How Central Banks (and Even Keynes) Misled the Public About Banking and Money

By Perry Mehrling, a professor of economics at Barnard College. Originally published at his website.

In his recent paper, “A Lost Century in Economics:  Three Theories of banking and the conclusive evidence”, Richard Werner argues that the old “credit creation theory” of money is true (empirically “accurate”), while both the newer “fractional reserve theory” and the presently dominant “debt intermediation theory” are false.  For him, this matters mainly because the false theories are guiding current bank regulation and development policy, leading down a blind alley.

But it matters also simply because we need correct understanding of how the economy actually works, “we” meaning not just economists but also the general public.  “Today, the vast majority of the public is not aware that the money supply is created by banks, that banks do not lend money, and that each bank creates new money.”

Why is the public ignorant of the truth?  Much of Werner’s paper is devoted to an account of how the correct theory was pushed out of the conversation, first in the 1930s by the fractional reserve theory, and then after WWII by the debt intermediation theory.  One culprit was a shift toward deductive and away from inductive methods.  Another culprit, he suggests, was the self-interested “information management” by central banks, i.e. direct suppression of truth in their own publications.  And in this suppression, he further suggests, Keynesian academics were at the very least complicit:  “attempts were made to obfuscate, as if authors were at times wilfully trying to confuse their audience and lead them away from the important insight that each individual bank creates new money when it extends credit.”

In this history, Werner gives special attention to Keynes himself since Keynes seems to have held each of the three theories in succession throughout his life.  Keynes’ own intellectual trajectory thus foreshadows the subsequent evolution of monetary thought, and so probably is partly responsible for leading successive generations astray.   Just so, one apparent legacy of Keynes is that the Bank of England is currently holding all three theories at the same time!  “Since each theory implies very different approaches to banking policy, monetary policy and bank regulation, the Bank of England’s credibility is at stake.”  BoE credibility is thus a third reason that all of this matters.

But is it really true, as Werner claims, that these three theories are “mutually exclusive”?

He is at considerable pains to show that they are mutually exclusive, by using a succession of stylized balance sheet examples.  The credit creation theory says that banks make loans by creating deposits, essentially expanding their balance sheets on both sides by the same amount.  (The borrower of course also expands his own balance sheet, the loan being his liability and the deposits being his asset.  In my own “money view”, I call this a swap of IOUs.)  In this way, money (bank deposits) is created that was not there before.

By contrast, the debt intermediation view says that banks make loans by lending reserves that they are already holding, essentially swapping one asset for another, these reserves having previously been obtained by someone’s deposit.  The balance sheet expands when the deposit is made, not when the loan is made.  Banks merely intermediate between savers and borrowers, and do not create money.

In between these two views, the fractional reserve view says that individual banks make loans by lending reserves, but that the banking system as a whole can and does create money, up to a multiple of reserve holdings.  The banking system does create money, but only after and as a consequence of the central bank increasing reserves–this is the famous “money multiplier”.

So the difference between the theories seems clear, and it also seems like that difference should be testable empirically simply by watching actual bank balance sheets and seeing what happens when a loan is made.  Does the balance sheet expand or does it not?  With the cooperation of an actual bank, Werner books a dummy loan and finds that the balance sheet of the bank does in fact expand.  This he takes to be scientific proof that the credit creation theory is correct and the others are false.

Not so fast.  Let’s look a bit closer.

Let me begin by admitting my sympathy for Werner (as I have already hinted by mentioning my own “money view” as a version of the credit creation view).  In fact, Werner’s heroes–H.D. McLeod and Joseph Schumpeter–are my own heroes as well, and I suspect that graduate school exposure to these authors sent him off on his own intellectual journey just as it did me.  Even more, thirty years after that initial exposure, I find Werner’s (co-authored) money and banking textbook “Where Does Money Come From?” one of the best introductions to the subject.  Last fall I assigned Chapters 2 and 4 in the first two weeks of “Economics of Money and Banking” which I teach at Barnard College, Columbia University.  I’m sympathetic.

But I don’t think these three theories are quite as mutually exclusive as he makes them out to be.

For me, the central analytical issue is the distinction between “payment” and “funding”.

Let us suppose, with Werner, that Citibank makes a mortgage loan to me of $200,000, simply by swapping IOUs.  I then transfer my new asset (the new Citibank deposit) to you, and you transfer your house to me.  As my payment clears, you have a new deposit in your own bank (let’s say Chase, to make it interesting), Citibank has a “due to” at the clearinghouse, and Chase has a “due from”.  Again, to make it interesting, let’s suppose that Citibank has no reserves, so it enters the interbank market to borrow some, from Chase.  At the end of the day, what we see is that the Citibank balance sheet is still expanded, so is Chase’s, and so is mine.  Only your balance sheet stays the same size, since you have swapped one asset (your house) for another (money).  That’s the payments perspective.

What about the funding perspective?  If we follow the balance sheets through, it is clear that your money holding is the ultimate source of funds for my borrowing. (You lend to Chase, which lends to Citi, which lends to me.)  In this sense, we can think of both Chase and Citibank as intermediaries, channeling funds from one place in the economy to another.  But, in this example, there is no saving and there is no investment.  The sale of the house adds nothing to GDP, it is just a transfer of ownership.  The expansion of the banking system has facilitated that transfer of ownership by creating a liability (the deposit) that you apparently prefer to your house, at the same time acquiring an equivalent asset of its own (the loan).  Citibank collects the spread between the mortgage rate and the interbank rate; Chase collects the spread between the interbank rate and the deposit rate.

But all of that is only what happens right at the moment of payment.  What happens afterwards depends on the further adjustment of all of these balance sheets.  One way this could all work out is that Citibank packages my mortgage with others to create a mortgage backed security, and that you spend your Chase deposit to acquire a mortgage backed security (perhaps indirectly through a mutual fund that stands in the middle).  In this scenario, the newly created money is newly destroyed, the balance sheets of both Citi and Chase contract back to their original size, and the end result is that you are funding my loan directly.  But again, no saving and no investment, just a change in your asset allocation, away from money toward fixed income investment.

Obviously this final scenario is a limiting case on one side.  The limiting case on the other side is that you (or whoever you transfer your money to) are willing to hold the newly created money balances as an asset, so you continue to fund my loan indirectly.  Now when Citibank securitizes and sells, it is able to repay its interbank liability to Chase, and for simplicity let’s say that Chase uses that payment to acquire a different money market asset.   One way this could all work out is that a shadow bank–money market funding of capital market lending–acquires the security and uses it as collateral for wholesale money market borrowing from Chase.  Again, no saving and no investment, but the new money stays in circulation and is not destroyed.

These are the limiting cases, and obviously anything in between is also possible, depending on the portfolio decisions of Citibank, Chase, and you.  But in all the cases, the debt intermediation view of banking is perfectly consistent with the credit creation view of banking.  One focuses on the ultimate funding, while the other focuses on the initial payment.

That said, I have to agree with Werner that the credit creation process is all too commonly left out of the story–most modern courses never even mention the payments system–and it is a real (and important) question how this came to be so.  It is a further real (and important) question why the intellectual memory of how the process actually works was left to marginalized sections of academia–Werner mentions specifically the Austrians and post-Keynesians.  I’m not so sure that it was a central bank plot, though I do think that the shift in academic fashion toward studying equilibrium of a system of simultaneous equations played a role in obscuring the kind of dynamic balance sheet interactions that are the essence of the story.

