3. Why do we have two kinds of money and why are private banks allowed to make money?
One can say that bank money creation is an historical remnant. Since the Renaissance, private banking has existed in Europe. In Venice, the technique of book-keeping was invented and does not fundamentally differ from today’s methods. Northern Italian bankers developed bank accounts, book money and remittances. London banks later added credit money creation and paper money. Finally, the states reacted and began to take control. The state claimed the monopoly on issuing paper money, organised the foundation of a central bank, the central bank began to create its own central bank money, then the banks were put under the control of the central bank, and in a final step the central banks officially switched from partial gold backing to pure fiat money, that they can create infinitely. The only thing that the states never touched at its core is the banks’ right to create deposit money.
A two-stage monetary system was therefore created with two types of money and the following division of labour. Firstly, the state central bank produces the actual currency, the central bank money. It is used in four ways: by the government for its spending, between the banks as a means of accounting, by the central bank itself to hedge the banking system, and finally as cash which is used by the people.
The banks, on the other hand, may derive a second-order form of money from it by creating deposit money for the private sector. This is due to practical reasons; commercial banks have always been keeping the accounts for households and companies, they had branches all over the country and when granting loans, they benefited from their long familiarity with the local economy and profit prospects. At the same time, the bank-users are protected, because the bank money is subordinated to the central bank via cash and other mechanisms and regulations.
Also, the interest rate is controlled by the central bank via the key interest rate. This division of labour between the state and private banks seems justifiable – as long as banks do nothing more than keep accounts and hand out loans to the private sector, as was the case in the first decades after the Second World-War.
Since the 1980s, however, a phase of financial deregulation has been taking place. Since then, banks have used their money-creation privilege and privileged access to central bank money for highly speculative and risky business models in order to generate high profits. Such business models led to the global financial crisis of 2008, from which, in particular, many European countries still have not recovered. You can find many descriptions of the damage and risks that the global financial system brings to the general public, with institutions such as certain banks, hedge funds, and shadow banks, methods such as exorbitant derivatives trading, high frequency trading, and even business models such as cum-ex or cum-cum, all of which explicitly exploit state funds.
However, proposals for sensible countermeasures do exist. Therefore, regarding the banking system, this piece emphasizes that re-regulation is not only necessary, but also possible. This is because although the financial sector has grown and differentiated over the past decades, the systemic hierarchy between the state and the banks has not changed; the state still has the currency monopoly. Therefore, in purely technical terms, banks always need central bank money from the state for their business models.
By contrast, the state does not need the banks’ bank deposits. In fact, for the state, a private banking system is not indispensable. As money is a public good, it should be self-evident that the state at least ensures with sufficient control and regulation that the banks do not use their derived money creation privilege to harm the greater public good. All the more since in any major crisis it is the government that has to save banks by assuming their debts and the economy with new deficit spending, inevitably, as the state must guarantee a functioning financial and economic system.
