Chapter 29 - A Lesson from The Bank of England Bulletin

This is quite an amazing document that you can find on the Bank of England website. Like a scream from the inside the banking system, this is telling us to “wake up”. What is significant is that it reveals that the economics profession has been misleading gullible young economics students. Read every line. Then read it again. There are some little gems written in the clever wording that only the smartest amongst you are going to recognize:

Excerpts from a ‘Bombshell’ Bulletin by the Bank of England (2014 Q1) [1]

“This article explains how the majority of money in the modern economy is created by commercial banks making loans.”

Andy Chalkley  My comment: 3% of money is created as Cash Currency by the Bank of England. 97% is created as bank-credit when banks make loans. A bank creates one million pounds of bank-credit and one million pounds of debt at the same time and the two make a zero-sum total. There is then one million pounds more money in the nation and one million pounds more debt. The debt then magnifies with interest.

“Money creation in practice differs from some popular misconceptions - banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.”

Andy Chalkley  My comment: ‘Popular’ means almost everybody. ‘Misconceptions’ means they are wrong. A polite way of saying that most of the economists have it wrong.

Andy Chalkley  The ‘Money Multiplier’ concept that economics students are taught is wrong. The next question is: “Were they purposely deceived?”

“The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates.”

Andy Chalkley  They state: “majority of money in the modern economy is created by commercial banks making loans.” The central bank tries to adjust the loan habits of banks by adjusting the interest rate. They have no direct way of controlling the volume of money in the Money Supply. They have no mechanism to control how much fresh bank credit is created. The central bank has no mechanism to force loans on the civilians. They have no mechanism to control the areas to which money is lent. They have no mechanism to ensure that business has adequate credit to operate. They pretend to control the magnitude of the Money Supply with the hopelessly ineffective approach of adjusting the interest rate. When this goes wrong, as it invariably does, they try some other desperate measures, that also fail. One desperate measure is to purchase government debt with money they create out of thin air. Unfortunately, they purchase them off institutional investors that have more money than they can spend and the money never gets into the ‘real economy’. We get a recession and the government gets the blame.

“The central bank can also affect the amount of money directly through purchasing assets or ‘quantitative easing’.”

The velocity of money equals two by Andrew Chalkley. Creative Commons Attribute.

Andy Chalkley  In ‘abnormal’ times, they purchase bonds (or assets) using fresh bank-credit which the central bank creates out of thin air. This increases the Money Supply. This desperate measure is called ‘quantitative easing’. It is also called ‘open market operations’. However, the freshly created bank-credit moves to institutional organizations and tends to become Hoarded Money. The action usually fails because the money does not reach the real economy. The central bank creates money out of thin air whenever it wishes but government only gets more money by getting into debt.

Bank of England purchases bonds
Forced spending as a way of increasing the Circulating Money does not work. (Andrew Chalkley)

“In the modern economy, most money takes the form of bank deposits. How those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”

Graph of United Kingdom Money Supply and Debt

“The reality of how money is created today differs from the description found in some economics textbooks:”

Andy Chalkley  The textbooks are misleading our economics students.

“     Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.”

Andy Chalkley  Bank credit is not created by placing cash with the bank. Bank credit is created when loans are made.

“    In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits. In normal times, the Bank of England implements monetary policy by setting the interest rate on central bank reserves. This then influences a range of interest rates in the economy, including those on bank loans.”

Andy Chalkley  They state: "the central bank does not fix the amount of money in circulation"

Andy Chalkley  The ‘Money Multiplier’ is a myth.

Andy Chalkley  This is called collusion in most industries.

“In exceptional circumstances, when interest rates are at their effective lower bound, money creation and spending in the economy may still be too low to be consistent with the central bank’s monetary policy objectives. One possible response is to undertake a series of asset purchases, or ‘quantitative easing’ (QE). QE is intended to boost the amount of money in the economy directly by purchasing assets, mainly from non-bank financial companies.”

