Why can private banks create money?

Discussion in 'Economics' started by PragmaticIdeals, Jun 22, 2009.

  1. I've been struggling with this question for the past week and I just can't figure it out.

    I've come to the conclusion that it shouldn't be allowed for the following reasons:

    1) Fairness

    In a fair capitalist free-market system, no one is able to generate wealth without accepting their fair share of risk.

    When a banker takes a $1000 deposit to create $9,000 (10% reserve rate) for an annual loan with 10% interest, for example, and accepts the risk that ~10% of the loans won't be paid back (very high risk), the banker has the expected virtually RISK FREE return of (9,000-1000)/1000 = 800%...

    2) Inflation due to conflict of interest (negative externalities)

    Whenever money is created and whenever that money isn't used to produce an exactly off-setting amount of productivity / goods, there is price inflation or asset inflation.

    Banks have no interest in reducing inflation, they will loan out the maximum amount of loans possible so long as they are likely to be repaid. So expected asset or good inflation is not likely part of the bank's calculations, leading to the likelihood of negative externality for society of high inflation even when banks make money.

    According to shadowstatistics.org, inflation has been remarkably high for the last couple decades as the fed keeps interest rates low and therefore gives banks incentives to increase the quantity of the loans they make.

    And what about when loans (money creation) are made for consumption expenditures, debt/interest repayment and imports. How can anyone argue these aren't inflationary activities in a stable economy? This is nothing more than monetization of debt.

    Imagine a company that has a long term debt of $1,000. This credit was initially created out of thin air and added $1,000 to the money supply. Then, the company takes a loan from a 2nd bank and pays back the original loan. There is now a total of $2,000 created by banks even though the actual productivity associated with the debt can be no more than $1000 since this is what the firm actually has access to for its daily operations and investment.

    3) Banks feed bubbles, especially in low-interest rate climates (banks can create / loan more money and be more assured of pay-bank even when productivity is low)

    Bubble phenomena is a very real characteristic of asset markets because it is often hard to know when assets are fundamentally overvalued. Especially new markets and markets with new characteristics.

    The dot-com and subprime bubbles were both incredibly exacerbated by the fact that banks are able to create money and make loans to investors (leverage) / consumers. This puts inevitable inflationary pressure on the assets and on their equities because:

    a) banks have no limits on lending quantities since they can create money out of thin air,

    b) investors think the market is strong since it has a history of high returns and increasing share price (which is only caused by money creation by banks who don't care about inflation but only maximizing returns)


    Since the creation of money can have profound and severe negative externalities for the population in terms of bubble formation and inflation, I believe that only government-run banks should be able to create money.

    More information:



    Can anyone counter my arguments?
  2. jprad


    Can't have an argument until you get the facts straight:

    Banks do not create money, they create debt. It is the government that creates money.

    In an asset-backed monetary system the government has to acquire more of the underlying asset in order to increase the money supply.

    In a fiat based system the government "creates" money by debasing their currency.

    EDIT Debasement is applicable to both systems...
  3. Gotta get YOUR facts straight now. The government does not create money. The Federal Reserve does. The Federal Reserve is a PRIVATE corporation. It is not owned by the government. 98% of people do not understand this. Most people think the government issues money, but it doesnt....its the Federal Reserve bank.
  4. Obviously when I say "create money" I am talking about credit.

    The two are virtually synonomous.

    Bank creates $10,000, gives to company.

    Company uses $10,000 to pay for supplies.

    Money enters system.
  5. Stosh


    I agree with most of your comments. In short, from any given level of money supply, the banking system as a whole can increase or decrease the money supply by way of the fractional reserve banking system. Of course, this ability is based on and is under the influence of the Fed. It is a house of cards, because at its core, huge, momentous, far reaching decisions have to be made by a few powerful, flawed human beings at the Fed and in gov't......and when they get it wrong, the results can be disastrous, as has happened throughout the history of governments of all kinds.. Would like to hear any learned critique. Stosh
  6. burn8


    Youre gripe is regarding the fractional reserve system, not one of banks printing money.

  7. Stosh


    By the way, this stuff about the Fed being an independent, private corporation is literally true, but in practice it is a distinction without a difference. Ben Bernanke has a tatoo on his ass that says "Property of the U. S. Gov't." Such a tatoo will also be placed on Larry Summers' if/when he replaces Ben......then he will be as independent as he was when he was President of Harvard (until he said girls aren't as good at math or something similar). Stosh
  8. jprad



    The Fed is a bank, and like all the others, creates debt.

    The Treasury, at the direction of Congress, creates money.
  9. jprad


    But, they're not. When a dollar is created via credit it doesn't increase the monetary base.

    Only the government (Congress) can change M0.
  10. Thank you captain obvious.

    But increasing M2 / M3 is still inflationary if there isn't a corresponding and proportional increase in productivity / supply of goods.
    #10     Jun 22, 2009