The Fruits of Civilization (26-10-1) Banking


The process by which banks create money is so simple that the mind is repelled. ~ John Kenneth Galbraith

In allocating societies’ liquid resources, banks are the special institution at the heart of capitalism. The ostensible task of banks is to profitably find productive uses of capital.

Banking embodies a core contradiction: safety and risk. Depositors expect a safe place to stash their funds and gain some return for doing so. Banks must lend money out to earn a return: a practice with inherent peril.

The art of banking is managing risk. It is a black art, whereupon its weavers often deceive themselves as to the essential alchemy. History has repeatedly shown this to be so.

A bank’s decisions are all atomic: to whom to lend, whereas the fortune of the future is molecular: inextricably bound to economic reactions outside the purview of either lender or borrower. Capitalist economies transact in waves, and banks are caught in those waves, as are all who invest their bank loans.

Whereas customer deposits are liabilities, a bank counts outstanding loans as assets. Unlike other economic institutions, bank assets are only nominally under a bank’s control.

Money is created each time a loan is made. This comes from considering the same money to be in 2 places at once: the bank counting the loan as an asset, while the actual holder of the loaned money spends it. Banks inflate the money supply by lending.

Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money. Just as taking out a new loan creates money, the repayment of bank loans destroys money. Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy. ~ The Bank of England

Growing the money supply risks inflating the general price level, and vice versa. This is what happened in the run-up to the 2008 recession.

Money washed through the US economy like water rushing through a broken dam. ~ US Financial Crisis Inquiry Commission in 2010