The following arguments represent a general criticism of various ideas asserting a creation of money out of nothing. Those who don’t know the work of professor Huber which the present article is meant to refute (Monetäre Modernisierung, 2016 Metropolis) need not be afraid. The following text may be read and fully understood without such knowledge. I will systematically contrast the view of orthodox money theory with the view proposed by the adherents of money ex nihilo (prefixed “N”). For further reading I recommend “Creating Money out of Nothing: The History of an Idea” by Mike King – an excellent survey which, apart from providing a very useful historical summery, contains logical arguments supplementing those the reader will find in the following analysis.*1*
a) Money created by the Central Bank
Money is generated by the Central Bank and passed on to commercial banks in exchange for securities of equivalent worth. Central interest rates (which I would like to call “steering rates”) are used to regulate the amount of money thus created. Inflation-generating surplus money is drawn back to the Central Bank by means of a high steering rate while, in the event of a deflation-producing lack of money, a low steering rate is meant to stimulate the demand for money.
It is true that this regulation is anything but perfect, but this shortcoming is caused by the fact that the public enjoys a free disposal of money (both cash and book money). It may withdraw large quantities from circulation by way of hoarding or else throw hoarded money back on the market. In both instances it may do so in an unpredictable way, so that deflation and inflation, independently of the monetary policy of the Central Bank, can also emanate from the public.
N-a) Money created by the Central Bank
According to professor Huber not only commercial banks but even the Central Bank itself produce money out of nothing. It is true that, in his opinion, the Central Bank still creates money in exchange for securities which it receives from commercial banks, but these securities do not in any way represent objective economic activity (so that it makes sense to increase or decrease the total amount of money according to the increase or decrease of total economic activity). For the sake of his argument, he refers to government bonds which (in more recent times) the Central Bank accepts as collateral. In professor Huber’s opinion, government bonds (once thought to be a safe investment) are not backed by private money deposited by savers in commercial banks, but created by the latter themselves out of nothing (50, see also below “N-d4”).
Hence Huber makes a quite unambiguous claim: Even the money creation of Central Banks proceeds from nothing.
So Huber in his latest book does not start with private banks when defending his thesis that money is created ex nihilo – that was his original thesis. He now extends the argument to the entire system. The Central Bank too, a public institution, ultimately generates all money which it passes on to commercial banks out of nothing. In Huber’s view, the demand for collateral or securities represents nothing more than a sham action, which does not establish any real relationship between money supply and economic performance.
This represents antithesis No. 1 with regard to orthodox doctrine.
b) Cash and Book Money
In principle, banks and the public could handle all economic transactions by means of banknotes and coins. Then circulating money would consist of nothing but cash. For modern economy this would, however, constitute a great disadvantage, since the physical transport of notes and coins would cause huge costs. Therefore, a second kind of money was developed: book money consisting of immaterial numbers or even mere digital entries, which can be easily transferred over any distances in real time.
Now, it is of crucial importance for orthodox theory that book money, in principle, only functions as a substitute or proxy: originally a corresponding sum of cash was deposited for every amount of book money appearing on the register of a commercial bank. Since, however, book money was increasingly favored by the public for more than a century, cash has largely disappeared from circulation despite the fact that it continues to be the basis for every increase in the total amount of its proxy.
Thus, the fact that the total amount of book money steadily increases while cash recedes is easily explained by its replacing the latter because of changing payment habits. For this reason, the control by the Central Bank of the total amount of money (cash plus book money) is in no way diminished, even if, due to changing payment habits, book money would completely displace all cash in daily traffic. The process of substitution thus in no way proves that book money is or could be “created” by commercial banks. The fact that the latter hold huge sums of book money, while cash plays only a minor role, is due, firstly, to changed payment habits and, secondly, further explained by the fact that commercial banks must pay “steering fee” for all cash in their possession. For this reason they only hold as much of it as they really need for daily traffic.
Book money being, according to the orthodox view, a mere substitute, proxy or replacement, it is not created, but generated by cash deposits. As a consequence it is, under normal circumstances, just as well secured as cash itself.
