________
Source: Science Direct
Abstract
This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money 'out of nothing' and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as 'fairy dust' produced by the banks individually, "out of thin air".
Larry & Carstens' Excellent Pandemic
The only solution is genuine populist-driven monetary reform:
Source: Science Direct
International Review of Financial Analysis
Volume 36, December 2014, Pages 1-19
Abstract
This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money 'out of nothing' and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as 'fairy dust' produced by the banks individually, "out of thin air".
"The choice of a measure of value, of a monetary system, of currency and credit legislation — all are in the hands of society, and natural conditions … are relatively unimportant. Here, then, the decision-makers in society have the opportunity to directly demonstrate and test their economic wisdom — or folly. History shows that the latter has often prevailed."1
Wicksell (1922, p. 3)
1. Introduction
Since the American and European banking crisis of 2007–8, the role of banks in the economy has increasingly attracted interest within and outside the disciplines of banking, finance and economics. This interest is well justified: Thanks to the crisis, awareness has risen that the most widely used macroeconomic models and finance theories did not provide an adequate description of crucial features of our economies and financial systems, and, most notably, failed to include banks.2 These bank-less dominant theories are likely to have influenced bank regulators and may thus have contributed to sub-optimal bank regulation: Systemic issues emanating from the banking sector are impossible to detect in economic models that do not include banks, or in finance models that are based on individual, representative financial institutions without embedding these appropriately into macroeconomic models.3
Consequently, many researchers have since been directing their efforts at incorporating banks or banking sectors in economic models.4 This is a positive development, and the European Conferences on Banking and the Economy (ECOBATE) are contributing to this task, showcased in this second special issue, on ECOBATE 2013, held on 6 March 2013 in Winchester Guildhall and organised by the University of Southampton Centre for Banking, Finance and Sustainable Development. As the work in this area remains highly diverse, this article aims to contribute to a better understanding of crucial features of banks, which would facilitate their suitable incorporation in economic models. Researchers need to know which aspects of bank activity are essential — including important characteristics that may distinguish banks from non-bank financial institutions. In other words, researchers need to know whether banks are unique in crucial aspects, and if so, why.
In this paper the question of their potential ability to create money is examined, which is a candidate for a central distinguishing feature. A review of the literature identifies three different, mutually exclusive views on the matter, each holding sway for about a third of the twentieth century. The present conventional view is that banks are mere financial intermediaries that gather resources and re-allocate them, just like other non-bank financial institutions, and without any special powers. Any differences between banks and non-bank financial institutions are seen as being due to regulation and effectively so minimal that they are immaterial for modelling or for policy-makers. Thus it is thought to be permissible to model the economy without featuring banks directly. This view shall be called the financial intermediation theory of banking. It has been the dominant view since about the late 1960s.
Between approximately the 1930s and the late 1960s, the dominant view was that the banking system is 'unique', since banks, unlike other financial intermediaries, can collectively create money, based on the fractional reserve or 'money multiplier' model of banking. Despite their collective power, however, each individual bank is in this view considered to be a mere financial intermediary, gathering deposits and lending these out, without the ability to create money. This view shall be called the fractional reserve theory of banking.
There is a third theory about the functioning of the banking sector, with an ascendancy in the first two decades of the 20th century. Unlike the financial intermediation theory and in line with the fractional reserve theory it maintains that the banking system creates new money. However, it goes further than the latter and differs from it in a number of respects. It argues that each individual bank is not a financial intermediary that passes on deposits, or reserves from the central bank in its lending, but instead creates the entire loan amount out of nothing. This view shall be called the credit creation theory of banking.
The three theories are based on a different description of how money and banking work and they differ in their policy implications. Intriguingly, the controversy about which theory is correct has never been settled. As a result, confusion reigns: Today we find central banks – sometimes the very same central bank – supporting different theories; in the case of the Bank of England, central bank staff are on record supporting each one of the three mutually exclusive theories at the same time, as will be seen below.
