Continuing my October submissions in accordance with the review of the RBA announced by Treasurer Jim Chalmers in July. The continuation of my letter to the RBA addresses some of the public’s misperceptions concerning money, banking and the Reserve Bank of Australia. If you have not yet read how my letter commenced, you can find it [here].
Dear Minister Chalmers,
Continuing with my opportunity to contribute to this review of the Reserve Bank of Australia.
The issues of monetary approaches to affecting Unemployment and Fiat economies I have previously addressed are among many common public and media misrepresentations of the banking system. In these areas, it should be incumbent upon the government to educate the public through public broadcasting so that the expectations of the Reserve Bank are properly evaluated. These myths include:
- Banks can only lend out money they have from depositors.
- Credit is an extension of a money multiplier based on deposit reserves.
- Quantitative Easing is printing free finance into the money supply.
- Federal Treasury deficits are a liability to taxpayers.
At a Keystroke.
Money in Australia’s economy has two sources. First, that which the Government Treasury supplies through its fiscal agent, the Reserve Bank. In short, that money is spent into existence by the Federal Government. This money is called “Vertical” money, which exists as an Exchange Settlement Account between the Reserve Bank and the Private banks. As the public is not a joint holder of that account, it is not available for lending to the public. Its only purpose is for interbank transactions. Secondly, a larger pool of credit via lending is generated “ex nihilo” in the economy through private banking, referred to as “horizontal” money. [Also, the Bank of England: https://www.youtube.com/watch?v=CvRAqR2pAgw] When banks lend, they create deposit IOUs within that bank. Bank’s customer deposits are their liability, and the loan is their asset created by keystrokes. Deposits are fundamentally an IOU from the bank. Similarly, when a bank makes a loan, they generate an IOU deposit for the lender at that bank. The complementary asset for the bank is the loan. Banks create money for borrowers and profit (the interest) for themselves. Unlike the banking franchise myth, deposits or reserves do not create or limit loans. The perpetuation of this myth in public debate and political pronouncements does a disservice to the public good.
Credit creation is simply about a bank finding a credit-worthy customer with whom it can create a digital deposit as an account with that bank with the expectation of future interest payments. The loan to the borrower becomes a bank asset, with an accompanying liability created by a computer entry, which generates the deposit for the borrower. None of the aforementioned Bank reserves is touched, and neither are deposits. The exchange settlement Account reserves are used only when the borrower spends that deposit in another bank. The reserves held at the Central Bank of the lending bank are transferred to the account of the person being paid in the other bank. This is how all bank transfers work; by using the central bank’s reserve accounts. Instead of adequately describing this in High School and economics education, the government needs to explain how the monetary system works adequately. The government and a properly educated Board of the Reserve Bank need to address these realities. Regarding my familiarity with this, I worked at the Reserve Bank between September 2001 and October 2002, where I worked on both the operations and technical security teams at the Reserve Bank. In that capacity, I aided reversing the RITS system’s previous outsourcing of AlphaServers operating OpenVMS, previously managed by AustraClear/SFE. Back then, the money churned between banks via their reserve accounts oscillated between $9 to $16 billion daily. The monitoring of that transfer between private bank accounts is the RITS system at the Reserve bank running on an Alpha-VMS mainframe that monitors all account exchanges between banks, which is the system I helped bring back in-house.
