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I wanted to address some notions that you often see regarding banks and
the banking system.
Do banks print money, and then lend it out? They did once, but not
any
more. Today, the only producers of money (technically, base money,
which is the only thing actually used in monetary payment) are central
banks. Today, "money," produced by central banks, is very distinct from
"credit," which is the realm of commercial banks and also a great many
other financial instruments, such as a junk-bond ETF or a
mortgage-backed security. I admit this distinction is rather less clear
in the case of a "free banking" system where there are many banks
acting both as lenders and currency providers, and there is not a lot
of difference between a deposit liability and a banknote liability on
the balance sheet (as is the case for central banks today, where both
are combined in "base money"). However, even then, the situation
doesn't really change much, so it is worthwhile to think of them
separately.
How profitable are central banks? Their "profit" has two components:
one is the interest income on their assets, mostly government bonds.
The second portion is the amount by which these assets grow over time,
purchased by base money created out of nothing. If you print $100,000
and buy a nice car, then you have made a "profit" of $100,000
represented by the car, although the car does not pay interest.
So, we see that total assets of major world central banks are about
$14.2
trillion presently. If we assume an interest yield of 2% on this, it
comes to $284 billion per year.
That's a nice profit from the money-printing business.
Officially, these profits are paid to governments. However, many people
suspect this is a bit of a ruse, and that certain influential European
banking families, long connected with setting up these central banks
around the world in the first place in the 19th and early 20th
century, quite naturally enjoy the profits of the institutions they
established with such great effort. G. Edward Griffin's book The
Creature From Jekyll Island
is a nice account of this process in the founding of the Federal
Reserve in the United States, which was actually the fourth attempt by
the same European banking families, led by one in particular with a
made-up name -- let's call them the Bluehelmets. The first was the Bank
of North America, in 1781, followed by the First Bank of the United
States in 1791 and the Second Bank of the United States in 1816. The
National Bank System, dating from 1863, also looks like their handiwork.
In addition to this interest income, there is the increase in assets
itself, obtained basically by printing money. Although the rise in
assets since 2008 has been highly anomalous, nevertheless, there has
been about a $9 trillion increase since then, which is also a pretty
nice profit you have to admit. They can't really "spend" this money
(actually, they could but that's a more complicated story, and besides
they don't really have to), but one effect of owning so many government
bonds is likely that they have a lot of influence over governments
themselves, as any debtor would over the indebted. They could probably
also use these very large bondholdings in a great variety of ways to
influence asset market prices, as collateral for derivatives positions
for example.
Central banks don't really indebt governments by printing money. The
government bonds already exist, because the government wanted to borrow
money. The ownership of the bonds simply changes, from some
non-central-bank entity to the central bank. From the government's
perspective, it's really much the same either way. Central banks could
function without government bonds. They would simply own some other
sort of asset, most likely a private-market debt asset such as
mortgage-backed securities. If the government didn't want debt, then it
should just not borrow any
money; the central bank would be much the same either way. Japan's
government had essentially no debt in the 1949-1965 period, but there
was still a yen and still a Bank of Japan.
Let's look at the Federal Reserve's balance sheet:
http://www.federalreserve.gov/monetarypolicy/...ents-report.htm
It's pretty simple, although I would note the large holdings of
mortgage-backed securities among assets, which is a nice example of the
principle that a central bank doesn't have to hold government bonds.
(MBS are basically a securitized pool of home mortgages. The debtor is
the homeowner. There is an element of government guarantee related to
MBS, but that doesn't make it "government debt". MBS could function
perfectly well without this government guarantee, and technically did
not have such a guarantee until target="_blank" Fannie
Mae and Freddie Mac were nationalized in 2008.)
The liabilities are almost entirely currency in circulation, and
deposits. Together, these constitute "base money," which is, basically,
the currency of the United States.
The ECB's balance sheet is a little more complicated. We looked at it
earlier in 2015:
target="_blank"
http://www.newworldeconomics.com/arch...015/020115.html
We also took a look at the Bank of England's balance sheet, since 1696.
http://www.newworldeconomics.com/a...015/060715.html
Here's what it looked like in 1696, just after its founding:
target="_blank"
I am mentioning this in part because I previously thought of the Bank
of England and also the early U.S. central banks (the First and Second
Banks of the United States) as primarily commercial banks, but now I
see them as having been conceived essentially as currency-issuing
central banks. This is not a State Street or BB&T that just
happened to expand
into the currency-issuing business.
