Banks do intermediate.

Richard Murphy, affectionately known in some quarters as “Murphaloon”, wrote an article recently in which he gives advice to the economics Nobel laureate, Joseph Stigligz, on the question as to whether banks intermediate between savers and borrowers. This should be interesting. (I use the word “interesting” advisedly.)

Basically Murphaloon has fallen hook line and sinker for flavor of the month, which is that commercial banks when they lend, create the relevant  money out of thin air RATHER THAN acquire such money from savers. As he puts it, “The reality is that banks technically do not need any deposits to make a loan.”

If that were the case, one has to ask why banks have dished out hundreds of billions over the decades in the form of sweetners designed to attract the money of savers (i.e. shareholders, bond-holders, depositors etc). When I say “sweetners” I mean dividends for shareholders and interest for bond-holders and depositors.

The reality is that commercial banks engage in BOTH ACTIVITIES. That is, it’s beyond dispute that they create a certain amount of new money most years (apart from in the middle of severe recessions). That stares you in the face from the money supply figures. But at the same time, they DO INTERMEDIATE.

In support of his ideas, Murphy cites a recent Bank of England publication. As he puts it, “As the Bank of England conceded in April 2014, the idea that banks act as intermediaries between savers and investors is just wrong.” Well if you word search for “intermediate” in the BoE work you won’t find anything about the intermediation idea being “wrong”.

What the BoE publication DOES SAY (in the summary of its second section) is “…banks do not act simply as intermediaries, lending out deposits that savers place with them…”.

That’s correct. I.e., as I said above, commercial banks do intermediate, but that’s not all they do: in addition they create a finite amount of new money most years.


The intermediation process.

The reason why commercial banks must obtain a certain amount of savers’ money before lending is thus.

Additional loans means additional spending: people borrow specifically so as to spend the money on something. Assuming the economy is at or near capacity or “full employment”, additional loans / spending must be matched by a CUT IN SPENDING elsewhere. That cut could take the form for example of a cut in public spending, but assuming “all else equal” (including public spending), additional loans / spending must be matched by additional “abstinence from spending” somewhere, i.e. additional saving.

It could well be argued that when there’s additional lending, the free market does not raise interest rates by enough to cause an equivalent amount of extra saving. And if that’s the case, the central bank has to step in and boost any naturally occurring rise in interest rates by an artificial rise in interest rates.

But the fact remains that given additional loans, and assuming all else equal, and assuming full employment, there has to be additional saving.

Put another way, given EXCESS unemployment (i.e. plenty of spare capacity), additional loans can indeed be made with no corresponding saving. But unfortunately that point is of limited relevance because given a recession, the one thing that commercial banks DO NOT DO is the save the day by granting more loans. That is, commercial banks act in a pro-cyclical rather than anti-cyclical manner.