Guest Post: German Central Bank Admits that Credit is Created Out of Thin Air

Washington’s Blog.

Preface: Most people think that banks lend solely from their base of deposits. Some also know that with fractional reserve banking, they can loan out many times more than they actually have in reserves.

But very few people – with the exception of those in the banking industry and financial experts – know where credit really comes from. Many Naked Capitalism readers are in the banking industry or financial experts, so this may seem obvious.

I apologize if my populist tone is over-the-top. I am not trying to needlessly slam any type of business people, simply trying to  advocate on behalf of a more sustainable system that will benefit the most people.

Finally, as usual, any incorrect information in this essay is mine alone, and not Yves’ or the site’s.

Germany’s central bank – the Deutsche Bundesbank (German for German Federal Bank) – has admitted in writing that banks create credit out of thin air.

As the Bundesbank states in a publication entitled “Money and Monetary Policy” (pages 88-93; translation provided by Google translate, but German speaker and NC reader Festan von Geldern confirmed the basic translation):

4.4 Creation of the banks money

Money is created by “money creation”. Both [central banks] and private commercial banks can create money.  In the euro monetary system [money creation] arises mainly through the granting of loans, as well as the fact that central banks or commercial banks to buy assets such as gold, foreign currencies, real estate or securities. If the central bank granted a loan from a commercial bank and crediting the amount in the account of the bank at the central bank, created “central bank money.”


Money creation by commercial banks

The commercial banks can create money itself, the so-called bank money. The money creation process through which commercial banks can be explained by the related postings: If a commercial bank to a customer a loan, they booked in its balance sheet as an asset against a loan receivable the client – for example, 100,000. At the same time, the bank writes down the customer’s checking account, which is run on the liabilities of the bank’s balance sheet, 100,000 euros good. This credit increases the deposits of customers on its current account – it creates deposit money, which increases the money supply.

In other words, money is created as book-entry by purchasing assets or entering credits on the left side of the balance-sheet and corresponding deposits on the right side. In other words, credit is created out of thin air.

Frontiers of money creation

The above description might leave the impression that the commercial banks are able to draw an infinite amount of money in bank accounts. If this were really so, this could be inflationary. The central bank therefore takes effect on the extent of lending and money creation. It requires commercial banks to hold the reserve.

As I’ve previously pointed out, the Federal Reserve is taking the same tack, creating conditions that guarantee that American banks will have huge excess reserves so as to prevent inflation. Back to the publication:

Central banks, commercial banks can typically obtain only by the fact that the central bank granted them credit. For these loans, commercial banks have to pay the central bank interest rate. Increase this rate, the central bank, the “prime rate”, the commercial banks usually raise their part, the rates at which they lend themselves. There will be a general rise in interest rates. This, however, dampens the tendency of businesses and households, the demand for loans. By raising or lowering the key interest rate the central bank can thus influence the business sector demand for credit – and thus on Lending and bank money creation.

The commercial banks need central bank money to cover not only for the reserve, but also to the cash needs of its customers. Each bank customer may be credit in the bank account into cash to pay off. If the stocks of the banks in cash to be in short supply, the central bank can create only remedy. Because only they are permitted to bring additional notes in circulation. To meet the cash needs of its clients, the commercial bank must therefore include, where appropriate, with the central bank for a loan. This leads to the creation of central bank money. The so-purchased assets for central bank money can pay off the commercial bank in cash let. Thus, the cash is in circulation: from the central bank to commercial banks and from these to the bank customers.

Central Bank money is also to cover the non-cash payments are required: a customer transfers money from its credit to a customer at another bank, this results in many cases led to the sending bank central bank needs to transfer money to the receiving bank. The central banks then moves from one bank to another.


The commercial banks can use the surplus of central bank money and to award additional credits to businesses and households. As previously described, arises from the award of additional credits additional demand for central bank money – which can be covered in this special situation of great uncertainty among banks by the existing excess liquidity. The abundant supply of liquidity relief, a bank that wants to provide a loan, from the traditional consideration of how much money they need after the award of credit is, how it is constituted, and at what cost. Using the so-called money creation multiplier can be estimated how large the potential for additional Credit limit is.

Do you get it now?

Private banks don’t make loans because they have extra deposits lying around. The process is the exact opposite:

(1) Each private bank “creates” loans out of thin air by entering into binding loan commitments with borrowers (of course, corresponding liabilities are created on their books at the same time. But see below); then

(2) If the bank doesn’t have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);

(3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.

It’s not just Bernanke … the central banks and their owners – the private commercial banks – have been running the printing presses for hundreds of years.

Of course, as I pointed out Tuesday, Bernanke is pushing to eliminate all reserve requirements in the U.S. If Bernanke has his way, American banks won’t even have to borrow from the Fed or other banks after the fact to have reserves. Instead, they can just enter into as many loans as they want and create endless money out of thin air (within Basel I and Basel II’s capital requirements – but since governments are backstopping their giant banks by overtly and covertly throwing bailout money, guarantees and various insider opportunities at them, capital requirements are somewhat meaningless).

The system is no longer based on assets (and remember that the giant banks have repeatedly become insolvent) It is based on creating new debts, and then backfilling from there.

It is – in fact – a monopoly system. Specifically, only private banks and their wholly-owned central banks can run printing presses. Governments and people do not have access to the printing presses (with some limited exceptions, like North Dakota), and thus have to pay the monopolists to run them (in the form of interest on the loans).

See this and this.

At the very least, the system must be changed so that it is not – by definition – perched atop a mountain of debt, and the monetary base must be maintained by an authority that is accountable to the people.

Hat tip to Festan von Geldern.

