Table of Contents

FOREWORD. 1: INTRODUCTION. 1.1., Key questions. 1.2., Overview of key findings. 1.2.1., The money supply and how it is created. 1.2.2., Popular misconceptions of banking. 1.3., How the book is structured. 2: WHAT DO BANKS DO?. 2.1., The confusion around banking. 2.2., Popular perceptions of banking 1: the safe-deposit box. 2.2.1., We do not own the money we have put in the bank. 2.3., Popular perceptions of banking 2: taking money from savers and lending it to borrowers. 2.4., Three forms of money. 2.5., How banks create money by extending credit. 2.6., Textbook descriptions: the multiplier model. 2.7., Problems with the textbook model. 2.8., How money is actually created. 3: THE NATURE AND HISTORY OF MONEY AND BANKING. 3.1., The functions of money. 3.2., Commodity theory of money: money as natural and neutral. 3.2.1., Classical economics and money. 3.2.2., Neo-classical economics and money. 3.2.3., Problems with the orthodox story. 3.3., Credit theory of money: money as a social relationship. 3.3.1., Money as credit: historical evidence. 3.3.2., The role of the state in defining money. 3.4., Key historical developments: promissory notes, fractional reserves and bonds. 3.4.1., Promissory notes. 3.4.2., Fractional reserve banking. 3.4.3., Bond issuance and the creation of the Bank of England. 3.5., Early monetary policy: the Bullionist debates and 1844 Act. 3.6., Twentieth century: the decline of gold, deregulation and the rise of digital money. 3.6.1., A brief history of exchange rate regimes. 3.6.2., WWI, the abandonment of the gold standard and the regulation of credit. 3.6.3., Deregulation of the banking sector in the 1970s and 1980s. 3.6.4., The emergence of digital money. 4: MONEY AND BANKING TODAY. 4.1., Liquidity, Goodhart's law, and the problem of defining money. 4.2., Banks as the creators of money as credit. 4.3., Payment: using central bank reserves for interbank payment. 4.3.1., Interbank clearing: reducing the need for central bank reserves. 4.3.2., Effects on the money supply. 4.4., Cash and seigniorage. 4.4.1., Is cash a source of 'debt-free' money?. 4.5., How do banks decide how much central bank money they need?, 4.6., Is commercial bank money as good as central bank money?, 4.6.1. Deposit insurance. 4.7., Managing money: repos, open market operations, andquantitative easing (QE). 4.7.1., Repos and open market operations. 4.7.2., Standing facilities. 4.7.3., Quantitative Easing. 4.7.4., Discount Window Facility. 4.8., Managing money: solvency and capital. 4.8.1., Bank profits, payments to staff and shareholders and the money supply. 4.9., Summary: liquidity and capital constraints on money creation. 5: REGULATING MONEY CREATION AND ALLOCATION. 5.1., Protecting against insolvency: capital adequacy rules. 5.1.1., Why capital adequacy requirements do not limit credit creation. 5.1.2., Leverage Ratios: a variant of capital adequacy rules. 5.2., Regulating liquidity. 5.2.1., Compulsory reserve ratios. 5.2.2., Sterling stock liquidity regime (SLR). 5.3., Securitisation, shadow banking and the financial crisis. 5.4., The financial crisis as a solvency and liquidity crisis. 5.5., Endogenous versus exogenous money. 5.6., Credit rationing, allocation and the Quantity Theory of Credit. 5.7., Regulating bank credit directly: international examples. 6: GOVERNMENT FINANCE AND FOREIGN EXCHANGE. 6.1.,The European Union and restrictions on government money creation. 6.1.1., The Eurozone crisis and the politics of monetary policy. 6.2., Government taxes, borrowing and spending (fiscal policy). 6.2.1., Taxation. 6.2.2., Borowing. 6.2.3., Government spending and idle balances. 6.3., The effect of government borrowing on the money supply: 'crowding out'. 6.3.1., Linking fiscal policy to increased credit creation. 6.4., Foreign exchange, international capital flows and the effects on money. 6.4.1., Foreign exchange payments. 6.4.2., Different exchange rate regimes. 6.4.3., Government intervention to manage exchange rates and the 'impossible trinity'. 6.5., Summary.7: CONCLUSIONS. 7.1., The history of money: credit or commodity?. 7.2., What counts as money: drawing the line. 7.3., Money is a social relationship backed by the state. 7.4., Implications for banking regulation and reforming the current system. 7.5., Towards effective reform: Questions to consider. 7.6., Are there alternatives to the current system?. 7.6.1., Government borrowing directly from commercial banks. 7.6.2., Central bank credit creation for public spending. 7.6.3., Money-financed fiscal expenditure. 7.6.4., Regional or local money systems. 7.7., Understanding money and banking. APPENDIX 1: THE CENTRAL BANK'S INTEREST RATE REGIME; A1.1., Setting interest rates - demand-driven central bank money; A1.2., Setting interest rates - supply-driven central bank money. APPENDIX 2: GOVERNMENT BANK ACCOUNTS; A2.1., The Consolidated Fund; A2.2., The National Loans Fund; A2.3., The Debt Management Account; A2.4., The Exchange Equalisation Account (EEA). APPENDIX 3: FOREIGN EXCHANGE PAYMENT, TRADE AND SPECULATION; A3.1., Trade and speculation; A3.2., The foreign exchange payment system; A3.2.1., Traditional correspondent banking; A3.2.2., Bilateral netting; A3.2.3., Payment versus payment systems: the case of CLS Bank; A3.3.4., On Us, with and without risk; A3.3.5., Other payment versus payment settlement methods. LIST OF EXPLANATORY BOXES: Box 1: Retail, commercial, wholesale and investment bank; Box 2: Building societies, credit unions and money creation; Box 3: Bonds, securities and gilts; Box 4: Wholesale money markets; Box 5: Double-entry bookkeeping and T-accounts; Box 6: Money as information - electronic money in the Bank of England; Box 7: What is LIBOR and how does it relate to the Bank of England policy rate?; Box 8: Seigniorage, cash and bank's 'special profits'; Box 9: Real time gross settlement (RTGS); Box 10: If banks can create money, how do they go bust? Explaining insolvency and illiquidity; Box 11: The 'shadow banking' system; Box 12: The Quantity Theory of Credit; Box 13: Could the Government directly create money itself?; Appendices: Box A1: Market-makers; Box A2: Foreign Exchange instruments. LIST OF FIGURES, CHARTS AND GRAPHS: Figure 1: Banks as financial intermediaries; Figure 2: The money multiplier model; Figure 3: The money multiplier pyramid; Figure 4: 'Balloon' of commercial bank money; Figure 5: Growth rate of commercial bank lending excluding securitisations 2000-12; Figure 6: Change in stock of central bank reserves, 2000-12; Figure 7: UK money supply, 1963-2011: Broad money (M4) and Base money; Figure 8: Decline in UK liquidity reserve ratios; Figure 9: Indices of broad money (M4) and GDP, 1970-2011; Figure 10: Liquidity scale; Figure 11: Commercial banks and central bank reserve account with an example payment; Figure 12: Payment of GBP500 from Richard to Landlord; Figure 13: Simplified diagram of intra-day clearing and overnight trading of central bank reserves between six commercial banks; Figure 14: Open market operations by the Bank of England; Figure 15: Balance sheet for commercial bank including capital; Figure 16: Bank of England balance sheet as a percentage of GPD; Figure 17: Net lending by UK banks by sector, 1997-2010 sterling millions; Figure 18: Change in lending to small and medium-sized enterprises, 2004-12; Figure 19: Government taxation and spending; Figure 20: Government borrowing and spending (no net impact on the money supply); Figure 21: A foreign exchange transfer of $1.5m; Figure 22: The impossible trinity. Appendix: Figure A1: Corridor system of reserves; Figure A2: The floor system of reserves; Figure A3: The exchequer pyramid - key bodies and relationships involved in government accounts; Figure A4: The UK debt management account, 2011-12; Figure A5: Assets and liabilities of the exchange equalisation account 2011-12; Figure A6: Amount of foreign currency settled per day by settlement method (2006); Figure A7: Foreign exchange using correspondent banking; Figure A8: CLS (in full) Bank operational timeline. LIST OF T-CHARTS: T-chart 1: Loan by Barclays Bank; T-chart 2: Bank simultaneously creates a loan (asset) and a deposit (liability); T-chart 3: Balance sheet of private banks and central bank showing reserves; T-chart 4: Private banks' balance sheets; T-chart 5: Private and central bank reserves; T-chart 6: withdrawal of GBP10; T-chart 7: QE on central bank balance sheet; T-chart 8: QE on pension fund balance sheet; T-chart 9: QE on asset purchase facility (APF) balance sheet; T-chart 10: QE on commercial bank balance sheet.

