Saturday, March 29, 2014

Central bank money creation renders commercial bank money creation superfluous.

A system in which there are commercial banks but no central bank would work without any big problems, far as I can see. Obviously there’d need to be some generally agreed money unit, e.g. a gram of gold, to start with. But once the system was up and running, the relevant country could abandon the “gold standard”.
As to settling up between themselves, commercial banks would not have the convenience of using central bank money. But that wouldn’t matter too much. First, they’d just let inter-bank debts stand for longer in the hope that those debts were eventually wiped out by countervailing debts. Indeed, even under the existing system, i.e. where there IS A CENTRAL BANK, commercial banks don’t always settle up inter-bank debts immediately. Second, there is no limit to the number of assets that can be used to settle up: shares, bonds, property, etc.
It’s possible that in a “commercial bank only” system, and absent a gold standard, banks would lend too much and bring hyperinflation, but that’s not what I want to concentrate on here.
Rather, the point I want to make is that money creation by commercial banks is inherently expensive, compared to central bank money creation. That is, to monetise an asset, a commercial bank has to check up on the value of the asset, and that involves significant costs. Plus there is the risk that something goes wrong, e.g. the person depositing the asset / collateral might be a fraudster and doesn’t actually own the asset. The bank has to insure against that risk.
In contrast, once a central bank is established, and everyone accepts that it issues money in a reasonably responsible way, the cost of creating and spending that money into the economy is next to nothing. And even when government is an IRRESPONSIBLE issuer of money, as used to be the case with Robert Mugabe, people will still use the government’s money until levels of inflation become totally absurd, at which point (as was the case in Zimbabwe) people will start using some other currency (US dollars and South African Rands in the case of Zimbabwe).

P.S. (31st March 2014). My above claim that central bank money creation is more efficient that commercial bank money creation begs the question as to why commercial banks manage to compete with central banks. That is, how come commercial banks manage to create money at all?
One answer is that central banks create an inadequate amount of money, which leaves room for the “counterfeiters” so to speak. A classic example of this is taking place right now in the UK. That is, politicians and half the economics profession cling to the daft notion that a deficit leads to increased national debt, and thus that we have to be ultra cautious with deficits. As I’ve pointed out a trillion times before on this blog, Keynes stated quite rightly that a deficit can be funded either by debt or new money. But the latter ignoramuses immediately start changing “inflation” as soon as the words “print” and “money” appear in the same sentence. But for some bizarre reason they think that private bank lending / money creation WON’T BE inflationary.
The latter delusion is in overdrive mode just at the moment in the UK in that politicians and economically illiterate economists are having a nervous breakdown about the deficit, while doing all they can to encourage excessive private bank lending: “funding for lending”, “help to buy”, etc.


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