Martin Wolf: Money versus Banking

Martin Wolf addresses how money and banking can be separated in this FT article here.

30 replies on “Martin Wolf: Money versus Banking”

This looks like a book that would be worth investing in. (H/t one of the FT bloggers).

MW must know that his proposal is impractical at every level now and after the next crisis and the one after that. But it must serve the very valuable role of informing the public that governments have farmed out the creation of money to banks and have, with just a few exceptions, failed to adequately police this enormously important and lucrative franchise.

Not to mention the quasi-banking role of the “shadow banking” sector about which,it seems, being unregulated, it would be even impolite for a bank regulator to enquire!


I would suggest that ploughing on with the present system is impractical.

The money supply has doubled every decade since the 1970s. Look at this chart. This rate of expansion is what has kept the system somewhat fit for purpose until 2008. It’s not feasible for us to double the money supply like this because, as it stands, every euro has to have a matching debt. There’s no way businesses and households can carry the debt burden needed for this rate of expansion.

Mortgages have always been able to increase in duration but they now involve two incomes most of their careers.

Household debt to income ratios have also needed to increase in recent decades but obviously this trend cannot continue forever.

In the words of Mervin King, former Governor of the Bank of England, “Of all the many ways of organising banking, the worst is the one we have today” and that “Change is, I believe, inevitable. The question is only whether we can think our way through to a better outcome before the next generation is damaged by a future and bigger crisis. This crisis has already left a legacy of debt to the next generation. We must not leave them the legacy of a fragile banking system too.”

Anyway, we have a smooth transition towards this system all mapped out over the course of around thirty years.

To summarise, we’d announce a date by which banks would have to secure existing money from investors from which to fund their loans.

As people repay pre-changeover debts, the banks will delete the money as they do today. The central bank would monitor how much is being deleted this way and would replace it according, crucially by issuing money which doesn’t have a matching debt at source. Thus when the last repayment of a loan made before the changeover is made, the transition would be complete.

In terms of controlling the indirect creation of money by banks we have a publication which demonstrates the accountancy procedures which would make it almost impossible for banks to create money.

Skip to section 2.6 on page 16 of A guide to sovereign money creation in the euro zone for sample balance sheets.



Given that the likes of Martin Wolfe now sees the merit in your argument one hopes that the light will be switched on for a few more readers to see that the current system as designed, is guaranteed to fail.

The next time disaster looms, and there will be one, Govts mightn’t be as keen to provide the backstop. What then?

@ Yields of Bust

Wolf concludes that the although this change won’t come about immediately, we should remember the possibility of making these changes, because ‘When the next crisis comes – and it surely will – we need to be ready.’

Naturally, we’ll be working to try to bring about this change before the current system causes another crisis. If/when a crisis occurs, what then? We simply get the ECB to create all euros and have banks do banking!

For anyone who can’t access FT articles you can google the title ‘Strip private banks of their power to create money’ and view it there. I’ve highlighted some below:

“Printing counterfeit banknotes is illegal, but creating private money is not. The interdependence between the state and the businesses that can do this is the source of much of the instability of our economies. It could – and should – be terminated.

Wolf questions some moral aspects of the system and the fact that the ability of banks to create money requires governments and taxpayers to underwrite the banking system:

“Banking is therefore not a normal market activity, because it provides two linked public goods: money and the payments network. On one side of banks’ balance sheets lie risky assets; on the other lie liabilities the public thinks safe. This is why central banks act as lenders of last resort and governments provide deposit insurance and equity injections. It is also why banking is heavily regulated. Yet credit cycles are still hugely destabilising.”

“What is to be done? A minimum response would leave this industry largely as it is but both tighten regulation and insist that a bigger proportion of the balance sheet be financed with equity or credibly loss-absorbing debt. … A maximum response would be to give the state a monopoly on money creation.

The article then refers to the book Modernising Money that was published by our sister organisation in the UK, Positive Money before highlighting some of the benefits of this reform:

“The transition to a system in which money creation is separated from financial intermediation would be feasible, albeit complex. But it would bring huge advantages. It would be possible to increase the money supply without encouraging people to borrow to the hilt. It would end “too big to fail” in banking. It would also transfer seignorage – the benefits from creating money – to the public. In 2013, for example, sterling M1 (transactions money) was 80 per cent of gross domestic product. If the central bank decided this could grow at 5 per cent a year, the government could run a fiscal deficit of 4 per cent of GDP without borrowing or taxing. The right might decide to cut taxes, the left to raise spending. The choice would be political, as it should be.”

