Bank of England: loans create deposits


Doing the rounds has been a recent Bank of England Bulletin on modern money and money creation. For whatever reason, the Bank has seen fit to put some effort into explaining the realities of the monetary system.

Let me post a snippet of the summary:

In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans.

Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.

The reality of how money is created today differs from the description found in some economics textbooks:

Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.

In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.

Although commercial banks create money through lending, they cannot do so freely without limit. Banks are limited in how much they can lend if they are to remain profitable in a competitive banking system.

Prudential regulation also acts as a constraint on banks’ activities in order to maintain the resilience of the financial system. And the households and companies who receive the money created by new lending may take actions that affect the stock of money — they could quickly ‘destroy’ money by using it to repay their existing debt, for instance.

While the recent publications from the Bank of England seem to emphasise that competition is a limiting factor on bank lending for an individual bank, there is no agreement that this holds true in aggregate. As Keynes noted many years ago in his Treatise on Money:

…it is evident that there is no limit to the amount of bank money which the banks can safely create provided they move forward in step.

As a banking system, there is no limit, and hence the ability to for massive cyclical swings in aggregate lending.

On the role of Quantitative Easing, the Bank has this to say (my emphasis):

Moreover, the new reserves are not mechanically multiplied up into new loans and new deposits as predicted by the money multiplier theory.

QE boosts broad money without directly leading to, or requiring, an increase in lending. 

While the first leg of the money multiplier theory does hold during QE — the monetary stance mechanically determines the quantity of reserves — the newly created reserves do not, by themselves, meaningfully change the incentives for the banks to create new broad money by lending. 

It is possible that QE might indirectly affect the incentives facing banks to make new loans, for example by reducing their funding costs, or by increasing the quantity of credit by boosting activity.

But equally, QE could lead to companies repaying bank credit, if they were to issue more bonds or equity and use those funds to repay bank loans. 

On balance, it is therefore possible for QE to increase or to reduce the amount of bank lending in the economy. 

However these channels were not expected to be key parts of its transmission: instead, QE works by circumventing the banking sector, aiming to increase private sector spending directly.

This makes it sound like QE’s main outcome is to prop up asset prices. While the story we hear about stimulating lending and investment simply may not happen unless firms were already planning to do it!

For me the key message from this Bulletin is that the monetary system is completely misunderstood by the supposed experts themselves, the economists. Major errors in understanding the rather practical matters of money and banking are still being passed down though mainstream textbooks, with little change in sight.

Indeed, some reactions to the Bank’s publication have been very defensive, bordering on ridiculous. It makes me wonder how apparently learned professors can teach classes on monetary policy from the textbook knowing that it contradicts reality. Or have they fooled themselves into thinking they know more about the mechanics of money than one of the world’s oldest central banks.

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  1. If this is true, then bank runs should now be impossible, correct?

    So why do they freeze withdrawals when crisis looms, a la Cyprus?

    • Rumplestatskin

      Impossible? Depends on what you mean.

      Cash is still supplied by the central bank only. A commercial bank does not have all its deposits in cash and can run out of cash bills (only a tiny fraction of money is in notes and coins).

      Is that what you mean?

      • There you have it as close to an admission that we have a debt based economy. That is why house prices will go not just to the moon but to other star systems. They cannot and will not allow a reduction in lending it must always grow, even small nominal growth risks blowing the system.

        Maybe the modern bank run is when people pay of loans en masse leading to a reduction in “money”. This brings about a crisis as asset prices collapse which forces less lending and more people to pay off loans out of fear. Thus killing the banks

        I am not sure which statistical release it is but in Australia Gross lending is actually very high but there is so many loans being discharged the net figure comes at around 5% or so.

        UE has shown those figures from the Vic Govt detailing net mortgage discharge in Victoria.
        It would be interesting if we just run out of new investors seeing a third of taxpayers are already ball deep.

      • That is why house prices will go not just to the moon but to other star systems. They cannot and will not allow a reduction in lending it must always grow, even small nominal growth risks blowing the system.

        This is not true. It all depends on the perception of value. Many countries with similar banking systems have had housing corrections.

        If everyone suddenly start believing that houses are not worth the asking price and don’t borrow money, what happens?

    • Jason,

      When a bank has a run, it loses a deposit to a competitor bank. To facilitate the transfer, the first bank transfers its reserves (ESA) to the new bank. Reserves are essentially the Bank’s money on deposit with the Central Bank.

      When a Bank runs out of reserves, the game is over. The Bank can bid for new reserves from other banks, but if they are perceived to have poor asset quality (like Lehman) , they will not get the reserves needed to sustain daily banking ops.

      But from a system wide perspective, the banking system is always fully funded under a floating exchange rate regime. Cyprus operates under a fixed (pegged) rate regime.

      • “But from a system wide perspective, the banking system is always fully funded under a floating exchange rate regime. Cyprus operates under a fixed (pegged) rate regime.”

        Sorry, but I’m only learning this stuff now… Could you please elaborate on why a floating exchange rate means the system is ‘fully funded’? (I’m struggling to understand why the system would ever be ‘partially’ funded)

        Thanks in advance.

      • And the FX Market is a conduit for capital flows into and out of a country – CAPITAL FLIGHT.

        The sooner you @b_b acknowledge the flight of capital and the value that is stored in it – for example the US/AUD exchange rate the sooner we can have an enlightening conversation about CAPITAL FLIGHT and the implications for the Australian economy.

        Case in point, the flight of capital (the Rubel) out of Russia as we speak……and into other countries in whatever form of currency they employ such as the Euro.

      • Hi Klogg,

        With a floating exchange rate regime, for every seller of AUD there is a buyer. Apart from loose change on qantas flight, no Australian dollars actually move over seas. There is no reason to use them overseas.

        If you buy a Honda from Japan, you (or the Honda Dealer) takes your AUD deposit and buy Yen. The Yen is delivered to Honda and you get your Bike. However, for you to buy Yen, someone else bought your AUD. What does the buyer do with the AUD? They can;
        – Put it on deposit back with an ADI (Aust Bank)
        – Buy Aust shares / property / bonds (but the seller of these asset then has AUD which goes back into the banking system).

        So although you bought a Honda, and cause a Trade and current account deficit, your AUD deposit is now simply owned by someone else in the Aussie banking system. The change in ownership of AUD deposits and assets from this is known to be a Capital account surplus and matches dollar for dollar the Current account deficit.

        Either way, the Stock of AUD in the banking system remains unchanged.

      • From an evidence perspective see the following easy to find papers from the USA Federal Reserve Board and from John Maynard Keynes. A plethora of academic literature can found in addition to these poignant papers:

        “Capital Flight from the Countries in Transition: Some Theory and Empirical Evidence”

        “On Keynes and Capital Flight – Keynes’s General Theory: A Different Perspective.” by Allan H. Meltzer

        Perhaps other bloggers can contribute to the limited perspective @b_b offers on this topic.

      • Michael hudson has written extensively of this anemic factor of capital flight:

        “Another key macro economic contributor to the flight surge was “asset based” flight, based on ill managed privatizations and other state asset rip-offs, especially in countries with natural resources and other assets to steal. This became especially
        important in the 1990s, as country credit dried up in the wake of the debt crisis. Third World privatizations and the looting of state resource in general were very important sources of private banking lucre, especially in countries like Russia, Brazil,
        South Africa, and Nigeria. Many cash strapped debtors came under enormous pressure to liberalize capital markets privatize state owned assets phone companies, energy companies, airports, ports, mines, public utilities, wireless spectrum, and so forth and over deplete their natural resources. The result, as
        described in Chapter 8, was one of the greatest “primitive accumulations” for Third World elites in history, and another huge opportunity for pirate bankers.”

