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Give up commensurable consideration

19 June 2013

Introduction

In my previous article, I semantically analysed questions that people in the MPE movement have posed to central banks. My conclusion was that the questions were rather unclear and that several interpretations are possible. I promised to answer these questions, in all the senses I could distinguish.

Of course I will not answer the questions on behalf of the central banks they were posed to, because I have no connection with any banks whatsoever, central or otherwise.

I reply only from the desire to see things as clearly as possible myself, and where I succeed in achieving such clarity, I feel strongly like sharing it with anyone willing to read.

Barking up the wrong tree

First, the questioners are barking up the wrong tree. That’s because the questions are, among other issues, about money creation.

By definition, money (in the monetary sense!) consists of coins, and claims on banks, held by the public (meaning: households and companies). In the words of Modern Money Mechanics (hereafter: MMM): “[...] only the cash and balances held by the nonbank public are counted in the money supply.

Central banks don’t normally deal directly with the public. As a consequence, by definition, central banks do not have any money and do not create money.

Central banks do issue banknotes. Banknotes are money when held by the public, because they represent claims on the central bank that issued them. However, central banks don’t usually put banknotes into circulation directly, but rather via non-central banks.

I said central banks do not create money. Non-central banks do, and it is the central bank of the currency and country or state in question, that monitors money creation and sets limiting conditions for it.

That means questions about money creation should be asked to non-central banks, because that is where money creation happens; or to central banks in their role of monitoring and controlling non-central banks’ money creation. Not in central banks’ role of creating money themselves, because they don’t.

The above isn’t quite true. Central banks do sometimes create money directly: when buying securities from non-bank traders. For an example see MMM, in the beginning of the section headed “Bank Deposits – How They Expand or Contract”. Details, details, … .

The questions

Where found?

The questions I take as my starting point are here.

In one case, because of the confusion between “lawful consideration” and “commensurable consideration”, I draw in a remark by Mike Montagne from this page, posted on 29 May 2013.

Question 1

1) What lawful consideration do you claim the BoE gives up when it creates money ?

(Note: “BoE” stands for ‘Bank of England, the central bank of the United Kingdom.)

My interpretation 1, plus answer

First I assume the question means this:

‘Who (governmental authorities) and what (laws, contracts) gave the bank the right to create money? Why does the bank think it is allowed to create money, while others are not?’

My answer then is:

No such consideration or justification is needed. That’s because money creation is not something that banks wilfully do. Instead, it is an automatic and inevitable side-effect of credit granting by banks to the public.

An analogy:
If you lean over forward, but fail to also move one leg to the front, you will fall. You don’t need a government permit for that, it doesn’t matter if any legal basis or justification for it exists or not, if there is a law that says you are allowed to fall or obliged to fall. You just fall. It simply happens. Always. (Unless you do put a foot forward. And you will, because that is an automatic life-saving reflex. So in fact: not always, but never.)

Money creation, as a result of a bank granting credit to someone in the public, logically follows from two elements:

  1. The monetary definition of money: total money supply consists of coins in the possession of the public, banknotes in the hands and pockets of the public, and credit balances in (on demand and short term savings) bank accounts held by the public.

  2. The rules of accounting, as outlined (probably based on already existing best practices) by Luca Pacioli in 1494, now 519 years ago.

Granting a loan to someone in the public (a person, household or company) entails two entries in the bank’s books:

  1. A debit entry in the client’s loan account.

    This represents the client’s promise (or in fact: obligation) to pay the amount back at some point in time. (When and in how many instalments will vary, as agreed in more detailed arrangements between bank and client.)

    This entry shows an amount that the borrower owes the bank, in other words, a claim of the bank on the borrower, in yet other words: a financial asset owned by the bank.

  2. A credit entry in the client’s current account (checking account, on demand account; various terms exist).

    This represents the bank’s promise (or in fact: obligation) to make the loan sum available to the borrower, so he can use it for payments or set it aside as savings, or take it out as cash, whatever pleases the borrower.

