Rising Tide at Sunset

The Credit Crunch

The Cause and the Cure - 2

by Bob Keall

Banks, Money and the Reserve Bank

The Banking System

The Banking System is essentially a clearing house for settling trade exchanges in monetary terms and for matching capital needs with supply, e.g. Postbank, Trust banks and finance companies. A single national institution could (some say should) fulfil the function, avoid the need for a Reserve Bank and thus isolate the remaining inflationary factor which is outside the banking system. The banking system including the Reserve Bank, can only deal with cards given to it by Government, including the wild card of unearned gains. No bank can sift out the unearned gains element from countless transactions each day. Nor is it their responsibility.

Savings with a bank intended to finance loans to other parties for chattels on hire purchase, working capital, overdrafts, credit cards etc is a legitimate use of the medium of exchange. Monetising a tradeable unearned gain abuses the medium. Financing the purchase of another misuses it. Currently, the several functions confuse it. Defining the basis for the currency is the Government's role. The value of an artificial privilege convertible into cash is not a legitimate component of the currency base, but it is not the role of the banking system to distinguish it.

Bank loans as such, like credit cards or Bills of Exchange have to be repaid, normally from earnings. They are not in themselves a permanent, artificial, unproductive expansion of the currency.

In N.Z. Banks, like finance companies can only lend the deposits made with them¹. The Reserve Bank requires a proportion of these deposits to be lodged with it (currently 10%) as a means of constraining lending. If their lending exceeds that proportion of their deposits (90%) then they must borrow from the Reserve Bank (or other banks) sufficient to validate the excess². The overnight interest rate charged by the Reserve Bank sets the benchmark interest rate (O.C.R—Official Cash Rate). Some Governments have been known to apply 100% reserve ratios to offset the effect of their Budget Deficits as far as maybe. Certain capital reserves are also required.


Money is not some separate, elusive quantum which has to be controlled, and somehow has to service countless transactions from very small to very large. The technical term Money Supply³ of M1, 2, 3 is a small liquidity sequence, not to be confused with the supply of money4

Money is essentially a measure of the relative labour content of goods and services permitting the exchange of consumables, perishables, or durables, now, progressively or later. It assesses the relative value of the labour content, whether of brain or brawn, applied by the seller or avoided by the purchaser, for exchange purposes. Even gold has a dollar price, for these reasons.

When the capitalized value of a gratuitous licence which has no labour content, but does have an effective purchasing power and exchange value for the labour of others, is introduced to the labour exchange process, then the measure is thereby expanded but with no corresponding increase in the goods and services. That's inflation. Too much money chasing too few goods; future money but only present production. Over time the goods and services diminish in value whereas the rights appreciate, compounding the effect.

The valuable licences or tradeable rights become part of the indiscriminate exchange of goods, services and equities, all freely interchangeable, quantified in dollar terms, and convertible into cash, as maybe minimally required. Electronic transfers now replace cheques, paper notes and coins. Whilst it may be interesting to quantify M1, 2, 3 and the velocity of circulation, it cannot influence the external rogue factor which drives them.

Earnings $ + Non Earnings $ = Total Money $
Goods & Services + Tradeable Rights = M1 to infinity
Cash & Cheques + Certificates = Cash, cheques & Certificates, all in $, Interchangeable freely

"The Reserve Bank can't directly determine the total amount of money there is in New Zealand. But it does control the banking sector's key source of cash."
(RB on Inflation).

If the Reserve Bank temporarily corners some of the system's current assets, it reduces liquidity and so stifles trade. This inhibits the unearned gains that expand the currency but it does not eliminate them. The trade in power shares, which is demonstrably inflationary, has not been stopped. The significant, gratuitous profits and the share values are a fiscal factor expanding the currency.The Stock exchange should reflect productivity without being all mixed up with the fortunes of those who own "The Economy."

It is not the Reserve Bank's province to set wage rates, interest rates, exchange rates, rent or the price of anything. These are economic not fiscal matters. Relegating to the Reserve Bank responsibility for "price stability" is a misleading abrogation of the Government's own responsibility to deal with the currency inflation that causes the price inflation. Nor is the Reserve Bank accountable for Government misuse of Reserve Bank credit. As above, the Reserve Bank often, appropriately, explains its statutory limitation.

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1. In other countries this constraint does not apply. As a commercial risk privately owned banks lend 8 or more times their Deposits. This multiplies the inflationary and social risk from failure elements. The Federal Reserve, World Bank (51% owned by the US Treasury) and I.M.F are also privately owned by the Banks.

2. A fall in land values nullifies this constraint. Hence the Deposits Guarantee Scheme now in place.

3. The Money Supply:

M1: notes, coins and cheque accounts;
M2: call deposits
M3: term deposits; as a liquidity sequence.
The NZ Monetary Aggregates (ex RBNZ)

M1 is only 3% of M1, 2, 3 which totalled $280bn in Feb 2007 and could not possibly be the basis for every transaction.

4. Money:

  1. as a medium of exchange:
    • Money is a medium of exchange, a standard of value, and a store of wealth. It is not just notes and coins, but anything used to effect transactions denominated in terms of money.
    • There is no unique practical definition of money!
    • The quantity of money will move in proportion to the value of the transactions(!)
    • Since money represents generalised purchasing power, it might be linked over time with the nominal value of total spending and output of goods and services in the economy.
  2. RBNZ G94/5
    • The CPI and GDP influence M1, not the other way.
    • M1 grows in line with nominal income growth.
    • Short run M1 growth is influenced by equity returns growth.
    • M1 does not lead development in the real or nominal economy. Thus M1 growth implies nothing for future output growth or inflation.
    • The Money Supply is not determined by the central bank.
    • M1 growth is determined by output growth and inflation. In the short run the stock market plays an important role.
    • M1 is found to have no empirically relevant influence on either output, growth or inflation.