How money is created

4 Apr, 2020 at 10:29 | Posted in Economics | 59 Comments

Everything we know is not just wrong – it’s backwards. When banks make loans, they create money. This is because money is really just an IOU. The role of the central bank is to preside over a legal order that effectively grants banks the exclusive right to create IOUs of a certain kind, ones that the government will recognise as legal tender by its willingness to accept them in payment of taxes.


There’s really no limit on how much banks could create, provided they can find someone willing to borrow it. They will never get caught short, for the simple reason that borrowers do not, generally speaking, take the cash and put it under their mattresses; ultimately, any money a bank loans out will just end up back in some bank again. So for the banking system as a whole, every loan just becomes another deposit. What’s more, insofar as banks do need to acquire funds from the central bank, they can borrow as much as they like; all the latter really does is set the rate of interest, the cost of money, not its quantity. Since the beginning of the recession, the US and British central banks have reduced that cost to almost nothing. In fact, with “quantitative easing” they’ve been effectively pumping as much money as they can into the banks, without producing any inflationary effects.

What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow. Government spending is the main driver in all this … So there’s no question of public spending “crowding out” private investment. It’s exactly the opposite.

David Graeber

Sounds odd, doesn’t it?

This guy must sure be one of those strange and dangerous heterodox cranks?

Well, maybe you should reconsider …

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 …
Most of the money in circulation is created, not by the printing presses of the Bank of England, but by the commercial banks themselves: banks create money whenever they lend to someone in the economy or buy an asset from consumers. And in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money. The Bank of England is nevertheless still able to influence the amount of money in the economy. It does so in normal times by setting monetary policy — through the interest rate that it pays on reserves held by commercial banks with the Bank of England. More recently, though, with Bank Rate constrained by the effective lower bound, the Bank of England’s asset purchase programme has sought to raise the quantity of broad money in circulation. This in turn affects the prices and quantities of a range of assets in the economy, including money.

Michael McLeay, Amar Radia and Ryland Thomas
Bank of England’s Monetary Analysis Directorate


  1. Inflationary effects are where you find them: banks borrow from the central bank at near zero rates and lend on credit cards at usurious rates — funny how that works and is somehow not “inflation”.
    The neoclassical aka mainstream economics account of money and banking is ridiculously detached from reality, but that does not make heterodox accounts accurate or valid. It is not always helpful to build a narrative attacking a false account, especially if the false account becomes a prop holding up its challenger, rather than an obsolete doctrine discarded to history.
    The quantity theory of money haunts both of the accounts quoted and instead of discarding the quantity theory altogether — as would be appropriate in an analysis of money as credit — each account relies on the quantity metaphor. It is a rhetorical choice that is understandable, I suppose, given the hold that metaphor has on the imagination behind various expressions — “printing presses”, “effectively pumping as much money as they can into the banks” and so on — but it is ultimately preventing popular enlightenment.
    Ultimately, it is not possible to arrive at an accurate appreciation of money and its role in a credit economy without describing the business of banks as maturity transformation, the role of leverage in controlling the behavior of business corporations, the uses of financial speculation, arbitrage and accounting, and the effects of debt and savings on the dynamics of income distribution. All of these topics are treated with considerable sophistication by mainstream economics, but the implications rarely reach or inform popular accounts meant to educate public opinion. Oddly, they do not seem to inform the worldviews of even many of the experts who have developed these insights and even less do they make it into the narratives of the introductory textbooks or newspaper columns. Minsky’s instability hypothesis is the exception, perhaps, but Minsky’s views are most often presented as a kind of potted mass psychology, not as a theory of how money works as insurance in a financial economy.
    The rhetoric of quantity — even in the negative — is not helping to change the deeply flawed ideas blocking shared understanding of money and monetary policy.

    • Bruce, Re your first para, is not correct to classify private banks borrowing at a zero rate and lending at a much higher rate as inflation. Inflation is a rise in prices, and it would be perfectly possible for banks to make extortionate profits (e.g. because they’d formed a cartel) without there being any inflation as a result – e.g. if government and central bank countered the inflation by raising interest rates or raising taxes.

      Second I fail to see a huge amount wrong with the idea that the quantity of money influences inflation, if that’s what you’re suggesting. As to central bank created money, it is surely obviously that if the Fed printed enough $100 bills and distributed them to everyone, those bills would become worthless. Same would apply if the Fed created a similar amount of money digitally and credited it to everyone’s bank account.

      As to private / commercial bank created money, a rise in that form of money can also have an inflationary effect: if enough people borrow and spend new money, demand rises, which tends to boost inflation. Steve Keen has done a lot of work in the exact relationship there.

      • Re: my first paragraph: I was being sarcastic. Conservatives in the mode of Milton Friedman have defined as the only possible fault of the monetary system, “inflation”, and ignore usury and upward redistribution of wealth in general as unquestionable market efficiency.

      • You may not see what is wrong with a theory that posits the “printing press” mechanism, but I can tell you that in the U.S. the Treasury prints $100 bills in high volume and the Federal Reserve distributes them freely to meet the demand for currency. That is a normal, daily operation, to ensure there is never a shortage of coin or currency. Scarcity of currency is not a factor in establishing or maintaining the value (in real goods) of the unit of account. Nor should it be — that would be insanely inefficient.
        States and their central banks have sometimes chosen to inflate as a policy, but the printing of currency is entirely incidental to carrying out such a policy, it is not how such a policy is implemented in a credit system. Debasing the coinage is not a policy lever either.

