
Money creation in the modern economy (2014) [pdf] - adamnemecek
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
======
mendelsd
Most people are unaware of the true mechanism of money creation, therefore
don't understand how the current mechanism and its (lack of) constraints
affect society, therefore don't see the potential for societal improvement
through systemic change around money creation and allocation.

Prof Richard Werner is worth listening to on this topic. [1]

I'd also recommend Steve Baker's heroic speech in UK parliament. [2]

[1] [https://youtu.be/9bQkfN_pe44](https://youtu.be/9bQkfN_pe44)

[2] [https://youtu.be/bXOkmD8Eozs](https://youtu.be/bXOkmD8Eozs)

~~~
razakel
>I'd also recommend Steve Baker's heroic speech in UK parliament.

What's astonishing is that 85% of MPs _do not know how money is created_. 70%
believe that only the government can create money!

That's like the CEO of GM not knowing what powers a car...

------
namelost
You can't miss the accompanying videos that they recorded down in the
basement:

1)
[https://www.youtube.com/watch?v=ziTE32hiWdk](https://www.youtube.com/watch?v=ziTE32hiWdk)
(beginner)

2)
[https://www.youtube.com/watch?v=CvRAqR2pAgw](https://www.youtube.com/watch?v=CvRAqR2pAgw)
(advanced)

------
dwd
Highly recommend this article for a dose of reality (he also covers the theory
of money creation)

[http://www.debtdeflation.com/blogs/2009/01/31/therovingcaval...](http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/)

------
ThomPete
Can't recommend "The end of alchemy" by Mervyn King former CEO of Bank of
England enough.

------
manjushri
It seems like leverage has shifted from the central banks to commercial banks
over recent decades, and indeed there has been massive consolidation of power
in the commercial sector. The central bank seems more like an insurance proxy
for the tax payer to the commercial bank, as evidenced by the 2008 rescue
packages.

------
codeulike
An aspect of this I wonder about is that many years ago a bank account is what
you opened when you explicitly wanted to lend money to the bank to earn
interest. But these days a bank account is pretty much mandatory for any sort
of normal existence.

------
wazoox
One thing that is astonishingly glossed over again and again is energy. There
is no activity, no economy of any sort without energy. Energy availability
therefore is absolutely central to any economic activity. Energy availability
is not infinite, or infinitely elastic to demand. You cannot either infinitely
yield more output from a given amount of energy. In last resort, we could say
that all money is an energy debt (every dollar amounts to some energy quantity
that varies). Making untenable promises by printing large amounts of money
doesn't change this (promising that in 20 years, we'll have x% more energy
than today doesn't help making this actually happen).

In a finite world, you can't grow economy infinitely, period. Frigging laws of
physics.

See for instance

[https://dothemath.ucsd.edu/2011/07/can-economic-growth-
last/](https://dothemath.ucsd.edu/2011/07/can-economic-growth-last/)

Or start here for more

[https://dothemath.ucsd.edu/post-index/](https://dothemath.ucsd.edu/post-
index/)

~~~
dsr_
Energy availability is effectively infinite if you can plan for what you need
and invest in the necessary infrastructure.

Total insolation for the Earth is around 170 petawatts. If you need more than
1% of that, space-based solar will be cost-effective.

The long-term problem with energy is getting rid of your waste.

~~~
jamoes
Yep, this is exactly the point economist Julian Simon made in his essay, "Can
the Supply of Natural Resources - Especially Energy - Really Be Infinite?
Yes!" [1]

This exert from the conclusion sums up his argument well:

> Incredible as it may seem at first, the term "finite" is not only
> inappropriate but is downright misleading when applied to natural resources,
> from both the practical and philosophical points of view. As with many
> important arguments, the finiteness issue is "just semantic." Yet the
> semantics of resource scarcity muddle public discussion and bring about
> wrongheaded policy decisions.

[1]
[http://www.juliansimon.com/writings/Ultimate_Resource/TCHAR0...](http://www.juliansimon.com/writings/Ultimate_Resource/TCHAR03A.txt)

~~~
wazoox
This is utter BS. It relies on bad analogies and not physical reality. The
example given (copper) is absurd; recycling implies using energy (and disposal
of waste heat), therefore you substitute a resource (copper ore) for another
(used copper and energy). The analysis supposes that every resource is
substitutable (they aren't), and that energy is infinite (it isn't).

------
simo7
This should not come at a surprise as money really is debt.

Say you get a loan of 100$: now you have 100$ more to spend...but your
creditor can still factor his/her credit (sell it at a discount) and spend
that sum.

That initial 100$ can be spent twice (minus discounting factor).

