Tuesday, 27 January 2015

Privately created money involves fraud and theft.

Private banks create money when they lend, as pointed out in this recent Bank of England work. That point was actually being made decades ago in some economics text books, e.g. R.G.Lipsey’s “Principles of Economics”.

To be more accurate, if loans are being REPAID to a bank at the same rate as new loans are granted, the bank does not on balance create money. On the other hand, the TOTAL STOCK of private bank created money tends to rise, year after year, so as distinct from the latter “repayments equals new loans” scenario, private banks ARE INTO THE BUSINESS of creating entirely new money in that the total stock of privately created money expands most years.

An alternative and perfectly valid way of looking at this process is to say that money is destroyed when a loan is repaid and created when loans are granted. The difference between those two ways of looking at the process is not important.

Money creation brings benefits.

In favor of private money creation, there is the point that money is useful stuff, ergo creating it brings benefits. And certainly if there were no central bank, then private banks would be performing a useful service in creating money. Indeed, that’s exactly what those proverbial goldsmiths did when they first issued paper receipts for non-existent gold a few hundred years ago.

However, we have central banks nowadays, thus the question arises as to whether money is best produced by 1, private banks, 2, central banks or 3, both types of banks (as is currently the case).


Privately created money involves big risks.

Privately created money has several serious problems. It gives rise to bank runs and credit crunches plus private money creation is a form of fraud and theft. We’ll start with bank runs and credit crunches.

Money is a liability of a bank: in the case of a loan, it’s an entirely artificial debt owed by a bank to a borrower which the bank undertakes to transfer to anyone else when instructed to do so by the borrower using the borrower’s cheque book, debit card or similar. Moreover, the debt is advertised by the bank as being money and a characteristic of money is that it is FIXED IN VALUE (inflation apart).

That is, we expect for example a $100 bill to be worth very nearly $100 in a months time, as distinct from for example shares which can fall or rise dramatically in value in 24 hours.

The net result is as follows. After a borrower has spent what they’ve borrowed and the relevant money has been deposited in some private bank, the private bank system then has a liability that is fixed in value and an asset (the loan the borrower) which can fall in value. That is, some borrowers fail to repay their debt.

The latter scenario (having a liability that is fixed in value and an asset that can fall in value) is clearly risky. That risk works out OK roughly nine years out of ten. But the inescapable reality is that in the tenth year it all goes wrong:  the brute fact is that private banks have gone bust by their hundreds over the centuries.

In short, risk is an inherent characteristic of private money creation. Or as  “Douglas Diamond and Raghuram Rajan say in the abstract of this paper, and in reference to the liquidity / money creation that private banks offer: “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”


Private money creation is fraudulent.

Not only does private money creation involve the near inevitability of 1929 crashes and credit crunches, it can also be argued to be fraudulent. That is, for a bank to promise its creditors they’ll be able to get $X back for every $X deposited when in fact the money concerned has been put at risk is either totally fraudulent or at least semi-fraudulent. It’s little different from borrowing money from a friend, promising to repay it, and then putting the money on a horse or a roulette table. As Martin Wolf, chief economics commentator at the Financial Times put it, “If we were not so familiar with banking, we would surely regard it as fraudulent”.

(Incidentally I’m not arguing that banning private money creation would bring a total end to bouts of irrational exuberance or the opposite, i.e. recessions. But the ban would certainly help.)

Private money creation is theft.

Money printing is profitable, as counterfeitors will attest. And what private banks do is essentially the same, but private bankers wear smart suits, drive smart cars and they take great care to befriend top politicians. That makes bankers immune from prosecution.

To explain why private money creation equals theft, let’s concentrate on the process whereby private banks EXPAND the money supply as distinct from RECYCLING existing money.

When a private bank grants a loan, the borrower spends the money and gets themselves a car or whatever. So as a result of a few book-keeping entries, the borrower manages to acquire a real and valuable assets. Nice work if you can get it! And at the same time, the rest of the community loses a real and valuable asset and in exchange gets some book-keeping entries (or numbers in a computer, which is the form that book-keeping entries take nowadays).

Someone has been diddled, haven’t they?

And do the bank and borrower ever need to repay the loan? Well not if that new money becomes a PERMANENT ADDITION to the money supply. Let’s illustrate that point by reference to paper money as distinct from the above digital or book-keeping money.

Suppose everyone decides they want to carry an additional £10 around with them, the central bank / government would need to create an extra £10 per person, and spend that money into the private sector (in the form of extra spending on roads, law and order, education or whatever).

