Recep Erdogan, the Turkish president, has been claiming since at least 2012 that interest rates cause inflation, with his claim generally dismissed but is he right?
“The more vicious the interest rate lobby, the more diminished the purchasing power of our citizens – who are the consumers – will be,” Erdogan said back in 2012, adding:
“Entrepreneurs will be forced to cut down on investment, because as seen in loans, interest rates are high. The policy rate is around 5.8 percent. However, market interest rates are hovering around 13-14 percent.”
He has repeated the claim since, stating recently: “As interest rates fall, inflation will fall. The real problem is interest. I am an economist.”
The general response is perhaps best given by Foreign Policy (FP) which says:
“Higher interest rates will reduce inflation by reducing economic growth. If the central bank increases the cost of borrowing liras, it would put immense pressure on Turkey’s banks. The banks fund themselves in part by borrowing billions of liras, in part from the central bank. They have to roll over a substantial portion of that debt on a weekly or monthly basis.
At the same time, almost all the loans Turkey’s banks hand out themselves—providing money for Turks to buy houses or cars, for example—are of longer duration and with fixed interest rates. Every time the central bank hikes interest rates, it thus raises the banks’ costs without increasing their revenue.
The result is a credit crunch. As banks cut back lending, consumers buy less, businesses invest less, and the economy slows.”
These are two very different views on the role interest rates have on inflation, but at least they both agree that an increase in interest rates slows down and maybe even crashes the economy.
Hence why central bankers are blamed for creating this boom and bust cycle, but Foreign Policy is providing a very limited view of just what effect interest rates have on lending and money supply, thus on inflation.
And although they, as well as the corporate media in general, are keen to dismiss this claim, when the president speaks people usually listen and listen very carefully.
That’s especially if the president makes a claim that goes against the grain which people usually consider fully to see if he is right.
We think he is because we came to the same conclusion on our own after years of reporting on money.
The Mysteries of Money
There’s hardly a topic more obfuscated and taught in a more misleading manner than the matter of money to the point the Bank of England itself came out to say:
“Money creation in practice differs from some popular misconceptions—banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.”
Such textbooks probably have still not been updated, but the current monetary systems starts with gold and with the Bank for International Settlement (BIS).
When a nation makes a payment to another nation, it does so by the central bank of that nation, through BIS, transferring gold to the other nation’s central bank.
That’s usually only in time of crisis or war, so explaining why Putin has been piling up on gold as the value of Russian money kept falling.
That gold reserve in practice has no further role in the matter of money, but does in a very subtle way affect its value because that’s where money begins and where it ends. The foundation of the current monetary system.
One layer above it are central bank money. These are created completely out of nothing by commercial banks borrowing money from central banks.
As FP says, commercial banks do so and very often. What happens here is basically lets say Goldman Sachs wants to borrow 1,000. FED just types 1,000 on a spreadsheet and that’s that, Goldman Sachs now has 1,000. When they pay it back, FED just deletes that 1,000 they typed.
Only banks have access to this money. Even the government does not. The government, both say the Whitehouse as well as state governments, local councils, etc, have to borrow money from the public – which usually translates to commercial banks – in what they call bonds.
Corporations and even banks can issue debt bonds, but the practice is highly regulated and restricted. So ordinary people and startups can’t just raise money from the public without going through significant barriers.
Ordinary people instead operate on cash, which is quickly disappearing, and on primarily commercial bank money.
“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money,” the Bank of England says.
Money thus enters the system from commercial bank lending, which again is say Barclays typing 1,000 on a spreadsheet. When you pay back this 1,000, they just delete it. So the money created is destroyed.
Banks, however, transact with other banks only with central bank money. Barclays, for example, can’t just type 1,000 and say to Goldman Sachs you now have 1,000. They need the central bank and all the clearing houses and all the rest to move 1,000 from their central bank account.
So the picture is almost complete. BIS is the banker of central banks. Central banks are the banker of commercial banks. Commercial banks are the banker of all of us.
Yet one crucial aspect is missing from official confirmation/clarification and it is because that is missing that we’re even having this debate on whether Erdogan’s claim is right or otherwise.
Interest Rates, Why so Secret?
That 1,000 you borrow or the commercial bank borrows from the central bank is not quite free. You have to pay interest on it, and for credit cards in the west that can be 20% a year. Meaning you have to pay back $1,200.
So what happens to this $200? The 1,000 is destroyed, it is deleted from the spreadsheet. It no longer exists. But this $200 is a bit of a mystery because according to the Fed, explaining it has “a high risk that it will trigger political controversies.” They say:
“All instruments that are currently discussed have the characteristic that the central bank pays, in some form, interest on reserves (see Berentsen, Kraenzlin, and Müller, 2018).
There is a political economy issue with these payments since, as of today, they are paid only to the few financial intermediaries that have access to central bank electronic money.
The general public might not consider such large payments equitable or beneficial, and there is a high risk that it will trigger political controversies that have the potential to affect central bank independence (see Berentsen and Waller, 2014).
Central bank electronic money is an elegant way of avoiding possible political upheavals with regard to these interest payments, by allowing the whole population to have access to these interest payments and not just a small group of commercial banks.”
By reserves here, they mean central bank money. Commercial banks basically have an account with central banks like you have with Citibank or whatever bank you use.
It is there where commercial banks keep their central bank money, or “real” money as you might call it, and on such money they’re paid interest.
