Modern governments claim a monopoly over the creation of cash, and this is often said to be the wellspring of their economic power. But the state’s grip on the money supply is weaker than it seems. In the UK, notes and coins adorned with images of the Queen’s head may be the most visible instruments of economic exchange, but they comprise less than a 20th of the money supply. Much of the rest consists of bank deposits – in effect, private debts that financial institutions owe their customers. These deposits function like money; they can be transferred from person to person with the flick of a pen, the wave of a card or even a mobile phone. Yet they are created by private contracts between citizens, not by government fiat.
Writing in these pages, Martin Wolf has argued for the abolition of such “private money”. Our economies would be more stable, he believes, if money creation were left entirely to the state. It is an alluring proposal; the monetary system is fiendishly complicated, and simple solutions to complex problems are often attractive. But it is misguided.
When an account holder gives a bank some cash in return for an increased deposit balance, the bank keeps only a tiny fraction of what it has received in the form of liquid reserves. The rest is lent out to borrowers, who in turn deposit the money, creating still more private money. Because borrowers pay interest, this process leads to the peculiar position that I both receive interest on my current account balance and pay no charges for the bank’s transaction services.
