I have already dealt with money creation ex nihilo with regard to Central Banks. Now I want to consider the same problem in view of commercial banks.
As a matter of principle, the latter are in a position to make money out of nothing by means of a so called balance sheet extension; theoretically, they may even raise credit creation to a degree where the demand of borrowers sets the only limit. The question we need to address is, therefore, not whether or not they are able to do so, but whether it is economically worthwhile for them to indulge in this practice.
Anyone who wants to decide this matter must clearly distinguish between two different situations. Firstly, the case of intense competition between commercial banks A to Z and, second, the case of a single monopolistic commercial bank A, representing the only banking instance apart from the Central Bank.
A monopolistic commercial bank may well expand credit creation
In the case of a monopolistic bank, it may be taken for granted that the interest on deposits, that is, on all cash that savers put on a savings account, will be zero. The bank does no longer rely on such savings because the money it creates out of nothing is, of course, much cheaper than the money of savings deposits, for which it usually has to pay a minimum interest to the saver.
Thus, a monopoly bank will soon be able to reject all savings deposits for the benefit of money ex nihilo.
In this case – but in this case only – we may agree with those who believe that the creation of book money out of nothing constitutes one of the most dangerous problems in the financial sphere.
Commercial banks in perfect competition
But let us now consider the case where there is perfect competition between all commercial banks A to Z. Each single bank will still be capable of creating credit by a mere extension of its balance sheet. It must, however, reckon with borrowers using their giro credit with bank A for the purpose of acquiring goods or services from a producer who maintains an account at Bank Z. Now, if the producer in question wants to get cash for the money transferred from bank A to bank Z then A will be obliged to settle the balance with Bank Z in banknote money. In other words, bank A, when creating money out of nothing, must, at the end of the day, pay the corresponding amount in banknotes to other banks.
Bank A, however, does not own such money
As it started with mere book money, in the first place, the amount in question was, of course, not received in cash from a saver. The bank is therefore obliged to borrow the amount in question and pay interest for it.
Three different interest rates are eligible for such borrowing. The rate of interest paid on a savings account, the interbank rate if the money is borrowed from another bank, or the interest the commercial bank would have to pay when getting the money right from the Central Bank.
Obviously the interbank rate always exceeds the rate for savings accounts. And as to the rate for money borrowed from the Central Bank, this nearly always exceeds the interbank rate (the general rule being invalidated only in those rare instances where mutual mistrust between banks leads to a drying up of the interbank money market).
Interest rate for savings is always cheapest, so commercial banks are so keen on getting their money from savers
The interest rate to be paid for interbank money or fresh money from the Central Bank being nearly always considerably higher than the rate paid to savers for the cash money placed by them on a savings account, commercial banks pay substantially more money when relying on credit creation ex nihilo than in the normal case of savings deposits.
Such higher burden of interest payment due to money creation ex nihilo will, of course, be shifted to the bank’s clients, that is to borrowers – which means that a commercial bank creating credit out of nothing impairs its competitiveness with regard to competitors relying exclusively on saving deposits.
In a system of functioning competition, creating money out of nothing becomes too expensive for commercial banks
This explains why, in a system of functioning competition, commercial banks de facto refrain from creating money ex nihilo, even if perfectly capable of doing so. Economically speaking, it does not make sense for them to switch from a system of lending based on savings accounts to one of book money credit creation.
Since borrowed liquidity is expensive, functioning competition is indicated by the fact that only small amounts of non-giro money are shifted between banks at the end of the day (we may call this the “interbank liquidity shift indicator”).
And it is, of course, the same costliness of liquidity that further explains why banks may slide into bankruptcy due to bad credit without being able to save themselves through money creation.
Now, which of either system prevails in Germany: monopoly or interbank competition?
The question whether the current commercial banking system relies on functioning competition so that credit creation ex nihilo virtually plays no role at all, or whether we have to accept the alternative view as more realistic because the banking system is moving towards cartels or even towards monopoly, cannot be decided theoretically, but only in an empirical way, first, by what I called the “interbank liquidity shift indicator” and, second, by comparing total savings volume with total credit output.
Empirical investigations made by Helmut Creutz provide an unequivocal answer: „Savings do not only precede loans, but their amount consistently exceeds the latter… Looking at the total balance sheets regularly published in the statistical section of the Deutsche Bundesbank’s monthly reports on pages 20 to 23, we get the following numbers for 2002:
Loans to non-banks and other assets: 4258 billion euros
Deposits from non-banks and other liabilities: 5003 billion euros
“This results in a deposit surplus of 745 billion euros or approximately 15 per cent, which roughly corresponds to the upper limit of this excess over the longer term„ (H. Creutz, Die 29 Irrtümer rund um das Geld, Munich 2004).
In other words, the German commercial banking system relied on functioning competition in 2002, which was still the case in 2008 (see Creutz, Das Geldsyndrom, 2012: 205). There is no reason to believe that things have substantially changed since that time.
100% Money based on illusions
In view of the above demonstration the problem of commercial bank credit creation ex nihilo may be said to be solved once and for all. For years, one could read nonsensical statements of the kind that loans have nothing to do with savings, as business banks may and do produce all or at least 95% of all credits out of nothing (see Huber 2016: 20, 52, 68, etc.)
The truth was turned upside down, for such credit creation may only occur in one very definite and theoretically constructed case, which hitherto has never been realized and will probably never happen: the case of a banking system where the supply of credit has become the monopoly of one single business bank (or a strict cartel behaving as such). In this, and only in this very specific case, the creation of money out of nothing would completely displace deposit savings.
However, within systems of functioning competition such credit creation by commercial banks does simply not happen. Theories like „100% Money“ or the German so-called „Monetative“, both of which are based on this assertion, must be considered mistaken.
The theorists of credit creation ex nihilo were led to their wrong beliefs because they did not succeed in explaining why modern economies hardly use cash, but have rather turned to book money instead. The explanation is, however, rather simple.