In a financial crisis – such as the Pandemic – excessive needs for Exchange Settlement Reserves become evident. The overused strategy of Central banks globally during the Pandemic has been Quantitative Easing. Despite the talk of “printing money”, that is a red herring. Printing money depends on the demand for cash in the private sector – generally around 3% – and never reaches a point where it even approaches a small portion of the digital money supply. Hard currency demand during the Pandemic reached 17%. Digital money is the normality between the Reserve Bank and the private banking systems. Quantitative Easing affects the money supply by increasing the banks’ ESA reserves at the Reserve Bank. This is done by the Reserve Bank repurchasing Treasury bonds from the private non-bank sector (i.e. pension funds & asset managers) and the private banks. The purchases from the private banking sector rise in digital money extend the ESA reserves. Many private sales of Government Bonds mean more money is circulating in the private sector that may be used to pay off bank loans, reducing the likelihood of borrowings. Technically, increased reserves, while facilitating extensions of interbank transactions, have no direct impact on any credit creation expansion. Precisely what area of the economy Quantitative Easing serves is also of concern, as “employment growth” wasn’t one of them. The inequality of protecting financialised assets amongst the wealthy ruling class financial markets rather than the working class who lost jobs in the millions. As Adam Tooze, in his recent publication, “Shutdown”, observes:
“For the central bank, that meant holding interest rates down. Once again, it came down to financial markets. As far as anyone could figure out, QE worked by driving government bond prices up and yields down. Lower interest rates helped to encourage borrowing for investment and consumption. Lower yields also prompted asset managers to reallocate funds from Treasury markets, where prices were driven up by central bank buying, to riskier assets, like equity and corporate bonds. This boosted corporate borrowing and the stock market. It increased financial net worth and boosted demand. The supportive cooperation between central banks and treasuries in the common struggle against the coronavirus was thus, the central bankers adamantly insisted, no more than an incidental side effect of their frantic and clumsy efforts to manage the economy by way of financial markets. Despite the relentless accumulation of government debt on their balance sheets, the central bankers insisted that this had nothing to do with financing public spending. Their priorities were to manage interest rates and ensure financial stability, which in practice meant underwriting the high-risk investment strategies of hedge funds and other similar investment vehicles. Rather remarkably, they insisted that tending to financial markets was a more legitimate social mission than openly acknowledging the highly functional, indeed essential role they played in backstopping the government budget at a time of crisis.” [pg 149]
When Financial markets become more important to the Reserve Bank than the well-being of the vast majority of Australians, then the bank’s philosophy is served and managed by too many businessmen & women with a neoliberal ideology to serve the interests of the few above that of the whole economy. As Curtin espoused, the Reserve bank’s original social mission is to “pursue a policy of low inflation, sustainable output and employment growth”. This mission has evidently fallen, by the way, because of the people chosen to run the Board of the Reserve Bank.
Finally, It can be demonstrated simply by viewing the balance sheets (irrespective of the accuracy of dollar amounts) of the entities known as
- the Treasury,
- Reserve Bank,
- the collective private banks and
- the collective non-bank private sector
that the federal deficit of the Treasury is the surplus of the Australian economy’s private (and foreign) sector. Deficits are just the government’s way of provisioning the private sector. If a government wishes to pull the spending of an economy back and throttle the growth of an economy, it pursues a surplus for the Treasury, depriving the private sector of funds. John Howard, for example, achieved that when he throttled back the economy to provide the Treasury with a surplus. Consequently, the private sector, desperate for money, borrowed heavily from the Banks. Private debt expanded considerably under John Howard. [See here: The Howard impact or here: Debt, home repossessions portent for Australia poll]. But of course, Mr Chalmers, you should already know this. Taxpayers are not on the hook for a government’s treasury deficit as that deficit just boosted taxpayers’ finances. The government’s debt is your problem, not ours, since the Treasury and Reserve Bank issue the dollar (which taxpayers don’t because that is a crime called “counterfeiting” with which you would charge us). The currency-issuing government can pay their debts off any time they choose by issuing the dollars to cover them. Admittedly the wedging by political opponents and the Murdoch media would require of this government political courage, not financial inability.
The public frequently believes that the issuance of the Australian dollar is the domain of the taxpayer. Aside from this being the description of the crime of counterfeiting for which the Australian government would jail the offender, the Reserve Bank definitively sees the issuance of currency as their role. Despite the myth of “Taxpayer’s money“, the distinction of the taxpayer is not as an issuer of money, but as a “user” of it. The distinction between the issuer and the money user is critical to the public understanding of monetary reality. The issuer of a sovereign currency is not operationally constrained and can not be forced into default in its own currency. However, non-sovereign monetary currency issued or pegged to a foreign-issued currency (amongst other features), such as the Eurozone or the example of Sri Lanka’s debts in a foreign currency, can, of course, lead to default. Australia, although, like America, Japan, New Zealand and many others, are monetarily sovereign economies with no significant foreign debt and only face the constraints inherent in resource depletion and inflation. Users of Currency are everyone else, including taxpayers, municipalities, and the States facing monetary constraints. They must earn, budget and use the limited money they can acquire through business, taxation and exchange. Monetary issuers are not so constrained.
Knowledge is power
The problem is, if submissions for a public review of the functions of the Reserve Bank are to be effective, it is incumbent on the reviewers to have a realistic appreciation of how the banking system works and the Reserve Bank’s role in our financial system. Holding to the public franchise myth, the NAIRU myth, and the Taxpayer funds myth, as many in the media (and possibly members of the Bank Board), will limit the usefulness of any submissions. Providing faulty recommendations to politicians who frequently use the analogy of a household budget to describe how fiat economies work is a recipe for disaster and subsequent legislative policies that will hamper the workings of the Reserve Bank to aid post-pandemic financial recovery. So we need governors and heads of departments within the RBA who know and understand inflationary causes, recognise the differences between supply vs demand causation and know that raising interest rates is an over-zealous intervention that cures symptoms by killing the patient. Thank you for the opportunity to submit this letter for your review.
John Haly. (Auswakeup Media)