Peter J Morgan
Peter J Morgan BE (Mech.), Dip. Teaching – professional forensic engineer, retired economics, mathematics and physics teacher
PART 2 of 18
In PART 1 readers learnt that there is a widespread – but false – belief that banks are financial intermediaries that take in money from savers, aggregate it, and on-lend it to borrowers, and that banks make an honest living from the differences (margins) between the interest rates that they pay savers and the interest rates that they charge borrowers. Unfortunately for the reputation of the University of Auckland – and all other universities in New Zealand, and most likely Australia, that teach this nonsense, the loanable funds model of banking was thoroughly discredited by Bank of England staffers and more importantly, way back in 1956 by the unanimous Report of the New Zealand Royal Commission on Banking, Monetary, and Credit Systems.
To his great credit, former prime minister the Rt Hon. Jim Bolger, now well into his 80s, in recent interviews has indicated that he now understands how the money and banking system actually works. He is also on record as having recently said that neoliberalism, which in New Zealand began in the mid-1980s, driven by Roger Douglas and Richard Prebble under a Labour government and continued under National, was a great mistake and should never have happened.
Only approximately 2% (a proportion that is continuously falling) of the money in circulation (the money supply, in economics jargon) is notes and coins. The remaining 98% of the money in circulation consists of bank deposits. The public is largely unaware as to where bank deposits actually come from. Some people erroneously think that bank deposits can only come from people depositing notes and coins in their bank accounts. The unanimous Report of the 1956 New Zealand Royal Commission on Banking, Monetary, and Credit Systems stated unequivocally that banks are not financial intermediaries, and that banks do not lend out their customers’ deposits. The Report made it clear that in fact, bank deposits are created by banks when they make loans or purchase assets, including – incredibly – the land and buildings they occupy. To repeat, the 1956 Royal Commission’s unanimous Report explained that banks create money ex-nihilo when:
1. They grant loans (In effect, a bank and its customer give each other a promise to pay notes and coins, and the public in its ignorance chooses as a matter of convenience to use banks’ promises to pay money, as if it were money, and so it becomes money when it is accepted as payment by any third party. – PJM), or
2. They purchase any assets, e.g. a building, or shares, or motor vehicles, etc., which they do simply by crediting the vendor’s bank account.
What a shame it is that these basic facts are not common knowledge! Most economics students are not taught them! Worse, they are taught, falsely, that banks are financial intermediaries – the thoroughly discredited loanable funds model of banking.
Thus the present banking and monetary system – which truly is a parasitic, ‘funny money’ system – is systemically unstable, as banks will almost always seek to maximise their profits by creating more money than is necessary to keep pace with economic growth – as evidenced by the massive surge in real estate prices caused in major part by people having access to banks’ freshly created mortgage money and using it to compete with each other to buy real estate, thus bidding up prices. If we had kept the system we had until the mid-1980s, when mortgagees had to borrow – mostly via financial intermediaries such as building societies – already-existing money, in the form of other people’s actual savings, and banks other than trustee savings banks (which were either absorbed by the trading banks or converted themselves into trading banks) generally did not grant house mortgages on existing houses, it is self-evident that there would not have been enough money available for people to borrow to enable prices to be bid up so excessively. Inevitably, since the mid-1980s, inequality in our society has increased dramatically. The situation was exacerbated by the fact that in 1999 the land portion of house prices was removed from the Consumers Price Index (CPI). From then on, the Governor of the RBNZ has been kidding himself – and the nation – that he has been doing a good job in keeping inflation down, while house price inflation, and hence inequality, increased dramatically.
In a very brief article in Newsroom on 14 April 2021, Dr Michael Rehm, who is a senior lecturer in property at The University of Auckland Business School, points to loosely regulated bank lending, together with the fact that banks are money creators, as the central reasons behind the dislocation between household incomes and house prices in New Zealand and around the world.
In a further article in Newsroom on 2 February 2022, Dr Rehm had this to say:
Although landlord greed seems to be the primary target of the new housing policies, there is an even larger, greedier actor behind the housing markets: banks. Without the eagerness of banks to lend increasing amounts of debt onto the shoulders of owner-occupiers and residential investors, the current obscene prices would not be possible. Arguably, loosely regulated bank lending is the central reason behind the gulf between house prices and household incomes in New Zealand and around the world.
It is critically important to appreciate that when banks expand their lending they create new money in the process. Banks are not simply an intermediary between depositors and borrowers. The creation of new money is an immensely profitable enterprise and the polar opposite of running a rental property ‘business’ which is primarily a gamble on future capital gains.
According to the Deloitte Top 200 Index, ANZ bank generated $NZ1.8 billion in after-tax profit in New Zealand in 2020. With 9000 employees, that is just over $NZ200,000 in annual profit (after operating costs and tax) per employee. Much of this profit leaves New Zealand to be paid out in Australian dollars as dividends to bank shareholders.
New Zealand banking is unique within the OECD. According to the IMF, Australian subsidiaries account for 86 per cent of the New Zealand banking sector’s assets. The country with the next highest foreign ownership of banks is Mexico, with 41 per cent controlled by Spanish banks. New Zealand is in a league of its own.