Ten easy ways to neither understand nor have a say in the making of money

For a start, from last night’s Ken Craggs’ piece on today’s backbench debate in parliament, the nature of money creation is going to be covered.

The reasons you and I will do nothing on this are many:

1. The source is untrusted – it comes from someone you don’t know, Ken Craggs and is brought by someone you’re not over-enamoured of, James Higham. So it’s off to a bad start.

2. Even the fairminded see no corroboration anywhere they read, so it seems some invention, although invoking the name Carswell in this debate brings a familiar face into it. And it does seem to be actually happening if you follow the links, although it’s ‘just another backbench debate in a sideroom’.

3. You’re overwhelmed by what you yourself must do today – get into the commuter grind to get to work, do what they require all day or else you have a dozen jobs to do in your unemployment or retirement. You’ve no time for this blip on the radar in parliament, the MSM are not trumpeting it, therefore it is not real.

4. Time is ticking by, even as we read this – you must do your next job, mine is to go to town to do my … er … banking. I’m not feeling well, some medical issues of late. Anyway, there are too many bloody issues just now, they’re coming at us from everywhere and everyone thinks his or hers is the most important, plus there’s Kim Kardashian’s bum to look at and the book I’m currently reading and the kids to feed, Christmas shopping to get done.

5. Even if I do have the time to read Ken’s piece and maybe even click on one of the links, I get South Park and simply haven’t the day to day time. There are too many links to be bothered.

6. It’s boring:

Bob Welham 
In general UK government borrowing does not create new money.
Please see page 304 of Modernising Money.

Auburn Parks 
Sorry Bob, but thats just objectively wrong. And here’s why:

The Tsy is the Govt securities monopolist
The Central Bank is the reserve (currency) monopolist
The only way to “buy” Govt securities is with Govt currency

These are facts, they are not my opinions. And your understanding and framework of the monetary system must incorporate these facts. So where does the currency that the Govt “borrows” come from? Well, it necessarily comes from the Govt.

Furthermore, Govt securities are digital pound accounts at the BofE, reserves (excluding the negligible amount of physical cash) are digital pound accounts at the BofE. Both account types are liabilities of the Govt (just different Govt agencies). Why anyone would count one type of account as “money” and not the other is confusing.

Bob Welham 
Using the scenario from page 304 of MM, we suppose that a
pension fund P, which has its bank account at Megabank, buys £1M of new gilt edged stock. Then:

(1) P’s bank balance (Megabank’s liability) decreases by £1M
of commercial bank money.

(2) £1M of central bank money (Megabank’s asset) is transferred from Megabank’s BoE reserve account to HMG’s BoE account.

(3) HMG transfers £1M of central bank money from its BoE
account to the BoE reserve account of Regalbank (a new asset for Regalbank) where the NHS has a regular bank account from which it can spend into the general economy.

(4) Regalbank credits the NHS account with £1M of spendable
commercial bank money (a new liability for Regalbank).

We deduce from (1) to (4) above that:

Megabank’s balance sheet shrinks by £1M and Regalbank’s
balance sheet expands by £1M. The integrity of each is maintained.

The aggregate amounts of central banks money and commercial
bank money in the system both remain unchanged.

No new money, of either sort, is created.

Auburn Parks
deficit spending adds pound deposits to the banking system, these pound deposits can either be in the form of reserves or gilts. Either way the Govt’s liabilities (Non-Govt assets) increase.

If you want to count pound deposits in reserve accounts as money and not pound deposits in gilt accounts, then you would have to apply the same logic to checking and savings accounts at private banks.

When you personally shift your bank deposits at RBS from on-demand checking accounts to a term deposit account (CD), do you consider that money as gone? Of course not, so why would consider the same operation at the public bank any differently?

Auburn Parks Bob Welham • 14 days ago
Sorry Bob, even though you have the accounting right you are getting the implication wrong:

Where did the MegaBank get the reserves? They got them from the only place they can come from, the central bank.

The Central bank provides the currency with which to “buy” the gilts.

This is why QE doesnt add anything to the economy and its not “printing” money in any meaningful sense. The Tsy only spends and taxes in Govt currency. So when the Tsy spends 1M and taxes 900K, there is 100K in Govt currency left in the banking system. This currency can only be used to either “buy” gilts or pay taxes, there is no third options in the aggregate (again, cash withdrawals are not really relevant to this process).

Bob Welham
Page 304 of MM demonstrates convincingly that each individual event of UK government borrowing changes neither the amount of central bank money in the system, nor the amount of commercial bank money.

Extrapolating, the series of such borrowing events which constitutes government deficit spending also changes neither amount of money.
It follows that UK government deficit spending of itself does not create money. I doubt that this can be made any clearer and I leave the matter at that.