What I would emphasize however is not the negative but the positive.  The fact of the matter is that today the credit creation view is out of the shadows, and no longer the exclusive property of the marginalized.  In evidence of this, I would direct your attention to the two Bank of England papers that Werner himself cites:  here and here.  But I would add to that also the most recent report coming out of the Group of 30 “Fundamentals of Central Banking, Lessons from the Crisis”.  On page 3 you will find the following:

“In a barter economy, there can rarely be investment without prior saving.  However, in a world where a private bank’s liabilities are widely accepted as a medium of exchange, banks can and do create both credit and money.  They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet.”

That’s the truth that Werner wants central banks to admit, and now it appears that they have admitted it.  The next question is what difference it makes, and that’s a question for next time.  Already it should be clear that progress toward answering that question will require us to be more careful about issues of payment versus funding.

P.S.  BTW, the title of this post [at Merhling’s site, which is “Great and mighty things which thou knowest not” [?]] is taken from Jeremiah 33:3 which Werner references in a footnote to his title: “should grains of wisdom be found in this article, the author wishes to attribute them to the source of all wisdom.”  Werner is apparently listening to powers higher than just McLeod and Schumpeter!

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  1. tricky rick

    Chris Martenson and other “tin foil” folks have been laying this out in well documented studies for over a decade.

    welcome too late to the party.

  2. John Merryman

    I think another aspect that should be considered is the preservation of surplus money through government debt.

    For example, Volcker is credited with curing inflation through higher interest rates, but that slowed the economy as well and so reduced the need for money. It wasn’t until Reagan had increased the deficit to 200 billion in 82 that inflation seemed to come under control enough that they could lower rates.

    Now one way to create higher rates is for the Fed to sell debt it bought to create the money in the first place. So what is the difference between the Fed selling debt it is holding and the Treasury issuing fresh debt, other than the Fed destroys its money and the Treasury spends it on public works, thus Keynsian pump priming.

    So who buys this debt, but those wealthy enough to have surplus money. Which suggests that if there is a surplus of money in the system, causing inflation, the easiest place to remove it is from those with a surplus of money.

    Now money really does function as an enormous, glorified voucher system and what is more destructive of such a system, than enormous amounts of surplus vouchers?

    So given that those with lots of such excess vouchers consequently have leverage over the rest of the system, what way to better preserve this wealth, than to have the public borrow it back and pay interest, even if much of what it gets spent on doesn’t produce sufficient income to pay that interest, if not actually lost?

    Eventually though even the public can’t afford to keep this up, so what is the alternative?

    Now most people save for predictable reasons, from raising children, housing, healthcare, to retirement and funerals. So what if the government, i.e., the public, were to threaten to tax excess money back out of the system, rather than just borrow it? Necessarily people would quickly find means to invest into these future needs directly, rather than trying to save up notational value. The problem is that we don’t know exactly what we will need for what, which would mean we would have to invest into community and public projects, rather than save for our own specific needs.

    While this might seem onerous, consider that we currently live in a highly atomized society, that is largely mediated by that failing financial mechanism. So if we had to start functioning as a more holistic group, with more organic interactions and public spaces and commons, people might have to come out of their shells a little more and deal with lots of other social and personal issues, which might not be a bad thing.

    Basically we treat money as both medium of exchange and store of value, but these are different functions, as a medium is dynamic and a store is static. For instance, in the body, blood is the medium and fat is the store. Try storing fat in the arteries and you get clogged arteries, poor circulation and high blood pressure to compensate, which is analogous to our financial issues, with a clogged banking system, poor circulation to the rest of the economy and quantitive easing to compensate.

    While the brain might need more blood than the feet, it does neither any good for the feet to rot and die from lack of circulation, nor does it do the brain any good to have excess blood. Similarly we need a stronger social structure and a leaner, more efficient economic medium, in which the excess is stored as the muscle of a stronger society and a healthier environment, rather than just treating them as stores of wealth to be monetized and siphoned away.

  3. Helmholtz Watson

    Yes, the money creation process has been a big lie for a long time.

    In any case the Bank of England came clean a couple of years ago and admitted that standard story of money creation was false. They even acknowledge that it is not properly explained in most money and banking textbooks, which is a staggering admission.

    Paul Krugman wrote a column a couple of months ago where he claimed that banks take in savings from depositors and lend them out to borrowers which tells you either: 1) he doesn’t’ know how banking works or 2) he is part of the conspiracy to keep the public in the dark.

    The truth right from the mouth of the worlds’s oldest central bank.

    1. fresno dan

      Yeah, I saw that.
      It is amazing that a supposedly foremost Princeton Nobel winning economist apparently doesn’t understand where money comes from…

      1. jsn

        In the mainstream world money is just a “veil” that obscures your view of how the divine markets work. They deliberately leave it out because it just confuses things…

        No wonder no one in that world saw the GFC coming, they still all claim whocuddaknowed?

    2. diptherio

      Paul Krugman wrote a column a couple of months ago where he claimed that banks take in savings from depositors and lend them out to borrowers which tells you either: 1) he doesn’t’ know how banking works or 2) he is part of the conspiracy to keep the public in the dark.

      There are actually many more than 2 possibilities here. That is literally taking a black-and-white view of the world: it’s either this or that. Maybe he thinks that the reality is too nuanced and messy for the average reader and presents one aspect of the thing as the whole, even though he knows better. Maybe he’s just a dick who likes to argue for the sake of it and refuses to admit that he’s wrong, even when he knows better. Maybe…you could be more creative than boiling everything to just two possibilities, is all I’m saying.

      1. larry

        There is evidence that Krugman seems to have great difficulty admitting he was wrong. He even contends that using IS-LM is a good too for introducing students to the macroeconomy, even when they must unlearn it when they delve deeper in to the workings of the macroeconomy, and this is after Hicks himself rejected it as being an inaccurate depiction of the macroeconomy later in his life. I can’t say what Krugman is thinking, but then I don’t have to. I can go just by what he writes. And what he writes makes me think he doesn’t know how banking works. I find it difficult to believe he is part of any conspiracy. But I may be wrong.

        1. helmholtz watson

          Yes it’s hard to believe that Krugman might not know how money/banking works but he is a very ideological guy. I happen to be sympathetic to many of his ideological views but any one who is intensely ideological is rarely a critical and independent minded thinker. Ideology is way of simplifying complex things and making your self more comfortable, and doesn’t lead to knowledge. I am no expert on money and banking but I have read ten books on the subject over the last four years and numerous papers. I am pretty sure I understand it now. I think this guy Werner is right. It seems probable that there was an orchestrated campaign to obfuscate how banking and money creation work and one can imagine why that might have happened. Banking is quite literally a pyramid scheme under even the most conservative circumstances! Such a system can work and makes sense if it is prudently managed, regulated and limited in scope.

          My take is that the fractional reserve and intermediation models are just ways of obfuscating the way banking actually works and the credit creation model is the accurate one. I have some advice for anyone who is struggling with the concepts which is as follows: always merge all the banks in the banking system into one bank in your mind. Assuming multiple banks as the author above does is irrelevant to the analysis and only serves to add confusion.

