8 and
This is the elaboration of what I already summarised here.
This is from page 17 of The Positive Money Proposal:
“In short, neither profit-seeking
bankers nor vote-seeking politicians can be trusted with the
power to create money, as the incentives both groups face
will lead them to abuse this power for personal, party, or
company gain. Instead, we must ensure that the creators of
the money supply do not benefit from creating it. This
requires the separation of the decision on a)
how much new money is to be created from b) how that
newly created money is to be used.
The two decisions are therefore given to completely separate
bodies. We recommend that an independent body, the Monetary
Creation Committee (MCC), should take decisions over how much
new money should be created, while the elected government of
the day should make the decision over how that money will be
spent. Alternatively, the MCC may lend money to the banks to
on-lend into the ‘real’ economy, in which case
the decision over where the money is lent will be made, within
broad guidelines, by the banks.”
On pages 19 and 20 of that same document there is a text that appears nearly identically on page 28/29 of Creating a Sovereign Monetary System. I quote from the latter, newer document:
“This newly created money could
then enter the economy in either or both of two ways,
depending on the estimate from the second figure:
1. The first (and most common) of these would be to grant
the money to the government (by increasing the balance of
the Central Government Account). The government would then
spend this money into circulation, as discussed in the next
section. This process would increase the money stock without
increasing the level of private debt in the economy and can
therefore be thought of as ‘debt-free’ money
creation.
2. The second method would be for the central bank to create
new money and lend it to banks, with the requirement that
this money would be on-lent to businesses that contributed
to GDP (but not for mortgages or financial speculation).
This option would provide a tool to ensure that businesses
in the real economy did not suffer from a lack of access to
credit.”
The authors promise: “Both options are considered in more detail below.” and for the second option (which is the subject of my article) this happens on page 30, under the heading “LENDING MONEY INTO CIRCULATION VIA BANKS AND OTHER INTERMEDIARIES”.
That however is about lending policies (which indeed is important), not about the technical side of how this on-lending is actually done. I think that is important too, because from it we can a better view of what actually results as a net effect.
So I’ll analyse that myself now.
(Continued writing the text on 10 June 2015.)
In the new system proposed by Positive Money, in all interactions of non-central banks with the public, that involve saving and borrowing money, the so-called investment pool plays an essential role. We see this account on pages 19, 20, 40 and 42 of the Positive Money Reforms Transition Presentation.
The investment pool of a non-central bank is at the debit side of its balance sheet, representing a claim on the central bank. Correspondingly, it resides at the credit side of the central bank’s balance sheet, representing a liability of the central bank. In other words, the investment pool is owned by the non-central bank and is held in an account at the central bank.
Normally, the investment pool is filled by households and businesses (‘the public’) as they save money or repay loans. This creates new room for non-central banks for credit granting to other clients.
Now under some circumstances there isn’t enough room in the investment pool. Then the decision can be made (regardless of who makes it) for the central bank to create extra money into the investment pool.
The central bank does this by simply adding amounts to non-central banks’ investment pool accounts. This is money creation by the central bank.
In the traditional system, this would mean creating bank money (base money, MB), which is not already money (M1) in the sense of ‘claim of the public on bank’. But in the system proposed by Positive Money, the distinction between MB and M1 is no longer relevant.
Of course the central bank’s balance sheet must always remain balanced. So to compensate for the addition of an amount to the investment pool (right side or credit side of its balance sheet), something must also be added at the debit side. This could only be a loan to the non-central bank.
So in fact, the central bank simply borrows extra money to the non-central bank, so it can on-lend that to the public. This new bank loan (or addition to an existing one) appears at the left side of the central bank’s balance sheet, and correspondingly at the right side of the non-central bank’s balance sheet. For the central bank it is an asset, for the non-central bank it is a liability.
Accounting for providing a loan to a borrower, from the investment pool, is quite simple for the non-central bank: all at the debit side of the balance sheet, the same amount is credited to the investment pool and debited to the loan. So the investment pool decreases in size and the loan increases (from zero, or from what it already was, in case of enlarging an existing loan).
In the existing banking system, the borrower receives the borrowed money in that it is credited to his on demand account, at the credit side of the non-central bank’s balance sheet. However, in the new system that Positive Money proposes, this is different. On demand accounts are still administered by non-central banks, but they are no longer a liability of the non-central banks. Instead, the on demand accounts, of all the clients of all banks, would be liabilities of the central bank.
This is reflected by the posting that corresponds to what happened at the debit side of the non-central bank’s balance sheet: at the central bank, the investment pool (at the right side) is debited and the borrower’s on demand account (also at the right side) is credited.
So in fact, at the central bank, a bit of the investment pool (bank money, MB) becomes money (M1); while at the non-central bank, a bit of the investment pool becomes the loan. Amounts stay at the same side of the balance sheets, but only change character, and change owner.
It may seem in this lending procedure, in imbalance is introduced:
The non-central bank gives up part of its claim on the central bank (decrease of the investment pool), but there is no compensation for that at the credit side of the non-central bank’s balance sheet.
Likewise, the central bank accepts some extra liability towards a client of the non-central bank, also seemingly without compensation.
In fact however, any contra entries are unnecessary, because the above two effects are already each other’s compensation.
In my original summary of this article, written before I wrote the article itself or even making a rough sketch of it, I stated:
“[...] only it doesn’t essentially change anything: effectively the central bank then takes over what is now the commercial banks’ lending business.”
I now see I was wrong: it’s the other way round: in the new system the non-central, commercial banks would still be in the lending business, only they now provide the money that they lend to the borrower indirectly: via the central bank, which holds the actual on demand account liabilities.
The loan between central and non-central bank, created when the central bank provider extra funds for the investment pool, becomes an intermediate account for the non-central bank, to give its client the money she asked for.
Although Positive Money’s proposal are still hypothetic (and as far as I’m concerned, they should remain that), such an indirect way of making the loan money available is not uncommon at all. It often happens like that in the existing banking system as well: if the loan and the on demand account are with a different bank.
And also if the money provided is immediately used to pay for something. An example is when the borrowed money is used for buying a house: the bank will then not pay it to the borrower, but instead to the notary who handles the purchase. (At least that is the procedure in the Netherlands.)
The notary passes the money on to the seller’s bank (who may use all or part of it as redemption for any remaining mortgage loans). If that bank is not the same bank as the borrower’s bank, then the provided borrowed money is not a liability of the lending bank to its client, but of the lending bank to that other bank. Or, in case the central handles the interbank settlements, to the central bank.
That is the same situation as in the system proposed by Positive Money. Nothing much really changes.
If the bank pays out the loan as cash, the similarity is even more striking. Banknotes are a liability of the central bank. If a non-central bank provides the borrowed money to its client, not as its own liability, but as a liability of the central bank, the compensation for that imbalance is that the non-central bank has to buy those banknotes from the central bank (or it has bought them at some point in the past), for which its reserve account with the central bank is debited (central bank’s view), meaning it’s credited in the non-central bank’s own books.
So then the new loan to the bank client (debit side of non-central bank’s balance sheet) is compensated by a liability (credit side), not to the borrowing client, but to the central bank, who itself has a liability towards the client. The central bank serves as an agent, an intermediary, through which the non-central bank provides the borrowed money.
That is the same situation as in the system proposed by Positive Money. Nothing much really changes.
No reform is necessary, because we already have what is proposed.
Copyright © 2015 R. Harmsen. All rights reserved.