Of course that loan needs to be repaid at one point. But what if you keep on
making new debt to repay the previous debt? And what if the credits you
generate have a particular utility for your creditors (eg. government-bonds
for banks) so that you get 0 or even negative interest rate?

You got really close to creating money. The difference between different types
of debts and money is rather quantitative (interest rate) than qualitative:
[https://en.wikipedia.org/wiki/Near_money](https://en.wikipedia.org/wiki/Near_money).

------
stephen_g
Yes, learning how banks create money for me was a huge turning point in
realising most of what people think they know (and what I thought) about
money, debt and economics is actually wrong. That the money supply grows when
banks lend and contracts when people pay the debt down is a big point to get
your head around.

The other big one is the national accounts and sectoral balances - see [1] for
a much more detailed run-down.

To summarise, take the definition of GDP:

(1) GDP ≡ C + I + G + (X – M)

where C is household final consumption, I is private investment including
inventory, G is Government spending, and (X-M) are net exports.

Add net external income flows (FNI) to (1) and you get GNP:

(2) GNP = C + I + G + (X – M) + FNI

Subtract total transfers and taxes from each side:

(3) GNP – T = C + I + G + (X – M) + FNI – T

Collect terms by sector (private, Government and External)

(4) (GNP – C – T) – I = (G – T) + (X – M + FNI)

Then we can simplify - (GNP - consumption - taxes) is equilivalent to private
saving (we’ll call that S), and (X - M - FNI) is called the Current Account
Balance (CAD):

(5) (S – I) – (G – T) – CAD = 0

or (6) (S – I) = (G – T) + CAD

What this means is that by definition, if your external sector is balanced, a
Government budget surplus _must_ reduce the net assets of the private sector
by exactly the same amount as it is in surplus. With a trade deficit and a
Government surplus, the private sector’s net assets are reduced by the sum of
those.

This is quite clear graphically too [2].

So the end result is that you can only have economic growth when the
Government is running a surplus and the private sector is in balance or
deficit through money creation from banks. Is relies on people borrowing more
and more money - but because equal amounts of debt are also created (no higher
net wealth), eventually the sector in aggregate can’t borrow any more, and the
system falls apart (the second derivative of credit growth dropped a little
while before the GFC, which is how some non-mainstream economists predicted
that it was coming).

But at the end of the day, this means a balanced or surplus Government budget
is actually _bad for the economy_ by definition unless you have a big trade
surplus (like Germany for instance), because it’s sapping the private sector
of wealth.

Do you have to start taking a more nuanced view of Government debt, when
Government debt actually represents the net actual savings of the private
sector!

1\.
[http://bilbo.economicoutlook.net/blog/?p=32396](http://bilbo.economicoutlook.net/blog/?p=32396)

2\.
[https://skeltonphd.files.wordpress.com/2013/06/slide1.jpg](https://skeltonphd.files.wordpress.com/2013/06/slide1.jpg)

~~~
nopriorarrests
>Government debt actually represents the net actual savings of the private
sector!

Excuse me, but when Federal Reserve conducts QE and buys 1 trillion of freshly
issued government debt, what does it have in common with actual savings of the
private sector? Who saved that paltry trillion? :)

~~~
stephen_g
Yes, QE is interesting. Definitey goes against the “Government must tax before
it can spend” idea. Remember the Fed is part of the US Government sector, so
spending as a result of QE should go into the private sector, minus what is
taxed back later.

Government securities generally represent savings because the Governments are
generally legally required to match deficit spending with bonds, etc. QE was a
bit of a departure from the norm (perhaps only temporarily though) and shows
what modern monetary theory says - that it isn’t really necessary, not is it
necessarily inflationary (this is because _all_ spending carries inflationary
risk, and inflation has to do more with aggregate demand than money supply
etc. - and the most generally anti-inflationary force is actually taxation)

~~~
nopriorarrests
I have a different view. Unfortunately it's not possible to make a real
scientific experiment to validate your or my assumption.

My thinking is that QE is quite inflationary.I think that after 2008 crisis we
were expected to have a long period of strong deflation (let's say, with
prices falling 4% each year, for 8 years straight), but QE reverted that and
we had 1% of inflation or something like that instead. So, formally we are in
"mild inflation" ground, but in fact the QE effect was quite dramatic. We just
can't observe it because we don't have a "control group economy".

~~~
stephen_g
Well, all spending carries inflation risk - what really matters is what
aggregate demand is like and how much spending and taxing alters that.
Certainly QE could be inflationary, but as it was it was mostly just buying
back securities it was mostly asset neutral so shouldn’t have done much (just
like issuing Government securities to match deficit spending (just in reverse)
- it doesn’t actually alter whether deficit spending is inflationary or not
since there is a quite liquid market for those assets so they’re very similar
to cash).

