Only someone who doesn’t know where money comes from, could possibly believe that the UK was ever in danger of becoming like Greece. Will Hutton calls the idea risible. So, giving Nick Clegg the benefit of the doubt over his veracity, the Bears will explain for him where money comes from …
“Modern finance is generally incomprehensible to ordinary men and women….. The level of comprehension of many bankers and regulators is not significantly higher.
It was probably designed that way. Like the wolf in the fairy tale:
“All the better to fleece you with.”
Economist J. K. Galbraith :
“The process by which banks create money is so simple that the mind is repelled. When something so important is involved, a deeper mystery seems only decent.”
Physical cash accounts for less than 3 per cent of the total stock of money in the economy. Commercial bank money – credit and coexistent deposits – makes up the remaining 97 per cent of the money supply.
There are several conflicting ways of describing what banks do.
The simplest version is that banks take in money from savers, and lend this money out to borrowers.
This is not at all how the process works.
Banks do not need to wait for a customer to deposit money before they can make a new loan to someone else.
In fact, it is exactly the opposite; the making of a loan creates a new deposit in the customer’s account.
More sophisticated versions bring in the concept of ‘fractional reserve banking’.
This description recognises that banks can lend out many times more than the amount of cash and reserves they hold at the Bank of England.
This is a more accurate picture, but is still incomplete and misleading.
It implies a strong link between the amount of money that banks create and the amount that they hold at the central bank.
It is also commonly assumed by this approach that the central bank has significant control over the amount of reserves banks hold with it.
We find that the most accurate description is that banks create new money whenever they extend credit, buy existing assets or make payments on their own account, which mostly involves expanding their assets, and that their ability to do this is only very weakly linked to the amount of reserves they hold at the central bank.
At the time of the financial crisis, for example, banks held just £1.25 in reserves for every £100 issued as credit.
Banks operate within an electronic clearing system that nets out multilateral payments at the end of each day, requiring them to hold only a tiny proportion of central bank money to meet their payment requirements.
New Economics Foundation – ‘Where does money come from?’ (video clip) http://www.youtube.com/watch?v=l7L3ZtCSKKs&feature=related