        • Supplying $100 bills to those who want them clearly has no effect on inflation in that to get hold of those bills, private sector actors (private banks, individual peple etc) must sacrifice digital base money. Ergo on balance there is no effect on the total money supply. Of course govt and central bank CAN CHOOSE to increase the money supply, but that’s a separate matter.

          • I do not think the base money distinction matters. What matters is the productive effort people are willing and able to make to get those $100 bills. The point of the game is to motivate the organization and effort to produce goods and services of real value; money is just how we keep score in that game. Running out of $100 bills would be like the refs running out points at a Knick’s basketball 🏀 game.

      • if enough people borrow and spend new money, demand rises
        Perhaps. Demand rises, but so too debt, and with debt, obligations to repay, setting up the prospect of income and wealth transfers, inflation possibly or debt deflation, with deleterious effects on real economic activity (money may be efficiency-enhancing or not, but never is it “neutral”).
        Money is not primarily about having enough tokens to buy avocados at the supermarket. Money is about the debt instruments used to finance the growing of avocados and their distribution to supermarkets. The “quantity” of money is less important than the integrity and resilience of the web of contingencies and recourse built into those obligations and the effect they have on the economic behavior of those undertaking the risky and uncertain businesses of growing, harvesting, processing and distribution of avocados.

        • But the INITIAL effect (as Keen shows) of more people borrowing and spending, its to raise demand and hence perhaps inflation. of course that money may be repaid at some point, in which case there is an “anti-inflationary” effect. And of course debts rise, as you say. It’s widely accepted that when people repay bank loans, the stock of money declines.

          • Paying the debts should not have any effect at all, because it is simply a transfer from debtor to creditor. It is when debts can NOT be paid off that the real fun begins, when banks fail and the paradox of thrift drives debt deflation into depression.

  2. In _Debunking Economics_, 2nd edition, Steve Keen cites a conference paper of 1969 by Alan R. Holmes, then a senior vice-president at the New York Federal Reserve Bank. The paper is about FOMC operations, but in passing Holmes mentions:

    “The idea of a regular injection of reserves-in some approaches at
    least-also suffers from a naive assumption that the banking system
    only expands loans after the System (or market factors) have put
    reserves in the banking system. In the real world, banks extend
    credit, creating deposits in the process, and look for the reserves
    later. The question then becomes one of whether and how the
    Federal Reserve will accommodate the demand for reserves. In the
    very short run, the Federal Reserve has little or no choice about
    accommodating that demand; over time, its influence can obviously
    be felt.
    In any given statement week, the reserves required to be main-
    tained by the banking system are predetermined by the level of
    deposits existing two weeks earlier.”

    The paper was delivered fifty years ago last year. It’s truly remarkable that the news about ordinary bank lending still surprises people.

  3. Graeber does not seem have much of a clue on this subject. He claims in his third sentence that it’s the fact that government accepts private bank created money in payment of taxes which makes it legal tender. Not true.

    First, governments do not accept private bank created money in payment of taxes. You can of course send a cheque to the tax authorities with a view to settling your tax liabilities. But government (i.e. the tax authorities) will not actually accept that in final settlement of the tax bill: i.e. it will demand an equivalent amount of BASE money from the relevant bank, in exactly the same way as individual private banks do not accept each others home made money. They demand central bank money (base money) in final settlement.

    Second, legal tender is simply a form of money which government has declared cannot be refused in payment for goods and services or in settlement of a debt. Not unsurprisingly governments classify their OWN “home made” money as being legal tender. But governments could, if they wished, declare lumps of gold or gold coins to be legal tender.

    Next, Graeber says “any money a bank loans out will just end up back in the same bank again.” Wrong again, and for reasons which should be obvious. If I borrow money to have a house built, the money goes initially to the architect, building contractor, bricklayers, plumbers etc who build the house. But they very quickly spend it on the usual consumer items. Thus the money ends up as deposits at the LARGE selection of banks.

    Of course you could argue that when one of those “other banks” creates and lends out money, that also ends up as deposits at a large variety of banks, thus it is certainly true to say that money created by the PRIVATE BANK SYSTEM ends up as deposits at the banks making up that system. But if an individual bank makes silly loans, i.e. lends to incompetents, those incompetents will hemorrhage money, which in turn will mean the relevant bank hemorrhages money: i.e. the deposits it receives WILL NOT equal the amount of money it creates and lends out. That bank will end up as a Northern Rock or a Lehmans.

    And finally in his last para, Graeber says the amount of money in circulation is limited by the amount people are willing to borrow. Also wrong: it would clearly be possible, as hundreds of people have pointed out, to have a helicopter drop, which consists of government and central bank creating money and handing it out to the population, or spending the money on the usual public sector items: health, education and so on.

    Indeed the extent of the latter activity has been of unprecedented proportions in reaction to the 2007/8 crisis and in reaction to the Corona crisis.

