Pixies in the Garden? Making money



In 2009, John Key said “there aren’t little pixies at the bottom of the garden printing cash” (John ArmstrongColin Espiner).

He was wrong of course. Just about every country has its own pixie-in-chief, though not at the bottom of the garden. In 2009 there was a world pixie-in-chief frantically printing money; his name was Ben Bernanke. New Zealand currently has quite a stern pixie-in-chief, resident nine-to-five in The Terrace (#2) garden. And the Reserve Bank Governor has many pixie helpers in the country’s commercial banks.

Money remains for most of us a matter of supreme mystery. And we would rather leave it that way, as if it was just a pile of gold coins created by some mythical being. Part of the problem is that we use the word money to mean different things: ‘wealth’; ‘income’; ‘savings’. What money really is, is a circulatingmedium of exchange that may also be used as a store of credit. In other words, the purpose of money is to be spent on goods and services, but it doesn’t have to be spent straight away. Money is a social technology, and, as such, it is made by human rather than otherworldly pixies.

In comments on some of my past Daily Blogs, I am frequently reminded that banks create money out of “thin air”, and that this must a problem. Most debates about money (always arcane) are between those who believe that money is a commodity (like gold) – or at least behaves as if  it were such a commodity – and people who are aware that money is no such thing but wish it was.

The reality is that modern money is credit money, which is code for debt money; and that makes many people uncomfortable, because debt (like blood) makes people uncomfortable. Yet debt is absolutely intrinsic to any economy beyond that of a small stone-age tribe.

So, avoiding any narrow technical meanings, conceptually debt means enjoying something today in return for an obligation to forego something tomorrow; debt arises from borrowing. (‘Something’ here means some mix of goods and services. ‘Enjoying’ means consuming or investing, where ‘investing’ means purchasing something like a new building, machine or an education.) Debt’s exact counterpart is ‘credit’, which means having foregone something today in return for a claim on something tomorrow; credit arises from lending. Lending equals borrowing, by definition.

Debt therefore is an accumulation of borrowed enjoyment, and credit is an accumulation of foregone enjoyment. The process of foregoing enjoyment of goods and services is more commonly known assaving, and accumulated saving is called savings. Savers are creditors, and borrowers are debtors. Creditors and debtors are ‘joined at the hip’ to use Margaret Atwood’s phrase in her very readable 2008 book Payback.

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Commodity money was created (minted) by Kings converting gold, silver or copper bullion into coins. The believers in commodity money still hold that it was the amount of that metal in the coin that gave the coin its value, and they still yearn for the days of the gold standard when this belief was vaguely credible. In fact it was the imprint of the King’s head that gave coins their value, as Felix Martin convincingly argues in Money: The Unauthorised Biography. Debased and clipped coins generally exchanged for their face value as if they were complete. The king’s image was equivalent to a signature; a promise. We believe that kings have the capacity and moral authority to make good their promises.

Modern credit money is a promise, initially of individual banks, but nowadays of the banking system as a whole. And it is a product of double-entry book-keeping, one of the great unsung inventions (attributed to Luca Pacioli in the 15th century, but essentially the Venetian system of bookkeeping) without which capitalism would have been impossible. (See Double Entry: how the merchants of Venice shaped the modern world – and how their invention could make or break the planet, by Janet Gleeson [2011].)

So what is the dark art of the modern garden pixie?

Money is created when a bank adds the same number to both sides of its ledger. So both a new debt and a new credit are created. If I borrow money to buy a house, a new debit account is created while the money is transferred into (say) my cheque account. I am simultaneously debtor and creditor. When I pay the builder the credit balance is transferred to the builder’s cheque account. I am now debtor, and the builder is now creditor. I get to enjoy the house now. The builder foregoes the house he created, but has a claim on goods of equal value (or the ability to discharge a debt). I am in debt; he is in credit.

From the point of view of the banking system the critical transaction was the initial crediting of the loan, not my paying the builder. That new double-entry was brand-new money, printed by two strokes of a banker’s pen. The banking system is indifferent as to whether the credit balance is in my account or the builder’s account.

So far so good. What most irks the money-reform brigade is the matter of interest. Interest is really a conflation of two concepts, and it is widely believed that it must be a positive number. One meaning, that of ‘yield’, derives from agriculture and animal husbandry.

The other meaning is essentially a compensation price. So if wannabe lenders are scarce and wannabe borrowers are abundant (the normal state of affairs in the minds of most economists) then lenders must be compensated by borrowers. So if I borrow $10,000 I may agree to repay $10,500 a year later. My debt would be $10,500 inclusive of $500 interest. And the lenders’ credit would be $10,500 inclusive of interest. There is no mystery about interest. A bank’s margin on interest is simply a service fee (or ‘clipping the ticket’, which amounts to the same thing).

