Monday, 14 April 2014

Banks do not create money when they lend.

Assume the economy is at capacity. If commercial banks lend more, and sums borrowed are spent, that raises demand, which is not allowable: government / central bank will raise interest rates. So (roughly speaking) no increase in lending takes place and no net money creation takes place.
Alternatively, if interest rates are not raised, then inflation will ensue, which reduces the real value of all existing loans and money. So again, no net money creation takes place, roughly speaking.
However, there is a way in which commercial banks do create money, but it doesn’t involve lending, and it’s as follows.
Where a non-bank entity is looking simply for liquid working capital or day to day transaction money, and has no intention of being in debt to their bank ON AVERAGE AND OVER THE YEAR AS A WHOLE, then a bank will happily oblige: that is, it will “monetise the non-bank entity’s collateral”. Put another way, in exchange for dumping £X of collateral with a bank, the bank will credit about £X to the relevant customer’s account.
But if the customer is simply after transaction money rather than loan, the balance on that account will be MORE THAN £X as often as it is LESS THAN £X.
In fact in scenario, far from the customer being in debt to the bank, the bank is in debt to the customer. That is, where the balance on the account is £X, the customer owes the bank nothing. Whereas the bank owes the customer something very real: the collateral.
QED. Well, food for thought, anyway.

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