N-b) Cash and Book Money
Huber’s remarks about book money are in sharp contrast to orthodox doctrine. According to him, book money lacks the substitute or proxy function. He can not, of course, deny the fact that in daily traffic between banks and their clients book money comes into being by deposits of cash and is, likewise, destroyed by cash withdrawals. But for him this evidence does not really count, as, in his view, commercial banks primarily create book money out of nothing. This leads him to the conclusion that book money comes into being as “credit”. This, obviously, contradicts the orthodox view according to which it would make no sense to define book money as credit since it represents nothing more than proxy money backed by previously deposited cash.
The credit theory of book money is found at the very beginning of Huber’s book (22) and constitutes the foundation of his theory, in my opinion it is the sand which he has built it upon. But such a specious foundation then serves him as a basis for further conclusions. Commercial banks being able to produce book money out of nothing in an unscrupulous and unrestrained way, Huber may then assert that the control of money is, as a matter of fact, taken away from the Central Bank, a public authority, only to be handed over to private profit-seeking organizations, that is, to commercial banks. “In order to be clear and unambiguous, commercial banks have, indeed, the money monopoly” (68, 94).
It is understood that a reform of the current system in the sense of some kind of “Positive Money” and the founding of a new type of Central Bank, called “Monetative” would make no sense unless such usurpation really happens instead of being a mere theoretical construct in the head of a misled German professor. Huber’s theory stands and falls with the assumption of book money being a credit ex nihilo.
This is antithesis No. 2 vis-à-vis orthodox doctrine.
N-b1) Cash and Book Money – why relative amounts are so different
In accordance with his basic assumption, Huber tries to explain why economic transactions predominantly take place in book money and why, at the same time, cash tends to disappear. For him this fact is not at all due to changing payment habits and the extra-expenses banks would incur if holding excessive cash, instead he believes that the large amount of book money arises from permanent ex nihilo creation. He does not, however, provide anything coming near to a convincing proof of this contention.
Later on (see “N-f2”), I will explain why Huber’s theory is untenable for purely economic reasons. It is simply not worthwhile for business banks to create book money out of nothing, although they are theoretically quite capable of doing so. The reason: money created out of nothing is just too expensive.
b2) Fractional Reserve Banking – a term without meaning
The more book money replaces cash in commercial traffic, the lower the requirement for reserves to be held by the banking system as cash. Inevitably, the amount of such cash reserve will dwindle to an insignificant fraction of the total sum of book money.*2* No particular intellectual benefit may, therefore, be derived from designating the present monetary order as “fractional reserve banking”.
I would rather speak of an intellectual loss, when changed payment habits are equated with “book money creation out of nothing” and Central Banks are wrongly supposed to have surrendered the control of money production to private actors.
N-b2) Fractional Reserve Banking – a term without meaning in Huber’s theory
With Huber (28, 42, 44), this designation loses all definite meaning as he explicitly notes that reserves are ultimately irrelevant to the extent of book money “credit” creation (48). In fact, his theoretical preconceptions compel him to make such an assertion, as the Central Bank would otherwise be able to control the volume of book money creation by adjusting reserves. As stated above, this is exactly what Huber categorically denies.
If, however, the concept of “fractional reserve banking” is fundamentally irrelevant, why does Huber again and again relate the creation of money out of nothing to the “fractional reserve system”? It should be clear from such contradictions what I mean by the sort of “bad thinking” one constantly meets with in his work.
c) Cash Reserves and the Run on Banks
To the extent that daily inflows and outflows of cash largely cancel each other, both in any individual bank and in the entire banking system, cash reserves are largely meaningless. However, due to a serious economic crisis or a massive loss of confidence the system may incur an existential risk as soon as a sudden panic leads to a run on banks. At such a moment, the normal balance of inflows and outflows of cash is, of course, completely out of balance. Without the Lender of Last Resort, the Central Bank, the system would collapse.
N-c) Cash Reserves and the Run on Banks
In essence, the same as O-c though with the notable exception that the constructional error of the current money system is supposed to be a fractional reserve banking system with multiple credit creation.
Of course, Huber, like the theorists of a 100% money system, is totally right when he warns us that in the present money system a run on the bank – although exceptional in a functioning system – remains a possibility to be triggered by an outbreak of panic at any time.