So modern money is created by banks, not kings. It represents a promise by the banks, analogous to the promises of kings in relation to ancient money. The banks cannot redeem that promise, except by giving a customer another form of money (eg $US). The promise is that the other people we do business with choose to believe in it as much as we ourselves do, because it’s in everyone’s interest to believe in money as a social medium of exchange.

The global banking system has a near unlimited capacity to create money, and the global financial system has a near unlimited capacity to create promises. In the lead-up to financial crises we see banks creating money that is spent mainly on financial assets (other promises) or real assets (land and buildings) rather than on goods and services. The reason this happens is because there are relatively many people (savers) who want to forego goods and services today, and relatively few bankable people who want to enjoy goods and services today in exchange for an obligation to forego more goods and services tomorrow. Savers outnumber borrowers. It’s called a global savings glut.

Before banks existed we could save and invest by planting seedcorn, retaining livestock for breeding, or building ourselves a house or workshop; individually or by forming a company. Or we could save by finding a willing borrower who we could trust. Otherwise the goods we saved would just rot or wither.

Nowadays banks virtually guarantee us that we can save by lending to them, and that they will find suitable borrowers on our behalf. We expect the banks to do that, and we expect a positive rate of interest as well. We expect our savings to mature in storage like a good wine, rather than to depreciate like old nuts. We expect banks to be tantamount to alchemists. Sometimes the pixies at the bank have to work very hard to meet these expectations we place upon them. Sometimes they cannot find debtors who will have the capacity to repay us. Commonly we refuse to spend our savings, ever. And we do not like to accept that our unspent incomes, including interest, represent others’ unpaid debts to us.

Both right-wingers and left-wingers expect too much of our banks. Indeed banks do much for us; they make our money. But did they cause the global financial crisis? No. Look in the mirror for that culprit.



    • Yes, I suggest that the 12-year-old girl has done rather better than Mr Rankin.
      Some points to ponder: What other industry creates its product out of thin air? And has a virtual monopoly? What other industry expects its customer to bail it out (Open Bank Resolution)? Or the government to bail it out? Of course if banks aren’t bailed out, the payments system is devastated. Our economy is devastated. Banks are inherently unstable.
      The loan and interest example provided shows a flat fee and nothing like the reality of compounding interest. A borrower can repay more in interest than the principal. And that money comes from the real or productive economy and people’s work and not out of thin air.
      When no money is created to cover future interest then money is always scarce. More loans must be taken out to provide more “money” (read “debt” because that is what bank money is) to provide an opportunity for others to repay loans. Capitalism is based on debt.
      And where do banks make most of their money? Mortgages. Safe. Easy to liquidate. No wonder we have a housing bubble.
      Lord Adair Turner, former head of UK’s Financial Markets Authority places the blame for the crisis on our failure to constrain bank credit, money, creation.
      Our Reserve Bank stood by and did nothing and still has very little control.
      With state issued money (no interest attached) our country would at last reap what the kings and queens of old used to benefit from: seigniorage. It’s what we are missing out on year in and year out apart from the 2% issued as coins and notes.
      There is no legislation to say: private banks will issue our money as debt. But they do.
      There has been very little serious study of how our economy would operate with debt-free, interest-free money issued by the state. So few economists even understand how money is created let alone the implications for us all. It’s a great big blind spot.

      • To expand and clarify, banks like mortgages because they are backed by the value of a house. Productive lending to businesses suffers because the companies have limited liability (you can’t extract more money than the company is worth, or take money from the shareholders).

        Also, Basel rules for banks say that the more mortgages a bank has the less capital it needs to hold against loans failing, therefore it can get more profits.

        At least Keith Rankin does understand where money comes from even if he is totally blind to the implications.

        Separating the payments system from the investing/money recycling system would be a great start.

  1. I’ve waited a long time for you up write about this. Annoyingly I’m away from my desktop pc for a few days so I’ll follow this comment up later.

    My short reply is that I was with you most of the way, but I totally disagree with your conclusion though.

    PS: I finally understand what you were trying to say about a global savings glut now, but I still disagree with that too.

    • To say that bankers aren’t responsible for the GFC might be technically correct, after all they didn’t make the rules, they just played by them (an unenforced law is not law worth paying attention to as far as I’m concerned).

      But realistically is was frequently the bankers and their economist allies who pressured and convinced the politicians to change the law to favour solely them.

      Financial instruments do nothing to help with real-world outcomes for the 99%.

      The population has been coached to expect interest for nothing, but that doesn’t mean we have to keep this system. Forcing more transparency here by reforming banks so that everyone has to choose whether or how much of their money goes into a 100% safe call account (0% interest) and a somewhat risky timed deposit (~1%+ real interest rate) isn’t impossible.