Note 1: When I receive a better translation I will post it.

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About George Washington

George Washington is the head writer at Washington’s Blog. A busy professional and former adjunct professor, George’s insatiable curiousity causes him to write on a wide variety of topics, including economics, finance, the environment and politics. For further details, ask Keith Alexander…


    1. cool

      It should be news. There should be a *public debate* about the current money system in every country, because there is very significant evidence to suggest that the current money-system is unsustainable.

      A good overview of the challenges, including the (in my view) fatally flawed money-system is at

    2. Stevie b.

      Bill G – it’s news to me, but alas I’m not as smart as you. Why don’t you suggest to Yves that folks like me should be banned from both reading this blog as well as committing the more heinous crime of daring to respond to smart folks like you?

  1. Owe Jessen

    The google translation is at least misleading in the part “Both state and private commercial banks” – the original says “Sowohl staatliche Zentralbanken
    als auch private Geschäftsbanken können Geld schaffen.”, which translates into “governmental central banks as well as private commercial banks”… So no points for public banking there.

    1. fresno dan

      I think it is news to most people, and I appreciate every post on it. I have been reading for a while Keen, and a few others who have been in the vanguard of explaining that credit creates deposits, and not vice versa.
      As someone who is by no means financially sophisticated, I have had some economics courses, and I was taught the classic money multiplier method of credit formation.
      I think understanding that that theory may not be correct is important, because at its heart the financial problem is not a liquidity problem, (solvency is what the problem is), but what caused it is an agency problem. It seems to me in the past credit was constrained in large part due to the social milieu, i.e., stay out of debt.
      Now, after years of erosion of that belief, banks (or more accurately the people who run them)can loan out as much money as they desire. Selling the loans, they don’t have to even worry about the interest, never the less the principal.
      Like a ponzi, everybody seems to get rich…until they don’t.
      But understanding that there are no “natural” limits to how much credit they choose to create is an important part of the puzzle.

  2. Kevin de Bruxelles

    Billy Blog also has a post up today on this subject.

    Professor Mitchell does not seem at all worried that the Fed is dropping the reserve requirements; he says this has already happened in Canada and Australia with no problems. It would be interesting to hear the reasons why you think reserve requirements are helpful.

    1. EmilianoZ

      Canadian and Australian bankers are of the “boring” kind.

      Dropping reserve requirements for US bankers is like giving away WMD to trigger happy GIs.

      1. i on the ball patriot

        The Military Banking Complex,
        Is at war with you and me,
        It controls the flow of credit,
        We all pay an outrageous fee,

        Its weaponized the use of credit,
        With a low interest bubble bomb,
        And bunker busting derivative products,
        All dropped without a qualm,

        Corporate fascist generals,
        Who once had profit as a goal,
        Now work to rape and eliminate,
        The battle is now for control,

        We are now the enemy combatants,
        We are the Indians of yore,
        We are the raped, the pillaged and the decimated,
        We are imperialism’s newest gore,

        So rise up my fellow citizens,
        Throw off these banker scum,
        See through their lies and deceit,
        Beat their deceptions until they are numb …

        Deception is the strongest political force on the planet.

        1. Kevin de Bruxelles

          Great stuff.

          You need to find someone who can sing these lyrics to something like Sabbath’s War Pigs!

      2. Kevin de Bruxelles

        Yes I looked into it and both Canada and Australia have mostly recourse loans. In other words the demand (customer) side is constrained by the fact that you will have to pay that loan back come hell or high water. That’s how it works here in Belgium. Therefore less regulation is needed on the supply (bank) side of credit.

        Frankly a recourse system makes much more sense to me.

        1. anon

          Non-recourse loans for RRE make more sense to me because the banks, who are the repeat players, have much better access to information than residential buyers. They have better information about the local RRE and CRE markets and developers, how well or poorly local businesses (and residents) are doing, overall credit expansion or contraction, etc. Also the appraisers work for the bank (even if they are nominally independent, though they often aren’t, they want to make the banks and RE agents happy so they can get more business). Buyers are in a poor position to determine/quantify the actual risks involved in buying a home. Since the risk of loss should be on the party best able to prevent that loss, I think the banks should bear most of the risk in RRE loans, especially for risks like lending on inflated values. OTOH, I think buyers should have some skin in the game since some risks (e.g., buyer’s loss of income or poor money management) are generally more in the buyer’s control than the lender’s. I think non-recourse loans with more than a nominal down-payment work fairly well to allocate risk. I’m sure there are better methods but IMO recourse loans are worse.

  3. clearlyadunce

    What I fail to understand in this account is how this process ‘creates’ money that can be spent. OK, the bank’s B/S balances at the moment of loan creation. But as soon as some of the loan cash is withdrawn so that the borrower can spent it, the funding has to be replaced. Thus the bank has to take more deposits or issue bonds or do a repo with the central bank. In other words, ALM demands that they replace the lost funding with either old (already created) money from someone or with money the central bank has created. Thus it seems (perhaps wrongly – please explain) that only the central bank can create new money as they are the only people who can turn on the printing presses to funding themselves.

    1. vlal21

      it’s called fractional reserve clearlydunce. For every 1 euro a bank has it can lend out 9 euro. The cycle continues and by the time it has finished 1 euro has created 99,000 euro in the system. Check out the movie called The Zeitgeist, it explains it all. You will be shocked I will warn you. Only Bankers, Traders, and Top government officials. You can find the videos on this site. It’s free to watch.

      Video Link:

    2. Fed Up

      clearlyadunce, here is a simple example with one bank. Bank creates a $100,000 mortgage (debt). Bank “creates” a $100,000 check (debt) for the purchaser. The purchaser gives the check to the builder. The builder deposits the check back into the bank.