This danger could, nonetheless, be easily averted even in the current monetary system if all cash deposited on a current account would have to remain in the bank, there to be “mothballed” as it were (the status of book money as substitute or proxy would then be fully evident!).
Of course, this is not the case at present, since commercial banks retain only a small legally required reserve, while they treat the rest like savings deposits, but of a short-term nature.
Now, if banks were required to retain all cash, the consequences would be economically forbidding. In view of the enormous amount of book money, the bank and hence its customers would not only incur extremely high “steering fees” but such mothballing of cash in the strongboxes of banks would substantially impair or even block the circulation of goods as the latter reflects the circulation of money.
As a matter of fact, commercial banks always choose between two evils, one of immediate effectiveness which would result from the mothballing of all cash on current accounts (higher costs, the deceleration of the money and commodity circulation) and another rather remote and exceptional danger resulting from panics that lead to a run on the bank. The latter evil is not only much more remote, as a rule it may still be averted by the Lender of Last Resort, the Central Bank.
d) Saving and Credit
Except for the fact that they pass money drawn from the Central Bank to the public, commercial banks still have a second, no less important task. The money deposited with them by savers is passed on to borrowers – the latter being private investors or the state.
It is of primary importance to establish the true nature of such savings. The total volume of fresh savings on a yearly basis represents a real surplus, that is, economic capacities not used for consumption, but available for investment. As a result, the upper limit of the annual volume of fresh savings is set by the real economy (in Germany, it amounts to an average of about 10 percent of total household income).
d1) Accumulated Savings
A strict difference should be made between the annual volume of fresh savings (the above mentioned yearly 10%) and savings accumulated in the course of time. Rich people earn so much more than they need for consumption that they usually reinvest all loaned money paid back to them at maturity; that is, the original sum enlarged by interest is again deposited at a savings account (unless, in times of low interest they prefer to invest outside the banking sector in shares, real estate, commodities, etc.) This so-called roll-over is practiced not only by the rich, but also by states. It is generally known, that the latter rarely settle their debts (i.e., reduce them to zero).
In contrast to annual fresh savings, there is no limit to accumulated savings and the corresponding debt. However, these are not money, but monetary claims which have no influence on the volume of money (either cash or book money). Even in a stationary economy characterized by a constant economic output and a constant amount of money, savings and debts may swell indefinitely.
This holds true for the mechanism of interest as well. The steady increase of private assets by interest payments is, in principle, entirely independent of the amount of circulating money. Its main effect consists in a transfer of control over money: The latter gets increasingly concentrated in the hands of creditors (a minority) while debtors (a majority) are obliged to work for them. This relationship of debt increase above a constant money base could be observed in stationary societies such as old India, where usurers accumulated enormous wealth and their debtors enormous debt without thereby affecting the constant amount of circulting money.
N-d) Saving and Credit
Antithesis No. 3 to the orthodox doctrine emerges from Huber’s treatment of credit from savings deposits (at first, we dealt with the alleged creation of book money, which he also called “credit” – wrongly as far as orthodox doctrine is concerned).
According to Huber, this real credit – the only one deserving this designation in orthodox theory – is by no means the result of savings, which banks transfer from depositors to borrowers, for he asserts that in its turn it is the result of pure creation out of nothing, in other words a perfect counterpart to book money equally arising ex nihilo.
In his view the creation of this type of “credit” out of nothing is just as boundless as the rotation of a perpetual motion machine. “In the book money regimes of commercial banks, there are normally no quantitative limits on money and credit … ” (80).
So, according to Huber, commercial banks are, in principle, in a position to produce loans on an infinite scale entirely ex nihilo. He does not seem to notice that his reiterated insistence on “fractional reserve banking” as the outstanding trait of the present money system becomes totally meaningless if minimum reserves do not play any role in the emergence or the quantitative control of loans.
N-d1) The error of a purely monetary view
The thesis of a potentially limitless credit, which emerges from nothing, totally ignores factual reality which, on the contrary, plays a prominent role in the context of orthodox doctrine. As mentioned above, the total volume of fresh annual savings represents a real surplus, i.e. existing economic capacities not used for consumption and for this reason available for investment. As a result – this crucial point should be emphasized once more – savings reach an upper limit imposed by the real economy (in Germany, an average of about 10 percent of the total household income).
