Despite what you are told, banks do not “create money”

When addressing the ridiculous, it’s probably best to start with something basic. Let’s say you, the reader, have $1,000 in cash. As the owner of these funds, you have no limit to what you can do with them. In other words, you could lend someone else the total $1,000.

Which raises a question: how much would you have after lending $1,000? That you would have $0 is an obvious statement, but sometimes the obvious requires a statement.

This is the case given the popular view among financial journalists and Fed officials that banks, as banks, can create money. A recent book review in the the wall street journal claimed just that. In an analysis of former Fed official Lev Menand’s new book, The Untied Fed, the Examiner argued that the banks, ostensibly because they are banks, are also unrelated. According to the Examiner, when you take out a mortgage, “your bank credits your account with dollars that didn’t exist before.” Yes, the Fed official and the examiner believe that banks operate without borders. No, this reflection is not serious.

If so, why would banks pay interest on deposits? If banks can simply create the medium of exchange that borrowers go to to access banks, why pay savers rent for their savings? After that, why doesn’t Southern Bank in Cairo, IL lend with “dollars that didn’t exist before” so that it can build an asset base similar to that of JP Morgan? Above all, if banks can simply create assets with “dollars that didn’t exist before,” why has Citibank demanded so many bailouts over the past thirty years?

From there, we move on to the fundamental question of the value of the dollar. If banks, as banks, can create money out of thin air, then why is the world’s most valuable company – Apple
AAPL
– have a cash balance of more than $200 billion? Really, why would Apple hold dollars and dollar equivalents that, if Fed officials and Log are we to believe the writers, are shrinking in an unbridled way via the multiplication by the banks?

As readers can hopefully see, banks don’t actually create money. As the Examiner acknowledges, banks are required to retain a portion (usually 10%) of funds deposited with them. In other words, if you deposit $1,000 in a bank account, the bank is authorized to lend you $900. In a rational world, there would be no limits to the lending of deposited dollars, but we are getting ahead of ourselves.

We are because what the critic and Menand are really insinuating is that money deposited in a bank account does not lead to the creation of money as much as the money deposited magically multiplies! Try not to laugh reading this, but it seems the guys at the Fed and the reporters who cover them believe in magic. According to their supposed logic, $1,000 deposited in bank A soon reaches bank B as $900, then reaches bank C as $810, then reaches bank D as $729. The “dollars that didn’t exist before” are apparently just the fruits of the original $1,000 loaned out again and again. Magic!? Actually no.

If in doubt, return to the bank with $1,000. And in your case, you have no 10% reserve requirement. If you lend the $1,000, you don’t have $1,000. And if the person you lend the $1,000 to later lends it, your client doesn’t have the $1,000. There is no multiplication of money in your bank, nor multiplication when real banks are lending. If there were, as if banks – again, for being banks – could multiply money to nil, why would anyone borrow dollars that would quickly lose value after being loaned out? Why save money either?

There is simply no multiplication to speak of, nor is there “invented digital currency” as the Examiner and Fed official claim. If there were, not only would Apple not accept dollars for its products, but you, the reader, would also not accept dollars for your work, nor the producers (the dollar arbitrates most global transactions) in the whole world.

The Examiner then points out that the Fed “allows banks to borrow from the central bank when they are in trouble.” Okay, but such an observation assumes that there were no entities before the Fed that did the same thing the Fed was created to do: lend to solvent banks when they are short. short-term cash. Except that liquidity for solvent banks has long been and remains the norm in the market, with or without the Fed. Indeed, what the examiner omits is that financial institutions generally avoid borrowing from the Fed simply because it is an admission of bankruptcy, and it is an admission of bankruptcy simply because it There are large private sector entities ready to lend against quality assets held by banks.

Which is kind of the goal, or should be. As the Examiner notes by Menand, “non-bank money” represents an increasing amount of funding. Which is, of course, a statement of the obvious. Again, however, the obvious increasingly demands to be stated in today’s world. While critics and others who follow finance believe that low interest rates paid by banks and subsequent low interest loans signal “easy money”, the reality is that they report just the opposite. US banks pay very little interest on deposits because they take little or no risk with the funds deposited with them. In other words, as banks moved away from risk, their migration was accompanied by a strong growth in non-bank sources of funding.

The mistake once again of Menand and the Examiner is to believe that these non-banking institutions are also engaged in “money creation”. They are not. Again, if we ignore that counterfeiting is illegal, we cannot ignore that if financiers could create money by virtue of being financiers, what we consider “money” would not be. more. Money in circulation is a consequence of production, period. Nothing else. If the banks could just create it through a relationship with the central banks, the Soviet Union would still exist and it would eat Haiti abundantly.

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