Sunday, 30 April 2017

World Economic Forum article claims private banks don’t create money.

The article is entitled “Do banks really create money out of thin air?” though the WEF do not officially endorse the arguments in the article.

The article starts with the hypothetical example of person S who sells a house to person B. “S” is obviously short for “seller” and “B” is obviously short for “buyer”.

The initial assumption is that B does not have any cash, so after the sale, B simply becomes indebted to S for the value of the house. And that, as the article rightly points out, is an arrangement which will not suit the vast majority of house sellers. Among other things, it involves S in collecting regular repayments and interest in respect of the debt from B for 20 years or so.

Next, the article explains that banks can help with the latter problem: a bank can open an account for B, credit the account with an amount of money equal to the value of the house (produced from thin air), which B then pays to S. S is now relieved of the inconvenience of collecting the debt from B, plus S has money with which to buy an alternative house.

But despite the obvious admission referred to in the latter paragraph that a bank has in fact created money from thin air, the article in the final paragraph then says:

“But this is only the prima facie appearance and not the truth of the matter because the outside observer has neglected to acknowledge that the deposit value records the value-for-value exchange conducted through an underlying transaction.”

Well the cognoscenti (which includes me needless to say) have always been aware that commercial bank created money nearly always RESULTS FROM the desire of people and firms to do business. I.e. if B did not have any need for a large amount of money, there’d be no point in B going along to a bank and asking for a loan, would there? But the fact that that money creation results from something or other does not stop that money creation being money creation, unless I’ve missed something.

The second flaw in the latter final paragraph, is that in fact banks will create money even where there is no immediate desire to do business. This is unusual, but if a particularly credit worthy bank customer went along to a bank and said “I have no immediate business deals in mind, but please lend me a million so that when a profitable looking deal comes my way I can pounce on it.”, the bank might well go along with that (and of course charge for the service provided). 

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