Monday, 25 October 2010

A new way to rob taxpayers and subsidise banks.

This debate between Tim Congdon and Robert Skidelsky is worth a read.

Tim Congdon has long had thing about the monetary aggregates. He has discovered there is a relationship between the money supply and GDP, and in particular that the money supply collapses in recessions. From this he concludes that if the money supply is boosted, that helps us out of the recession.

The big flaw here, as Skidelsky rightly points out, is that it is questionable as to which way the cause effect relationship runs. Commercial bank created money is created when a private sector entity thinks it’s worth their while borrowing from the bank, and the latter condition will tend to obtain when businesses have full order books and/or the economy is at full employment and everyone runs out to get mortgages to fund house purchases. I.e. the cause effect runs from GDP to money supply (at least as far as commercial bank created money goes).

Indeed, what exactly IS the cause effect relationship running from money supply to GDP?

Congdon actually proposes a solution to the recession which we can use to examine the latter question. His proposal is for money to be created by government borrowing from commercial banks. So let’s say government borrows a trillion from commercial banks. What of it? If the mere fact of crediting government with a trillion has an effect, I don’t see it. Of course, as soon as government starts SPENDING that money (a la Skidelsky), then there is an effect. But not before. David Hume made very much the same point 250 years ago when he said in respect of money supply increases “If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated.”

Anyway, moving on, the next question in relation to Congdon’s idea is: what on earth is government doing letting commercial banks create money out of thin air, when the government / central bank machine can perfectly well do this itself? Moreover, this proposal is a stealth subsidy for commercial banks (to add to the various subsidies of this nature already in operation). That is, a 100% reliable debtor (i.e. government) would be added to such bank’s balance sheets. Now that kind of dilutes the toxic debtors on those balance sheets, doesn’t it?

And finally, note that the above argument between Congdon and Skidelsky is one of the many problems that come out in the wash under Modern Monetary Theory (MMT). I drew attention to a couple of other problems that come out in the wash here.

Under MMT, given a recession, government prints money and spends it (and conversely, given an inflationary boom, government raises taxes and/or cuts government spending, reins in money and extinguishes it). In a recession, whether the effect comes the act of spending (as per Skidelsky) or from the money supply increase (as per Congon) doesn’t matter!

Afterthought (26th Oct): Congdon is not the only one to advocate the above “have government borrow from commercial banks” policy. Another advocate of this policy is here:


  1. Commericial banks don't create money out of thin air as you well know. They cannot create anything as the sum of their efforts is always zero.

    The 'ex nihilio' stuff only happens if, and only if, you subscribe to the idea that demand deposits are not in fact loans to the bank. Since we don't have bank runs every week, they clearly are.

  2. Neil, If I’m wrong in thinking commercial banks create money out of thin air, there are an awful lot of people and organisations much better qualified than me suffering from the same delusion as me. You’ll find some of them by Googling something like “money, “thin air”” etc. These deluded entities include the European Central Bank and Huerta de Soto who has long campaigned against the right to commercial banks to create money “ex nihilo”. See my recent posts on de Soto below.

    This creation of money ex nihilo is compatible with the idea that commercial bank’s activities net to nothing. When a bank lends £X to customer Y, it enters Y as a debtor of the bank (to the tune of £X) on the asset side of its balance sheet, and plonks £X of “monopoly money” in Y’s account. The latter is liability in the sense that Y is entitled to grab this money from the bank when Y chooses.

  3. "The latter is liability in the sense that Y is entitled to grab this money from the bank when Y chooses."

    I am not comforted by the knowledge that such fundamental concepts are open to debate.

    Hi, Musgrave. I'm new at "winterspeak" and saw your recent comments there. Stopped by to have a look around.



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