Bank buys all public debt for free?

7 and 8 April 2016, translated from Dutch by the author


Thanks to money creation, can a bank buy the whole of the national debt, without any cost to them, just for free? Banks can create money themselves, right?

That question was posed – in somewhat different words – to the Dutch Minister of Finance, Jeroen Dijsselbloem, by Member of Parliament Teun (also Tony) van Dijck, speaking for the Freedom Party (PVV) on 16 March 2016.

Is it really the case? Is that really possible? I think not, and I will go through the figures. I will be looking at five scenarios (no, six, at the end there’s also one about Draghi):

  1. A bank buys existing government bonds from a non-bank.
  2. A bank buys existing government bonds from a different bank.
  3. A bank buys newly issued bonds from the government, the government does not yet spend the money.
  4. The government spends the money it acquired by issuing the bonds.
  5. A pension fund buys new bonds, the government first does not spend the money, later does.

Bank buys government bonds from non-bank

Always those bank balance sheets again. But they are necessary. Without them, the discussion keeps floating in the air. That is unless you can visualise the bookkeeping reality in your head, just from words. Lately I often can, but that was different in the past. Perhaps that is why my later articles are less clear than the older ones. This article does have balance sheets.

For the buying bank I assume the following simplified initial situation. All amounts in millions of euros, or billions, whatever, it’s the principle that matters:

Description Debit (assets) Credit (liabilities)
Reserves account with central bank 10
Capital 10
Outstanding loans 100
Savings and transaction accounts 100

The balance sheet of the bank where the current owner of the government bonds has his account, I assume to be totally empty. Not realistic of course, but easier to handle.

The bank wants to buy government bonds worth 1 million, from the non-bank party that currently holds them. Via the debenture market, settlement mechanisms or whatever the details are, the result is that the bank’s balance with the central bank changes from 10 to 9 million. Despite the very real phenomenon of ‘money creation’ – which we will look at in a moment – the bank simply has to pay for the securities, just like everybody else who wants to buy something.

As a consequence, the former owner’s bank’s balance with the central bank goes from 0 to 1 million. That is to compensate for the fact that the former owner of the bonds, who is a client of that other bank, now has a balance of 1 million. So the new situation is like his:

Buying bank:

Description Debit (assets) Credit (liabilities)
Government bonds 1
Reserves account with central bank 9
Capital 10
Outstanding loans 100
Savings and transaction accounts 100

Seller’s bank:

Description Debit (assets) Credit (liabilities)
Reserves account with central bank 1
Savings and transaction accounts 1

Did this transaction involve money creation? Yes.

That’s because beforehand the money supply (counting just these two banks) was: 100 million in demand deposits, owned by clients of the buying bank.

Afterwards these are still there as before, but in the selling bank, the former owner of the government bonds exchanged those for a 1 million euro bank balance. Total money supply (I keep it simple and don’t distinguish M1, M2, M3 etc., but throw everything together) went from 100 to 101. So there was an increase of money supply.

In other words: those 1 million euros the bank used to pay for the bonds, while in the bank was MB (bank money) but not M1; but as a balance held by the former owner of the government bonds, it has become M1 – because in the current scenario, the former owner is a member of the public, e.g. a pension fund. So in terms of M1, the money supply has increased.

Not because there was an addition of value somewhere, not because the bank conjured up money. The buying bank still has the same balance sheet total and the same equity. The previous owner of the bonds and his bank didn’t get any richer nor poorer either (disregarding commissions, price risk etc. for the moment). Because a certain amount changed character, and therefore statistically counts differently, there was, as the expression goes, money creation.

Did this money creation make is easier for the bank to buy the bonds? Were they effectively cost-free? No, the bank had to pay for them using its balance at the central bank. The bank had ten million and now only has nine left. But it has an extra one million in securities.

Money creation does NOT mean a bank makes money, which it can then use for some purpose. Money creation means that as a result of some transaction, a certain type of money supply (one of the aggregates) increases, based on definitions. In essence that definition is: money is claim by the public on banks. Banks and governments are not the public.

Bank buys government bonds from a different bank

Same as the previous scenario, except that the former owner of the government debentures is not a client of a different bank, but is that bank itself. For the buying bank, that makes no difference. For the selling bank however, the situation changes from:

Description Debit (assets) Credit (liabilities)
Government bonds 1
Capital 1
Reserves account with central bank 0
Savings and transaction accounts 0


Description Debit (assets) Credit (liabilities)
Government bonds 0
Capital 1
Reserves account with central bank 1
Savings and transaction accounts 0

Now no money creation has taken place. Instead of the former owner (member of the public) obtaining a balance in the bank, it’s now the selling bank (not a member of the public) getting a balance in the central bank. That is bank money (MB), not M1. The money supply in terms of M1 is still the same. So no money creation.

Now too, the purchasing bank simply had to pay for the securities. In the earlier scenario, the bank did not benefit from the money creation taking place; the lack of it now does not mean a disadvantage. Simply pay for what you purchase, just like everybody else, bank or no bank.

Bank buys new government bonds, government does not yet spend

There is no difference for the buying bank. However, the money the bank pays, is now paid not to an earlier holder of the securities, but to the issuing government.

As long as the government does not spend the money, but instead keeps it in a bank account (central bank or non-central bank), there is no money creation: the money was not in the hands of the public (held by a bank) and still isn’t (held by the government).

M1 remains equal.

The government spends the money acquired

Only when the government start spending the money it borrowed, for example by paying a teacher’s salary of ordering to build a new road, money creation occurs.