      1. helmholtz watson

        ok, second oldest central bank. Unfortunately the Swedish Central Bank is responsible for creating the Nobel Prize in economics. Awarding a Nobel in economics is like awarding a Nobel in astrology.

  4. fresno dan

    I enjoyed the article very much. And it does seem to me that money creation is made to seem very, very, complex. Now maybe I’m just too stupid, but it always strikes me that when people simply describe something, they either really don’t know, or they are trying to bamboozle you…

    I think the article would have been more enlightening though if the example had been for a house that was TO BE BUILT.
    Using that as an example, it seems to me that money is LOANED into existence – the person who wants the home loan has a good reputation, but the whole point of the loan is that they don’t have nearly enough money to buy the house.

    The carpenters and other workers don’t get paid until they have done work (they loan their work to their employer), i.e., produced a house (or some portion of it). The money in the loan becomes real because a house that didn’t exist now exists. There is more stuff in the world, and there is more money. And I think it explains something important – not any loan is useful. A house worth 100K that is sold for 1000K but than is foreclosed upon – somebody has to take a real loss – either the person who got the home loan, and to the extent that they can’t pay the loan back, a builder or the bank takes the loss (if the foreclosed value is less than the original loan value)
    So, is that correct?

    Again, thanks for the article and I am looking forward to the next one!

  5. paulmeli

    Pick any year post WWII (because the data is readily accessible).

    Compare the levels of federal spending and credit expansion.

    Federal spending created more money every year except for the years 1998 thru 2007, where it was about even, and for 2006 and 2007 credit expansion was some 50% higher.

    Then we got the mother of all credit crises.

    Over that post WWII period federal spending created ~$78T while credit created ~$46T.

    The common refrain is that federal taxes subtract from federal spending so it ends up being less.

    Except in what universe do income taxes accrue only against income resulting from federal spending? It’s nonsense and should be derided as such. It’s an accounting convenience that does not reflect what is actually happening.

    It may make sense for National Accounting (and to keep banksters in the drivers seat) but it makes zero sense in a rational analysis of a real-world system. That is the only way banks could be touted as the source of most of our money.

    Despite an otherwise sound argument this article perpetuates the myth.

    The banksters apparently have a hold on everyone, including the so-called ‘good guys’.

    Some justification based on the level of bank reserves or some other convoluted argument in 5,4,3,2,1 …

  6. financial matters

    Very interesting and I’m looking forward to your next installment.

    I’m especially interested in the transfer of reserves from Chase to Citi and as you further point out ‘Chase possibly using its reserves to acquire a different money market asset. One way this could all work out is that a shadow bank–money market funding of capital market lending–acquires the security and uses it as collateral for wholesale money market borrowing from Chase.’

    This seems to be a transmission mechanism for asset appreciation as Eric Tymoigne is getting into is his excellent series:

    “post 7 will start the private-bank posts) on monetary policy and the QE -asset price channel will be explained. But here is a short answer:
    No bank’s don’t use cash to buy assets. If they deal with non-bank agents they just credit bank accounts, if banks deal with a fed account holder they debit their reserve balances to make payments.

    The link works through interest rate, arbitrage, search for yield, and the fact that QE reduces the quantity of securities available in the market.”

    “the issue is how they would transfer the funds to make the purchase? They could buy securities if they find a fed account holder willing to sell them securities: Treasury is one, GSE is another one. Non-financial institutions no.”

  7. craazyman

    All they do is talk about how the parts of the machine move — which is itself an amazing problem of conceptual collinearity — but not the phenomenon of the machine itself.

    More and more you just say “Why not go to Youtube and check out a Rhianna video, rather than read another one of these essays.”

    Eventually maybe they’ll get it. But when they study economics their whole adult life — and nothing else — it makes it hard. It’s not like they’re dumb or that they lack mental ability. In fact, they’re all intelligent individuals who are quite capable in most areas of thinking. It’s just that the conceptual language they need to use in order to perceive the phenomenon itself is a language they do not know. And so they look at reality and they try to make sense of it using the language they do know, and because words themselves and the ideas in the words catalyze perception, their limited language is not fully adequate, and they don’t see or know that. What can you do? Everybody has to see it for themselves.

    At any rate, you’d think by now it wouldn’t be so hard. But most people aren’t interested in this sort of thing so progress is really slow. Most people just go right to Youtube.

    1. susan the other

      Adenosine triphosphate. The example several years ago in the comments, by a biologist, that it would be an extinction event for a colony of amoeba if a few of them decided to short amoeba futures and just hoard all the adenosine triphosphate – the one chemical every amoeba must have to transfer energy. Wish it had been an analogy to symbolic ADP which had usurped the real stuff and was being hoarded to make sure it maintained its value.

      1. craazyman

        very nice! you have always impressed me with your thoughtful and penetrating intelligence.

        (even though you go off the wacko, foo-foo, hug-the-trees cliff sometimes.)

        1. Clive

          You assured me susan was a bona ride adjunct professor of theosophical studies at the University of Magonia. I want, nay, I demand my tuition fee, which apparently I had to pay in advance because otherwise 42 other Chinese applicants would be in line for my place, back.

          1. craazyman

            she’s a full profeser of creative analysis. she hugs trees as an adjunct profeser of foo foo philosophy

    2. craazyboy

      Dunno why they have all these theories. It’s simple. The Fed lowers interest rates, the mark to market value of bank assets go up, which greatly improves cap ratios, then banks don’t need liabilities anymore. They just can make endogenous money and give it out to borrowers’ banks.(it’s all done electronically and fast so no one notices) All the Big Guy econ types know that.

      All the rest of it is just details banks go thru just for show. Plus they can securitize and sell any assets they think may drop in value. They’re smart people.

      Now, the other thing all the Big Guy econ dudes always say is once us little folk figure it out, something wonderful is supposed to happen. Maybe I missed it, but what thing is that???

  8. Maude

    You forgot one piece…

    Let us suppose, with Werner, that Citibank makes a mortgage loan to me of $200,000, simply by swapping IOUs. I then transfer my new asset (the new Citibank deposit) to you, and you transfer your house to me. As my payment clears, you have a new deposit in your own bank (let’s say Chase, to make it interesting), Citibank has a “due to” at the clearinghouse, and Chase has a “due from”. Again, to make it interesting, let’s suppose that Citibank has no reserves, so it enters the interbank market to borrow some, from Chase. At the end of the day, what we see is that the Citibank balance sheet is still expanded, so is Chase’s, and so is mine. Only your balance sheet stays the same size, since you have swapped one asset (your house) for another (money). That’s the payments perspective.

    Is the house owned free and clear? If not, the exchange eliminates that original liability/asset on someone else’s balance sheet so everything is now at a net zero as far as new money circulating in the economy. Banks did not create anything new. They only exchanged one Asset/Liability for another Asset/Liability. Even if the house was paid off 20 years ago, there is no new money created from this transaction. The only way “new money” is created would be through interest paid on Treasuries, and direct deficit spending by federal government.

