Newbie Corner

Beginners start here by Bill Kruse
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Where Money Comes From In The First Place.

Apart from a few percent, banks make it up, it's as simple as that. Don't believe me? Read on...

Ever wonder why the bailout money went to banks and not small businesses? If a central bank creates a pound and gives it to small business, it stays as a pound. If it creates a pound and gives it to the banking system then (in the old days) using the system known as Fractional Reserve Banking the banks turn it into many pounds. Note that these days, since banking deregulation, the banks create money for people based more on whether they feel confident about the 'borrower's' ability to 'repay' the 'loan' than observing any rules of FRB. Here's the President of America on the subject in a speech at Georgetown University on April 14 2009. Obama said: "although there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks "'where's our bailout? 'they ask" the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth."

For further explanation, download Modern Money Mechanics, a PDF of a booklet circulated by the Federal Reserve Bank of Chicago, describing how money is created by the (really rather outdated concept of the) fractional reserve process; "[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts."

Here's a direct quote on the subject from The Right Honourable Reginald McKenna P.C., British, and a former Chancellor of the Exchequer (1915-16). This is taken from his book Post-War Banking Policy, which I have a copy of myself; "While banks have this power of creating money it will be found that they exercise it only within the strict limits of sound banking policy."
Hmmm. Well, we might disagree there. He goes on to acknowledge the power of banks to create money is kept quiet; "I am afraid the ordinary citizen will not like to be told that the banks or the Bank of England can create or destroy money. We are in the habit of thinking of money as wealth, as indeed it is in the hands of the individual who owns it, wealth in the most liquid form, and we do not like to hear that some private institution can create it at pleasure. It conjures up a picture of an autocratic and irresponsible body which by some black art of its own contriving can increase or diminish wealth, and presumably make a great deal of profit in the process."
Indeed it does. Many would suggest that's because autocratic and irresponsible is exactly what the banks are.

At least, this blanket silence on the subject of money creation by the banks could be said to be true until very recently; a ground-breaking (for our generation) event occurred recently in the UK's Daily Telegraph where then economics editor Edmund Conway wrote ""Capitalist societies chose some decades ago to have a "fractional reserve banking" system - where banks lend out more cash than they have in their vaults - because this helps provide money for companies and households to invest." There it is, albeit outdated as I say above, from a mainstream UK news source. At least the cracks are starting to show now.

More recently MP Douglas Carswell was interviewed all too briefly on Sky News explaining that the banks created credit and that their legal privilege of fractional reserve banking should be revoked. He tabled a motion calling for an end to FrRB and while it apparently got no mentions at all in the print media amazingly it made it on to pan-European Sky News. This was the 22nd September 2010. Read about the original motion and see a video of the proposal to the House of Commons. It's well worth reading all through. I don't agree with it, but I welcome any discussion in the public eye as it promotes general education on the subject. 

Here's the Bank of England on the subject;

"... 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." Readers might note that any attempts to preserve the fiction of FrB have been dropped by this stage.  

from this PDF file

Here's the German Bundesbank explaining where money comes from, and that banks aren't intermediaries as popularly imagined, "In terms of volume, the majority of the money supply is made up of book money, which is created through transactions between banks and domestic customers. Sight deposits are an example of book money: sight deposits are created when a bank settles transactions with a customer, ie it grants a credit, say, or purchases an asset and credits the corresponding amount to the customer's bank account in return. This means that banks can create book money just by making an accounting entry: according to the Bundesbank's economists, "this refutes a popular misconception that banks act simply as intermediaries at the time of lending – ie that banks can only grant credit using funds placed with them previously as deposits by other customers". By the same token, excess central bank reserves are not a necessary precondition for a bank to grant credit (and thus create money)"

How money is created

This time it's the ECB’s [European Central Bank] turn to describe how money is created as debt by the privately-owned commercial banks, when they explain: “Commercial banks can also create so-called “inside” money, i.e. bank deposits – this happens every time they issue a new loan. The difference between outside and inside money is that the former is an asset for the economy as a whole, but it is nobody’s liability. Inside money, on the other hand, is named this way because it is backed by private credit: if all the claims held by banks on private debtors were to be settled, the inside money created would be reversed to zero. So, it is one form of currency that is created – and can be reversed – within the private economy.”

