Money creation

Social Credit described the action of the Reserve Bank to curb its purchases of government bonds from private banks as a sensible and responsible decision.

At the same time, it must now curb the avalanche of money creation that has hit the commercial banks.

Failure to do so will allow inflationary pressures in the economy to continue to rise.

These commercial banks create an average of $ 20 billion in new money each year, and that amount has almost doubled in the past two years.

The ASB’s move to raise mortgage rates is just a cynical scam, preying on customers who have borrowed at the record-breaking interest rates offered by banks and will affect not only homeowners, but consumers. businesses, the very sector of the economy. which must retain staff and increase the production of goods and services to meet the demand of the economy.

ASB’s decision will be quickly followed by the other banks, all of which will be keen to increase their profits as well and will attempt to intimidate the Reserve Bank into raising the official exchange rate.

Any increase in Reserve Bank in OCR will simply drive up interest rates even further, add to already record profits for commercial banks, and worsen the effect on borrowers.

The Reserve Bank must determine who is in charge of the country’s financial system, itself or the commercial banks.

It should encourage banks to channel a greater proportion of their loans to the corporate sector, thus providing working capital for businesses to grow, invest in new technologies to overcome the labor shortage and increase the production.

Falling into the trap of rising interest rates will make the problem worse, leading to higher costs, reduced production, and hardship for businesses and homeowners.

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When Facebook announced its intention last June to issue a digital currency, Libra, the official industry was put on hold in its initial response. Central banks could not be seen as being too overtly unwelcoming to innovation and new ideas, but also, the concept hit quite directly the sovereign privilege of issuing money. They also worried in private about the possible consequences for their conduct of monetary policy *.

Since then, central banks have remained largely silent. The main news on Libra were the resignations of the consortium supporting the project; Visa, Mastercard, eBay and PayPal, among others, have ended their involvement. This stripped the project of a lot of payments systems expertise, and while Facebook has found other companies to take its place, the consortium is now less balanced and much more clearly a Facebook-dominated operation.

But the authorities’ silence does not mean that they have ignored the subject or overcome their initial mistrust. Much research on digital currencies continues to be done by the central banking fraternity, and two issues in particular arise.

The first of these is the effect on the Orthodox banking system, in particular its role in the creation of money. In a split banking system, banks are able to grant loans (i.e. create money) that are a multiple of their deposits, keeping only a small portion of their balance sheet in assets. liquids such as central bank reserves. This process allows the money supply to expand and, in any modern economy, is a critical contributor to economic activity and growth.

But if digital currencies become an important part of the economy, that money creation will be halted. Calibra – the Facebook subsidiary that develops Libra – has made it clear that it has no intention of offering loans or overdrafts, as that will immediately make it a bank and therefore subject to banking regulation. But it does mean that any money customers take out of banks to place in their Libra accounts will be wiped out not only from banks’ balance sheets, but from the money creation process as well.

Indeed, the introduction of Libra threatens to split the banking sector’s currently unified balance sheet, shifting a significant proportion of customer deposits (i.e. banking system liabilities) to digital money issuers. , while leaving loans and overdrafts customers (the bank’s system assets) with the banks. The inevitable result would be to force banks to reduce the assets on their balance sheets to match the reduced liabilities, that is, to reduce their loans.

This would almost certainly lead to a significant credit crunch, which would be very damaging to economic activity. The threat that “narrow bank” (non-lending) digital institutions could reduce or even replace the role of existing commercial banks is of deep concern to central bankers. There is no precedent for a prosperous modern economy without commercial banks and their role in money creation.

Unfortunately, central banks don’t have an easy answer to this. Relaxing banks’ reserve requirements and allowing banks to offer more loans per unit of deposit would allow them to maintain the same volume of loans despite the reduction in their deposits, but would weaken banks and risk bank insolvency in the event of a loss. economic downturn. Alternatively, central banks could issue loans themselves directly (or guarantee bank loans, which would have a similar effect by removing the need to build up reserves against them) – but this direct involvement in the economy of the private sector is even less attractive to them. Not only would such a move run counter to all existing central bank theories, but in purely practical terms, it would open up the central bank to much more direct contact with the general public and therefore, almost inevitably, to oversight. much more political. No central banker enthusiastically envisions getting drawn into the world of the “three Cs” – customers, complaints and call centers.

The second issue that arises from the introduction of private sector digital currency is that of cost. Libra and any other digital currency rival will need a revenue stream to pay their costs (and provide feedback to consortium partners). How are they going to increase this income?

If they can’t generate an income stream from paid loans and overdrafts, they must come from user fees. In principle, these charges will be levied on the commercial service provider, not the retail consumer, but in practice they will inevitably be paid by the consumer in the end.

This raises important questions of efficiency and value for money. It is by no means clear that such a private sector payment system would cost less to operate than the existing banking system, even on the narrow point of cost per transaction, especially if, as seems likely, a currency digital quickly becomes dominant for the exclusion of competitors. But there is the larger question of whether society is benefiting from big tech that takes even more money out of the economy into an unaccountable, tax-free and often overseas giant.

The current trials of Libra may mean that its introduction has been delayed. Many consider it to be in no way guaranteed to work. But central banks are well aware that even if Facebook fails to make its plan a reality, sooner or later someone else will succeed and introduce a private sector digital payment system. And the problems and implications for the central bank, the commercial banking system, and the wider economy that their current research has highlighted will not go away.

John Nugée, former Managing Director of Reserves at the Bank of England, is Senior Advisor to OMFIF. This is an abridged version of an article published by Laburnum Consulting.

* See http://laburnum-consulting.co.uk/facebook-enters-the-digital-currency-world/ for a more detailed discussion of the initial reaction of central banks to Facebook’s announcement.

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Money creation in fiat and digital money systems

Author / Publisher:

Marco Gross; Christoph Siebenbrunner

Publication date:

December 20, 2019

Electronic access:

Free download. Use the free Adobe Acrobat Reader to view this PDF file

Summary:

To support the understanding that issuing debt by banks means creating money, while intermediary lending from centralized nonbank financial institutions and decentralized bond markets does not, the paper aims to convey two related points: Loan creation is compatible with the notion of liquid financing needs in a multi-bank system, in which transfers of liquid funds (reserves) between banks occur naturally. Second, monetary policy based on interest rates affects macroeconomic dynamics precisely because of this multi-bank structure. It would lose its impact in the hypothetical case of only one commercial bank (“singular”). We link our discussion to the emergence and design of central bank digital currencies (CBDCs), with particular emphasis on how loans would be made in a CBDC world.