Is 97% of money created by commercial banks?

Positive Money claims it is. But I beg to differ.

Positive Money has done a good job in some respects, as pointed out by Victoria Chick. (See first two minutes of this video clip.) PM has stirred things up, and made everyone think about money. Plus some of PM’s critics are intellectual pigmies, who have no grasp of economics at all, e.g. UK Column and  Detlev Schlichter (who never uses one word when a hundred will do).

Indeed, Schlichter wrote an entire book predicting that hyperinflation would result from QE, and has now gone into hiding perhaps out of embarrassment at the failure of hyperinflation to materialise.

Anyway, PM does make some mistakes (as indeed we all do). In particular, the argument behind their much publicised claim that 97% of money in circulation is commercial bank created isn’t quite right. Their argument goes as follows.

3% of money is physical cash (£10 notes, etc), ergo the rest must be commercial bank created. Now the flaw in that argument is that it leaves out central bank created money (monetary base) which is not physical cash. That’s central bank created money (which like most money) takes the form of a book-keeping entry (done on computers nowadays).

The ACTUAL AMOUNT of the latter “central bank book-keeping” money is normally no large compared to the other above mentioned types of money, thus the 97% figure won’t be far out – NORMALLY. However, we aren’t in normal times at the moment: in particular, central banks have created large amounts of money recently so as to effect QE.

So, at a wild guess, the proportion of money which is not commercial bank created might be about 90% at the moment, rather than 97%.


Are reserves a form of money?

Doubtless some readers will claim there’s a flaw in the above argument, namely that bank reserves (or monetary base in the books of the central bank) is not a form of money available to bog standard bank depositors like you and me. Well it’s true that standard depositors don’t have DIRECT access to central banks. But they do have access using their commercial bank as an agent.

To illustrate, if person X is paid money by the central bank as a result of the above QE (i.e. X sells government debt to the central bank), then X’s account at their commercial bank is credited. Plus the latter bank’s account at the central bank is credited.

But X has complete freedom to do whatever they want with that central bank money. If X wants the money in the form of physical cash, then X’s commercial bank just has to get that money, and sharpish, from the central bank, and give it to X.






3 thoughts on “Is 97% of money created by commercial banks?

  1. “But X has complete freedom to do whatever they want with that central bank money.”

    If X is a non-Bank entity, as I believe you infer, then does X really have control over the “central bank money” to do as it pleases? Are you referring to the mirror image deposit created in the process?

    • Hi Alex,
      Sorry about my slow response. The non-bank entity has control over BOTH the deposit at a commercial bank and the corresponding amount at the central bank. E.g. if I have an account at bank X and write a cheque for £A in favor of someone who banks at bank Y, then my account at my bank is debited to the tune of £A, the account of the payee at their bank is credited and £A is transferred from the account of bank X in the books of the central bank to the account of bank Y (in the books of the central bank).

      • Thank you for the response Sanjay. Allow me to make sure I follow. One point, I understand, is that QE is not inflationary. I can see that, as it entails very simplistically a swap of one form of “money”, for another: Bank exchanges Gov securities on its books, for reserves. Since banks don’t lend reserves, no major impact there. If the counter-party is a non Bank (X), then X obtains money for its securities, and no major change there either, as it could have done this without QE, and moreover, Gov securities are a form of money. It would be as if X changed its money from its “savings” account, to its “checking” account. Yes?

        Now, what I further understand you are saying is that in the process related to X above, X’s bank will have correspondingly increased its level of reserves, and in order for the T accounts between X and its banks to balance: at the Bank level, the increase in reserves (asset) is matched by a deposit (liability); that deposit is an asset for X… an asset that in turn used to be Gov securities, and is now instead bank money.

        If the above is all correct and coincides what you are saying, I guess my only doubt is the statement “X has complete freedom to do whatever it wants with the central bank money”. What you mean is that X can control the deposit (bank money) linked to that CB (reserve) money, yes?

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s