Despite What You’re Told, Banks Do Not ‘Create Money’

Policy Despite What You’re Told, Banks Do Not ‘Create Money’ John Tamny Contributor Opinions expressed by Forbes Contributors are their own. New! Follow this author to stay notified about their latest stories. Got it! Aug 21, 2022, 10:00am EDT | Share to Facebook Share to Twitter Share to Linkedin In addressing what’s ridiculous, it’s probably best to start with something basic.

Let’s imagine you the reader possess $1,000 in cash. As the owner of those funds you have no limits on what you can do with them. In other words, you could lend to someone else the $1,000 in total.

Which elicits a question: how much would you have after lending $1,000? That you would have $0 is a statement of the obvious, but sometimes the obvious requires stating. It does given the popular view among financial journalists and Fed officials that banks, for being banks, can create money. A recent book review in the Wall Street Journal asserted just that.

In an analysis of former Fed official Lev Menand’s new book, The Fed Unbound , the reviewer contended that banks, seemingly for being banks, are similarly unbound. According to the reviewer, when you take out a mortgage “your bank credits your account with dollars that did not previously exist. ” Yes, the Fed official and the reviewer believe banks operate without boundaries.

No, this thinking isn’t serious. If it were, why would banks pay interest at all on deposits? If banks can just create the medium of exchange that borrowers go to banks in order to access, why pay rent to savers for their savings? After that, why doesn’t Southern Bank in Cairo, IL lend with “dollars that did not previously exist” so that it can build an asset base similar to J. P.

Morgan’s? Most of all, if banks can just create assets with “dollars that did not previously exist,” why is it that Citibank has required so many bailouts over the last thirty years? From there we just go to the basic question of the value of the dollar. If banks, for being banks, can create money out of thin air then why does the world’s most valuable company – Apple AAPL – have a cash balance of over $200 billion? Really, why would Apple hold dollars and dollar equivalents that, if Fed officials and Journal writers are to be believed, are being rampantly shrunken via multiplication by banks? As readers can hopefully see, banks aren’t actually creating money. As the reviewer goes on to acknowledge, banks are required to hold onto a portion (usually 10%) of the funds deposited with them.

In other words, if you deposit $1,000 in a bank account, the bank is allowed to lend $900. In a rational world there would be no limits on the lending of deposited dollars, but we’re getting ahead of ourselves. We are because what reviewer and Menand are actually implying is that money deposited in a bank account doesn’t lead to money creation as much as the deposited money magically multiplies! Try not to laugh as you read this, but it seems Fed types and the journalists who cover them believe in magic.

By their presumed logic, $1,000 deposited in Bank A soon reaches Bank B in the form of $900, only to reach Bank C in the form of $810, only to reach Bank D as $729. The “dollars that previously did not exist” are apparently just the fruits of the original $1,000 being lent over and over again. Magic!? Actually, no.

MORE FOR YOU Biden’s Proposed IRS Bank Account Snooping Authority Runs Into State Resistance 2021 Diversity Green Card Lottery Winners To Be Shut Out Because Of Visa Deadline The Swamp Grew – Even Under President Donald Trump If you doubt this, just make yourself the bank once again with $1,000. And in your case you have no 10% reserve requirements. If you lend out the $1,000, you don’t have $1,000.

And if the person you loan the $1,000 to subsequently lends it, your customer doesn’t have the $1,000. There’s no multiplication of money in your bank, nor is there multiplication when it’s actual banks doing the lending. If there were, as in if banks – once again, for being banks – could multiply away money to nothingness, why would anyone borrow dollars that would proceed to rapidly lose value upon being loaned? Why save dollars either? There’s quite simply no multiplication to speak of, nor is there “made up digital money” as the reviewer and Fed official contend.

If there were, not only would Apple not accept dollars for its goods, but neither would you the reader accept dollars for your labors, nor producers (the dollar referees most global transactions) around the world. The reviewer then points out that the Fed “allows banks to borrow from the central bank when they’re in distress. ” Ok, but such an observation presumes that there weren’t entities before the Fed that did the same as the Fed was set up to do: lend to solvent banks when they’re near-term short on cash.

Except that liquidity for solvent banks has long been and remains the norm in the marketplace, with or without the Fed. Indeed, what the reviewer leaves out is that financial institutions as a rule avoid borrowing from the Fed simply because doing so is an admission of bankruptcy, and it’s an admission of bankruptcy simply because there are voluminous private sector entities willing to lend against quality assets held by banks. Which is kind of the point, or should be.

As the reviewer notes per Menand, “nonbank money” accounts for a growing amount of finance. Which is, of course, a statement of the obvious. Again, though, the obvious increasingly requires stating in today’s world.

While reviewer and others who follow finance believe low interest rates paid by banks and subsequently low interest loans signal “easy money,” the reality is that they signal quite the opposite. U. S.

banks pay very little interest on deposits because they’re taking little to no risk with the funds deposited with them. In other words, as banks have migrated away from risk, their migration has occurred in concert with major growth of non-bank sources of finance. The mistake once again from Menand and reviewer is in believing that these non-bank institutions are similarly engaged in “money creation.

” They’re not. Again, if we ignore that counterfeiting is illegal we can’t ignore that if financiers could create money by virtue of being financiers, what we deem “money” would no longer be. Money in circulation is a consequence of production, period.

Nothing else. If banks could just create it via a relationship with central banks, the Soviet Union would still exist plus they’d be eating abundantly in Haiti. Follow me on Twitter .

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