Don Brash: The banking system creates money, not banks

An individual bank cannot create money by "the stroke of a pen or a computer entry". Photo / 123RF

In last Friday's Herald, under the headline "Brash blind to facts with money creation denials", Bryan Gould returned to his assertion that banks are really "charging interest on money that they themselves create" by "the stroke of a pen or a computer entry".

He seeks to defend his assertion by citing a Bank of England article which notes that it is a "common misconception... that banks act simply as intermediaries, lending out the deposits that savers place with them". This "ignores the fact that... in the modern economy, commercial banks are the creators of deposit money".

I have no quarrel with the Bank of England's argument, of which I am well aware of course. As I made quite explicit in my first reply to Mr Gould, "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... So an initial loan may end up considerably increasing the total lending by the banking system".

But an individual bank cannot create money by "the stroke of a pen or a computer entry".

If it could, as I asked in my first reply to Mr Gould, why do they bother paying interest on deposits, or borrow overseas to fund their operations? Why do they ever run out of an ability to repay depositors in the event of a "run" on the bank?

I have been involved in the banking sector for roughly half of my professional career and have never yet felt able to ignore the funding side of a bank's balance sheet, confident that the bank I was involved in could always create money by the stroke of a pen or a computer entry.

Another of Mr Gould's assertions was that it is the ability of banks to conjure money out of thin air which lies behind the grossly unaffordable Auckland housing market. I certainly agree with him that Auckland house prices are grossly unaffordable.

But if this ability of banks to "conjure money out of thin air" was truly the cause of the extremely high price of Auckland housing, surely one would expect houses to be unaffordable wherever commercial banks operate.

And that is not true of course. There are a great many large and fast-growing cities in the United States, for example, where average house prices are about three times average household income, despite American banks operating in essentially exactly the same way as New Zealand banks do.

The reason house prices are outrageously expensive in Auckland (some 10 times average household income) is not the nature of the banking system but the constraints on the availability of land for development, as successive studies by the Productivity Commission and others have found.

Far from being the result of the ability of banks to create money out of thin air, or the consequence of Mr Gould's other pet hatred, "neoliberalism", unaffordable housing is a direct result of the planning constraints imposed by local and regional councils.

• Don Brash is a former Governor of the Reserve Bank of New Zealand.