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Money and Banking Today

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Abstract

This chapter deals with the functioning of the present money and banking system—the mechanisms of how money is created and enters into circulation, how it circulates, how it may temporarily be deactivated, and how it is finally deleted. There are popular as well as scholarly misconceptions about these questionsthat will be discussed, including the rhetoric about endogenous money and the false identity of money and credit.

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Notes

  1. 1.

    ECB, Monthly Bulletins, Table 2.1.2.

  2. 2.

    Also cf. Kumhof and Jacab (2015), Keen (2014), Lavoie (2014), and Werner (2014b).

  3. 3.

    That banks have the proactive lead in money creation, while central banks afterwards accommodate the resulting bank demand for fractional reserves, was developed by Moore (1988a, pp. 162–63, 1988b) as the horizontal or accomodationist approach of post-Keynesianism, and became later on revised as the structuralist approach (Palley 2013). The position contrasts with the verticalist view which has it that central bank credit comes first and can thus control the banks’ credit creation according to a multiplier mechanism. Also cf. Rochon (1999a, pp. 155–201, 1999b), Keen (2011, p. 309), Constâncio (Vice-President of the ECB) (2011), also referring to Alan Holmes in 1969 who then was vice president of the Federal Reserve of New York.

  4. 4.

    Galbraith (1975, p. 18).

  5. 5.

    Schemmann (2011b, pp. 16–25).

  6. 6.

    Krueger and Seitz (2015, p. 7).

  7. 7.

    McLeay et al. (2014). There is a workbook published by the Federal Reserve of Chicago from 1961 to 1994. In this document, the functioning of credit creation is explained reasonably well (Nichols and Gonczy 1961–1994). At the same time, however, that document maintains the misleading story of loanable funds.

  8. 8.

    On the payment finality in bank and interbank payment processes also cf. Rossi (2005, p. 142).

  9. 9.

    Regarding these and related aspects also see Rossi (2003, pp. 339, 348).

  10. 10.

    The Continuous Linked Settlement (CLS) Foreign Exchange Payment System, Swiss National Bank, Nov. 2009, 5. Ryan-Collins et al. (2012, p. 166).

  11. 11.

    Examples for such RTGS systems include Fedwire and CHIPS in the US, CHAPS in Britain, CNAPS in China, Target2 in the euro area, or BoJ-Net in Japan. CHIPS = Clearinghouse Interbank Payments System. CHAPS = Clearinghouse Automated Payment System. CNAPS = China National Advanced Payment System. Target2 = Trans-European Automated Real-Time Gross Settlement Express Transfer System, second generation. BoJ-Net = Bank of Japan Funds Transfer Network System.

  12. 12.

    Also see Keen (2014, p. 280).

  13. 13.

    Also see Werner (2014b, p. 75).

  14. 14.

    Seiffert (2012, p. 44).

  15. 15.

    For example Keynes (1930, p. 26) and Gocht (1975, p. 29).

  16. 16.

    Werner (2014a, 2015) distinguishes three banking models: (1) the financial intermediation theory of banking, which is linked to the loanable funds model, (2) the theory of fractional reserve banking or reserve circulation, and (3) bank credit creation out of nothing.

    Werner rejects (1) the loanable funds and financial intermediation models as well as (2) the theory of fractional reserve banking, while (3) credit creation out of nothing is considered the only correct one. This is not quite right. Even though the typology overlaps in important aspects with the explanations given in this book, the three models of the typology are partly inaccurate or incomplete, can be misread and thus be misleading.

    Rejecting the loanable funds model can basically be endorsed, but a number of related aspects should not be left out. Not only can banks not make use of customer deposits for funding bank loans or making other payments; equally, banks cannot on-lend reserves to customers. (It is different, however, with cash. Banks can on-lend cash they have received from customers, as banks can pass on cash from the central bank to customers). Beyond the banks’ primary credit creation there are secondary credit markets where customer deposits (bankmoney) are on-lent to, or invested in, nonbanks. On secondary credit or capital markets, the loanable funds model fully applies. It also applies to the interbank money market on the basis of reserves. Finally, although commercial banks are definitely not financial intermediaries, they are monetary intermediaries, mediating the cashless payments among nonbanks by way of interbank clearing and/or final settlement in reserves.

    Model (2) on fractional reserve circulation does not reflect the entire truth about fractional reserve banking. The model combines fractional reserve banking with the loanable funds model and equates that combination with the multiplier model and the reserve position doctrine. Even if inconsistent assumptions in this vein may have been present in authors such as Keynes, Samuelson, Tobin, Minsky and others more, this does not justify reducing fractional reserve circulation to that mishmash and then presenting fractional reserve banking and bank credit creation as ‘mutually exclusive views’, while in fact both elements—bank credit creation and fractional reserve circulation—go hand in hand.

    Fractional reserve theory is certainly misguided, and rightly rejected, when combined with the loanable funds model and identified with the multiplier model and the reserve position doctrine. Such a mishmash, however, does not represent the entire spectrum of fractional reserve theory, as in fact the existence of fractional reserve circulation in connection with bankmoney circulation cannot be denied.

