deposit money on a bank account with 1% interest and borrowers pay 15% for it. How can they think this
would be seen well?!!
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"And what is the problem? That once in a centary house prices get out of control? By simply regulating housing sector, by example tying house prices to
rental rates like Steve Keen has proposed you get rid of that problem. Job done. Simple isn't it?"
It would be simpler if governments would suspend their policies of driving up house prices in the rst place.
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Besides, when you think about it, it is an impossibility. If a government were to try to decit spend enought for banks to have reserves, if would drive
private sector wealth way up (public debt/money issued is a private sector asset) and that would cause consumption to surge, rst employing all available
resources and then causing high ination.
If money were to come into existence without debt you could not have enough money saved in the banking system to nance all activities that modern
economy needs. Unless you want super-rich people to have trillions in wealth instead of billions.
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Recently both IMF and Bank of England came out and said that textbook version about money creation is not true: banks don't lend out reserves. Now this
stuff is on the news!
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Olaf von Rein
City Slick-er
You have wrong models in mind mr. Marting Wolf.
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There seems to be no end to bad ideas coming from economists. If private sector lending is, say, 50 trillion in the us, where would those 50 trillion come
that banks need to raise to their reserves?
Banks could sell govt bonds to get reserves, but total amount of govt bonds out there is only about 15 trillion! overnment would have to decit spend rest
of the money in the existence. And this is supposed to save money?
We dont need this, government already creates new money as it spends. It faces no scal constraint! Stop living in a fantasy land. ou can't have a
prosperous economy by doing a knife job to your nancial system, you need to be able to nance economic activities.
And what is the problem? That once in a centary house prices get out of control? By simply regulating housing sector, by example tying house prices to
rental rates like Steve Keen has proposed you get rid of that problem. Job done. Simple isn't it?
These laa-laa-land living fools are danger to us all.
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"Opponents will argue that the economy would die for lack of credit. ... We could nd other ways of funding this." Well, in this hypothetical world there
must only be equity nance. Loans would have to be proscribed since otherwise the fractional reserve banking would make an immediate come-back -
legally or otherwise.
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@im oung: here is no eciency gain in the current system. As I have pointed out to you in the past, there is no overhead in holding numbers in a bank
computer system. There is an overhead in maintaining NHS beds.
he only reason that we currently require bank credit money creation is that there is an insucient supply of BoE money available to facilitate trade in the
economy. Also, the only BoE money available to consumers is in the form of cash, which in the modern world is not good enough. If *all* money was BoE
money and the payment systems were opened up so that ordinary people could use electronic payments of BoE money directly, then we would have no
need for commercial bank created money. If a 100% reserve system was implemented, with sucient "indestructible" money added to the system to
counteract ination / deation, then savers' money could sit quite happily in "storage" with no lost productivity in the economy. In fact, in such a system
we would expect to see large increases in economic activity as spending power would increase across the whole of society as people we freed of the need
to "rent" the money supply (ie: far less need to resort to bank credit and hence less interest payments to make). Informed savers could of course make a
choice to forgo access to their money for a while in investment accounts, allowing them to make a return as their money is lent out.
ou are too far entrenched in the status-quo to see that your arguments are only valid whilst the current system is in place. he only sector that benets
from the current system is the nancial industry. Money is a tool for trade and banks should be akin to a utility, facilitating storage and transmission of
money rather than its *creation and destruction*. They have proved many times over that they cannot be trusted to provide the correct amount of money
to keep the economy working smoothly. They must, as Mr Wolf says, be stripped of that power before they do further harm.
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wow. the world is really changing.
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Weary sigh.....Keynes, Theory of Money, volume II, pp.383-7, (ch. 37). Nuff said.
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Brecon Clovis
The Bogan
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"No one is the right person to pull the levers. That is why I suggest checks and balances."
When it comes to checks and balances on lending, nothing replaces fear and greed.
