The fact that commercial banks – and not the government – create the vast majority of money in society, can be pretty hard to believe at first. You probably have a suspicion that I (and the other few hundred writers on this subject) have made a mistake – misread something, or misunderstood economics, or got our terminology confused. So it might help you to hear it from someone slightly better known.
The President of the USA Admits That Banks Create Money
On April 14th 2008 Barack Obama made the following statement in a speech at Georgetown University. Watch from 13.53 onwards.
“[A]lthough there are a lot of Americans who understandably think that government money would be better spent going directly to families and businesses instead of banks – ‘where’s our bailout?,’ they ask – the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.” (Find the original transcript on the New York Times site.)
Or in plain English:
If we give one dollar to you, we’ve created one dollar. But if we give one dollar to the banks, they’ll lend it over and over again until there are eight or ten dollars of loans to families and businesses.
Now, it’s surprising and infuriating that someone as allegedly as intelligent as Obama can make this statement without being embarrassed, or realising the injustice that he is referring to. From the lack of conviction in his voice at this point, I would say he doesn’t really understand what he is referring to (he sounds like he’s reading out loud, rather than speaking from the heart). Here’s the implications of the system that he describes.
$1bn of bailout money becomes $10bn of debt
When bailout money is given to the bank to shore up their capital, it allows the banking system as a whole to create a mountain of debt on the back of this initial money injection. $1bn injected by the government and given to a commercial bank will eventually – through the ‘multiplier effect’ – become $10 billion of debt from the US public to the banks.
The system that Obama refers to has the destructive effect that, every dollar that is given to the banks to improve their capital base will increase the debt burden of the US public by ten times that amount!
Who Benefits From the Extra Loans Created?
If a $1 billion injection of capital can lead to $8-10billion of loans, as Obama points out, then we should ask some questions about what happens to this money. Specifically:
- Who gets to charge interest on these loans? (Answer: the banks)
- Who gets to keep the money that is created once the loans have been repaid? (Answer: the banks)
- When only $1 billion has been created by the government, but a further $9 billion has been created by the bank, where will we find the money to pay the interest on this new debt? (Answer: the banks).
The banks charge interest on every loan made as they ‘multiply’ the original injection by ten times. When the principal amount of the loans is repaid, the debt from the public is canceled, but the money is not destroyed – it returns to the banks, and is used to fund even more loans, creating a permanent legacy of debt. The money to pay the interest on the loan also has to be borrowed from the banks!
$1 billion from the US Government = $25 billion Windfall for the Banks
As $1 billion injection from the US government results in $10 billion of outright debt from the US public to the commercial banks. However, because interest is charged on every loan, the total amount that the banks earn from this $1 billion of bailout money is likely to be over $25 billion. As the loan and interest is repaid, the banks count this as profit.
So, by giving bailout money to the banks directly, the government is providing the banks with a windfall profit 25 times greater than the amount that it injects! For every $1bn that the government gives to the banks, the American public will lose $25bn of their own wealth!
Obama – Why Don’t You Get It?
Obama seems to be intelligent, so why doesn’t he appreciate the following points?
- A bailout for the public would reduce the debt burden of the public, effectively making them richer. In contrast, a bailout to the banks increases the debt burden of the public by 25 times more than the money actually injected – making them much much poorer.
- The interest on the ‘eight or ten dollars of loans’ that is created is money that goes to bankers rather than to shops and real businesses. In effect, every dollar that you inject to the banking system will reduce spending in the real economy by $15, as money is diverted from the high street to pay the interest on loans.
- Consequently, this ‘bailout for the banks’ is laying the foundation for the next recession.
Even more outrageous is the fact that, if the bailout money had been given to the people first, they could have used it to pay down their debt, and the money would then have ended up in the banking system to create more loans. In other words, he could have given the money to ‘the people’ first, allow them to improve their financial position, and still create the desired stimulus for the economy.
So, Obama – why do you condone a process that a) traps your country’s citizens in debt, b) provides a massive windfall profit for banks (and bankers)? Is it because you don’t understand it?
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