11: Money creation: is the truth finally out?


Barely a day passes by without some headline about how public money is spent or taxed. MPs lecture each other for hours on the deficit while dozens of parliamentary committees scrutinize the details of public spending. In contrast, the topic of how money in Britain is created, by whom and for what, has been largely ignored for 170 years.

One reason may be that most MPs have been living in a state of ignorance on the subject: just one in 10 understands that private banks create 97% of the money supply when they extend loans. But on Thursday afternoon [November 20th] Parliament will finally gather again to debate one of the most important questions of any democracy: where does our money come from?

Britain was still on the Gold Standard the last time the issue was discussed in the House of Commons. It followed a series of banking failures which massively drained The Bank of England’s gold reserves. The resulting Bank Charter Act 1844 banned the creation of any new banks with note-issuing power and led to its eventual control by the Bank of England.

But, importantly, the Act exempted demand deposits – the accounting entries that banks make when people deposit money with them or are created as a result of lending. Because these account balances are technically a promise by the bank to pay the depositor, they were not restricted by the Act in the same way that bankotes were. Part of the reason was that it would have been difficult for the authorities to know whether the new deposits at any given bank were the result of bank lending (i.e. money creation) or simply a customer depositing existing money into their account.

The rest is history. As NEF has demonstrated in our work on the topic going back to 2000 and more recently in our guide to the UK Monetary system, private bank money creation, with minimum regulation by public authorities, is failing to deliver in terms of both sustainable economic growth and financial stability.

The chart below shows the growth of commercial bank credit (or money) creation as a ratio of GDP in the UK since 1964, broken down in to three different categories. Economic textbooks assume banks mostly lend to the real economy – i.e. to non-financial businesses for investment purposes – the blue line. The chart shows this gently growing but remaining at a fairly constant 1:1 ratio with GDP.


Figure 1: Credit aggregates as a proportion of GDP growth, 1964-2014, commercial bank net lending page/-/money creation GDP.png
Sources: Bank of England; ONS; NEF calculations

In contrast, since the early 1980s the ratio of mortgage and consumer credit to GDP – the red line – has quadrupled, and by the time of the financial crisis in 2008, lending to the financial sector (including the so called ‘shadow banking’ sector) – the turquoise line – was three times GDP.

It is now widely accepted that these developments in credit and money creation are key contributors to unsustainable house prices, financial instability and the growing level of debt that is preventing recovery. In the UK, since the crisis, lending to Small and Medium Sized Enterprises has shrunk every year.

That MPs are finally looking at our monetary system again is in no small part due to the awareness raising efforts of the campaign group Positive Money, whose members have written to virtually every MP in the country on the topic over the past five years.

That establishment figures such as Martin Wolf and Lord Adair Turner are publically questioning the current arrangements and calling for central banks to put money directly in to the economy (not in to the financial system as with Quantitative Easing) shows that money creation has now moved in to the mainstream.

Let’s hope the debate does the topic justice and leads to new legislation or, at the very least, a commission on money and credit. Then at least we may have a chance of preventing another financial crisis.

The ‘Money creation and Society’ backbench debate is being hosted by a cross-party group of MPs: Steve Baker (Conservative), Caroline Lucas (Green), Michael Meacher (Labour) and Douglas Carswell (UKIP) and can be seen live on Parliament TV at around 12.30pm, November 20th

[The attendance at that debate was pathetic, but the debate must have given those not initially supporting the case for refom much food for thought. I only hope that some of the MPs absent from the chamber will have watched the broadcast of it. One point missing from the case put was the inevitability of the growing, but already insupportable burden of interest-charges on ‘the 99%’, in the absence of reform.