Here's a selection from the Independent Banking Commission Interim Report (the Vickers Commission) 2011 (bolding is mine - BB)

On page 65;
"Fifth, even before the crisis banks enjoyed various kinds of state support, including the effective right to create money, ...."

On page 98;
"Like narrow banking, a complete move from fractional to full reserve banking would drastically curtail the lending capacity of the UK banking system, reducing the amount of credit available to households and businesses and destroying intermediation synergies. To its proponents, this shrinkage of credit is a benefit, as it removes the current ability of banks to 'create money', a prerogative they consider should be reserved for the state."

Here's Sir Richard Body, MP, speaking in the House of Commons, 1999; (these next references are a bit lengthy but you do need to understand that the issue of 'debt-free money' versus 'money as debt' is not new by any means)
"Over the years, a large number of economists have urged another way of making up the budget deficit. When we issue short-term gilts and Treasury bills, they are effectively IOUs, and they bear interest. When they mature, there is almost invariably a further issue for the same amount plus the interest. That is essentially why the national debt tends to rise year after year. The appalling fact is that, if we continue on that course, within about 20 years from now, the national debt will, according to the estimate of those who study the matter, have risen to 1,000 billion.
The hon. Member for Northampton, North talked about public services, as she did so eloquently earlier, I beg of her to bear in mind what the interest on that national debt will be in 20 years time if we carry on as we are doing now. We will not then be able to talk about increasing expenditure on this, that or the other; on all the good things about which she spoke and on all the goods things that Conservative Members would like to see spending on increase. That will not happen because we will have to pay the interest on the national debt.
One does not have to be a mathematical genius to work out what the interest is likely to be in 20 years time if that forecast is right.. One has only to look at the latest Budget statement to see that we are on the upward path again. If one looks at some of the other figures, one sees that the proportion of debt-free money in circulation is in steady decline. Some 30 years ago, it was 17 per cent and it has been dropping ever since. We now have what I might call a 3 per cent. Chancellor, because only 3 per cent of our money stock now is directly in his hands. Next year, it will almost certainly be 2 per cent. One cannot go below 1 per cent. I beg the hon. Lady to bear in mind what will happen, almost in the lifetime of this Parliament, if we do not put on our thinking caps and consider how we will cope with the decline in debt-free money.
For some half a century on and off, a number of distinguished economists have argued that the Government have exclusive control of debt-free money. Only the Government are in charge of the Royal Mint. Only the Government can authorise the manufacture of notes or coinage. Therefore, they should be using that mechanism - MO - to pay off an increasing amount of the debt. However, if they go on, as they have done for far too long, merely reissuing those IOUs on which interest has to be paid - that may benefit the banks, some of the pension funds and some of the other institutions, but it certainly does not benefit those who are arguing for improved public services - there are bound to be severe and unjust cuts in public services. I cannot believe that any hon. Member on either side of the House would want that to happen. We should all be agreed on that, but I fear that we must change direction in this respect.
We must also recognise what so many distinguished economists have said. I do not know whether I ought to mention Milton Friedman. That name does not always appeal to Labour Members, although the Treasury has imbibed every syllable that he uttered about monetary policy, which is very good. He is one of the many distinguished economists who have argued that the Government should increase the amount of debt-free money to pay for that deficit, particularly when it is caused by an increase in capital expenditure. That is not inflationary. The issuing of gilts and bills is inflationary because they are used as a deposit by the banks to enable them to re-lend, often by a multiple of 10.
My plea to Treasury Ministers is that they should look again at those forecasts for a steady rise in the borrowing requirement. It was clear in the Budget statement that it will increase again next year and the year after, but, in the meanwhile, we may have to accept our moral duty to play a part in the reconstruction of Yugoslavia, if what I said about the Yugoslav Government proposal of 23 March is correct. In all events, I believe that the Government will be blown off course, and when the Chancellor of the Exchequer has to speak on this subject again - next year or perhaps in years hence - he will have no cause to be complacent"

