Some context

From a top banker's point of view, our financial system is great. It is awfully maldesigned in a way that makes it mathematically unsustainable under the conditions of a finite planet, at the same time it gives the upper crust marvellous opportunities to covertly enslave the proverbial 99% to their interests.

Once one has paid attention to the excellent resources at positivemoney.org, the flaws become horrifyingly obvious. The most horrifying of insights arise when one realises that most journalists, politicians, economists and to a lesser extent even bankers don't have the faintest clue of how this money system works.

Obscurity

Such blatant incompetence might appear surprising in our relatively enlightened times, times of ubiquitous instant access to information via the internet. Another conspiracy? Not really, no crew of aliens hogging a cyclops-eyed pyramid required.

Take a stretch of history where politicians at best play catchup with the bankers, where the system develops towards ever greater complexity and where there is all incentive to those in power (i.e. bankers, not politicians) to silently keep things as they are and foster society's general inertia.

Take this arcane mess and use inconsistent, redundant and misleading terminology to describe it, don't teach that stuff at schools and spread textbooks teaching fancy models that aren't implemented in reality. As a result, Wikipedia drowns the reader with this terminology and the false models. Without truthful textbooks, the few well-meaning and knowledgeable Wikipedians have a hard time improving the pages.

Case study

Grab a random "expert", e.g. @econtrader, who offers a dodgy website that pretends to provide expertise in financial matters.

http://www.econtrader.com/featured/is-a-gold-backed-currency-better-than-fiat-money.htm

Now let's dissect the little flash animation at the bottom, step by step (steps added where necessary). It claims to explain how high-street banks create money (at least it admits the fact, unlike the UK Treasury).

If the table is just gibberish to you, watch this bullshit-free introduction to our cherished money system and read this pdf for an explanation of banks' balance sheets.

img no balance sheet total money (cash, commercial bank money) comment
assets liabilities
1
$1 cash $0 $1 ($1,$0) The bank has $1 in cash, registered on its balance sheet as an asset. Fine.
1.1
$1 cash
$1 loan1
$1 loan1 $2 ($1,$1) Omitted step between between img 1 and img 2:
The consumer borrows money. The bank's balance sheet now has $2 in assets ($1 in cash and $1 for the loan contract) and a liability of $1 to the consumer.
At this point, commercial bank money is created. Despite the fact that the animation claims to explain exactly that process, the step is just skipped and not mentioned.
2
$1 loan1 $0 $1 ($1,$0) The consumer withdraws the complete borrowed amount which reduces the banker's balance sheet by $1 on both sides (the $1 cash asset was used to cancel out the $1 liability). Fine so far, image and balance sheet are consistent.
The caption does not fit, though, it would fit the omitted step 1.1 above. By swapping his commercial bank money for cash, the consumer destroys the $1 of commercial bank money the banker has created in step 1.1 by making the loan.
3
$1 loan1 $0 $1 ($1,$0) No complaints.
4
$1 loan1 $0 $1 ($1,$0) No complaints.
5
$1 loan1
$1 cash
$1 saving $2 ($1,$1) The farmer deposits his $1 at the bank. The caption parrots the myth of banks lending savers' money, by implying the bank would need to wait for cash in order to make a loan. Then it makes plenty of noise about the asset not matching the currency it is "supposed to represent" (which it isn't).
What does happen is that by depositing his money, the farmer undoes the destruction by withdrawal (img 2) of the commercial bank money that was created when the consumer borrowed money (step 1.1). Thus the total amount of money increases again at this point – nevertheless, money creation took place in step 1.1 when the loan was made. In reality, most transactions (by value) don't involve cash so the scenario above is highly artificial and misses out the crucial point enabling banks to create money.
6
$1 loan1
$1 cash
$1 saving $2 ($1,$1) Here, "lends" is an awfully deceptive misnomer for creating money. It's common language, though, no need to blame @econtrader for this one.
6.1
$1 loan1
$1 cash
$1 loan2
$1 saving
$1 loan2
$3 ($1,$2) Omitted step between img 6 and img 7:
The bank makes another loan to the consumer, analogue to step 1.1 above. Again, commercial bank money is created at this point. Again, this is not mentioned.
7
$1 loan1
$1 loan2
$1 saving
$1 loan2
$2 ($1,$1) The consumer completely withdraws the borrowed amount, analogue to step 2.
8
$1 loan1
$1 loan2
$1 saving
$1 loan2
$3 ($2,$1) New cash magically adds itself to bank's balance sheet, the caption offers no explanation whatsoever.
In reality, the central bank might decide to print cash, private banks can not do so. They'd have to buy it from the central bank in exchange for some assets, usually government bonds.
Since @econtrader's plot is totally broken here anyway, let's follow them and magically add $1 to the cash supply.
The lack of explanation backs the fairy tale of central banks irresponsibly starting the printing press, a common theme in the media and hence in pub talk. They could do so but what causes the money supply to inflate is private bank's irresponsible lending.
9
$1 loan1
$1 loan2
$1 saving
$1 loan2
$2 ($2,$0) The farmer withdraws his complete savings.
So as a conclusion, the animation offers a totally unrealistic scenario where all money in the economy circulates as cash. Under such circumstances banks would not be able to create money, nevertheless @econtrader closes with the following sentence: "That is how money is created by banks". Priceless.

Yeah. That's what happens when you haven't done your homework, then try and explain money creation by private banks without properly distinguishing cash from commercial bank money.

internationalmoneyreform.org



(contact: @abuveliki)

changed September 6, 2014