Hoh hoh look what the cat dragged in…. (p11, top of second column)
Far more important for the creation of bank deposits is the act of making new loans by banks. When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created.
Banks can create new money because bank deposits are just IOUs of the bank; banks’ ability to create IOUs is no different to anyone else in the economy. When the bank makes a loan, the borrower has also created an IOU of their own to the bank. The only difference is that for the reasons discussed earlier, the bank’s IOU (the deposit) is widely accepted as a medium of exchange — it is money.
Ah, an admission. More than that, a statement of fact, and one clearly intended to stick a big fat pin in the oft-repeated nonsense in economics textbooks and in college courses (never mind High Schools.)
I went through the standard rubric in Leverage, and noted at the end that while this is a convenient means of explaining how the banks balance transactions out and such in reality banks create the loans first, not the other way around, and then those funds are deposited back to satisfy reserve requirements.
Now let’s look at this objectively.
The size of the economy is stated in units of “money”; we call that GDP.
Yet there is a statement right here, by the Bank of England, that banks create “money” out of literal nothing by making a new loan.
It is a basic principle of mathematics that when you have an equation and modify a term that exists on both sides of the equal sign that adjustment must be made to both sides!
If the economy produces 100 bushels of corn (and only that) and there are 100 “dollars” (units of currency), and those are the only two items in the economy, the natural clearing price of a bushel of corn will be approximately one of the dollars.
Now here’s the problem — if a bank comes along and issues 100 new dollars that are indistinguishable from the old ones, simply because someone asked for a loan, how much is a bushel of corn assuming the same 100 exist?
That ought to be obvious.
That would be where the problem lies with so-called “mainstream” economics when it comes to monetary mechanics, and it is a central point I made both in Leverage and in calling for a One Dollar of Capital standard for lending.
I find this paper ground-breaking and surprisingly frank. I wonder exactly why the BOE decided to “come clean” with it at this time, but no matter — the fact is that they did so and once you are given to understand this then you also wind up understanding how both commercial banksand central banks (when they engage in “QE” and similar schemes) are in fact robbing you.
And that, my friends, becomes a problem for the apologists of these programs.
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