It is considered to have inflated prices of certain financial assets though
(shares etc.)

~~~
nopriorarrests
stephen_g, if you are interested, then I wrote a very simple scenario of how
QE could (and IMHO did) spill over into "real economy" here --
[https://news.ycombinator.com/item?id=16606140](https://news.ycombinator.com/item?id=16606140)

------
dunk010
While informative I think that this article is somewhat misleading as it omits
any discussion that the reserves described are, in fact, fractional reserves.

~~~
spiralx
Well no, because the whole point of the article is that fractional reserve
banking doesn't actually exist and that there is no money multiplier.

------
known
[https://en.m.wikipedia.org/wiki/Chiemgauer](https://en.m.wikipedia.org/wiki/Chiemgauer)
is a good experiment on local currency

------
nosuchthing
It seems quiet ironic that Bitcoin/Cryptocoin advocates claim the minting and
production using algorithms like Satoshi's BTC will be better than fiat when
it just creates a new oligarchy... easier to co-opt due to the consolidation
of control within the cryptocoin ecosystems.

Banks and the finance sector took note of BTC prior to 2014, and with the way
BTC is produced anyone with enough capital entering into BTC - especially
during the first few years would be in a position to take vast amounts of BTC
at low cost and simply wait and attempt to convince other people to exchange
their wealth for BTC which due to how the supply begins to be cut off, serves
to enrich the minority of oligarchial squatter-speculators.

Bitcoin is often misunderstood as "deflationary" yet checking the math under
the hood and we see that's a half truth. The supply inflates every 10 minutes,
and for the first few years Bitcoin was hyperinflationary, granting a small
group of users the majority of the supply.

    
    
      Satoshi Nakamoto
      Thu Jan 8 14:27:40 EST 2009
      I made the proof-of-work difficulty ridiculously easy to 
      start with, so for a little while in the beginning a 
      typical PC will be able to generate coins in just a few 
      hours. It'll get a lot harder when competition makes the 
      automatic adjustment drive up the difficulty.
    
      first 4 years: 10,500,000 coins
      next 4 years: 5,250,000 coins
      next 4 years: 2,625,000 coins
      next 4 years: 1,312,500 coins
      ____________________________________________________
      ____________________________________________________
    

[https://medium.com/@balajis/quantifying-
decentralization-e39...](https://medium.com/@balajis/quantifying-
decentralization-e39db233c28e) :

    
    
      One important point: if we actually include all 7 billion 
      people on the earth, most of whom have zero BTC or 
      Ethereum, the Gini coefficient is essentially 0.99+. And  
      if we just include all balances, we include many dust 
      balances which would again put the Gini coefficient at 
      0.99+. Thus, we need some kind of threshold here. The 
      imperfect threshold we picked was the Gini coefficient 
      among accounts with ≥185 BTC per address, and ≥2477 ETH 
      per address. So this is the distribution of ownership 
      among the Bitcoin and Ethereum rich with $500k as of July 
      2017.
    
    
      In what kind of situation would a thresholded metric like 
      this be interesting? Perhaps in a scenario similar to the 
      ongoing IRS Coinbase issue, where the IRS is seeking 
      information on all holders with balances >$20,000. 
      Conceptualized in terms of an attack, a high Gini 
      coefficient would mean that a government would only need 
      to round up a few large holders in order to acquire a 
      large percentage of outstanding cryptocurrency — and with 
      it the ability to tank the price.
    
      With that said, two points. First, while one would not 
      want a Gini coefficient of exactly 1.0 for BTC or ETH (as 
      then only one person would have all of the digital 
      currency, and no one would have an incentive to help boost 
      the network), in practice it appears that a very high 
      level of wealth centralization is still compatible with 
      the operation of a decentralized protocol. Second, as we 
      show below, we think the Nakamoto coefficient is a better 
      metric than the Gini coefficient for measuring holder 
      concentration in particular as it obviates the issue of 
      arbitrarily choosing a threshold.
    
    
      ...However, the maximum Gini coefficient has one obvious 
      issue: while a high value tracks with our intuitive notion 
      of a “more centralized” system, the fact that each Gini 
      coefficient is restricted to a 0–1 scale means that it 
      does not directly measure the number of individuals or 
      entities required to compromise a system.
    
