HOW BANKS CREATE MONEY

Most of the money in our economy is created by banks, in the form of bank deposits, the numbers that appear in your account. Banks create new money every time they lend. 97% of the money in today’s economy exists as bank deposits, while only 3% is physical cash. This short video explains:

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The money the banks create is not paper money with the government-owned Bank of England logo. It’s the e-deposit money that appears on the screen when you check your balance at an ATM. Right now, this money (bank deposits) represents more than 97% of all money in the economy. Only 3% of the money is still in that old money form that you can touch.

Banks can generate money through the accounting that they use when making loans. The numbers you see when you check your account balance are just accounting records on the bank’s computers. These numbers are a “liability” or a bill of exchange from your bank to you. But by using your debit card or internet banking, you can spend these bills as if they were £ 10 notes. By creating these electronic bills, banks can actually create a substitute for money.

In the video below, Professor Dirk Bezemer of the University of Groningen and Michael Kumhof, an IMF economist, explain where the money comes from in less than 2 minutes:
Every new loan a bank makes generates new money. While it is often hard to believe at first, it is common knowledge among the people who run the banking system. In March 2014, the Bank of England published a report entitled “Money Creation in the Modern Economy” in which it stated that:

Bank of England: Money Creation in the Modern Economy

“Commercial [ie commercial banks] create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it usually doesn’t do so by handing you thousands of pounds in banknotes. Instead, you credit your bank account with a bank deposit the size of your mortgage. At that point, the new money is
Sir Mervyn King, Governor of the Bank of England from 2003 to 2013, recently explained this point in a business conference:

Mervyn King, Governor of the Bank of England

“When banks make loans to their customers, they create money by crediting their customers’ accounts.”

Sir Mervyn King, Governor of the Bank of England 2003-2013 (speech)

 

And Martin Wolf, who was a member of the Independent Banking Commission, put it bluntly, telling the Financial Times that: “The essence of the contemporary monetary system is the creation of money, out of thin air, by private banks, often stupid loans ”(article).

By creating money in this way, banks have increased the amount of money in the economy by an average of 11.5% per year over the past 40 years. This pushed house prices up and put an entire generation out of service.

Of course, the downside to this money creation is that with every new loan comes new debt. This is the source of our mountain of personal debt: not borrowing from someone else’s life savings, but money that the banks created out of thin air. Eventually, the debt burden became too high, causing the wave of delinquencies that triggered the financial crisis.

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