    • Graeber says: “grants banks the exclusive right to create IOUs of a certain kind, ones that the government will recognise as legal tender by its willingness to accept them in payment of taxes.”
      You say: “You can of course send a cheque to the tax authorities…”
      I say the banks promise to pay their debts in base money. The government sees to it that they always can. Consequently, everyone accepts their IOUs as being as good as base money. Graeber could be clearer but he’s not wrong.

      And Graeber said “some bank” not “the same bank” so you are straw manning him there.

      Graeber says: “Government spending is the main driver in all this…” which I think covers your last point, though I am mystified why you think “spending the money on the usual public sector items: health, education … has been of unprecedented proportions” lately.

      • Crash Carson, You’re right: he said “some bank” not the “same bank”. I misread. My bad.

        Re your last para, what I had in mind there is the combination of fiscal stimulus and QE. Fiscal stimulus equals govt borrows $X, spends $X back into the private sector and gives $X of bonds to lenders. QE equals the central banks prints $X and buys back the bonds. That all nets out to “govt and central bank print $X and spend it”.

        • Fiscal stimulus would be the government spending on health and education, period. (Education spending has fallen, health barely risen.) Borrowing the money they spend is a wash. The gymnastics you describe only stimulate the price of private assets; QEing the bonds back just leaves former bondholders looking for somewhere else safe to stash their cash. Since the interest is no longer being paid there is less money entering the private sector.

          • You can buy bond Exchange Traded Funds that increase in value as interest rates fall. And if people with more money just buy inflating assets, why not make everyone rich and export inflation to the financial sector?

            • Yes, and somehow the process doesn’t make “everyone” rich; it makes some into reckless predators and the rest of their, their prey. hmmm.

    • “government (i.e. the tax authorities) will not actually accept that in final settlement of the tax bill: i.e. it will demand an equivalent amount of BASE money from the relevant bank, in exactly the same way as individual private banks do not accept each others home made money. ”
      In practice this gets very loose. The Treasury Tax & Loan program explicitly allows the Treasury to deposit tax receipts in private banks. The bank can also borrow (currently at 0%) reserves from the Fed to settle the taxes. The Fed expands its balance sheet, often permanently as we’ve seen since 2008, to create new money to backstop the privately-created money, after the fact.
      Thus the private sector is creating new net financial assets before the Fed creates the reserves to backstop them. (MMT gets this point wrong.)

      • That’s interesting. I didn’t know the US Treasury was allowed to open accounts at private banks and deposit tax receipts there. I’m surprised they do that because they are of course taking a risk with taxpayers’ money, even if only a small risk. Do you know if other countries do that?

        • In practice, it’s a scheme to avoid stripping private banks of reserves when the quarterly tax payments come in, and the banks have to clear all those peoples’ tax checks. It’s another way of lending reserves to banks.

      • MMT doesn’t get it wrong. Banks don’t create new net financial assets- whatever banks create has to be paid back except in bankruptcy. Banks create spending ability via loans but also financial liabilities to repay- net zero on the financial asset side. Central Banks usually guarantee that the funding of those loans will be available for banks- but that is the government’s Central Bank. Government creates the net financial assets through spending more than taxing.

        • “net zero on the financial asset side.”
          Since Net Worth is on the liability side, the assets of bank investors increase without a corresponding liability. The consolidated private sector balance sheet shows a net asset increase, if you include investor balance sheets rather than stopping at bank balance sheets as MMT ignorantly does.
          “whatever banks create has to be paid back except in bankruptcy.”
          The net increase in assets represented by Mortgage Backed Securities, i.e. the premium over the returns of individual mortgages that bundling commands, was paid by the Fed, who assumed the risk of defaulting mortgages, which had led to a collapse in the market value of MBS.
          Basically banks created a lot of bank money for loans and multiplied that money by bundling mortgages and also selling insurance on their inflated price value. When market prices for MBS (especially when used as repo collateral) collapsed, the Fed bought the toxic assets. If those loans were destroyed when repaid or defaulted on, the Fed’s balance sheet would have shrunk. Instead, we see the Fed on track to double its balance sheet to $9 trillion by the end of this year …
          The private sector creates new bank money that represents new net financial assets, then the central bank backstops the new asset creation, after the fact, as necessary. I reiterate, MMT fails to understand this.

          • I will try to research this Robert- that is the best I can do. But I am going to be upset if I conclude you aren’t correct with your assertions. This may take a few days but I will make it absolutely clear if I was wrong or you were.

            • Look at what is happening right now: the Fed’s balance sheet is increasing as it swaps new money for anything banks want to sell them. The banks created a lot of dodgy new net financial assets on their balance sheet, and now that those assets have devalued, they can still sell them to the Fed, which expands its balance sheet as needed to convert privately-created assets into money. The private assets were created first, then sold to the Fed. The Fed is willing to hold those assets and mark them at above-market prices (face value rather than current market value). The Fed is creating money now to pay for assets that were created before by the private sector …

              • Robert, we are not going to get anywhere here if you don’t understand that the US Fed is actually a part of the US federal government created by the US Congress by law and, while given a little leeway here and there, always is ultimately at the service of the US government.

                When the Fed buys crappy assets that is US government exercising its monopoly of issuance of the US Dollar. That is not the private sector creating net financial assets- It is a form of US government policy just in other words. The Federal Reserve System is not at all part of the private sector.