        Pirate Bankers indeed, sound familiar. One only has to look at the Australian Government. Now we all understand the bank balance sheet and accounting entries and can apply this knowledge to understanding the Balance Sheet Recession/Depression of the USA mortgage lenders Fannie Mai and Freddy Mac, perhaps @b_b can comment on Capital Flight.

  2. “Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.”

    So what is my bank savings account if not a deposit?

  3. Undergrad here; How exactly does this differ to the typical textbook understanding of bank reserves that are taught? The two elements highlighted in this article seem to be:

    A) There are big swings in bank lending
    B) Money can be destroyed when it is used to pay back loans instead of spent

    In regards to A), textbooks provide contextual examples of how the reserve deposit ratio changes significantly in response to policies like QE, and specifically highlighted the massive increase in US reserve holdings following the GFC.

    And for B) it’s not clear to me how this money is ‘destroyed’ in any way – if a loan is paid back, surely the banking system gets that money back, to loan away again. Bank loans might have a net decrease and so the reserve deposit ratio may increase, but the money isn’t destroyed.

    • So I earn $1000, deposit it in my bank account. I also have a car loan for say $1000, which I used to by my car (still have it).

      Tomorrow I pay off my loan with my $1k deposit. My deposit account now has a $0 balance, and my loan is closed off ($0 balance). That $1k can not be found anywhere on the banking systems books now – so if money was not “destroyed” by this process, where did my $1k deposit end up?

      • tomascokis’ point about the repayment is that it ends up “freeing up” lending capacity at the institution from where you borrowed it, not to mention the interest earned ending up in the bank’s coffers (and subsequently to pay its staff and shareholders and whatnot).

      • Rumplestatskin

        “it ends up “freeing up” lending capacity at the institution from where you borrowed it”

        Assuming that lending was constrained prior to that point. However, I note again Keynes point there. Has there ever been a situation where a bank says it is unable to lend because of internal constraints?

      • The bank received 1k when you paid back the loan, it might not be associated with you anymore, but the money is still in the banks ‘books’.

        With regards to RumpleStatSkins point, one would hope that banks, to protect against, and so deter bank runs, desire to hold some kind of ratio of reserves against deposits, as goes the theory. While they could loan to their hearts content if they really wanted to, these risks deter them from doing do. The desire to keep reserves for their loans creates a kind of internal constraint.

      • @tomascokis – the $1k is *not* on the banks books anywhere after. It was on their books as a liability (deposit) in my name. Likewise they had an asset (loan) for $1k with me as the borrower. When I paid the loan off, both the liability and the asset on the banks books went to $0.

        That $1k is no longer on that, or any other banks books. It wasn’t converted to cash, or ESA reserves, or anything else – it’s now gone. Extinguished.

        Re your “reserve ratio” point, there is no requirement / mandate around that. However, banks are constrained by prudential regulations, which require that they hold certain types of capital as a mandated proportion of their assets (loans).

        The banks operationally need to always ensure they have enough reserves to meet their day-day cash settlement demands.

      • @tomascokis

        to protect against, and so deter bank runs, desire to hold some kind of ratio of reserves against deposits

        You would think right? No such requirement in Oz.

      • The true constraint for Banks are

        – Equity risk capital (regulated)
        – Credit worthy borrowers.

        Banks have risk weighted assets. The more assets (loans) the more equity. Too many loans means the Banks have to raise more equity which dilute earnings per share.

        Banks prefer to lend to (by their measure) credit worthy borrowers. It take two to make a loan. When a Country runs out of credit worthy borrowers banks move up the risk curve (i.e.: make bad loans) and we approach what Minksy described as “ponzi finance” – debt can only be repaid from more debt. A credit crisis then follows.

      • My apologies, I misinterpreted the example. My point about the destruction of money is that money given out by the central bank can’t be ‘destoyed’ in that fashion. If the 1k in the example is not earned but given to you by the central bank in some bizarre process, then whether you spend it or pay back a loan, it ends up on in a banks balance sheet.

        Whether or not an increase in the banking systems reserves leads to any increase in loaning is an interesting debate and I’m curious as to what evidense there is towards that.

        Surely if it had no affect at all, then monetary policy itself wouldn’t affect the economy at all

      • b_b

        More correctly

        The expected constraints for Banks, i.e.

        Equity risk capital (regulated) and credit worthy borrowers.

        have been altered via banks’ political capital to …

        abrogate requirements for the higher risk weighting of certain assets. This means the more non-residential property loans, the more equity required. Too many non-residential property loans means the Banks would either have to raise more equity (which would dilute earnings per share) or face a decline in lending growth (which would reduce earnings per share). Accordingly, banks prefer to lend (by their own systematic design) to people who want to buy a house. It now take three to make a loan – the bank and the two incomes repaying the debt. When a country runs out of domestic credit worthy borrowers banks apply political pressure to ensure homebuyer handouts, increased immigration, access to superannuation, easier access for foreign buyers, whatever it takes to maintain the value of the assets (residential property) securing the debt.

      • Spleen,

        I don’t entirely disagree. There is a preference to residential lending because of risk weighting. BUT, it us a price issue not volume.

        Since the loan creates the deposit, there is no real crowding out by resi loans. Butt, because non resi loan require more equity, they will be extended at at much higher price (to maintain the same bank roe). That is why commercial loans attract higher rates of interest compared to resi.

        If you own your home you will always fund your small business via your mortgage because it is way cheaper. Shows up as a home though in the credit aggregates.

      • @gonderb, I am afraid you will have to go a lot further down the rabbit warren to convince me. Where did the $1k you earned come from? Would it have been transferred from the bank account(s) of your employer or your customers by any chance? How did it get into their accounts? Et cetera, et cetera.

  4. “Today the Australian dollar is not redeemable for Gold, it is not pegged at a fixed exchange rate against other currencies and the number created doesn’t have a fixed limit (a la Bitcoin), today most Australian dollars are borrowed into existence.

    I have seen it suggested that a bank must receive a deposit from which it can then lend a majority portion. In fact when someone borrows money from a bank, the bank can create new money (or credit) out of thin air. It will credit the borrower with a deposit (which might be paid in form of a cheque or deposit into the borrowers account) and will also create a loan account for which the bank charges interest on the created money (this is an asset for the bank, earning it income).

    When a bank lends money, the deposit ends up in the hands of the borrower without anybody else having less, hence we have just seen an increase in the total money available. In today’s monetary system ‘money is debt’, it is backed by the ability of borrowers to repay their loans, that is something that should strike fear into the hearts of savers given the reckless abandon with which banks lend today.

    Australian dollars can be borrowed into existence by the government running a deficit (borrowing to spend more than it receives in revenue) or via the private sector.”


    The process is no real secret, but IMO just as many economists get it wrong on the creation, there are also MMT loonies that think that confidence will remain in the monetary system regardless of how reckless central banks and governments are with managing it.

    I only wish that those who wanted to opt out had the opportunity to do so via competing currencies (something that Glenn Stevens recently & wrongly claimed we have:

    By the way, kind of ironic that they held those interviews (first link in the article) in front of Gold bars in the BoE’s vault!

    • Bullion,

      I do not know of any mmt argument that states there will alway be confidence in the monetary system irrespective of govt behavior.

      Can you please link relevant articles.


      • I do not know whether it forms the basis of the official theory (if there is such thing?), I have only seen such rhetoric spewed out in various comments by loonies as mentioned (yes, well aware there are plenty of Gold loonies too).

