Positive Money’s flawed ideas on debt.

I agree with some of PM’s ideas, in particular their advocacy of full reserve banking. But then there’s plenty of brain power behind full reserve, e.g. the idea was advocated by Milton Friedman (see 2nd half of Ch 3 of his book “A Program for Monetary Stability”). Plus the idea is currently advocated by Lawrence Kotlikoff (economics prof. in Boston).

As to PM’s ideas on debt, let’s run thru the 3 minute video on the subject of debt they’ve produced.


The video starts (0.00 – 0.20) by claiming that debt in the UK more than doubled between about 1995 and 2005. Well a significant proportion of that increase will be attributable to inflation.

As for the rest, there is a whapping great problem with the idea that the increase in debt is attributable (as the video claims) to the fact that banks create debt when they create money. And that’s the fact that the banking system concerned (fractional reserve) has been going for a good two hundred years and arguably much longer. Thus if the current banking system inevitably leads to debts doubling every decade, we ought by now to have debts of about £10million per person.

Put another way, if it was the current banking system that gave rise to a doubling of debts between about 1995 and 2005, as the video claims, why didn’t that same system also cause a doubling of debts in any previous decade you care to mention?

Next, the video claims that when people borrow from banks, the relevant money does not come from what the video calls “an army of grannies who have spent their lives putting money away for a rainy day” (0.26). Apparently the money is simply created out of thin air by commercial banks.

Now there’s a problem there, which is that having created that money (and after the borrower has spent it), the money must end up in someone else’s account. And that person must be willing to leave it there for an extended period, i.e. not spend the money: if they don’t, we’d just get inflation (assuming the economy is at capacity before the extra lending takes place).

So in effect, and contrary to the claims of PM’s video, borrowing IS MADE POSSIBLE by an army of grannies or put another way “willing savers”.

Next, the video trots out the famous 97% figure: that’s the proportion of money which Positive Money claims is created by private banks. Now while the vast majority of money is indeed created by private banks rather than central banks, the argument behind the 97% figure is nonsense. The argument runs thus.

3% of money is physical cash, ergo the rest (i.e. 97%) must be privately created. Well now, that completely leaves out a large chunk of money namely central bank money which does not take the form of physical cash. Indeed, thanks to quantitative easing, that chunk of money is unusually large just at the moment. Indeed, far as I can see, it makes up about 20% of the US money supply. Thus not only is the THEORY behind the 97% figure flawed, but at the time of writing, the 97% figures is WAY OUT. I.e. the figure for the US at the moment is around 80%.

Next, the video claims (up to about 2.15) that since debt equals money equals debt (so to speak) then any reduction in debt equals a reduction in the money supply, and a reduction in the money supply will cause “less spending and less spending means fewer jobs”.

Well the flaw in that argument is spelled out very eloquently by Positive Money themselves and it’s as follows. As part of their switch to full reserve banking, they advocate the setting up of what they call “investment accounts” which are for depositors who want their money loaned on or invested by their bank, and who are prepared to accept some of the risk that those loans and investments inevitably involve. (Incidentally other advocates of full reserve like Lawrence Kotlikoff advocate something pretty similar to PM’s investment accounts).

Now as Positive Money rightly says in relation to those investment accounts, the so called money in them cannot be viewed as money or be treated as money and to that end, Positive Money (quite rightly) advocates steps to prevent the contents of those investment accounts being used in the same way as normal money, e.g. the £10 notes in your wallet. For example PM advocates a period of notice before investment account holders can gain access to their money.

And that’s very much in line with conventional ideas as to where to draw the line between money and non-money. That is, most countries have various definitions of money, and the universal tendency is to NOT COUNT AS MONEY, the contents of a term or deposit account where access to the money requires more than a month or twos notice.

Now if a bank “lends money into existence” for the benefit of some mortgagor, and the ultimate recipient of that money (i.e. a “granny”) decides to leave it in their bank account for an extended period, the likelihood is they’ll put into some sort of deposit or term account: at least how they’ll be able to get a decent rate of interest. But that means that the contents of the account is not money!!!!

Thus PM’s claim that because debts are reduced, therefor the amount of money is reduced is nonsense.

And even if the latter “granny” leaves the relevant chunk of money in a current or checking account for an extended period, that so called money is not being used as money: it’s more in the nature of a long term loan to the bank – i.e. a long term loan to the mortgagor.




Private banks do lend on money they receive from depositors.

Advocates of the view that “loans create deposits” have been getting too uppity of late. That is, they’ve been claiming that the view that banks lend on deposits is old hat. That’s going too far. What commercial banks do is actually a mix of the latter two activities.

As an example of the latter “uppitiness”, Positive Money quotes Mervyn King, former governor of the Bank of England who said “When banks extend loans to their customers, they create money by crediting their customers’ accounts.”

The reality is that the commercial bank system cannot increase loans unless there are people out there prepared to lend: i.e. leave money for relatively long periods in bank accounts. That is, assuming the economy is at capacity, one person cannot consume more (i.e. raise demand) unless someone else cuts their consumption (i.e. cuts demand).

Moreover, those who “leave money for relatively long periods” in bank accounts will tend to put their money into so called “term” accounts: that’s accounts where there is no instant access to the money. And that so called money is often not counted as money – though the EXACT practice there varies from country to country.

Of course banks engage in a certain amount of maturity transformation: i.e. lending on money placed in instant access accounts. But certainly if loans rise, that will to a large extent be funded by so called money in term accounts, which is not really money. And to the extent that loans are funded out of instant access money, there has to be an increase in instant access deposits to enable banks to lend.

So do loans create deposits or do depositors make loans possible? It’s a chicken and egg question.