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Bank of England & Northern Rock

by ChrisCook Tue Feb 12th, 2008 at 07:26:41 AM EST

One or two friends and colleagues of mine with an interest in monetary matters have been in correspondence with the Bank of England re Northern Rock.

I wrote to the Governor of the Bank of England asking about where the Bank's money for Northern Rock came from, and was it created out of nothing.  

The reply ....(from an acolyte)....  claims the money comes from " 'reserve balances which is money held by the banking system in accounts at the Bank....".

Note that these reserve balances are essentially interest-free loans by the clearing banks to the Bank of England.

There was then this startling admission

"These balances are a form of 'central bank money' and the Bank has taken steps to offset the creation of central bank money by lending less in its regular market operations than it would otherwise have done."

that the banking system is being starved of liquidity as a result of the (hugely profitable) harvesting by the Bank of England of "seignorage" in respect of its loans to Northern Rock. These profits arise out of the fact that the Bank of England is lending to Northern Rock at base rate (plus an accumulating penalty payable in due course to the Treasury) money which it is funding at zero cost.

ie as pointed out twice in the FT by Tim Congdon, and documented here, the truth of the matter is that the more that is lent to Northern Rock in this way, and the longer these loans go on, the more money the long-suffering "tax payer" will actually make through the resulting Bank of England profits, provided there are no defaults.

Bu what if there were defaults?

So, all in all, there is an admission that the money was created by the Bank and the fun really will come if the money gets lost by Northern Rock because I happen to know that somebody has written to the Bank asking how that loss would be written in the Bank's accounts..........Watch this space....---

Again, we have discussed in ET at some length the effect upon the system and the poor bloody taxpayer of a default by the Northern Rock in its loans from the Bank of England.

My view is that the taxpayer would suffer no loss at all, and that the actual monetary effect of such write offs would be zero.

Now, on to a slightly different question , relating to the effect of government borrowing in itself.

....in response to another question the acolyte says that Article 101 of the Maastricht Treaty makes it illegal for central banks to provide loans to governments.

Er hem -- except when it's Northern Rock, of course.

But I asked about lending to the government in the context of loans to governments for public capital projects (thereby halving or more the cost of the projects).  So you can see how the banking system has worked to stitch up everything so that all lending is always done at interest -- even lending for hospitals.

And, of course,  the acolyte, said that lending to a government "could be inflationary".

Which brings us to the key fallacy at the heart of our monetary system, which is the official - unassailable and undiscussable - position that the creation of money - ex nihilo - by private bank lending at interest is by definition less inflationary than the creation of money ex nihilo by Central Banks without an interest burden.

In my view, Central Banks and all other banks are - like all other intermediaries in the age of the Internet - no longer necessary.

The point is that credit in itself costs nothing to create: the real value provided by the banking system lies in the guarantee provided (and backed in the case of private banks by an amount of "regulatory capital").

Unfortunately, this guarantee function has essentially been opaquely "outsourced" by the banking system either totally (securitisation); partially (credit insurance) or temporarily (credit derivatives) with the result being the ongoing "Credit Crash" which is in its first (driver hitting the windscreen) phase.

I believe that it is essential, and actually, quite straightforward, to reconfigure the credit markets to establish an alternative disintermediated mutualised structure.


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