                Jerome Powell works for the US government. He was hired by them and the President can fire him at anytime and nominate someone else to head the Fed.

                This is easier than I was afraid it might be.

                • I think I would score this one for Robert Mitchell on points. The financial sector can indeed create new financial assets. That might be efficiency-enhancing or not. These financial assets might be a con-game or ruinously usurious for someone or otherwise socially injurious. It is worth inquiring as to their social value and durability. “I’ll be gone; you’ll be gone” and all that.
                  Robert’s point is that the Fed has made some of these assets “good” when it is questionable whether that was morally right or prudent. The policy of the Treasury under Obama was to foam the runway for banks with foreclosures on millions of families. You can argue that the MBS which had financed a lot of imprudent mortgage-lending and a housing price bubble on the strength of foreign demand for what looked vaguely like U.S.-backed securities (Fannie Mae, Freddie Mac, IndyMac and all that) were ultimately redeemed, but of course a lot of people suffered a loss of savings and equity. Policy made the collapse of housing prices and financial losses attendant on that prospect into mere wealth transfers and rents rose.
                  Robert sometimes writes with sunny optimism about these developments and I think the situation stinks. Clearly Jerome Powell does not work for people like me.

                • The original phrase was “new *net* financial assets” (emphasis mine). No doubt that the FED can create a new net financial asset and use it to prop up somebody whose financial asset has fallen out of the money, as the phrase goes.

  4. @ Mel who wrote: “No doubt that the FED can create a new net financial asset and use it to prop up somebody whose financial asset has fallen out of the money”
    Before crashes, the private assets are booked as new net financial assets and are traded as such. After crashes, the Fed has the power to determine if it wants to support the previous valuation of the asset. While the asset is in the money, it is a new net financial asset. When it falls out of the money, the Fed buys it to put it back in the money. Net, the private sector created an asset first and then, if necessary, the Fed supports that asset.
    Very simply: if a stock goes up, is that a new net asset created without necessary government involvement? Then if the stock crashes but the Fed buys it at an above-market price, isn’t the Fed supporting a previously privately-created new net financial asset?

    • No. The value of a stock (as in stock-market) is a chimera. It’s just a result of someone somewhere being willing to pay that amount for shares in that issue of stock. And when they pay they accept the liability in paying, and the ex-owner accepts the asset of the money paid.

      • Net Worth of Households is a chimera? I think the issue here is that MMT ignores holding gains. Yet Net Worth includes holding gains. And if the Fed acts to buy assets in support of holding gains, then I can always find a buyer (the Fed as a last resort).
        When stocks go up, the Fed will print enough money to let someone borrow enough to buy it (or buy it themselves to support prices). That, to me, is private sector new net financial asset creation, backstopped as necessary by the central bank.
        While the stock is in-the-money, it can be used as collateral, so it has a value independent of someone outright buying it. Bill Gates doesn’t have to sell his billions in stock to benefit from it. Kurt Cobain wrote a “kind of gibberish” IOU and a restaurant owner accepted it from him, because of his reputation (source: Gates’s or Buffet’s Net Worth is not a chimera, it is a new net financial asset, implicitly supported by the central bank willing to expand its balance sheet after the fact.
        In other words, the private sector is in the driver’s seat. The Fed reacts. The private sector creates new net financial assets, and the Fed creates money to backstop them as needed. MMT holds that the central bank has to create the money first, before stocks can realize gains; but the gains themselves are a result of the private sector’s new money creation. If I sell stock to someone who banks at my bank, no Fed reserves are needed …

        • You are right that the central bank largely reacts to what the private sector is doing. That is what MMT says. That is what endogenous money idea says.

          But don’t screw up where you are correct by believing the central bank is not really part of government- it is.

          Private sector creates new financial assets for sure. If the Fed buys them that creates new net financial assets. I think it is important to understand the sequence here.

          • I never disputed that the Fed is part of government, because I too believe that.
            You can use MMT definitions and define away private net financial assrt creation. But practitioners understand that the private sector holds more net financial assets than the Fed and Treasury produce.
            Private net financial assets are five or six times GDP. Government money is not enough to cover that. Those private assets are considered new net financial assets by everyone except MMTers who handwave away the NFA by defining them away. But private sector banks don’t pay any attention.

        • ” the private sector holds more net financial assets than the Fed and Treasury produce.”
          So what? What has that to do with money creation. There are other ways of creating private net financial assets – saving.

          • The money you save was created by private firms …
            I just realized the graph I just linked to twice did not say “net” as I had thought. So here’s a household Net Worth graph showing positive private household net worth of $120 trillion, which exceeds measures of government money by a factor of 5 or so. That net worth is implicitly convertible to central bank money, after the fact …

  5. Bruce, the question is can the private sector within itself create what are called “net financial assets”. These are financial assets that come with no liabilities attached. Obviously if I gave you a $20 US Federal Reserve Note in some act of charity then your net financial assets have increased through a private sector action. But mine have decreased by the same amount. But when I receive that $1200 check from the government as part of the economic response to the pandemic my net financial assets will increase by $1200 and no one else in the private sector will experience a similar decrease.

    Banks create financial assets all the time- every time they make a loan. They give you a promise to pay that amount and you give them a promise to repay that amount. Both of those promises are financial assets- but not ‘net’ financial assets because they offset.

