A counterfeiter is someone who produces a form of currency which is such a close imitation of the official national currency that it’s widely accepted in lieu of the real thing. Thus it goes into circulation, and displaces the real thing. Plus the counterfeiter profits from the process.
Here’s why private banks are counterfeiters on that definition of the word.
It is now widely accepted that “loans create deposits” to quote a popular phrase. Or as the opening sentence of this Bank of England article put it, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.”
Put another way, the private bank system when granting loans, DOES NOT NEED to obtain money from anywhere: it can simply credit the account of borrowers with money produced from thin air (much like a traditional backstreet counterfeiter produces money from nowhere using paper and ink).
Now people and firms do not borrow money just to sit on it: they borrow so as to SPEND it. And that extra spending will be stimulatory / inflationary. But assuming the economy is already at capacity, the extra demand stemming from that new money has to be negated in some way, else inflation rises too much. And governments do that “negation” by imposing deflation in some way, e.g. by confiscating money from the population at large: by raising taxes and/or cutting public spending. An alternative deflationary measure is to INDUCE the private sector to give up immediate access to some of it’s “official national” money by raising interest rates.
So there is at the very least a close similarity between traditional counterfeiters and private banks. That is, for every £X produced by traditional counterfeiters, the state has to withdraw about £X from the private sector in order to keep inflation under control.
Likewise with banks: for every £X printed and loaned out by banks, the state has to confiscate official money from the private sector to compensate.
Profit.
As for the PROFIT that private banks make from creating and putting their home made money into circulation, that comes about in a slightly different way as compared to traditional counterfeiters.
Traditional counterfeiters print money and spend it. In contrast, private banks print money and LEND it. But that doesn’t alter the fact that private banks PROFIT from their money creation activities (and remember that PROFIT was one of the elements in the definition of “counterfeiter” at the start above).
Imagine the going rate of interest for a mortgage is 5% and you can simply print money and lend it out at 5%, that would be nice little earner, wouldn’t it?
Banks have to PAY to attract funds.
There is however a slight reservation to be made about the latter point. This reservation doesn’t DESTROY the point. But for the sake of accuracy, the reservation is as follows.
It was stated above that when granting a loan, a bank “can simply credit the account of borrowers with money produced from thin air..”. Notice the word “can”. That is a private bank does not NECESSARILY obtain much or all of the money for a loan from thin air: i.e. to some extent, banks obtain funds from depositors, bond-holders and so on.
Now in that a bank is engaged in the latter activity, it’s doing what most people THINK banks do: attracting deposits and lending on those deposits. Obviously no counterfeiting is involved there.
Put another way, possible counterfeiting is involved only in that banks print NEW MONEY. But the indisputable fact is that the money supply expands year after year. Thus there is no question but that a significant amount of “printing” and thus possible counterfeiting takes place every year.
Borrowers share in the profits.
A further point that complicates the issue, but doesn’t destroy the point that private banks are engaged in counterfeiting, is that it’s not just banks that benefit from counterfeiting: borrowers do as well, and for the following reasons.
If a bank is going to print and lend out money, clearly it has to undercut the going rate of interest. Now in that banks lend out HOME MADE money, that undercutting is easily done: after all, it costs a bank virtually nothing to come by that money. But that artificially low rate of interest benefits borrowers of course.
So another distinction between traditional backstreet counterfeiters and private banks is that the former keep the profit for themselves, whereas banks share the profit with borrowers.
I.e. the agreement between banks and borrowers is to a significant extent along the following lines.
Bank to potential mortgagor: “Ere mate. I’ve got a sack-full of freshly printed £50 notes. You want several thousand for your mortgage. How’s about I lend you the sack-full? I’ll charge you less than the going rate of interest. You’re happy. I’m happy. Everyone’s happy.”
So: are private banks counterfeiters?
The answer is a definite “yes”. That is, what private banks do fits the description of counterfeiting set out at the start. To reiterate, that was as follows (word for word).
A counterfeiter is someone who produces a form of currency which is such a close imitation of the real thing that it’s widely accepted in lieu of the real thing. Thus it goes into circulation, and displaces the real thing. Plus the counterfeiter profits from the process.