Thus, antithesis No. 4 results from Huber’s one-sided interpretation of loans. He exclusively regards them as a monetary phenomenon, which leads him to the following statement: “In order to be able to invest today, it is not necessary to save money and accumulate net assets (original accumulation), the required money may be freely created in advance according to the will and the requirement of the relevant actors” (53).
This is blooming nonsense, already disproved by the syllable “sur” in sur-plus, because in the real economy one always has to mobilize excessively existing economic input – raw materials, machinery and human labor – to enable any investment beyond consumption. Savings are nothing else but material surplus input expressed through money.
But Huber freely indulges in metaphysical theory transcending the world of material things. According to him, all savings arise by pure magic, that is to say, by means of mere account numbers written on sheets of paper: credits are, has he says, conjured out of the hat “in advance”! He does not seem to realize that he contradicts himself diametrically when he says elsewhere quite correctly: “Money constitutes value to that degree that it represents the continually produced economic product consisting in goods and services (62). This and this only provides the material base and covering of money – of any money whatsoever” (63).
N-d2: But what then becomes of savings in Huber’s theory?
If long-term loans, as Huber maintains, are fundamentally created out of nothing, the question unavoidably arises, what then happens to all that money which depositors place on their savings accounts? After all, the fact itself is hard to deny. Unfortunately, the phenomenon does not fit into Huber’s conceptual scheme, therefore he treats it in a perfunctory way assigning to such deposits a role that radically differs from the one attributed to it by orthodox doctrine. According to the latter, the yearly fraction of total household income transformed into savings (in Germany about 10%) represents a surplus of economic activity, which instead of being used for consumption is made available for investment.
Not so with Joseph Huber. According to him, these deposits instead of being transmitted as loans to borrowers merely serve as a cash reserve, in other words, they only provide the basis for credit creation.
Huber then proceeds to offer his own, very particular explanation why banks are nevertheless happy to receive the money of savers albeit they do by no means need it for credit creation according to his theory. His argument: since interest on cash provided by savers is, as a rule, much cheaper than interest the bank would have to pay for cash borrowed from other banks (interbank credit) or from the Central Bank, savings deposits are welcome in order to replenish reserves (64). In this way, Huber explains the otherwise inexplicable fact that banks are so bent on getting the money of savers, even if, in his opinion, it has no function in credit creation.
This is antithesis No. 5 with regard to the orthodox view.
N-d3) A Credit Bubble of truly astronomical Proportions
I wonder if the theorizing professor is really aware of what he is saying? If Germans were indeed to bring ten per cent of their income to commercial banks and if the latter would only use this already tremendous amount for the sole purpose of making it the one-percent obligatory reserve whereupon to erect a ninety-nine-fold tower of freely created loan money (depending on which “multiplier” one would like to employ), then the resulting credit bubble would indeed assume truly apocalyptic proportions.
Such a “quixotism” – an expression which Huber himself likes to apply to the opponents of his doctrine – can only arise among theoreticians who let themselves be led astray by detaching the monetary sphere from the real economy. As a matter of fact, even those 10% of total household income, which German citizens entrust to their savings account, can hardly be accommodated in their own country, because their home industries are not ready to invest that much. Savings therefore flow abroad or are, to a certain extent, absorbed by the state, which then substitutes public for private investment – thus following the advice of Keynes in the event of low interest rates leading to a “liquidity trap”.
Why did Huber not ask himself the following most evident question: Given the usual case that actual savings of rich nations largely exceed the needs of home investment what sense does it make to conjure a fictitious credit bubble of astronomical proportions supposedly produced out of nothing?
Huber’s theoretical construct seems all the more embarrassing in view of the fact that he considers reserves to be ultimately meaningless (“N-d2”). Why then does he assign the role of building such a reserve to the deposits of savers? Contradictions of this kind are frequent but they do not seem to disturb the author of Monetary Modernization.
