Banks are not intermediaries, the loan comes before the deposit

20130323_LDP001_0A key thing missing in last week’s coverage of the Cyprus crisis is that banks create a loan before they create a deposit.  Almost all journalists and commentators all fall into the trap, believing that banks are true intermediaries between saver and borrower.

Michael Kumhof, a former bank manager at Barclays, disposes of this myth in his article with Jaromir Benes called the Chicago Plan Revisited, and in subsequent lectures and papers. Kumhof, an IMF economist, says clearly; “The loan precedes the deposit. I know because I did it and if anyone like Paul Krugman tells you otherwise he doesn’t know what he is talking about.”

I was explaining to a friend the other day that if banks have 100% backing for their deposits there is no risk of a run on the bank. Her reply was “But then they would have nothing left to lend out.” This friend was believing, as is fed to her in the daily media, that banks lend out their deposits. Kumhof goes further than this by saying “The chief function of banks is to create the nation’s money supply. They are solely in charge of it.”

So when rich Russians deposit their money in the Laiki Bank in Cyprus the deposits are not lent out at all. The bank itself decides who will have loans, issues the loan and at the same time writes an equivalent deposit on the other side of the ledger. How do you think the size of the banking sector in Cyprus reached eight times the size of the economy in 2011?  The banks made loans and were solely in charge of the credit blowout.

And it is the same with the rapid expansion of the Iceland banking system. Banks made loans for houses, cars, aeroplanes, condominiums and seldom asked questions. In fact as Hordur Torfason the Iceland activist explained, he was called into the manager’s office and offered a big loan when he didn’t even want one. We know that the bank staff have incentives for issuing more loans. They are paid more if they do.

The tragedy of all this is that the universities are not teaching it honestly to each generation of students of economics. The economists tell the journalists and so the myth continues. Hopefully Cyprus will help the public understand the whole horrible faults of the way we rely on banks to create and decide on the country’s supply of credit.

A transcript of the first seven minutes of Michael Kumhof’s talk is here.


Stealing money from savers in Cyprus

Anti-bailout protesters raise their open palms showing the word "No" after Cyprus's parliament rejected a proposed levy on bank deposits in NicosiaYou will have noticed the banking crisis in Cyprus. It has absorbed my twittertime for 24 hours. I understand Iceland activist  Hordur Torfason, currently on a speaking tour of NZ, is going to Cyprus after New Zealand. It should be interesting.

As a condition for a massive loan from the ECB, their government is required to tax ordinary savers from 7-10%. This is ground breaking policy. ‘What is different this time is the nakedness of the Cypress heist’, writes Adita Chakrabortty in the Guardian. His article explains how the European powers pushed Cyprus into a politically suicidal pact. They demanded an impossible deal and it is no surprise when the politicians see how unpopular this measure is, they delay doing it.

As I write this, the banks are closed in Cyprus for another two days and heaven knows what will happen when they open. See Guardian article, for example

Senior bondholders (and it looks as though there aren’t many) will be exempt. This is not true in New Zealand, where Open Bank Resolution only touches deposit holders. As Geoff Bertram and David Tripe pointed out in their Victoria University article, there are at least six classes of creditors who are ahead of us in the queue to be reimbursed. They include holders of Covered Bonds held mostly by pension funds. These are illegal in South Africa and were so in Australia until recently.

All this makes it doubly important for us to get behind our petition asking for a Parliamentary Enquiry into the best ways of making banks stable. We want a lasting durable banking system not one which gets into such crises.  So why not write to your MP, the Minister of Finance and the Prime Minister about this?

Jill Abigail has led the way in having her letter on the subject lead the Dominion Post letters today.  Here it is:

As a superannuitant dependent on interest from term deposits to top up my pension to a livable level, I am horrified to learn that the Reserve Bank is planning to set in place a process (called “Open Bank Resolution”) where ordinary bank depositors will – without notification and without our consent – have our savings used to bail out a bank in financial distress.  If a banking crisis arises, your bank will be able to freeze your bank account overnight and release it the next day. But the account will have been “shaved”, and you will have less money than you had yesterday. A nameless amount will remain frozen while liquidators examine the financial state of the bank and then some or all of it will be used to bail out the bank. This process, which readers can check out on the Reserve Bank website, will all be in place by June 30. There has been no public warning of this undemocratic proposition.  Is it legal?  Isn’t it theft?

Those of us who suffered loss of retirement savings in the finance institutions’ crashes in 2008 thought we would be safe by keeping the remainder in our banks, especially the Kiwi-owned bank.  What a shock now for us to learn that our money is not safe after all. This is a terrifying prospect for those of us who have no means of replacing any losses because our days of being able to earn are long behind us.