    If I am building a house that is the private sector creating ‘real’ assets. If you thought it was a good idea and that I might realize a profit when it sold maybe you would put some money into helping me finance the construction- as in buying a share of the house for a share of the sale price hoping to get more back than you risked initially. The money you invested is a financial asset for me and the promise of a percentage of the sale price is a financial asset for you. No “net” financial assets created within the private sector. Assuming the house didn’t fall down we would have created a real asset though.

    Jerome Powell does work for an agency created by the US federal government. He may not be serving your interests just like you might believe Donald Trump is not serving your interests- but he is still working for the government ultimately. If Powell directs the Fed to purchase mbs that is federal government policy in action and it is the federal government creating net financial assets- not the private sector.

    Anyways, that is how I see it- you obviously do not have to agree with me.

    • I appreciate your taking the time to clarify your views for me.
      If you and I cooperate in the work of building a new house, we have allocated resources to and expended energy in producing a durable good and in the process created some pollution and destroyed some previous allocation of resources — demolished an older structure perhaps or subdivided farmland for a residential lot, perhaps. At some remove, caused a tree to be lumbered, copper to be smelted, and so on. Whether we will have created something of net value to society would be problematic to calculate with certainty. But, thanks to the magic of money, we would know with virtual certainty of a sort whether we have in our housebuilding venture together, netted a profit at the time we finish and sell the new house. And, the owner(s) of the house will, thru time, allocate the durable good of the house to producing a stream of “housing services” for themselves or for people to whom they rent the house. And, again, thru the magic of money, everyone involved will be able to calculate “the cost” on the basis of actual or imputed (!) money expenses.
      Neoclassical economics generally waves its hands at the magic of money, at how unfathomable cost becomes accounted a bookkeeper’s expense. At how money supplies a numéraire. It is in that mysterious process of buying and selling, borrowing and lending, generating entries in numerous ledgers, that a house becomes “an asset”. There is no such thing as “a real asset” by the way — that would be a contradiction in terms. “Asset” is a financial and accounting term of art, conjured in the necromancy of double-entry bookkeeping, where every transaction is recorded by pairs of entries, noting the putative effect of the transaction simultaneously on the two sides of the ledger, the assets and the equities. I know you have probably always heard, “assets and liabilities, debits and credits” but strictly speaking, the right-hand side of the ledger are collectively, “the equities”, subsuming both the liabilities (the claims of outside persons or entities on the possessions of the firm under the English law of equity) and the residual claims of the firm’s principals, termed the “owners’ equity”.
      Still, I understand the felt need for the term, “real asset”. We want to distinguish “real assets” from purely (!?) financial assets. The house as a durable good producing shelter as a “flow of services”, for all its conceptual abstractness, remains a tangible artifact of its builders and the home of those dwelling within. If, as collateral for a mortgage, the house becomes a financial asset, and then the mortgage is securitized and sold, to become at several removes from anything real or tangible, a derivative, say a collateralized debt obligation, we feel the need to remember, knock on wood, that somewhere outside Alice’s Wonderland stands a house.
      Instinctively, neoclassical economists want money to quietly supply the numéraire and leave the room, silently cry tatonnement and fade into the deep background, neutral in the long-run, leaving only a passively reflective finance, that simply mirrors in flows of credit the flow of goods, every cost an expense, every value correctly priced. Maybe, we all want that for its simplicity, for the elaborate fictions with which we conduct our affairs to fall away revealing concrete truth has been their inspiration all along. We can want that, we can want the web of fictions to be real and true altogether, but it does not work that way. The actual economy is not “real”, it is financial, and its fictions are only tested and tried in limited ways and at intervals. Because of money, the actual economy — that is, the monetary economy — is legible to us, or at least its fictions are, while the objectively real economy remains unfathomable in the existential uncertainty of unknowable consequences receding into an indefinite future. You can choose and pay the price of a meal in a restaurant without ever having to assess all the future and dispersed costs and consequences of clogged arteries or depleted rainforests.
      But, I digress. LOL.😂 You wanted to know if private bankers can create new “net” financial assets independent of the monetary sovereign and its faithful servant, its central bank.
      Net asset, by definition, means asset net of liabilities. You are asking if banks can turn a profit in positive-sum transactions with non-bank parties. Without inquiring into the details of how banking works, I would think it obvious that banks are in business to turn a profit, meaning create net assets for themselves (and for others for a fee). Whether that profit-making must be accommodated by the policy of sovereign fiscal and monetary authorities in order to be realized and sustained is a nice question, which Robert answered archly but affirmatively. With deep qualifications and ambivalence, I concur. And, apparently so do you. We all three are in furious agreement. Still, I imagine we have only talked past your intended point and not answered.
      On a deeper level, I sense you want banking to be a slave in a system of reflective finance, constrained against the dreaded innovation of new net financial assets. The bedrock truth that just as every sale is a purchase and every credit is a debit, so every debt has two sides: a lender and a borrower, is offered as proof of such constraint.
      Money, like Newtonian energy and mass, would seem to be conserved. We talk as if money is used up in spending, but money is not destroyed by being spent, it is just passed on. Not so debt. Money spent on debt extinguishes the debt. And, when people talk of money — fiat money of a monetary sovereign — as being by nature an instrument of debt, itself a special kind of debt if you will, it creates a fascinating conceptual confusion concerning whether and how money qua debt is created or destroyed.
      In an ordinary transaction creating or paying back a debt, money is neither created nor extinguished; money is simply transferred intact while the debt is created or extinguished, as the case may be. The claim that banks create money as they create debts is a challenge to the base idea of ordinary borrowing and lending. Another wrinkle — one that simplified MMT obscures — is that banks are intermediaries in a process of maturity transformation and not, as neoclassical economics would have it, conduits in a flow of funds between savers and borrowers.
      Years ago, when I became for a time, nominally self employed as an independent consultant, I had to go to a bank and borrow money. Not to spend, so much as to have and hold, tiding me over as my income became much more volatile even as it rose a small bit compared to salaried security. The bank did not channel some frugal pensioner’s lifetime savings to me. Essentially, they borrowed the money they lent me from me. I mortgaged my house (again) and banked my business payroll and other balances, household as well as business, with the bank. The bank’s credit enabled me to lease an office and some office equipment and to prove my financial bona fides to new clients and vendors.
      Did the bank create new financial assets in their transactions with me? I guess they did. And, thru the many fees, I am sure there was plenty of “net” for them. But, there was no great flow of money from them to me. (I sometimes felt there was an inordinate flow from me to them!). My portfolio of assets and liabilities changed in ways better adapted to the way I was doing business and they enabled that change by taking on the counterparts of my new portfolio. That is the business of “maturity transformation” that is the main gig for commercial banking. It has to be accommodated by the central bank maintaining a normally sloped yield curve, enabling the bank “to borrow short to lend long” in mirroring the balance sheet portfolios of their business customers. It is a nice question in banking whether the better part of prudence is assessing the customer’s balance sheet or the reliability of the Central Bank’s policy backstop.
      Banks as intermediaries become simultaneous lenders and borrowers. They borrow the money they lend you. As in my case, they may be borrowing the money they lend business from the business they are lending to, setting up financial assets describing new channels for money flows that serve to support carrying on business activity in a volatile and uncertain world. Whether the fictions the bank writes in the language of money prove true in a happy ending of loans serviced and paid or turn toxic in an extortionate scheme of “your money or your economy!” is a challenge for policymakers, who may well favor extortion as we have seen.

