COMMERCIAL BANKS MAKE MONEY OUT OF NOTHING
The textbook, relying upon the Bank of England's 2014 study, stated that commercial banks create money through the act of lending.
The Companion Website restates the thesis and raises questions. A 2017 Forbes article explains the phenomenon of commercial bank money creation. The same story may be told in different words. Frances Coppola, How Bank Lending Really Creates Money, And Why The Magic Money Tree Is Not Cost Free, Forbes 31 Oct. 2017 at https://www.forbes.com/sites/francescoppola
/2017/10/31/how-bank-lending-really-creates-money-and-why-the-magic-money-tree-is-not-cost-free/?sh=62b858c53073.
In her article, Ms. Coppola, states: "Money is created when banks lend". When banks lend, the rules of double entry accounting require that the new loan is recorded on the asset side of the ledger and that the new demand deposit is recorded on the liability side of the ledger. Ms. Coppola stresses that the new "money" is fully backed by an asset - the loan. She also stresses how minimum capital requirements constrain the bank's ability to create money. When banks lend, their balance sheet increases. The proportion of the balance sheet comprised of equity, generally shareholder funds or retained earnings, decreases. Should the bank lend until its equity slice approaches zero, the bank effectively is insolvent. Hence, minimum equity requirements imposed by a version of the Basel Accords prevents a bank from over-lending, at least in theory.
In contrast, central banks create money only constrained by their government and the ability of the government to tax the population. [The latter is underscored as it may be questioned as to its accuracy.] Ms. Coppola argues that central bank creation of money is asset backed, that is, the central bank purchases assets generally from commercial banks, and if necessary, from other debt holders. She claims that central banks may issue currency without collateral, invoking Milton Friedman's "helicopter drop", but risks insolvency as a result. The ultimate brake on central bank money creation is inflation. Hence, commercial banks cannot behave like central banks.
By a series of regressive observations, Ms. Coppola first states that money requires faith in the government that guarantees it. But that requires faith "in the future productivity of the economy". Since productive capacity comes from people who work, it then may be said that faith in money is faith in people, now living and those to be born. Consequently, the "magic money tree" is made of people, not banks.
The Companion Website restates the thesis and raises questions. A 2017 Forbes article explains the phenomenon of commercial bank money creation. The same story may be told in different words. Frances Coppola, How Bank Lending Really Creates Money, And Why The Magic Money Tree Is Not Cost Free, Forbes 31 Oct. 2017 at https://www.forbes.com/sites/francescoppola
/2017/10/31/how-bank-lending-really-creates-money-and-why-the-magic-money-tree-is-not-cost-free/?sh=62b858c53073.
In her article, Ms. Coppola, states: "Money is created when banks lend". When banks lend, the rules of double entry accounting require that the new loan is recorded on the asset side of the ledger and that the new demand deposit is recorded on the liability side of the ledger. Ms. Coppola stresses that the new "money" is fully backed by an asset - the loan. She also stresses how minimum capital requirements constrain the bank's ability to create money. When banks lend, their balance sheet increases. The proportion of the balance sheet comprised of equity, generally shareholder funds or retained earnings, decreases. Should the bank lend until its equity slice approaches zero, the bank effectively is insolvent. Hence, minimum equity requirements imposed by a version of the Basel Accords prevents a bank from over-lending, at least in theory.
In contrast, central banks create money only constrained by their government and the ability of the government to tax the population. [The latter is underscored as it may be questioned as to its accuracy.] Ms. Coppola argues that central bank creation of money is asset backed, that is, the central bank purchases assets generally from commercial banks, and if necessary, from other debt holders. She claims that central banks may issue currency without collateral, invoking Milton Friedman's "helicopter drop", but risks insolvency as a result. The ultimate brake on central bank money creation is inflation. Hence, commercial banks cannot behave like central banks.
By a series of regressive observations, Ms. Coppola first states that money requires faith in the government that guarantees it. But that requires faith "in the future productivity of the economy". Since productive capacity comes from people who work, it then may be said that faith in money is faith in people, now living and those to be born. Consequently, the "magic money tree" is made of people, not banks.
