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posted on 07 July 2017

Money Is Created From Nothing

Written by , Econoblog101

Debate on Money Creation at the ECB

The consequences of the debate are shocking! The mainstream view of economics is wrong, according to the German central bank Deutsche Bundesbank. This is a revolution.

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Modern capitalism is impossible without money. We do not exchange goods against goods - we buy goods with money. The interesting question for economics is hence: where is money coming from? The Bundesbank has now delivered an answer that is revolutionary: Money is created from nothing - by accounting processes inside banks. This may sound abstract at first, but the consequences are far-reaching. The Bundesbank says that the mainstream theory in academic economics is wrong. Millions of students at universities learn a fairy tale.

This fairy tale is spread by, for instance, Gregory Mankiw, whose textbook "Macroeconomics" has sold millions of copies and is widely used at German universities. For Mankiw, banks are just middlemen, called intermediaries: they allegedly get money from savers that they then pass on to other customers.


The Bundesbank says that the mainstream theory in academic economics is wrong.


The Bundesbank says that the mainstream theory in academic economics is wrong. The idea of the mainstream theory might sound reasonable, but has little to do with reality. Banks do not need savers to extend loans. They are not intermediaries, but create money by themselves. The Bundesbank says that unequivocally.


Millions of students at universities learn a fairy tale.


The prose is a bit awkward, nevertheless it is worthwhile to read the main passage (Bundesbank):

"If a bank extends a loan, she books the credit to the customer connected to the loan as his deposit [...] This refutes a widely held erroneous view in which the bank acts as an intermediary in the moment of lending, in which loans can only be funded by deposits that the bank has received from customers before."

Harvard professor Gregory Mankiw, with his theory of intermediation, subscribes to "a widely held erroneous view", according to the Bundesbank.

New money is born

Words like credit or deposit sound complicated, but one can imagine money creation like a scoreboard in a football stadium: first goals are scored, then the scoreboard is adjusted accordingly.

This is how banks, work, too: first, the bank signs a loan contract - and then the money is added to the client’s account. The money did not exist before, it is created through the extension of a loan.


... one can imagine money creation like a scoreboard in a football stadium: first goals are scored, then the scoreboard is adjusted accordingly.


Let us assume, that a customer applies for a loan of a thousand euros to buy a used car. Then the bank tops up his account. Done. New money is born. When the client repays the thousand euros - the money is gone again.

This insight has enormous consequences, because the Bundesbank says: the relationship between debts and savings is rather different from the view of the "Swabian housewife". This figure of speech, which is generally known, thinks that saving is always good - and debs are to be avoided. The German language also suggests that loans are evil. The German word for debt - Schulden - instantly reminds one of the idea of moral sin - moralische Schuld. He who takes out loans is quickly regarded as disreputable.

Two practical questions

As the Bundesbank has shown, loans are the driver of the economy. Without them we would have neither investment nor economic growth. Only when loans are taken out can savings be created. The world of the Swabian housewife is turned topsy-turvy: savings are accommodating items, seen from macroeconomic accounting.


The debt of one person becomes the financial wealth of another.


Let’s stay with the banal example or a car purchase. When someone borrows a thousand euros to buy a used car - then money is created, which then is transferred to the seller, who now has additional savings of a thousand euros. These savings were created from nothing just like the loan.

Or, in economese: The debt of one person creates the financial wealth of another.

It is not the other way around: the wealth of one person is not used to create a debt for another.


Sidebar: Of course, within the economy there are loans from one person with money to another who desires additional money. But these transactions outside of formal banking constitute an insignificant fraction of loans. Their existence does not repudiate the assertion that most debt is accrued via the accounting operations of banks which create new money for the loan.


Two practical questions remain: If banks do not need savings to extend loans - why do we save at all? And why, at least in the past, high rate of interest were paid for savings deposits, if these are essentially superfluous?

To start with the savings: most Germans do know instinctively why they would like to save some money. They make provisions for the future. They save to buy a house, for old age or to finance their kids’ education. Firms also like to save. Profits only arise if income is higher than expenditure.

The Germans are saving

Households and firms hence save even when interest rates are low or zero. We can see this phenomenon now: Whereas many banks offer negative interest rates or raise account fees, the Germans continue undauntedly.

This leads us to the second question more urgently: why are there interest rates in the first place, if savings takes place anyway - and banks do not need those savings to extend loans?


With interest rates rising, taking out more loans will not be attractive. Money creation is stopped for the time being.


The interest rate is a brake for credit creation and inflation. If money is created from nothing through the issuance of loans, then theoretically an infinity of money could be pumped out into the world. When people consume and invest without limited, at some point all factories and workers will be busy, and inflation starts to rise.

This is when central banks intervene: They raise the interest rate as soon as high inflation seems to occur. With interest rates rising, taking out more loans will not be attractive. Money creation is stopped for the time being.

What follows from this?

The Bundesbank has entered history books with their account of money creation. But that is only in Germany. Truth is, other central banks were quicker. The Bank of England wrote the facts about money is creation from nothing on their homepage in 2014.

What follows from this politically? The Bundesbank remains silent on this issue. However, it is obvious that finance minister Schäuble’s "policy of a black zero“ - a balanced government budget - is just as wrong as the austerity policies of the Eurozone.


If Schäuble saves and avoids any creation of debt he prevents his citizens from building up new wealth.


Recalling the Bundesbank’s presentation: Savings can only be created when loans are extended. Debt and wealth belong together. But this reality is ignored by most Germans and their finance minister. They rather trust their guts: They would absolutely like to save - but also reduce their public debt. That does not work. If Schäuble saves and avoids any creation of debt he prevents his citizens from building up new wealth.

It’s even worse in the Eurozone: The crisis countries are forced to slash their government spending and are supposed to not incur any new debts but pay off old ones. This also will not work.

Schäuble should start to borrow

Where do incomes come from which are needed to repay the debts? What repays debts, in matter of fact, is saving. But savings can only exist if someone increases his debts.

Mainstream economists often mock this statement by claiming that it would be nonsense to fight a debt crisis with new debts. It may be paradox, but this is how the world of money works, as the Bundesbank has explained to us.


What repays debts, in matter of fact, is saving. But savings can only exist if someone increases his debts.


ECB president Mario Draghi, an experienced central banker, has understood much earlier than the Bundesbank that new public debts are needed. No speech, in which he does not call on the economically stronger Eurozone countries, mostly Germany, to engage in expansive fiscal policy. What he means is: Schäuble should finally take out new loans. There are enough investment projects worthy of financing. Everybody agrees that the internet is the economic future - yet powerful internet connections are lacking in many locations in Germany.

Also, there now is a brand-new investment project, which is mandatory: all university libraries need new textbooks on macroeconomics. Mankiw and the other mainstream economists have finally been paid off, since the Bundesbank spoke its mind.


This article was adapted from a transltion from German by the author of his article at taz.de: Das Geld kommt aus dem Nichts. The unedited translation can be reviewed at Econoblog 101.


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