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Money Creation Money creation • Who does make money and who is making money out of it? You remember these guys? 2 Monetary misconceptions • Money doesn’t make you happy. Or does it? • Money is the ‘mud of the earth’ and it is the root of all evil • Pecunia non olet……….. • A world without money would be a better world. Which is true.. • …….if you are fond of extreme poverty • …….if you dislike economic freedom • …….or both • Money is an essential precondition for economic freedom in an advanced society 3 Content: above all a lot of questions! • What is money? (wrap up) • Who creates money and why? • Is the production of money very profitable? • What kind of reform is possible, if necessary? Some questions to start with • All money is created by the central bank (Yes/No) • Some money is created by commercial banks (Yes/No) • Allmost all money is created by commercial banks (Yes/No) • The government can create money ‘for free’ (Yes/No) • Commercial banks can create money at will (Yes/No) • Commercial banks create unlimited amounts of money (Yes/No) • Commercial banks generate seigniorage income (Yes/No) • The ‘money creation privilege’ is highly profitable (Yes/No) • You can create and destroy money yourself (Yes/No) Today’s situation • Governments/central banks create money: • Coins • Banknotes • Bank reserves • Sometimes: bank deposits (in case of monetary financing) • Commercial banks create bank deposits • Today, this is the lion’s share of the money supply 6 The Dutch money supply (source: DNB, based on ECB-data, Oct. 2017) Commercials banks Central bank and governments 7 Position 1: governments should decide on the money supply • Do you agree? • Why? • Who created money in the past? • During the early coining of gold and silver, private parties decided on the amount of coins in circulation! • Question: why did governments monopolize money creation? 8 Sound money? 9 Sound money! 10 Is money creation still profitable today? Yes it is. Enter seigniorage! • Seigniorage (in Dutch: geldscheppingswinst) : the income earned by the entity that produces the money and that is the first to bring it into circulation. • Example: the production of a € 100 banknote costs € 0.01 per note. Which means that its production is very profitable (to be precise € 99,99 pro note) for the first issuer. In this example: the central bank/government • Printing banknotes (both by public and private entities) is potentially highly profitable and therefore a dangerous thing • The production of bank money is of a different order……. 11 “History is largely inflation engineered by government” “The source and root of all monetary evil …..[is] the government monopoly on the issue and control of money” Friedrich A. Hayek (Nobel prize economics, 1974, 1978) 12 Is money creation by the government a bad thing? • Not by definition. The creation of money by the government is a form of taxation and taxation is a legal form of fund raising of governments. • Especially in countries with weak institutions seigniorage may be an essential part of the funding of the government budget. Absolutely no problem with that. • The danger is that in countries with weak institutions and lack of effective parliamentary control it may be very dangerous. • Germany 1923, Zimbabwe 2008, Venezuela 2018, Turkey 2019? 13 The road to hyperinflation “A Government can live for a long time, even the German Government or the Russian Government, by printing paper money.” What is raised by printing notes is just as much taken from the public as is a beer-duty or an income-tax. What a government spend the public pay for. There is no such thing as an uncovered deficit.’ John Maynard Keynes, A Tract on Monetary reform (1924) When money dies…… Germany 1923 15 ……. Zimbabwe 2008 16 The ugly face of hyperinflation (national currency/USD, index) 1E+15 1E+14 1E+13 1E+12 1E+11 1E+10 1E+09 100000000 10000000 1000000 100000 10000 1000 100 10 1 t=1 t=2 t=3 t=4 t=5 t=6 Germany Turkey Venezuela Zimbabwe 17 German hyperinflation: the run the hyperinflation: German Reichsmark/US dollar (1914 - 1921) 160 140 120 100 80 - up 60 40 20 0 18 feb-15 feb-16 feb-17 feb-18 feb-19 feb-20 feb-21 aug-18 aug-19 aug-20 aug-21 aug-14 aug-15 aug-16 aug-17 nov-14 nov-15 nov-16 nov-17 nov-18 nov-19 nov-20 mei-21 mei-15 mei-16 mei-17 mei-18 mei-19 mei-20 When money died money When Reichsmark/US dollar (1914 - 1923, logaritmische schaal) 1E+13 1E+12 1E+11 1E+10 1E+09 100000000 10000000 1000000 100000 10000 1000 100 10 1 19 jul-19 jul-21 jul-20 jul-22 jul-23 jan-21 jan-23 jan-19 jan-20 jan-22 sep-19 sep-22 sep-20 sep-21 sep-23 mrt-21 mrt-23 mrt-19 mrt-20 mrt-22 nov-19 nov-22 nov-20 nov-21 nov-23 mei-19 mei-21 mei-20 mei-22 mei-23 Hyperinflation: when money