        The very nature of suggesting that a country cannot go broke (see just about any Mike Norman youtube clip for an example) because they can print as much as they want (to pay off their debts or fund spending) is to avoid any consideration of confidence in the currency.

      • Bb – the rba prints every day. That is the nature of the system. It calls open market ops and it indirectly funds the treasury.

      • Bb, you seem to think printing money is a bad thing. From an mmt perspective is is a strange position.

        You need more information than that to determine if is a bad thing. Printing fir what? To give money to your mates, or build a hospital. Context is everything.

        For the record, mmt is fully aware of the issues of the end of fiat currencies. Look in Google for mmt/Weimar or mmt/Zimbabwe etc. tonnes of academic peer reviewed articles. That is why I pulled you up on your first statement. It made you look silly.

        It is about getting the context right.

      • My statement was simply pointing out that there are loonies making ridiculous claims about MMT. Why do I look silly pointing that out? They are doing so (fact) and they are wrong (fact).

        You completely side stepped the example I provided and started straw man attacks, speculating on what I am thinking, talking about peer reviewed papers (WTF?).

        So answer me this, do you agree with Mike Norman’s claim that the United States cannot go broke? Can the US print whatever they want, to cover whatever costs arise, with no limit, without running the risk of “going broke”? And by going broke, I mean “printing” to the point where their currency is decimated by lack of confidence in USD denominated debt/money (this could materialise through hyperinflation or force the US to change their currency in some way to restore faith, whether that be putting their Gold reserves up as collateral, replacing the currency or restructuring the debt, for continued international acceptance of their debt &/or currency).

        Mike doesn’t highlight any limits when he is mouthing off.

        He does not add any provisos.

        He does not otherwise suggest his claims are hyperbolic.

        Here is one of his rants as an example:

        “The Unites States can’t go broke because it issues it’s own currency. If it needs dollars to satisfy a debt or spend fixing infrastrucutre or pay for international defense or any entitlement like social security, it’s just a matter of changing numbers in a bank account. That’s it, the numbers just get marked up. That’s how the government spends & that’s why the US cannot go broke.”

        You either agree with his claim (as specifically worded above) or you don’t. Which is it?

        If you don’t agree with him, then it proves my initial statement is justified (not silly). If you do agree with him, then you’ve just earned the loony title too as far as I’m concerned.

      • @BB

        From their perspective, your the looney one! Why ? Because all that needs to happen is that the numbers balance. CR=DR. What does the money buy you? Doesn’t matter. The state will just print more.

        If you don’t need to import, your fine. Else you’re s*****d

      • flyingfox, you are probably right, they are looking at it simply from a balance sheet view and how it is technically created (how can the US go broke if they can print the notes to payoff their debt?) without considering the practical, real world implications of these actions. That doesn’t excuse the ridiculousness of their claims IMO though.

        In theory I could create a currency for my own household, pay everyone in an imaginary currency called the baron peso, each of my family members could have unlimited debt denominated in the baron peso, but they would never go broke because I can print them at will. But realistically we do not have all the resources required on my property to survive without outside help, so when trying to pay someone else with the baron peso for outside goods, they do not accept it, we are broke.

      • You guys raise an interesting issue; what is the limit in printing?

        In a closed economy, the central bank can keep printing as long as the currency is backed by the total output of goods and services that the nation is capable of producing.

        In an open economy, there is a question of imports and international competitiveness. The total amount of goods and services that the nation is capable of producing may never be realized if cheaper imports flood the domestic economy.

        But then again, over-printing should lead to devalued currency, which in turn should restore competitiveness.

        This is getting complex, and it is getting late.

        Now, as for baron peso……, one can refuse payments in baron peso. But it is illegal to refuse payments in AUD here!!

      • “However although transactions are to be in Australian currency unless otherwise agreed or specified, and Australian currency has legal tender status, Australian banknotes and coins do not necessarily have to be used in transactions and refusal to accept payment in legal tender banknotes and coins is not unlawful”

        Interesting. What happens if someone refuses to accept payment in AUD? Go to the court?

      • Rumplestatskin


        Real resources are the limiting factor on money printing, and you know when you are hitting real resource limits because you will see inflation. From my beginner understanding of MMT is seems they always say that there are no limits within the banking system, only physical limits which will lead to inflation if too much money is being generated.

        At the same time they say that when you get inflation you should be in a situation of high employment, high investment etc.

        So yes, the US can’t go broke in the sense that they are unable to pay dues in USD, but they certainly could destroy the value of their currency by printing money without limit even in the face of very high (>20%) inflation.

        Would they be broke then?

        But I’m not sure why you need ‘confidence’. Many countries have operated perfectly well with inflation rates >10%pa for many years without major detrimental effects.

        Also remember, that during the property boom of the 2000s, private banks essentially created money without limit. In Australia they created $170billion in loans and deposits PER YEAR in the decade to 2009.

  5. Isn’t the important think to acknowledge that only the principal gets created in this system. As a result there is almost no money created that is not encumbered with interest. So for the money to exist to pay the interest it is necessary for someone else to be generating some more money elsewhere in the system (which is also encumbered with interest), and on the cycle goes. National economies are essentially in a battle with each other to capture money that does not owe interest in their national economy, so existing debt can be paid off with requiring even more debt to generate the funds to pay then interest.

      • @HnH I was thinking the same. Two sides to the same coin. Always back slapping each other.

        Well atleast PF tries to engage in the discussion.

      • PF is not b_b.

        They may share some views but unless they have been keeping a schizo game up for 4+ years across multiple sites they aint the same person. I really struggle to see what that would achieve anyway.

        MMT etc is about the only thing they both fire up about.

    • Yep net bank interest margins run at 2-3%

      Exactly the target band of reserve bank inflation…now you know why 🙂

      • Exactly.

        Keep increasing money supply, year in year out, for infinite number of years.

        As long as they wish to keep the current system, they have no choice.

    • I am not PF. I have said this twice now. And with all due respect to Peter, he does not really get the full mechanics of MMT. He is a bit of a late comer, but he certainly understands more than most.

      I am not necessarily a believer in all of MMT – but I have spend many years analysing the financial system, and have a background in Economics, Finance, Accounting and Statistics.


      The loan creats the deposit. The interest accrued creates the interest paid. Think of future interest bills as future interest income for deposit holders. They are all mini-loans and mini-depostit (for ease of explanation I am ignoring bank profits and employee costs – it seems to confuse people).

      So the money “must come from somewhere” argument is easy to answer. Accrued interest income which sits on the other side of a banks balance sheet.

      A simple example is the loan is repaid when the loan plus interest transacts with the deposit plus interest. (Gondreb has an excellent example above).

      I can go on and include the external account and government from here, but so many people can not even get this point.

      • @b_b Let’s cut to the chase. If all money is debt. Then new debt has to be created to pay interest on existing debt. To infinitum, this is a geometric series.

        For every loan amount a at interest r, you need to create ar/(1-r) of new money to pay the interest.

      • It is a bit misleading to say the interest accrued creates the interest paid. Capitalised interest receivable may have a corresponding accounting journal for interest payable, but the interest is only paid when it’s actually paid (i.e. from future income or realisation of equity). The accounting of it doesn’t really address the crux of people’s concern here, which is growing levels of debt (with interest) secured by assets whose value is dependent on the continued growth of replacement borrowers, whose future prospective income (and capacity to lead a balanced life) is currently being menaced by vested interests who are concurrently seeking to maintain those asset prices.