      Notice there was NO CURRENCY involved.

      You might want to check this link and comment out by JKH | November 29, 2009 at 05:32 PM:

      It is LONG but worth reading it.

  4. craazyman

    George, that translation is to the English language as Hitler was to Poland. Wikipedia does a good job on the same topic. I second the doubts expressed about the newsworthiness of this stuff (And I’m not an economist or a finance big shot, I’m just an average dude). For good or for bad, there are historical reasons why the “system” evolved this way. It’s not necessarily an evil thing, but it can be abused for evil, like almost any thing.

    I’m sure folks would be amazed at the way an LCD screen works if they looked into the physics. If they looked into the way their minds worked, they’d really be amazed. But generally people don’t go there. Ho ho ho.

        1. i on the ball patriot

          The great thing about being thrust into this great big cannibalistic frenzified mystery is that we all get to make our own morality — our own ethics … we get to pick and choose what we think is evil …

          When some cannibals proclaim that they are more equal than other cannibals, and can deceptively control the creation and flow of credit that controls the use of resources, then i say fuck em! I say that’s newsworthy and lets call them evil and shit on their heads.

          In history? How about compared to Hitler who proclaimed that the Germans were the superior race and should control everything … that’s pretty evil …

          Deception is the strongest political force on the planet.

  5. sam hamster

    Thank you for describing the conveyor belt between the natural resources of the world and the over-embellished, shelters that we live in. As it turns out, slime is a good lubricant.

  6. Cathryn Mataga

    Restricting lending based on reserves is
    pro-cyclical. That’s the problem —
    as stuff rises in value, banks lend
    more and prices spiral up. Lending
    is restricted as the capital declines in
    value, which is exactly the opposite of
    what we want.

    Does that mean banks should be able to
    create infinite money? I don’t know.
    I believe the current system is fatally
    flawed but I’m not sure exactly what
    should replace it.

    1. eric anderson

      What should replace the system of money creation out of thin air? Well, pretty much anything that can’t be created out of thin air on a political or corporate whim would be a good start.

      Milton Friedman once suggested a fixed rate of monetary expansion each year. Even that would be an improvement.

      Yes, this is news to most people, that credit comes from nothing. If it ever sinks in so that they really start to understand it, most people are going to say, “Nooooooooooo!!!!” At least that is my guess. But have no fear, the mainstream moron media will never catch on, and neither will most of the public. If they do, I’ll be pleasantly surprised.

      1. Martin

        And why do you think is the Bundesbank explaining that is advertised in the preface to be read by high school student?

        Actually it is a quite good system, and George’s claim, that capital requirements are irrelevant is not only false, but irrelevant. A bank can run on a bit negative equity, but if you are seriously in negative equity, the bank will become insolvent regardsless of accounting tricks.

        The problem is not the banking system, but bailouts without erasing the equity.

        1. Psittakos

          About the significance of capital requirements, I think the author of the post is only suggesting that the too big to fail banks are backstopped by the government and are not going to be shut down for insolvency.

          Indeed, it is my impression that innumerable banks in the US beyond the too big to fail banks would be shut down if the FDIC were to do its job.

  7. zanon

    Regulatory capital requirements actually constrain lending.

    As you make loan, your balance sheet grows but your capital stays the same — you become more leveraged. if you go beyond your regulatory capital then you can be shut down. So, if you make too many loans regulatory can crack down on you, or if too many loans go bad and eat your capital FDIC can shut you down too.

    Unless you are Goldman Sachs in which case Obama just gives you money.

  8. marxbitesall

    For the Net’s BEST website dealing with Freedom, America’s intermeshed economics and history by non-eastablishment economist/historians please see the 7TBs of free online content incldg mp3 lectures, videos, recent & oop books, economics blogs, economics journals, daily articlces, etc.,

    then please goto

    that is if you value freedom and dont want to see your grandkids and their’s become bigger slaves than they already are at birth.

  9. Kid Dynamite

    GW – I’ve been working on grasping this concept all week. i hope you can clarify one thing for me.

    you wrote:
    “Private banks don’t make loans because they have extra deposits lying around. The process is the exact opposite:

    (1) Each private bank “creates” loans out of thin air by entering into binding loan commitments with borrowers; then

    (2) If the bank doesn’t have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);

    (3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.”

    in fact, it’s even worse than that isn’t it? reserves are held against DEPOSITS, not loans… so when a private bank creates a loan out of thin air with no deposits, they have to go and borrow that entire amount from the Fed (or elsewhere), don’t they? the Fed essentially gives them deposits to lend. of course, we hope that the Fed does this based on the bank’s credit worthiness and established equity.

    in other words, the Fed doesn’t just lend them reserves – the Fed lends them the full amount – assuming they (the private bank) don’t have deposits to lend from.

    and THEN, the private bank must post reserves on the Fed’s deposit? ie, with 10% reserve requirements, they borrow 110% from the Fed? (100% to pay out the loan, and 10% to have reserves on hand?)

    1. zanon

      Kid Dynamite:

      “in fact, it’s even worse than that isn’t it? reserves are held against DEPOSITS, not loans… so when a private bank creates a loan out of thin air with no deposits, they have to go and borrow that entire amount from the Fed (or elsewhere), don’t they? the Fed essentially gives them deposits to lend. of course, we hope that the Fed does this based on the bank’s credit worthiness and established equity.”

      Reserves are simply accounting entry held as asset by bank and as liability at Fed. Primarily they are used for settlement balances. When bank creates loan, it creates deposit as a matter of double entry bookkeeping necessity. This deposit may or may not be held at a different bank, and reserve accounts are required to manage settlement balances across the system as a whole. There is nothing nefarious in this.