Hansard July 1999

Here's the Commons in 18th April 1944 discussing (or refusing to discuss) money creation;
"Mr. Stokes asked the Chancellor of the Exchequer whether he will in future have recourse to the creation of new money without interest instead of adding to the volume of bank advances to the Treasury as this would be no more inflationary and would cost the country less.
Sir J. Anderson No, Sir.
Mr. Stokes Will the Chancellor explain why it is preferable in the national interest to create new money with interest rather than create new money without?
Sir J. Anderson My hon. Friend knows very well that I do not accept his monetary theories. He really cannot expect me to argue the matter with him at Question time."

Taken from

Later on the 27th April 1944
"Mr. Stokes asked the Chancellor of the Exchequer how he keeps check of the amount of new money created.
The Chancellor of the Exchequer (Sir John Anderson) I do not find it necessary to attempt any such record as my hon. Friend suggests.
Mr. Stokes But that is not an answer to my Question. Am I to understand from the Chancellor that he keeps no check on the amount of new money brought into circulation?
Sir J. Anderson I keep no such check as my hon. Friend seems to have in mind. If he will study the White Paper, published on Tuesday - which he will find a veritable mine of information - perhaps he will then be good enough to indicate to me just what practical purpose he thinks such a record or check as he has in mind would serve.
> Mr. Stokes But is the Chancellor aware that competent authorities are of the opinion that something in the order of 1,500,000,000 has been created by the banks since the war began, at little cost to the banks and at great cost to the community? Does he not think it is his responsibility to see how much new money has been created? Surely it b a matter of business.
Sir J. Anderson My hon. Friend referred to "competent authorities," but I am aware that the question of who is a competent authority is also a matter of opinion."

It looks to me as though here we have Mr Stokes trying to get an open discussion going on the real and wholly unnecessary financial cost of the war. The then Chancellor, Sir J. Anderson, just wouldn't go there. BB.