It matters which of the three theories is right — not only for understanding and modelling the role of banks correctly within the economy, but also for the design of appropriate bank regulation that aims at sustainable economic growth without crises. The modern approach to bank regulation, as implemented at least since Basel I (1988), is predicated on the understanding that the financial intermediation theory is correct.5 Capital adequacy-based bank regulation, even of the counter-cyclical type, is less likely to deliver financial stability, if one of the other two banking hypotheses is correct.6 The capital-adequacy based approach to bank regulation adopted by the BCBS, as seen in Basel I and II, has so far not been successful in preventing major banking crises. If the financial intermediation theory is not an accurate description of reality, it would throw doubt on the suitability of Basel III and similar national approaches to bank regulation, such as in the UK.7
It is thus of importance for research and policy to determine which of the three theories is an accurate description of reality. Empirical evidence can be used to test the relative merits of the theories. Surprisingly, no such test has so far been performed. This is the contribution of the present paper.
The remainder of the paper is structured as follows. Section 2 provides an overview of relevant literature, differentiating authors by their adherence to one of the three banking theories. It will be seen that leading economists have gone on the record in support of each one of the theories. In Section 3, I then present an empirical test that is able to settle the question of whether banks are unique and whether they can individually create money 'out of nothing'. It involves the actual processing of a 'live' bank loan, taken out by the researcher from a representative bank that cooperates in the monitoring of its internal records and operations, allowing access to its documentation and accounting systems. The results and some implications are discussed in Section 4.
2. The literature on whether banks can create money
Much has been written on the role of banks in the economy in the past century and beyond. Often authors have not been concerned with the question of whether banks can create money, as they often simply assume their preferred theory to be true, without discussing it directly, let alone in a comparative fashion. This literature review is restricted to authors that have contributed directly and explicitly to the question of whether banks can create credit and money. During time periods when in the authors' countries banks issued promissory notes (bank notes) that circulated as paper money, writers would often, as a matter of course, mention, even if only in passing, that banks create or issue money. In England and Wales, the Bank Charter Act of 1844 forbade banks to "make any engagement for the payment of money payable to bearer on demand." This ended bank note issuance for most banks in England and Wales, leaving the (until 1946 officially privately owned) Bank of England with a monopoly on bank note issuance. Meanwhile, the practice continued in the United States until the 20th century (and was in fact expanded with the similarly timed New York Free Banking Act of 1838), so that US authors would refer to bank note issuance as evidence of the money creation function of banks until much later.8 For sake of clarity, our main interest in this paper is the question whether banks that do not issue bank notes are able to create money and credit out of nothing. As a result, earlier authors, writing mainly about paper money issuance, are only mentioned in passing here, even if it could be said that their arguments might also apply to banks that do not issue bank notes. These include John Law (1705), James Steuart (1767), Adam Smith (1776), Henry Thornton (1802), Thomas Tooke (1838), and Adam Müller (1816), among others, who either directly or indirectly state that banks can individually create credit (in line with the credit creation theory).9
2.1. The credit creation theory of banking
Influential early writers that argue that non-issuing banks have the power to individually create money and credit out of nothing wrote mainly in English or German, namely Wicksell, 1898, Wicksell, 1907, Withers (1909), Schumpeter (1912), Moeller (1925) and Hahn (1920).10 The review of proponents of the credit creation theory must start with Henry Dunning Macleod, of Trinity College, Cambridge, and Barrister at Law at the Inner Temple.11 Macleod produced an influential opus on banking, entitled The Theory and Practice of Banking, in two volumes. It was published in numerous editions well into the 20th century (Macleod, 1855–6; the quotes here are from the 6th edition of 1905). Concerning credit creation by individual banks, Macleod unequivocally argued that individual banks create credit and money out of nothing, whenever they do what is called 'lending':
"In modern times private bankers discontinued issuing notes, and merely created Credits in their customers' favour to be drawn against by Cheques. These Credits are in banking language termed Deposits. Now many persons seeing a material Bank Note, which is only a Right recorded on paper, are willing to admit that a Bank Note is cash. But, from the want of a little reflection, they feel a difficulty with regard to what they see as Deposits. They admit that a Bank Note is an 'Issue', and "Currency," but they fail to see that a Bank Credit is exactly in the same sense equally an 'Issue,' 'Currency,' and 'Circulation'."
Please go to Science Direct to read the entire paper.