dies Vrije Universiteit Amsterdam The highest hyperinflations Hungary (1946) > 900.000.000.000.000.000.000.000.000% Greece (1944) > 30.000.000.000% Germany (1923) > 20.000.000.000% Venezuela (2018) > 1.000.000.000% Zimbabwe (2008) > 66.000% Poland (1923) 51.699% Russia (1990) 13.535% Nicaragua (1987) 13.110% Peru (1990) 7.482% Brazil (1990) 2.948% Source: Reinhart & Rogoff, This time is different, 2010, 182 -187 Vrije Universiteit Amsterdam Is money creation profitable? How about banks? And their clients? • Banks don’t earn seigniorage: the money created by commercial banks is not owned by the bank but by their clients. And the clients are the first to bring it into circulation. • But clients don’t earn seigniorage either. This is because against the newly created bank deposits (owned by the clients) stand newly created debt (owned by the banks). • Money creation by the banks does not change net wealth or debt positions • What changes is the degree of liquidity! 22 23 “Banks coin illiquid assets into liquidity” Milton Friedman, Nobel prize economics, 1976 24 25 Money creation: governments and banks compared Money creation by: Governments Commercial banks Seigniorage income Yes No Free funding Yes Yes Automatic brakes No Yes ‘out of thin air’ Yes No Initiative of money With the government With the banks and/or creation their clients Note that seigniorage income is a form of taxation 26 In Europe monetary financing of public spending is explicitly forbidden by law. • It is part of Treaty, article 123.1 • This reflects the German trauma of 1923, when hyperinflation effectively eliminated the middle class and paved the way for fascism. • Germany would rather kill the euro than accept a government monopoly on money creation! • Keep this in the back of your mind, we will come back to this later…… 27 Monetary financing of government spending Monetary base Banks can lend increases, bank more money , reserves larger which will result in increase of M1 Increase in government Money lands in bank spending, financed by accounts of Money is spend the central bank companies and and/or saved employee, involved in public projects (M1 increases) Money comes directly in circulation and economic activity will increase Helicopter Money Monetary base Banks can lend increases, bank more money , reserves larger which will result in increase of M1 Government hands out Money lands in bank money to citizens as a accounts of the Money is spend present, financed by people that receive and/or saved the central bank this present Can money creation by commercial banks also run out of hand? • Yes, it can. Banks can extend too much credit, buy to many securities…… • But supervisors have all instruments available to regulate it! • Central banks regulate the size and costs of bank liquidity • Banking supervisors demand minimum levels of solvency and liquidity ratios • Competition authorities prevent dominant market positions 30 What seems to be the most stable situation? • Governments: no, or little seigniorage by money creation • Central banks: regulate market liquidity • Bank supervisors: close monitoring of banking ratios • Commercial banks: creating liquidity for their clients • Central banks: ex-post monitoring of monetary aggregates and, if necessary, adapting market conditions 31 Central bank Loans to banks and goverments Open market operations Government Base Money (M0) Foreign sector General public Banks (cr) Money multiplier (rr) Loans to consumers, business and governments Money in circulation (M1, M2, M3) What are the problems with this system? Banks are vulnerable for bank runs Banks have a privilege in the shape of ‘free funding’ Bank may make mistakes in their lending decisions People make take up too much debt Supervisors may be too lax and/or make mistakes The system may be procyclical 33 What are the problems with this system? Banks are vulnerable for bank runs This is a serious item, which only the central bank can solve Banks have a privilege in the shape of ‘free funding’ If this is the case, it can be easily solved by paying interest on payment accounts Bank may make mistakes in their lending decisions and/or people make take up too much debt. Yes, they usually do Supervisors may be too lax and/or make mistakes. Yes, but they’ve learned a lot The system may be procyclical. Yes, but supervisors have many way to prevent this to happen 34 Reform proposals • There are several proposals, viz. 1. The Chicago Plan (100% money) (Fisher, 1935) 1. Make payment systems a public function, executed by a public institution (basically the same proposal) 2. Digital cash 3. Denationalization of money (Hayek, 1975) • We will focus on ad 1) and give some brief thoughts on ad 2).
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