Banks don’t create money out of thin air, they make cash circulate more quickly

Malcolm Parkin’s 3 January letter to The Scotsman is so full of economic illiteracy that it is difficult to know where to begin…

(1) All cash in circulation (notes and coin) is a debt of the Government.

(2) All cash is money but not all money is cash. Bank deposits are money but are not cash.

(3)Banks do not “create the nation’s money supply from thin air by electronic bookkeeping”. What they do is to increase the velocity of cir- culation of cash by means of the credit multiplier, that is, they put otherwise idle cash to work. The size of the credit multiplier is determined by rules set by the Bank of England, and therefore ultimately by the Government.

(4) Banks do not “lend their magic money to whoever wants it, in whatever quantity they choose, and for any purpose their borrower wishes”. Borrowers must usually provide collateral for any loan, and must provide the means of its repayment, as typified by “seed to harvest” loans to farmers. Rules laid down by the Financial Conduct Authority cover this.

(5)“No government could hope to control an economy while the money supply is in private hands.” This is utter nonsense, as any first year economics student knows, as the Bank of England has many different ways of controlling the money supply. What it cannot do, as a monopolist, is control both the money supply and the rate of interest. At the moment it has chosen to control the rate of interest, hence the huge expansion of the money supply by QE, Quantitative Easing.

(6) Mr Parkin confuses the National Debt, which is the debt owed by the Government (mostly to us, as large quantities of government bonds are held by insurance companies and pension funds) with foreign debt, which is that part of the National Debt held by foreigners. Britain has never defaulted on foreign debt, nor has it defaulted on its domestic debt either. except in the usual way governments do, and that is by inflation which reduces the real value of money debt.

(8) The collapse in our banking system in 2008 was partly because the Financial Supervisory Authority created by Gordon Brown was asleep on the job. Previously, the Bank of England did this. Add in the 1986 Financial Services Act which deregulated most of the financial system and allowed building societies like Northern Rock and Halifax to become banks, and it is no surprise irresponsible behaviour crept in.

Bank of Scotland was Britain’s most successful bank before being taken over by the Halifax. Former Halifax group chief executive Andy Hornby was a marketing man and former RBS chief executive officer Fred Goodwin was an accountant. Neither had a banking qualification.

COLIN MCALLISTER South Street, St Andrews