Cowdung and Credit Creation

Today is a momentous day for the United Kingdon, as Teresa May officially invokes article 50 to leave the European  Union.

Sadly, I am not yet ready to add commentary to current events, however important. My initial theme is to carry on explaining the operations of the UK banking system, presented in a way that should be available and understandable to anyone who is concerned about the economic reality we live in. No-one should be denied such access and needs to be equipped to detect and avoid the distortions presented by the COmmon Wisdom of the DominaNt Group a.k.a. “CowDung”. hopefully these posts can help in that regard.

In my last post on this topic, Can Banks Create Credit?, I noted that you should not take my word for this. This post is the first answer to that.

The Bank of England publishes an online  quarterly magazine called the Quarterly Bulletin. The Quarterly Bulletin 2014 Q4  contains two important articles with accompanying video overviews:-

This is essential reading for anyone interested money, pretty much everyone!

Money in the modern economy: an introduction

Money is essential to the workings of a modern economy, but its nature has varied substantially over time. This article provides an introduction to what money is today. Money today is a type of IOU, but one that is special because everyone in the economy trusts that it will be accepted by other people in exchange for goods and services. There are three main types of money: currency, bank deposits and central bank reserves. Each represents an IOU from one sector of the economy to another. Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.

This article has introduced what money means and the different types of money that exist in a modern economy. Money today is a form of debt, but a special kind of debt that is accepted as the medium of exchange in the economy. And most of that money takes the form of bank deposits, which are created by commercial banks themselves. A companion piece to this article, ‘Money creation in the modern economy’. describes the process of money creation by commercial banks in more detail.


Money creation in the modern economy

This article explains how the majority of money in the modern economy is created by commercial banks making loans. Money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits. The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.[My emphasis]

This article emphasizes some of the themes I have noted in previous posts regarding the myths of  Loanable Funds, Fractional Reserves and the Money Multiplier and the implications of these myths will be explored in following posts. Note that “some popular conceptions” (and other statements in the article) are a polite and diplomatic way of calling bullshit (or cowdung) on the banking sections of economics textbooks.

I need to finish with a  couple of caveats.

First is that just because this is published by the BoE does not mean it is immune from criticism. Far from it. Indeed a theme I will develop is how many central banks have misled themselves as well as others with distorting if not fatally flawed in-house models of their economies. Still I do regard the above two articles as very accurate given my background in actual banking.

Second, these articles were published in 2014, there are other and older references for these accurate descriptions of money in the Uk and elsewhere. I have not yet found a good summary post of all those central bank references and am slowly building up a file which I will post when I am satisfied with the content.

5000 Years of Debt

As I noted last Friday, my posts on Friday are for weekend reading. This week I am highly recommending David Graeber‘s Debt – Updated and Expanded: The First 5,000 Years.[1]

No time for a review but the publisher’s overview does present a very good idea about the issues covered in the book:

Here anthropologist David Graeber presents a stunning reversal of conventional wisdom: he shows that before there was money, there was debt. For more than 5,000 years, since the beginnings of the first agrarian empires, humans have used elaborate credit systems to buy and sell goods—that is, long before the invention of coins or cash. It is in this era, Graeber argues, that we also first encounter a society divided into debtors and creditors.

Graeber shows that arguments about debt and debt forgiveness have been at the center of political debates from Italy to China, as well as sparking innumerable insurrections. He also brilliantly demonstrates that the language of the ancient works of law and religion (words like “guilt,” “sin,” and “redemption”) derive in large part from ancient debates about debt, and shape even our most basic ideas of right and wrong. We are still fighting these battles today without knowing it

All the key themes I wish to explore on this blog, specifically over money and debt, are presented with anthropological evidence in support. You may or may not agree with his overarching model of virtual versus physical money eras and I too am undecided about that. Regardless the evidence over the origins and evolution of money and debt is very still very relevant.

[1] There is also an earlier edition freely available online, although I am not sure as to whether this is with the permission of the author or publisher – I will let you decide and search for that.