The check on reckless lending is fear of loss.
That's why government lenders can never be relied upon to promote sensible lending.
Of course, a bank CEO who can earn $200 million between now and December won't be too worried about future losses, either, although his investors
may care (unless they know the government will insure their losses).
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What are the main similarities and differences between this approach and the Social Creidt parties of Canada and other countries?
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Mosler (who understands the monetary system exceptionally well) has commented on this article:
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@ Moogle "I think bubbles are indeed very hard to foresee, so it is hard to blame Helicopter Ben for all of that."
No doubt, but to the point of this discussion, it's a bit optimistic to hope that our primary bubble blowers/deniers at the Fed will someday become reliable
crisis avoiders.
The Economist was calling the US housing market a bubble back in early 2003 ("Castles in hot air", May 2003), yet another 2.5 years later, after housing
had risen much further, Ben was still assuring us that no bubble existed. A few months later arrived the popping.
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@ RiskAdjustedReturn
I think bubbles are indeed very hard to foresee, so it is hard to blame Helicopter Ben for all of that. Even JM Keynes and Benjamin Graham were wiped out
at the Great Depression. Let set aside one's opinion on Mr Helicopter, but I will give most people will say Keynes and Graham were not stupid. Even the
fathers of modern economics and nance couldn't see the reat Depression was coming (though you have to give that both persons did not panic after
the crash).
The old saying is that "Don't time the market". Predicting bubbles are like market and business cycle timing. Even the greatest couldn't time it.
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To fundamentally change the role of banks in our economy require a lot of political courage and bargaining chip from the government. The problem
changes from an economics problem to a political problem. Any curtail or change of banks' power is likely to see extreme opposition from the City.
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Bravo Mr Wolf. The best piece I have read in the FT in years.
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Tim Young
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@ JustYield -- "Lending to productive businesses is the positive role of credit in society. Where credit went off the rails was in the housing market, as by
now most people have slowly come to accept. I see no need for banks to be prevented from their role in creating credit secured against future economic
activity. But they surely must be limited in their lending to the housing market."
I'm sympathetic to the notion that a distinction could/should be made between lending for productive and non-productive assets, although I'm not sure
that such a line can be drawn. (If you lend mortgage money to the CEO of a business, are you betting on his income or on his real estate market?)
But who would do the limiting on lending to the housing market?
In the US, the State has acted as the primary promotor and insurer of aggressive real estate lending through a variety of agencies (Freddie, Fannie, FHA,
etc). They have also acted as the most prominent bubble deniers, with Ben Bernanke assuring the nation that no housing bubble existed, right up to the
moment it popped. Lastly, they protected all the bondholders of these agencies.
If sane real estate lending is the goal, I'm not sure why you'd want to get the State even more involved.
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"The annual amount of money that the state controlled authority (i.e. the central bank) would create should be according to the growth of the GNP."
OK, but what if the loan is creating GNP by its very nature?
If a bank makes a loan to an entrepreneur who proceeds to start a business that earns enough to not only pay back the loan but also make a prot on top
of it, then the GNP produced will follow and exceed the money created by the loan.
So I don't see why, necessarily, a NP increase has to be noted rst before money can be created.
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@dant, "What we really need, is for banks to become intermediaries in the way that most people understand how lending works. For them to increase the
value of one bank account (lending money to that account holder), they should have to *decrease* the value in another account (that of the saver)."
I am afraid that you appear to be being driven by a fundamental misunderstanding of the ideas of an intermediary and of a bank, and therefore of their
merit. Your description is that of an agent, like a peer to peer lender, rather than of an intermediary or a bank. Much of the merit of a bank, however, is that
it serves as a principal to both lenders and borrowers.
