Forum Post: Central banks create money, And commercial banks create credit. by Dr. Michael Hudson

(c. 23:03) “I’m going to elaborate in a different direction from what Stephanie has said. I’m going to discuss the difference between central bank credit, or money, and commercial banks. Central banks create money, you can say. And commercial banks create credit. The last three years since September 2008 have seen the largest money creation and credit creation in history in the United States. And, yet, prices have not gone up at all. That is, consumer prices have not gone up since 1980. Wages in the United States have drifted downwards for 30 years. And consumer prices and commodity prices have been stable. But there has been an immense inflation; the largest bond market price increase in history has occurred, as interest rates have fallen from 20% to only one-quarter of 1% today. What has gone up is the price of real estate, the price of bonds, the price of stocks. So, the result is that the value of wealth—and most wealth is held by the wealthiest1% of the population—wealth has gone way up relative to wages. The result is a new kind of class war, as I said last night. It’s not the typical kind of class war between employers and employees. It’s a war of finance against the economy.

(c. 25:10) “Under industrial capitalism, the idea was that credit would be created productively to fund capital investment that would employ labour. That is not what is occurring today. When commercial banks create credit, it is create claims on wealth. It is create mortgage debt. It is create corporate debt. It is to create personal debt, and student loans, and credit card debt. This is what makes commercial bank credit creation different from the central banks’ creation of money.

(c. 26:00) “When central banks create money, they do so for a long-term public purpose. They fund government spending and capital investment and public infrastructure. In most countries in the world, public infrastructure, roads, communication systems, railroads, water and sewer systems have all taken a capital investment that is larger than all the manufacturing capital investment. In the United States, the value of New York’s real estate, alone, is larger than the value of all of the plant and equipment in the United States. The result is: The textbooks that are taught in the United States ignore this difference that we have been talking about. There is a formula, MV = PT. It means an increase in the money supply increases the price level. But the price level that the textbooks talk about are only consumer prices and commodity prices. Nowhere in the textbooks do you find a relation between the credit supply and asset prices, real estate, stocks and bonds. And, yet, 99% of the credit spent in the United States economy is spent on these financial claims. Every day an amount equal to the entire year’s gross national product passes through the New York monetary clearinghouse and the Chicago Mercantile Exchange. The vast amount of payments are within the financial sector. And, within the last ten years or so, all of the growth of bank lending is to other financial institutions.

(c. 28:17) “In the textbooks there are happy pictures about banks lending to industry to build machines and factories with a smokestack coming out and employing labour. But this is a fiction; this is not what occurs in practice. All of the increased capital investment in the United States economy comes from the retained earnings of corporations—not from banks. Banks do not lend to bring new capital investment into existence. They lend against mortgages, against capital in place, against real estate, against assets that already exist—not to create new assets.

(c. 29:14) “So, when we talk about government money. We talk about government spending that is, indeed, to spur the economy, to spur economic growth, to spur new investments. The function of government investment and government central bank money creation is very different from the private banks. The government money is, indeed, debt, the lira that you have in your pocket are debt. Paper currency is debt. But it’s debt that nobody ever intends to be repaid because, if government currency is debt, than to repay it would mean that you would not have any currency left in the pocket.

(c. 30:00) “The commercial debt is expected to be repaid; and it bears interest. And, as this commercial debt has grown—the mortgages, the bank loans to companies, the corporate raiding debt—this has loaded down the economy with an enormous debt overhead. The more money commercial banks lend, the more interest has to be paid to carry this debt overhead. And the problem is that money that is spent on paying banks debt cannot be spent on goods and services. So, the result is that when commercial banks create debt, you have a diversion of income away from spending on goods and services—to pay debt service—and that is known as debt deflation. And when debt deflation proceeds as long as it has today, we move into a late stage of finance capitalism, which is the debt deflation stage—the austerity stage. And that’s the stage that Europe finds itself in today.