How banks create money out of nothing with Richard Werner:
Wicksell (1922, p. 3)
1. Introduction
Since the American and European banking crisis of 2007–8, the role of banks in the economy has increasingly attracted interest within and outside the disciplines of banking, finance and economics. This interest is well justified: Thanks to the crisis, awareness has risen that the most widely used macroeconomic models and finance theories did not provide an adequate description of crucial features of our economies and financial systems, and, most notably, failed to include banks.2 These bank-less dominant theories are likely to have influenced bank regulators and may thus have contributed to sub-optimal bank regulation: Systemic issues emanating from the banking sector are impossible to detect in economic models that do not include banks, or in finance models that are based on individual, representative financial institutions without embedding these appropriately into macroeconomic models.3
Consequently, many researchers have since been directing their efforts at incorporating banks or banking sectors in economic models.4 This is a positive development, and the European Conferences on Banking and the Economy (ECOBATE) are contributing to this task, showcased in this second special issue, on ECOBATE 2013, held on 6 March 2013 in Winchester Guildhall and organised by the University of Southampton Centre for Banking, Finance and Sustainable Development. As the work in this area remains highly diverse, this article aims to contribute to a better understanding of crucial features of banks, which would facilitate their suitable incorporation in economic models. Researchers need to know which aspects of bank activity are essential — including important characteristics that may distinguish banks from non-bank financial institutions. In other words, researchers need to know whether banks are unique in crucial aspects, and if so, why.
In this paper the question of their potential ability to create money is examined, which is a candidate for a central distinguishing feature. A review of the literature identifies three different, mutually exclusive views on the matter, each holding sway for about a third of the twentieth century. The present conventional view is that banks are mere financial intermediaries that gather resources and re-allocate them, just like other non-bank financial institutions, and without any special powers. Any differences between banks and non-bank financial institutions are seen as being due to regulation and effectively so minimal that they are immaterial for modelling or for policy-makers. Thus it is thought to be permissible to model the economy without featuring banks directly. This view shall be called the financial intermediation theory of banking. It has been the dominant view since about the late 1960s.
Between approximately the 1930s and the late 1960s, the dominant view was that the banking system is 'unique', since banks, unlike other financial intermediaries, can collectively create money, based on the fractional reserve or 'money multiplier' model of banking. Despite their collective power, however, each individual bank is in this view considered to be a mere financial intermediary, gathering deposits and lending these out, without the ability to create money. This view shall be called the fractional reserve theory of banking.
There is a third theory about the functioning of the banking sector, with an ascendancy in the first two decades of the 20th century. Unlike the financial intermediation theory and in line with the fractional reserve theory it maintains that the banking system creates new money. However, it goes further than the latter and differs from it in a number of respects. It argues that each individual bank is not a financial intermediary that passes on deposits, or reserves from the central bank in its lending, but instead creates the entire loan amount out of nothing. This view shall be called the credit creation theory of banking.
The three theories are based on a different description of how money and banking work and they differ in their policy implications. Intriguingly, the controversy about which theory is correct has never been settled. As a result, confusion reigns: Today we find central banks – sometimes the very same central bank – supporting different theories; in the case of the Bank of England, central bank staff are on record supporting each one of the three mutually exclusive theories at the same time, as will be seen below.
It matters which of the three theories is right — not only for understanding and modelling the role of banks correctly within the economy, but also for the design of appropriate bank regulation that aims at sustainable economic growth without crises. The modern approach to bank regulation, as implemented at least since Basel I (1988), is predicated on the understanding that the financial intermediation theory is correct.5 Capital adequacy-based bank regulation, even of the counter-cyclical type, is less likely to deliver financial stability, if one of the other two banking hypotheses is correct.6 The capital-adequacy based approach to bank regulation adopted by the BCBS, as seen in Basel I and II, has so far not been successful in preventing major banking crises. If the financial intermediation theory is not an accurate description of reality, it would throw doubt on the suitability of Basel III and similar national approaches to bank regulation, such as in the UK.7
It is thus of importance for research and policy to determine which of the three theories is an accurate description of reality. Empirical evidence can be used to test the relative merits of the theories. Surprisingly, no such test has so far been performed. This is the contribution of the present paper.
