Friday, 26 August 2016

Part of the explanation for low interest rates and high levels of debt.

Money lenders (aka banks) print or “create” money. See the opening sentences of this Bank of England article (1) for verification of that. In contrast, other types of firm and corporation don’t do that: or at least their freedom to create money is severely restricted, as Richard Werner explains (2).

Now that’s pretty obviously a big leg up for the money lending industry. I mean most firms when they want to come by money have two options: earn it or borrow it. In contrast, and to repeat, private banks are in the happy position of being able to just print the stuff, or at least some of it.

And that is an entirely artificial bias in favour of private banks. GDP is maximised where every firm, industry and product is treated equally,  unless there are good reasons which are specific to a particular industry for doing otherwise. E.g. special laws relating to fire-arms and alcoholic drinks are fair enough.

So what good reasons might there be for the latter special treatment of private / commercial banks?

Well one ostensible reason is that letting private banks print and lend out money is stimulatory: it boosts demand. Well sure it does, but so does having the CENTRAL bank do the same thing. I.e. central banks can print and spend new money into the economy (and, in cooperation with government, they can do it in an entirely impartial way, that is, not involving special favours for any particular industry).

Interest rates.

Another ostensible excuse for private money printing by banks is that it reduces interest rates which according to some is beneficial.

Indeed, Joseph Huber describes that interest rate reducing effect in more detail in his work “Creating New Money” – see para starting “Allowing banks to create new money…” (3).

Well actually low rates have disadvantages as well as advantages: for example low rates encourage asset price bubbles. In more general terms there must be an OPTIMUM rate of interest.

As I’ve pointed out before on his blog, the concept “optimum” seems to be beyond the comprehension of most of the population and a sizeable proportion of the economics profession. But hopefully most readers of this article understand the concept. So how do we achieve the OPTIMUM rate of interest?

Well how about just letting interest rates be determined by market forces (unless someone can clearly demonstrate that market forces go wrong in this area). And a free market is a scenario where government abstains from granting special favors to one particular industry, e.g. letting money lenders print money.

Free markets.

It was argued above that the nearest thing to a free market involves having the state “print and spend new money into the economy” (i.e. do some helicoptering). That might seem questionable in that having the state doing anything is not normally regarded as a characteristic of the free market. In fact as explained in the previous post on this blog, the latter “print and spend” policy is a very close imitation of the free market. Briefly that’s because the free market’s cure for a recession is the Pigou effect, which involves an increase in the money supply.

Also, when it comes to money, there is really no such thing as a totally free market: “money is a creature of the state” as the saying goes. Or to quote another popular phrase, “money is a social construct”. That is, for any sort of money to work, there has to be general agreement as to what the money unit is, and how to control its production.



To put all that another way, the existing bank system (sometimes called fractional reserve) involves an artificially low rate of interest and hence an artificially large amount of lending, borrowing and debt. Under the alternative system, full reserve banking, commercial banks are barred from creating / printing money, and full reserve is a closer approximation to a free market than the existing bank system. Thus full reserve banking is the GDP maximising bank system.


1. “Money Creation in the Modern Economy” by Michael McLeay & co-authors. Published by Bank of England (Quarterly Bulletin 2014, first quarter.)

2. “How do banks create money, and why can other firms not do the same?”. Richard Werner. Published by Science Direct.

3. “Creating New Money”. Joseph Huber & James Robertson. Published by the New Economics Foundation.

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