He points out only 10% of UK bank lending actually goes to businesses, meaning that restricting the level of bank lending doesn’t have to mean that businesses will suffer. (Speculative credit to property bubbles and financial markets could be restricted whilst preserving credit to businesses).

Wolf summarises by saying that:

Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.”

It’s a brilliant article and I’m sure it adds some credibility that Martin Wolf agrees with me.

‘It’s a brilliant article and I’m sure it adds some credibility that Martin Wolf agrees with me’

Exactly what I thought when reading it last night. You have been beating the drum on this for quit one time now. The article does in a small way increase the chances that ‘Chicago plan – revisited’ will get revisited.

@ Paul Ferguson

I would subscribe to this view rather than that of MW.

I think I made the point before that a parallel can be drawn between moving to a new banking system and ending the dominance of Microsoft. It is not that it is the best operating system but that it is installed ubiquitously. Ditto the current international banking system!

However, this is not to deny that the points that have been doggedly made by reformers are having a beneficial impact.

The stat that ‘Only about 10% of UK bank lending has financed investment other than commercial property’ was some what shocking to me. I know that sector employs a lot of people, but 90% of financed investment!!

So much to criticise in this article. I’ll start with one.

“In 2013, for example, sterling M1 (transactions money) was 80 per cent of gross domestic product. If the central bank decided this could grow at 5 per cent a year, the government could run a fiscal deficit of 4 per cent of GDP without borrowing or taxing.”

I think this is what Mario and his chums at the ECB would call monetary financing. I thought Wolf stood for monetary rectitude. I find this observation a breathtaking contradiction.

@Paul Ferguson / Others

I think the Martin Wolf proposal would be relatively easy to implement on a technical level. The customer deposits become transaction accounts, (with a nice little fee earner); the loan accounts become investment accounts.
It would remove the ‘money’ creation away from banks and therefore should in theory stop the boom bust cycles caused by the creation of bank credit.
We seem to witnessing such a cycle right now in UK property, and that has spilled over to Dublin property just as happened in 1988/1989, before the UK property crash of 1990 put a stop to it.
While it would be possible in the UK, US or a country with its CB, it would be virtually impossible in the Euro area, as the same issues of need for one Money expansion target to fit all economies, would cause the same political and ideological divide as currently exists over monetary expansion.

@John Foody:

The statistic that only 10% of all UK business investment went outside the commercial property sector is a startling statistic.
So much for investing in the ‘productive’ economy!
Yet, these banks are lauded for their strategic role in allocating capital.
Some allocation!

” A Preliminary Report on the Sources of Ireland’s Banking Crisis” by Klaus Regling and Max Watson
Page 6
“This was a plain vanilla property bubble,compounded by exceptional concentrations of lending for purposes related to property-and notably commercial property.”

Page 29
“The problems lay in plain vanilla property lending(especially to commercial real estate),facilitated by heavy non-deposit funding,and in governance weaknesses of an easily recognisable kind.”

Page 35
“However the report has a duty to answer the question where and how bank management and governance were to blame for their parts in the Irish banking crisis. Four key areas standout;
First, a critical weakness in bank risk management was the concentration of bank assets in activities relating primarily to property,and more specifically commercial property”

Accounting Standards: A Mixed Blessing? by Geoffrey Whittington
The above article is taken from the book ” Essays in Accounting Thought”: A Tribute to W T Baxter edited by Irvine Lapsley. 1996
The last chapter of this essay reads;
“Professor Baxter’s original eloquent critique of accounting standards(1953),although written when the state of auditing,accounting and accounting standards were very different,was perceptive enough to disturb the complacency of the accounting standard-setter more than forty years latter. His fundamental attachment to the liberal values of free discussion supported by a sound education must be shared by any academic who is seriously concerned to follow in his footsteps in developing accounting as an academic discipline and as a learned profession. In the same spirit of free discussion, the present paper has attempted to evaluate the relevance of the Baxter critique to the present -day situation,particularly in the context of the work of the ASB.
It has been argued that accounting standards are necessary and that an underlying conceptual framework is desirable,but that we must attempt to avoid the consequent dangers identified by the Baxter critique and attempt to deal with them. Important avoidance measures which may help include emphasising the provisional nature of statements of principles,deriving such principles,where possible by the inductive generalisation of current practice rather than deductive reasoning from normative assumptions,encouraging disclosure of forms or types of information beyond the minimum required by standards,and perhaps most of all,retaining the “true and fair” over-ride,which allows standards requirements to be over-ruled when accountants and auditors are willing to justify their judgement as being better,in a particular situation,than that of the standard-setter”.

