My last post argued that the thing that issues money, whatever it is, necessarily runs a deficit (given the normal definition of ‘deficit’.) Some will disagree with what I posted on the grounds that I misrepresented how money is created. The will argue that banks create money, and lend it to us and the government.
It could be argued, given a narrow view, that banks create money in the sense that if you go to a bank and ask them to lend you a grand, you get a grand to spend. It’s more accurate, however, to say that banks create spending power, or what economists call demand, not money. The create promises to provide pounds, not pounds. In order to see why you just have to look at any bank’s accounting system.
Firstly, banks can create money. Anyone can. That’s why I’m talking about Pounds, not money in general. There is a key difference. Pounds are issued by, and can only be issued by, the British Government. That’s really what a Pound Sterling is. So why do some people believe that the thing that issues pounds has to borrow them? Who knows. I suspect, mostly, propaganda. Anyway, what happens when you borrow a grand?
The bank creates a deposit account with a grand balance. To the bank this is a liability, because you can demand it at any time. The transaction also creates a debt, of a grand, issued by you. The bank now has a liability and an asset, each worth exactly the same. The bank’s balance sheet total is unchanged. You, if you are keeping standard accounting records, now have an asset in the form of a deposit account and a liability in the form of the debt you owe the bank, both worth the same, so your balance sheet total stands unchanged.
The situation has created no money. Neither yours nor the bank’s balance sheet has changed. Further, if we add interest in then not only has the bank not created any money but it’s also absorbing money from you. This shows up on the bank’s cash-flow account in the form of interest payments over time. So balance sheets are unaffected while the bank’s cash-flow is net increased while yours is net decreased. So how can this create money? It can’t. You have to pay more money back, where do you get the money? Other bank loans? Pay from employers? Where do they get it? People like you? Other banks? There is no part of this in which banks create pounds because they simple can’t. Of course this is obvious when you realise banks are businesses. If they could issue pounds why do they bother doing anything? They could just issue themselves profits. They could open themselves huge deposit accounts, but if you look at the above that would result in net zero on both balance and cash-flow accounts. Ultimately banks are interested in making useful money, like Pounds, which they can’t create.
What if you go to the bank and withdraw your grand? Simple, the bank gives you some of the cash it had lying around. Where did it get that cash? It bought it off the Royal Mint, paid for out of their reserve account at the Bank of England. Similarly, if you want to send your pounds to another bank (for example if you bought something of someone that has a bank account in that bank) your banks sends reserves to the other bank. In both cases the banks loses both an asset (reserves) and a liability (part of your deposit balance), worth the same amount: the amount you withdrew or transfered. Net zero to the balance sheets, but your bank retains your interest cash-flow. Banks can’t issue themselves reserves. They get reserves, ultimately, from the Treasury. Usually this is achieved by the bank buying bonds off the Treasury that pay interest.
Many have a bizarre interpretation of banking by looking at the fact that the treasury issues bonds and conclude that the treasury is ‘borrowing’ and running a deficit to fund spending, while the money creator is really the Bank of England (funnily also a branch of the government anyway), which runs no deficit, and that the treasure simply prints cash and mints coins. The BoE runs no deficit because it is funded by the Treasuries deficit, issued via bond sales. The treasure creates the pounds that the BoE puts in commercial banks’ reserve accounts. The process of creation takes the form of bonds, that’s all.
This is why the talk of ‘government debt’ is misleading. A large chunk of the government’s deficit takes the form of debt in accounting terms because that’s how the Treasury choses to control the reserve level in the banking sector, it’s not even funding spending, the Treasure can just spend pounds out of nothing, this is how it pays for… everything. If the government wants to pay benefits, build a hospital or a road or a train track or a tank, it just puts money directly into a bank account: no borrowing. The ‘debt’ part of the deficit is just the sum total of treasury bonds issued by the Treasury. The interest that the Treasury pays on those bonds is just the total cash flow of new money creation (minus money created through real government spending), and is entirely optional*. The government could pay zero if it wanted to, and it can pay whatever it wants because it can just create the pounds to pay for it. There is no funding / debt servicing problem. It’s just a matter of choosing the rate at which to create new money.
*in fact the Treasury only pays interest on these bonds to limit interest rates. If you take out a saving account your bank funds that with a Treasury bond. The bank wants to make a profit so it takes a chunk of the interest it earns and gives the rest to you. If the bank took no cut at all, then you would get what the Treasury is paying, so that is effectively the limit your savings account will pay (unless the bank decides to run a loss).