  2. For me the concern about money being made out of “thin air” has been mixed up with the fact that paying interest on the imaginary money is forcing us to have a perpetually expanding economy

    It’s only because of your article today that I’m able to see where I’d got confused – and it’s still taking me a long time to get my brain around what I want to ask next and how to phrase it.

    You’re right that interest is the thing that irks many of us – and its based on the perception that this is the reason we have been forced into a perpetually growing economy on a finite planet.

    So my questions is; is that perception correct and if so what can we do about interest to make the economy work in a steady state?

    I know historically they have used 50 year jubilees and you talk about the concept of negative interest, but what is your suggestion for dealing with the perpetual growth conundrum?

    • Thanks Aaron,

      I don’t see a link between interest and perpetual growth, although perpetual growth allows for increased debt/savings without the ratio of debt to GDP increasing.

      The perpetual growth thing is much more about income distribution. In the absence of any general recognition of public equity, workers can only maintain their income shares through the bargaining power that full employment gives. It is only when we have full employment that workers can gain a share of the productivity dividend. But that means that the global economy must be a supply-constrained economy that grows every year by the percentage growth of population combined with the percentage growth of labour productivity.

      Public equity serves as an alternative means of paying productivity dividends to the many rather than just to the few. With recognition of public equity, we can easily visualise a future in which decreased labour supply is seen as a goal rather than as a problem, and we can look increasingly towards means other than wages to reward the many.

      Hope that helps.

      • Productivity keeps increasing, which equals more unemployment as illustrated nicely in this 15 minute video: https://www.youtube.com/watch?v=7Pq-S557XQU

        The problem is just going to keep getting worse and worse until eventually something will be done about it.

        So why don’t we just decrease the 40-hr working week to a 30-hr week or similar, etc? A lack of imagination is the only reason I can see.

    • Aaron, re your penultimate paragraph, interest tends to slow down growth, because it’s paid in the main by people who want goods and services to people who don’t. So it adds to debt while making GDP less than it would otherwise be.

      Japan has what amounts to a negative interest rate policy to stimulate growth. Thus they now have 3% inflation alongside near-zero interest rates. But, interestingly, Japan is in recession and would be seen as the prime exemplar of a steady-state economy.

      Certainly, by seeing interest rates as a compensation price, that price should be paid by savers to borrowers whenever borrowers are scarce and lenders are abundant. Japanese are clearly willing to save at negative effective interest rates. I suspect that they are not the only ones. Households in economically developed countries are making decisions towards steady state economies. But the actual steady-state economy will not arrive until these households give away rather than lend most of the income they don’t want to spend.

      • I find this article to be very illuminating on what has happened with Japan:


        A true steady-state economy will not arrive while economists/politicians are more interested in measuring medium-of-exchange activity (GDP) rather than outcomes (General Progress Indicator or similar – look it up).

        When most people say “the economy” the really mean solely “the GDP”. When you read the news try replacing the word economy with GDP and it starts to make a whole lot more sense.

  3. Recently I have come to believe that a major driver behind climate change is our global finance system. I too am still trying to get my head around it all but here goes : Banks create money by way of loans, but they don’t create the interest. So in order for a loan to be paid back plus interest, some one has to default on their loan (creating inequality). Or the banks can create a further loan which requires growth but once again, requires interest to be paid back. And so it goes on, like a ‘pyramid’ system. But we can’t grow forever on a finite planet – thus the system requiring continued growth to stay afloat is at odds with the global environment, one such symptom of which is climate change. In simplistic terms, is that how it works?

    • Try to think of climate change as just a sub-set of the larger problem of general pollution. Each type of pollution needs to be regulated separately to be in safe levels, of course each polluting business will want to fight that so they don’t go under/lose profits, in the case of carbon/methane the businesses are winning so far.

      Perpetual growth is a different problem altogether. That is related to the accelerating debt I think. In order to keep up with paying the interest the GDP has to keep growing too, but it is never enough in the end and there is always a debt crunch at some point where a large amount of loans have to be written off.

      The two problems are slightly related, but not intrinsically so.

      • Thank you for your explanation. Can I keep picking your brains please? Just read an extensive article (link attached) which makes the statement “There has never been any global economic growth that is not also accompanied by increased energy use and carbon emissions. The only yearly decreases in emissions ever recorded have come during massive recessions” which tends to support my original comment??


        • I disagreed with several aspects of the article, but about the quoted bit: the global economy is still almost entirely fossil fuel run so not seeing CO2 emissions uncoupled from growth is no surprise. I suspect methane emissions might even be growing faster than GDP right now (due to meat and fracking). I struggle to think of any countries government outside of Western Europe that is very concerned about climate change. Until that changes expect only a slight tapering in emissions compared to growth as consumers exert the very limited power.

