Monday, October 5, 2009

Funny Money

The Cooking the Books column from the October 2009 issue of the Socialist Standard

We have received a letter from Paul Grignon, of Canada, ( challenging the analysis in our article “The Myth of Magic Money” in this column last December. He enclosed for review a DVD of his "animated movie series ‘Money as Debt’ which”, he says, “has been viewed by millions worldwide and universally praised as the best explanation of our money system ever produced”.

Sorry, but we can't join in the chorus of praise as the DVD incorporates all the myths about money and banks that currency cranks have been propagating for years. It even has a top-hatted banker taking off his hat and using it to produce money out of it just as a magician produces a rabbit.

Apparently, all you need to start a bank is to deposit a sum of money with the central bank and, hey presto, you can start lending out nine times that amount and charge interest on it to boot. Obviously this is nonsense. It's the familiar mistake of assuming that a 10 percent cash-to-other-assets ratio means that, for a given amount of cash deposited with it, a bank can lend out nine times that amount whereas what it means is that it can only lend out nine-tenths of it as it has to keep 10 percent as cash.

Banks are no different from anyone else who lends money – individuals, pawnbrokers or loan sharks – they can only lend what they've got (either because it's theirs or because they've borrowed it themselves). Grignon’s confusion is partly the fault of academic economics which teaches that bank loans are a form of money in addition to the money the bank already has (Grignon is right about one thing: money deposited in a bank is a loan to that bank).

In his letter Grignon quotes from an explanatory booklet Modern Money Mechanics, first issued by the Federal Reserve Bank of Chicago in 1975, which says that from an initial deposit of cash the banking system can go on to eventually make total loans of nine times its amount. Quoting this booklet seems to be obligatory for modern currency cranks, but they could just as easily quote from any economics textbook (except that they see US Federal Reserve as their main enemy).

This theory, however, does not say or even imply that the extra loans have been created out of nothing by a mere stroke of the pen or, in Grignon’s contemporary version, by "the flash of a few keystrokes". If you follow the theory carefully you will see that each extra bank loan has to be preceded by an extra bank deposit of which only nine-tenth can be re-lent. Grignon accepts this for when the first loan supposedly "created out of nothing" finds its way back to the banking system. The bank receiving this, he says (correctly), can only lend out nine-tenths of it. Logically, he ought to accept this for the first deposit and the first loan too.

His ideal is a capitalism in which banks have become like savings-and-loan institutions in the US (building societies would be the nearest here) and where the state has a monopoly in the creation of interest-free money. What he doesn't realise is that this is the actual situation: banks are glorified savings-and-loan institutions and the only the state bank has the power to create money out of nothing. And cash is interest-free.