Home > Uncategorized > Money creating banks ARE special – the statisticians view

Money creating banks ARE special – the statisticians view

Are money creating banks ‘special’? At this moment there is a little discussion is going on about the nature of money creating banks (look here for the interesting interfluidity ideas). But I’m still missing something in the blogs I read – a more down to earth, institutional, real world view. So let’s turn to the people who estimate this real economic world, the economic statisticians.

According to Tobin banks could de jure be called special as they can create the money ‘with a fountain pen’ but the rational consumer constricts them in this capacity. Without borrowers no lenders. And as borrowers are rational net lending will de facto be limited and banks will not be different from other financial institutions, like pension funds. End of story. But what do the statisticians tell us about this? You can’t estimate anything when it’s not properly demarcated.  And to estimate macro-economic variables, like money and debt, you need a macro-economic model, with proper demarcations. And one of these demarcations is a dividing line between money creating banks and other financial institutions. And this demarcation is totally based upon the idea that money creating banks are special and do require special regulation. what’s the idea? Why are money creating banks special?

According to Nick Rowe, banks might be special as ‘Banks are financial intermediaries whose liabilities are used as media of exchange‘. But that’s not special. Liabilities of every non-bankrupt company can be and are used as a medium of exchange. These liabilities are called ‘receivables’ on the balance sheet of the selling company and ‘payables’ on the balance sheet of the buying firm, the receivables are quite liquid (albeit at a haircut) and this stream of (admittedly: temporary) money runs into trillions and trillions a year. The ‘media of exchange’ thing is not enough to single out money creating banks as ‘special’. The reality is that money creating banks are financial intermediaries whose liabilities can be exchanged for government money at a guaranteed 1:1 exchange rate. And that’s special. This (plus a little technology) enables you to use bank credit money to pay your taxes or the hairdresser – without any kind of haircut. Read this magnificent post from Francis Coppola about a little bit of the history of this remarkable state of affairs.

And this state of affairs does require special attention. According to the European Central Bank, it does need information from exactly these money creating banks:

Balance sheet statistics for monetary financial institutions (MFIs) are some of the core statistics used by the ECB and provide information that is crucial for the conduct of euro area monetary policy.

But the sector is not just demarcated for statistical reasons, it’s not just about ‘crucial information’ – according to the statisticians. There is a reason why we need this information. The ESA 95 manual, which is the basis for European National Accounts, states (emphasis added):

The other monetary financial institutions sub-sector (i.e. credit banks excluding the central banks, M.K.) is regarded as equivalent to the other depository corporations sub-sector as defined in the 1993 SNA 4.88 – 4.94. While the definition of the other monetary financial institutions sub-sector (see paragraph 2.48.) is intended to cover those financial intermediaries through which the effects of the monetary policy of the central bank are transmitted to the other entities of the economy ... The combined sub-sectors S.121 and S.122 coincide with the monetary financial institutions for statistical purposes as defined by the EMI.

We need the information because the government wants to have a special hold on these banks, to control lending and the amount of money. Which indicates that these banks are indeed special – ‘equilibrium’ in a neo-classical sense is not guaranteed. To the contrary. They can, in stark contrast with the ‘rational consumer market discipline’ idea of Tobin and when de-holding gives them a chance, indeed turn their remarkable prerogative into a ‘widows cruse’, for instance by ‘Ponzi real estate lending’ which leads to inflated house prices and billions upon billions of seigniorage profits (in the shape of interest) for the banks. According to Tobin, an increase of house prices would have led to a decline of the rate of return of houses which would have led to less borrowing by households and therewith to the exclusion of a bubble. Hmmm….

  1. rddulin
    August 30, 2013 at 11:47 am

    There are two types of lending: 1. lending that creates money. 2. lending that creates velocity. What counts in an economy is “buying power” or Money X Velocity. To confuse the two brings us to the current state of understanding that presently exists. Any individual lending Gold or other “hard money” creates velocity but no new gold. The borrower can re-lend the gold borrowed or the person that the gold was paid to can re-lend it. Fractional reserve banking is solely a mechanism to co-ordinate lending between multiple lenders.

  2. August 31, 2013 at 12:52 am

    The MFIs’ privilege to create state-sponsored money seems incompatible with their practice of holding assets bought with the money they created as collateral. Presently the asset class of choice is houses and this leads to a predictable bubble in housing. If instead it was common for banks to lend people money to buy gold and hold the gold as collateral there would be an MFI fiat money induced bubble in gold (and we could laugh at the Gold Standard folks). Same if it was common to take out loans to buy stocks (as with CFDs).

    Either MFIs have to make only unsecured loans, in which case inflation and bankruptcy of MFIs are the rebalancing mechanisms, or there has to be some strong criterion of value-add to limit the amount of new money creation by MFIs. In other words borrowing to buy assets makes bubbles. Borrowing to effect a value-add transformation may be OK if it’s honest.

  3. August 31, 2013 at 4:04 am

    Why do economists spend so much time citing old or dead gurus like religious prophets? In the process, simple things are made to sound so complicated? Why don’t they open their eyes and look around and describe what they see? The discussion on money has been complicated by inappropriate references to past and different economic circumstances.

    Today, when banks are regulated by a government, they are special because the power of the state can be brought potentially to bear, as for example in bail-outs and bail-ins. The stated intention is to provide confidence and systemic stability. Academics describe only the normal situation of trust of banks and compliance to authority. But this is only the simple part of understanding money.