About the Author

JOSH RYAN-COLLINS is a Senior Researcher at nef (the new economics foundation) where he is leading a programme of research on the history and practice of monetary systems. He is studying for a PhD in finance at the University of Southampton. TONY GREENHAM is Head of Finance and Business at nef. He is a former investment banker, a Chartered Accountant and regular writer and media commentator on banking reform. PROFESSOR RICHARD WERNER is Director of the Centre for Banking, Finance and Sustainable Development at the University of Southampton and author of two best-selling books on banking and economics. He is credited with popularising the term 'quantitative easing' in 1994 whilst Chief Economist at Jardine Fleming Securities (Asia), following a spell as visiting research fellow at the Japanese Central Bank. ANDREW JACKSON contributed to this book after graduating from the University of Sussex with an MSc in Development Economics. He is currently studying for a PhD in finance at the University of Southampton. JOSH RYAN-COLLINS is a Senior Researcher at nef (the new economics foundation) where he is leading a programme of research on the history and practice of monetary systems. He is studying for a PhD in finance at the University of Southampton. TONY GREENHAM is Head of Finance and Business at nef. He is a former investment banker, a Chartered Accountant and regular writer and media commentator on banking reform. PROFESSOR RICHARD WERNER is Director of the Centre for Banking, Finance and Sustainable Development at the University of Southampton and author of two best-selling books on banking and economics. He is credited with popularising the term 'quantitative easing' in 1994 whilst Chief Economist at Jardine Fleming Securities (Asia), following a spell as visiting research fellow at the Japanese Central Bank. ANDREW JACKSON contributed to this book after graduating from the University of Sussex with an MSc in Development Economics. He is currently studying for a PhD in finance at the University of Southampton.