  9. Mustsign topost

    debt intermediation theory is this: consumer loans -> salary -> pension funds
    kleptocracy is this: privatization -> state spending -> profit

  10. Anon

    As the commenters on the post at Prof. Mehrling’s site have observed, his argument is logically flawed. He concludes: “But in all the cases, the debt intermediation view of banking is perfectly consistent with the credit creation view of banking.”

    The intermediation view of banking “says that banks make loans by lending reserves that they are already holding,” as he explains at the beginning of his piece. In his example, the deposit that is created by the banking system funds the loan. Of course, in both case intermediation takes place but the nature of the intermediation is not comparable.

    In the first case, banks have no special status in the economy. After all any of us who has a balance of $100 can lend out that balance of $100. In the second case, the only reason the bank can make the loan is because of a social norm in which the public trusts the banking system and is willing to keep its money in banks. This fact has always been a fundamental component of the credit creation theory of money — it is founded on the public’s trust in the banking system. This trust allows banks to expand the money supply — at the potential expense of the public.

    While I have great respect for Prof. Mehrling, it is far from clear that he has a good understanding of the credit creation view of money.

    1. diptherio

      When I looked into the data about 5 years ago, it appeared that only a few large banks were actually operating on a credit-creation basis. Most banks (meaning your local, independent banks and credit unions) appeared to be operating on an intermediation model. Deposits are always the cheapest way to fund a loan, and for small banks, that looks like pretty much the only way they do it – iirc, loans were 60-80% of deposits in most banks. However, at JPM, BofA, etc, their loans were well over 100% of their deposits…like waaaay over. So it looked to me like just a few big players were driving endogenous money creation, while most banks actually were doing, essentially, what fractional-reserve theory says they do.

      That’s my understanding, but I don’t claim to be an expert.

      1. Anon


        Banks no longer keep their loans on balance sheet, so a simple static analysis of their balance sheet doesn’t tell us much about how much credit creation they are doing. To study the degree to which banks create money you have to look at the role they play in the shadow banking system as well.

        1. Skippy

          Too some degree… my concerns about the shadow sector vastly out weigh the traditional sector e.g. has the traditional sector become [increasingly] just a front house op to generate velocity for the shadow sector, and the latter just needs a – store of – when the economy gets a black eye.

        2. Skippy

          Therein lies the rub e.g. some fixate on one component of a veritable galaxy of operational scope, so at this juncture on can surmise that new universes of credit are created and inserted into the multiverse to survive on their own [inhabitants luck of the draw]. Maybe theoretical physics would be a better methodology of describing credit activity’s at this juncture than thermodynamics, ideology, or socio-economic-political optics…

      2. JeffC

        There’s a confusion here. Suppose a bank with reserves R and corresponding deposits X, in addition to other balance-sheet items, has

        R X.

        at the top of its balance sheet. It makes loan L, which creates new deposit D to obtain balance sheet

        L D *
        R X.

        The borrower/deposit-holder transfers her deposit to another bank, so the original bank’s balance sheet drops down to

        L X,

        while the new bank gains this on its balance sheet:

        R D.

        So the sequence is (1) create new deposit D and (2) transfer the deposit to the new bank. This is the money-creation model in action. It is correct.

        When we imagine that reserves are being loaned instead, we are actually skipping the balance sheet marked * above. Comparing the balance sheet before and after the skipped one, we come to believe that reserves have been turned into a loan. This is incorrect. The newly created deposit is simply in a different bank. To see what is really going on, we have to consider the loan and transfer separately.

        1. Jason

          Many textbooks discuss the money multiplier in exactly this manner. Yes the bank expands its balance sheet on both sides at the loan creation stage. But it needs reserves because D is going to get transferred to another bank when the borrower spends. And if it didn’t have R and borrows it from the Fed Funds market that just meant (pre crisis) another bank did not use R to fund its own lending. Reserve availability is thus the constraint on credit expansion, at least prior to QE.

    2. JTMcPhee

      Can anyone tell me where that $100 came from? Or the $200,000 to buy that archetypical house? We got lots of “blind philosophers feeling their part of the elephant and pronouncing its essence” but where does “wealth” originate, as opposed to money and “assets?”

      1. cnchal

        . . . but where does “wealth” originate

        (MMT – Material Meets Tool X sales) – expenses = profit or loss. If it’s profit, that is wealth. If it’s loss that is hell.

    3. nothing but the truth

      “In the first case, banks have no special status in the economy. After all any of us who has a balance of $100 can lend out that balance of $100”

      yes you can lend it out, but the bank is 1) at the top of collectors line 2) has backing from the FDIC. When you loan 100$ to someone, you dont have that money anymore. When you lend 100$ to the bank, you still have that money, and about 10 other people have it as well.

      1. JTMcPhee

        I’m sure it must be obvious to brighter and more subtle folks than me, but where does that $100 that’s referenced here come from?

        I have an antique wood-bodied block plane (the woodworking kind) made by my great-grandfather ( except for the perfect cast iron blade and two nails). He used tools he made or bought to carve the body and chisel out the throat and make the wedge. I was offered $100 for it recently. Where does the wealth or value that my ancestor’s plane, now mine by inheritance and survival, come from? Or all the other $100s that make up ” the economy” that the MorgulBankers are conjuring derivatives out of?

        1. cnchal

          . . .I was offered $100 for it recently. Where does the wealth or value that my ancestor’s plane, now mine by inheritance and survival, come from?

          From your ancestor’s labor in creating the plane and an ongoing demand from people interested in acquiring the plane.

          Where the $100 offer comes from is the perceived value of the plane compared to other planes on offer, such as for example the Chinese made crap in Home Depot.

          Since it sounds like you didn’t sell it for $100, you value it at a higher price. Wondrous market eh.

          1. JTMcPhee

            Seems to go around to an “Assume a can opener” loop… I get the perceived value-“market” bit. But a “$100 offer” does not explain where the $100 comes from, as an entity.

            1. Anon

              That question is too hard. What we treat as wealth is in many ways just a social convention. But the fact remains that if I hold a $100 bill (or can get one from the bank) everyone will acknowledge that I have $100 in wealth — and nobody will ask where I got the $100.

              1. JTMcPhee

                …they may care whether that $100 bill is counterfeit. They won’t care that it has traces of cocaine on it, along with a lot of fingerprints and pathogens… “filthy lucre?”

                But still begs the question, where does that “$100” come from? I’m guessing it’s just too complicated — thinking about it takes me back to contemplation of the Krebs/citric acid cycle, I couldn’t keep more than a fraction of that in my head, even long enough to get through an exam or three. Maybe that’s the problem: I’m just not complex and smart enough to “understand” something that “just is,” even though unlike the Krebs cycle that arises from deeper essences, it, money, is something that is created by belief out of culture and a whole lot of very ugly (and occasionally noble or just “practical”) motivations, hedged about with a complex set of rules and behaviors but capable of going malignant and metastatic in a heartbeat, or processor cycle…

      2. Anon

        nbtt: Expansion by fractional reserves relies precisely on the willingness of the public to redeposit their earnings in banks which was my case 2.

