BOE: “Money creation in the modern economy”

The Monetary Analysis Directorate of the Bank of England this quarter published a research report explaining money creation in the modern economy, admitting quite bluntly and openly that commercial banks create deposits in the economy (i.e. create money), by making loans.

Bear with me, this might seem boring, but this will get interesting just now. The common narrative in modern macro-economics and taught in textbooks is that it is the central bank, and only the central bank, that creates money in the economy.

This is only partially correct. It is only correct as it relates to the creation of base money, i.e. physical notes and coin. After central banks have created base money, commercial banks (in South Africa that’s all the institutions listed here, but mostly FNB, Absa, Std Bank, Nedbank) take over the money printing role. They are the creators of broad money, or known as fiduciary media in economics jargon. This money is mostly electronic, digital entries on computers, and is what you spend when you swipe a debit or credit card, or make payment through electronic bank transfers.

This electronic money is created by a bank at virtually no marginal cost, it’s free money. As the Bank of England explains:

In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.

The reality of how money is created today differs from the description found in some economics textbooks:

– Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.

– In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.

So there you have it, right from the oldest-central-bank-in-the-world’s mouth. Banks print money. In the Austrian literature, this is a commonly known fact that runs from the days of Mises’ Theory of Money and Credit.

The data also shows that banks print by far the most money.

In South Africa in December 2013 there was R106 billion worth of base money in existence, and R2.6 trillion worth of broad money in existence. This means commercial banks have in the history of the rand created 24.5 times more of the total money supply than the Reserve Bank has.

In 2013, the Reserve Bank printed R9.243 billion worth of base money, and the commercial banks printed R204.108 billion worth of broad money (see figure below).


And, as the Bank of England points out, this money was created out of thin air, by lending more money to government and the public. At least the Reserve Bank has to buy cheap paper and cotton, ink and stamp some security features onto the money they print, so they have a marginal cost to printing new money. The banks, depending on central bank regulations, can create near limitless money at no marginal cost. And when they create new money, it dilutes the value of the rands you have worked hard for, and saved for retirement. It’s an unseen form of redistribution from savers and earners of rands, to printers, borrowers and spenders of rands.

The economic effects of banks printing money is no different to a bunch of opportunists in the townships printing counterfeit money. Whoever has the ability to print money that they are able to exchange for real goods and services in the economy, are going to become wealthy. With this context, does it surprise you that the banking sector has grown so massive relative to the rest of the economy, or that doctors, engineers, and scientists are leaving their fields for banking? It shouldn’t, like a bee’s attraction to honey, they’re only being attracted to where the easy (read: free) money is to be made.

Full BOE report here.

To learn more about the intricacies of money and banking, download this free textbook by Professor Murray Rothbard, here. It’s in ebook (.epub) here.


About Chris Becker

Chris Becker is Market Strategist and Economist at ETM Analytics. Becker is Co-Founder of the Mises Institute South Africa. Visit his personal blog Follow him on twitter @chrislbecker.
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  • Daniel

    Do this recent money printing have something to do with the recent devalue of the Rand compared to the Pound?