Back in the 1930s, Henry Ford is supposed to have remarked that it was a good thing that most Americans didn't know how banking really works, because if they did, "there'd be a revolution before tomorrow morning".
Last week, something remarkable happened. The Bank of England let the cat out of the bag. In a paper called "Money Creation in the Modern Economy", co-authored by three economists from the Bank's Monetary Analysis Directorate, they stated outright that most common assumptions of how banking works are simply wrong...
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf
... the kind of populist positions more ordinarily associated with groups such as Occupy Wall Street are correct. In doing so, they have effectively thrown the entire theoretical basis for austerity out of the window.
http://www.theguardian.com/world/occupy-wall-street
To get a sense of how radical the Bank's new position is, consider the conventional view, which continues to be the basis of all respectable debate on public policy. People put their money in banks. Banks then lend that money out at interest...
The central bank can print as much money as it wishes. But it is also careful not to print too much... Institutions such as the Bank of England or US Federal Reserve were created to carefully regulate the money supply to prevent inflation...
... the Bank of England... To quote from its own initial summary: "Rather than banks receiving deposits when households save and then [lend] them out, bank lending creates deposits..."
In other words, everything we know is not just wrong – it's backwards. When banks make loans, they create money. This is because money is really just an IOU... So for the banking system as a whole, every loan just becomes another deposit...
What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow...
Why did the Bank of England suddenly admit all this? Well, one reason is because it's obviously true. The Bank's job is to actually run the system, and of late, the system has not been running especially well. It's possible that it decided that maintaining the fantasy-land version of economics that has proved so convenient to the rich is simply a luxury it can no longer afford.
But politically, this is taking an enormous risk. Just consider what might happen if mortgage holders realised the money the bank lent them is NOT [funds held on deposit]...
Historically, the Bank of England has tended to be a bellwether, staking out seeming radical positions that ultimately become new orthodoxies. If that's what's happening here, we might soon be in a position to learn if Henry Ford was right.
http://www.theguardian.com/commentisfree/2014/mar/18/truth-money-iou-bank-of-england-austerity?CMP=fb_gu
Related article:
http://co-creatingournewearth.blogspot.co.nz/2013/03/55-trillion-can-not-pay-off-1600.html
The Bank of England from the air
Image source