    4. helmholtz watson

      Agreed completely! Mehriling is logically wrong when he says: “But in all the cases, the debt intermediation view of banking is perfectly consistent with the credit creation view of banking.” I was enjoying the article until I got to that sentence. I am glad to hear others caught it. That’s probably why he teaches economics and not something like physics or electrical engineering. Not enough intellectual horsepower. I just finished Yale professor Gary Gorton’s book “Misunderstanding Financial Crises”. Gorton taught at the Wharton Business School for 24 years and was a consultant to AIG Financial products and all I can say is: no wonder there was a financial crisis” with people like Gorton teaching finance and economics to generations of students. The book isn’t bad but it’s a story of a professor coming to finally realize what he didn’t know and understand the previous thirty years.

  11. Helmholtz Watson

    What is truly amazing about this is that in year 2016 there is still massive confusion and ambiguity about how money and banking work. How can that be? Bizarre!

    1. MaroonBulldog

      Q. How can that be?

      A. Easily: “the false theories are guiding current bank regulation and development policy, leading down a blind alley.” If correct understanding would lead to a correct regulation, then those whose interests would no be served by correct regulation will obfuscate correct understanding.

  12. OpenThePodBayDoorsHAL

    *Great* to see this truthiness finally seeping out (though it will be decades if ever before this basic knowledge discredits and reforms all of the economics departments and MMT’ers and central banks of the world).
    But let’s ponder a system that might make more sense: why not separate “money” from “credit” altogether?
    Conflating them means that every banking crisis becomes a monetary crisis too, so for the supposed “greater good” we’re told we need to bail out banks no matter how badly they are run as companies and no matter how many laws they break along the way (look at Kuroda’s actions yesterday, he was very explicit: he said the purpose was *solely* to help banks, who apparently have not had enough “help” yet over the last 30+ years).
    Declaring that a huge swath of the economy (banking) is perpetually exempt from capitalist creative destruction means you eventually get (as we have today) a gigantic set of walking zombie corpse organizations that must be coddled with FASB fictions, monetary giveaways (IOER), and immunity from prosecution. And when they invariably use their unnaturally privileged position to issue too much credit (or pay executives too lavishly), we get serial crises that everywhere and always take the real economy with them, by design.
    Banks should have no more special protections than retailers or software companies or airlines, if they compete with smart management, good products, and good prices then they will be strong because customers will flock to them. If not, bye bye. We can still have things like deposit guarantee schemes, and money can continue to be created and to flow, but the entire society will not just be a marionette on strings held by masters that do not need to obey any rational economic rules other than pure self interest.
    Look at what Ecuador is doing: the *central bank* is now the only entity creating money. Another model, free banking, could also be an answer. Asset-backed money is another…but this marionette routine is getting very old indeed.

  13. kevinearick

    Psychograpic Marketing, LSD & Mind Control

    Baby yoga for kids living in the forest, who never go outside alone; the highest real mortality rate in the US; and the prototype for Family Law feeding Obamacare in the big city – does it get any dumber than that?

    The psychologists are just smart enough to get the majority killed. The markets are an exercise in control, a game, and nothing more, until Little Johnny jumps off Science Building and shorts the insanity all together. Did you see that last impulse, transferring wealth to the Soros clan, now demanding another bailout?

    The assumption of emotion-based decisions, lest one be a robot, is ludicrous, but that is the basis of empire marketing. The majority short-circuits itself, with the false assumptions presented by empire media broad band, the frequency it chooses to occupy, to mirror itself, and obsessive-compulsive behavior begets itself. The brain stem is a geared Archimedes Screw.

    Because the body is grounded to earth, the dc side of the brain is self-obsessed, and LSD offsets the signal into the noise of the clutch, is no reason to hand your life over to a psychologist printing money. Because the predicitive subconscious exists in a feedback loop with adaptation doesn’t mean that everyone is sick, stuck on an empire frequency, and mentally ill if they don’t seek diagnosis. Money is not reality, except for those who choose it.

    Wall Street sells mortgages with increasing duration, Madison Avenue produces crap for compliance at increasing cost, and the majority indentures future generations with bonds, until they can’t. Global finance simply liquidates natural resources and moves, in planetary rotation. Relative to unincorporated farming, the land is largely fallow, but the participants have TV, cardboard and gadgets, dependent upon empire for a battery.

    Net, populations vacillate between denial and depression, with growing impulses of anger, in a market for psychologists who see others as a reflection of themselves. Married people raising independent children cannot afford to be quite so stupid. And without such children, the economy can only implode, reflecting the psychologists’ own self-obsession.

    Do you remember that story about the natives not seeing Christopher’s ship, until the shaman pointed it out, when the natives were slaughtered by war, disease and poverty?

    Females can breed on equal rights for a thousand years, with males providing the technology, but they will just end up a thousand years behind the curve. Women are bred to think in linear time, and men to think in frequency, because that is what children need. One is the counterweight and the other is the cab.

    The majority, focused on self, rides the counterweight to floors on one side, all dead ends, and is jealous of children exiting on the other side. The choice at the crossroad is always the same, investment or consumption. The majority is not experiencing falling living standards and increasing income inequality because some banker provided the money, an excuse, for multicultural unicorn dreaming.

    Retired people generally prefer a Fred and Wilma economy, city kids generally prefer a rat race, and once separated for the purpose, the police are generally dispatched to slice and dice families into sausage to feed the former, by authorities always pleading ignorance, majority vote. Once you see those cops, promoting gang awareness, it’s time to go. At empire cycle begin, you have plenty of time; now you have none.

    When I began writing this, I had no idea where the focus would be, but I do have a pattern database and a linear time translator, such as it is. My wife can tell you the weather 25 years, 3 months and 10 days ago. Choose a wife that enjoys living in the moment, and a husband that enjoys an independent frequency, compliments capable of trust in an untrustworthy world.

    My mind is a steel trap, my wife’s is Disneyland, and we live in the feminist capital of the world, as you might suspect with an ac mind. Your perspective is your own, if you choose to have one, and we all go through phases, climbing and descending the ladder of consciousness. I am simply sharing, after decades of listening and saying not a damn word, in the empire, on the eve of WWIII.

    From the perspective of legacy, which has no clue what is in those libraries, the Internet was designed to extend linear thinking, to nowhere. From the perspective of labor, the Internet was designed to demonstrate the fallacy of limiting yourself to linear thinking. Contrary to popular mythology, choice is not about the color of your tennis shoes made in China.

    If it’s not anonymous cash, it cannot store value, because independent children are reared beyond empire’s grasp, the physical manifestation of intellectual self-obsession, which Sweden is now learning, way to late, a slave to Germany, and Austria in particular. Knowing what needs to be done and doing it are two different things. The psychologists in New Hampshire produce drug addiction, their solution is drug rehab, and Iowa is supposed to be nuts.

    You didn’t think Keynes sprang from nothing did you?

      1. ke

        Thanks. The wife likes to keep track of water. She’s like a human testing machine. Best water I had was up at bay of fungi, big moose. That document on Ford’s car made of hemp and plastic was pretty cool, before he was told he would be making cars out of steel, finance.

        Always thought I would end up in Australia, but like the doctor thing, the critters have to destroy everything they touch.

