Peter J Morgan
Peter J Morgan BE (Mech.), Dip. Teaching – professional forensic engineer, retired economics, mathematics and physics teacher
PART 5 of 18
If banks respond to an increase in the OCR by increasing the interest rates that they pay and charge, the mainstream media (MSM) often report that the banks are maintaining their “lending margins”, and in so doing the MSM journalists help to perpetuate the popular myth that banks lend the money that they borrow from the RBNZ (at the OCR + 0.5%) and add their “margins” to arrive at the interest rates they charge for mortgages. This explains why a significant proportion (nobody knows even closely quite what proportion) of the public mistakenly believes that all new money is created by the RBNZ and that banks are merely financial intermediaries that on-lend it. The banks are more than happy to go along with this notion, because they obviously do not want the public to know that their loans are created ex-nihilo (out of nothing)! More than likely, a greater proportion of the public believes that the major source of money that banks lend is their deposits, also at a margin, reinforcing their mistaken belief that banks are merely financial intermediaries – the fallacious ‘loanable funds’ model taught in almost all secondary schools, polytechnics, and universities. The use of the terms “margin” and/or “margins” in describing what banks do is in fact a misnomer because banks are not moneylenders – otherwise known as financial intermediaries. In fact, as explained above, banks are our money creators and have been for hundreds of years.
Naturally, as profit seeking companies, if banks can find sufficient willing and able borrowers, they tend to create new money at a faster rate than the economy is growing, thus causing inflation, if not in consumer prices as measured by the CPI, which does not include land prices, then in the prices of real estate or shares on the stock market. (Note: The land content of house prices was removed from the CPI in 1999.)
Creating too much new money can also cause demand-pull inflation. Both Prof. Huber and UK economist Lord Adair Turner say, and they are not alone in saying this, that this extra money being created ex-nihilo by banks when they grant mortgage loans for the purchase of real estate is the primary driver of real estate and other asset price bubbles. Lord Adair Turner was the chairman of the UK’s Financial Services Authority when the Global Financial Crisis (GFC) hit in 2008. He has admitted that he was taken by surprise by the GFC and was then on a steep learning curve that caused him to re-think much of what he thought he understood about macroeconomics – and he has a PhD in economics!
Another economist who understands how financial bubbles are fuelled by banks’ money creation is Ib Ravn, of the Danish School of Education, Aarhus University. Citation: Ravn, I. (2021) “How financial bubbles are fueled by money creation a.k.a. bank lending: An explanation for public education.” Real-world Economics Review, issue no. 97, 22 September, pp. 143-154, www.paecon.net/PAEReview/issue97/Ravn97.pdf
The major reason that banks pay interest on term deposits and savings accounts is to grow their market share of depositors, to increase the likelihood that the deposits created when they grant new loans will be spent with, and banked by, their own customers rather than the customers of competing banks, thus reducing their need for RBNZ reserves and increasing the rate that they can safely lend more. (This follows from the observation that “reserves follow deposits”), Banks are, however, now subject to RBNZ liquidity requirements.
This system of interest-bearing ‘debt-money’ is systemically unstable, and should rightly be called ‘funny money’, as nobody – not even the governor of the RBNZ – has effective control of the rate of money creation. This inevitably leads to periods of excess money creation, a major cause of asset bubbles, which eventually burst. When an asset bubble bursts it is usually because people and businesses over-optimistically take on too much debt and then find (especially when interest rates are unexpectedly increased) that they cannot meet their loan repayment schedule. They then start defaulting on their mortgages and loans, and banks get into financial trouble and start calling in their loans. Suddenly, panic selling sets in and asset prices plummet. Many people are bankrupted and businesses are liquidated at fire-sale prices. People and businesses pay back their loans as best they can, and are unwilling to take out so many new loans. Simultaneously, banks get very choosy about whom they will grant new loans. Thus, the rate of repayment of old loans (the rate of destruction of money) exceeds the rate of the banks’ granting of new loans (the rate of money creation) and voilà! – the amount of money in circulation (the money supply) shrinks, causing a recession, or even worse, a depression.
From 2008 to 2013, the US money supply shrank by $4 trillion, because US businesses and people had such an aversion to new debt, and kept paying down their old debts. Quantitative Easing (QE) did not – and never will – increase the money supply directly, because QE just creates more reserves for banks – and banks do not – indeed cannot – lend out reserves. Rather, they create new deposits (electronic money) only by ex-nihilo granting of new loans. If you don’t believe that banks do not lend out reserves, try going into your bank and asking for a loan – in banknotes!
As recently as the early 1980s, a high proportion of young people wanting to save to buy their first home belonged to a building society and saved their money into an account with their building society on the expectation that when they had enough for a deposit, they would be able to borrow from their building society the necessary amount of other people’s savings by way of mortgage. Building societies were true financial intermediaries, much as finance companies are today. Building societies were not money creators – they lent out existing money that they had borrowed from their depositors.
A significant proportion of young people wanting to save to buy their first home, but who chose not to belong to a building society, saved instead with either the Public Service Investment Society (PSIS), or one of the several trustee savings banks (such as the Auckland Savings Bank, the Taranaki Savings Bank, etc.) and were granted mortgages by those institutions. Alternatively, house-buyers seeking a mortgage would apply to a firm of solicitors to borrow money through the solicitors’ trust account. Note that the PSIS, the trustee savings banks, and solicitors, were not money creators as were the banks. Rather, they were on-lenders of existing money that they had borrowed from their depositors.