Monday, 8 August 2016

Admati and Helliwig’s odd claim that bank deposits are not money.

Anat Admati is an economics prof at Stanford and Martin Hellwig is a German economist currently at the Max Plank Institute.

I normally agree with A&H, and in particular I fully support their call for much higher bank capital ratios and their criticisms of the corrupt banker  / politician / regulator revolving door.

But their claim in section 5 of a recent article that private banks do not create or “print” money is flawed. The article title is “The Parade of the Bankers’ New Clothes Continues:  31 Flawed Claims Debunked”.

Their argument is very short – so short that I’ll reproduce section 5 in its entirety below. In reference to the claim that bank deposits are not a form of money, they start as follows.

“This claim rests on an abuse of the word “money.” The notion that  banks  “produce”  or  “create”  money  is  based  on  the  observation  that  people  can  easily  transform deposits into cash and that they regard the funds they have in a bank deposit as being similar to cash and are able to use those funds for payments, such as by checks and credit cards. Monetary  economists  therefore  refer  to  people’s  total  holdings  of  cash  and  of  deposits  in  the  economy as the amount of “money” in the economy.”

Well now, it’s easy to “transform” your CAR into cash. You can do that within about two hours anytime at your local used car dealer. But that does not make cars a form of money.

What makes bank deposits a form of money is that they comply with the definition of the word money found in economics dictionaries and economics text books, which is something like “anything that is widely accepted in payment for goods and services or in settlement of debts”.

Offer your car in payment for something and you are highly unlikely to succeed. In contrast, offer a cheque or plastic card issued by a commercial bank, and you’ll almost certainly succeed.

In short A&H’s above “easily transform” point certainly HELPS make bank deposits a form of money, but that “transform” point is not good enough on its own.

A&H’s next para then contradicts their claim that bank deposits are not money. It reads:

“Money creation” in the sense described above is related to banks’ holding so-called fractional reserves, i.e. keeping a fraction of the funds deposited with them as cash reserves and using the remainder  for  loans.  As  the  banks’  borrowers  use  the  funds  they  get  to  make  payments, the  recipients  will  keep  parts  of  these  payments  in  bank  deposits.  In this  way,  fractional  reserve  banking causes total deposits to be larger than the amount of central bank money deposited with the banks. The amount of “money” measured as the sum of deposits and cash in the economy is thus bigger than the amount of money that the central bank has issued.”

Eh? That last sentence says that private banks do indeed cause the total stock of money to be larger than what the “central bank has issued”. I quite agree!

The next para reads:

“Putting demand deposits and cash into the same macroeconomic  aggregate does not mean that they are literally the same.  A critical  difference is that deposits are a form of debt. Banks are obliged to pay the  depositor  when  he  or  she wants the money  back.  If a bank cannot repay depositors, there is clearly a problem.  By contrast, cash, issued by a central bank, is nobody’s debt. (For a detailed discussion, see Chapter 10.)”

The first answer to that para is that the fact that two types of money are not “literally the same” does not stop them both being money, or complying with the dictionary definition of the word money. For example in some economies in the past, gold and silver were both used at the same time as a form of money. Gold and silver are clearly not the same thing, but there is nothing to stop them both being acceptable as money, if that’s the law or custom in the relevant country.

As to the point that central bank money is debt free whereas private bank money is debt encumbered so to speak, well Positive Money would certainly agree with that, as do I. But there again, the fact that there is a difference between two types of money does not stop them both being money. (Incidentally the opening sentences of a Bank of England article entitled “Money Creation in the Modern Economy” also make the point that private banks create money.)

As for A&H’s claim that this matter is more fully discussed in Chapter 10 of their book, I looked and didn’t find much enlightenment there.

And finally, as most readers will doubtless have noticed, my disagreement with A&H is as much about semantics as about substance. But it's important to get everything right in this area because millions of jobs depend on getting this banking stuff exactly right.


  1. I suppose it is useful to differentiate between cash and bank deposits.They are very easily interchangeable and for most people they see them as the same thing,but of course in reality they are not.This is something everyone should know about,it makes you think about money,where it comes from and who gets the first use of it.This is the key to understanding how banks/money work.

    As the old alleged Rothchilds maxim goes,""Let us control the money of a nation, and we care not who makes its laws".... they seemed to have no qualms about calling bank credit "money".

  2. I, too, am a fan of A&H and their book, "The Bankers' New Clothes"; however, I completely agree with Ralph in this case.

    The subtitle of the A&H article is "31 Flawed Claims Debunked" and specifically Claim #5 states, "Banks are special because they create money."

    The only points I would add to ones that Ralph makes in the article are:

    * Most of the recent and well-respected "Money, Banking and Financial Markets" and "Macroeconomics" college textbooks I've read call "coins, currency and central bank reserves" either "high-powered money" or "base money" to differentiate the distinct attributes of that type of money, compared to deposits. Yet, that doesn't mean that deposits aren't money.

    * Deposits are included in the most widely used Money Supply definitions, at least in the U.S., M1 and M2.

    * If banks functioned in the way some textbooks describe them... with the classic definition and examples of fractional reserve banking and the money multiplier, one could make a case that "banks don't create money", but, "money is created through the fractional reserve banking process, when banks elect to not keep 100% of their deposits in reserves". Where A&H fail to make the case is that if a bank doesn't have enough depositors to make a loan, in theory, they can simply create an offsetting deposit liability account out of thin air for the corresponding loan asset ledger entry. How anyone can contend that this is not creating money is beyond me.

    * Finally, Ralph has made this point well in the past, but A&H really dug themselves a deeper hole when they say, "Banks are "SPECIAL" because can create money. They didn't need to use the word "special", but they did and bank are certainly special. What banks do when they create money would be considered counterfeiting if anyone else did it. They can create money for a loan and and not have to borrow it and pay interest on it, thus allowing the full interest income to drop down to net income income. It's funny then that banks sometimes price loans based on a cost of funds + a spread, but, really in certain cases they have no cost of funds. That sounds pretty "Special" to me.

    I haven't reviewed A&H's other claims they are attempting to debunk, but, they are better off deleting claim #5 and rounding off their list to 30!


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