    
      Specifically, for a given blockchain suppose you have a 
      subsystem of exchanges with 1000 actors with a Gini 
      coefficient of 0.8, and another subsystem of 10 miners 
      with a Gini coefficient of 0.7. It may turn out that 
      compromising only 3 miners rather than 57 exchanges may be 
      sufficient to compromise this system, which would mean the 
      maximum Gini coefficient would have pointed to exchanges 
      rather than miners as the decentralization bottleneck.
    
    
      Conversely, if one considers “number of distinct countries 
      with substantial mining capacity” an essential subsystem, 
      then the minimum Nakamoto coefficient for Bitcoin would 
      again be 1, as the compromise of China (in the sense of a 
      Chinese government crackdown on mining) would result in 
      >51% of mining being compromised.

~~~
freejulian
Anyone can mine. Anyone can earn bitcoin. Early adopters have been rewarded,
sure, but the distribution of bitcoin has been steadily increasing. The vast
majority of the world is able to exchange their local currency for bitcoin
should they decide to take that risk.

How exactly do you propose a decentralized currency controlled by no one
bootstrap itself?

~~~
Retric
The reasonable choice would be to mine a fixed amount of coins per year over
~100+ years not have a perimid scheme designed to artificially reward early
adopters, and simulate a pyramid scheme.

And that's sidestepping the issue with ~1/5 of all possible coins already
being lost.

~~~
gruez
>The reasonable choice would be to mine a fixed amount of coins per year over
~100+ years

But that doesn't fix the underlying problem which is that early adopters can
get the coins for pennies, whereas late adopters have to pay thousands.

~~~
acjohnson55
That presumes there's a pressing reason to pay thousands of dollars for a
bitcoin. Which seems absurd to me. If it ceased to exist, my life wouldn't be
affected in the least.

~~~
freejulian
You’ve chosen an arbitrary amount of Bitcoin and said “1000$ for this
arbitrary amount is absurd!!1”

Would you feel better if I told you one satoshi is worth $0.00008?

~~~
nosuchthing
Completely missed the point.

The work required to acquire 50 Bitcoins every 10 minutes was trivial for a
small group of users.

Imagine some guy pressing a button and receiving a 50 Bitcoins. Now imagine
you pressing a button 700 times to receive .0001 Bitcoins.

~~~
freejulian
I understand how proof of work functions, thanks.

The person I was replying to claimed $1000 was an absurd amount for a bitcoin.
I was merely pointing that 1 btc is an arbitrary amount of satoshis.

Anyways, my point stands: how do you expect a grassroots currency to bootstrap
itself? Of course the first miners had it easy, no one took the currency
seriously back then.

~~~
nostrademons
Regardless of the numbers, the other posters on this subthread are making an
important point: too much wealth concentration deters new adopters.

Think of it in terms of the Ultimatum Game [1]: when faced with a new system
of wealth distribution, potential new participants not currently within the
system have two choices. They can choose to trade something they possess that
would be of value to the existing participants (labor, wampum, or $USD, for
example) for the new currency. Or they can say "Fuck you, I'm not playing in
your sandbox."

The challenge for Bitcoin is that only ~0.3% of the population is involved in
it, but the amount of money you have to spend to get a tiny fraction of the
wealth that early adopters got just for showing up early is ridiculous. Under
those conditions, the incentives for the remaining 99.7% is to say "Fuck you,
I'll stick with my dollars". Or, alternatively, to create new currencies with
their own pyramid schemes in the hopes of replicating Bitcoin's success.

Too little reward for early adopters and the new currency never gets adoption.
Too much, and its adoption stalls out before it reaches a critical mass of the
population. Ramp up the inflation rate later, and you can get continued growth
after adoption, but at the expense of overall trust in the currency. It seems
like you need a steady stream of broken promises, buried history, and
disaffected outsiders to both gain adoption of a new currency and continue its
growth.

(Interestingly, fiat has the same problem now: a significant number of people
believe their chance of amassing significant wealth is near-zero within the
current system, which is one of the major factors driving adoption of Bitcoin.
They're effectively saying "Fuck you, I'm not playing in your sandbox" to the
financial system of the developed world. But the other posters in this thread
are pointing out that this problem is not unique to fiat, and that Bitcoin
itself has this problem too, as does every other attempt to coordinate a new
store of value.)

[1]
[https://en.wikipedia.org/wiki/Ultimatum_game](https://en.wikipedia.org/wiki/Ultimatum_game)

~~~
hndamien
So I take it you will leave the fiat game then?

------
hidenotslide
Here is a simple way to demonstrate the point of the article. If I deposit
$100 in a bank, the bank can lend out around $90 to someone else (fractional
reserve banking). That person now deposits the money at another bank, and the
"money supply" is $190 instead of $100.

On the other hand when a central bank "prints money", they use it to buy
assets with an equivalent value, so there is no net transfer of wealth done by
the central bank. That assumes they don't affect asset prices, which not a
great assumption.

The way central banks affect the money supply is through interest rates to
change the supply and demand of private loans that banks make, which
indirectly affects the money supply.