It’s so ironic: people who find money creation by lending banks scary and undesirable, often want to make it the government’s job. In reality every government expenditure ALREADY involves money creation. Public education teachers are paid using freshly created money. But stating it that way is just as inaccurate and misleading as saying that banks provide loans from self-made money.

Pension fund buys new debentures

Also fun to look into: scenarios three and four, but then with a pension fund in the role of the bond buying bank. Then the purchase causes money destruction!

That’s because the pension fund (being a member of the public) had money in the bank, obtained for example from contributions, interest or dividends, or from the sale of earlier investments.

That money counts towards the money supply, but once it has arrived, after the purchase, with the government, it no longer counts. That means money destruction. This destruction is made up for, by the money creation that happens as soon as the government spends the amount it obtained. That is unless the payee is also a non-member of the public, like when the government pays for banking services.

Just like for buying banks it makes no difference if money creation occurs (scenarios 2 and 3) or doesn’t (scenarios 1 and 4), the purchasing pension fund doesn’t get any poorer as a result of the money destruction taking place either. In all cases the buyer first had money (of a certain monetary kind), then has government debentures. Just buy them and pay for them. That is normal and not unfair.

So what about Draghi?

So what about Mario Draghi? Doesn’t he buy (as president van the ECB) 80 billion euros worth of euro zone government bonds every month? That’s the so-called Quantitative easing (QE).

How does the ECB pay for that? Using made-up virtual money, surely?

Answer: they borrow that money indirectly from banks and investors.

Late July/early August 2012, when I already understood things better than by the end of June that year, but not half as well as I do now, I wrote:

I do believe central banks can create money at will, simply by physically printing extra banknotes. They have the monopoly of doing that.

I now see that that isn’t true. Central banks too cannot make money from nothing and get richer doing so. Not using banknotes and not on accounts. That’s because the central bank sells printed banknotes to banks, who have to pay for them with a lower balance or a higher loan. The banknotes themselves become a debt of the central bank, once they leave their vaults. So in fact they are a loan by the public or by the receiving bank.

The central bank can create bank money (MB), using similar mechanisms as for the creation of M1 by non-central banks, but in all cases value is added on both sides of the balance sheet, while only one side counts towards the money supply. The net value of debit and credit is the same, that is: zero. Always and by definition.

In concrete steps: we go through scenario 1 again, but we turn it into a Draghi transaction by now giving the ECB the part of the buying bank. In this scenario too, the bonds to be purchased are in the hands of a non-bank party who has a bank account with a non-central bank. The hypothetical, very much simplified balance sheet of the European Central Bank, before the transaction:

Description Debit (assets) Credit (liabilities)
Gold and securities 10
Capital 10
Outstanding loans to banks 100
On demand reserves of banks 100

Situation after the purchase of 1 million worth of government debentures (I disregard the technical complication that the ECB probably doesn’t deal with individual banks directly, but rather through national central banks):

Description Debit (assets) Credit (liabilities)
Gold and securities 11
Capital 10
Outstanding loans to banks 100
On demand reserves of banks 101

The security holding has changed from 10 to 11 million. (Just an example, in reality it seems to be about several tens of billions a month.) Banks, among which the former bond owner’s bank, used to have on demand reserves worth 100 million, now have 101. MB has increased, so has M1 – that’s because the account holder with the non-central bank also received 1 million extra in his account. The bank has more cash reserves, so in theory, based on that criterion, it can lend more, which is one of the objectives of the QE policy. (Although I don’t think that works, but that’s off-topic.)

On balance, the central bank did not become any richer: its security holding has grown, but so have the bank claims, which are debts in the ECB’s books. Hence my statement, now well-founded: Draghi buys public debt using borrowed money, not created money. He borrowed it from those who first owned the securities.

And where newly issued bonds are concerned: from euro zone countries’ governments. For those states obtain a higher claim on a bank, which the bank gets compensated for by a higher claim on the central bank.

The ECB both borrows from (the acquisition price) and lends to (the bonds) governments. On balance nothing happens, purely looking at the amounts, except that the conditions are asymmetrical. That’s not strange, that is the essence of bank credit.


Purchasing securities, such as government debentures, depending on the situation sometimes causes money creation, sometimes money destruction, sometimes neither. That involves MB or M1 or both.

In all those cases the buying party simply has to pay for the securities. The occurrence of money creation or destruction does not make the transaction any cheaper or more expensive.

That’s because money creation is something different than what the expression seems to suggest. It is not a wilful act, it is an automatic phenomenon. Money creation can only be properly understood through careful accounting using examples. Discussions with just words will soon turn out to confusion of tongues and stubborn misunderstandings.

PS: helicopter money

Some people are saying the ECB shouldn’t be buying national debt, but instead give all citizens a thousand euros. That is the so-called helicopter money, a term based on metaphorically scattering banknotes from a helicopter.

Then I wonder: who pays for that? Paying it from money creation is not possible. I’m not gonna do the calculations right now (a homework assignment for the reader?), but it seems likely to me that one side of the ECB balance sheet will then be lacking something. Perhaps the ‘solution’ is a backing by fake securities again?

I suspect this is the truth: even disregarding whether helicopter money would really stimulate the economy, and whether the economy needs to be stimulated at all (enough is enough): helicopter money isn’t even possible.

Because the central bank cannot afford it. It can afford buying public debt. Because then the assets back the money.

Addition 15 april 2016

See also this concise comparison, which clearly shows why a bank cannot ever pay anything with money they themselves created. Simply the wrong side of the balance sheet!!

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