Last week, Assistant Governor of the Reserve Bank of Australia, Christopher Kent, made a speech about money and credit.
Sounds boring, right?
Well, that’s what the bankers would like you to believe. ‘Yes, yes, nothing to see here, move right along please…’
But read carefully, and I’ll show you why the bankers would prefer you didn’t know this. It’s one of the greatest thefts in human history.
First, some context. The founder of the House of Rothschild, Mayer Amschel Rothschild, is alleged to have said:
‘Let us control the money of a nation, and we care not who makes its laws’.
How do banks control the money of a nation?
Well, as Christopher Kent tells us, they create it. But he doesn’t explain exactly how it works. That would give the game away. I’ll let you know the ‘game’ in a moment. First, I’ll let Mr Kent explain the process of how money comes into existence:
‘Money can be created, however, when financial intermediaries make loans. Accordingly, the concepts of money and credit are closely linked in a modern economy, albeit not one for one. When a bank extends a loan, it makes money available to the borrower, for example, to buy a car, a house or equipment for a business. The bank may credit the deposit account of the borrower, who withdraws the funds to make their purchase. Alternatively, the bank may directly credit the deposit account of the seller on behalf of the borrower. In either case, the loaned funds will tend to find their way into a deposit somewhere in the banking system. This process adds to the supply of money.
‘If I stopped here, you might be left with the impression that the process of lending allows the banking system to create endless quantities of money at no cost. However, the process of money creation is constrained in numerous ways and depends on the behaviour of borrowers, banks and regulators, as well as the stance of monetary policy.
‘In the first instance, the process of money creation requires a willing borrower. That demand will depend, among other things, on prevailing interest rates as well as broader economic conditions. Other things equal, lower interest rates or stronger overall economic conditions will tend to support the demand for credit, and vice versa.’
The banking business model
Let me explain in the form of a familiar example.
Say you go into a bank and apply for a home loan. When the bank approves this loan, it doesn’t go into the market and look for the money. No, it simply creates it with a few computer keystrokes.
That is, it ‘credits’ your account with ‘money’. The credit/money wasn’t there before. The bank simply created it…a near zero manufacturing cost.
It is only after you ‘spend’ the money (by transferring payment to the vendor of the home you just bought) that a bank might need to go into the market and get more to balance its books.
This bit can be confusing, so let me explain…
When a bank credits your account, it creates a liability to the bank. This is balanced on the asset side of the balance sheet by the loan amount (secured by the property). So every loan made is both a liability and an asset.
If the payment you make to the vendor is in turn deposited into another bank, then your bank will need to make up the liability by attracting local deposits or borrowing offshore.
This is pretty much how the cosy oligopoly that is the Australian banking system works. They all have roughly the same deposit and lending rates, and so all make similar loans and attract a similar amount of deposits.
The common refrain is that banks create money ‘out of thin air’. This isn’t entirely true. The truth is that banks create credit on your good character…and then charge you for it!
Take this exchange from J.P Morgan’s testimony before the House Committee on Banking and Currency in December 1912:
Samuel Untermeyer: ‘Is not commercial credit based primarily upon money or property?’
Morgan: ‘No, sir; the first thing is character.’
Untermeyer: ‘Before money or property?’
Morgan: ‘Before money or anything else. Money cannot buy it.’
Can you see why banking is such a great business?
What is an appropriate return for a bank?
It costs nothing to manufacture money or create credit. The only thing it takes is your good character, which you bring to the table! And then you pay the bank for it for the next 30 years!
OK, it requires good judgement from the banker to decide the quality of someone’s character. At least, it used to. But now, with central banks ready to bail out banks that make too many bad loans, even this skill is redundant.
Why do you think Europe and America’s most powerful bankers conspired in the early 1900s to create the Federal Reserve? It was to ensure they had an emergency source of money (which the Fed could create out of thin air) when they got into trouble.
The creation of central banks ensured that banks could behave recklessly and still get rescued. Look at the multi-trillion dollar bailout afforded to Wall Street in 2008/09, while millions of families were turfed from their homes.
The creation of money/credit is not entirely cost free, though. Obviously, it requires significant investment to set up the infrastructure to make and administer loans. A bank should be able to generate an appropriate return on that investment.
What is an appropriate return?
In a highly efficient and competitive market, it should be something just above a banks’ cost of capital. For Australian banks, a rough estimate for the cost of equity capital would be around 7–8%. Banks therefore should earn closer to 8–9% returns on equity.
I say that because they’re not manufacturing anything. There’s no high tech R&D involved in maintaining or improving their product. Banks simply create and administer a commodity, albeit one that has a theoretical infinite supply. When returns exceed the cost of capital by too much, a healthy market should ensure these excess returns are competed away.
But that doesn’t happen. The banking system is a protected species — an effective cartel. The Commonwealth Bank of Australia Ltd [ASX:CBA] generates a return on equity (ROE) of over 14%. At the height of it’s profitability back in 2011/12, it generated a ROE over 20%! All for monetising your good character!
The banking system needs to open to competition, or be regulated as utilities providing a public service. And that service is the administering of money flows created on nothing but individual character or business reputation.
Of course, that will never happen. When you have the ability to create money you can stuff it in the pockets of those whose job it is to oversee your conduct.
The fox really is in charge of the henhouse. And they’re eating very well indeed.
Editor, Crisis & Opportunity
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