      • When interest is paid on deposits, is the money for the interest created out of nothing, or is it paid from money already in existence?

      • B_b,

        What is your understanding of the process by which a bank goes broke. By that I mean how a bank might find itself insolvent or the subject of an application for liquidation.

        Your interpretation of bank accounting would not seem to allow it.

      • Pfh

        b_b might be right about accounting entries balancing out in aggregate.

        But insolvency for a bank means there has been a massive systemic shock including a bank that makes very risky loans and or an out right GFC / depression onset.

        In the normal course of events (and i should say with normalised IR) the bank LVR would cover the principal and interest in case of default.

        In our low IR environment creating high leverage then I’d agree that accounting entries are meaningless without a high certainty of avoiding a property crash or a property melt.

      • Mig – your link does not contradict anything I have said. Did you even read your own link?

        Pfh – read one of my first entries in this thread. It explains how banks can go broke using accounting entries. In short when reserves go to zero.

      • migtronixMEMBER

        Of course I read the paper, they go on about the ways banks recap none of which would be necessary in your world

      • b_b,

        Are you talking about your response to Jason?

        You realise what you are saying about exchange settlement accounts is completely wrong?

        Especially calling them ‘reserves’

        Did you read that RBA link i posted yesterday.

        They are a convenient means of settling accounts between banks that is all.

        The banks entries between each other net to zero because they are just double entry accounting but the ES accounts are used for a lot more than settling accounts between banks. Buying currency, buying and selling securities to the RBA, taxes paid to govt, payments by govt.

        The RBA explicitly does not want to lend money to banks who heading for a debit balance, it wants the other banks to so and it wants them to do so at the target rate. It uses OMO to make it rational for them to do so.

        Note: Banks do not want to have debit balances at the end of the day – it is preferable if their ES accounts are close to zero as there is a penalty for positive balances that are not lent at the cash rate. That is cheques to be honoured by them equal checks to be honoured by other banks. As that paper notes when banks think the world is sweet and they believe their brethern are not going broke the RBA can get them to lend without much encouragement – i.e the ES credit balances can be lower.

        When a bank makes a loan to another bank to settle a debit balance on their ES ACCOUNT it is a loan and must be settled like any other loan. Keep in mind these are called overnight loans for reason.

        If a bank cannot settle the loan it is like anyone else who fails to repay a loan.

        Serious issue.

        You make it sound as though a bank who has to honour lots of checks drawn on loan accounts it creates is entitled to borrow endlessly to settle daily debit balances on its ES account.

        It cannot.

        The moment it struggles to settle those over night loan -i.e. with liquid assets it is going out the back door.

        Liquid Assets ! That stuff they need to attract from people – even the corporation type.

        The fear that banks may not be able to settle those over night loans is why the RBA had to crank up the OMOs 2007-2009. It had to increase the incentive for banks to lend to each other.

        Sure they did lend but if the loan was not settled – BINGO.

        Bank goes broke like any other bank who does not have cash flow to meet its obligations as and when they fall due.

      • Bottom line

        A bank can create as many loans as it likes – up to whatever limits APRA is inclined to police.

        Reserves do not determine how many loans a bank can create in Oz.

        The ES accounts at the RBA are not ‘reserves’ they are a score sheet to simplify settlements.

        Banks who hit a deficit at the end of the day must borrow to settle their account.

        The RBA does not do that lending but it tries to influence the rate – which it can do most of the time because it can twist arms with OMOs

        Banks who have to keep borrowing because they keep hitting a debit balance – because they wrote too many loans and too many cheques on those accounts get presented – need liquid assets to settle those over night loans.

        That is why they need to compete to attract deposits and offer attractive rates.

        If they don’t they will go broke.

        And double entry accounting will not save them.

  6. How is it going to grow “to the stars” with a world in terminal demographic decline??

    • 200 year mortgages. Check out Denmark . Less people yes, but borrowing for three lifetimes instead of one.

  7. I do love these conversations , as most would know on this site I am a MMx guy, but for some reason these conversations always seem to miss the point about capital.

    In the modern monetary world, and in the context of Basel etc, the thing that restrains lending is non-encumbered liquid assets owned by the bank, that is capital. Reserves, although interesting to discuss, certainly in the context of IR control , are basically irrelevant.

  8. Events of the last decade are swinging me around to accept the idea that powerful banking and finance families rigged crises in the late 1800’s specifically so their favourite “cure” – Central Banking – could be imposed.

    Banking and Finance are capturing a larger and larger share of the total profits made in the economy, due to the way the whole system works.

    I am agnostic on whether “stable money” – like a gold standard – is “the” essential alternative. It seems to me that increases in the money supply COULD be neutral as regards the essential thing – the creation of REAL WEALTH – that is, actual stuff in which there is as much consumer surplus as possible. BUT the way the whole system is geared under the status quo, the means by which there is increase in the money supply essentially creates “economic rent”, which I firmly believe REDUCES the creation of real wealth.

    Even MMT “might” work PROVIDED it was set up to NOT create economic rent for someone in the process. But pigs might fly. Give politicians the money-printing press and who can expect rent-seekers to remain in their boxes? Much government spending already IS a cause of destruction of creation of real wealth, simply because it involves so many people getting something in return for NO consumer surplus. No matter how “fair and just” it is that someone gets something for nothing, it WILL erode the creation of real wealth.

    Real wealth creation – that is, the utilisation of resources to create goods and services in which there is as much consumer surplus as possible – is a completely separate matter to the monetary units in which people trade stuff. The supply of monetary units is irrelevant to how “REALLY” wealthy people in an economy are.

    The mechanism by which monetary inflation destroys wealth, is simply that it reduces the creation of real wealth by a variety of mechanisms.It is virtually impossible to utilise resources to create goods and services in which there is consumer surplus, when there is hyperinflation. It becomes increasingly difficult to utilise resources to create goods and services in which there is consumer surplus, when a bigger and bigger share of the total “monetary units” in circulation are being captured by sectors that get their share for nothing.

    I suppose it is impossible to define and administer a QE or MMT system that would actually put the newly created money into the economy via the wealth creators rather than the rentiers, and thus create the right incentives for growth.

    • “Events of the last decade are swinging me around to accept the idea that powerful banking and finance families rigged crises in the late 1800′s specifically so their favourite “cure” – Central Banking – could be imposed. “

      There is abundant evidence to support this view.

    • You should have a read of The Creature from Jekyll Island for an insight into the formalization of this conspiracy.

    • I am now almost certainly convinced that this is probably the case that b_b is either Steve Keen or Bill Mitchell, or possibly Steve Mitchell or Bill Keen. Or neither. The slippery bastard wouldn’t own up up to it anyway.

      • No, b_b doesn’t sound like Bill.

        He is a little mysterious in the sense that he seems very keen on a lot of MMT ideas but I don’t get the impression that the laudable social justice element of MMT -eg the job guarantee – is what is driving his interest.

        But I could be wrong about that.

        Anyway, I like his contributions as I do those of PF ‘missing an H’ even if I am inclined to disagree with some of his broader statements.

      • Why does it matter who he is?

        If people make judgements on the content of a post based on their view of the person who made the comment rather than the value of the comment itself, then I consider that a reflection on them not on the post.

      • “…Why does it matter who he is?..”

        I completely agree – it doesn’t.

        All that is relevant is whether people are interested in discussing issues on their substance and being open to changing their mind.

        If people find they are not questioning every day, at least some of what they were sure about yesterday, they have probably switched their brain to broadcast only.

        The absence of that on the part of almost everyone who participates in these threads is what makes it interesting.

