What does Varoufakis mean by 'banks can make up money' in 'Talking to my daughter about the economy'?

Question

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:

(...)

2. 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."

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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?

Answer 1

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.

Answer 2

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/

Answer 3

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.