[P2P-F] Fwd: Nef : "Where does money come from"

[Michel Bauwens]

---------- Forwarded message ----------
From: Dante-Gabryell Monson <dante.monson at gmail.com>
Date: Fri, Sep 30, 2011 at 1:31 AM
Subject: Nef : "Where does money come from"
To: econowmix at googlegroups.com, gtmonnaie at gtmonnaie.be


New Economics Foundation
is opening up and replying to a question
some of us may have explored :

http://www.neweconomics.org/press-releases/bank-reform-will-fail-without-action-on-credit-creation-warns-think-tank

http://www.neweconomics.org/publications/where-does-money-come-from

*http://www.youtube.com/watch?v=l7L3ZtCSKKs*

*Download the Foreword and Overview for
free*<http://www.neweconomics.org/sites/neweconomics.org/files/Where_does_money_come_from_OVERVIEW.pdf>
http://www.neweconomics.org/sites/neweconomics.org/files/Where_does_money_come_from_OVERVIEW.pdf

///

 There is widespread misunderstanding of how new money is created. This book
examines the workings of the UK monetary system and concludes that the most
useful description is that new money is created by commercial banks when
they extend or create credit, either through making loans or buying existing
assets. In creating credit, banks simultaneously create deposits in our bank
accounts, which, to all intents and purposes, is money.

Many people would be surprised to learn that even among bankers, economists,
and policymakers, there is no common understanding of how new money is
created. This is a problem for two main reasons. First, in the absence of
this understanding, attempts at banking reform are more likely to fail.
Second, the creation of new money and the allocation of purchasing power are
a vital economic function and highly profitable. This is therefore a matter
of significant public interest and not an obscure technocratic debate.
Greater clarity and transparency about this could improve both the
democratic legitimacy of the banking system and our economic prospects.

Defining money is surprisingly difficult. We cut through the tangled
historical and theoretical debate to identify that anything widely accepted
as payment, particularly by the government as payment of tax, is, to all
intents and purpose, money. This includes bank credit because although an
IOU from a friend is not acceptable at the tax office or in the local shop,
an IOU from a bank most definitely is.

We identify that the UK’s national currency exists in three main forms, the
second two of which exist in electronic form:

   1. Cash – banknotes and coins.
   2. Central bank reserves – reserves held by commercial banks at the Bank
   of England.
   3. Commercial bank money – bank deposits created either when commercial
   banks lend money, thereby crediting credit borrowers’ deposit accounts, make
   payments on behalf of customers using their overdraft facilities, or when
   they purchase assets from the private sector and make payments on their own
   account (such as salary or bonus payments).

Only the Bank of England or the government can create the first two forms of
money, which is referred to in this book as ‘central bank money’. Since
central bank reserves do not actually circulate in the economy, we can
further narrow down the money supply that is actually circulating as
consisting of cash and commercial bank money.

Physical cash accounts for less than 3 per cent of the total stock of money
in the economy. Commercial bank money – credit and coexistent deposits –
makes up the remaining 97 per cent of the money supply.

There are several conflicting ways of describing what banks do. The simplest
version is that banks take in money from savers, and lend this money out to
borrowers. This is not at all how the process works. Banks do not need to
wait for a customer to deposit money before they can make a new loan to
someone else. In fact, it is exactly the opposite; the making of a loan
creates a new deposit in the customer’s account.

More sophisticated versions bring in the concept of ‘fractional reserve
banking’. This description recognises that banks can lend out many times
more than the amount of cash and reserves they hold at the Bank of England.
This is a more accurate picture, but is still incomplete and misleading. It
implies a strong link between the amount of money that banks create and the
amount that they hold at the central bank. It is also commonly assumed by
this approach that the central bank has significant control over the amount
of reserves banks hold with it.

We find that the most accurate description is that banks create new money
whenever they extend credit, buy existing assets or make payments on their
own account, which mostly involves expanding their assets, and that their
ability to do this is only very weakly linked to the amount of reserves they
hold at the central bank. At the time of the financial crisis, for example,
banks held just £1.25 in reserves for every £100 issued as credit. Banks
operate within an electronic clearing system that nets out multilateral
payments at the end of each day, requiring them to hold only a tiny
proportion of central bank money to meet their payment requirements.

The power of commercial banks to create new money has many important
implications for economic prosperity and financial stability. We highlight
four that are relevant to the reforms of the banking system under discussion
at the time of writing:

   1. Although useful in other ways, capital adequacy requirements have not
   and do not constrain money creation, and therefore do not necessarily serve
   to restrict the expansion of banks’ balance sheets in aggregate. In other
   words, they are mainly ineffective in preventing credit booms and their
   associated asset price bubbles.
   2. Credit is rationed by banks, and the primary determinant of how much
   they lend is not interest rates, but confidence that the loan will be repaid
   and confidence in the liquidity and solvency of other banks and the system
   as a whole.
   3. Banks decide where to allocate credit in the economy. The incentives
   that they face often lead them to favour lending against collateral, or
   assets, rather than lending for investment in production. As a result, new
   money is often more likely to be channelled into property and financial
   speculation than to small businesses and manufacturing, with profound
   economic consequences for society.
   4. Fiscal policy does not in itself result in an expansion of the money
   supply. Indeed, the government has in practice no direct involvement in the
   money creation and allocation process. This is little known, but has an
   important impact on the effectiveness of fiscal policy and the role of the
   government in the economy.

The basic analysis of this book is neither radical nor new. In fact, central
banks around the world support the same description of where new money comes
from. And yet many naturally resist the notion that private banks can really
create money by simply making an entry in a ledger. Economist J. K.
Galbraith suggested why this might be:

*The process by which banks create money is so simple that the mind is
repelled. When something so important is involved, a deeper mystery seems
only decent.*



This book aims to firmly establish a common understanding that commercial
banks create new money. There is no deeper mystery, and we must not allow
our mind to be repelled. Only then can we properly address the much more
significant question: Of all the possible alternative ways in which we could
create new money and allocate purchasing power, is this really the best?

*Download the Foreword and Overview for
free*<http://www.neweconomics.org/sites/neweconomics.org/files/Where_does_money_come_from_OVERVIEW.pdf>



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