      Capital requirements determine if bank can make loan or not. And yes, one hopes Fed keeps track of how leveraged bank is, quality of its assets, sufficiency of its capital, and when bank is undercapitalized, we want Fed to have the balls to shut bank down.

      In obama’s america that does not happen of course.

      “and THEN, the private bank must post reserves on the Fed’s deposit? ie, with 10% reserve requirements, they borrow 110% from the Fed? (100% to pay out the loan, and 10% to have reserves on hand?)”

      No, you are confused about this. See above.

      1. Kid Dynamite

        thanks zanon – there is no doubt i am confused.

        but i need you to clarify the key question: if my bank, the Bank of Kid Dynamite, has no deposits, how do I loan you money when you come in asking for a loan? I have to get that money (even if it’s only digital money) from somewhere right? if i have no deposits, I borrow it from the interbank market, or from the Fed. no? i borrow the entire amount – because i have to give my customer (who takes out a loan) the full amount – I need to come up with that money from somewhere. or does it come out of my equity capital?

        forget about reserves for the moment – i’m not even talking about that.

        in other words, you said “capital requirements determine if a bank can make a loan or not”

        ok – yes – is that the same as saying “if you don’t have any deposits, then capital requirements will determine if the Fed or other banks will lend you money to lend to your customers” ??? that’s how I’m understanding it. The Bank of KD has equity of course, even though i don’t have deposits, and the Fed will lend me money to re-lend because I have equity. >???

        1. Hu Flung Pu

          Eventually you have to have deposits, KD, but not immediately. Think about it this way: You start up Bank of KD with $10 million in equity. Right off the bat, you can lend up to maybe $8 or $9 million of that equity even though you don’t have any deposits (you’ll still have to keep a little liquidity around for working capital). But… if you want to expand your balance sheet – say make loans of $20 or $30 million more – then you’ll have to take in deposits to fund these new loans(assets = liabilities + equity). But… because the depositors will not all demand their deposits to be redeemed in cash all at once, you won’t have to keep these deposits in cash – thus, you will lend a portion out (in the form of loans), invest a portion in investment securities (typically bonds), and only keep maybe 10%-15% in actual cash to meet the redemptions of those folks who do have immediate cash needs. And THAT is where money/debt/credit gets created “out of thin air.” That’s the “fractional reserve” system at work. Because you only have to keep a small portion of deposits in the form of readily available cash (and the rest can get lent out or invested in securities), money is created out of thin air. Does that make more sense?

          Unfortunately, I think there’s a lot of confusion on this subject most folks who don’t understand bank accounting and reserve/liquidity requirements.

          1. Kid Dynamite

            thanks for the reply HuFlungPu. so you’re saying that if i have not deposits i lend FROM my equity, and not that I lend by borrowing (From the fed/interbank market) against my equity?

            i’m actually not even asking about reserves right now. I’m trying to figure out how I can make loans BEFORE i take in deposits – as a practical matter.

            in this post, GW wrote “Each private bank “creates” loans out of thin air by entering into binding loan commitments with borrowers.”

            I think that’s probably correct, but how do I actually give the borrowers the money that I loan them? I have to give it to them NOW, not in the future when I get my deposits in… so do i borrow the full amount right now from the Fed?

          2. zanon

            Kid Dynamite:

            HFU is incorrect.

            Sat you have a new bank with $10 in equity. Capital requirements are 10%, say. You have no deposits.

            Someone comes in and wants to borrow $90. You can do this immediately. You create an asset — the receivable of $90 (which is the loan) plus you create a liability — the deposit of $90.

            Note, your equity has not changed. You still have $10, but now you have $90 of liability on top of it as well. If the deposit is at your bank the story is over. You have created money out of this air through power of accounting.

            If deposit is at a different bank, then instead of crediting deposit you debit reserve account (another asset). You go into overdraft when you do this in my example.

            You then spend rest of day trying to attract deposits from other bank so you can credit reserve account and liability. Maybe you get it, maybe you do not.

            Sun goes down, it is night time, you do not have deposit yet. So, you borrow via repo at overnight interbank market. This is how the federal funds rate is set btw as Fed intervenes heavily in this market to hit target.

            OK, so you should get what you need to hit reserve requirement, but maybe no one lends to you because system is net short reserve. Is possible.

            Then Fed either lends directly at discount window, or Fed lets FFR spike.

            That is all.

  10. marxbitesall

    I should have added the kinds of issues addresses and illuminates:

    The Revolution and what and who informed the founders.

    America’s banking and financial history and who and how its cooperating politcians, bankers and industrialists were always behind our wars, their familial, business and govt connections. The Bank of NA, 1st & 2nd BanksUS and the bankers coup the Federal Reserve. Was it needed to finance WW1? Was its creation for that reason alone? Who owns the FED and who controls it?

    EVERY question in the above realm and more can be truthfully answered for you at

    It is the history and economics course online we were ALL denied in school, and for that the one most important we get as the Establishment/MICCs worst fear; and informed and and therefore activated electorate for freedom.

    The meaning of freedom and money, and the right to remain uncoerced by others, esp govt.

    What is inflation really, higher prices, or the printing of more fiat money chasing the same amount of goods? Is it moral – what are the short & long term consequences – do some get richer while some get poorer from it, and who is whom? Does it contribute to less freedom and rights for the people and more for the govt and its puppeteers?

  11. zanon

    Please, for the love of Gods, do not go to Mises to learn about this stuff.

    The Austrians think we are on gold standard, which has not been true in US for quite some time now.