N-d4) Government Bonds
Antithesis No. 6 results from Huber’s understanding of government bonds. According to orthodox doctrine, the state finances its regular expenditures with taxes and its excess expenditure with government bonds. In the first case, he imposes legally fixed amounts on his citizens; in the second case, he accesses part of their savings. Although the state generally offers a low interest rate, this deficit is generally offset by greater security (generally – the rule does not necessarily hold any more).
With Huber, this too becomes a “quixotism”. As deposits (real economic surplus expressed in money) become irrelevant in his theory, commercial banks must need create all money they make available to the state in the same manner as all other credit – in other words, such money too they produce out of nothing (49, 81).
Again we are faced with an eccentric theoretical construct. The fact that government bonds may serve as collateral can, of course, only be justified if they represent real economic worth, as presupposed in orthodox theory. But within professor Huber’s theoretical frame there is no place for such evidence. In his view, bonds are financed by commercial banks exclusively with money created ex nihilo – which means that they represent no real worth at all.
This strange assertion does not explain why creditors (savers), who, according to the orthodox view, finance government bonds with their deposits, become successively richer while future generations become poorer, as they are forced to pay creditors with rising taxes imposed on them by the state. Nor does it explain why in this process states may ultimately be destroyed by high debt. Huber’s theory needs logical pirouettes of a very special kind, indeed, in order to derive dire consequences like state bankruptcies from a mere expansion of nothingness! However, its author does not seem to mind such obvious contradictions.
e) Multiple Credit Creation
According to orthodox understanding, as to be found in current textbooks, this type of alleged multiple money creation does not refer to fractional reserve banking in the above mentioned sense (see “b1”) but to the following:
Let a saver deposit 10,000 € at a bank and let the bank immediately pass this sum on to a borrower (since the bank pays interest on deposits, it is, indeed, keen on passing the sum immediately on to some borrower in order to obtain interest on debt which is markedly higher than interest it pays to the saver!). Now let the borrower buy some investment material from a manufacturer who, at that moment, happens to have no use for this money, so he, in his turn, places it on his savings account. Thus the bank again holds 10,000 euros, which it instantly passes on to some other borrower.
Let this sequence be repeated indefinitely and in such a way that, ideally, it takes place at the same instant. If, furthermore, reserve requirements are equal to zero, so that banks need not retain any fraction of those 10,000 € as obligatory reserve, it would be theoretically possible to expand the total amount of savings and credits beyond any limit! In real life, this does, of course, never happen, because Multiple Credit Creation suffers from several logical errors.
Logical error No. 1 is based on the assumption that there is an increase of credits against deposits. This assumption is wrong because each new loan of € 10,000 is based on a further saving of exactly the same amount. In other words, nothing is created and the process may be considered multiple only in so far as any owner of money or recipient of a transfer may either consume the corresponding sum, or make it available to the bank for further loans.
Logical error No. 2 consists in the opinion, often brought forward, that the individual banker may not be able to know about such a process because the transaction is carried out by several banks. This is wrong, it may happen exactly in the same way within a single bank.
Logical error No. 3 concerns the cash initially deposited. If we look at the chain more closely, nothing changes, whether we start the process with cash amounting to 10,000 € or with a transfer of proxy money, that is, with book money.
Logical error 4 results from giving any meaning at all to the above mentioned chain. It does, in fact, make no difference at all whether a thousand investors make successive savings of € 10,000 within a chain or whether they do so independently from each other (i.e. outside a chain). As already stated under Logical error No. 1, any owner of money or receiver of a book money transfer is able to provide the bank with the corresponding sum for further loans.
Logical error No. 5 consists in the erroneous view that this fictitious credit creation is in any way dependent on minimum reserve requirements (fractional reserve banking). Up to this point, I assumed reserve requirements to be equal to zero. Now, let us assume an obligatory reserve of 50%. In this case, the same sum total of loans could be obtained by doubling the number of deposits. If there were no limit to the available number of depositors an indefinite creation of loans would still be possible. The same argument applies to all reserve values between 1 and 99.