        Having regard to how little humans really know about how to run a modern civilisation, if we agreed on everything that would be a definite warning sign that we are kidding ourselves.

  9. The BoE report doesn’t seem very contentious to me. Most economists know that banks credit new deposits when they make loans. The implication of this is where the disagreement seems to be I think.

    The MMT people seem to be saying that banks can self finance loans and the CB provides reserves to accommodate any level of deposit creation.

    This is where I disagree. As the BoE report also says; profitability and ultimately CB policy act as a real constraint on deposit creation.

    Re profitability: A bank can create a zero percent interest paying deposit initially when it makes a loan. But deposits are an asset – and there is liquidity/return tradeoff. If liquidity demand is satiated, the demand deposit will end up back in the banking system as a term deposit. So the bank needs to weigh the profitability of every loan as though, in effect they needed to attract the deposit in the first place by offering a competitive interest rate. Even if the sequence is slightly different the result is the same. At the margin, this becomes a real constraint.

    As the BoE report also says, the CB has ultimate control over deposit creation. CB’s set a price for their money (the inflation target). Commercial banks set a price for their money (1 unit of deposit money = 1 unit of base money). So creation of deposits is ultimately limited by CB policy to maintain the price of base money (the inflation target). The confusion in this comes because people see the CB as setting an interest rate and then providing reserves to maintain the interest rate. But suppose banks self financed a heap of loans through zero interest paying deposits. This would raise base demand. Yes in the very short run the CB can maintain its interest rate and provide the reserves. But in the not so short run they have to maintain the price of their money. In other words they have to raise their interest rate. Raising the interest rate lowers quantity demanded and puts an end to deposit creation.

    Btw. When the short rate is stuck at zero all this stuff goes out the window. There is basically no link between deposits and lending. Commercial banks end up becoming narrow banks, buying securities in exchange for deposits. So credit growth could be negative while broad money growth was 10% or something. That’s basically what happened in the US post Lehman.

  10. b_b et al,

    I think there is a better approach to use to help to clear up this confusion about the effect of interest in the system. IMO much of the confusion arises from confusing a stock with a flow. The fact that interest is charged in this system doesn’t compound and automatically result in an ever-increasing money supply. The same AUDs can be recycled (velocity) to repay the interest charges for a number of loans over time i.e no increase in the money stock.

    Lending deposits into existence adds to the stock of money. Repaying loans reduces the stock of money. Paying interest is a redistribution of the existing money stock. Note also that banks do not retain the bulk of their profits. In fact they actively try to minimize the amount of capital tied up in order to improve their return on equity/capital. So only a small proportion of this flow, if any, is captured by the banks themselves.

    The transfer of wealth from other sectors to the FIRE sector occurs through other mechanisms e.g. raising the price of existing assets, ever-greening debt (revolving credit and re-financing), reducing the ratio of deposit to debt required for a mortgage, control fraud (fake profits collected as bonuses by executives on loans that are ultimately guaranteed to result in losses for others), penalizing saving…..the list goes on.

    Again this is merely my opinion but I think there are two main objectives served by mandating the currency issuer/CB to maintain an inflationary bias and allowing them to manipulate interest rates in a complementary manner. It erodes the liabilities of governments and the biggest debtors in an economy – the FIRE sector in terms of purchasing power parity.

    As a result debts are easier to repay over time as reckoned by currency. Tough luck if you, like many retirees, don’t have the ability to force the price paid to you higher to compensate for the loss of purchasing power you suffer from inflation induced rises in the general price level.

    • Paying interest is a redistribution of the existing money stock.

      Yes and no.

      If you start with the notion that all money, M0, at time t=t0, at some level is borrowed into existence with interest charged on it. Then by definition, at time t=t0+1, you need to have M0+ dM money in the system to repay principal + interest.

  11. Fascinating discussion.

    No doubt, I’m very obtuse but what springs to mind when I go through all this information is how indebted I am to old Hans Christian Andersen for expressing my feelings for me:

    “A child, however, who had no important job and could only see things as his eyes showed them to him, went up to the carriage.
    “The Emperor is naked,” he said.”

  12. Hi Folks

    Would someone mind settings out the DRs and CRs like a formal journal entry so I can understand.

    To avoid long chains of journals that complicate things, could you please jump to the final journal as this will give the self evident answer. Can you please setout which general ledger account the entries hit ie assets, liabilities, issued capital, pre tax profit (which account exactly ie interest income, interest expense, other expense) or income tax expense.

    It is just I am totally confused whenever I read this type of discussion, and if you set out the accounting I will immediately understand. Why not just assume to make it easier there are say just two commercial banks and the reserve bank in a closed economy.

    Where am I heading with all this. I think economists have a different view of loans and deposits to accountants so I am just trying to understand. At the end of the day accountants prepare statutory accounts that reconcile and I struggle with the discussion on this point

    Let me add a twist. This is the crux of the issue I think from which I can determine the rest. When the reserve bank creates money is the entry in its books

    DR Cash (magically appears from thin air)
    CR Income (it creates net equity out of thin air)


    DR Cash
    CR Liability to unsecured creditor

    (no free money as it must settle claims at some point in the future with real goods)

    I read the govt treats anyone that holds currency as an unsecured debtor. So when the final day comes and it attempts to settle all claims against it, does it just hand over goods in its ownership, and if does not have any goods, it is then in default and effectively bankrupt. I suspect journal two is what RBA does but does anyone know.


    • When CB creates money entries in CB book are:

      1. Dr Securities (Asset)
      Cr Monetary Base (Liability)

      2. Dr Future Seigniorage Income (Asset)
      Cr Equity

      They don’t actually book the second entry. But they could because its the economic reality (I don’t know enough about CB accounting standards)

      In commercial banks book:

      Dr Reserves at CB (Asset)
      Cr Securities (Asset)

      • Thankyou Sweeper, much appreciated for your time and help. may I impose a bit more and raise some queries. When you use CB I presume you mean central bank RBA rather than commercial bank so I am proceeding on this

        In jnl 1 could you please explain
        a. is the security asset owned by RBA an entitlement against a commercial bank for lending it money? i.e. RBA gave value to commercial bank in form of cash (i.e. I think you call it reserves) and received a asset loan as compensation
        b. who is monetary base liability payable to? Is that anyone who holds cash as an unsecured creditor?
        c. commercially what is Future Seigniorage Income and why is it an asset i.e. is it a future right to interest income for lending in the form of cash to the commercial bank? i.e. usury compensation for lending money and wanting a return based on time and rate

        In commercial bank book
        a. are reserves at CB do you mean cash held by commercial bank on deposit with RBA when the RBA exchanges cash for a loan entitlement?
        b. why are securities a CR asset? do you mean a liability owed to RBA which would mean an offsetting to the DR entry in rba books

        thus thinking about it I think you use the term security to mean loan payable / receivable between the two parties, which arises because value is shifted from the RB A to commercial bank in the form of cash (which i think you call reserves which is effectively cash sitting on deposit)

        I hope you agree with me because I would like to take this discussion further with you and if we can sort out the differences here I can have a go at some journals trying to really understand how and if commercial banks can create unlimited loans payable and receivable, or if there is a mathematical impediment in the system because of artificial restraints used by R BA / APRA in the form of reserves (which to my mind are restrictions on the use by a commercial bank of their asset base or liability base rather than what an accountant would call profits sitting on the equity side of the balance sheet)

        Many thanks

      • CB = central bank

        Securities = marketable securities (in non QE times, treasury bills)

        monetary base = payable to anybody who holds cash yes.

        seigniorage = future return on CB assets.