Taken from

Here's discussussion in the house from 1940;
Mr. Loftus I was describing, without commending, certain proposals for the least harmful kind of capital levy put before me by a former colleague in this House who is no longer a Member. His idea was that there might be a compulsory loan bearing interest at a nominal rate - say, half of 1 per cent., or 1 per cent. - and that every individual with assets above a minimum, say, of 500 - or whatever the minimum might be - should always hold a certain percentage of his assets - we will assume 5 per cent. - in this compulsory Government loan with a nominal rate of interest. The mechanism which he proposed was as follows. In the annual Income Tax return there, would be one or more extra pages added in which the individual would make a return of his total assets and their value. I admit there would be a difficulty in valuation. Stocks and shares could easily be valued on current quotations. Land, houses, factories, and so on, would be more difficulty, but there might be a rouough and steady method of using assessments as a basis for valuation. Each year the individual would have to show among those assets the particular percentages - say, 5 per cent. - of the compulsory Government loan. This loan would be issued at par by the Bank of England, it would not be dealt with on the Stock Exchange, and it would be redeemed at par by the Bank of England and could be used for the payment of Death Duties. If an individual's assets fell heavily in a year, the Bank would be under the obligation to redeem at par by paying out in cash the proportion of the compulsory loan that had to be cancelled.
The effect over a long period of years would be this. National wealth increases, and therefore, there would be over a period a continuous issue of this nominal loan, and the issue would raise money that could be used to decrease taxation which is so heavy to-day that it is checking enterprise, which we want to encourage. It may be replied that in times of slump the Bank of England would be cancelling so much of this returned stock that there would be inflation; but in times of slump and falling prices this increase in the money paid by the Bank in cancellation would be a useful corrective of the slump. It would be a valuable thing. There is one safeguard that would have to be made. A great deal of the capital required would have to he borrowed, and those who borrowed for this purpose only would have to be assured of a very cheap rate of interest - possibly 2 per cent. or 1 per cent. above the Bank rate - by direct Government intervention. I have not time to set out the details of the proposals, but that is the general idea.
If there is a danger of inflation, if we have to expand credit, do let us face the fact. Let us not indulge in wishful phrases, such as, "We will never have inflation," unless we mean to take the sternest measures to prevent it. We have had enough wishful thinking in military matters during the last 10 months. Let us not indulge in wishful thinking in economic matters, or it may lead us to disaster. Let us organise and plan any necessary and moderate inflation in such a manner as to do the State the least possible harm and leave the least possible burden for the future. I have pointed out before in the House what I want now briefly to repeat. I ask the Chancellor of the Exchequer to study that remarkable article which appeared in the "Economist" last November under the heading "The Technique of Inflation." Whatever we do, we must not follow the same technique as in the last war - the creation of credit by the banks, the lending of those credits to customers, the customers buying War Bonds and depositing those War Bonds as a basis for loans for more War Bonds. This had a kind of snowball effect and left a vast burden of debt to the nation. The "Economist," which is a most orthodox paper, suggested that a new technique was necessary by which the Government should borrow any inflationary money, any credit created for the purpose, direct from the joint stock banks, paying a charge to cover their overhead costs, book-keeping, etc. The charge mentioned by the "Economist" was one half of 1 per cent. I commend that article not only to the Chancellor, but to all hon. Members who are interested.
I turn now to another subject, and that is the mechanism of the creation and cancellation of money and of credit, which is vital in considering a Budget of any kind, but particularly necessary in considering the present grave financial difficulties. My hon. Friend the Member for Kidderminster (Sir J. Wardlaw-Milne) said on Tuesday last that the whole of our system of raising money will have to be looked into with fresh eyes after, or even during, the war. I profoundly agree with him, but he may not agree with the application which I would give to his text. Let me first say this. I have the highest admiration for the management of our joint stock banks. I admire the great ability and the high integrity with which they are conducted and which make our banking system the envy of the world. I have always deprecated foolish attacks on the banks, and anything I say is not in criticism of the management of the banks, but of the system; for I have never concealed my opinion that the system whereby most of our money - and three-quarters of our money is cheque money - is created by companies and not by the State is a wrong system, and that it is responsible for many evils. I am convinced that under our privately controlled issue of money, money that is burdened with interest from the moment of its creation, we shall never be able in peace time to develop fully our agriculture and industry, and we shall be able to do so in war time only at the cost of piling up vast burdens of debt. I will go further. I will say that under this system you will of necessity always be hampered and hindered and delayed, as we have been during recent years in dealing with the great problems of unemployment, Colonial development and rearmament. I do not believe that the delays in our rearming were due to optimism or the short-sightedness of our politicians, or even so much to the desire of the Treasury to preserve our rate of foreign exchange, but that they were inherent in this present financial system.
Now that we have reached this breakdown of the old financial system, I urge the Chancellor to do what ought to have been done long ago, and that is, that the Crown should resume the essential right of every State - the right given away by William III in return for the Throne - to control the issue and cancellation of every kind of money. I do this in order to help my right hon. Friend. By this means, if and when inflation becomes necessary - and controlled inflation may be desirable at times, and it would certainly have been desirable in 1932 and 1933 at a time of falling prices - the State itself could issue debt-free money and credits under due safeguards, perhaps redeeming, when desirable, by an annual instalment, and thereby getting rid of the burden of interest which raises so much the rents of our municipal houses. I hold that if the Crown resumed this ancient right, the functions of our great joint stock banks would remain, under the same ownership and the same management, just as necessary, just as honourable, and just as profitable, as they are to-day.
I know that many will say that these words are merely the mutterings of a currency crank, and that I shall be accused of being a green shirt and a follower of Major Douglas. I never have been, although I have admired greatly his diagnosis, without agreeing with the remedies he proposes. My reply is that I have learned these ideas as a result of taking the advice of Lord Baldwin, who told us to study the work of Benjamin Disraeli. I followed his advice, and I now quote the words which he used. Disraeli wrote that King William III 'introduced into England the system of Dutch finance. The principle of that system was to mortgage industry to protect property. This system has made debt a National habit. It has made credit the ruling power, not the exceptional auxiliary of all transactions.' Disraeli described the results of this system in typical Disraelian florid rhetoric: 'A mortgaged aristocracy, a gambling foreign commerce, a home trade founded on a morbid competition and a degraded people.' It might be objected that Disraeli wrote these words before he had the experience of office, and before he shouldered the heavy burden of being Chancellor of the Exchequer. I will quote, in reply, the words of one who was Chancellor of the Exchequer more times than any other man in our history, Mr. Gladstone. He said: 'From the time I took office as Chancellor I began to learn that the State held, in the face of the Bank and City, an essentially false position as to finance. The Government itself was not to be a power in matters of finance, but was to leave the money power supreme and unquestioned.' These are voices from the long distant past, but I would call in the voice of one of the greatest of living Liberals, Senor Madariaga, who at one time was President of the League of Nations. He said: 'These great financial institutions have attained two aims; they have all but evicted the State from its position as the only dispenser of money: they have all but evicted the industrialist from his position as manager and controller of industry. The absorption of all powers by the dispensers of credit is one of the most fantastic phenomena of modern life.' But that is a voice from the Left, and it may not be acceptable to Right Wing opinion. May I then quote from the recent writings of Pope Pious XI, who, in an Encyclical, said: 'It is patent that in our days not wealth alone is accumulated, but immense power and despotic domination are concentrated in the hands of a few, who, for the most part are not the owners, but only the trustees and directors of invested funds, which they administer at their own good pleasure. This domination is most powerfully exercised by those who, because they hold and control money, also govern credit and determine its allotment, for that reason supplying the life blood to the entire economic body and grasping in their hands, as it were, the very soul of production, so that no one can breathe against their will.' I do appeal to the Chancellor of the Exchequer to consider now, in this hour of grave peril, the resumption by the Crown of its ancient right to control the issue and cancellation of all kinds of purchasing power. I invite him to read the remarkable leading article which appeared in the "Times" last Thursday: It states: 'Much harm can be done to our cause, both in Europe and overseas, by the insinuation that we stand for the old order. This charge should be emphatically and authoritatively refuted.' The Chancellor of the Exchequer can refute this charge both in Budget speeches and Budget practice.
Finally, I make this appeal, not only to my right hon. Friend the Chancellor of the Exchequer, but to every Member of this Committee and every Member of this House. There are multitudes, in this country and throughout the world, of men and women who realised before this war that the whole modern system of finance was breaking down; that it had failed to solve in any country the unemployment problem, that it had destroyed vast stores of food desired by the people, and that the system stood condemned. But they regarded with horror the alternatives offered to them by the disciples of either Karl Marx or Adolf Hitler - the degradation of man to the level of the hive or herd, the revival of slavery of mind and body, destructive to the soul of man. They look for and believe in a better order, and many of them look to this country for a lead. I believe that these multitudes have their own vague ideal of what the future should be. They desire a varied society of free men, where the productive resources are used to the utmost, and where consumption keeps pace with productive power. They desire individual liberty to be maintained, and they desire every encouragement of legitimate private enterprise. They also wish freedom of choice in the market and that international trade should no longer be a savage struggle to obtain favourable balances, but rather an equal exchange of goods to the mutual advantage of all nations. These people look to Britain now to give a lead, and I pray God that they do not look in vain."

Taken from


Bill Kruse - - Permission granted to freely distribute this article for non-commercial purposes if attributed to Bill Kruse, unedited and copied in full, including this notice.

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