        Thank again

  14. nothing but the truth

    keynes is describing a dollar based on gold standard.

    your problem is that you refuse to see meaning in the real. you see meaning only in money. and money, now, is nothing. it is a fiction.

    all these articles are symptoms of your cognitive dissonance. all your meaning is eventually money and money is eventually nothing.

    and from this seems to come the idea that since money is nothing, reality can be created from nothing.

    not so easy.

    1. animalogic

      Fiat money is not a “nothing”. But it can certainly become a nothing…if everyone loses belief it it.

      1. nothing but the truth

        for you it is not nothing, because you need to work for it.

        but if the fed can create four trillion just because it can from nowhere with no constraints, it is nothing.

        so in the ultimate analysis, you work for something that is nothing. or rather, you work for those that control creation of nothing-money from nowhere,

        1. Plenue

          Money is at all times by its very nature a shared fiction. Any currency ultimately has value because enough people accept that it does. You’re assuming that gold (or whatever) inherently has value. It doesn’t. In fact gold is one of the most useless things that can be dug out of the earth. The Spanish arrived in the New World to find it awash in gold, but the natives had no interest in it beyond it being a shiny decorative trinket. The dominate currencies among the Aztecs were the cocoa bean and cotton cloth. All currency is fiat.

    2. TheCatSaid

      We create reality from nothing all the time. We’re just not aware we’re doing it.
      Becoming more adept and consciously involved in the creation process is an interesting place to be.

  15. Darthbobber

    “Contradictions, of which money is merely the palpable manifestation, are then to
    be transcended by means of all kinds of artificial monetary
    manipulations. It is no less clear that many revolutionary
    operations with money can be carried out, in so far as an attack on
    it appears only to rectify it while leaving everything else
    unchanged. We then beat the sack on the donkey’s back, while
    aiming at the donkey. But so long as the donkey does not feel the
    blows, one actually beats only the sack, not the donkey;
    contrariwise, if he does feel the blows, we are beating him and not
    the sack.”

    At the end of the day, what ultimately needs to be impacted is not the pieces of paper.
    All we can ever do with those is hand people claims against future production.

    And when the theory of “managing” an economy stops at the control of aggregate numbers as its only allowable tool to influence the process, it can never accomplish the objective of avoiding major crises.

  16. Stephen Clark

    “In a barter economy, there can rarely be investment without prior saving. However, in a world where a private bank’s liabilities are widely accepted as a medium of exchange, banks can and do create both credit and money. They do this by making loans, or purchasing some other asset, and simply writing up both sides of their balance sheet.”

    What about in a world in which such things were not widely accepted. Minsky said “Anyone can create money the problem lies in getting it accepted”

    A more complete statement would be Anyone can create money but not everyone may. As I understand modern monetary theory here at NC the credit and money created by banks achieves its acceptability by being acceptable for paying taxes. That is the may. What does the government accept as payment of taxes. The government could set any set of rules for the money that it accepts for taxes. It allows bank created money and credit to be acceptable for the payment of taxes. If it did not these would not be “widely acceptable”, they would be as Maurice Allais has pointed out the monetary equivalent of counterfeit. Of course this assumes that modern governments have any independent existence. Reserves, fractional or otherwise, endogenous or exogenous, are simply that the government allows Johnny to created in his play house. Unfortunately we all must live in that play house.

    What is missing from the entire discussion and makes the hard headed analysis of the “real world” is that real world is the activity of a set of thieves. Banks create money. Is this a good idea? Are there other ways to do it.

    Accounting practices are traditions that were originally created to help keep track of money, they are now traditions to lose track of money. Maybe accounting practices and definitions need to change as well. Bill Black has identified liars loans and the criminogenic nature of modern finance. That criminogenic atmosphere has spread to the entire economy. Knowing how the real world works may be of no value other than to stop doing it that way.

      1. financial matters

        I think the problem comes in when the Fed directly and indirectly supports these activities as Carolyn Sissoko has pointed out.

        January 13, 2016 at 1:06 pm

        One additional points:

        The whole tri-party repo market (at least to the degree that securities other than treasuries serve as collateral) was explicitly prohibited by Glass-Steagall. In fact, there is still a law on the books, 12 USC s. 374a that reads: “No [Federal Reserve] member bank shall act as the medium or agent of any nonbanking corporation, partnership, association, business trust, or individual in making loans on the security of stocks, bonds, and other investment securities to brokers or dealers in stocks, bonds, and other investment securities.” (All banks regulated by the OCC must be Federal Reserve members.)

        Only due to the absurd fiction that repos are not loans, but sales and repurchases can JPM and BNY play the role they do in this market.

  17. Moneta

    When I was in university, I was taught that the first bankers were on the banks and worked to finance trade shipments. It was explained that the bankers at first might have held the same amount of deposits as loaned but they quickly noticed that only a percentage was ever claimed. That’s when they resorted to fractional reserve banking. The ratio used to show us how it works was 10%.

    I never took this story as gospel. I took it as a story that helps explain how we got to what we have today. With a little imagination it is easy to concede that some bankers were probably more corrupt, optimistic or greedy than others and this probably impacted the regulation of reserve requirements over time.

    Canada has gone from something like 10% to 4% to 0 as now it Is based on capital requirements vs. risk weighted assets.

    Money creation is an abstract concept complicated by feedback loops. From my perspective, nothing was even hidden from me. I always understood that I was being fed the basics so I could move onto more complicated stuff. From what I see, we would need to create a special curriculum that would first teach literalists how to think outside the box.

    The reality is that most people are lacking in basic math. The second issue is that most people have trouble thinking in multiple dimensions. Most tend to be very linear so grasping the feedback loop is hard.

    BTW, we can see this linear thinking also at play with the austerity strategy where those promoting it do not seem to realize that all costs are revenues.

    And when one looks into different personality types, one quickly sees that for most, the brain is not hard wired to love the study of finance. So at the root of our collective problem is that our system is based on knowledge that most have no desire to understand.

    1. JTMcPhee

      …and where the very few who do understand happily use that knowledge to vastly increase their personal command of huge amounts of money, at the enormous expense of the people who don’t. Who it seems to me are the mopes and muppets who create the substantial stuff on which the froth of Funny Munny floats. What’s the current dollar “notational” value of derivatives and other Funny Munny on the global balance sheet? And gee, how and by whom do all the pre-defaulted markers the casino types have minted get paid up? See, eg, recent GFC…

    2. MaroonBulldog

      System based on knowledge that most have no desire to understand …. and those who do desire to understand it, desire that not for the love of their science, but for the gain they can derive from it. Like lawyers.

  18. Keith

    “But it matters also simply because we need correct understanding of how the economy actually works, “we” meaning not just economists but also the general public”

    40 years ago most economists and almost everyone else believed the economy was demand driven and the system naturally trickled up.

    Now most economists and almost everyone else believes the economy is supply driven and the system naturally trickles down.

    Economics has been turned upside down in the last 40 years.

    Which way is up?
    Is today’s Capitalism upside-down?

    In the 1960s and 1970s we had some of the lowest levels of inequality in history.

    The new upside-down economics is driving inequality.

    Today’s ideal is unregulated, trickledown Capitalism.

    We had un-regulated, trickledown Capitalism in the UK in the 19th Century.

    We know what it looks like.