Andy Chalkley  I did not notice the implication of this last statement until I re-read it, much later. This one is important. They are talking about the magnitude of the Money Supply. When banks collect more loan repayments than they create new loans, the Money Supply drops with the unpleasant consequence of a fall in Circulating Money. The government has no control over this whatsoever. The banks can neither encourage nor force the public to take on more debt. More debt is needed to create more credit. The farce that the Money Supply can be adjusted by adjustment of the interest rate is exposed. They mention that the interest rate is reduced to ‘stuff all’ and still the public will not take on more debt. You can see that he is cagey about the effect of QE. “QE is intended to boost the amount of money...” It does put more money into the Money Supply but in the wrong place. It puts it into the hands of institutional investors.

Now I need to explain how government bonds are purchased. I will dot point them because this is tricky. You may need to puzzle through this a few times. Contact me by email if you still don’t understand. It is essential that you understand this:

Now it gets even more complicated. If the government sells bonds, it receives bank credit that it spends on government expenditures which almost always goes straight into the Circulating Money. They are often sold to institutional investors who pay with Hoarded Money. So money has moved from Hoarded Money to Circulating Money. If the central bank creates fresh money and purchases bonds, the freshly created money passes to a financial institution and tends not to get into the Circulating Money. This is one massive error on behalf of the ‘talking heads’.

On occasions, they force the hand of the government to take on more debt. The term ‘Quantitative Easing’ is a doublespeak to obfuscate the reality that the central bank is incapable of controlling the banks that issue bank-credit. They do not slow the banks when they issue too much bank-credit. They panic when the banks reduce the bank-credit. They purchase government bonds and often force the government to take on more debt to increase the Money Supply. This has the potential to work, but lifting the economy is not as simple as pushing more money into the Money Supply. It is true that a fall in the Money Supply removes Circulating Money and damages the economy, but the reverse is not true. Increases in the Money Supply are more likely to go to Hoarded Money than Circulating Money. So I go through the dot points again:

Andy Chalkley  The central bank can actually buy any assets to give the same effect because it is using fresh bank-credit to do so.

“money is largely created by commercial banks making loans.”

Andy Chalkley  Only 3% of the Money Supply was created as Cash Currency by the Bank of England. 97% is virtual credit created by private companies called banks. The virtual credit has a habit of collapsing economies.

“The vast majority of money held by the public takes the form of bank deposits.”

Andy Chalkley  It is credit, not money.

“One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them.”

Andy Chalkley  ‘Deception’ is probably a better word than ‘misconception’.

“Saving does not by itself increase the deposits or ‘funds available’ for banks to lend.”

Andy Chalkley  Saving increases the Hoarded Money which, besides creating instability, reduces the available Circulating Money. This requires an increase in the Money Supply which means that more debt has to be put around someone’s neck.

“Indeed, viewing banks simply as intermediaries ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. This article explains how, rather than banks lending out deposits that are placed with them, the act of lending creates deposits - the reverse of the sequence typically described in textbooks.”

Andy Chalkley  Not only are the textbooks wrong they are totally wrong. Commercial Banks are the creators of deposit money. They create bank credit on an as needs basis without reference to the central bank.

“Another common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money - the so-called ‘money multiplier’ approach. ...”

Andy Chalkley  I think they are admitting that they have utterly no control over the volume of money. If you believe that the central bank is capable of controlling the Money Supply, you have been deceived. The central bank is a front organization enabling the banks to extract nearly as much money as interest as the government collects as tax. This inappropriately named Bank of England may be owned by the government but, like my daughters’ car, the government has no control over it. It operates as a collusion exercise for the private banks in their creation of loaned virtual bank-credit.

“...In that view, central banks implement monetary policy by choosing a quantity of reserves. And, because there is assumed to be a constant ratio of broad money to base money, these reserves are then ‘multiplied up’ to a much greater change in bank loans and deposits. For the theory to hold, the amount of reserves must be a binding constraint on lending, and the central bank must directly determine the amount of reserves. While the money multiplier theory can be a useful way of introducing money and banking in economic textbooks, it is not an accurate description of how money is created in reality.”

Andy Chalkley  My comment: A very polite way of calling the economics profession a bunch of idiots. The banks can borrow the reserves. They do not need wads of real money.

“In reality, neither are reserves a binding constraint on lending, nor does the central bank fix the amount of reserves that are available. As with the relationship between deposits and loans, the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks.”