    If you want to understand fiat currency, go read Mosler’s required readings. Avoid austrians, they have no idea what they are talking about and absolutely cannot help you understand system in US today.

    1. Martin

      That is not true. The Austrians do not think anybody is on a gold standard. They think we should be.

      1. zanon

        Fair point Martin.

        But the reason they think ppl should be on gold standard is because they do not understand current system. They think it is a big fraud or whatever.

        So, if you want to learn about current system, do not ask austrian about it as they have no idea.

  12. Mr Stoat

    The original blog seems not be able to comprehend the difference between accounting conventions and cash. When you make a loan you create two entries – an asset and a liability. This grosses up the assets and liabilities of the bank. This is not the same as creating credit out of thin air. If you believe this, it is time to go back to school.

    If you move away from the accounting and look at the movement in cash or the economic reality of what is happening; when the bank is making a loan it is using shareholders’ and depositors’ cash to lend to the borrower and taking a cut on the interest rate. The credit (i.e. the money) is not created out of thin air at all.

    Technically grossing up the assets and liabilities of the bank does increase the wider measure of money supply. However, in reality as most banks try to run efficient balance sheets all the time they lend near to their maximum permitted leverage. In practical terms new loans can only be made when repayments are made on existing facilities. The amount of leverage a bank is permitted is constrained through regulation of their capital adequacy ratios.

    If only it was possible for banks to invent money.

    1. Mark

      “The credit (i.e. the money) is not created out of thin air at all.”

      Or to think of it another way…where else would credit be created from? All it takes is for two parties, some paper and pen, and hopefully a legal system to create credit. Mr. Smith writes Mr. Jones an IOU for $1M, and trades it for a Mr. Jones’s home, and they just created credit “out of thin air.” There was no cash involved in the transaction.

      Throw a bank into the mix, where Mr. Smith now owes the bank $1M, and the bank owes Mr. Jones $950K (taking it’s cut and effectively insuring Mr. Jones against non-payment from Mr. Smith) and the credit was created from the same place: “thin air”. The fact “cash” is involved and changing hands at some level is almost irrelevant.

      There is really nothing sinister or mysterious about this, but with the advent of blogging and a financial crisis, I suppose this kind of thinking was bound to make the rounds for a while.

      1. Mr Stoat

        People are confusing accounting entries within banks with money creation. The analysis is slightly opaque because the wider measure of money supply does include credit given within banks.

        Commercial banks do not create the money. They are the agent that allows money to be distributed to where it is needed by loaning money deposited with them and invested by shareholders to people who want to borrow it. Nothing they do creates additional money.

        The economy creates money through growth. The banks distribute the money. Statisticians measure this growth in money through credit given by banks.

        Asset appreciation and bubbles create money because people believe assets are worth more, creating profits as these are bought and sold, and as a result, growth in the economy and hence money supply.

    2. PS

      “when the bank is making a loan it is using shareholders’ and depositors’ cash to lend to the borrower and taking a cut on the interest rate.”

      Not sure how you define “using”, but there is no sense in which a bank lends either its deposits, or shareholders capital to borrowers.

      Banks don’t lend deposits, nor do they lend reserves (to non-bank borrowers). Nothing of substance is loaned at all, there is merely an exchange of promises to pay. Drawdown of the loan may subsequently involve ‘behind the scenes’ transfer of base money, but this is a distinct operational issue from the creation of the loan itself.

      Banks don’t require reserves, or deposits, prior to initiating a loan. Reserves can be obtained later if needed, and deposits are the consequence, not a necessary precursor, of loans.

  13. Martin

    Sorry, but this post is really ridiculous. As indicated above, it is cited from a book, that the Bundesbank intents to be read by High School students.
    I don’t want to explain here, what exactly happens when to prevent the banks looting the public with this mechanism.
    But everybody who thinks it is scandalous should really think, why the monetary establishment wants everybody to know this and is engaging into such educational efforts
    In reality capital ratios of course play a role, and the rendite on equity in German banks is painfully low.

  14. Question

    Non-financial person here:

    Doesn’t this just mean that the banks don’t have a dollar bill in the local vault for every dollar they own? It seems this is about accounting. When I write a check to someone from another bank, dollar bills are not transferred between our banks, the federal reserve is simply instructed to move the $200 from my bank’s column to the column of the other bank. The same thing is true when I buy a house. I get a $150,000 loan, which immediately goes to pay for the house, and the seller’s bank account shows up with $150,000, which has been in turn credited to their bank from my bank on the balance sheets at the federal reserve. No literal dollar bills are ever moved. And if my bank needs an overnight loan to cover itself, it can get one from the fed. But my little local bank cannot simply ask the fed for billions of dollars and get it on a whim. The fed will only loan the money on a short term basis based on the size of the banks assets and it’s capital ratio.

    Please explain what I am missing.

    1. NotTimothyGeithner

      The point is your little bank or you can’t get that loan, but larger corporations and banks are getting the loans to cover their bad bets and pay their CEOs who made those bad bets.

      1. Question

        But don’t the same constraints apply to larger banks, just on a larger scale? The fed loans money to the large banks at the same rate on the same short term basis that it loans money to a smaller bank. The fed does not simply give them money. Now I am, of course, talking absent the big bank bailouts that did nothing to wipe out the banks’ shareholders. But in the normal course of the fed, big banks face the same capital ratio restrictions as small banks and cannot simply be given money by the fed to profit from any more than a small bank can get this kind of deal. The ability to get a short term loan from the fed is proportional to the size of the bank. Yes? No? What am I missing?

    2. sam hamster

      Check out this video: “Money as Debt”

      See the section beginning at 13min,05secs.

