Where does money come from?

New book offers clear understanding of core economic issue

At the heart of our dysfunctional financial system is a poorly understood fact: private banks create the vast majority of the money supply – 97% according to most estimates. These are not central banks, or institutions which could be viewed as democratically accountable or representing the public interest, but private banks.

Banks create money when they ‘extend credit’. What this really means is making a loan, fulfilling an overdraft or buying a financial asset. When a bank makes a loan it creates both an asset (the loan), which you owe to it, but also a liability (a deposit), which it owes to you. This is double-entry bookkeeping. The bank doesn’t take the deposit out of anyone else’s account. The balance that appears in your account is a brand new deposit.

But unlike an IOU between me and you, scribbled on a piece of paper, this electronic bank IOU is impersonalised; it is accepted by everyone else in payment for goods and services and by the government for taxes.

Banks are usually described as ‘financial intermediaries’ that ‘recycle’ the deposits we’ve put in them for safekeeping, as loans. In fact, it’s the other way round. Bank loans create deposits. Banks are better described as credit creators than intermediaries.

In an effort to banish these misunderstandings and create a shared reference point upon which to build arguments for alternatives, at the New Economics Foundation (nef) we decided to write a book on the topic: Where Does Money Come From? A Guide to the UK Monetary and Banking System. It lays out the facts in clear jargon-free language suitable for all audiences.

We’ve written the book in conjunction with Professor Richard Werner from the University of Southampton, a globally recognised expert on the relationship between banks and the economy. There is also a forward by Professor Charles Goodhart, one of the world’s leading monetary economists and a founding member of the Bank of England’s Monetary Policy Committee.

In researching the book we read hundreds of documents published by the Bank of England and other sources and consulted with experts from banking and academia as well as former bankers themselves.

The book reviews theoretical and historical debates on the nature of money and explains how we arrived today with a system controlled by banks. It includes in-depth explanations of the role of the central bank, regulators, the government and the European Union in influencing the creation and allocation of money. Controversial topics are covered in depth, including the emergence of bond issuance, fractional reserve banking, the ‘money multiplier’ theory, fiscal policy, crowding out and quantitative easing.

The book concludes that the current monetary system is inherently unstable, depending as it does on the confidence of private banks themselves. Interest rate adjustments have proved to be a weak tool in influencing bank’s lending decisions. The central bank and the government have chosen, through successive rounds of deregulation, to exert less and less control over either the quantity of new money created or whether it is used for productive or speculative purposes. This has lead to increasingly severe credit booms and busts, culminating in the financial crisis of 2008-09.

Ultimately, it is the private banks’ decisions on how much credit to create and to whom it is allocated that determines the shape of our economy. Without a shared understanding of this vitally important dimension of our financial system, reforms will not be effective and our economy will remain at the mercy of a dysfunctional banking sector.

Where Does Money Come From? A Guide to the UK Monetary and Banking System

by Josh Ryan-Collins, Tony Greenham, Richard Werner and Andrew Jackson

Foreword by Charles A. E. Goodhart

Published by the New Economics Foundation

ISBN: 1908506075

Read it and don’t weep.

Headlines about what’s going right in the world are now being shared with millions of people through digital screens on high streets and in shopping centres all around the UK.