A reply to Richard A. Werner

A reply to Richard A. Werner's "Can banks individually create money out of nothing? - The theories and the empirical evidence"


In this blogpost I want to reply to Richard A. Werner's excellent paper on money creation. Werner takes great effort to give empirical evidence on money creation by individual banks.

He recognizes a big muddlement in the different theories of money creation.
"How can the issue be settled and the ‘muddlement’ cleared up? One reason for this “state of muddlement” is likely to be the methodology dominant in 20th century economics, namely the hypothetico-deductive method. Unproven ‘axioms’ are ‘posed’ and unrealistic assumptions added, to build a theoretical model."
I would fully support his view. We need different approaches! He provides an interesting approach of finding the truth by testing the outcomes of a bank lending process empirically. In his paper, he describes how he lent out € 200,000.- and carefully watched and analysed the bank's accounts.
I really must thank Werner for this unique approach.

But, from my point of view, there are a few flaws in his interpretation or at least points, which I'm not very sure about:

Two little flaws

  • One point, which struck me immediately, was the change of cash reserves by € 158,329.86, the cash growing from about € 182,000 to € 340,000 in one day. Why did this happen? Did the cash-transport arrive? Is it normal for a small bank to increase its cash that much in one day?
  • The claims on financial institutions dropped significantly by € 219.000, which interestingly corresponds somehow to the sum lent out. This could be a sign for the bank refinancing itself!
Werner discusses these points. He simply puts them together:
"What may have happened is that the bank withdrew legal tender from its account with the cooperative central bank, explaining both the rise in cash and decline in balances with other financial institutions."
This is one possibility. The other would be, that the bank significantly raised its cash holdings for some reason and refinanced the loan with the other banks. It is a totally different picture if you don't take the two interpretations together. Because it would also support the fractional reserve theory.
Werner himself states: "The evidence is not as easily interpreted as may have been desired [...]". That is true.

Another bigger flaw

Another flaw comes from the distinction between money on a bank account (which is basically a claim by the customer) and cash.
In my opinion it is clear that a bank can create deposits for clients "out of nothing". Because everyone can do. I could also write on a piece of paper the name Werner and a credit of 200,000.-. It is possible for everyone to just create credit that way (see also Alfred Mitchell Innes' text about money from 1913!).

The important question is: what happans to the bank, if you want to use your deposit to actually pay? What happens, if you want to transfer your credit to someone else's bank account? What happens in the balance-sheet of the bank? Does the bank have to refinance itself? Does it have to use centralbank money for this?

Werner states that it was possible to use the money credited:

"An extension of the experiment, to be reported on separately, used the balance the following day for a particular transaction outside the banking institution, transferring the funds to another account of the researcher, held with another bank; this transfer was duly completed, demonstrating that the funds could be used for actual transactions"

But what happened to the banks balance sheet? If the bank had to refinance itself with centralbank money, the bank actually did not create money out of nothing. If the banks always need money they can not create themselfs as soon someone wants to transfer money from account to account, you can not say that the credit creation theory is right.

In my opinion this experiment would have been even more important: To see what happens if you want to transfer the amount credited by the bank. This experiment would rather give an answer to the question, which theory is right!

I hope that my points were clear and appropriate. However I still think that Richard A. Werners work is important and interesting and worth doing!

It is funny that we live in a world, where you have to make empirical tests to find out how banks work. Why is it not just possible to ask them?!

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