“Broad money is made up of bank deposits - which are essentially IOUs from commercial banks to households and companies - and currency - mostly IOUs from the central bank.(4)(5) Of the two types of broad money, bank deposits make up the vast majority - 97% of the amount currently in circulation.(6) And in the modern economy, those bank deposits are mostly created by commercial banks themselves.”

“Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.”

Andy Chalkley  When a bank lends money, it creates the principal out of thin air by writing a credit amount in a ledger. It writes a million pounds with a plus sign in one account and a million pounds with a minus sign in another account.

“Similarly, both sides of the commercial banking sector’s balance sheet increase as new money and loans are created.”

Andy Chalkley  Plus one million pounds and minus one million pounds equals zero. Debt and credit are created in equal amounts at the time of making a loan.

“While new broad money has been created on the consumer’s balance sheet, the first row of Figure 1 shows that this is without - in the first instance, at least - any change in the amount of central bank money or ‘base money’. As discussed earlier, the higher stock of deposits may mean that banks want, or are required, to hold more central bank money in order to meet withdrawals by the public or make payments to other banks. And reserves are, in normal times, supplied ‘on demand’ by the Bank of England to commercial banks in exchange for other assets on their balance sheets.”

Andy Chalkley  This is quite and admission! If the banks need reserves, they borrow the shortfall from the Bank of England!

“In no way does the aggregate quantity of reserves directly constrain the amount of bank lending or deposit creation. This description of money creation contrasts with the notion that banks can only lend out pre-existing money, outlined in the previous section. Bank deposits are simply a record of how much the bank itself owes its customers.

Andy Chalkley  The bank does not have the money in your account. Your bank balance is the amount the bank owes you in government Cash Currency. Your bank account is virtual.

“So they are a liability of the bank, not an asset that could be lent out. A related misconception is that banks can lend out their reserves.

Reserves can only be lent between banks, since consumers do not have access to reserves accounts at the Bank of England.”

Andy Chalkley  They borrow reserves.

“Just as taking out a new loan creates money, the repayment of bank loans destroys money.”

Andy Chalkley  Thus, if repayments are greater than the issue of new loans, the Money Supply shrinks. The economy is destroyed.

“Money creation is also constrained by the behavior of the money holders - households and businesses.

Households and companies who receive the newly created money might respond by undertaking transactions that immediately destroy it, for example by repaying outstanding loans.”

“As discussed earlier, repaying bank loans destroys money just as making loans creates it.”

Andy Chalkley  It thus follows that if loans are repaid faster than new loans are made, the Money Supply falls damaging the real economy.

“One of the Bank of England’s primary objectives is to ensure monetary stability by keeping consumer price inflation on track to meet the 2% target set by the Government.”

Andy Chalkley  A convenient way of making the government the scapegoat. It may be an objective, but they are not capable of achieving their objective. The central bank is present to make it look as though the economy is being controlled.

“This demand for base money is therefore more likely to be a consequence rather than a cause of banks making loans and creating broad money. This is because banks’ decisions to extend credit are based on the availability of profitable lending opportunities at any given point in time.”

Andy Chalkley  Banks lend for profit, not for the benefit of society. I believe the authors are saying that it is counter-cyclical. When more money is needed they lend less and when less money is needed in the Money Supply they lend more.

Observations and Comments

 The Bank of England has produced a bulletin that destroys the concepts that the economics faculties have been teaching in their hocus-pocus economics courses.

 The banks are creating the money.

 The government is not creating money.

 Bank Credit and debt are created at the same time.

 For each pound of Bank Credit created, there is a pound of debt created.

 Banks do not lend out other people’s deposits.

 The economics books are wrong about the multiplier effect.

 The economics books are giving false information to young economists.

 Reserve requirements tend not to be able to control the Money Supply.

 Loans are issued without reference to the central bank

 Loans are issued without transactions occurring at the central bank

 Loans are created by merely making a credit in one account and a debit in another account.

 Reserves of the central bank are not required before a bank makes a loan.

 Reserves can be borrowed from the central bank (or another bank).

 Repayment of loans destroys money.


I suggest that you read this page again.