2. The banks, the government, and that Money Tree
Back in the late 1970s, after qualifying as an accountant, I went to work for a large city practice. I was told by those who had experience of them that, if I valued my will to live, I should avoid bank audits. Whilst training I had seen hundreds of clients’ bank statements, for all types of account, and so felt I knew all I needed to know about banking.
Up until recently I believed the conventional wisdom that, when my bank lent me £500 to start my own practice back in 1981, it could only do so because it was backed up by the money sitting in the accounts of other customers.
I received the first bank statements for my business loan and current accounts, seeing £500 credited to the latter and debited to the former, but even as a wizard bookkeeper, I never appreciated that this was the end of the story, one credit, one debit, nobody else was involved.
Last year I watched a 2014 video on the Bank of England’s website explaining that 97% of the money available to us in the economy is created by what I describe above. In other words, my bank created that £500 out of thin air and I spent it out into the economy. Then, when I finally repaid the £500 loan, the money was effectively destroyed.
Along with the video there was a debate in Parliament about this money creation and it turns out that, in a poll, 90% of MPs had no idea that it worked like this. Like me, they believed banks were constrained by the amount held in customers’ accounts.
My retired auditor’s brain then dug deeper and I learned that as well as high street banks being licenced by the Bank of England (BoE) to create this new money it too has a similar role in relation to government spending. So when the government tells the BoE to pay the NHS £4bn, the bank credits the NHS’s bank account with £4bn and debits the Treasury’s overdraft account with £4bn. That’s it, nothing else.
The surprise was that this overdraft is created anew every day, the BoE doesn’t turn to the Treasury and say, “hold on there’s only £3bn of taxpayers’ money sitting in your account”, it just spends the £4bn into existence on overdraft, rather than loan.
So, the Government instructs the BoE to create money for its own spending and commercial banks create the rest whenever they lend to anyone.
The above view on government spending reflects a new way of looking at how governments, like the UK, who issue their own currency, control the money flowing around their economies. There are several threads but, in general, it’s known as “Modern Monetary Theory” (MMT) and this is explored further in the following pieces.
2. The banks, the government and that Money Tree