Renowned economist Richard Werner says popular textbooks miscast banks as mere middlemen and ignore their central "power to create money," an omission he claims distorts debates over credit just as the U.S. economy slows and the Federal Reserve weighs rate cuts.
What Happened: "Banks are special. They have a unique power that no other player in the economy has and that is the power to create money," Werner told Tucker Carlson on an episode of his show that aired last week. He said most economists still teach the "financial-intermediary" model in which banks simply recycle deposits, "but that's wrong."
Werner laid out three broad theories of banking. The “intermediation theory” says that banks gather deposits and lend them. The second theory is what he calls the “Fractional-reserve theory,” which describes banks as a body that holds only a portion of their customers’ deposits as reserves and lends out the remaining portion. Lastly, there’s what Werner calls the “credit-creation theory,” which shows that each bank “creates money” when it books a loan.
Macroeconomics "has not been successful for 200 years," Werner said, because models leave banks "frozen out." He noted that mainstream economists once dismissed credit-creation advocates as "cranks," echoing John Maynard Keynes' critique. Banking's omission, he argued, explains why forecasts often miss turning points.
Why It Matters: The debate lands as credit demand weakens and lenders tighten standards. According to Reuters, a May Fed survey found the sharpest drop in small-business loan appetite in a year. Similarly, Wells Fargo recently reported a 2% year-over-year decline in average loans, citing commercial real estate stress.
Analysts at Fundstrat and Goldman now expect two Fed cuts by December after payroll gains slowed to 73,000 in July. Minneapolis Fed President Neel Kashkari said this week that easing "would be reasonable" if the slowdown deepens, as revealed in a Reuters report.
While the Fed grapples with growth below 2% and inflation still near 3%, Werner contends that understanding banks' money-creation role is "the solution to many other puzzles in economics."
Photo Courtesy: Doidam 10 on Shutterstock.com
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