A real change only occurs with a 100% reserve requirement. In the case of book money accounts, this would mean that all cash left with the bank should remain there together with the corresponding book money entries. In other words, no single cash euro would be allowed to leave the bank. In the event of a run on the bank, the customer would have nothing to fear – all his money (cash money) remains at his disposal.
This alternative was already discussed above in “N-c”. It is extremely expensive and, for this reason, economically unviable. The same arguments are valid for savings deposit.*3*
Logical error 6: The decisive mistake of Multiple Credit Creation theory, so widespread in orthodox thinking, must, however, be looked for on an altogether different level, namely in its failure to duly acknowledge the intimate relationship between money and the real economy. Huber, together with other theoreticians of his kind, tends to treat the monetary sphere as if it could escape the constraints of the latter. In the above example, we made a very special assumption. We supposed that a potentially infinite number of savers would immediately transfer all the money they had received by way of remittance on their current account to their savings account so that banks would then be able to use it as credit. This assumption is, however, totally unrealistic, since in every economy the sum total of all real surpluses available for investment is strictly limited – and the same holds true of the money values in which these surpluses are expressed: As stated above, they correspond exactly to the respective saving rate. If the latter amounts to about ten percent, this is tantamount to the statement that the average citizen transfers only about every tenth euro to his or her savings account, thus making it available as a credit. There can be no question of an infinite amount of deposits and credits (only limited by minimum reserves), as the theory of Multiple Money Credit Creation suggests.
N-e) Multiple Credit Creation
As I just tried to prove, this particular construct must be considered mere fiction even within orthodox theory. Helmut Creutz had recognized this correctly, but his reasoning was still incomplete. Prof. Senf also considers Multiple Credit Creation to be illusionary (and he even apologized to his students for having taught them falsehoods for years), but in his works I did not come across any convincing reasons for his rejection.
Be this as it may. As far as Huber’s doctrine of money creation ex nihilo is concerned, we may confidently assert: It either occurs independently of non-existent Multiple Credit Creation and independently of any fractional reserves of the system – or it does not occur at all.
f) Transformation of Book Money into Cash
It is in the interest of each bank to achieve the highest possible bank margin, i.e. the greatest possible difference between the interest rate obtained from borrowers and the interest rate paid to savers. Due to competition among banks, their endeavors to maximize this margin meet with narrow limits. In the case of complete competition, all profits would disappear: bank margins would shrink to the minimum necessary just to maintain one’s own business. They could even be lower, supposing that other banks started to cut the salaries, pensions, etc. of their employees or to drastically reduce the number of their subsidiaries so that their operation could be carried on at much lower cost.
According to the orthodox view, banks must pay particular attention to liquidity. All banks form A to Z are permanently exposed to the risk of loosing liquidity, because a lending bank A, in competition with other banks, must always be prepared that one of its borrowers uses the book money credited to him for the purpose of acquiring goods or services from a customer maintaining an account with bank Z. There, the amount of book money transferred from bank A either remains credited to the account of said customer or the latter redeems it in cash. In the second case, bank Z must directly provide such cash, which, however, is not at its disposal since it was not previously deposited by a saver; in the first case it must increase the proxy money on the customer’s account, which for the same reason is missing. In both cases, bank Z would lose own liquidity unless, at the end of the day, the balance is settled with bank A on the cash account both banks keep with the Central Bank.
Liquidity represents a most costly item for all commercial banks, so daily balances are carried out between bank A to Z no matter whether transfers between banks originate in current or in savings accounts.
That does not, of course, render spontaneous balance sheet extensions impossible, that is, spontaneous creation of book money not backed by simultaneous cash deposits. However, as these are ultimately to be settled in liquidity (vis-à-vis the banks own customers, vis-à-vis competing banks or the Central Bank), this may only be done on a small scale.
N-f) Transformation of Book Money into Cash
In Huber’s theory, the same imperative prevails as previously described for the orthodox one. In order to prevent liquidity outflows, banks A to Z have to settle balances with each other at the end of the day. Otherwise it could happen that one of them has to pay for transmitted book money in cash, which it doesn’t have and for this reason would have to acquire at high cost from the interbank market or from the Central Bank.
Not to have taken this into account leads to antithesis 7a, the cardinal error of the Huber theory building.