    When a government abuses its authority and overuse its power to create fiat currency (e.g. listening to MMT or the Keynesian crowds), then the foundation of the monetary system is undermined. The special trust of banks debt-money then rest on a shaky foundation. The temptation to abuse the power of creating money, aided by bad economic theories, is so great that no government (with its banking system) in history has been able to resist it.

    The important problem about money today is no longer about how banks could have created so much debt or the mechanics of loans and deposits creation. It is about the viability of the global fiat money system, as Voltaire observed, “paper money eventually returns to its intrinsic value – zero”, which may be happening.

    • Demurrage
      August 31, 2013 at 10:46 am

      The King smiled at the request and said, “I cannot imagine what pleasure you Europeans find in our yellow clay; but take away as much of it as you will, and much good may it do you.”

      Candide – Voltaire (old dead guru)

      • August 31, 2013 at 3:18 pm

        you think paper money has 0 value equilibrium? that’s false. i’ve used it for kindling. paper burns, not rocks! (the marx brothers also showed education in the form of books has intrinsic value—-when you run out of wood, you can just put economic journals in there. i did it with a bible once too, in alaska).
        voltaire was against the hereidtary monarchy and clerisy, and thought the encylopediasts and rationalists shoud replace them. as he pointed out, when asked about the peasants, ‘someone has to work the fields’.

  4. rddulin
    August 31, 2013 at 12:20 pm

    The heart of the matter is the nature, mechanics and results of lending money. Lending distorts any money system that its practice is allowed in. It is not totally the interest expense but problems with the lending itself. Why don’t teachers and professors “lend” grades? The student could get a better paying job immediately at the expense of other students who actually did the work as long as they could fake competence. The professor should be a good judge of who could fake it and who couldn’t. No one could tell the difference between a $100,00 A or an honestly earned A.
    Number ONE rule of thumb is that you can not “lend” in a measuring system and retain integrity or that system.

  5. PeterN
    September 1, 2013 at 3:19 pm

    Major forest fires are impossible. Fires require fuel, and the larger the fire and the faster it burns, the more quickly it exhausts its fuel thus restoring equilibrium. It works for me.

  6. September 2, 2013 at 6:03 am

    Economists do not discuss “good money” and “bad money” these days, like they used to e.g: Gresham’s “bad money drives out good”. Yet that is exactly what they need to discuss with debt-money. MMTers and Keynesians are fond of ignoring quality and emphasizing quantity, that debt-money can be created by commercial banks and fiat money can be created by central banks “out of thin air” (without constraint).

    As debt-money increases, its quality decreases, in the sense that debt-owners increase their risk of loss of their money through defaults. Macroeconomics only consider quantities measured through aggregated variables and ignores underlying qualities of the composite variables.

    The GFC was an example of “bad debt-money driving out good debt-money”. Bad lending (through securitisation and deregulation) was far more profitable (risk-adjusted) than traditional good lending, which is regulated. While bad lending was permitted, no banker could resist it due to competition, as Charles Prince (ex CEO Citigroup) said in 2000, “As long as the music is playing, you’ve got to get up and dance”. He was still dancing in 2007.

    Bad money which is largely ignored these days is what needs to be understood.

  7. rddulin
    September 2, 2013 at 11:22 am

    Lending is what turns good money into bad money. Lending increases the velocity making the money worth less (creates inflation). If the profit from lending does not correspond to increased productivity it is just a complicated way of stealing. Since it very rarely does, there is no such thing as “Good lending”.

  8. Allen
    September 3, 2013 at 10:08 am

    lyonwiss “When a government abuses its authority and overuse its power to create fiat currency (e.g. listening to MMT or the Keynesian crowds), then the foundation of the monetary system is undermined. The special trust of banks debt-money then rest on a shaky foundation. The temptation to abuse the power of creating money, aided by bad economic theories, is so great that no government (with its banking system) in history has been able to resist it.”
    Untrue! There are are a number of examples E.g. Guernsey.
    There is no reason why 100% reserve banking has to be unstable. It is normally assumed that the money creation would be in the hands of a central bank or monetary authority, not politicians.
    On the other hand private banks are always seeking to increase their money creation because they are in a competitive industry where, unless there is a crash and the greediest banks are not bailed out, the responsible money creators fail to withstand the lending competition.

    • September 3, 2013 at 12:06 pm

      A 100% reserve banking system is not really a fiat system, because there is no need for an authority to coerce acceptance in legal tender.

  9. rddulin
    September 3, 2013 at 1:32 pm

    Ladies and gentlemen, please understand. It is the LENDING itself that screws up the money system. Even if the money is gold or other specie, even if it is only all lent out once you have twice as much “Buying Power” or M x V.
    Twice as much “Buying Power” is the same as twice as much money. This means twice as much inflation.

    When you factor in the possibility of the lender not spending their interest but “re-investing” that interest in more lending, any money system becomes a shadow ghost of what one would think a money system should be.
    Lending = screwed up money system and no lending = accurate money system.

    Under the present system we need the government to abuse its authority and create excess money for us to pay the compounded interest generated by the investors lending.
    If the government does not “borrow” the money the private sector has to.

    If the human race can not understand “lending” that destroys their money systems and the means of accurate property exchange they need be taken care of like any animal that can not run their own affairs. Maybe aliens will show up looking for human slaves and render this tortuous subject academic history.

  10. February 24, 2014 at 5:41 pm
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