Interesting series of articles in The Herald, where Bryan Gould schools Don Brash on how money works. It started with this piece by Gould:
Bryan Gould: Banking should be under closer Government control
It’s not every day that monetary policy dominates the news.
It is normally seen as a technical issue, very much within the realm of the Governor of the Reserve Bank and, apart from the odd unexpected move in interest rates and, therefore affecting mortgage rates, of not much significance to anyone else.
But, in the past week, no fewer than three people have made the headlines by virtue of their views on monetary policy.
Gould discusses comments by Joyce, Robertson, and Sonny Bill Williams. But here’s the bit that Brash objected to:
Most people believe, and it is a belief assiduously promoted by the banks themselves, that the banks act as intermediaries between those wishing to save and those wishing to borrow, usually on mortgage. … The banks make their money, so it is said, by charging a higher rate of interest to the borrowers than they pay to the depositors, the equivalent of a small fee for the administrative costs of bringing the parties together. But this benign view of their operations is inaccurate and misleading. The banks do not lend you on mortgage money deposited with them by someone else.
They lend you money that they themselves create out of nothing, through the stroke of a pen or, today, a computer entry. The banks make their money, in other words, by charging interest on money that they themselves create. Not surprisingly, they are keen to lend as much as possible.
But the consequences of this bizarre scenario go much further. It is the willingness, not to say keenness, of the banks to lend on mortgage that provides the virtually limitless purchasing power that is constantly bidding up the prices of homes in Auckland and, now, elsewhere.
It is the banks that are fuelling the housing unaffordability crisis, a crisis that is leaving families homeless and widening the gap between rich and poor.
Don Brash took exception:
Don Brash: Sonny Bill Williams and Bryan Gould both wrong about banks
A few days ago, Bryan Gould wrote an article for the Herald headlined, “Sonny Bill has a point about banks amid crisis” [links to the piece above which now has a different name]. Almost everything he contended was wrong, writes Don Brash.
[Summarises Gould above] He then goes on to blame this money creation for the housing affordability crisis which Auckland now finds itself in, and to attack the Government for washing its hands of this aspect of the housing crisis. Mr Gould is not alone in peddling this nonsense, but that certainly doesn’t make it correct.
The banking system does create money. When Bank A lends money to one of its customers, the customer may use those funds to buy something from somebody who banks with Bank B. Bank B then finds itself with an additional deposit, a part of which it can lend out to its customers (keeping some of the additional deposit as a liquidity reserve). So an initial loan may end up considerably increasing the total lending by the banking system.
But from the point of view of each individual bank, it can only lend out a part of the money which its customers deposit with it, or money which it borrows from other sources, possibly overseas.
If individual banks really could create money by “the stroke of a pen or a computer entry”, as Mr Gould contends, why do they bother paying interest on deposits, why do they borrow funds from parent banks overseas, why do they borrow funds in the international market, why do they need to hold some funds in government securities as a liquidity reserve, why do some banks occasionally run out of money when customers lose confidence in them?
As well as being a former Governor of the Reserve Bank, I now chair the small New Zealand subsidiary of the Industrial and Commercial Bank of China, the largest bank in the world. It would certainly make life very much easier if we could, “by the stroke of a pen or a computer entry”, simply create the money which we lend out to New Zealand borrowers. Unfortunately, we can’t.
In a further piece, Bryan Gould replied:
Bryan Gould: Brash doesn’t seem to understand banking
I said the vast majority of new money in circulation is created by the banks “by the stroke of a pen”, and they then make their profits by charging interest on the money they create. If this is “nonsense”, the “peddlers” include some very distinguished economists. My legal training has taught me the value of being able to turn to reliable authority to support what I say.
In my original piece, I referred to a Bank of England research paper, published in the bank’s first Quarterly Bulletin 2014, which describes in detail the process by which banks create money.
First, they say,”One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them…[that] ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money…Rather than banks lending out deposits that are placed with them, the act of lending creates deposits – the reverse of the sequence typically described in textbooks.
“Bank deposits make up the vast majority – 97 per cent of the amount [of money] currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themselves.”
It is a pity (and a surprise) that Don Brash seems unaware of these findings in one of the most important research papers published in recent years. If he would care to proceed with his charge of “peddling nonsense”, I could introduce him to the authors of the paper, with whom I have corresponded, and he could put that charge directly to them.
“Commercial banks create money, in other words, by placing loans [or credits] into the bank accounts of borrowers. They then charge interest on, and demand security for and repayment of, those loans. They have no capacity to create money in any other way or for any other purpose [though the central bank can pursue “quantitative easing” to increase the money supply if it thinks that is needed].
But the capacity they do have is hugely important. I concluded by asking whether it was wise to entrust such wide-ranging powers – so significant in their impact on the whole economy – to the banks, and then to arrange that the only person able to regulate that impact was himself a banker – the Governor of the Reserve Bank.
That concern is surely heightened if a former Governor seems not to understand what is really happening.
NZ really dodged a bullet when we declined to elect Brash. I wonder if Bill English understands this stuff?
Here’s the Bank of England paper cited – Money creation in the modern economy (pdf). With accompanying video: