How Banks Create Money Through Loans and Deposits

But what exactly is their role? I just quickly,

I'd like to reflect on that.

Banks are being thought of as intermediaries, but-

Are they?

-this is not really what's happening.

Banks-

What, what are they then?

They're creators of the money supply.

So you're firmly of the view that banks create money out of thin air?

Yes. Well, I-

And, uh-

... I produced the first empirical studies to

prove that, um, in the

5,000 year history of banking. Banks are thought of as, uh, deposit

taking institutions that lend money.

The legal reality is banks don't take deposits and banks don't

lend money. So what is a deposit? A deposit is not actually a deposit.

It's not a bailment. It's not held in custody.

Uh, at law, the word deposit is meaningless.

The law courts and various judgments have made it very

clear, if you give

your money to a bank, even though it's called a deposit, this

money is simply a loan to the bank.

That's true. Yeah.

So there is no such thing as a deposit.

There's just loans-

So you think it's poorly, inadequately named then?

... to the bank. So banks borrow from the public.

Okay, so that much we've established. What about lending?

Surely they're lending money.

Um, no they don't. Banks don't lend money.

Banks, again, at law it's very clear, they're in the business of purchasing

securities. That's it.

So you say, "Okay, don't, you know, confuse me with all that

legalese."

No.

"I want a loan. I want a loan."

Yeah.

Fine. Here's the loan contract, here's the offer letter, and you sign.

At law it's very clear you have issued a security, namely a

promissory note, and the bank is gonna purchase that.

That's what's happening at law.

Put it in layman's terms, what does that mean?

It means that, um, what the bank is doing is

very different from what it presents to the public

that it's doing. How does this fit together? So you say,

"Fine.

The bank purchases my promissory note, but how do I get my money?

I want, you know, this is a loan."

I want my 200 grand. Right.

"I want my money. I don't, don't care about the details,

I want the money." The

bank will say, "Well, you'll find it in your account with us."

That would be

technically correct. If they say, "We'll transfer it to your account,"

that's wrong because no money is transferred at all-

It's already in the bank

... from anywhere inside the bank or outside the bank. Why?

Because what we call a deposit is simply the bank's record of its

debt to the public. Now, it also owes you money,

and its record of the

money it owes you is what you think you're getting as money, and that's all it is.

And that is how the banks create the money supply.

The money supply consists to 97% of

bank deposits, and these are created out of nothing

by banks when they lend because they invent

fictitious customer deposits. Why?

They simply restate, slightly incorrectly

in accounting terms, what is an accounts payable liability arising

from the loan

contract having purchased your promissory note as a customer

deposit, but nobody has deposited any money.

I wonder how the FCA deals with this

because in the financial sector, you're

supposed to not mislead your customers.

Um, anyway.

I would... So I ha- I, I don't think they understand

So the, so the banks create the money supply-

Yes

... by inventing these claims on themselves,

the, you know, the

fictitious deposits. That can be actually positive for the

economy as long as this

money creation is in line with the creation of new goods and

services, uh, implementation of new technologies, and

therefore adding value. And adding value in the economy

is funded by this

money creation. If that happens, and we're talking about, um,

business investment, productive loans,

productive bank credit, you will

have no inflation. These loans can also be serviced

and repaid, and you have a

stable economy without problems and with low inequality.

And so countries that achieve

this, that the banks lend mainly for productive

purposes, whether it's Germany in much of its

200-year history,

or, um, in the last century-

The-

... the East Asian economies where bank credit

was largely for productive

purposes, then you find... But there's two more cases.

I quickly need to point them out 'cause that's the contract.

But just, just cl- just clarify

that, that inequality is, is significantly

lower.

Lower, yes.

Inflation is low.

If, if... Yes.

And the real-

And you have stable growth

... and the, and the real economy thrives.

Is booming, yes. That's when bank credit creation is

focused on, um, productive lending for productive

purposes.

As opposed to speculation and, and asset price-

As, as opposed to... There's, uh, two other types.

If banks create credit for consumption-

... it's obvious what's gonna happen.

... it's obvious what's gonna happen.

You suddenly have more money creat- created and more demand for goods,

but it's the

same amount of goods and

services, so you're creating consumer price

inflation.

Price goes up.

That's well understood, and, and central banks are watching

that a little bit.

And what's the third thing?

But what's, what's less well understood is,

and what's the biggest in the UK,

um,

it's probably more than 70% of all lending, um,

actually way more than that-

Mortgages

... um, is bank credit creation, so money creation,

uh, for financial transactions,

for asset transactions, for purchasing

ownership rights. Now, then you have a problem. Why?

Because you're creating new money,

but you're not creating new goods and services.

You're simply-

They're constant, aren't they?

... you're giving

somebody new purchasing

power over existing

assets,

and therefore you must push up asset prices.

So this, you can, you can draw a chart where you show,

you know, asset prices,

land prices, property prices in the UK, and

they will match very closely, as,

as I have, I've shown in, in Japan and other countries, and

that also creates the

inequality. So when the, the banking sector has focused

too much on unproductive lending, in the UK it's dominant.

It strikes me that what you're telling me, and tell me I'm wrong, is that

lending, in order to get round this deposit stroke

loan situation,

needs to be categorized.

You're right. Exactly.

Is that right?

That's right. Um, we need to look at where the money is

going. That makes a whole world of difference.

Difference. Okay.

So if money is, is, bank credit is

extended for productive

purposes, you're fine. You'll get a good economy, no inflation,

and financial stability, and also you don't have this inequality

problem.

And do you think there should be different

capital ratios towards each-

No.

You don't.

Capital, the whole Basel capital approach doesn't

work. Why?

Because it's, it's premised on the idea that banks

are just financial

intermediaries.

But they're not. They're money creators.

We need bank regulation that recognizes reality of how the banks

actually operate.

So what you're saying, this is a regulation problem.

Clearly, yes, it's a regulation problem. That's right.

We need a different regulation, and the only regulation that actually

has succeeded in, in history, and we have good data for the 20th century

in particular, in preventing asset bubbles

and banking crisis, which are all

driven by this bank credit for financial transaction.

It leads to this asset boom, and it's, it's a game of musical chairs, you know.

You have to play it.

Mm-hmm.

It's rational to play while the music is playing, which is how asset prices are

driven by ever more bank credit for financial transactions.

The moment it stops, asset prices fall, you

get the first bankruptcies, banks get

risk-averse, the whole thing goes into reverse,

and banks go bust.

But you can avoid this, and the only regulation

that has succeeded in avoiding this

is guidance of bank credit. Simple rules.

Um, the simplest form of bank credit guidance

is to simply

ban bank credit for, um, financial

transactions. It doesn't mean financial transactions

are bad. No.

Let the speculators speculate, and let them even borrow money,

but not from

banks. That would make a whole world of

difference.

Where, where do they borrow it from?

Well, they can issue bonds or, you know-

Right

... borrow in the markets, whatever they want.

But that's risk-averse lending.

But they, they shouldn't get access-

It's not gonna happen

... to the public privilege of money creation,

you see?

I know what you mean. Yeah.

And that creates the

problem that creates the boom-bust cycles