The fact that banks “create money” is a red herring. People create money, these days almost universally by accepting bank transfers in transactions. And that is because the they trust bank IOUs. What Wolf is arguing is that this trust is an illusion which ultimately has to be honoured by the taxpayer. What he is inexorably arguing for is a total match between a banks assets and its liabilities. Thus people will know that Account type A depends only on CB reserves, Account type B depends only on some mortgage pool etc. Either can be defaulted on independently of the other. Presuming this is entirely transparent possibly with cigarette type picture warnings then the people will decide what constitutes money. They will likely retain faith in Account type A cheques and credit transfers but many will have signs on their premises saying “Sorry Account type B cheques not accepted here”. No need to have an artificial ban on people using Type B transfers as money as Wolf requires.

It will still be a shock to the system when TBTF Bank B declares that it is paying 80c in the euro on its Type B Accounts but possibly not systemically catastrophic.

So this has nothing to do with what people use as money but to do with the perceived and actual safety and ranking of a bank’s liabilities.

Wolf would have a system where there is no maturity or risk transformation enacted by the banks as intermediaries. They are merely brokers matching up their liability customers with their asset customers.

It is undoubtedly in some senses safer. So to would be our roads if motorised transport was banned.


On the other hand, MW is a serious commentator and he is unlikely to have given his imprimatur to this unlikely approach unless he has abandoned the hope that governments will do something about capital adequacy aka leverage. In this, he is IMHO mistaken.

I came across this description of the “capital” of banks in a blog recently.

“In the economics of banking, “capital” is net worth. It is the difference between the total of all a bank’s assets and all of its liabilities. It is not a type of asset. Capital is not “cash” or “money” from the point of view of a bank. It is owners’ equity.”

To someone such as myself unversed in the technical detail of banking (the vast majority of people) this statement clarified a lot, including the criticism made regarding the misrepresentation of “capital” by the banking fraternity in the book the Bankers’ New Clothes. This boiled down to the contention that it was somehow “expensive” when for the vast majority of businesses it is taken as normal that an adequate level of equity is essential to their health and future prospects and is not seen as anything other than a basic requirement. Or put another way, as is seemingly the case in Germany, paying dividends to shareholders is seen as having priority over contributing to the common necessary business insurance fund with the taxpayer left to pick up the bill should things go wrong.

Governments, it seems, are caught in the dilemma of trying to get the banks to increase lending i.e. take more risks while at the same time trying to ensure that they are adequately covered in terms of capital to enable them to do so. It will clearly take years to remedy the situation, if it can be done at all. The authors of the Bankers’ New Clothes, if my memory is correct, consider that a 30% level would be appropriate!


I respect MW’s intellectual grasp of his subject matter. All the same, when he opens an article in the FT by drawing a comparison between counterfeiters and bankers one notes that he is not above a bit of populist sensationalism.

Those who study these matters know that money is not quite what people think it is. The BoE produced two very informative notes which acknowledged as much. (My thanks to PF for drawing my attention to these.) In paraphrase they point out that modern money is nothing more than IOUs from the banking system.

The difference with the BoE is that they go on to explain how this system works very well thank you. Unfortunately the likes of Wolf and Paul take a different route, almost suggesting that the whole edifice is a scam.

Wolf is indicating a way to prevent banks in future either failing individually or en masse. But he does this by allowing them to pass on the risks in their assets to different categories of their customers. Life assurance companies have been doing this for 50 years. No life companies that I know of failed during the crisis or needed bailing out. But they did suffer massive losses – these were passed on to their policyholders through the unit linked system.

Wolf would have banks operate similarly. Yes, that avoids collapse of the banks but it would also transform our financial paradigm with considerable negative consequences. Risk and Maturity transformation are, like alcohol, wonderful things if exploited in a controlled manner.

Wolf is advocating throwing out the baby with the bathwater.

Is it just me who is in intensive care? My recent contributions have been opened by the thought police before posting, I wonder will this get through!!

It is heartening to see Martin Wolf write about this and agree that the present system needs to be changed.

In one sense I agree with DOCM, it will be very difficult to implement the proposed solution of Full Reserve Banking – desirable though it seems.

