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Varoufakis' book contains some arguments and explanations. I don't have the book in English with me, so this is a 'free translation' of a couple of points (bold is mine):

"Contrary to the entrepeneur, the banker does not organize production. (...) We're wrong to think that he is an intermediary between those with excess money and those who wish to lend that money (...). Before, it was like that. Centuries ago. Now, only in very rare occasions does the banker have that role. (...) In developed market societies, the banker does not obtain existing value (money) from some to then give it to others. He obtains it from the future, so that it's possible to use it in the present. (...)"

['Talking to my daughter about the economy', Chapter 4, section 'The "hand" of the banker']

He later, on the same chapter, goes on to say:

"Every society has its legends. Market society is no exception. The fundamental legends of our time are these four:

(...)

  1. Bankers lend money from savings accounts deposits.

(...)"

Finally, later on (Chapter 5), when listing reasons for why people can't get loans after a crisis, he lists some reasons:

"First, because banks won't lend them money, since they are themselves based on money that they don't own, that is, the debts of private parties and the State to them, which will never be payed."


What does he mean by 'banks lend money from accounts' being a legend?

I am admitedly very naive about economy in general (hence what may seem a very ignorant question) but I was always under the assumption that banks make money by charging higher interest from the money they lend then they pay people for their savings accounts. What is this 'borrowing from the future' mechanism that he describes?

Finally, doesn't the last bit contradict that? If banks can 'make up' money 'from the future', why do they depend on the money from the debts of people, companies and the State?

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This is quite a complicated subject, maybe not in a technical sense, but it takes some time to wrap your head around it. I will try to do my best to give a basic answer, and maybe someone else can give more details.

Varoufakis could be referring to one or two different but related things.

The first thing is that the modern monetary system is based on so-called Fiat money (or paper money). Up until 1971 and the collapse of the Bretton Woods system, the US dollar and other Western world currencies were backed by a gold standard, e.g. US dollars were legal tender whose value was directly comparable to the value of a certain amount of gold. The advantage of such a system was that the amount of gold in the world put a limit on how much the value of a dollar could be diluted by inflation (printing more money). For reasons I will not develop further here, the Bretton Woods system fell apart following the Vietnam War and the energy crisis of the 1970s. Today, there is no physical object backing up the value of currency.

Instead, trust in the economic institutions are what gives money its value. As long as people are willing to exchange goods, services and securities for money, the system works. When the financial crisis struck in 2008, the world-wide banking system was on the verge of a situation where people became afraid to engage in economic activities, because if trust dissipates, in a crisis scenario, everything stops in the economy and people can no longer transfer their funds, have their wages paid, buy goods with their credit cards, etc.

Because currency is Fiat money, central banks can “print” money at will. Or in reality, what's happening is that the central bank tells its computer network to make a big number with a bunch of trailing zeroes, and then use that money to buy assets from the market. That way, they can give banks and other financial institutions access to "fresh cash". Of course, in the long term, this is merely an artificial boost that dilutes the value of each currency unit in the total money stock. But it has a short-term stimulating effect on the economy.

The other part of this is that the financial system is based on what's known as Fractional Reserve Banking. There are good videos and articles explaining how it works. But in a nutshell it means that: when a creditor deposits funds into a bank account at Bank A, the bank is only required to keep a fraction of those funds in the bank. The rest can be used for proprietary investments, lending out to other customers, etc. When that happens, those funds are often effectively just being deposited into another bank account at Bank B. This means that Bank B just needs to keep a fraction of the deposits, and can lend out the rest which lands in the books of Bank C. This repeats ad infinitum (as far as I recall), but since a fraction is taken away all the time, in the end there will be a limit on how many times a single unit of currency can be multiplied.

The advantage of the Fractional Reserve System, as I understand it, is that if the bank has to hold a small reserve requirement, the expansion of economic activity is much greater than if a bank had to hold a large fraction in reserves. Of course, if the bank had to hold 100 % of the deposit available for withdrawal at any time, there wouldn't be much lending going on at all. The problem is when the investments are badly managed, or if there is a bank run and everybody wants to withdraw their money at the same time. This was one of the fears in the 2008 financial crisis. At that point, those deposited funds on your bank account are not really there, because they are invested in burgeoning investments whose dividends may not have materialized yet. Or even worse, they are invested in asset bubbles which may burst at any time, which happened in the subprime mortgage crisis of 2007-2008.