      “It also shows how central bank money is used to create commercial bank money from an initial deposit of $100 of central bank money. In the example, the initial deposit is lent out 10 times with a fractional-reserve rate of 20% to ultimately create $400 of commercial bank money. Each successive bank involved in this process creates new commercial bank money on a diminishing portion of the original deposit of central bank money”

      1. Question

        I read the Wikipedia entry. Yes, this expands the money supply. But this is fundamentally about accounting. What it basically says is that the money circulates, is deposited in other banks, and the other banks lend the money out again. If a bank is required to hold 10% of capital in reserves, then on any given day, if everyone tried to empty their bank account, the bank would only have 10% of what is in the bank accounts.

        If you subtract debt from assets in the example on Wikipedia, you have the original $100. So while there is an extra $357 on the positive side of the ledger, there is also an extra $357 on the negative side of the ledger. If you want to call this creating money, then you would have to say that for every positive dollar that is created a negative dollar must be created. That sounds a lot less scandalous though.

  15. Ancaeus

    I don’t think that the process outlined in this post can be rightly described as “creating money out of thin air.” Here’s why:

    The other essential ingredient in this process is a willingness on the part of someone to commit to a somewhat odious contract — to “borrow”. The process dissipates this willingness — converting it into money. It is this willingness that is currently in short supply.

    People talk about the value of U.S. dollars being based on the “full faith and credit” of the U.S. Government. It seems to me that it is really based on the full faith and credit of the typical borrower of U.S. dollars.

    Why am I willing to exchange my goods for dollars? It is because I have a firm expectation that those dollars will be accepted in exchange for what I need. This is a reasonable expectation because ultimately those dollars will find their way into the hands of someone who owes money to a bank. His contract with the bank is to repay dollars — not chickens or gemstones — so I know that there will continue to be demand for those dollars.

    Suppose, instead, that I thought that the typical borrower of U.S. dollars was going to default. Those defaulting borrowers aren’t going to need dollars to repay the bank. I would then have serious doubts about continuing demand for dollars, and would seek compensation in the form of chickens and root vegetables!

    1. Toby

      Agreed, there is a balance in the form of a willing and able borrower, but the process does draw money towards money ‘creators’ because they are always owed interest on their ‘creation.’ The debt is expunged when the last payment is made, the bank keeps the interest, the borrower whatever was purchased. The problem is that, over time, and especially considering the constant systemic pressure to make as much money as possible — it’s all about profit after all — banks (or money makers) end up with too much power. As we all know, money makes the world go around. They who control the money, control the world. The longer this system runs, the more power accrues to the money makers. We end up with a very unbalanced system, with ‘TBTF’ players messing everything up.

      And this is hardly the first time this has happened. History is littered with the problems of usury. It’s a mathematical problem, which has only radical solutions as far as I can tell — debt jubilees, sovereign defaults, which are only temporary fixes, or, my preference, a total redesign along the lines of a resource-based economy. So, the expression “out of thin air,” while not strictly true, does help draw people’s attention to the fact that all is not well in the Kingdom of Denmark, and helps puncture the illusion banks willfully promote of rock-like stability and wise, mature handling of their customer’s money.

      We have a broken system and a very precarious situation. As many people as possible need to be aware of this. I welcome GW’s work and all debate on this topic.

  16. M.G. in Progress

    What is the difference between money created out of thin air and a Ponzi scheme? I do not see it particularly when banks buy governments bonds (that is they lend money to governments) and governments then intervene to save banks and central bank continue to lend cheap money to banks accepting governments’ bonds as collateral. If you run this system cross-border like Germany-Greece crisis one could wonder if we should not stop this creation of money out of thin air and let Greece default (German and ECB will have to stop the money creation).

  17. Paul Tioxon

    I am not sure if this set to attempt to disabuse the general populace of notions bouncing around in their collective consciousness about the nature of reality. Aside from the formal structure of banking with its rules and generally accepted accounting practices, it should be clear that money is simply created, whether coined or printed, as part of the social order, which is our invention. I am not sure how much there is a transference of religious awe and wonderment at the miracle of creation or the mystery of the origin of life, but money is usually seen being printed on presses, in large uncut sheets, nearly everyday on some evening business or national network news program. Its formal introduction into the economy and its role in it, in a way that is theoretically sound and complete as a system is no different than our own personal social identities, which are made up, as you say out of thin air. What is important to my thinking is the theoretical model of money and the larger system that it is a part of.

    The typical metaphors employs simple Newtonian Mechanics, in particular, the fluid properties of a liquid. The cash is flowing, the pump is being primed, it is a liquidity problem etc. I believe a more complex system at work would better employ information theory as a model and money would be viewed in terms of its cybernetic function. I believe this would have a lot more explaining power and a better model, commensurate with econometrics that is actually used. Money then is the data that is turned into the information that organizes the behavior of people into more efficient organizations of production, distribution and consumption. The moralistic tension between those who do not like the idea, the term or the policies of welfare economics and those that are simply trying to make a world without needless poverty and suffering as far material well being is concerned, can be seen with more more clarity. People do not always get what they deserve, in terms of some people doing all of the work and others doing none of it and compensation varying from billionaire godhood to meager trailer park subsistence even after working 2 jobs. I know there is a different theoretical calling on this site, but I believe a multi-disciplinary approach is needed, considering that Yves has created a meta conversation about the political economy. Historic antecedents, such as Ghengis Khan instituting the use of paper currency along the silk road, to be recognized under the penalty of death, helped to establish a working international, transcontinental currency and banking system. This first, created out of thin air, shows what social orders can be created and sustained to the benefit of the general populace. It is quite clear that we are in a cultural crisis equal to and coinciding with the financial crisis. The many posts and Yves own searing passion to expose and outrage any educated banker as to baseless intellectual claims and criminal fraud in operations raises the conversation beyond the academic, the lonely voice in the wildness or someone ahead of their time. There needs to be a very real political debate and restructuring of the way we do business, in addition to any policy directions for national goals, such as moving to solar electric, from fossil fuel. I see Yves and her contributors as an Institute of Quantum Economics, moving decisively beyond the discredited and outmoded theories of the past. If equilibrium economists were valid, if they were any good at all, we would not have an ongoing collapsing banking system, the back bone of our manufacturing sector bankrupt, and two handed economists with at least 4 opinions.

