18 March 2008

You only give me your funny paper

The really mysterious thing about the operation of central banks around the world is how they can - as if by magic - 'inject' money into failing banks and finance businesses. Where does this money come from? (Here is what Richard Douthwaite has to say about this.)

Although the Bank of England is officially apolitical, it is in fact deeply political. It can create money by selling government bonds, in other words mortgaging the country in order to create money. At present it is creating money in this way to bail out banks and investment houses who have bought worthless assets. They took the risk but we are paying for it. They took their bonuses when they made the deals, but those bonuses are being paid by ourselves and future taxpayers.

I confess the workings of the central banks are highly arcane and deliberately obscure, so I may have this wrong. If so, I would be glad to be informed of where BoE can find a hidden stash of gold that is not available to others.

The nature of money creation is a shared scam by the commercial banks. They create debts which other banks accept as credits, and this allows the banking system as a whole to create money from nothing, which they share between themselves to create their massive profits.

The problem is that the reverse also applies. In troubling times a bank will refuse to accept another bank's paper but will rather ask for something of real value. Since the very nature of the system of money creation means there is nothing of real value there, the circle which was once (at least if you are a bank) virtuous, will very rapidly become vicious.

This explains the anomalous situation that, as the central bank cuts its own interest rate (meaning we are getting less back for our bonds), banks are actually charging us higher interest rates. They have become more risk-averse which means they have less trust about whether we (or other banks) will repay, which they reflect in making money more expensive. This also has the handy side-effect of increasing their profits at a time when their traditional means for doing this has folded up.

In the face of such disastrous mismanagement of the financial system the obvious solution is for political authorities to take back the power to make money. I predict that any suggestion along these lines will be met with some worthy bank stooge (my money would be on the Ken Clarke-Denis Healy double-act) waffling on about inflation. A shame they forgot to mention that when they allowed the banks to create worthless paper money.


  1. It is indeed obscene that some of the very institutions that got us into this appalling mess are now stacking up fat profits on the resultant panic. And we are paying the cost, and being 'gifted' a series of state mortgages...
    It's time, it seems to me, to start talking about nationalising the banks... As they were doing on no less an august national institution than the TODAY programme, this morning! ;-)

  2. The way the banks do things is at once strange and not so strange. The entire act depends on us accepting the idea that the paper has value and so long as we do accept this it does but if we stop believing it stops having value. Value is, therefore, dependent on faith alone... hmm... sounds quasi-religious.

  3. Yes, it is indeed true that “some” banks undertook risk which they neither understoond nor cared to understand, as long as the profits came in. However I don’t accept your premise that the current credit squeeze is a function of banking malfeasance in general. This is just not support by the facts. I would also like to point out to you (in case you missed that part!). At no time were any of the mortgage applicants held to ransom in undertaking mortgages to which they could not afford.

    It is a function of the global economy that cycles exist, and yes unfortunately people lose their houses. This is tragic, but let us not gets carried away! – If I choose to undertake a mortgage, I have to be prepared to accept the consequences should I be unable to live up to my obligations, that’s just life.

    Banks are in the business of making money, just as any other private enterprise.


    It is true that banks create money out of thin air. Yet, the real issue whether we can develop a credible financial system which would solve many of the woes of our world. See my project...