    • “They give you a promise to pay that amount and you give them a promise to repay that amount.”
      You give them a promise to repay more than that amount. The difference goes into the bank’s Net Worth. The money I use to repay can also be privately-created bank money (by the same bank, or by a bank that uses the same clearinghouse). The net result is an increase in private sector assets, only implicitly backed by government money, when needed.
      Reviewing: a bank creates a loan and books the interest due under Net Worth, today. Say I plan to default on the loan. The bank can sell the loan to the Fed first. The bank has created a new net financial asset, with a phantom liability, which is taken on by the Fed after its creation.
      This is how private credit turns into money, a point that Hicks recognized; see page 57 of A Market Theory of Money: “The bank notes could become a quasi-money, in rather general use.” That quasi-money is a new net financial asset, implicitly backstopped after the fact by the central bank.
      Mehrling makes the point in “Global Money, A Work In Progress” (
      “Today global money is largely private credit money, the issue of a profit-seeking bank that promises ultimate payment in public money which is the issue of some state, quite possibly a different state from the one where the bank is chartered and does its business.”
      The private money is a new net financial asset issued before tge government knows about it …

      • Sadly one has to take in the totality of humanity in reconciling, not only money, but the system it works in – across the ages. All accentuated by whatever dominate sociopolitical / religious / otherwise optics are at play and all interacting with each other from that geographical back drop as it moves through time and space.

        Currant economic orthodoxy has a preponderance of … lets say … ex ante ideological baggage. That baggage as it has move from its dominance, not won on academic rigor, but on raw power has more agency than any notion of money creation or destruction.

        Too put not to fine a point on it – I found your recent opinion about your personal umbrage at having some movements restricted, considering the circumstances, highly emotive and the logic superficial at best, considering its base line of how it effects – your – perception of rights at a given moment vs others. How that all plays into your perception about money and its role in society as administered is the question – human tool user problem E.g. you can’t imbue an inanimate object with morality or ethics in circumventing a sociopolitical problem[.] I.e. money works with in a system and how that system shapes the populations perspectives about themselves and others – never the less the natural world [precedes us] its imposed on.

        There are many books on path dependency in psychology and even economics – if your game.

  6. Jerry,
    I agree with you.
    Robert has slid the argument off on to another tangent.
    Under discussion is the creation of money by banks making loans.
    I can’t see that this creates new net financial assets of the system. The bank’s liabilities and assets rise equally. The borrower’s assets and liabilities also rise equally. There is, consequently, no net increase in assets of the system.
    Paying interest on the loan results in a decrease in the net worth of the borrower and an increase in the net worth of the lender – so not net increase in system assets.
    Robert introduces the acquisition by the Central Bank of financial assets of banks and the creation of base money by the CB to effect this. This is his tangential expedition into new territory and has nothing to do with the creation of money by banks.