~~~
millstone
> If I deposit $100 in a bank, the bank can lend out around $90 to someone
> else (fractional reserve banking)

This is the textbook explanation which the article strongly rejects. In
practice the bank will lend out as much as possible - it is not effectively
constrained by reserve requirements since it can and will simply borrow the
difference. What constrains it is market forces (the demand for loans, and
their profitability), and financial regulations, and finally the interest
rates set by the central bank.

If a retail bank believes it can turn a profit by lending money borrowed from
the central bank, in compliance with the law, it will do so until it exhausts
the opportunity. Consumer deposits are irrelevant.

~~~
quantumofmalice
Exactly. There is no reserve limit: any pretense of that was washed away once
sweep accounts became standard.

Banks lend as much as they possibly can, and then a bit more, and then expect
the taxpayers to pick up the pieces when it all falls apart.

The irony is that there need not be a reserve ratio: if we just adopted
duration-matched banking, where a bank had to demonstrate it had ownership of
a given dollar it was lending for the duration it loaned that dollar (e.g. via
a CD) it would be fine.

This is the fundamental problem with banking, and I don't understand why no
one talks about it. Banks are lying about having money they don't have (i.e.
they are promising the same dollar to more than one person at the same time).
If we forced them to just stop lying it would all work out, and there wouldn't
be any need for a reserve ratio.

~~~
grenoire
You do realise that the loans banks take are liabilities, right? Banks are
risk averse regardless of whether bailouts exist or not.

~~~
quantumofmalice
> whether bail-outs exist or not

lol

------
freejulian
“QE involves a shift in the focus of monetary policy to the quantity of money:
the central bank purchases a quantity of assets, financed by the creation of
broad money and a corresponding increase in the amount of central bank
reserves. The sellers of the assets will be left holding the newly created
deposits in place of government bonds. They will be likely to be holding more
money than they would like, relative to other assets that they wish to hold.
They will therefore want to rebalance their portfolios, for example by using
the new deposits to buy higher-yielding assets such as bonds and shares issued
by companies — leading to the ‘hot potato’ effect discussed earlier. This will
raise the value of those assets and lower the cost to companies of raising
funds in these markets.”

The fed is literally giving asset holders free money at the expense of people
trying to save in traditional ways (savings accounts). They buys whichever
bonds they decide which then enables the holders of those bonds to collect
free money. All the new money slowly works it’s way into the rest of the
economy, inflating away the value of our savings.

Crap like this is precisely why bitcoin will succeed. Eventually people will
realize what the Central Banks are doing and will decide they’ve had enough.

~~~
fwdpropaganda
> The fed is literally giving asset holders free money at the expense of
> people trying to save in traditional ways (savings accounts).

If you believe this, isn't the rational thing to use your dollars to buy
assets?

I think you're betraying a deep mis-understading of how money works. QE has
been raging for 10 years, but inflation is incredibly low (2.5% US, 1.5% EU).
In other words, even though you claim that the FED "gives asset holders free
money", when you hold cash you're not really losing purchasing power. How do
you square the two things?

~~~
freejulian
Absolutely, had I realized what the fed was doing when QE was happening I
would have definitely done that. And a lot of people smarter than myself did
do precisely that! Inflation is only “incredibly low” if you cherry pick the
basket of goods used to measure it.

~~~
nopriorarrests
It's amazing that you are being downvoted for explaining exactly what Ben
Bernanke himself said back in 2010. [0].

"This approach eased financial conditions in the past and, so far, looks to be
effective again. Stock prices rose and long-term interest rates fell when
investors began to anticipate this additional action. Easier financial
conditions will promote economic growth. For example, lower mortgage rates
will make housing more affordable and allow more homeowners to refinance.
Lower corporate bond rates will encourage investment. And higher stock prices
will boost consumer wealth and help increase confidence, which can also spur
spending. Increased spending will lead to higher incomes and profits that, in
a virtuous circle, will further support economic expansion".

[0]
[https://www.federalreserve.gov/newsevents/other/o_bernanke20...](https://www.federalreserve.gov/newsevents/other/o_bernanke20101105a.htm)

~~~
yxhuvud
I downvoted him for the conspiracy claim that the inflation numbers are
intentionally kept lower than they should.

~~~
fwdpropaganda
I have noticed a great overlap between crypto-fundamentalists and conspiracy
theorists.