        Because all CB assets can in theory be financed to maturity at 0%, a seigniorage asset could be taken up whenever money is created. Seigniorage Asset = PV of future seigniorage income. CB’s don’t do this, and therefore vastly understate their equity.

        in commercial banks book:

        – reserves – deposits with CB yes
        – Entry is:
        Dr Reserves (Asset)
        Cr Securities (treasury bills) (Asset)
        Because the commercial bank has swapped securities it owned for reserves

      • Thanks Sweeper for your further message below. I think i get it and will think a bit more and come back in the future when i have done more reading. I had a think about Tom browns blog below and want to get my head around that. Thinking out loud, if the RBA does not inject cash into the system, i cannot mathematically see how banks can create ever expanding debt in the first place because when it is all aggregated it comes to nil. But I will leave that for now to I prove it out to myself

        once again thanks

    • Look up Tom Browns blog. He does lots of accounting for bank lending and monetary policy, all simple enough to follow

      • Thanks I will definitely read and i appreciate your time

        The language is a bit different to what i would expect but think jnls are below. If I am not correct could you let me know. I am totally confused by fact pattern as where does X get his hands on cash? X has a loan payable and receivable with two banks that come to nil, where does X get the cash. This is just a big round robin of loans with no cash coming in between X and A and B so what is its purpose? Is this really a real world example because i can see value being shifted but it is in the form of loans, not cash as RBA is out of the picture. Note how Tom uses the terminology deposit but to me there is no deposit because I associate it with cash whereas there is no cash here


        Bank A
        DR Loan receivable (X) – asset $100
        CR Loan payable (B) – liability $100

        Bank B
        DR Loan receivable (A) – asset $100
        CR Loan payable (X) – liability $100

        Person X
        DR Loan receivable (Bank B) – asset $100
        CR Loan payable (Bank A) – liability $100

        If that is the case, no extra debt in the system because they all cancel out. Is that your view? That is, there is no economic increment created and no change in debt in the system if we collapse all loans because they come to nil

        Many thanks

      • tetama,

        This may also assist but I recommend reading this first

        Treasury sells $100 bond to Buyer A.

        Buyer A writes check $100 drawn on his account with Bank A. – treasury presents check $100 to Bank A.

        Treasury ES up $100. Buyer bank – Bank A ES down $100

        Buyer has an IOU. A treasury bond that they frame and put on kitchen wall to show they have invested in Australia!

        Now Bank needs to settle the $100 debit in its ES and it must do so by the end of the day as being able to settle the ES account each day is a condition of having an ES account.


        Bank might offer to sell a $100 bond to RBA during OMO (offers may not be accepted) – RBA will credit Bank A ES account with $100 and debit RBA asset account to show it now holds $100 bond. (This is creation of money by the RBA)

        OR bank might present a check for $100 received by its customers from Bank B and get a $100 credit to its ES – Bank B ES will get a $100 debit (which of course it then has to settle)

        OR bank might sell back to RBA an old torn $100 note and RBA gives a credit to its ES for $100. RBA will debit its account for notes.

        OR bank might borrow $100 from Bank C – when RBA is told about this they credit Bank A ES with $100 and debit Bank C ES with $100.

        But Bank C is now holding an IOU from Bank A. RBA tries to influence the rate charged by Bank C to make the loan to Bank by pouring money into ES accounts or draining money from ES accounts. It does this by OMO – buying and selling securities to ES account holders and crediting or debiting ES accounts as required. Because of the rules regarding interest paid on ES balances, banks with credit balances have a reason to make loans to banks with debit balances.

        The perception of the risk of making those loans will influence how much encouragement is required from the RBA – more risk = higher ES balances required = RBA buying more securities in OMO.

        If Bank C finds Bank A keeps seeking loans day after day because Bank A keeps ending up with debit balances on its ES, Bank C is going to get increasingly twitchy as they are just loans and no one likes bad debts. RBA may need to do more OMOs to create more encouragement to Bank C to continue to lend at the target rate.

        If Bank A actually fails to pay back or settle one of those loans it is in default. That is when a bank goes BUST.

        Generally Bank A will not borrow from the RBA to settle its ES account (there is a penalty interest rate to discourage this) and I don’t think (not sure about this) it can borrow from Treasury either even though Treasury has an ES account as well.

        The whole idea is to create a market for a specific short term loans between banks where the RBA can strongly influence the rate of interest charged. This rate then influences the whole rate structure.

        QE is just an attempt to influence other longer term rates in the rate structure rather than rely on the effect of on those rates of influencing the short term rate.

        Meanwhile back at Treasury.

        Next day Treasury spends the $100 in its ES account (from the bond sale to Buyer A) by writing a dole check to buyer A who deposits it with Bank D.

        Buyer A (bond buying dole bludger) used his account with Bank A to buy the $100 treasury but deposited the dole check into the account of Bank D.

        Treasury ES Down $100 (back to zero). Bank D ES up $100.

        Bank A still owes Bank C $100 if it borrowed $100 to settle its debit account that resulted from Buyer A using his Bank A account to pay for the treasury.

        Bank A puts a sign in its window offering a more attractive interest rate than Bank D to anyone with $100.

        Buyer A writes a check on his account at Bank D containing his dole money.

        Bank A ES is up $100 and Bank D ES is down $100.

        Bank A now repays the loan from Bank C it may have taken out yesterday when it worried it would have a $100 debit balance in its ES account after Buyer A bought the bond.

        Bank A ES down $100 Bank C ES is up $100

        Of course now Bank D is looking at a $100 debit balance and it needs to decide what it can do to settle that balance. Tender to sell some bonds to the RBA during OMO, borrow some money from other banks (wonder, ‘do they think I am in trouble’) hope its customers deposit some checks drawn on the other banks etc.

        It matters a great deal to bank solvency and interest rate competition where the $100 is located in the banking system.


        If the original source of Buyer A’s $100 to buy the treasury bond was a loan by Bank A to Buyer A then it was private bank created money that is being used to buy the bond.

        If the original source of the $100 was the RBA buying a bond from Bank A which Bank used to buy window cleaning services from Buyer A then it was reserve bank created money.

  13. Loving this thread people – great work

    This (and demographics) are the heart of the issue IMO

    If all money is debt – then you have to conclude that you need to increase the money supply (by 2-3% per year) to feed the monster

    This has to continue indefinitely (hence most of the issues that are discussed daily on MB) otherwise it collapses (GFC was a taste of that where some 11 trillion of credit money was extinguished against some 3 trillion QE in the US)…

    And with much of the world having gone off the demographic cliff so to speak – you have to wonder how this monster keeps growing…

    So you get demographic decline …

    And after a period of time out and out deflation

    Which is exactly what we are seeing in Japan & Europe where demographics are the worst

    And soon China…


    • Yes Andrew.

      2-3% net new money.

      Some business receive 5-6%+++ new money. While others receive less and others again actually go backwards and become insolvent.

      The net new money isn’t spread even. You need to have a compelling case for it to come your way.

      Lately that compelling case is property. But that’s another discussion.

      • @Escobar

        Lately that compelling case is property. But that’s another discussion.

        Really? It’s been pretty much the only “compelling” case. Why else would people borrow money and banks lend?

      • Yeah 2-3% is the inflation target band of central banks

        Inflation is caused by an increase in the money supply…

        Ever wondered why that is considered the textbook optimum level of inflation?

        Why is there even an optimum level of inflation?

        I thought it was better when stuff got cheaper?

