This post is a continuation of a spur of another thread where these opinions made me a minority of one. Hopefully, either others will enlighten me or vice versa.
Why pawnshops? Banks buy, sell, and make loans against financial assets: securities (debts, equities, derivatives), currencies, and in some cases hard assets (e.g., houses, cars, inventories, etc.) on which they occasionally foreclose.
Why counterfeiters? They pay with money that not currently part of the money supply and often freshly issued out of thin air. Suppose that I sell a Treasury bond to a bank. They can pay me any of three ways:
- They can reach into their vault and pay me in cash, but that vault cash is not part of the money supply, but cash in my hands is.
- They can pay me with a bank draft (cashier’s check), but that is freshly created money, which will become part of the money supply as soon as I deposit in my checking account at some bank.
- They can pay me by incrementing the credit in my checking account at that bank, which increments the money supply by the same amount.
In all three cases they’ve taken a financial asset (the bond) out of circulation and introduced new money into the money supply — some might say they’ve monetized the asset. Note that, in the last two cases, the money is created on the spot, out of thin air. Also, note that the bank has the same payment options when they make a loan.
Finally, note that no matter which form I get the money in, I can immediately convert it to either of the others. If I get the money as check or cash, I can immediately deposit it in my account at that bank. When I have the money in that account, I can ask for cash or cashier’s check or simply leave it there.
Why pseudo? The term “pseudo counterfeiter” is an intentional double negation; it means “a fake fake.” And, indeed, bankers are not counterfeiters and for one and only one reason: the federal government recognizes the money they create as “good as cash,” especially in payment of taxes, and thereby, making it “coin of the realm.”
So what? I made this same point in a prior post, Fool’s Gold, and it seemed uncontroversial. In the more recent thread, it seems agreed that banks can pay for loans with freshly created money. And, the point under dispute is whether banks can buy securities that way.
To me the most compelling argument that loans and asset purchases can be handled in the same way is that the books are kept the same way in each case, i.e., the asset (bond or loan agreement) is debited to the current-asset account and the corresponding amount is credited to the seller’s or borrower’s checking account or the account on which the cashier’s check is drawn. But here are some relevant quotes.
* Here is a recent reference by Nick Rowe:
“An individual commercial bank can create money out of thin air simply by buying something.”
* From Washington’s Blog:
Germany’s central bank – the Deutsche Bundesbank (German for German Federal Bank) – has admitted in writing that banks create credit out of thin air.
As the Bundesbank states in a publication entitled “Money and Monetary Policy” (pages 88-93; translation provided by Google translate, but German speaker and economic writer Festan von Geldern confirmed the basic translation):
4.4 Creation of the banks money
Money is created by “money creation”. Both [central banks] and private commercial banks can create money. In the euro monetary system [money creation] arises mainly through the granting of loans, as well as the fact that central banks or commercial banks to buy assets such as gold, foreign currencies, real estate or securities. If the central bank granted a loan from a commercial bank and crediting the amount in the account of the bank at the central bank, created “central bank money.”
* Also from Washington’s Blog:
“Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”
-Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)
“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”
- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.
“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. [...]”
- Graham Towers, Governor of the Bank of Canada from 1935 to 1955.
As a side note, Paul Krugman recently made the foolish mistake of claiming that banks are constrained in their loaning by their capital on hand. Here is Scott Fullwiler of Bard College tearing Paul to pieces.
UPDATE: The fact that banks don’t have to spend real money on the assets they bid on and acquire explains the propensity of our economy to form asset bubbles, especially over the last thirty years, when the Fed has been run by neoliberals who believed that regulation was neither necessary nor sufficient and, in fact, impossible. (According to Larry Summers, it’s impossible to find regulators who are both honest and competent.)
And, during that period, we’ve seen many asset bubbles: junk bonds, dot-com equities, subprime mortgages, etc., all due to the fact that banks can invest without paying. And, this last bubble wrecked the world economy.
UPDATE2: Per John Kenneth Galbraith writing in ‘Money: Whence it came, where it went’ (1975):
“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.”
Again, here’s how it’s done. Whenever a bank pays for anything:
- The relevant inventory or service account gets debited.
- If the vendor has an account at that bank, it gets credited; otherwise, the vendor gets a cashier’s check and checks-payable gets credited. In either case, that credit constitutes freshly created money within the banking system.
When a check against the vendor local account or that cashier’s check gets deposited at another bank, reserve at the Fed moves from the paying bank to that other banks, i.e., the freshly created money gets moved from one bank to another, but it still exists within the banking system.