a common myth

that Banking Has No Impact on Economic Activity

a supplement to

Into the Heart of Darkness—of Money

Upstream to Its Source

by  Agent d’Amore

A common view in the world of economics is that banks don’t impact economic activity, as they are merely acting as intermediaries on behalf of savers and borrowers.

Contrary to what the economics profession thinks, banks create credit and have major economic impacts.   For instance, the 2008 bail-out was not what most people think.   Why?

The basics of banking allow a bank to create new credit (that is to say: to create new money “out of thin air”) when it buys a security (makes a loan). [*2]   It does this through balance-sheet bookkeeping.   Assets are what you own.   Liabilities are what you are obligated to pay someone else.   Banks function because they are “deposit-taking” institutions and allowed to use their balance sheet to carry what people owe them as assets, while their liabilities look like money.   They are special that way.   If you or any business owes someone money, I think you’ll agree that it doesn’t show up anywhere as money.

Balance-Sheet Accounting and the 2008 Rescue of Banks

The role of banks in the credit-creation process (the money-creation process) is either not well understood by economists or is dismissed.   If banks can create credit that acts as money, by engaging in purchases of securities and in simple bookkeeping, where is this power accounted for in economic theory?

The decision to invest in certain types of businesses versus others has an analogous effect to that of a water authority sending irrigation water to some farmers and not others.   Those that do not receive funding or water will not be as successful as those that do.   Banks direct newly created credit into economic sectors that the bankers see as profitable.

There are arguments that have been put forth in favor designing alternatives to the current system of creating credit (of creating money) through the use of private, for-profit banks.   One such example is a system of credit creation (money creation) through the use of publicly-owned banks.   If, for example, a large city with large tax revenues and large expenditures were to keep its money in a city-owned bank, the city would be able to create loans (new credit) to do things like build schools.   The interest paid on the loan would go to the city rather than the shareholders of a for-profit, private bank.

These decisions can impact many people, but the political ramifications of bankers’ decision-making is not included in the political process.   So far, politicians have delegated economic policy to the banks.

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