        Is deflation in itself really that bad? Cheaper stuff? Are the people in Japan suffering after 20 years of cheaper prices?

        Why are all the economic leaders so scared of it??

        Because banks net interest margins are about that level?

        And what happens to the money supply per capita in a population growing at 2% pa where credit is not growing more than about 5% (2-3% for the interest and 2% to keep up with the population)

        See why we have a much focus on the property ponzi???

      • ff

        Yes. Yes yes.

        But before property (in a galaxy far far away) you’d have saving and investment in productive enterprise.

        It was about making things happen. Railroads, industry, infrastructure. …..
        film making, music…silicon valley…widgets iphones.

        You actually had to be good at something.

        This has been covered before.

        I guess now we’re good at financial wizardry. … derivatives and all.

      • Not neccisarily – with strong immigration and a better demographic situation I think we can come out the other side perhaps better than most

        But not without a significant day of reckoning first IMO

        I don’t think China can actually keep it up much longer on balance of their absurd credit boom against the backdrop of a demographic tsunami…

        And as mining keeps unwinding…

      • It’s that day of reckoning I’m referring to, but yes I agree we are positioned better than some when we come out the back end of it.

        Good comments above on deflation. I’ve been asking myself some of those questions…

  14. At the end of the day it all amounts to claims on future resources and the resulting externalities associated, this is where the rubber meets the road i.e. subjective values become physical reality’s.

    • Some choice quotes from what I’ve read so far in Hudson’s tome:

      “… economists throughout the ages have been aware that interest-bearing debt grows purely by mathematical principles independent of the economy’s course and ability to pay. Contrary to textbook free-market theory, interest rates are not based on the expenses of creditors or linked to the production of real output. Interest is a transfer payment, much like a tax — a charge without a corresponding cost of production, paying for the privilege of creating bank credit electronically in today’s world. It is predatory rather than productive, adding to price without reflecting intrinsic cost-value. It is a form of economic rent…”

      “Some 80% of bank loans in the United States and Britain are mortgages, and consequently they account for 70% of the economy’s interest payments. This has reversed the major thrust of classical economic reform seeking to tax land rent, “de-privatizing” it from the old landed aristocracies.”

      “Because real estate is the largest asset category in modern private sectors, some 80% of ‘capital gains’ actually take the form of rising land prices.”

      “This tax favoritism to real estate — and behind it, to bankers as mortgage lenders — has spurred a shift of U.S. investment away from industry towards speculation, mainly in real estate but also the stock and bond markets. Today’s financialized economies carry their debt burden by borrowing against capital gains to pay the interest and taxes falling due.”

      “Credit is debt, and debt extracts interest. Financial salesmen who promise investors, ‘Make your money work for you’ actually mean that society should work for the creditors — and that means for the banks that create credit.

      The effect is to turn the economic surplus into a flow of interest payments, diverting revenue from tangible capital investment. As the economy’s reproductive powers are dried up, the financialization process is kept going by easing credit terms and lending — not to produce more goods and services, but to bid up prices for the real estate, stocks and bonds pledged as collateral for larger and larger loans.”

      “The key to understanding the financial sector’s strategy is that its activities and revenue do not constitute part of economic growth, but a subtrahend, paid out of the economic surplus.”

      “Inasmuch as interest is a cost of production and enters into the cost of living, financialized economies become more high-cost and hence uncompetitive.”

      “When one finds wrongheaded policies continued for decades on end (today’s financial orthodoxy is the same that endorsed many decades of destructive IMF austerity ‘stabilization’ programs), there is always a special interest benefiting. Neoliberalism supports the interests of banks seeking to extract debt service against alternatives to rescue the real economy from over-indebtedness… More giveaways to the financial sector are urged to ‘restore confidence’, defined as renewed borrowing to bid asset prices back to their former Bubble levels.”

      “Interest can only be paid out of economic growth, or else it shrinks markets and creditor claims collapse.”

      “So the world finds itself drawn into a new form of economic warfare. Waged by finance against industry as well as labor, it is also against government — at least, democratic government, which is turned into a vehicle to extract revenue and sell off assets to pay a creditor oligarchy. The trick is to convince voters to support a policy that shrinks the economy and throws government budgets into deficit, adding a fiscal crisis on top of the debt crisis — which the financial sector sees as an opportunity to turn nations into a grab bag for assets and further control.

      The effect is to make financialized economies higher-cost and hence less competitive — and less able to pull themselves out of depression by exporting more. Competitive advantage shifts to less debt-ridden economies, especially those whose real estate is less debt leveraged and public infrastructure provides basic services at cost or at subsidized rates. Politically, this means economies whose financial sectors have not gained enough power to capture the state, its central bank and regulatory agencies — or the academic economics curriculum, for that matter.

      But financialized globalization seeks to widen the web of debt throughout the world, achieving what formerly was won by military force. In the name of ‘wealth creation’ the financial sector has euphemized and transformed political ideology to such a degree that most countries are applauding the most predatory grab of the public domain (government enterprises, land and mineral rights) since the Enclosure Movements of the 16th through 18th century in England, and earlier military conquests of the New World and most of Europe.”

      “The business plan of finance capital is to expand interest and amortization charges to the point where they absorb all disposable consumer income over and above essentials, all business cash flow and real estate rent over and above break-even costs, and government revenue over basic police and other necessary functions.

      And then the economy collapses…”

      “The first major American economist, Daniel Raymond expressed his belief that: ‘Every money corporation is prima facie injurious to national wealth, and ought to be looked upon by those who have no money with jealousy and suspicion. They are, and ought to be considered, as artificial engines of power, contrived by the rich for the purpose of increasing their already too great ascendancy and calculated to destroy that natural equality among men which God has ordained and which government has no right to lend its power in destroying. The tendency of such institutions is to cause a more unequal division of property and a greater inequality among men than would otherwise take place.'”

      “The finance industry has fought to support special tax breaks for real estate, recognizing that the money that is freed from the tax collector will be available to pay interest.”

    • And a couple more (esp. for you Mig 😉 ):

      “The Magic of Compound Interest: Mathematics at the Root of the Crisis”

      “Ever since interest began to be recorded in ancient Mesopotamia, the defining financial character of economies has been the tendency for debts to multiply so rapidly that large numbers of debtors have had to settle their obligations by selling or forfeiting their property.”

      “As the process is essentially an exponential function, the dynamics of interest-bearing debt can be understood only through mathematics. The laws governing the growth of debt were at the core of religious doctrines of the ancient Near East, of Judaism, early Christianity and Islam. Matters hardly could have been otherwise in light of the role played by rural usury in the expropriation of families from their land, reducing them to bondage to their creditors.

      Economic models that neglect the self-multiplying character of debt will miss the source of today’s most pressing financial problem: the tendency of debts to grow more rapidly than the economy’s ability to carry them.”

  15. Speaking of Mortgages – FCIC Marketing
    700 witnesses, 19 days of public hearings, 4-5 million homes lost or in some phase of foreclosure during the 2008 period.

    Crisis was avoidable. It was called a collision of forces (notice they do not start off with fraud). Stewards (CEO’s) let us down all along the way. Conclusion: you cannot offer a loan to someone who cannot pay it back (WOW, what insight). There are 3,000 lobbyists for the industry and Greenspan/Bernanke had few regrets (Ayn Rand et al).

    Mass failures inn regulation and supervision along with corporate governance, risk rating agencies. This led to SDI Systemically Dangerous Institutions.

    In addition, wait for it…….. excessive borrowing occurred at multiple levels. Risky investments were constructed and there was a lack of transparency. This is combined with a complete absence of accountability along the securitization food-chain and an ethic to pass the buck or ignore the trend.

