$$$ — Where does it all come from?

Australia, like other neoliberal-capitalist states, undertakes its process of monetary creation in facilities such as the Note Printing Australia (NPA). Unbeknownst to most, the central bank is issuing its own liabilities as the currency. Whilst physical printing is the most commonly considered form of monetary creation, it in reality only represents approximately 3% of legal tender in circulation in the world.

United Kingdom pre 1840s banknotes were handed out to members by banks, representing their total savings. Before long these evolved and began to actually represent money. Until 1844, these notes could be created by organisations other than the central bank of a state, which enabled the organisation to effectively print money. Post 1844 the central banks became the only entity legally able to create money, the newly coined central bank money. This became aggregated with other valuable commodities such as commodity certificates, and banknotes.

A states’ monetary policy is able to directly influence the amount of money in circulation through internal processes. Processes such as modifying reserve requirements and changing short-term interest rates and through conducting open market operations. Whilst these are forms of money creation and regulation, as indicated above, they only represents 3% of the total base. The remaining 97% is comprised of ‘commercial bank money’.

The most common misconception about commercial banks is that post 1844 the central bank is the sole producer of money, while banks only act as deposit lending financial intermediaries. This misconception is fuelled by economists’ lack of incorporation of commercial banks within their working financial theories. They are culminated into three distinct theories:

The first and current conventional view that banks, as stated above, merely act as financial intermediaries, redistributing the members resources, and not possessing any special powers. This view is known as the financial intermediation theory and was influenced by Keynes and Tobin from the 1960s until today.

The second view differs slightly from the first in stating that the commercial banks can collectively utilize the fractional reserve in order to create money, but as individual entities they are not unique in such a fashion. This is referred to as the fractional reserve theory and became prevalent up until the 1960s due to the influence of Keynes, Crick, Phillips and Samuelson.

As stated, the above two out of three theories do not include commercial banks as credit creators in their financial models. They are considered akin to non-financial institutions, any variance from this presupposed view would be due to regulation. Any statistics to the contrary would be “effectively so minimal that they are immaterial for modelling or for policy makers”. However, do either of the above theories effectively explain the 32:1 ratio of commercial money to central?

The final and ironically initial financial theory differs from its legacy, stating that not just banks as a collective can create money. Commercial banks can individually create “credit” out of nothing. This is referred to as the credit creation theory, lead by Macleod and Schumpeter.

Examining the credit creation theory further, what is credit?

“[C]redit is essentially the creation of purchasing power for the purpose of transferring it to the entrepreneur, but not simply the transfer of existing purchasing power. … By credit, entrepreneurs are given access to the social stream of goods before they have acquired the normal claim to it. And this function constitutes the keystone of the modern credit structure.” — Schumpeter

This credit is created through a process known as double entry bookkeeping; when you deposit your funds into a bank two things happen, firstly, the bank enters a ‘liability’ into one column of its books, this is essentially the credit that the bank has created (not lent), and put into your account. This is also known as demand depositing. Next, the bank enters an asset into the second column of its books, this is the money that you now owe the bank. When you repay this loan, that credit is destroyed. This should rectify this inflation if there were no interest owing on the principal amount. From 2002–2012 commercial banks were able to make $1.2 trillion dollars worth of profit from this process compared to $18 billion made from physical currency. In essence banks create money whenever they extend their credit, buy existing assets, or make payments on their own account. This process is partly fettered by a state’s monetary policy, lending limits and the behavior of money holders.

On top of the gross profit associated with this method of creation, there are a plethora of other negative affects. The most concerning being this system’s role in the maintenance of the inequality rife throughout the global capitalist system. The revolving debt maintained by the majority becomes a self maintaining economic shackle, rarely allowing one to rise to the top of the plutonomy.

If there is no deviance from the credit creation theory discussed above, the world will continue to witness the impacts of financial crisises such as those seen in 1997 and 2007.

References

97% Owned — Economic Truth documentary. in , , 2012, <https://www.youtube.com/watch?v=XcGh1Dex4Yo> [accessed 22 August 2016].

“Could These 3 Simple Changes to Banking Fix the Economy?”. in , , 2016, <http://positivemoney.org/> [accessed 22 August 2016].

“faq | Royal Australian Mint”. in , , 2016, <https://www.ramint.gov.au/faq> [accessed 22 August 2016].

Gallant, C, “How do central banks inject money into the economy? | Investopedia”. in Investopedia, , 2007, <http://www.investopedia.com/ask/answers/07/central-banks.asp#ixzz4I2JZsaqZ> [accessed 22 August 2016].

McLeay, M, A Radia, & R Thomas, “Money creation in the modern economy”. in Bank of England — Quarterly Bulletin, 2014 Q1, 2016.

“The role of central bank money in payment systems”. in , , 2003, <http://www.bis.org/cpmi/publ/d55.pdf> [accessed 22 August 2016].

Werner, R, “Can banks individually create money out of nothing? — The theories and the empirical evidence”. in International Review of Financial Analysis, 36, 2014, 1–19.