Anyone who hears for the first time that banks are creating money out of nothing is easily led to believe that banks may become addicted to such a procedure as nothingness seems to be free of charge.
In truth the exact opposite applies. Regardless of what Huber and his followers maintain, banks continue to base loans on actual savings instead of conjuring them out of a magic hat. And the reason for doing so is quite simple: Creating money out of nothing is far too expensive! (Huber knows this argument (64), but tries to evade it by means of a specious interpretation, as was shown above under “N-d2”).
N-f1) Creating Savings out of Nothing is far too expensive
To have overlooked this elementary fact is, among the many others already mentioned, probably the grossest error in the theory of professor Huber. It is true that its author is well aware that banks are always eager to grab the money of savers because it is much cheaper than any money they acquire from the internet market or from the Central Bank. But the only conclusion Huber draws from this undeniable fact is a false one (described above, see “N-d2”): He believes that savings deposits only serve to fill up reserves.
But in this way Mr. Huber misses the crucial point. Let us assume that there are 100 commercial banks in a country: banks A1, A2, A3 to Z1, Z2 … Then each individual bank like bank A1 carries out a large part of its business with the remaining 99 banks, to which at the end of the day it must cede that amount of cash which a customer of any of these banks finds on its current account because of a book money transfer from A (see example in “f”). Balance settlement thus requires Bank A to cede a certain amount of cash to Bank Z which it does at substantially lower cost if the amount in question has previously been deposited in cash on a savings account. On the other hand, the same procedure is much more expensive if bank A has to borrow (refinance) this money with higher interest rates as an interbank credit or from the Central Bank.
It is this difference in interest rates which in mutual competition determines the economic efficiency of each bank.For reasons of cost, money generation out of nothing is not a viable economic option – even though balance sheet extensions are quite possible.
N-f2) Creating Book Money out of Nothing – too expensive for Commercial Banks!
This argument not only applies to interbank competition for savings, which for the reasons just mentioned may only exceptionally be created out of nothing; it is just as valid when applied to current book money accounts, where ex nihilo creation, being too costly, is equally out of question (this is antithesis 7b with regard to orthodox teaching).
Let us first consider a stationary society, where growth is equal to zero, the economic output per year having a constant value. In this case, commercial banks would not need any fresh money from the Central Bank, since all available money (cash as well as book money) satisfies the requirement of a constant purchasing power. Whenever book money is generated from cash deposits (and is even continually increased by less cash withdrawals because, due to changed payment practices, customers prefer book money transactions), this increase practically occurs free of charge for the banks concerned. On the other hand, banks would have to pay a lot more interest if instead they turned to creating book money out of nothing, because, in this case, they would have to settle the balance with other banks by means of cash for which, in the manner shown above, they would have to pay substantially higher interest rates. Again, it is the competition between banks, which prohibits the creation of money from nothing.
Matters remain pretty much the same, if we now consider a society in the process of growth, where the Central Bank is required to provide the economy with fresh money in order to prevent deflation. To be sure, banks will now be forced to pay the higher interest rate (the higher “steering fee”) for all fresh money they acquire from the Central Bank. As, however, the quantity of fresh money required is negligible compared to the money already in circulation, this is but a minor item (the economic output itself only grows by a few percent at best!).
Only for a single case can I imagine an economically worthwhile creation of book money out of nothing. Let us suppose that banks enjoy such a high interest margin from short-term lending of current account book money that they have no difficulty in offsetting the additional costs they incur when borrowing the needed cash for their balance settlements with other banks (Huber does not seem to take this case into consideration). This possibility seems to be rather theoretical. Functioning competition among banks should limit the interest margin to such a degree that such a behavior becomes quite unlikely. If, however, competition were really defective, the state should interfere with a legal ceiling for interest margins.
As we said at the outset, the criterion of truth content is decisive for the assessment of scientific theories. Statements should be falsifiable according to Popper’s criterion. If a theory is built on sand, it has no more value than the most beautiful mathematical equation which yields nothing but false results.
In the case of Huber’s theoretical constructs, I am tempted to go even one step farther. His remarks on the subject of money are harmful because they replace existing correct insights with false ones (errors 1 to 7).