    The OTC market derivatives amplified the problem and credit agencies were rubber stamping their quality based on what the investment banks were telling them. This is classic bait and switch stuff with a bit of chaotic, selective truths built in for garnish.

    Interesting Bits
    Somewhere in the document there are two interesting pieces: 1) there is an admission that as early as 1999, appraisers were being pressured by banks to inflate their home appraisals. Of course, this means more money to be borrowed and higher fees. Several thousand appraisers came forward and wrote a letter to regulators saying they were being forced to inflate or face black-listing. This is a full 9 years before everything blew up.

    2) Mortgage Industry data was well known that an epidemic of liars loans were being sold throughout the system – FBI 2004 and MARI 2006. Different parties knew but either had little man power (after 9/11) as in the case of the FBI (expertise too) or chose to ignore the incidence 90% of bad loans as a general business practice of do not rock the boat.

    Essentially, the deregulatory, desupervised, and decriminalized patterns won out in the mid to late 90′s and this culture led to an anything goes western shootout of graft and fraud. Everyone knew, but no one is responsible. That is their story and they are sticking to it.

    **** This information was gather sitting in on a course with Dr. Black this fall. It is a brief summary of the 663 pages, Hope you have a good weekend, MRW.

    H/T – John Mc

    • migtronixMEMBER

      That’s right skippy systemic, wholesale, industry-wide, infiltrating as far as politics and as wide as LIBOR fixing, fraud is the only logical outcome of MMT/MMR as intellect is dragged into that vortex from which money grows on spreadsheets…

      • MMT is only accountancy, now if your accountant is a crook and ripping you off… it does not mean the accountancy or the mathematical underpinnings have malevolent intent…. that would be human agency migtronix.

        Hate to tell you migtronix, you have a – human – tool using problem. Something along the lines of – “A monetary principle stating that “bad money drives out good.”” – Gresham’s Law.

        The Iron Law of Institutions is: the people who control institutions care first and foremost about their power within the institution rather than the power of the institution itself. Thus, they would rather the institution “fail” while they remain in power within the institution than for the institution to “succeed” if that requires them to lose power within the institution.

        That you assign criminal agency to a thing MMT/MMR and compound it by tautological use of the reductive “only logical outcome” is indicative of rank institutionalized ideological bias. Seriously, does the finding of the royal commission on child abuse indicate religious, private or state symbolism [cross, seals, logos] compel care takers in positions of societal responsibility are compelled by – inanimate things – to inflict horrors upon the vulnerable and weak?

        Fraud – Criminality occurs no matter what form of exchange we utilize, see history.

        skippy… I’m more compelled by evidence which assigns agency to narcissistic ideology’s cobbled together by ex nihilo reductive “totality of thought” armchair deep thunkit and that process is magnified by deep pockets which have a self centered agenda.

      • @skippy

        The fraud and corruption that is associated with human agency seems to be unavoidable because as along as there are powerful institutions, they will be corrupted (at least that’s what I think you’re saying).

        Is there a solution or are we forever doomed by our human nature?

      • @Capitialist,

        Human Nature is a idiom or massive gross generalization.

        Calvin said children were seething sacks of sin and only hard labour would countenance that condition.

        skippy…. psychology and neuroscience illuminate such unfounded conclusions.

      • @skippy

        Maybe human nature is not the best term.

        My main question is, what solutions exist to prevent or minimise problems arising from human agency?

      • Enforce the laws on the books, let the criminals work somewhere else were they can blow themselves and those that hire them up.

        Get private money out of public service.

        And reverse the trend that awful sociopolitical ethos dressed up as economic science i.e. rational self interest trope homo economicus. Its bad enough that there is a small natural background wrt sociopaths. No need to indemnify it and embrace it as a way to a glorious future.

        skippy… yeah I know its all commingled now… so where would you set the bar at for complicity…. the janitor?

    • dumb_non_economistMEMBER

      skippy, I enjoy reading your “stuff”, but sometimes (a lot!) your sign-offs are like…say what!

  16. Thanks for posting this RS.

    The Bank of England Quarterly Bulletin dealing with much of this is at:

    Understanding MMT requires a completely different mode of thinking to that which has been driven into most of us through mis-education (mainstream economics) and false analogy (between a household or political entity that does not issue the currency it transacts in on the one had and a sovereign issuer of a non-convertible fiat currency that only “borrows” in its own currency).

    Bill Mitchell/Randy Wray
    and Cullen Roche
    have both written extensively on MMT/MMR.

    There are still constraints on even the US in the form of capital adequacy, desire for price stability, political ideology of current government, misunderstanding by poiticians and public, desire for social stability and loss of value of currency in international or commodity terms, but all of these constraints are self imposed.

    The US and similar governments are capable, if they wish of never defaulting on a security they have issued which is denomiated in their currency as they pay for it in the fiat currency they control.

    Greece on the other hand has to repay in Euros which they don’t issue. Similary eg NSW which transacts in AUD which they do not issue.

    For those who actually want to know more, I recommend the links above.

    Thanks again for getting MMT and how money is created by commercial banks on the agenda on MB.

    • Exactly, but it takes quite a while for people to wrap their minds around that. When they do a lot more things start to make sense, and a lot of ideas held up as gospel suddenly look quite ridiculous.

      It’s not a description of a monetary system they way exponents would like it to be, it’s a description of a monetary system as it is, and understanding that monetary system is damn useful when making investment decisions.

      I daresay it would have saved a lot of people here from making rudimentary errors had they known how it works, but it’s never too late.

      • PF

        What are the investment decisions you are referring to that an understanding of MMT assists?

        And what are the rudimentary errors that you think people have been making by not understanding it?

        Have you found much interest in MMT amongst property investors generally?

        Do you find they become interested when you explain it?

        I am genuinely curious as generally I find that people interested in MMT see it is as an explanation for why economic policy should change and usually as a basis for a more activist role for government – i.e. job guarantees.

        While I don’t share their optimism I don’t question that their heart is usually in the right place.

        Change from the economic policy status quo is not usually on the mind of most property investors.

        Is there a growing enthusiasm for MMT amongst property investors?

    • Pfh007
      Firstly whilst I agree with the philosophy of the jobs guarantee policy I see great difficulty in implementation, so for me that’s a grey area and it’s political rather than an accounting explanation.

      Like a lot of people I expected high inflation from QE so I made errors as a result. So did all of the goldbugs although so many made the same error the herding kept most of them safe, but when they get the message it will be a tough time for them. MMT helped explain that. Similar for Japan, now I understand why its a widowmaker trade. I’ve heard well respected people here talk about bank deposits shrinking because people bought shares – ludicrous when you understand the system.

      Property investors don’t have much interest in MMT and gold bugs are appalled by it – both are fairly unsophisticated investors, the low end of the investor community, although property is a very large segment. There isn’t a lot to understand about property, all you need is a belief that prices appreciate at a healthy rate over time.

      Gold buyers need to believe that fiat currencies are ultimately stuffed so it’s a different belief system. Essentially one believes that CB’s will succeed and one believes that they won’t.

      What I’m attracted to the most about monetary theorists explanations is that it allows me to know who understands their subject and who doesn’t. You will be surprised at how many people you have considered knowledgeable who really struggle with this. You will be able to see where they are making the same mistake over and over again.

      I think that this will soon be mainstream, so your advantage over others won’t last long.

  17. Yes loans create deposits creating money – it’s called inflation, stupid!

    Nothing modern about it.