The remainder of the paper is structured as follows. Section 2 provides an overview of relevant literature, differentiating authors by their adherence to one of the three banking theories. It will be seen that leading economists have gone on the record in support of each one of the theories. In Section 3, I then present an empirical test that is able to settle the question of whether banks are unique and whether they can individually create money 'out of nothing'. It involves the actual processing of a 'live' bank loan, taken out by the researcher from a representative bank that cooperates in the monitoring of its internal records and operations, allowing access to its documentation and accounting systems. The results and some implications are discussed in Section 4.
2. The literature on whether banks can create money
Much has been written on the role of banks in the economy in the past century and beyond. Often authors have not been concerned with the question of whether banks can create money, as they often simply assume their preferred theory to be true, without discussing it directly, let alone in a comparative fashion. This literature review is restricted to authors that have contributed directly and explicitly to the question of whether banks can create credit and money. During time periods when in the authors' countries banks issued promissory notes (bank notes) that circulated as paper money, writers would often, as a matter of course, mention, even if only in passing, that banks create or issue money. In England and Wales, the Bank Charter Act of 1844 forbade banks to "make any engagement for the payment of money payable to bearer on demand." This ended bank note issuance for most banks in England and Wales, leaving the (until 1946 officially privately owned) Bank of England with a monopoly on bank note issuance. Meanwhile, the practice continued in the United States until the 20th century (and was in fact expanded with the similarly timed New York Free Banking Act of 1838), so that US authors would refer to bank note issuance as evidence of the money creation function of banks until much later.8 For sake of clarity, our main interest in this paper is the question whether banks that do not issue bank notes are able to create money and credit out of nothing. As a result, earlier authors, writing mainly about paper money issuance, are only mentioned in passing here, even if it could be said that their arguments might also apply to banks that do not issue bank notes. These include John Law (1705), James Steuart (1767), Adam Smith (1776), Henry Thornton (1802), Thomas Tooke (1838), and Adam Müller (1816), among others, who either directly or indirectly state that banks can individually create credit (in line with the credit creation theory).9
2.1. The credit creation theory of banking
Influential early writers that argue that non-issuing banks have the power to individually create money and credit out of nothing wrote mainly in English or German, namely Wicksell, 1898, Wicksell, 1907, Withers (1909), Schumpeter (1912), Moeller (1925) and Hahn (1920).10 The review of proponents of the credit creation theory must start with Henry Dunning Macleod, of Trinity College, Cambridge, and Barrister at Law at the Inner Temple.11 Macleod produced an influential opus on banking, entitled The Theory and Practice of Banking, in two volumes. It was published in numerous editions well into the 20th century (Macleod, 1855–6; the quotes here are from the 6th edition of 1905). Concerning credit creation by individual banks, Macleod unequivocally argued that individual banks create credit and money out of nothing, whenever they do what is called 'lending':
"In modern times private bankers discontinued issuing notes, and merely created Credits in their customers' favour to be drawn against by Cheques. These Credits are in banking language termed Deposits. Now many persons seeing a material Bank Note, which is only a Right recorded on paper, are willing to admit that a Bank Note is cash. But, from the want of a little reflection, they feel a difficulty with regard to what they see as Deposits. They admit that a Bank Note is an 'Issue', and "Currency," but they fail to see that a Bank Credit is exactly in the same sense equally an 'Issue,' 'Currency,' and 'Circulation'."
Please go to Science Direct to read the entire paper.
________
Professor Richard Werner interview with David Buik (City of London): How banks create money - Princes of Yen - 2017:
In the following linked article this demonstrates how the central bank's ability to create money out of nothing provides large sums of magic money to people intimately connected to the financial and banking system. It's a simple formula. Just pay them off with enormous sums of money. In this case, $7 million to Janet Yellen. Does anyone in their right mind think a regulator is going to step in and cut off Wall Street's easy access to magic money?
"The pandemic presented forensically for what it is, namely, a massive theatrical edifice intended to distract popular attention away from the fact that criminal bankers running the monetary system are making a massive push toward full-on totalitarianism through monetary and financial control."
Related:
This is what all that magic money makes possible:
Don't ever expect this discussion about the power of those who create "fairy dust" in the BoE to go into full motion reality through the British media either:
The only solution is genuine populist-driven monetary reform:
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