We may nevertheless understand the fascination Huber’s thoughts exert on a number of followers who actively pursue a reform of money according to his ideas. In recent years, too many financial scandals have shaken public confidence in the banking system and will probably shake it even more strongly in the future because of the ECB’s current policy. But it is important to find the right causes for the failure of the current system, rather than combating it with faulty fabrications.
Silvio Gesell, Helmut Creutz and Gero Jenner have described and even tried to quantify the most evident cause for the increasing concentration of wealth in a few hands. Huber certainly knows the texts of the first two, but, unfortunately, evident causes are of no real concern to him. In his book, he devotes no more than some casual remarks to Gesell and Creutz, for he insists on deriving all grievances from a theoretical preconception: alleged money-making out of nothing. His few critical remarks on Gesell are superficial (166), although it must be admitted that the introduction of a so-called “shrinking money” as proposed by Gesell never was a realistic option (at least on a large scale) because of the administrative effort required. All this has changed as the money system changes from cash to book money and does so at a growing pace. Nowadays, the increasing concentration of wealth due to a parasitic transfer from bottom to top could be effectively combated.
Huber knows all this. He has all figures ready, with which to prove that the rich are getting richer and the poor poorer. He knows quite well that this fact can be easily explained by savings and interest, while an explanation by credit creation out of nothing, requires greatest intellectual contortions – nevertheless, he prefers the fogs of a theory he stubbornly upholds against facts and logic.
It is this haughty disregard for facts and logic that makes Huber’s work strange reading indeed. The author of “Monetary Modernization” is extremely well read, he knows most objections and counterclaims, but he devotes his whole knowledge to the single purpose of defending thoughts which though not being of his own invention (they go back to Schumpeter and von Mises) would, certainly, turn money theory upside down if they were true.
1 While King’s treatment of money creation is quite convincing as far the above mentioned article is concerned, he falls back into traditional reasoning in a more recent article entitled “Who creates money?” There he commits the same error typical of Central Banks when they list savings and commercial papers under the head of money (M4). Doing so Mr. King has, of course, to cope with the problem why there is such a huge amount of “money”. He seems to forget that savings and commercial papers are but monetary claims, they are by no means money (otherwise my personal villa should have a better prospect to be counted as money because it is more easily transformed into cash than my savings book!). Money (M1) tends to be in a fixed relationship to GDP but M4 may swell indefinitely. As explained above (“d1”), the two are independent variables. Attempts to derive any conclusions on money creation from observing savings and commercial papers must therefore appear rather futile.
2 The meaning of “fractional reserve banking” should be discussed in general terms, irrespective of any practical implementation, which is regulated differently in each country and banking system. For example, reserve can theoretically mean that a certain fraction of cash deposits are retained by the bank for the protection of creditors (63). It can also mean that cash deposits themselves are fully available for loans, but a reserve, corresponding to a certain fraction of the deposits, must be set up alongside them.
In any case, reserves and equity are hard to distinguish in a logically unambiguous way. It makes sense to speak of a percentage reserve because a bank’s size, i.e. its balance sheet total, ultimately determines the size of its reserves or equity. In this sense it seems legitimate to define the latter as a fraction of the balance sheet total.
3 Fictitious multiple credit creation may be applied both to money parked in current accounts and to savings. In both cases, a reserve requirement of 100% represents a really interesting alternative. Applied to current accounts, it would be tantamount to 100% money, or, as others would name it: Positive Money. It would then come into being in the orthodox system itself, that is, without any help from Huber’s theory). As nowadays far more than 90% of all money passes book money accounts, an equal sum would be kept as cash in the bank’s vaults. I already explained above why this would be extremely costly for banks, their customers as well as the economy at large.
When applied to aggregated savings, a 100% reserve would not even be feasible, since the amount of savings assets (or the corresponding private and public debt) already exceeds the social product in many countries. To retain this sum as a reserve or equity is simply impossible. On the other hand, a nearly equivalent solution is already practiced in the prevailing orthodox system. It consists of issuing loans only with equivalent collateral (real estate, etc.). In the event of a credit default, banks may access these securities in order to pay depositors (creditors).