Let us suppose that all deposits and all loans are of the same term, to abstract from maturity transformation issues. By virtue of being a principal, the bank
is able to collect deposits of all sizes and distribute them as loans in all sizes - hence the name "bank" presumably. Moreover, from the depositor's point of
view, since their credit exposure is to the bank, their credit risk should be lower by virtue of the diversication of the bank's exposure. It is because the
bank is a principal that when a bank lends to one customer, it does not decrease the value in a depositor's account. In fact, if the new loan is not made out
of returning funds, it is necessary for the bank to increase the value in some depositor's account.
If the idea of banks creating money ex-nihilo really, really bothers you, then impose a rule like the naked short-selling rule that is sometimes applied to
market makers - the bank has to procure a deposit before it can arrange a loan. But this would make no practical difference as long as the central bank will
lend money on demand to banks at a stipulated rate of interest. In that case, a bank can effectively create new deposit money by arranging a loan - ie
getting a deposit - from the central bank rst. his will create new deposit money as the loan is drawn down and generates a deposit elsewhere. Not that
this willingness of the central bank to grant loans to banks on demand means that it has gone soft; the central bank controls the expansion of the money
supply by the rate it charges for deposits it makes in the banks' current accounts it hosts - aka "reserves". While in theory, the central bank could control
money creation by setting quantity limits, this would generate volatile short-term interest rates; as it is, reserves do not "constrain" balance sheet
expansion like in the textbook money multiplier explanation, but they do "restrain" balance sheet expansion.
When maturity transformation is allowed, which also offers eciency gains - like the NS bed management I mentioned before, or car sharing schemes
such as zipcar, do, the authorities can readily regulate the exposure that this involves too by setting risk and liquidity limits.
Strip private banks of their power to create money -
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Colin Doyle
There is nothing fundamentally wrong with the present money system; the problem has been the spinelessness of the individuals in charge of regulating it,
transmitted down from the politicians who appoint and oversee them (or rather don't appoint them if they do an inconveniently careful job, like Brooksley
Born did).
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@QuietlySpoken: All very well spoken, but the question still remains. What are the personal incentives for the central bankers to kill the party in the name
of systemic macro mumbo? Easing until oblivion (with an ination-linked pension backed by bars in the basement) seems like a politically more
streamlined option.
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Thought experiment:
Let's say in the rst year of a bank's business they acquire $1 million through loans (not deposits) and lend that to customers with loans that have an
average duration of ve years.
Now let's imagine that, in the second year of business, new creditors weren't lending the bank money but last year's creditors came to collect theirs. The
bank would not be able to meet all of its liabilities, because it still needs to wait for most of the money it has loaned to be repaid.
hus, we can see that eliminating a bank's ability to loan its deposits is not sucient to eliminate the risk of a bank run.
Now, requiring a bank to hold a dollar of equity capital against every dollar it has loaned might eliminate the risk of a bank being unable to meet its
liabilities. et, witness the ickering back and forth of a Necker cube: is that bank truly lending the capital of its depositors/creditors? Or, is it lending its
equity capital? You chose; there's no right answer.
What was created is a business with two halves: one that holds people's money, and another that acts like a bond fund, or a private equity fund. Neither
one needs the other, per se. Such regulation will have eliminated banking as we know it. This is problematic to those who think the current role of banks
serves some positive purpose in society overall. On the other hand, the harshest critics of banking might see a clever means of achieving a goal.
In a world where banks do not lend our deposits, the supply of credit would presumably contract. Perhaps banks could try to become makers of loan
markets. They might bring their depositors together with their former borrowers, hoping to facilitate lending between pairs in exchange for a fee.
Otherwise, for better or for worse, deposits would remain in the vaults.
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he Bank of England has itself conrmed that the traditional view you describe and taught in many economics courses is simply a myth. See this BoE
video :-
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No one is the right person to pull the levers. That is why I suggest checks and balances. Too many checks would slow central banks down to a legislative
pace, but we have some leeway before we hit that limit.
Let us try something, and it doesn't work, try something else.
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Strip private banks of their power to create money -
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Greg Posehn
Is it that easy?
