Private bank issued money is counterfeit money.

My Concise Oxford Dictionary (2004 edition) defines counterfeit as “made in exact imitation of something valuable with the intention to deceive or defraud.” The money created or “printed” by private banks clearly fits the above definition: the only question is just how close is the “fit”?

When obtaining a loan from a private bank, the borrower is told they have been loaned X dollars, pounds, etc. But those so called dollars etc are most definitely not the real thing. What the private bank lends out is not the country’s official central bank (CB) issued currency: it is certainly not legal tender. The proof of that is that when the borrower offers to pay someone for something using the so called money that the bank has loaned out, the potential payee is fully and legally entitled to refuse payment on the grounds that what is offered in payment is not legal tender.

Thus it is beyond dispute that there is a finite amount of “deception” there. What private banks ACTUALLY lend to borrowers is not dollars, but a promise by the bank to pay dollars. And that promise to pay itself is in effect a form of money which is quite widely accepted as money. But, to repeat, potential payees are entitled to turn it down, and sometimes do.

As to “made in exact imitation of something valuable”, well that’s a close fit as well!

It could be argued against the above “counterfeit accusation” that the accusation is very semantic or legalistic and hence that the accusation amounts to nothing if the counterfeiting doesn’t actually do any harm. That is a perfectly fair point. Thus the rest of this article is devoted to showing that the above counterfeiting does actually do harm.


Cheating the population at large.

The basic problem with traditional backstreet counterfeiters who turn out imitation $100 bills or imitation £10 notes is that they actually rob the general population. The reason is intuitively obvious even to those who have never read an introductory economics text book. But just to spell it out, the reason is as follows.

Assuming the economy is at capacity or “full employment” and a significant number of imitation $100 bills are produced and spent, that will raise demand. That additional demand will cause excess inflation given the above “at capacity” assumption. Thus the state has to take some sort of deflationary counter measure, like raising taxes and confiscating some of the private sector’s stock of base money. To illustrate, in a hypothetical economy where the only form of money was dollar bills and coins, for every counterfeit $100 bill that went into circulation, the state would have to confiscate one genuine $100 bill from the population. (BTW: “base money” is a common name for the above mentioned “official CB issued money”)

Now you’ll be horrified to learn that very much the same point applies to loans granted by private banks and for the following reasons.

Assuming, again, that the economy is at capacity, and private banks grant extra loans, the relevant money will be spent, which will raise demand. That will be inflationary, thus the state will have to take some sort of deflationary counter measure, like (is this starting to sound familiar?) raising taxes and confiscating some of the private sector’s stock of base money.

In short, assuming the economy is at capacity, when a private bank grants mortgage to Joe Bloggs, the bank and Joe Bloggs obtain a valuable real asset, which has been effectively stolen from the general population. The “counterfeit” charge is shaping up, wouldn’t you say?


Interest rate cuts.

The latter is of course a serious charge, but it could be argued in defence of private money creation that private banks in practice only lend more when the CB cuts interest rates. And the objective behind interest rate cuts is entirely laudable: the objective being to raise demand where demand is inadequate. Thus, so it might be argued, private money creation is justified.

Well the first problem there is that private banks do not lend more ONLY when CBs cut interest rates. That is, private bank lending varies even given constant CB rates. For example it is obvious from what went on in the 1800s when governments and CBs did little to control demand that booms and asset price bubbles, assisted by irresponsible lending by private banks, can take off all of their own accord. Unfortunately not much has changed since those days.

But even if lending by private banks is closely related to official CB interest rates, the whole idea that demand should be controlled by artificial adjustments to CB interest rates is badly flawed and for the following reasons.

1. Given a recession, there is absolutely no prima facie reason to assume the problem is inadequate borrowing and investment, rather than a deficiency in one of the other constituents of aggregate demand, like consumer spending or exports.

2. The basic purpose of the economy is to produce what people want: both the items they normally purchase out of disposable income, and the items supplied by government (e.g. education for kids). Ergo given a recession, the logical cure is to expand household incomes (e.g. via tax cuts) and raise public spending. (The revolving door brigade will of course be horrified at the suggestion that given a recession, Main Street should be given more spending power rather than Wall Street. The answer to that is that there is no better evidence that something is desirable than the fact that the revolving door brigade don’t like it)

3. Given a recession, there is no reason to suppose interest rates won’t fall of their own accord: witness the fact that interest rates have fallen dramatically over the last 25 years or so. Government interference in the free market is entirely justified where it can be shown that the free market is not functioning properly. Unfortunately, there have been next to no attempts by the economics profession to confirm that given a recession, interest rates will not fall to the extent that they would in a perfect market.

4. In contrast to the latter fall in interest rates, a properly functioning free market would actually implement the above mentioned increase in consumer spending, plus there is a VERY OBVIOUS and well known obstruction to that mechanism, as follows.

In a perfect market, and given a recession, wages and prices would fall, which would increase the real value of the monetary base, which in turn would increase household liquid assets, which would increase consumer spending. In effect, one of the free market’s cures for a recession is a helicopter drop. That mechanism is normally referred to as the “Pigou effect” after the economist, Arthur Pigou.

Unfortunately that mechanism is stymied in the real world because, as Keynes put it, “wages are sticky downwards”. I.e. wage cuts tend to result in strikes, if not political revolutions. But not to worry: if the real value of the monetary base cannot be increased by increasing the real value of each dollar of base money, an equally good alternative is to increase the value of the stock of base money by having the CB print more dollars and distribute them, e.g. via tax cuts or extra public spending.

To summarise, it is blindingly obvious that what is missing in a recession is “dollars for households and government spending departments”. In contrast, it is not at all obvious that interest rate cuts are a logical solution.

Ergo the potential justification for private money creation mentioned several paragraphs above, namely that that activity is “entirely laudable” if it results from CB interest rate cuts is now in tatters.

Ergo the initial charge against private money printing made above, namely that it amounts to counterfeiting seems pretty solid.

In other words it looks like the Scottish philosopher / economist David Hume had a point when he said in 1742 that private bank created money is counterfeit money (para II.III.4) The French Nobel laureate economist Maurice Allais said the same.