    1. Toby

      Good post Paul.

      Money is a tool to enable trade, but trade too is a technology (or tool) for distributing goods and services. Both are predicated on scarcity. There are two major problems with the system that has arisen out of these conditions of trade, price and scarcity. The first is that those who create money end up with too much power, and pretty much always collapse the system. The second is that technologically speaking we can produce more than enough of the basics, plus many “luxuries” like movies, music and transport, for everyone planet wide. That is, we are now at the stage where we can make scarcity of the necessities, and much else besides, a thing of the past.

      A side issue, though very important, is technological unemployment, dismissed by neoclassical economists as a lump of labour fallacy. It is not. Our ability to replicate and improve on all human abilities is accelerating. Soon, perhaps in thirty years, there will be virtually no task important to the economy that cannot be automated, and cheaply so. Should we crack the energy problem (we certainly have the know-how!), the multi-whammy of mass unemployment, TBTF money-making institutions, gross concentration of wealth to the tiny minority, the absurdity of perpetual GDP growth, and the mathematical problem of usury-based systemic crashes, will force us to change the rules of the game. The way I see it, and I have been studying this intensely these past 18 months, there is only one viable alternative: a resource-based economy.

      Because we can now technically make scarcity a thing of the past, because we can redesign cities, transport, buildings, factories etc. to increase unemployment and energy efficiency, we must transcend money, transcend systemically the need for all media of exchange. This is a fringe idea I know, but only because it is so alien to what we have lived with for millennia. The standard arguments against it are lazy/greedy/selfish human nature, there will always be scarcity, money is the only effective incentive, and, you need price information to distribute goods and services efficiently. All arguments are weak when properly addressed.

      However, such an idea can only take off if a sufficient number of people want to pursue it globally. The first thing a resource-based economy requires is a global declaration that the planet’s resources are the common heritage of all mankind. That’s a tall order, but these are desperate times, and a paradigm change, deeper than any before in known history, is upon us. Big problems need, typically speaking, big solutions. A resource-based economy is just such a big idea, and would change everything.

  18. A. Wells

    Why get exercised about this? Everyone would like the economy to grow, and the economy is measured in money. Is is such a big leap to conclude that in order for the economy to grow, money has to be created? Paper money is always created out of thin air (if you do not count the cost of paper, ink, presses, and the bureaucracy around it). And which government on Earth will give up the power it gains from having paper money, and subject itself to the discipline imposed by gold instead?

  19. Pat McClung

    This is hilarious!

    Anybody who does not believe that banks create the money that they lend ought to have their head examined, since they cannot discern the difference between an asset and a liability. Really! It is absurd that people are so mystified by money capitalism that they cannot see this simple fact. Money is what a bank owes you. Period.

    The banks cannot lend out the money you deposit. That is YOUR money, not the bank’s money.

    In fact, if a bank buys a Persian rug for the president’s office, it creates the money for that, too.

    A bank creates money every time it acquires an asset.

    Hope that isn’t too abstract for you. You really must learn about money, you know.

  20. joebhed

    Page One:
    Yes, money MUST be created out of thin air, like everything else, from non-existence into existence.
    Page Two:
    Because money that IS created out of thin air imparts the benefit of the money on the creator(why it’s the bankers that are rich), the question should become, who should create the money out of thin air.
    Page three:
    There are three accepted aspects of the nature of money; one involves something called the “national medium of exchange”. This ought to lead to a conclusion that it is the “nation” that should reap the benefit from creating the “national medium of exchange” out of thin air.
    Page four:
    The most comprehensive proposal for a national circulating medium created by the nation for the benefit of the people of the nation can be found at the American Monetary Institute: .
    Monetary reform now.
    The Money System Common

  21. alex_canadian

    This post is childish. I don’t understand how this site has such a mixture of quality posts by Yves and completely stupid posts by guests.

    Here is how system works (and I hope this subject will stop here).

    Banks HAVE to have assts to make loans.

    Can banks potentially make loans from thin air? Yes, they can but it is ILLEGAL. After audit bankers will go to jail.

    So, I repeat bankers HAVE to have assets. They can have assets in form of deposits, loan from other banks, or from the central bank.

    Hope it helps now.

  22. Ingolf

    It’s kind of weird that this badly translated bit of educational material from the Bundesbank can be considered newsworthy. A visit to the New York Fed website shows how old hat it is:

    “Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.”

    Or, to put the whole discussion in a much longer term context, consider this quote from Mises’ “Theory of Money and Credit” (p 271):

    “The only circumstance that is of importance here is that the loans are granted out of a fund that did not exist before the loans were granted. In all other circumstances, whenever loans are granted they are granted out of existing and available funds of wealth. A bank which neither possesses the right of note issue nor carries on current-account business for its customers can never lend out more money than the sum of its own resources and the resources that other persons have entrusted to it. It is otherwise with those banks that issue notes or open current accounts. They have a fund from which to grant loans, over and above their own resources and those resources of other people that are at their disposal.”