Is it that easy?
Suspect that Wolf writes this sort of stuff for fun and to create a good comments section...
ou don't need to upend the whole system to correct aws. for example too big to fail and deposit insurance. rst reduce the amount insured and make
the cost relative to the nancial condition of the bank. ou might charge the cost to the depositor so that he/she is more aware of risk. second capital
requirements are already up and will trend up if depositors are exposed to full risk. Third, let them fail. Once every so often a bid failure will cleanse the
system. In all of this you have to remind the individual that risk exists and politicians will not bail them out (regulators are supposed to look for fraud and
excessive risk).
As for destination of funds, that reects the economy, not the banks, and the idea that a committee of wise persons will do better is surely by now a
discredited one. Finally delever society; focus people on retirement and health savings (look at Chile for ideas). Making interest non-deductible might also
help but reducing tax rates would also.
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I think the real problem is not credit creation itself but the role of interest in generating surplus (or you may say unproduced) income from it. This is the
driver behind banks overleveraging and fuelling private indebtedness. If you were to abolish the ability to earn an automatic margin on loans then the
rationale for credit creation and the modern way of banking would dramatically change. Private borrowing in this non-interest world would happen when
people with surplus cash offered it to those who wanted to borrow, perhaps in a club where a fee has to be paid by both parties for belonging to it. You
may ask what incentive is there for a person with surplus cash to offer this to others and pay a fee as well - its simple they will need to borrow at some
point being a member will allow them to do this and the fee would be there to insure against non-payment. Also, some of the fee charged will also cover
the costs of managing the process.
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In this 100% reserve to deposit system, only bank capital could be lent. Depositors would earn as interest something less than the banks earn on their
deposits to the Central bank reserve account - to cover their costs and to earn some prot on the working capital needed to run the cash settlement and
clearing systems.
Borrowers would only have access to surplus equity as loans.
2 problems with this that I don't see addressed.
1) How would you deal with the credit crunch unleashed to transition from the leveraged banking system we have today, to a 100% reserved system. We
saw what happened to the European banking system when capital requirements were increased to strengthen the system. Imagine going from Basel 3
capital ratios to 100% capital.
2) How could you impose this on a system that is global? If the UK were to impose this, other international banks would be happy to step in and extend
credit in their own currencies. Gresham's law would soon drive the pound out of circulation.
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File this one under downright batty. A little interesting to see Wolf joining up with the Rothbardists in the call to end fractional reserve banking. Unlike
them though Wolf seems to want the economy turned over completely to a committee of philosopher oligarch economists.
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Dear Mr Wolf,
Congratulations on your Overseas Press Club award.
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Demand for money and its creation is determined by its price.
Strip private banks of their power to create money -
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looking from afar
At different price points, the demand has greater sensitivities for production or speculation.
Our problem is never ending credit expansion for nothing but speculation on non-productive activities through an ever lower price of money.
Central banks set this price of money.
Central banks are the root of ALL economic and societal miseries.
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@looking from afar:
If you are interested in how such a system could work, read the Positive Money proposals (very similar to the Chicago Plan and other such 100% reserve
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Financial liberalisations over the past 30 years, i.e. opening up competitions for nancial services and the use of technology to offer innovative
management of money, has created higher liquidity and more exibility demands by customers, but it has also led to the great nancial crisis. he
restrictions required under the system proposed in the article would solve the issue of moral hazard but it would also be a against the demands of
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If i understand the proposal is to have 100 percent reserve requirements (lending=assets), but the demand for money is still outthere. How do you satisfy
it? More base money? Also, the amount of credit is endogenous to the system, the non-banking nancial sector would grow to ll the gap. At the nal
equilibrium the cost of credit could go up and shrink economic activity.
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Slowly but surely you are getting there Mr. Wolf.
Free ride !
Next article don't forget to mention Big Caps, politicians,and central bankers alike.
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Strip private banks of their power to create money -
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