What is to be made of all this?
As long as the currency issuer is reasonably well-behaved, and
maintains a sound gold standard policy as the Bank of England did for
many years, banknotes are superior to coinage. It is not really
possible to "inflate or deflate the money supply" while on a gold
standard system, although there is some possibility for favoritism in
the matter of short-term discounting of bills. The potential for
"inflating or deflating the money supply" really lies in the realm of
commercial banking, which is not so much in the realm of central
banking and currency issuance.
Some people consider the Bluehelmets to be a rather sinister bunch.
This has produced a number of alternative proposals, to eliminate a
private monopoly currency issuer or "central bank":
One is to require all payment in the form of coins and bullion. This is
actually written into the U.S. Constitution, although we like to ignore
that. Typically, this proposal might include a "100% reserve bank of
deposit" along the model of the 17th century Bank of Amsterdam -- or
the Bank of Hamburg, since the Bank of Amsterdam in actual fact was
secretly making loans as early as its first decade, and did so
continuously thereafter. The contemporary equivalent of this kind of
"100% reserve" system would be GoldMoney, founded by James Turk, and
its more recent descendant, BitGold. Similar proposals are following in
the wake of decisions by states like Utah to make gold and silver coin
more usable in practical payment systems. This is an entirely workable
idea, although there are some issues regarding implementing it on a
very large-scale basis, due to the large amounts of bullion required.
These days, I doubt that many coins would actually be used; and those
that were would still likely be mostly token coins. Silver today is
really usable only as a token coin, and gold has such a high value that
it would not be used much unless people didn't want to leave a paper
trail. Thus, these "100% bullion" proposals tend, in practical terms,
to become largely "e-money" system target="_blank"s like GoldMoney/BitGold.
Another solution target="_blank"is the "free banking"
model, popular today as an "End the Fed" proposal (and is the Fed
alternative I mention in m target="_blank"y book Gold: the Monetary Polaris).
Banks would still make money from currency issuance, but the profit
would be distributed among many banks rather than being concentrated in
one central bank. The United States used a "free banking" model (more
or less) from 1789 to 1913. Conceivably, the Bluehelmet-types could
just as well own a dozen or three of these currency-issuing banks as a
single central bank, and thus end up controlling that system as well
(there's some evidence this was the case during the National Bank
System era), but it does hold some promise for decentralizing power,
wealth and influence.
A third solution is to make the government itself the direct currency
issuer, rather than a central bank owned by the Bluehelmets or their
ilk. This was promoted by Bill Still, in his docum target="_blank"entary The Money Masters,
and is also popular among the "Modern Monetary Theory" types.
Obviously, in this case the government would enjoy all the advantages
of currency issuance. Since the Federal Reserve claims that it pays to
the U.S. Treasury the profits (excepting some operating expenses)
enjoyed from the interest income on the Treasury bonds it holds, then,
according to this story, the U.S. Treasury is already enjoying about as
much financial advantage from currency issuance as it would if the
entirety of it were nationalized. (Even if this were true, there would
still be some issues regarding the influence of such a large holder of
government debt.) The main problem with this proposal is that
governments that issue currency directly have a long history of blowing
up their currencies with overissuance at the first incidence of need.
This was true of many Chinese governments from the 11th to 15th
centuries, the French government in 1720 and again in 1789, all of the
American Colonies, and also of the U.S. Continental Congress during the
Revolutionary War period. I suppose someone would claim that we would
never be so stupid today; but, judging by the output of the "Modern
Monetary Theory" types, they don't seem to have any notion at all
reg target="_blank"arding what
is and is not possible with such a system, and would be certain to
blow things up in short order.
With a gold standard system -- and ultimately, any system with some
modicum of stability of currency value, including any fiat floating
currency -- the amount of currency that is issued is related to the
demand for currency. You can't just print willy-nilly whatever you
want. With a proper fixed-value system like a gold standard system, you
don't really have any direct influence on the base money supply at all.
It is a residual of the mechanisms that keep the value of the currency
at its fixed-value benchmark. I talk about these issues in great det target="_blank"ail
in Gold: the Monetary Polaris.
Later, we will talk about bank deposits and various forms of short-term
lending, known colloquially as the "money market." This is really the
realm of credit, not money.
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