Modern Money Creation: Analyzing the Fraud Question
The modern banking system's ability to create money has long been a subject of controversy, with some critics characterizing it as a collective fraud while others defend it as a legitimate economic function. This report examines the mechanics of money creation in contemporary banking, analyzes arguments on both sides of the fraud debate, and distinguishes between systemic money creation and actual financial fraud cases.
The Mechanics of Modern Money Creation
How Banks Create Money
In contemporary societies, the great majority of money is created by commercial banks rather than central banks. Whenever a bank makes a loan, it simultaneously creates a matching deposit on the liability side of its balance sheet[1]. This process occurs during mortgage origination and even in everyday transactions, such as when a credit card is used for purchases. The money created essentially functions as an IOU from the bank, denominated in the national currency but actually representing the bank's own liability[1].
This creation process has been described in publications by major central banks like the Bank of England and Deutsche Bundesbank, bringing greater transparency to a process that has long been misunderstood by the general public[1]. When banks lend, they issue their own credit to buy the borrower's promise to repay. That credit is denominated in the state unit of account but represents a newly created liability of the banking system[2].
The Fractional Reserve System
The modern banking system operates on the principle of fractional reserve banking, where banks are required to hold only a fraction of deposits as reserves while lending out the remainder. When a loan is made by a commercial bank, new demand deposits are created and the money supply expands by the size of the loan[3]. This system amplifies the money supply beyond the actual physical currency in circulation.
In this system, money exists in two primary forms: central bank money (created or adopted by the central bank) and commercial bank money (demand deposits in the commercial banking system)[3]. The ability of banks to create this commercial bank money has led to significant debate about its implications.
Arguments That the System Constitutes Fraud
The Property Rights Argument
Some critics compare fractional reserve banking to a violation of property rights. They draw an analogy to scenarios where property left in someone's care (such as clothes at a dry cleaner or a car with a valet) is used without permission[4]. The argument suggests that when banks lend out deposited money, they are using property they don't own, which constitutes a form of fraud[4].
This perspective holds that gold or other deposits historically given to banks for safekeeping were held in a bailment relationship where ownership remained with the depositor. Under this view, the modern practice of lending out these deposits represents a violation of this trust[4].
The "Money Out of Thin Air" Critique
A more fundamental criticism claims that banks create "fairy dust" or money "out of thin air," enabling them to profit from something they create at virtually no cost[1]. This view suggests that the banking system creates currency at a much faster rate than real economic values grow, leading to devaluation of existing currency and erosion of purchasing power over time[5].
Some critics describe this as "the biggest scam in the history of mankind" where "a select few benefit immensely from this system while the majority bears the burden"[5]. The system is characterized as an "enormous cancer on humanity, draining life and livelihood from productive workers" through a mechanism that has been deliberately obscured from public understanding[6].
Systemic Inequality Concerns
Critics argue that the money creation process concentrates power and functions as "a machine for transferring property from the people to financial predators"[6]. The money creation ability supposedly gives banks power to "collect commission on transactions, interest on financing, dividends from stocks, interest on government bonds (people's taxes) and so on"[7]. Additionally, critics argue that the resulting inflation requires central banks to raise interest rates, bringing even more profits to the banking sector[7].
Arguments Defending the System
Money Creation Is Not "Out of Nothing"
Defenders of the banking system challenge the characterization of money creation as occurring "out of thin air." While acknowledging that banks create money when making loans, they argue that this is not creation from nothing, but rather the creation of financial instruments within an established economic and legal framework[1].
They point out that the bank creation of money is offset by corresponding liabilities and constrained by various factors including market competition, banking regulations, and central bank policies[1]. In this view, bank-created money is not a fraudulent conjuring but a legitimate financial service functioning within a regulated system.
The Money Destruction Aspect
An important counterpoint to the fraud allegation is that while banks create money when they issue loans, they also "destroy" money when loans are repaid. As one commenter in a discussion forum noted: "When a loan is repaid, it does not 'go into the bank's assets'. The bank's liability to you gets debited/deleted. But at the same time, their claim over you that they were holding as their asset is also debited and deleted"[2].
This cyclical nature of money creation and destruction challenges the narrative that banks are simply generating money for themselves without constraint or consequence. The overall impact appears balanced from an accounting perspective—the only thing remaining after a fully repaid loan is the interest earned[2].
Economic Utility and Official Legitimacy
According to some economic perspectives, money creation by financial intermediaries "does not pose financial stability threats"[8]. The system serves an economic function by mobilizing savings, enabling investment, and facilitating economic growth through an efficient allocation of capital.
The system also operates with the explicit authorization and regulation of governments and central banks, which provide deposit insurance, lender-of-last-resort facilities, and regulatory oversight designed to maintain systemic stability and public confidence[1].
Real Financial Fraud vs. Systemic Issues
Actual Financial Fraud Examples
Legitimate concerns about financial fraud should focus on actual criminal activities rather than the basic mechanics of banking. The search results document numerous examples of genuine financial crimes:
- Cloning Fraud: Unauthorized firms clone the details of legitimate financial institutions to deceive consumers, as in the case of Ireland Universal ICAV where fraudsters created a fake version of an authorized firm[9].