In contrast, since almost all QE gilt purchases were made from non-banks, the QE program did increase both the amount of central bank money and commercial bank money, each by £375bn.

Please see pages 90-100 of the following BoE publication, in particular figure 1, to confirm this:


Auburn Parks
As far as the accounting for QE:

Person A sells 1K gilt to B of E and uses private bank B:

Person A assets (private bank B checking account) +1K
Person A assets (gilt account at BofE) -1K

Bank B’s assets (reserves) +1K
Bank B’s liabilities (Person A’s account) +1K

Govt (Tsy) liability (gilts) -1K
Govt (BofE) liability (reserves) +1K

As you can see, nothing gets added.

Auburn Parks Bob Welham 
Even though I’ve addressed all the points you’ve written, you’ve not engaged with my examples at all. The reason for this is that once you do so, you must acknowledge that you are wrong.

Again, I agree with you (the accounting is undeniable), issuing Govt securities does not add any money, as it exchanges one type of pound bank account type for another (reserves for gilts). its the deficit spending that adds the money. Which is what I’ve said all along.

We already did the accounting on Gilt issuance, now lets complete the cycle and do the spending shall we?

Govt spends 1K on retirement for person A (who banks at private bank B)

Person A’s checking account at bank B +1K
Bank B’s liabilities (person A’s account) +1K

Bank B’s assets (reserve account at BofE) +1K
BofE liabilities (Bank B’s assets) +1K

Tsy reserve account (asset) -1K
BofE liabilities (Tsy account) -1K

So the private Bank B’s net position is unchanged
The Govt’s net position is +1K liability (Bank B’s reserves)
Person A has +1K

The accounting couldn’t be clearer.

Taxation reverses this process, and to the extent that there is spending above taxes (deficits), the non-Govt gets this income.
see more

Bob Welham 
Both taxation and government borrowing of themselves decrease
the aggregate amount of commercial bank money in the immediate term. Government spending of itself increases the aggregate amount of commercial bank money in the immediate term, whether that spending is funded by taxation or by borrowing, that is whether or not it is deficit spending.

These fluctuations of aggregate commercial bank money due to
government taxation/borrowing/spending are consequences of the government itself having an account at the BoE and thus holding its money there as central bank money. They exist because of the two-tier structure of the UK money system. Over time, allowing for a little fiscal lag, they balance out. Until it spends into the general economy, the government has no need to manifest its money as commercial bank money.

So the UK government tax/borrow/spend cycle has no net effect
on either aggregate central bank money or on aggregate commercial bank money. No enduring new money of either sort is created.

Government IOUs (gilts) are created by government borrowing
and, under certain circumstances, these are used as near-money, but that is a separate matter.

Auburn Parks 
bob- commercial bank deposits are just one type of money, certainly not the only type.

The nice thing about accounting is that, like physics and math, there is no ambiguity. Accounting is not an opinion, its not politics. I’ve laid out the accounting for you, and the result is clear.

Deficit spending adds Govt IOUs (money) to the non-Govt.
Issuing Govt securities merely changes the type of Govt IOU, not the number.

If you’d like to argue against these facts, please use the accounting.
But you wont, because you cant. The only thing that needs to change is your cognitive bias. You have personally never thought of Govt spending as creating money, you obviously think of Govt finances in terms of your personal finances, so when presented with evidence counter to that, you are experiencing cognitive dissonance. Thats totally normal, but it doesnt change the fact that you are wrong

Bob Welham Auburn Parks 
We seem to disagree over semantics. If gilts count as ‘money’ then of course deficit spending creates new money. If we stick to the three types of money outlined on page 3 of Where Does Money Come From, and regard gilts only as near-money, then it does not.
I would argue that the latter interpretation is the more conventional and certainly it is the one usually adopted in discussions on the PM website.

As far as I am aware, there is no cognitive dissonance on my part, and ad hominem attacks do not engage me. I simply recognize that we use the word ‘money’ differently.

Auburn Parks
What is the difference between a 12-month CD at the royal bank of scotland and a 12-month gilt at the bank of england?

Auburn Parks
I was certainly not attacking you Bob. Cognitive dissonance is something everyone is a victim of throughout their lives, its just human nature.

On the “are gilts money” front. If you dont think term deposit public bank accounts are NOT money thats fine, but then you must also exclude term deposit private bank accounts from the money supply count. You are free to do this, although it makes no sense.

7 Any the wiser? I understood some of that but as I’m in my blogrounds and have people to visit, I’ll put this aside, mentally, and determine to come back and try to understand it this evening although I’ll be dog-tired after my project and other things will get in the way today, e.g. having to sort out the goods which didn’t arrive yesterday, plus bills I have to pay and I dispute … and so it goes on.

8. And there goes possibly the only opportunity Carswell and others had to have a debate which involved the people of this land. If other people who read this reacted as I did, it fizzes out as an issue. The majority of the UK and abroad who don’t read OoL never find out about it anyway unless a blogger they visit mentions it.