    Mises was of course writing at a time when the monetary and banking system was very different from today’s. Still, the underlying principles haven’t changed. His analysis and definitional distinctions (with adjustments to take account of actual changes) still apply to our current system.

    The critical difference is that base money is now fiat currency and central bank reserves, whereas in his time it was gold. Taken together with a Fed policy that automatically supplies these reserves whenever they’re required, the constraints that during Mises’ time held back the creation of credit “out of thin air” (or “circulation credit” as he termed it) have all but vanished.

    Still, I don’t see that any of the principles have changed. Nor do I think Mises would for a moment struggle to understand what’s been happening. He might well be amazed at the shortsightedness of the policies that have produced the current structure, but it’s workings surely wouldn’t be a mystery.

    If anything, the mystery to me is why this whole business is seen as anything new rather than the operation of old money, credit and banking verities under a different set of rules.

  23. kssong

    did they abused this to loot and devastate companies and nations?(especially usA)
    does anyone know the functions of following;
    i.plunge protection team.(PPT) stabilization fund.(esh)
    iii.counter party risk management policy group.(CRMPG)

    1. Ruud J.


      Though probably outdated (and Keynesian), I liked reading Galbraith’s Money(“Whence it Came, Where it Went”), helped me a lot understanding money

  24. Ruud J.

    OK, first I’ve to admit I didn’t read all the replies. So much of what I write might already be typed.

    Born in 1956 I remember people getting paid with money issued by the state bank. So bankmoney creation was a bit out of sight then. State banks did have more control on the moneybase by issuing and collecting money. This has changed. Remember during the 60 and 70 suddenly everybody was lured into having a bank account (with no costs involved). So gradually the private banks gradually got hold on moneycreation. By sucking us into buying houses
    (and this also meant house prices were pressured up beyond what they are really worth ) with money supplied by them covered by us vowing to repay the debts and then by ‘securing’ unsecure debts they could broaden the base again, until it all snapped (because we couldn’t afford the debts). Now they will (have to) try again. But we cannot take more debts then we can repay. As I’m old fashioned and have to rely on the money I have I’m mad as hell because I feel this cannot be sustained in the way it has.
    Also keep in mind the way the money base has been enlarged it meant house prices blew off like mad beyond they are

  25. FESTAN

    Out of thin air?

    In essence banks don’t have to create money out of thin air. They should grant a loan against pledged goods or hard assets (which can’t be created as fast as the printing-press is able to run). In this way they bring into circulation not the present value of some goods and services as they ever did, but the present value of land and capital-goods which is rising through the emission of the newly printed money. Thus inflation is the very business of banks and central banks.

    1. Toby

      The “out of thin air” expression is a little dramatic and theatrical, but not so far from the truth that it’s preposterous. When a bank loans money to someone, say in the form of a mortgage, the bank is creating money, by double bookkeeping entry, that DID NOT EXIST BEFORE, and the borrower is promising to pay back the principal plus interest out of future earnings. Neither party brings consideration to the table. In terms of collateral, we all know what happened to the 20% down payment rule, and the bank’s fractional reserves of around ten per cent have been worked very far downwards. I believe some of the big banks have 80:1 leveraging, and Bernanke has proposed doing away with leveraging altogether. Consequently, “out of thin air” is appropriate, though not the whole truth.

      What is most certainly not the truth is claiming that private banks do not create new money. Also, all money is created as interest bearing debt. That’s how the system works. The economy does not create money per se, the economy “grows” as individuals and institutions and governments compete in the market place to pay back the principal plus interest. Steve Keen’s “The Roving Cavaliers of Credit”, posted on Naked Capitalism a while back, looks into the empirical data of money creation, and the facts flatly contradict neoclassical assumptions/thoery on the matter. No surprise there!

      1. FESTAN

        You are totaly right,

        the grand scam is, that few banks (member banks of the FED) knew how to create money for their companions, which they could cash in without limits. In the meantime most banks believed that they should have reservers before lending. Thus the big boys could expand credit creation (=inflation) at a much faster rate than others (country-banks).

  26. urgs

    Admit? They even teach that (not very detailed) at high school damnit. At least in Germany. So the Bundesbank hardly admits anything.


    Giralgeldschöpfung = creation of deposit money

    Best german-english dictionary:


  28. ttsing

    People and self-employed or companies accumulate “capital” by saving surplus from their salaries and by way of retained earnings. Capital only accumulates with Time; hence, Time is money. Borrowing is equivalent to future money being created today, with such money being destroyed ultimately by capital repayment. Since individuals and companies are not allowed to print money by themselves (counterfeiting) a Government/Central Bank system is put in place to do so LEGALLY via intermediary commercial banks as a conduit for lending/borrowing purposes. Indeed money/capital is created “out of thin air” temporarily with (printing) currency or with (book entry) digital money which then dissipates with Time. Only interest paid/received are PERMANENTLY created and REMAIN ETERNAL. The fundamental question is: why do people/companies incessantly demand “future” money?
    The future is always uncertain and thus allowing inordinate money creation may lead to dire consequences such as the ongoing financial and economic crisis.

  29. Andrew

    Naked capitalism has got horribly confused about money creation and the nature of reserves.

  30. Hans Suter

    If and when the credit is payed back is dissolves in thin air, leaving interests and commissions. This is called “Geldvernichtung” destruction of money. The money has been taken out of circulation. This is also written in 4.4. Maybe the poster should have it translated and study it thoroughly before posting again. I wonder how the poster thinks an insurance company makes its profits.
    Never the less the post has been helpful to me, I need no longer read Yves’ blog.

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