The other day, I ran across another stellar article about money creation at Washington’s Blog. The article, titled “A Loophole Allows Banks – But Not Other Companies – to Create Money Out of Thin Air” contains excerpts from a 2014 paper written by economics professor Richard Werner, the “inventor” of quantitative easing. The paper cuts to the heart of the method by which private commercial banks—as opposed to the central banks—create the nation’s money supply out of thin air while appearing to lend out money that has been deposited into the banks. In other words, the banks had to figure out some way to perpetuate the myth that banks can and do only lend deposits when in reality the banks can and do create money out of nothing, and they do so at will. Werner’s paper cuts to the chase on this point:
“What banks do is to simply reclassify their accounts payable items arising from the act of lending as ‘customer deposits’, and the general public, when receiving payment in the form of a transfer of bank deposits, believes that a form of money had been paid into the bank.”
We see then that it’s a simple word game—in banking language, a “loan” and a “deposit” are considered to be the same thing even though the definition of the word “loan” is “money that is given” and the opposite of “loan” is “deposit,” which means “money that is received.” So the banking industry decided to turn the antonyms “loan” and “deposit” into synonyms. That way, banks could technically say that they loaned deposits—as most people wrongly believe—even though the “deposits” are actually “loans.” They then achieved the goal of not only perpetuating the myth that banks are merely intermediaries between savers and borrowers, but also the goal of being able to get the public forever indebted to them at no cost and no risk to the bank. It has worked pretty well for decades now, with everyday people believing that if they don’t pay back “money” that was “lent” to them by banks, then they are not only stealing from the bank but also they are stealing from innocent bank depositors who are presumably just average working people like themselves.
Werner further details the implications of the voodoo semantics involved:
“The ‘lending’ bank records a new ‘customer deposit’ and informs the ‘borrower’ that funds have been‘deposited’ in the borrower’s account. Since neither the borrower nor the bank actually made a deposit at the bank—nor, in connection with this transaction, anyone else for that matter, it remains necessary to analyse the legal aspects of bank operations. In particular, the legality of the act of reclassifying bank liabilities (accounts payable) as fictitious customer deposits requires further, separate analysis. This is all the more so, since no law, statute or bank regulation actually grants banks the right (usually considered a sovereign prerogative) to create and allocate the money supply. Further, the regulation that allows only banks to conduct such creative accounting…is potentially being abused through the act of‘renaming’ the bank’s own accounts payable liabilities as ‘customer deposits’ when no deposits had been made, since this is also not explicitly referred to in the banks’ exemption from the Client Money Rules, or in any other statutes, laws or regulations, for that matter.”
Above, we see very clearly how the deception plays out, and have written about it many times here at Liberty Road Media. The “customer deposit” Werner refers to above is the face value of the promissory note that you or I give to the bank, and that amount is then said to be “loaned” by the bank to you or me, having been “deposited” into an account for us to use. That is the extremely meager and threadbare rationale for, as Werner calls it, the “reclassification” of loans as deposits.
Indeed, as Werner points out above, “neither the borrower nor the bank actually made a deposit” in this scenario. That is to say, neither the borrower nor the bank made a deposit of pre-existing money that came from either the borrower or the bank—meaning, neither the borrower nor the bank deposited cash into an account. It’s merely “creative accounting”—Werner’s words. And “creative” in the sense of actually creating something out of nothing.
Because loans between natural persons like you and me do not turn loans into deposits. I might loan you $5, and you may make a “deposit”—into my hand–of an IOU for that $5 to me. However, that IOU is not a deposit in the sense that it is money that I can then spend or loan again. I am out $5, and the IOU is merely for my own personal record-keeping. Some might argue that I might in fact be able to circulate that $5 IOU amongst my friends as though the IOU were actually $5. What is money, that argument goes, but debt–aka IOUs–from one person to another? That is true, but the ultimate test of this IOU-trading on a personal level is this: try passing off that IOU as $5 to the IRS and see what happens. That of course gets into a whole other discussion, but again, the difference between you and I and the banks is this—the bank gets to “deposit” IOUs (i.e., promissory notes) into accounts denominated in U.S. dollars and then circulate that “deposit” as U.S. dollars, even in payment of taxes, whereas you and I simply cannot.
As has been covered here at Liberty Road Media, the Bank of England fully corroborates Werner’s correct observation that loans are reclassified into deposits, to wit:
“Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.”
Orwell could’ve added a line to the party slogan in 1984: War is peace, freedom is slavery, ignorance is strength, loans are deposits… Indeed, it’s just word games, psychological trickery, and misinformation to conceal what is really going on, which is that banks are enslaving us in their debt despite the fact that they aren’t actually lending anything!