Who knows – you might strike lucky and Guido might mention it – that means a few thousand more get to see it and the people in his comments thread with the funny names can make fun of it all.

9. And thus nothing is done. Nothing is ever done, no one understands and those creating money and debt and all that stuff we hear about in our austerity keep doing as they do and we keep doing as we do, oblivious but moaning about our lot all the same.

Here was a chance, a tiny chance, we thought for a moment and then said, ‘Nah, have to finish breakfast and get going for the day.’

10. And there is money creation, debt creation and power in ten easy steps.

3 comments for “Ten easy ways to neither understand nor have a say in the making of money

  1. Junican
    November 21, 2014 at 2:50 am

    I don’t know enough to comment really. All my economics studies are way, way in the past.
    Decades ago, I read something which opened my eyes.

    What do you think is the foremost asset of the UK? Is it gold? Is it bank deposits? Is it shares in industry?
    No. By far and away the greatest asset is ……. The Housing Stock.

    I trust that you will immediately see where this post is going.

    All money, if it is to have value, must be based upon some sort of physical asset.

    Decades ago, I attended a lecture at Manchester University given by Enoch Powell. The lecture was about inflation. Enoch contended that inflation was caused by Government. It is so long ago that I cannot remember what his argument was, but it was damned convincing and withstood criticisms from the floor.

    I don’t know if I am right, but, essentially, all debt needs to have some sort of ‘asset’ as security. Even personal loans without physical security pledged, depend upon the “asset” of secure employment at the time when the loan is granted. If the “asset” turns out to be insecure, then the loan can go bad – which is comparatively rare. But that does not apply to mortgages, generally speaking, because of the real asset of the house. (Refer back to my first statement)

    Without being precise, because I cannot remember the detail and it is too late at night to be bothered, I bought my present home 25 years ago for £40,000 pounds. If I put it on the market today, I would probably get about £250,000 for it. I have created no vast extensions or anything like that, but I have ‘improved’ upon the original layout. But not so much as to justify, in itself, any significant increase in value.
    So, if I got £250,000, having outlaid £40,000 25 years ago, where has the difference (£210,000) come from? The “asset” is not significantly different from what it was 25 years ago.
    It is absolutely clear and obvious that £1 does not have the same value as a purchasing unit as it did 25 years ago. Why?

    The Government borrows money. But it has no ‘physical assets’. Instead, it give its creditors a piece of paper – aka ‘a bond’ – a promissory note. That promissory note is equivalent to the “asset” of future earnings which are the “asset” which justify personal loans. Because Government then spends that borrowing as ‘real’ money (as salaries etc), the money supply is increased. For example, Banks were obliged to take up gilts, whether they wanted to or not. What happened? Any Bank would gain a book-keeping ‘asset’ in its securities portfolio (a ‘plus’ on its balance sheet) and a ‘liability’ on the other side (a ‘minus’ on its balance sheet). In return for this manipulation, it gained interest at whatever the rate was at that time.

    What all the above means in reality is that the Government created money to actually spend from nothing except pieces of paper. When the Government creates money in this way, that money is REAL, in the sense that salaries can be turned into goods. Thus, there is more money chasing after goods than there was before, thus prices rise.
    Well, that was the theory when I was a lad.

    But there is a theory that goes deeper. That theory suggests that the Government, on behalf of the WHOLE PEOPLE, in its relationships with other countries, and especially the EU, can use the whole value of the housing stock of the UK as ‘a security’. Do not sneer. At any moment, there are billions upon billions of pounds ‘in suspense’ as money in the property market moves from the buyer to the seller, and the value of the housing stock is enormous.

    There is more that I could add, but my brain is tired. Suffice to say that inflation equals a sort of depreciation. It would not matter if your currency was gold or silver. What you can buy with a given amount is the only thing that matters.

    We could go into the matter of ‘the terms of trade’ (relative values of currencies). Perhaps better not to.

    • November 21, 2014 at 10:50 am

      That would have been fascinating to be at that lecture of Powell’s.

  2. Bunny
    November 22, 2014 at 8:59 am

    Thanks for the comment above, the debate reminded me of the Crisis of the 7th (iirc) of the Byzantine Empire, when the Empire was ripped apart and civil war broke out due to an argument whether representational art was blasphemous or not. Note this does also tie into Islamic expansion as well, as Islam is anti-iconoclast but that I digress.

    I doubt whether the debate in Parliament added anything to the issue and probably just confused the matter. It just reminds me of the whole Byzantine issue of people thinking nothing will change and that they can afford to spend time on things that really make not one iota of difference. I will be happily proven wrong, but if as a country you can make products people want to buy and can afford then that is pretty much what that country should be doing.

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