In a sense then, government “profits” in that it manages to acquire real goods and services (roads etc) in exchange for silly bits of paper which cost next to nothing to print.

But of course we don’t object to that profit because government is owned by the people: put another way, when a new road is built, we all benefit. In contrast, and in the case of a private bank and borrower, it’s the private bank and borrower who make the profit, not the community. Why do we let them get away with it?

Also, note that where a loan brings about a permanent increase in the money supply, the borrower DOES NOT (contrary to popular perception) borrow from the bank. At least no REAL GOODS OR RESOURCES are transferred from the bank to the borrower. Put another way, bank staff do not sweat their guts out making the new car or whatever the borrower acquires.

The only job performed by the bank is an administrative one: e.g. checking up on the value of the collateral supplied by the borrower. Thus the bank, strictly speaking, has no reason to charge interest: it DOES HAVE a reason to charge for the above ADMINISTRATION COSTS, and will almost certainly CALL THAT interest. But it’s not actually interest.

In contrast, in the case of RECYCLING (in the above sense), a private bank obviously gets the money it lends out from somewhere: it gets the money from depositors, bond-holders or shareholders. And the latter three will want interest or some sort of return on their money. And clearly the bank has to pass on that interest to borrowers. So in that case, borrowers pay BOTH the above administration costs and what might be called “genuine interest”.

To summarise, private money creation involves bank runs, credit crunches, fraud and theft! How low can you get?

So is there an alternative way of supplying the economy with the money it needs?  Well yes: have the CENTRAL BANK supply as much money as we need. And money creation is a job that central banks already perform: indeed they’ve been performing that task on a unprecedented scale in recent years in the form of QE.


Banning private money inhibits lending?

There might seem to be a problem in banning private money creation and having the central bank supply our money needs instead, and that’s that as pointed out above, lending by private banks seems to be inextricably tied to money creation. And if that were the case, then obviously banning private money creation would inhibit or bar lending by private banks.

However, as already intimated, it is legitimate to say that no money creation in fact takes place when most loans are granted in that ROUGHLY SPEAKING, loans repaid to a private bank each month equal new loans granted. Put another way, in that private banks just re-cycle EXISTING MONEY, they don’t create new money.

And if all money were CENTRAL BANK CREATED, the granting of loans would not be inhibited in that private banks just engage in the latter recycling process. Put another way, if there were a FIXED STOCK of central bank money, and private bank money were banned, then obviously expanding the money supply would not be possible.

But of course the latter is a total and complete non-problem because central banks and governments can and do expand the stock of central bank created money any time they want. QE is just one method.

Conclusion: privately created money has nothing going for it. It involves fraud and theft. It’s a left-over from those goldsmiths who issued paper receipts for non-existent gold, and made a fortune doing so. Private money creation only continues because of general ignorance about money: in particular the fact that private bankers run rings round economically illiterate regulators and politicians.


  1. While I support most of your points, one good thing about banks is not mentioned: banks are builders.

    When banks make a loan, the borrower promises to perform in a specified way. If the loan is to build a residence, a home should be built. If the loan is to buy trade goods, the goods should be available for trade.

    The usual desirable feature of bank loans is that the borrower promises good and constructive behavior.

    Now let us assume that the loan goes bad. The usual case is that the good part has been done (the house built, the trade goods in place) but the borrower fails to repay the money.

    Now failure to repay the money is a break in the monetary chain for the lender and may cause the failure of the bank with the bad features you describe. Money failure does not negate the good that has been done with the borrowed funds. A house built remains built. The trade goods remain in place, hopefully to be beneficially used by someone at some price.

    But certainly foolish lending practices will result in foolish investment or foolish consumption. A transfer of foolish private investment to the broad public shoulder makes the public into fools.

    In concluding summary, banks have a good side and a high risk side. The idea of an investment bank (for high risk loans) that is not insured by the public is a halfway measure towards the risk-free banking you are proposing.

  2. Roger, You seem to suggest in your 2nd last para that having just the state provide the money supply means that the state is then on the hook for irresponsible loans. Indeed, others have made that assumption. But actually that’s not the case.

    To illustrate, the state already provides part of our money supply: physical cash. If I lend a £20 note to someone, and they fail to repay it, it’s me and me alone that suffers the loss. Mark Carney, governor of the Bank of England would entirely indifferent to my plight!


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