- Romance Fraud: Five money launderers were convicted for exploiting victims through romance fraud, creating fake profiles on dating websites to trick people into sending money, resulting in losses of £3.25 million across 40 confirmed victims[10].
- Money Mules: Criminals recruit individuals to move illicit funds between accounts, targeting students, retirees, or lower-income individuals looking for financial relief. These schemes are sometimes promoted on social media platforms with "fast-paced music and an engaging speaker" that diminishes the perception of criminality[11].
- White-Collar Crime: The FBI investigates numerous forms of financial crime including health care fraud, corporate fraud, securities and commodities fraud, mortgage fraud, and money laundering—all activities that involve deliberate deception for financial gain[12].
Distinguishing Features of Criminal Fraud
True financial fraud involves specific elements that distinguish it from legitimate banking operations. These typically include:
- Deliberate deception: Intentionally misleading victims about material facts[13].
- Unauthorized actions: Operating without proper regulatory approval or licensure[9].
- Misrepresentation: Presenting false information to induce financial decisions[13].
- Unlawful personal gain: Diverting funds for personal benefit through deceptive means[12].
These elements are fundamentally different from the regulated, transparent, and authorized money creation functions of the banking system, regardless of one's opinion on the merits of that system.
Public Understanding and Misunderstanding
Common Misconceptions
Money is widely misunderstood by the public. Common myths include beliefs that money is directly controlled by governments, that it circulates in a durable form throughout the economy, that banks gather it up as the basis for loans, or that government spending is directly based on collected taxes[14].
These misunderstandings lead to "muddled policy debates in fields as diverse as taxation, monetary policy, inflation, fiscal 'austerity', bank failures, money laundering, phishing scams, cryptocurrencies, 'dollarisation' and loans for countries in financial distress"[14].
The Education Gap
The complexity of modern money creation, combined with the technical nature of banking operations, creates a significant education gap. This gap can be exploited by both those who wish to commit actual fraud and those who wish to characterize the entire system as fraudulent for ideological reasons.
Some commentators argue there has been deliberate obfuscation, claiming that "economists, bankers, politicians, historians and media professionals misrepresent and obscure what is going on"[6]. However, in recent years, central banks have made efforts to explain money creation more clearly, suggesting at least some institutional commitment to transparency[1].
Conclusion: Evaluating the Fraud Claim
The question of whether modern money creation constitutes a collective fraud requires careful consideration of multiple perspectives and ultimately depends on one's definition of fraud and economic philosophy.
From a strictly legal perspective, the modern banking system operates within established laws and regulations, with explicit authorization from governments and central banks. The money creation process is increasingly transparent and explained in official publications. By these standards, the system would not constitute fraud in the legal sense, despite legitimate criticism of its outcomes and effects.
From a broader ethical or philosophical perspective, critics raise valid concerns about the distributional consequences of money creation, the concentration of financial power, and questions about whether the public has truly consented to this system with full understanding. These critiques merit serious consideration even if they don't establish legal fraud.
What's clear is that distinguishing between systemic issues in money creation and actual financial fraud is crucial for meaningful reform. While the banking system may be criticized on various grounds, focusing on genuine criminal activity that victimizes individuals through deception remains an important priority regardless of one's position on the broader monetary system.
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- https://cepr.org/voxeu/columns/banks-do-not-create-money-out-thin-air
- https://www.reddit.com/r/mmt_economics/comments/1ftr1wx/do_banks_create_money_in_my_thinking_no/
- https://en.wikipedia.org/wiki/Fractional-reserve_banking
- https://mises.org/mises-wire/fraud-inherent-fractional-reserve-banking
- https://www.linkedin.com/pulse/unveiling-federal-reserves-narrative-john-chalekson
- https://positivemoney.org/archive/secrets-ignorance-and-lies-money-credit-and-debt/
- https://www.reddit.com/r/AskEconomics/comments/1b2djkx/are_nowadays_banks_a_huge_scam/
- https://papers.ssrn.com/sol3/Delivery.cfm/5106296.pdf?abstractid=5106296&mirid=1
- https://www.centralbank.ie/news/article/warning-notice-central-bank-of-ireland-issues-warning-on-unauthorised-firm-ireland-universal-icav-(clone)-23-feb-2024
- https://www.cps.gov.uk/cps/news/money-launderers-used-romance-fraud-scam-40-victims-out-estimated-ps325-million
- https://www.paymentsjournal.com/money-mules-up-the-ante-on-fraud-creating-significant-impacts-on-financial-institutions/
- https://www.fbi.gov/investigate/white-collar-crime
- https://lincolnandrowe.com/2024/10/07/fraudulent-misrepresentation-and-conspiracy-case-looks-at-elements-of-deceit/
- https://pursuit.unimelb.edu.au/articles/seven-common-myths-about-modern-money
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