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.