    • I do not understand this hangup on new net financial assets.
      Are you saying the bank never profits? Because that is what it would mean if the bank’s assets and liabilities always increased in perfect tandem.
      An asset net of liability is simply owners equity. Which has pretty much nothing to do with anything related to the “quantity” of money in the system.
      Banks as they expand create new financial assets — that is what they do. What part of that do not get?

      • Yes, they do create new financial assets but they do not create new net financial assets, when making loans.
        A bank, in making a loan, creates an asset and an equal valued liability simultaneously. Net equity of the bank does not increase. The net equity of the bank increases as the borrower begins to pay interest. Correspondingly, the net equity of the borrower decreases. There is no net increase in financial assets of the system.

        • That should be “there is no increase in the net financial assets of the system”.

        • If I, as an individual, loan you, Henry, one hundred dollars, that is simply a transfer of money, not a “creation” of money. And, Henry pays back the principal, that is not a destruction of money. But, I am not a bank.
          A bank is loaning other people’s money and banks are distinctively engaged in borrowing by taking deposits as well as lending. A bank, as I tried to explain above, is engaged in simultaneous borrowing and lending and as Graeber hints, the banking system as a whole is happily engaged in arbitrage between borrowing at short duration and lending at long duration by which it indeed does create new net financial assets from the gains attendant on that arbitrage. They do not make money from the interest paid on loans — they make money from the spread between what they pay and what they charge. And, that gain is capitalized. By borrowing the money that they lend, banks can, indeed, create new net financial assets.
          It is easiest, perhaps, to see this clearly when the process is reversed and a bank is forced, say, by a bank run by its depositors, to call in and liquidate its loans. The deflationary effect of drawing money and liquidity out of the economy as banks collapse can be profound.

          • The problem with that story Bruce is that banks really aren’t lending ‘other people’s money’ when they make loans. While it is possible that they can act as intermediators between savers and borrowers- that is hardly the extent of their business.
            It is true that usually (but not always) they need to ‘fund’ their loans fairly quickly and that deposits are often the least expensive way they can manage that funding, but that isn’t the only way they can fund their loan portfolios. This gets complicated very quickly and I am not a banker. But here are some other ways- they can sell the loan contract to another party, they can borrow against the loan contract from some other private sector party, they can use their own capital to fund the loan, they can go to the federal reserve discount window and use the loan as collateral for borrowing (still not net financial asset creation because it needs to be paid back).

            Banks do make money on the spread between their borrowing costs and what they charge interest on the loans they make. But that profit when realized is not a new “net financial asset”- it is financial assets that formerly belonged to the borrower that now belong to the lending banker.

            • Yes.
              There is also a fourth way of funding borrowers’ spending, and it is also the chief way. Cameron Murray described it in a blog post summarizing his book _Game of Mates_.
              In their everyday business, banks “surf” (my term) on the difference between
              – withdrawals as borrowers spend their borrowed money, and
              – deposits as *other* banks’ borrowers spend *their* borrowed money.
              This difference is what a bank truly has to fund day-by-day. This difference is the net transfer to or from the bank’s assets. If a bank can keep a wide and varied herd of customers, and doesn’t let its volume of lending get excessively out of scale with the amount of business the herd does, then net imbalances don’t get too wild, and don’t get beyond what the bank can fund.

              • Banks also make a lot of money off of fees they charge. Monthly ‘service charge for accounts’, fees for ‘insufficient balance’, fees for depositing a check from someone else that bounces, fees for making a loan often called ‘points’. When I was much poorer it got downright expensive to have a bank account and still I doubt any bank has actually paid me more in interest on my deposits than they collected in various fees over a year.

            • You seem remarkably obdurate about the implication of a bank simultaneously holding deposits and making loans by creating still more deposits. If I deposit a $1000 in a checking account and the bank loans me $900 to buy inventory for my business, they have taken my $1000 and made it into $1900, which is a damn fine trick I could not perform on my own. I could not otherwise spend $900 and keep it, too. The books of all concerned are balanced no doubt, but there is $900 lubricating the wheels of commerce that was not there before.
              It is true, in a manner of speaking, that “it must be paid back”, but in the meantime, which if things go smoothly may extend into a very long time indeed, it is enabling me to finance the stock necessary to carry on a profitable business. In the meantime, there is $900 that would simply disappear if I paid the bank back and the bank paid me back.
              I would say it is fair enough to say that banking systematically creates money. Otherwise, where did that extra $900 come from? How is it my $1000, while sitting quietly in my checking account, became across town an additional $900 to buy wholesale merchandise?

              • Bruce, I am hurt- I’m basically a bleeding heart as far as being compassionate. But yes I can be stubborn. Had to look in my dictionary for what ‘obdurate’ means and am surprised you think I might be remarkably so. Well life goes on 🙂
                I am not entirely clear why anyone one would deposit $1000 in a bank and then borrow $900. Doesn’t seem like the smart thing to do. But then I don’t know everything that is for sure.
                I don’t think I have suggested that banks do not create money, or more accurately spending ability, through making loans. I think they do. This has mostly been an issue as to whether they create an equal offsetting liability when they create that money. If they don’t then I will agree they create “net financial assets”. I’m not entirely obdurate.

        • Bruce,
          It seems to me we are pretty much saying the same thing but then, as with Robert, you slide off into other realms. We are discussing the act of making a loan by a private bank and creating money. That’s it. All the other stuff belongs elsewhere.

