There Really Is a Magic Money Tree

Every now and then this blog goes off-piste, just for the hell of it. Despite covering economics as part of my social work degree course (yes there was time in those days during four years of study) and managing reasonably well in balancing a household budget, I've never really understood what it's all about. 

We've all heard Theresa May say recently that "there's no magic money tree" and most of us will know Margaret Thatcher famously referred to running the nation's finances as not being that much different to running that of her household. We have a Budget very soon and there's talk of money, or the lack of it, everywhere. 

With news the other day that £60billion had been magically wiped off the public debt with a stroke of a pen, as far as I'm concerned it could all be magic, just like the computer I'm working on and the internet it's connected to. It all reminded me of this I saw in the Guardian several weeks ago:-    

How the actual magic money tree works

Shock data shows that most MPs do not know how money is created. Responding to a survey commissioned by Positive Money just before the June election, 85% were unaware that new money was created every time a commercial bank extended a loan, while 70% thought that only the government had the power to create new money.

The results are only a shock if you didn’t see the last poll of MPs on exactly this topic, in 2014, revealing broadly the same level of ignorance. Indeed, the real shock is that MPs still, without embarrassment, answer surveys.

Yet almost all our hot-button political issues, from social security to housing, relate back to the meaning and creation of money; so if the people making those choices don’t have a clue, that isn’t without consequence.

How is money created? Some is created by the state, but usually in a financial emergency. For instance, the crash gave rise to quantitative easing – money pumped directly into the economy by the government. The vast majority of money (97%) comes into being when a commercial bank extends a loan. Meanwhile, 27% of bank lending goes to other financial corporations; 50% to mortgages (mainly on existing residential property); 8% to high-cost credit (including overdrafts and credit cards); and just 15% to non-financial corporates, that is, the productive economy.

What’s wrong with that? On the corporate financial side, bank-lending inflates asset prices, which concentrates wealth in the hands of the wealthy. On the mortgage side, house prices rise to meet the amount the lender is prepared to lend, rather than being moored to wages. The lender benefits enormously from larger mortgages and longer periods of indebtedness; the homeowner benefits slightly from a bigger asset, but obviously spends longer in debt servitude; the renter loses out completely.

Is there a magic money tree? All money comes from a magic tree, in the sense that money is spirited from thin air. There is no gold standard. Banks do not work to a money-multiplier model, where they extend loans as a multiple of the deposits they already hold. Money is created on faith alone, whether that is faith in ever-increasing housing prices or any other given investment. This does not mean that creation is risk-free: any government could create too much and spawn hyper-inflation. Any commercial bank could create too much and generate over-indebtedness in the private economy, which is what has happened. But it does mean that money has no innate value, it is simply a marker of trust between a lender and a borrower. So it is the ultimate democratic resource. The argument marshalled against social investment such as education, welfare and public services, that it is unaffordable because there is no magic money tree, is nonsensical. It all comes from the tree; the real question is, who is in charge of the tree?

What could we do instead? We could do QE for the people, overt monetary financing in which a government creates money for social benefit, such as green infrastructure or education. Or helicopter money, a central bank distributing it to everyone, either in a one-off citizen’s dividend or a regular citizen’s basic income. The nature of centrally created money should itself be opened up for debate, whose starting point is: if we agree that commercially created money is skewing the economy, can we then agree that it should be created by a public authority, even if we don’t yet know what that authority would look like.

Zoe Williams

--oo00oo--

The article generated over 2,000 comments and here's the first eight:-

No. Not once in all of this article have you read the word 'collateral'. Banks really do not create money out of thin air. What High Street banks do is harvest collateral.

If you are a builder and you own the land and have bought all the necessary articles to build a house but are short of money for labour, a bank will lend against the assets. This money comes from either shareholders or depositors and not out of thin air. Of course, the bank , with high overheads wishes to lend out more, so it can do this by selling the collateral on to a third party at a lower rate of interest than the High Street bank charges.

All banks, by law, have to balance their books at the end of each working day. If one has lent out more than they have taken in, they have to borrow money on the overnight market to balance. The Bank of England also have a large roll to play as they inspect a banks collateral and only rate it at the level agreed with a third party.

If there is no collateral, there is no money in the sense that we know it. The moment you start to create money 'out of thin air', the perceived value of the currency will collapse in very short time, to the detriment of all.

******
Exactly, but collateral can be in the form of bundles of alleged AAA mortgage debt, for a load of homes that cost £100K to build, have a debt of £200K, and a load of people about to default, but you are not sure who. The worth of collateral is also rather subjective and shaky if valued poorly.

******
The Bank of England would disagree:

“Every new loan that a bank makes creates new money. While this is often hard to believe at first, it’s common knowledge to the people that manage the banking system. In March 2014, the Bank of England release a report called “Money Creation in the Modern Economy”, where they stated that:

“Commercial [i.e. high-street] banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created.”

http://positivemoney.org/how-money-works/how-banks-create-money/

******
I was, although there will be people along to tell you you are wrong but unable to explain why. Something to do with governments can't be trusted to assess risk but bankers can. It goes to the very heart of problems with the economic model and acceptance of austerity so don't expect it to be solved soon.

******
It pains me to say this but bankers have a better track record than politicians when it comes to assessing risk. It is partly why the former as so skillful when it comes to dumping dodgy investment decisions into the laps of politicians so the mug tax payer can bail them out.

******
This is "news" only to dumb people invested in Facebook (as the prime example) and lacking education to form critical thinking skills. Unfortunately, the "dumb" form too great of a populace. They are, we are destined to suffer their ignorance.

******
Well, I don't consider myself entirely "dumb", but it was news to me. So thanks to the journalist for an interesting and informative piece. I'm not a Facebook user or investor, which is a Good Thing, if I were I'd almost certainly be too dumb to read the Guardian.

******
News to me too, and I've got four degrees, including a PhD. The point made in the article has zero to do with 'critical thinking skills' - either you know it or you don't. Now I do know it, and I'm no less dumb than I was five minutes ago.

--oo00oo--

Actually a casual search on the internet reveals the subject has been discussed quite a bit over the 'austerity' years and by both the left and right, such as the Telegraph in 2015 'There is a 'magic money tree' - and five other facts about money'.

So, who are Positive Money? From their website:- 

OUR VISION - WHAT?
To deal with the big social, economic and environmental challenges we’re facing today, we need to transform our money and banking system. Positive Money’s goal is for a money and banking system that serves a fair, democratic, and sustainable economy. An economy that isn’t reliant on housing bubbles, stock markets booms and unsustainable levels of inequality and debt to keep it growing.

An economy that’s stable, with more secure jobs, less household and government debt, which does not automatically increase inequality and that will give us a solid footing to tackle the environmental crisis. Where the Bank of England works with the Government in a democratic way to implement economic policies to shift the UK economy to one that is fairer and more sustainable. Where implicit subsidies for banks are removed, and a diverse ecosystem of banks serve the needs of society.

WHY?
Right now the money and banking system causes house price bubbles, high levels of debt, and rising inequality. It lays the foundations for financial crises. It harms our environment. And there is a large democratic deficit in the way the money system works and policies are decided.

HOW
We pursue system change in four ways:

• We research the problems with the money and banking system, to develop our proposals for reforming it and to win the support of economists.
• We work to build a growing, skilled, and diverse network which works together to campaign for change.
• We influence key decision makers and influencers in the UK.
• We lead and support an international movement advocating reform around the world.