    This entry shows an amount that the bank owes the borrower, in other words a claim of the borrower on the bank, in yet other words: a financial asset owned by the borrower.

A financial claim of the public on a bank (ii) by definition is money.

A financial claim of a bank on anyone (i) by definition is NOT money.

So of the two entries made in the bank’s books, as outlined above, only one counts towards the money supply. The other one (at the debit side) does not!

That is why money creation happens! Not by choice of the bank, but as an automatic consequence of what money is, plus the consistent and logical working rules of the universally used double-entry bookkeeping system!

In fact this is nothing new, because I already described this is my articles  1 ,  2 ,  10  and  11 . But some people don’t seem to understand, so I thought I’d explain it again, in different words.

My interpretation 2, plus answer

So the question was:

1) What lawful consideration do you claim the BoE gives up when it creates money ?

I argued that a possible other interpretation of this question, when also involving the expression “commensurable consideration”, is this:

‘The bank creates money that never existed before, for its own benefit, just to demand interest for it, and it itself never paid for obtaining that money. It got the money for free itself and makes others pay for borrowing it and that’s unfair. So please show how the bank itself pays or compensates for the money it creates, and then borrows to clients against interest.’

Now in light of the previous answer, this one is easy: the created money itself is the consideration, is the recompense.

Many people think banks create money and then pass that money on to the borrower. But that’s not how it works. The created money is always (and by definition) at the credit side of the bank’s balance sheet, because, from the very first second of its existence, that money is in the possession of the bank client, the borrower.

The created money is something the borrower owns, not something the borrower owes to the bank. Money is claim, is possession. Money is not debt.

The borrower does also owe the bank something, initially (just after the loan has been granted, and it is still unspent) in the same amount. But that is in a different account in the bank’s books. It has to be so, because the conditions and duration of these two accounts (the loan account and the checking account) are so different.

If theoretically (but against proper accounting rules) we balanced those two accounts, the result (again: only initially, before anything of the amount has been used for payments) would be zero. No debt, no claim, no created money. But that would be incorrect bookkeeping, so that’s not how it’s done.

However, this theoretical zero balance corroborates my earlier statement: money creation does not make a bank richer. It does not give the bank more money, it does not result in money the bank now has and never paid for or sold any assets for.

Money creation does not result in money for nothing.

Question 2

2) How then does the bank (or does the bank) claim there is a debt to the bank ?

My answer:

From its books, just like any other company. Bookkeepers make the entries, external accountants check them, and every year this results in an annual report. In most countries, companies of some size are obliged to make their annual reports publically available.

They are often put on websites nowadays.

Question 3

3) What is the claim to interest then, when the bank can do no more than absorb the costs of merely publishing evidence of our promissory obligations *to each other* ?

(I assume that “our” here refers to clients of a bank.)

My interpretation is this question:

‘Banks have no other expenses or costs than those for said publishing, so their charging so much interest is unjustified’.

My answer:

Banks do a lot of things, but what they certainly do not do is publish, or even record, promissory obligations between their clients.

Like any other company, banks do record, in an accounting system a.k.a. bookkeeping system, what its own assets and liabilities are. Those include financial claims and obligations in relation to the many parties they do business with.

Keeping such records in most countries is obligatory for any company. Well, probably in all countries anywhere in the world.

I’ll discuss this issue later in a separate article, because this thing about those promises “to each other”, allegedly recorded by banks, is yet another misunderstanding that is at the heart of the MPE ideas.

Interest received by a bank serves to cover expenses, interest paid, dividends and reserves. I wrote about that before. The interest is also a reward for actual services being provided: transformations, risk bearing, etc.

Question 4

4) How is it possible even to maintain a vital circulation without accumulating inevitably terminal sums of debt ?

My answer:

This question is based on the delusional idea that interest causes a never stopping increase of debt, and a shortage of money in circulation. In reality, no such danger exists, for the following reasons:


Copyright © 2013 R. Harmsen. All rights reserved.

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