    1) Those at the top were very wealthy
    2) Those lower down lived in grinding poverty, paid just enough to keep them alive to work with as little time off as possible.
    3) Slavery
    4) Child Labour

    Immense wealth at the top with nothing trickling down, just like today.

    This is what Capitalism maximized for profit looks like.

    (The majority got a larger slice of the pie through organised Labour movements.)

    The beginnings of regulation to deal with the wealthy UK businessman seeking to maximise profit, the abolition of slavery and child labour.

    Where regulation is lax today?
    Apple factories with suicide nets in China.

    A leopard never changes its spots.

    Capitalism in its natural state sucks everything up to the top.

    1. Keith

      In our wonderful new, supply side, trickle down world we have taken our eye off the global consumer.

      How is the global consumer these days?

      1) The once wealthy Western consumer has had all their high paying jobs off-shored. As a stop gap solution they were allowed to carry on consuming through debt. They are now maxed out on debt.

      2) Japanese consumers have been living in a stagnant economy for decades.

      3) Chinese and Eastern consumers were always poorly paid and with nonexistent welfare states are always saving for a rainy day. Western demand slumped in 2008 and the debt fuelled stop gap has now come to an end.

      4) The Middle Eastern consumers are now too busy fighting each other to think about consuming anything and are just concerned with saying alive.

      5) South American and African consumers are busy struggling with economies that are disintegrating fast.

      Oh dear, no wonder there is no demand for Chinese products or any other products for that matter.

      Commodities that real things are made from?
      No one needs them; upside-down economics is laying waste to the global consumer.

    2. Keith

      Modern economics is a disaster area, not only is it upside down but it has two further fundamental flaws in its assumptions:

      1) Doesn’t differentiate between “earned” and “unearned” wealth

      Adam Smith:

      “The Labour and time of the poor is in civilised countries sacrificed to the maintaining of the rich in ease and luxury. The Landlord is maintained in idleness and luxury by the labour of his tenants. The moneyed man is supported by his extractions from the industrious merchant and the needy who are obliged to support him in ease by a return for the use of his money. But every savage has the full fruits of his own labours; there are no landlords, no usurers and no tax gatherers.”

      Like most classical economists he differentiated between “earned” and “unearned” wealth and noted how the wealthy maintained themselves in idleness, luxury and luxury via “unearned”, rentier income from their land and capital.

      We can no longer see the difference between the productive side of the economy and the unproductive, parasitic, rentier side.

      The FIRE (finance, insurance and real estate) sectors now dominate the UK economy and these are actually parasites on the real economy.

      Constant rent seeking, parasitic activity from the financial sector.

      Housing booms across the world sucking purchasing power from the real economy through high rents and mortgage payments.

      Michael Hudson “Killing the Host”

      2) Ignores the true nature of money and debt (as in article)

      Debt is just taking money from the future to spend today.

      The loan/mortgage is taken out and spent; the repayments come in the future.

      Today’s boom is tomorrow’s penury and tomorrow is here.

      One of the fundamental flaws in the economists’ models is the way they treat money, they do not understand the very nature of this most basic of fundamentals.

      They see it as a medium enabling trade that exists in steady state without being created, destroyed or hoarded by the wealthy.

      They see banks as intermediaries where the money of savers is leant out to borrowers.
      When you know how money is created and destroyed on bank balance sheets, you can immediately see the problems of banks lending into asset bubbles and how massive amounts of fictitious, asset bubble wealth can disappear over-night.

      When you take into account debt and compound interest, you quickly realise how debt can over-whelm the system especially as debt accumulates with those that can least afford it.

      a) Those with excess capital invest it and collect interest, dividends and rent.
      b) Those with insufficient capital borrow money and pay interest and rent.

      Add to this the fact that new money can only be created from new debt and the picture gets worse again.

      With this ignorance at the heart of today’s economics, bankers worked out how they could create more and more debt whilst taking no responsibility for it. They invented securitisation and complex financial instruments to package up their debt and sell it on to other suckers (the heart of 2008).

      1. nothing but the truth

        these guys consider political economy a career suicide.

        they only talk in nonsensical math equations that have no relation to anything, and the latest fashion. these days, it is the realization that we are not actually on a gold standard anymore. some 45 years after nixon went off it.

        they think this is a good thing, because the PTB will use the money to help the people at large.

        Why inequality, FIRE explosion and end of the gold standard happened at the same time?

      2. Moneta

        Debt is just taking money from the future to spend today
        Not if your debt permits sustainable production and proper velocity of money.

        I would say that debt permits taking resources from the future to consume today.

        1. JTMcPhee

          Glad you were careful enough to include the enormous “if” in the notion that debt is going to support sustainable production. And “proper velocity of money?” That’ll get you somewhere fast…

          1. nothing but the truth

            mario gisseell’s key insight was that the financial system creates problems because money is unnatural in the sense it is pretty much impossible to destroy.

            wheat is created, wheat is consumed. this is the natural cycle.

            this is why in his system, money would have a finite life. otherwise as simple arithmetic will show, money has to grow exponentially. this will eventually implode, but before that it will cause many distortions in the political economy.

            importantly, in his system, land could not be owned forever.

            1. Keith

              Money is being created and destroyed all the time.

              If you go into a bank and get a mortgage the amount of the mortgage is just typed into a keyboard and there it is.

              Reserve requirements are now so small the reserves required can be contained within the fee so the bank needs absolutely nothing to make the loan. It just creates the amount of the loan out of thin air by typing it into a keyboard and there it is in your account ready to buy the house.

              You buy the house but the bank owns it and can sell it to cover the mortgage repayments and get back that money they created out of thin air.

              Effectively the bank allows you to borrow your own money from the future to spend today, the repayments pay this money back and the interest compensates the bank for their trouble.

              If you default the bank can repossess your home and sell it to cover the future repayments that haven’t been made.

              When all the repayments are made the house is yours, all the money is paid back to the bank and financially the bank is back to square one, though it has collected the interest as profit.

              BUT …… when banks blow housing bubbles, when the bubble bursts and house prices drop rapidly there is no guarantee they can get their money back by repossessing and selling the house. When this happens on a big scale, like it normally does, then suddenly banks are sitting on big losses.

              If they have leveraged it up with derivatives, the losses are multiplied (2008).

              James Rickards in Currency Wars gives some figures for the loss magnification of complex financial instruments/derivatives in 2008.

              Losses from sub-prime – less than $300 billion
              With derivative amplification – over $6 trillion

              The derivatives did the real damage.

        2. Keith

          That is the idea and how it should work, but banks prefer lending to inflate real estate bubbles where nothing is created and existing houses just go up in price until the bubble pops and then they go down in price.

          1. Keith

            Assets bubbles and imaginary wealth ….

            One house worth £100,000
            Housing boom ……
            Same house worth £200,000
            Housing bust ……
            Same house worth £100,000

            £100,000 of imaginary wealth created and destroyed, underlying asset unchanged.
            Use appropriate multiplier for effect on national level.
            Oh my god it’s 2008, where did all that imaginary wealth go?

        3. TheCatSaid

          In an ideal world we consume in ways that are regenerative–that result in more than before our “consumption”.

        4. MaroonBulldog

          “Debt permits taking resources from the future to consume today.” That can’t be true, if Einstein’s special theory of relativity holds. Nothing real can be transported from the future back into the present.

