Episode 24 Money Matters: Central Banks Get Blamed for Money Commercial Banks Create

[00:00:18] Emanuel: Hi, everyone, and welcome to yet another episode of The Curious Pundits podcast. It's been a while since we've recorded an episode. We were on a small vacation, but we'll surely catch up. My name is Emanuel, and I'm the co-host of The Curious Pundits podcast.

[00:00:33] Kevin: My name is Kevin and I'm the other co-host.

[00:00:36] Emanuel: Today is the first of many episodes that will fall under a different category. It is still a Curious Pundits episode, and it is a rant that Kevin had on his list for a while. I will be sitting quietly, taking notes, and asking questions if I have any. This is the first of a series; can you give some context?

[00:02:06] Kevin: The umbrella term is macroeconomics. There are many well-known stories about how economies work that, as near as I can tell, are flat-out not true. The hard part is unlearning what we know to be true that isn't true. Once you've unlearned, you can be open to learning how things actually work.

[00:02:32] Emanuel: Do I need my tinfoil hat for this one, or save it for later?

[00:02:40] Kevin: Some of this may sound like conspiracy theory, but these are conspiracies done out in the open, easy to show to anyone interested in learning this stuff. We are going to start with the accepted narrative that central banks control the money supply.

[00:03:22] Kevin: In a modern monetary economy, approximately 97 percent of the money we use is demand deposits in banks. When you use your debit card, the number in your demand deposit goes down and the number in the merchant's demand deposit goes up. We principally use demand deposits as money.

[00:04:26] Emanuel: Does this apply to everyone around the world, and what is a central bank?

[00:04:49] Kevin: It does not apply to people who are unbanked, but it applies to a significant percentage of the global population. Banking happened first; central banking came later to fill a need. Credit cards put an intermediate short-term loan in front of a transfer from one deposit account to another.

[00:06:39] Kevin: The next question is what activities increase and decrease the aggregate level of deposits in the banking system. Deposits are money. Things that are not deposits are not money. Central banks do not create deposits; central banks create reserves, principally to settle payments between banks.

[00:07:19] Kevin: If we both bank at Toronto-Dominion and I buy something from you, the payment clears inside that bank. If I bank at Scotiabank and you bank at Toronto-Dominion, a higher-level clearing house settles the payment. My deposit and my bank's reserves go down; your bank's reserves and your deposit go up.

[00:09:08] Emanuel: So the central bank keeps a ledger that can be cross-referenced with the banks' internal ledgers.

[00:09:17] Kevin: Yes. Money is entries on a ledger. Deposits and reserves are accounting entries. Reserves maintain bank equity during interbank payments: loans are a bank's assets and the deposits it holds are liabilities. Without reserves, a payment between banks would improperly change their equity.

[00:11:13] Emanuel and Kevin discuss debits, credits, assets, liabilities, and why the accounting terminology can be counterintuitive. Kevin compares a payment to a Star Trek transporter: one account is decremented and another is incremented.

[00:13:29] Kevin: Central banks create reserves, not deposits. You cannot pay your rent or mortgage with reserves. There are special institutions, such as the United States Treasury, Canadian Treasury, and English Exchequer, that can accept reserves and spend the resulting deposits into the economy.

[00:15:16] Kevin: Two things increase aggregate deposits: federal government spending and bank lending. Governments spend money into existence and tax it out of existence. Banks lend money into existence, and when they collect principal payments, that money is destroyed.

[00:16:17] Kevin: The money supply is shaped by government spending, taxation, bank lending, and loan repayments. Central banks have limited tools to control it, even though they are blamed when things go wrong. Bank lending tends to create 90 to 97 percent of money in circulation; government spending tends to create 3 to 10 percent.

[00:18:20] Kevin: Nothing has a stronger influence on the shape of an economy than how much bank lending occurs and what it occurs for. Broadly, people borrow to consume, to produce, and to purchase financial assets such as stocks, bonds, and real estate.

[00:18:58] Emanuel raises Canada's experience during the 2008 financial crisis and the role of government spending in development, jobs, and stability. Kevin connects this to a broader criticism of neoclassical economic models that omit money, banking, and credit.

[00:20:26] Kevin: Credit, what it is created for, and where borrowers get the money to make their payments are dominant features of an economy. Excess lending for financial speculation tends to destabilize economies. Canada and nineteenth-century Scotland had comparatively stable banking systems, measured in part by low bank failures.

[00:23:17] Kevin: In the 1920s, people could buy stocks on margin. A person might buy $100,000 in stock with $10,000 and borrow $90,000 from a broker, whose funding ultimately came from a bank. If asset values fell, the borrower had to meet a margin call or the broker sold the stock.

[00:25:03] Kevin: When this happens at scale, it creates a doom loop: selling drives prices down, generating more margin calls and more selling. Loans being repaid or defaulted on, banks falling into negative equity, and bank closures can cause money to disappear from the economy.

[00:26:00] Kevin: Before deposit insurance, a bank closure destroyed deposits. Deposit insurance prevents insured deposits from disappearing, using funds from the insurance system. The contraction of money during the 1920s helped trigger the Great Depression.

[00:27:18] Emanuel: We will tackle more of this in future episodes. He then shares an anecdote from Leroy, Saskatchewan: during the Great Depression, farmers reopened a cheese factory but could not be paid until cheese was sold. The factory issued cheese-backed coupons that local businesses accepted like cash. Every coupon was redeemed, and the system supported the community until a larger dairy company bought the factory in 1936.

[00:29:09] Kevin: Fundamentally, money is someone's financial liability that we exchange for goods and services. During the Depression, municipal scrip existed in cities across the United States, including Detroit, Atlanta, and Los Angeles. There was a practical understanding that local economies needed a medium of exchange when U.S. dollars were scarce.

[00:30:31] Emanuel: Until then, my name is Emanuel.

[00:30:35] Kevin: My name is Kevin.

[00:30:38] Emanuel: Together we host the Curious Pundits podcast. This has been the first part of Kevin's rant about money, macroeconomics, and things that many people think are true but are not. Visit curiouspundits.com, like, share, subscribe, and let us know if you agree, disagree, or think we made a mistake.

[00:31:05] Kevin: Thank you for listening. We'll see you soon.