FP above looked at the matter only from the viewpoint of the bank borrowing money from the central bank. There is the other side, however, of the bank receiving money from the central bank in interest on their reserves.
Such interest would be just typed from the central bank with the commercial bank so getting real money not by borrowing, but by simply letting money sit at the central bank.
Likewise, if you have a savings account, commercial banks pay you interest too which is usually far lower than the rate they charge borrowers.
Managing that difference is the task of banks because they are limited in how much they can lend, and thus how much money they can create, by the amount of central bank money they have which is necessary to reconcile accounts between different banks – A. Smith from Barclays pays B. Jones from Goldman Sachs – and thus for banks to transact with each other.
So sending us back to this $200 and to just where does it go and what sort of money is this?
The only conclusion that can make any sense is that this $200 in interest payments by ordinary people becomes real money in that it becomes central bank money after we take out whatever the bank pays to savers.
In effect, the commercial bank has just printed out $200, and has given maybe $10 of it to savers, probably $170 of it to CEOs, employees, shareholders and so on, and perhaps it has sent $20 to the central bank to keep in reserves.
Regardless of to whom this money goes, the monetary supply has now just increased by $200. Thus, the higher the interest rates are, the more amount of “money” becomes “real” money, and thus the more the supply of money increases and thus the higher the inflation.
At this point things become a bit complex because the lower the interest rate, the less banks’ incentive to lend money as they’d be making less profit from it in interest payments. Thus the more stringent their requirement, and so the harder to get a loan.
On the other hand, the higher the interest rate, the more expensive it is to borrow, just as the requirements to borrow are the more lax. Thus both temporarily in new capital lent money created, and more medium term in the “real” interest money created, the supply of money increases with the increase of interest rates.
At some point banks’ requirements get so lax that people can no longer pay back any money, thus no new money is created through interest payments, so compounded by the destroyed money from the written off debt, all leading to a crash.
Meaning as far as the current system is concerned, very low interest rates as in Europe are not good because banks have no incentive to lend any money, thus people are stuck in paying way more interest in “rent” instead of buying a house with a mortgage and businesses can’t expand because the bank is too stringent.
On the other hand, high interest rates are not good either because too much value is taken out from ordinary people and is given to primarily very rich bankers.
So a balancing act is necessary in the current system to push banks to lend more, meaning ECB should probably raise interest rates, while keeping interest rates low to ensure banks are not extracting too much from the economy.
With all of the above looking at just the matter of money and its creation in the current system, but widening the picture, interest rates are probably not quite the best tool for economic management.
The Current System: Corporate Nation
It is said the fuel of the civil rights movement in the 60s was a government policy that ordered banks to discriminate against black neighborhoods where loans to buy a house were not given.
The enforcement of such policy was only possible because there are so few banks. Now, there are way less still.
Just four banks in the United States account for close to $200 trillion in derivatives according to the Office of the Comptroller of the Currency (OCC), which overlooks banks.
This incredible concentration means there is effectively no competition in the banking system and the primary reason there is no competition is because to set up a bank is almost impossible.
With the Federal Deposit Insurance Corporation (FDIC), which guarantees savings of up to $250,000, the current system begins to look very communist because to get such FDIC privilege obviously is almost impossible.
For good reason perhaps. Inflation is effectively a tax. You don’t want to just give out such $250,000. Yet this means there is pretty much no competition in the banking system, and thus in the matter of money.
The above applies to effectively every country. In an exaggerated manner to just simplify it, a coordinated bot like cloning of all central banks’ policies occurs at BIS in their secret meetings. So they’re all singing the same hymn.
Yet, though folklore blames them of all sorts, we don’t think they’re evil men. They just have a very difficult task and in most cases are too old to account for the new knowledge gained since the banking collapse.
Though some say money is at the root of all evil, it can also be the case that the state is at the root of all evil. In both cases, both aim for good, but the system is so complex in many cases no one quite knows just what is going on.
Specifically, one does wonder when was the last time our elected even looked at all the bank regulations and all the requirements to become a bank.
If setting up a new bank is pretty much impossible due to century old very outdated laws passed by what back then was happy to openly call itself an aristocracy, then there is no competition and in the absence of such competition the system obviously can’t function.
It is fine for Erdogan or Trump or others to complain about interest rates, but that is far too easy and easy things rarely achieve anything.
It is far harder, but more productive, to just look at these restrictions and licensing requirements and to gain the courage to push back the state to allow the market to compete by lowering the impossibility of becoming a bank to at least: difficult but doable.
For though the Fed is right the public will think it quite unjust this printed interest money is reserved for four banks – not even our government – there’s no need to jump straight to ordinary bank accounts with the central bank.
Instead, requirements to become a bank should be relaxed considerably so that maybe even a basement dweller can do it, with of course some sort of checks they’re not an outright scammer by perhaps having a special police force to lock them up.
There isn’t really much of a reason to require $50 million to even begin the bank creation process because if Fed itself is saying such free money handouts to banks is or can be perceived as unjust, then it is difficult to see why access should not become a lot more open.
Like the Mayans went off the maze with their complicated base 30 maths, so too century old stuffy banks can become bloated and confused, with only new ones hungry for the profit motive able to improve for the benefit of all.
Thus if politicians are considering looking again at this matter of money, they must begin by looking at the restrictive laws that are starting to turn our countries into outright communism.
There must be a wholistic approach and it must start with trusting your citizens engaging in free market competition would by far do so to the benefit of all.
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