Sadly, readers were left with the erroneous impression that the matter is not settled but is still one of contention.
The Herald’s decision did further damage to Don Brash’s reputation by giving him another chance to air the misapprehensions under which he seems to labour – but that’s cold comfort. Brash had nothing to say on the central issue of how money is created, other than to deny (without any evidence or countervailing argument) what is now almost universally accepted – that an individual bank, in the act of placing a credit entry in a borrower’s account, creates new money.
Don Brash betrays his failure to understand the process of money creation described authoritatively in the Bank of England paper published in 2014. As that paper says:
“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...In reality in the modern economy, commercial banks are the creators of deposit money...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.
“Bank deposits make up the vast majority – 97% of the amount [of money] currently in circulation. And in the modern economy, those bank deposits are mostly created by commercial banks themselves.”
The paper’s conclusions are accepted by almost all leading economists, including Lord Adair Turner (former Chair of the Financial Services Authority in London) and Professor Richard Werner of Southampton University. They were foreshadowed in a 2008 paper by the Reserve Bank of New Zealand itself.
Why don’t banks write cheques to themselves?
Brash seeks to undermine the clarity of these statements by asking why, if banks create money, would they bother to do anything other than write cheques to themselves? But this simply underscores his failure, or refusal, or inability, to grasp the point. Banks cannot of course write cheques to themselves – they create money by advancing credit to borrowers. They do need to have capital reserves for prudential purposes, but they have no capacity to create money for this purpose. As the Bank of England explains:
“The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the [central] Bank.”
Brash’s denial that commercial banks were responsible for creating most of the money in circulation had to be either a deliberate attempt to mislead, or the consequence of simple ignorance – or so I thought earlier. But since he states that he “is aware” of the Bank of England paper (and has therefore presumably read it), I can only assume that his continued denial of what that paper tells us is the consequence of intellectual limitations.
It is very frustrating that what is now a virtually undisputed truth has been continually confused by palpable errors in Brash’s contributions, and that they are given unjustified credibility by their publication in the Herald.
It is surely time that our own Reserve Bank should come clean and say whether or not they accept and agree with the conclusions of the Bank of England.
We could then have a properly informed debate about the policy implications of the banks’ virtually unconstrained power to create new money.
Bryan Gould – educator, politician, writer – has been a UK Labour MP and was Vice- Chancellor of Waikato University until 2004, when he was awarded an Honorary Doctorate and made a Companion of the New Zealand Order of Merit.