    Similarly, type (3)—credit creation out of nothing—is unspecific and incomplete. It is unspecific in that modern token fiat money, as it has no intrinsic value, is generally taken ‘out of thin air’, no matter whether it is about treasury coin, central bank notes and reserves or bankmoney. The value of modern money, its purchasing power, is conferred value relating to the prices of things money can buy, and ultimately covered by, or anchored in, real economic output. Money creation ‘out of nothing’ is a catchy metaphor regarding the nature of modern money. But this should not obscure the fact that creating money denominated in a specific currency, and ensuring the validity and value of that money, has many prerequisites that cannot be met ‘out of nothing’. One of these, as a technical and political requirement, is the availability of a fractional amount of reserves and cash on which the banks’ credit and deposit creation is still dependent. Bankmoney creation and fractional reserve circulation go hand in hand indeed.

    Serving as empirical evidence of credit creation out of nothing, Werner refers to the example case of crediting an internal customer account. For doing this, a bank does of course not yet need reserves or cash. If the bank in the example were to be very huge and represent, say, half of all customers within a currency area, then about half of all cashless payments would be carried out by simple internal rebooking of overnight liabilities among the internal customers. To that extent the Werner example would be right.

    In the real world, however, such gigabanks do not exist. The vast majority of cashless payments include interbank transfers. And when transferring a customer deposit into an external account with another bank, the sending bank will need to have or obtain reserves, the more so in today’s real time gross-settlement payment systems (Fedwire, CHIPS, CHAPS, Target2) all of which are reserves based. Extending credit without the credit being used does not make sense, and in this regard credit creation ‘out of nothing’, if taken literally rather than metaphorically, is misleading because using bankmoney in the split-circuit reserve system still involves a fractional base of cash and reserves.

  17. 17.

    Ryan-Collins et al. (2012, p. 75).

  18. 18.

    Sources: European Central Bank, Monthly Bulletins, Table 2.3.2. Schweizerische Nationalbank, Statistische Monatshefte, Tab. A1.17–19, B2.2–3 D1. Deutsche Bundesbank, Monatsberichte, Tab. IV.1–2.

  19. 19.

    Cf. Monetary Puzzlement. Why central banks perform worse than they could, and why sovereign-money reform would help to perform much better, http://www.sovereignmoney.eu/monetary-puzzlement.

  20. 20.

    For a criticism of the multiplier model also see Goodhart (1984), Keen (2011, pp. 306–312), Ryan-Collins et al. (2012, pp. 16–25), Jackson and Dyson (2012, pp. 75–80).

  21. 21.

    For a critical discussion of the reserve position doctrine, also including a comparison with the short-term interest doctrine, see Bindseil (2004) and Häring (2013).

  22. 22.

    Cf. Graziani (1990, p. 26). Quantum macroeconomics, by contrast, continues to treat M2/M3-deposits as loanable funds, and banks as both monetary and financial intermediaries. Cf. Cencini and Rossi (2015, pp. 53, 143, 165–169, 226).

  23. 23.

    After Seiffert (2012, pp. 44, 78–97).

  24. 24.

    Also cf. Ryan-Collins et al. (2012, p. 62).

  25. 25.

    Friedman (1971, p. 846).

  26. 26.

    Theurer (2014).

  27. 27.

    Office of the New York State Comptroller, The Economist, March 15, 2014, 81.

  28. 28.

    Philippon and Reshef (2009).

  29. 29.

    http://www.gehaltsreporter.de/gehälter nach branchen, January 18, 2015.

  30. 30.

    Turner (2012, p. 56).

  31. 31.

    Cf. Sobrun and Turner (2015) and Rachel and Smith (2015).

  32. 32.

    Cf. http://www.sovereignmoney.eu/monetary-puzzlement.

  33. 33.

    Cf. Fein (2013), Barghini (2015), and Pignal (2015).

  34. 34.

    McMillan (2014, pp. 54–79).

  35. 35.

    For example, McMillan (2014, p. 137).

  36. 36.

    Cf. Moore (1988a, b). Rochon (1999a, b, pp. 15, 17, 155, 163, 166). Rossi (2007, p. 29) and Keen (2011, p. 358).

  37. 37.

    Also see Ryan-Collins et al. (2012, p. 103).

  38. 38.

    Lagos (2006) and Roche (2012).

  39. 39.

    Mitchell-Innes (1913, pp. 392 | 30, 394 | 31). Similar statements in Mitchell-Innes (2014).

  40. 40.

    Soddy (1934, p. 25).

  41. 41.

    Wray (ed.) (2004, pp. 11, 255, 259, 269).

  42. 42.

    Walsh and Zarlenga (2012, p. 2). Also cf. Zarlenga’s critique of Innes’ ‘Credit Theory of Money’ written in 2002b. Distinctness of money and credit/debt also covers the circuitists’ understanding of money as a means of payment for the final settlement of a debt; which is remarkable, because circuitism clearly also stands for the theory of credit-based endogenous money. Basically the same position is also shared in the writings of Goodhart.

  43. 43.

    Knapp (1905, p. 42); author’s own translation.

  44. 44.

    Lerner (1947, p. 313). Both Knapp and Lerner, by the way, are considered by MMTers as their chartalist forefathers together with Mitchell-Innes. The quotes above, however, conflict with MMT’s absolute identification of money = credit = debt.

  45. 45.

    Graziani (1990, pp. 11–12, 2003 pp. 61–62).—Also cf. Bjerg (2014, pp. 105, 121).

  46. 46.

    Cencini and Rossi (2015, pp. 30–37) and Rossi (2005, p. 144).

  47. 47.

    Cencini and Rossi (2015, pp. 226–240) and Rossi (2001, pp. 169–184, 2007, pp. 126–132).

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Huber, J. (2017). Money and Banking Today. In: Sovereign Money. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-42174-2_4

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