Why an understanding of money creation is essential to financial reform – Josh Ryan-Collins

By , October 7, 2011 11:02 am

At the heart of our dysfunctional financial system is a remarkably poorly understood fact. Private banks create the vast majority of the money supply – 97% according to most estimates.  Not the Bank of England, nor the Government, nor any institution which could be viewed as democratically accountable or representing the public interest, but private banks.

Banks create money when they ‘extend credit’, to use the technical jargon.  What this really means is making a loan or honouring an overdraft. When a bank makes a loan it simultaneously creates a deposit in the borrowers’ bank account. The bank does not take the deposit out of anyone else’s account. The balance that appears in your account is new money.

This is no more than simple double-entry bookkeeping. The bank has increased its assets because I now owe it money. It has also increased its liabilities by the same amount because my bank deposit is simply the money that the bank owes to me – a bank IOU if you like.

But unlike an IOU between me and you, scribbled on a piece of paper, this electronic Bank IOU is impersonalized. It is accepted by everyone else in the UK in payment for goods and services. This is because it also accepted by the government for taxes. This means everyone wants it because everyone can use it to make their most regular payments.

If you are finding it difficult to believe that banks create money so easily, by just typing numbers in to a computer, you are not alone. Policy makers and economists, including civil servants at the Independent Commission on Banking, have found it very difficult to accept. Banks are usually described as ‘financial intermediaries’, ‘recycling’ the deposits that we’ve put in them for safekeeping as loans. In fact, it’s the other way round. Bank loans create deposits. Banks are better described as ‘credit creators’ than intermediaries.

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