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P.S. (8th May, 2016). For what it’s worth, David Hume writing in 1742 referred to private bank created money as “counterfeit” money.
There are a few misconceptions here.
ReplyDelete1. "for every £X printed and loaned out by banks, the state has to confiscate official money from the private sector to compensate."
No. Bank loans do not change aggregate demand unless there is no other source of finance. In fact there are many other much more important sources of finance for investments and consumption, including foreign sources, retained profits, etc.
2. "banks PROFIT from their money creation activities ... banks lend out HOME MADE money ... it costs a bank virtually nothing to come by that money".
No. When banks make a loan (an asset in their accounts) they simultaneously incur liabilities (deposits owed to customers). No counterfeiting or profit here.
Bank profits (or losses) from their lending activities arise from interest received on loans less the expenses due to lending activities and the costs of bad loans.
3. "to some extent, banks obtain funds from depositors, bond-holders and so on"
No. When banks make a loan there is simultaneously a 100% matching deposit creation.
4. "a bank ... has to undercut the going rate of interest ... that artificially low rate of interest benefits borrowers".
No. A bank has to offer interest rates competitive with other banks and other sources of finance, but the general level of interest rates is not artificially set by any one private bank or by banks as a whole. Interest rates are set by the Central Bank.
Hi KK,
DeleteThanks for your comment. I always appreciate having my ideas challenged: indeed that’s the main point of blogging. I’ll take your points in turn.
1. I agree there are “other sources of finance”, but that doesn’t invalidate my point that when a bank creates money and lends it out, then all else equal, demand rises. (I should probably have put the “all else equal” proviso in the above article). The fact that there are ways of getting from A to B other than by walking doesn’t prove that walking isn't a way of getting from A to B.
2. Good point. You’ve spotted a weakness in my argument (which I actually dealt with in an earlier draft, but mistakenly didn’t include in the final version). My answer is thus.
I agree that when a bank makes a loan, it “simultaneously incurs a liability”. However, those liabilities split into two basic types or categories, though the dividing line between them is not a sharp one. First, there are liabilities, i.e. deposits, where the depositor demands interest: relevant money there will tend to go into a term account. Second, there are deposits which depositors intend using for day to day transactions. Relevant sums there go into current accounts (or “checking accounts” in US parlance).
For most of the time since WWII, checking accounts in the UK have paid no interest.
To the extent that money goes to no interest checking accounts, there is profit there for private banks. That is, banks can create money and lend it out at interest, while there is no liability in the form of an obligation to pay interest to anyone.
You could argue that the CAPITAL sum involved in no interest checking accounts is a liability. But my answer to that is that it’s a strange sort of liability. To illustrate…
Suppose there are just two private banks. Total amount deposited in checking accounts in the two banks is a trillion trillion pounds. Depositors simply use sums in those accounts to make payments to each other. That trillion trillion so called “liability” might seem horrendous. But as long as the amount stays constant, it simply amounts to numbers being shuffled from one bank to another and/or one account to another. There is no obligation on the private banks system as a whole to pay anything to anyone.
In contrast to checking accounts, I agree that when it comes to accounts where depositors demand interest, when the private banks system makes a loan, it will then have to pay interest to someone when relevant sums are deposited in some bank.
3. I agree that “When banks make a loan there is simultaneously a 100% matching deposit creation.” But that doesn’t disprove my point that banks need to get SOME OF their funding from bond-holders and depositors. (Actually I should have said something like “depositors with term accounts”). Why else have banks dished out billions over the decades in the form of interest for bond-holders and term account depositors?
4. Your point that interest rates are “set by the central bank” is debatable. Certainly central banks AIM TO influence interest rates, and are quite successful in doing so. But there is NO LAW which states that a commercial bank has to raise its interest rate it when a central bank raises rates. And in practice, individual commercial banks’ reaction to a central bank interest rate rise varies widely: some raise rates immediately, while some don’t do so for several months.
Thus if a bank wants to gain market share by keeping its rates down for a few months, it can easily do so. I went into this point in more detail at the link below, p.8 under the heading “Private banks cut the rate of interest”.
https://mpra.ub.uni-muenchen.de/70162/1/MPRA_paper_70162.pdf