      • “Net financial assets” is a technical term that MMT economists use. When they say that only a Central Bank (or a CB’s business partner, a National Treasury) can create net financial assets, they give a hint to the meaning, and also the narrowness of the concept.
        The money held in CB accounts comprises net financial assets. Also promises of future payment in such money (e.g. Treasury Bonds.)
        Net financial assets are worth exactly what they say they’re worth. In “money as a promise”, they are promises made by the ultimate authority in the nation, the authority least likely to be obliged by force majeure to break its promises. They aren’t like non-net assets, whose value depends on being exchanged for something else of value.
        They get described as “base money”, or “high-powered” money, or “reserve money”. So it’s not a big deal. You knew all this already.

        • I concede that net financial assets is a technical MMT term. I am saying that private firms create assets that are the Fed’s implicit liability, before the Fed knows it. Private financial firms create financial assets that can be implicitly exchanged for central bank money, but the privately-created assets circulate for a long time (perhaps indefinitely) without the Fed’s needing to create a new net financial asset to backstop them. In effect, the private sector has created net financial assets because the Fed implicitly assumes the liabilities associated with the private assets.
          MMT probably says that the assets aren’t net until the central bank actually creates the government money to backstop them. I say the private assets can circulate as money long before the central bank creates the money as a liability that matches the private sector’s new asset creation.

  7. Bruce,
    ” If I deposit a $1000 in a checking account and the bank loans me $900 to buy inventory for my business, they have taken my $1000 and made it into $1900, which is a damn fine trick I could not perform on my own”
    Exactly. That’s what banks are licenced to do. They loan you $900 (bank asset) and create a $900 deposit (bank liability). Increase in bank assets, $900. Increase in net banks assets, zero. Increase in money supply (as defined by some), $900.
    Financial activity, making a loan, has created a potential economic activity, the potential spending of $900.
    What’s the problem?
    Entirely in keeping with what Jerry said.

    • “Increase in net banks assets, zero.”
      Balance sheets balance to Net Worth, not zero.

      • “Balance sheets balance to Net Worth, not zero.”
        The incremental change (in the case of loan creation) to net worth balances to zero.

        • No, because interest immediately goes into Net Worth, and can be spent as an IOU with only implicit backing by the central bank’s money.
          Look at this graph:

          Private sector net financial assets have been increasing far more than government money has increased.

          • “..because interest immediately goes into Net Worth,.”
            That’s what I said above.

    • Entries in ledgers are multiplying assets at the bank, at my business, at my wholesaler. I see the significance of a mere transfer of a financial asset being inherently limited: if I loan you a $1000, I do not have the $1000 until you pay it back; in its place I have your promise, which is a mere placeholder in my books. The bank has done something else. I loan the bank a $1000 and yet I still have the $1000. The bank loans me $900 without having had their own $900 to lend.
      Jerry says he does not think it the smart thing to do, to lend a bank $1000 and borrow $900, but that move enables me to have the working capital of my business: inventory plus cash-on-hand, when without the bank, I could have only cash-on-hand or inventory — not both, and so no business.
      You keep asserting that there are no “new net” financial assets while conceding that financial assets are multiplying like rabbits. And, I am puzzled. I cannot seem to grasp the significance you attach. It cannot be that you regard these transactions as being mere transfers as would be the case of my loan of cash to you. There is a genuinely new asset entering the world when the bank turns my $1000 into $1900. That you concede.
      As Robert says, “net” taken literally can mean accounting profit. Surely you do not mean the bank does not profit, I do not profit, my wholesaler does not profit? There is no booking any transaction without balancing debit and credit, asset and equity. That we take account by means of double-entry bookkeeping can have no significance of its own. I remain puzzled as to what you see as the significance of “no new net” when there can no asset net of equity (where “the equities” mean the sum of liabilities and residual interest).
      There is some economic significance in whether the bank in making loans is prudent about the prospect of fully realizing the promises made, on average across the bank’s portfolio and whether the loans finance business activities that are genuinely beneficial to society as a whole.

      • Bruce,
        “You keep asserting that there are no “new net” financial assets while conceding that financial assets are multiplying like rabbits. ”
        As I keep saying, we are largely saying the same thing. Yes assets have increased but net assets have not. That is technically correct. I am merely suggesting you endeavour to be technically correct as, I would say, Jerry was.
        What implications this has for the financial system and the economy is another thing.
        It seems you are baffled by the fact that, whilst there has been no increase in net assets, the money supply has increased.

        • Thank you Henry- I appreciate the help especially since it is much needed. I think you are right that mostly we have been arguing about technicalities. Maybe even about definitions of terminology.
          And maybe it is only important to make the distinctions when someone starts saying things like banks can create all these net financial assets so obviously the government should pay everyone $36,000 a year for doing nothing and that will be just fine and dandy. Which I very much doubt.
          Bruce, you have cracked my obdurate nature at this point. I will just leave you with my personal understanding that ‘net financial assets’ only come from government spending or from the government’s central bank. Mel explained that before I believe. The private sector creates plenty of financial assets- but they all come with a private sector liability attached. There can be a significant difference especially if you get concerned with private debt levels and financial fragility.

Sorry, the comment form is closed at this time.

Blog at
Entries and comments feeds.