Thirdly, the combination of Fiat Money and Fractional Reserve Banking means that when the bank allocates you a loan so you can build a house, that doesn't necessarily mean that they have the money in reality. In some sense, they are just creating a bunch of digits in your bank account and count on that the real value created by the building of the house will be able to cover those liabilities once finished.

So Varoufakis statements are a sort of criticism of the modern monetary system, with good reason. However, as long as the system works, it serves its purpose by accelerating economic growth in a higher rate than would have been possible in a more constrained system. But the backside is that there will always be booms and busts in such a system and great risks if greed triumphs and trust dissipates.

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    $\begingroup$ Re your penultimate paragraph: when the bank allocates a loan, it really does have to have the money in reality - at least by the time that the money's going to get spent, because it's almost always going to get transferred into accounts at other banks. $\endgroup$ – EnergyNumbers Apr 26 '16 at 12:37
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    $\begingroup$ @EnergyNumbers “Commercial banks create money, in the form of bank deposits, by making new loans. When a bank makes a loan, for example to someone taking out a mortgage to buy a house, it does not typically do so by giving them thousands of pounds worth of banknotes. Instead, it credits their bank account with a bank deposit of the size of the mortgage. At that moment, new money is created. For this reason, some economists have referred to bank deposits as ‘fountain pen money’, created at the stroke of bankers’ pens when they approve loans.(1)” $\endgroup$ – Winterflags Apr 26 '16 at 12:49
  • $\begingroup$ Source: Bank of England. $\endgroup$ – Winterflags Apr 26 '16 at 12:49
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    $\begingroup$ Please don't cherry pick. Instead, please do go on to read a few paragraphs later, on page five, and you'll see that the BoE agrees with me: when the transaction takes place, the new deposits will be transferred to the seller’s bank ... The buyer’s bank would then have fewer deposits than assets ... Banks therefore try to attract or retain additional liabilities to accompany their new loans. Remember, balance sheets have to balance. $\endgroup$ – EnergyNumbers Apr 26 '16 at 13:02
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    $\begingroup$ @Winterflags You are mixing up money money with money supply/stock. Private banks can increase the money stock but it is only the CB that can create new money (or some chinese bitcoin mining farm). $\endgroup$ – d-b Jul 29 at 7:47
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Banks and the finance industry have an essential function of allocating capital to productive uses, intermediating between savers and investors, and managing risk. However, banking deregulation, beginning in the 1970s (and not "centuries ago" as claimed by Varoufakis), has moved this industry toward rent-seeking activities. So, since then, bankers do not lend money from savings accounts deposits. This is "the legend". They offer financial services. They are engaged in lending by trading bonds and securities. They are engaged in futures markets (central financial exchanges where standardized futures contracts are traded - see wikipedia).

By the way, deregulation has been a very lucrative change because finance has become more profitable relative the rest of the economy. Philippon and Reshef show convincingly in a QJE paper that salaries in the financial sector have skyrocketed.

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  • $\begingroup$ Of course bankers lend money from savings accounts deposits. What else are they going to do with it? Leave it in a shoebox in the safe? $\endgroup$ – EnergyNumbers Apr 26 '16 at 12:39
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He points out the fact that the money we have in our bank accounts is actually created by the banks - and not just passed on from other depositors as is the common assumption. you will find a very clear 101 on the process on http://positivemoney.org/how-money-works/how-banks-create-money/

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    $\begingroup$ Please expand your answer to include the (core of the) argument here. Link-only based answers are of low quality and can be deleted. $\endgroup$ – luchonacho Jul 11 '17 at 7:20
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Varoufakis refers to the process of money creation in modern economies through bank lending. Banks create money out of 'nothing', as lending simultaneously generates an asset (the loan) and a liability (the deposit credited to the borrower's account) for the bank. What we call money today are mostly commercial banks' liabilities. This does not require banks to have any prior deposit or cash reserves. Accounting identities only require that the balance sheet of the bank is balanced, and should they find themselves short of funding sources (i.e. liabilities) they can borrow from other banks or the central bank.

The mechanism has long been known by a number of economists, but was given mainstream prominence in a recent working paper by the Bank of England, which has already been cited on this page ( https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf ).

Varoufakis then relates this process to his wider views about economics. While there is no technical constraint to this mechanism of money creation, this has to somehow be validated by the "real economy". So what Varoufakis means here is that effectively banks will lend (thus creating money) in the expectation that the borrowers will make some money in the future with which to repay their loans. So in a sense bankers are anticipating the 'value' that businesses will create in the future, and lending money against it.

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  • $\begingroup$ You are mixing up money and money supply/stock. $\endgroup$ – d-b Jul 29 at 11:04

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