Perhaps the way forward is for public banking like in Germany – regulated so that all interest is reinvested in the community, partially through costs of the institution itself. This would reduce or remove the problem of the inevitability of default as banks require repayment of more money than they actually lend out given that they charge interest.

Hopefully this would pave the way for full reserve banking so that the government could benefit from significant seignorage income and either reduce taxes or (preferably in this country in my opinion) increasse spending to benefit us all.


I am not coming to the defence of MW; I am just confused as to why he has, so to speak, gone over to the Utopian side of the argument.


Are there not two issues to be considered i.e. banking “reserves” and banking “capital”?

Herewith the opening paragraphs of the US blog that I found informative (the rest being a rather lenghty and tedious series of examples to explain the point).

“Reserves and Capital Confused?

In the economics of banking, “reserves” are a type of asset. There are two types of reserves: vault cash and reserve balances at the central bank. Vault cash is hand-to-hand currency held by a bank and epitomizes the concept of reserves. In the U.S., vault cash made up the bulk of reserves until recently. Banks need to hold reserve balances at the central bank to clear checks, but banks can deposit or withdrawal currency to or from those accounts.

From the point of view of a bank, reserves are “cash” or “money.” In fact, banks often follow accounting conventions and describe their reserves as “cash.” Since banks have direct access to the payments system, they can make payments by writing checks against themselves or else making electronic payments. However, if checks are “cashed,” they must be paid out of vault cash. Wire payments going to other banks or checks deposited into other banks are covered out of the bank’s balance in its reserve account.

In the economics of banking, “capital” is net worth. It is the difference between the total of all a bank’s assets and all of its liabilities. It is not a type of asset. Capital is not “cash” or “money” from the point of view of a bank. It is owners’ equity.”

As I understand it, banks are “creating” the money that they lend each time they “credit” a loan to a customer’s account i.e. not handing over to borrowers the “cash” they have to hand. This is what the helpful explanations from the BOE underline. The underlying weakness of the system relates to the problem of inadequate “capital” i.e. the buffer of the banks’ own equity in the event of loans going sour because of bad lending decisions.

This is exactly the political problem confronting the German finance minister i.e. Germany has a lot of small banks with a lot of dud loans but the shareholders are still convinced that their banks are profitable and they want their dividends. The “small banks” solution is no solution! Indeed, this is clear from the contrast between Germany and France where the former has many small banks and the latter several very big banks. This is the nub of the dispute – still unresolved, it would seem – between the large players as to what should be the “key” for deciding the contributions to the Banking Resolution Fund.

I have every sympathy for the arguments of both Paul Ferguson and, now, Martin Wolf. But they are IMHO coming at the problem from the wrong end i.e. imagining that it is the system that is deciding the context when the truth is the reverse cf.


Bank deposits are money because people accept transfers of same for transactions in goods and services. Wolf and PF want to stop this. Both, I think, require an authoritarian decree to stop folk accepting these transfers for transactions.


Typically when showing a banks balance sheet (in Ireland anyway), reserves and capital mean almost the same thing and both are liabilities – being the equity of the bank. Broadly, reserves are the accumulated profit or loss and capital is the originally invested amount.

The reserves you speak of would typically be called Cash on hand or Cash at Central Bank, or if the bank purchases bonds then Purchased Debt Securities.

I disagre that insufficient Capital is the weakness. None of the banks during the financial crisis required bailouts because they had insufficient Capital. The proximate reason was because they had insufficient liquidity or cash to meet depositors withdrawals and needed funds for this. Ultimately this was because they lent out to much due to ineffective controls – having a reserve ratio (cash/bonds held as % of loans issued) as is popularly received would help this.

However a still better solution is Full Reserve Banking or Sovereign Money Creation. Some might consider it unpalatable for states to be the ones creating money, but consider this: private banks only profit from the interest differential on created money as they must create a corresponding deposit. Sovereign states can spend the money into existence and benefit from the full principal value of the money. Even if the state is inefficient relative to the private sector, this will be outweighed almost certainly.

There would have to be limits on this money creation, Sensible Money and Positive Money propose a committee who would take into account inflation, productivity growth, population growth and other similar factors to determine how much would be created.

Public banking, which requires effective governance if it is to redistribute interest and not just copy the private banks, would be a step in the right direction and should be a lot easier to implement.


I have read in depth Sensible Money proposal for The Fix. The Fix, which echoes MW’s own fix, would have likely avoided the financial crisis, can’t argue with that. But that has nothing to do with the fact that people transact with each other by processing bank transfers.

