One of my correspondents recently referred me to an article and asked for my opinion about it. The article is Creating Money out of Nothing: The History of an Idea, by Mike King, dated April 2012 .
I read the abstract, the conclusions, and part of the body text, but could not bring myself to make a detailed read. “The history of an idea” is not relevant to my interests nor to the debt crisis that plagues civilization. Verbose and tedious, it seems to be an academic exercise that I doubt will be of interest even to historians.
On the positive side, it did prompt me to write a few words of clarification on the question, words that I think are both pertinent and helpful to those who truly wish to understand the nature of money and the role of banks in today’s world.
The accusation that banks create money out of nothing has, according to King, been made by many famous economists, including Schumpeter, von Mises, and Keynes. I too must admit to having once or twice used that statement as a sort of shorthand criticism of the global money and banking system.
It is surely true that saying that banks make “money out of nothing” is an exaggeration that can be misleading to the uninitiated.
Bank actually create money out of something. The question is, what is that something, and what is wrong with it?
The short answer is that banks create money on the basis of the promises of their borrowers to repay.
Mr. King would have us believe that banks simply take in money from savers and lend it out to borrowers. That is clearly wrong. Even the Federal Reserve, in its own publications, says that,
The actual process of money creation takes place primarily in banks.(1) As noted earlier, checkable liabilities of banks are money. These liabilities are customers’ accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers’ accounts.
In the absence of legal reserve requirements, banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amounts the holders of deposits want to convert into currency. This unique attribute of the banking business was discovered many centuries ago.–Modern Money Mechanics
As I’ve pointed out in all of my books, banks serve two primary functions. They act as both depositories, reallocating funds from savers to borrowers, and banks of issue that monetize the promises of their borrowers. I’ve explained that in detail in Chapter 1 of my book, Money: Understanding and Creating Alternatives to Legal Tender, and in Chapter 9 of my latest book, The End of Money and the Future of Civilization.
But not all promises provide a proper basis for creating money. As Edward Popp, describes it, banks create both bona-fide and non-bona-fide money. (See Money, Bona Fide or Non-Bona Fide at http://www.reinventingmoney.com/documents/bonafidePopp.pdf).
The vast majority of the non-bona-fide money that banks create, is created on the basis of loans made to national governments (when banks buy government bonds). Further large amounts of non-bona-fide money are created when banks make loans to finance purchases of consumer goods and real estate (see my books for details). This is a violation of the principle that money should be created on the basis of goods and services on the market or soon to arrive there, which includes promises of established producers who are ready, willing and able to sell for money the things they ordinarily offer.
The bottom line remains: the present global, interest-based, debt-money system, is dysfunctional and destructive.
The creation of money on the basis of interest-bearing loans is the cause of the growth imperative, and the creation of non-bona-fide money is the cause of inflation.
If we are to achieve a sustainable society and assure the survival of civilization, we must transcend the present money and banking paradigm and reinvent the exchange process. – t.h.g.
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