Brash shows up Gould’s ignorance

Don Brash writes:

But Mr Gould went further than Mr Robertson to praise Sonny Bill Williams’ highly negative attitude to banks in general. He said banks like to pretend they provide a useful service to the community by channelling resources from those who have no immediate need for them (savers) to those who do need them (borrowers), charging a modest spread for rendering that service.

But, said Mr Gould, this “benign view of [bank] operations is inaccurate and misleading. The banks do not lend you mortgage money deposited with them by someone else. They lend you money they themselves create out of nothing through the stroke of a pen or, today, a computer entry. The banks make their money, in other words, by charging interest on money that they themselves create”.

He then goes on to blame this money creation for the housing affordability crisis which Auckland now finds itself in, and to attack the Government for washing its hands of this aspect of the housing crisis.

Mr Gould is not alone in peddling this nonsense, but that certainly doesn’t make it correct.

The banking system does create money. When Bank A lends money to one of its customers, the customer may use those funds to buy something from somebody who banks with Bank B. Bank B then finds itself with an additional deposit, a part of which it can lend out to its customers (keeping some of the additional deposit as a liquidity reserve). So an initial loan may end up considerably increasing the total lending by the banking system.

But from the point of view of each individual bank, it can only lend out a part of the money which its customers deposit with it, or money which it borrows from other sources, possibly overseas.

If individual banks really could create money by “the stroke of a pen or a computer entry”, as Mr Gould contends, why do they bother paying interest on deposits, why do they borrow funds from parent banks overseas, why do they borrow funds in the international market, why do they need to hold some funds in government securities as a liquidity reserve, why do some banks occasionally run out of money when customers lose confidence in them?

As well as being a former Governor of the Reserve Bank, I now chair the small New Zealand subsidiary of the Industrial and Commercial Bank of China, the largest bank in the world. It would certainly make life very much easier if we could, “by the stroke of a pen or a computer entry”, simply create the money which we lend out to New Zealand borrowers. Unfortunately, we can’t.

I always think of Bryan Gould as the 1990s version of Jeremy Corbyn!