Jill Abigail




To tell the public or not to tell the public that they might have to help bailout their bank

Petition on Banking Reform

A friend has emailed me with her concerns about making Open Bank Resolution  public. That is when the banks demand their customers bail out a failing bank and it is coming to a bank near you soon. See website of Reserve Bank of New Zealand.  She said if everyone knew, they would take their money out of the bank and they would collapse. My friend has drafted a great letter to the Dominion Post but has qualms about sending it.

Well that is exactly why we have launched a petition asking for a Parliamentary Enquiry into the best ways of making banks stable. You see right now, because banks create loans and control the amount of credit in the economy, only 8% of the deposits now in banks could be redeemed at any time. (That is if everyone went to the bank at the same time for their deposits. What an incredible dilemma. No wonder the Government isn’t telling us that as customers we might, after June 30 be required to help bailout a bank. Join our FB page at

What we are suggesting is that Government takes the recent IMF paper by Jaromir Benes and Michael Kumhof seriously. It is called The Chicago Plan Revisited. It designs a system where banks have 100% backing for deposits, not just 8%. All the good economists who nutted out solutions after the Great Depression seemed to agree this was necessary. Ones like Milton Friedman, Henry Simons, Irving Fisher.

So back to the dilemma of to tell or not to tell the public. The banking system is inherently instable because it relies on fractional reserve banking, where the bank creates credit but doesn’t have a supply of what the authors call “indestructible money” to back it up with. This used to be gold. But it can be the type of money created by the Reserve Bank, the notes and coins we use. They don’t carry debt.

Is the current banking system inherently unstable? Yes. According to IMF data, there were 145 banking crises, 208 monetary crashes and 72 sovereign debt crises between 1970 and 2010. This represents a total of 425 systemic crises, an average of more than 10 countries getting into trouble every year.

How are we going to reform it if the public doesn’t have the knowledge? In countries like Argentina, Greece and Iceland they learn fast after a crisis.

You could always change to a Credit Union

Unknown-1Today I phoned the CEO of the NZ Association for Credit Unions, Henry Lynch. I told him that feedback we had had from our members about our petition on Open Bank Resolution had included people who said they banked with a credit union anyway so didn’t have to worry about Open Bank Resolution.

It seems there are three big credit unions in New Zealand. Baywide Credit Union based in Hawkes Bay has 15 branches. First Credit Union in Hamilton has 50,000 members and NZCU South covers the South Island. No limit on deposit size. And there are other smaller ones. They are owned by their members and you can go to their AGM etc.

They do have mortgages, but only at floating rates. They don’t have credit cards but their debit cards, where you preload your money, uses your own money and is fine for all online payments like Amazon etc. That is a relief for those wanting to change.

I also learnt by listening to a Radio Live interview with the CEO of the Co-operative Bank that people don’t have so many problems changing banks these days. The only situation in which they have problems is if they have a fixed rate mortgage and it costs them to break it.

Credit Unions in New Zealand are champing under controls which don’t exist in Canada, where almost one in three people bank with a credit union.  Last Sunday the Sunday Star-Times had an article which outlined the various laws and regulations which constrain credit unions or impose unnecessary costs on them. Obviously the New Economics Party would develop policies which address these concerns.


Adair Turner recommends Quantitative Easing for the People

A breakthrough speech on Monetary policy by journalist and financial economist Anatole Kaletsky was published by Reuters on Feb 7, 2013.

Kaletsky explains that one of the most influential financial policy makers in the world, Adair Turner, chairman of Britain’s Financial Services Authority has drawn attention to the fact that the combination of zero interest rates and Quantitative Easing as it is currently practised are neither alleviating unemployment nor halting declining living standards. Giving money (about $85 billion a month) to the banks and Wall Street investors by buying government bonds isn’t working.

Adair instead suggests dividing up this money evenly among American citizens and distributing it every month to stimulate the economy. It would work out a $283 monthly for every man, woman and child in America. He says it would be infinitely more effective than distributing money to bond investors and banks through QE.

Lord Adair Turner’s Feb 6 speech Debt, Money and Mesphistophales: How do we get out of this mess? is not for the faint hearted. At 46 pages it is a challenge, and after a quick skip through, I will trust Kaletsky’s summary. The references include Minsky, Milton Friedman (he invented the term “helicopter money”, often attributed to Ben Bernanke) Henry Simons, and the authors of the The Chicago Plan Revisited, Jaromir Benes and Michael Kumhof. Professor Steve Keen from Australia has been recommending Quantitative Easing for the People for some time.

As Ellen Brown says, “The Federal Reserve has lavished over $13 trillion in computer-generated bail-out money on the banks, and still the economy is flagging and the debt ceiling refuses to go away. If this money had been pumped into the real economy instead of into the black hole of the private banking system, we might have a thriving economy today.”