          Briefly some other issues:
          #I’ve never heard of supply constraints when discussing electric car batteries.
          Distributed power generation will look very different from the current system and not use as many batteries as you might think, and those that are used might well be industrial sized liquid batteries or hydro-batteries or your car as a battery.

          #I think nuclear and hydro can do a lot to power industry, while solar/wind powers homes.
          I would bet on thorium-nuclear doing a lot to replace coal. India is researching thorium.

          #I read yesterday that 97% of oil is used for transport. It that’s true electricity can power most cars, thorium could power most ships, but alas only oil can power aircraft (maybe bio-fuel).

          #There are so many efficiency gains that can still be had.

          #Deniers deny because they think their friends and family do as well, they just want to fit in. That’s why just using logic on them will never work (on a large scale anyway). They don’t deny because they think we have a sacred way of life that shouldn’t be changed. Hey that might explain economists as well! Huh, I never thought of that before, I always imagined them as just nurtured psychopaths rather than natural ones.

  4. “There is no mystery about interest. A bank’s margin on interest is simply a service fee”. I believe this statement to be totally misleading.
    Since the interest is simply a separate add-on to the newly created money, the expectation is that the interest can be paid for out of the existing money supply. On previous occasions commentators to this blog have suggested this but it is not true.
    Further you imply that the interest is charged at simple interest.
    There is a world of difference between a flat fee and a compounding interest charge. Compounding interest on debt will always grow faster than the ability of production to meet it, so it is in the long term unrepayable.
    THe process of money creation that you outline is correct. All loans are created by this means, so all new money created by the banks is not just the store of credit that you describe; it is an interest-bearing debt in its own right. The notes and coins (which you dont mention, perhaps because it amounts to only 2% of total money supply), which are created by the state, are debt-free and should be.
    The remaining 98% of bank-created money is debt-ladened and must be repaid at interest. It must be self evident that it is impossible to repay the interest component on such a huge debt out of the existing money supply without crashing the entire economy.
    This means that the interest on loans must also be created separately (probably from the overdrafts on plastic cards) and the loans which meet the interest requirements also bear interest etc ad nauseum. So the interest is compounded in this way and can never be repaid. This is not just an assertion. Look at the total debt statistics of almost any western nation and it is clear that total debt compounds endlessly unless a crisis wipes out large chunks of it.
    For a different perspective on this topic I recommend recent articles or videos from Martin Wolf, lead journalist of the prestigeous “Financial Times”; Lord Adair of the UK Financial Services Authority; Professor Herman Daly; the website of the Positive Money UK group (and its NZ version) which seems to be the inspiration for some of these opinions and also the website of DEmocrats for Social Credit: and research reports such as “The Chicago Plan re-visited” by IMF research economists Benes and Kumhof.
    I am confident that anyone checking out these authorities, will not share the laid-back views of Keith that all is well with the present system, and will want the system, where our money supply is created for private profit, abolished.

  5. The reality is that modern money is credit money, which is code for debt money; and that makes many people uncomfortable, because debt (like blood) makes people uncomfortable. Yet debt is absolutely intrinsic to any economy beyond that of a small stone-age tribe.
    Debt’s exact counterpart is ‘credit’, which means having foregone something today in return for a claim on something tomorrow; credit arises from lending. Lending equals borrowing, by definition.

    You really should try to avoid contradicting yourself. It’s bad form you know.

    Money is created by the loan. This is true but that loan doesn’t force anyone else to forgo anything as the bank didn’t need to have a deposit first nor is that money removed from the depositors ability to spend it.

    Basically, only one half of your equation exists and that’s the creation of money by the banks through loans.

    • Further down I said:

      When I pay the builder the credit balance is transferred to the builder’s cheque account. I am now debtor, and the builder is now creditor.

      When a debtor uses new money to buy a house from a builder, the debtor acquires the house and the builder foregoes that house. The builder has a claim on future output, and the debtor has an obligation to forego future goods and services.

      Saving is to cede an entitlement to goods and services to someone else (as the builder does) in return for a future claim. Borrowing is to acquire an entitlement to goods and services from someone else (as the house buyer does) in return for an obligation to cede goods and services in the future.

      The newly created money facilitates this example of inter-temporal exchange.

      • More bollocks.

        You go to the bank and take out a loan:

        1. The bank creates money and gives it to you
        2. you take the money and give it to the builder who gives you the house

        Now, if the builder built the house on spec then the chances are the builder also took out a bank loan which is also created money. When you pay the builder he pays off the bank loan and interest and keeps the difference. This difference is the amount that the banks have increased money in the economy.

        There is no saving involved in this transaction and that is the bit you seem determined to miss. Sure, there are people saving money but it’s not needed to power the economy and they have instant access to it without disrupting the economy anyway.

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