The Fix is safer because it segregates the bank’s balance sheet between those liabilities which it guarantees and those with which it passes the risks on to the customer. The guaranteed accounts must be backed by CB money, so called full reserve banking. As an aside The Fix also demands that people should only transact with each other using these guaranteed accounts, but this is not necessary. As Krugman points out the liquidity crisis was not because the money supply was called in but because the enormous amounts of wholesale funding were called in. That in turn triggered a crisis in confidence and a property collapse which led inevitably to a solvency crisis.

As I say, The Fix would probably have avoided the crisis as any of the liabilities backing credit with any risk would have been totally exposed to the risk of that credit. In the terminology of MW the investment accounts would be clearly linked to the performance of, say, the mortgages they were funding. They could go belly up without bringing down the bank itself just as investment accounts in life companies can tank with no direct impact on the solvency of the life company.

So The Fix would have avoided the crisis as there would have been minimal amounts of risky credit funded in the first place. And maybe we should stop young folk taking out mortgages and make residential ownership the preserve of wealthy private or institutional landlords.

The Fix has been promoted by a long line of Nobel Laureates stretching from Irving in the 30’s and from schools as far apart as Chicago and Austria. And yet Wiki asserts that fractional reserve banking is used everywhere on the planet – no takers whatsoever for The Fix. Even Karl Marx had a few takers.


To be frank, I find it impossible to view what befell Irish banks as simply a problem of liquidity. If this was the case, they would be back successfully trading without the enormous bill presented to the Irish taxpayer to plug the negative gap between their assets and their liabilities i.e. their “capital” of which they simply did not have enough.

@ All

The war rages on!

I posted this link on another thread on making sure that the next time, it will be the banks that pick up the bill.

While getting to that point, individual countries will remain responsible for picking up the pieces. But every journey starts with the first step! That will be the actual ponying up of the first contributions to the Single Resolution Fund (cf. recital 66). How the bill will break down has not yet been decided.


What befell Irish banks was certainly not just a problem of liquidity, but liquidity was what pushed them over the edge. They lent out such a volume of money that it overwhelmed the debt capacity of borrowers. There simply weren’t enough creditworthy people around for the amount of loans being pushed. So a sizeable chunk of these loans were inevitably going to go bad meaning the banks were insolvent. Accounting standards meant they didn’t have to declare all the losses at once and so could pretend they were illiquid (which they were) but not insolvent.
Higher capital levels would have helped yes but they would have to have been 2-3x the current levels at least to have made a difference. By contrast simply reinstating what most people think is the reserve ratio (10% of assets) would certainly have prevented the crisis.

@ Brian Woods II
It would certainly be a big move to leap straight into Full Reserve Banking, though I’m not sure lending would be as constrained as critics maintain and the advantages of the system are significant. I’m not sure that it sounds too different from much of Europe anyway if young people can’t get mortgages!

@ “By contrast simply reinstating what most people think is the reserve ratio (10% of assets) would certainly have prevented the crisis.”

That is plain wrong. The banks would have had no difficulty in meeting that requirement by either repo-ing or simply selling their government bond holdings to the CB. Put another way, if Anglo wanted another 90M for a developer it would simply borrow 100M from a German bank, deposit 10 of it with the CB and lend the other 90 to the devel. In fact that is probably exact what did happen albeit the 10 was not required to be deposited directly with the CB but was instead invested in Government bonds.


FYI this reference which explains, at least to my non-technical level of knowledge, how the banking system actually works. It also confirms my instinctive view that the political possibility of removing from banks the capacity to create money is zero.

cf. also this RBS adviser’s view of what is required to make the system more reliable which I posted on another thread; more banking capital (and RBS should know!).


I haven’t had a chance to look here for a while but I can’t let that statement “That is plain wrong” go unchalleged.

A reserve ratio of 10% means the max Loans to Deposit ratio is 90%. All Irish banks, and most British banks had a LTD ratio >100% at the time of the financial crisis, the highest ones being Northern Rock in the UK and Anglo in Ireland. Anglo could not have made their LTD <100% without immense difficulty, i.e. basically not lending out most of the money they did. HSBC on the other hand had <100%. All things being equal, the lower the LTD the lower the risk and <100% would make banks far safer. Admittedly Irish Nationwide complied with this but corruption seemed to be the issue there.

@DOCM That is only possibly true if you think the current system doesn’t need to be changed and it was a blip. I don’t subscribe to this view. Capital is an indirect means of controlling liquidity, why not control it directly?

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