          Debt permits my consuming resources today that might otherwise be saved for the future, or else go to waste, or else be consumed by the next cash paying customer to come along today. Back during the Great Depression, Wimpy would say, “I will gladly pay you Tuesday for a hamburger today.” That’s the principle of debt: in consideration of your immediate performance–tender of a hamburger that exists in the here and now–I will incur a contractual obligation to pay you money in the future (if I have any, if I am still alive, etc.)

  19. Siggy

    I subscribe to the theory that banks lend against reserves and that as a practical matter all circulating money is derived from loans. Or; when the bank creates a loan in some unit of account, the actual units of account do not exist, only the reserves.When the proceeds of a loan are spent, those units of account enter the circulating money supply.

    A very nice piece, thank you

  20. Norb

    Human folly. We are all operating under the assumption that human intellect and consciousness will prevail in this world. I’m beginning to wonder if this is true. What physical event will have to take place before those in power either loose legitimacy and are overthrown, or for the mass of people to demand a more just existence?
    It is a supreme cosmic joke that the most intelligent human beings have created such a destructive and self-defeating Rube Goldberg machine we call our economy and society. Our economic masters engineer the poisoning of an entire city, and have the temerity to demand patience as they devise a “solution”. Reminds me of the stories of a laughing trickster god.

    We have created the worst of all possible systems. Economic exploitation hidden behind the smokescreen of incompetent government. Where the role of money falls in that systems seems like a side issue to the main problem we need to deal with.

    1. helmholtz watson


      “Human folly. We are all operating under the assumption that human intellect and consciousness will prevail in this world. I’m beginning to wonder if this is true. ”

      It’s not true!

      From the incomparable John Gray in his book: The Silence of the Animals: “Human knowledge increases, while human irrationality stays the same. Scientific inquiry by be the embodiment of reason, but what such inquiry demonstrates is that humans are not rational animals.” and “If belief in human rationality was a scientific theory it would have long since been abandoned.”

  21. Ignim Brites

    A more interesting question is how is money destroyed? Or can money that exists in the balance sheet of one bank or another ever be destroyed except in the case of a bank failure?

    1. helmholtz watson

      It’s easy to destroy money, just repay a loan and poof the money and the loan disappear just as they appeared.
      That is the primary mechanism that removes money from the system. Remember, about 97% of all so called money is really just bank debt in the form of deposits.

      Also, when you pay taxes money is destroyed although the mechanism as to how that happens is a bit esoteric.

      You could also take some currency and light it on fire. That would destroy money as well but not recommended.

      1. MaroonBulldog

        When you pay federal taxes by check, bank-credit money is destroyed, but when you pay state and local taxes, the money survives.

        Destruction occurs when the federal reserve bank debits (subtracts from, therefore relieves )the reserve account of the commercial bank on which the check is drawn and credits (adds to, therefore charges) the Treasury account in an equal amount. Even though the total accounting liability of the federal reserve bank does not change, destruction of bank-credit moneys occurs because the commericial bank’s reserve account is part of the monetary base, but the Treasury’s account is not, so the amount of the check is removed from the monetary base.

        Paying taxes to a state or local government do not affect the monetary base. State and local governments do not have accounts at federal reserve banks.

        1. Ignim Brites

          The “fact” that Treasury accounts are not part of the monetary base would be news to people who receive paychecks from them.

          1. MaroonBulldog

            Nevertheless, it is true that the Treasury’s account at federal reserve banks are not part of the monetary base.

            New money is created when a check a check drawn on a Treasury account clears, by the process which has reverse entries that occur when a check payable to the Treasury clears (the process by which money is destroyed). Money is created when the Federal Reserve Bank debits (relieves itself of ) its liability to the Treasury account and credits (charges itself with) liability to the reserve account of the commercial bank presenting the check. The amount of the check thus becomes an addition to the commercial bank’s reserve account, and thereby an addition to the monetary base.

            MMT argues that the monetary sovereign creates money by spending it and destroys money by collecting it in taxes. I haven’t argued any new theory here. All I have done is explain the accounting entries that record the creation and destruction as it occurs, and where those entries are made, to wit: on the balance sheet of the Federal Reserve.

      2. Ignim Brites

        When I repay a loan the original money is long ago disbursed into the accounts of those whose products I purchased with the loan. The fact that the bank no longer has my loan on the books is irrelevant. It has the money with which I repaid the loan as an asset. So no money is destroyed.

        1. Helmhholtz Watson

          WRONG! You don’t understand money but don’t worry, most economists don’t understand it either.

          Money is NOT an asset of a bank, it’s a liability. When you repay the bank for the loan, the is extinguished and the deposit , i.e. the bank’s I.O.U. to you is extinguished as well. Sounds odd, but that is how it works.

        2. helmholtz watson

          wrong! money is destroyed when you repay the loan. money is not an asset of the bank. when you “repay” the loan the bank relinquishes it’s claim against you and you relinquish your claim agains the bank by giving up your deposit. All money is debt in the modern system.

          1. MaroonBulldog

            All money is debt in the modern system” also explains why the Treasury Account on the Federal Reserve Bank’s balance sheet is not part of the monetary base. The account shows up as a “liability” in the Fed’s account because it has a normal credit balance (credits to the account increase the balance, and debits reduce it), but it does not represent either an asset or a liability of the government. The Fed and the Treasury or both branches of the same government, and the government does not own asset claims against itself or owe debts to itself. The accounts are just bookkeeping entities that are necessary to keep all the other accounts in balance.

            Federal Reserve notes, held by the public, are assets of the holders of those notes and liabilities of the Federal Reserve Bank. Commercial bank reserve accounts at the Fed are assets of the commercial banks and liabilities of the Federal Reserve Bank. Together, these Federal Reserve liabilities (government liabilities) form the monetary base that allows for the creation of commercial bank-credit money on top of it. All money is debt, but some of it is government debt, and some of it is private debt loaned into existence by banks, on top of the monetary base of government debt.

        3. MaroonBulldog

          Money is fungible. There is no original money different from new money, so it may be futile to try to trace the money. But let’s try it anyway.

          The “money” you borrowed is disbursed when you send a check to a supplier, the supplier presents that check to its commercial bank for deposit, and its commercial bank presents that check to your commercial bank for payment, and then what happens? Reserve accounts at the Federal Reserve Bank are the utlimate “money” that records payment and settlement between the banks–the presenting banks reserves go up, and the paying bank’s reserves go down–and your checking account at the paying bank is debited–goes down–in an equal amount to the amount that its reservied account at the federal reserve goes down. No traceable physical money changes hands. Accounts in banking institutions are adjusted by bookkeeping entries.

          The only “money” that exists are accounting entries to accounts that are someone’s liabiliiies and someone else’s assets. Bank reserve accounts at the Federal Reserve Bank are key accounts in the creation, transmission, and destruction of money. Money is created when bank reserve accounts are credited (the fed’s liabiilities to commercial banks increase) and destroyed when reserve account are debited (the fed’s liabilities to commercial banks are decreased).

  22. bo

    What if I took the $200,000 out of the bank as cash and stuff it in my pillow? In this case, where does City get the reserve? Nowhere but the Central Bank otherwise the transaction would no go through.

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