Events are now spinning out of control. The banks remain shut. The ECB has maintained its liquidity freeze, and through its inaction is asphyxiating the banking system.
Factories are shutting down across the country as stocks of raw materials run out and containers full of vitally-needed imports clog up Greek ports. Companies cannot pay their suppliers because external transfers are blocked. Private scrip currencies are starting to appear as firms retreat to semi-barter outside the banking system.
The Tourniquet of the Central Bank
It is not just Greek banks but all banks that are dependent on central bank liquidity, because they are all technically insolvent. They all lend money they don't have. As the Bank of England recently acknowledged, banks do not actually lend their deposits. Rather, they create deposits when they make loans. They do this simply with accounting entries. There is no real limit to how much money they can create, so long as they can find creditworthy customers willing to borrow it.
The catch is that the bank still has to balance its books at the end of the day. If it comes up short, it can borrow from the banks into which its deposits (whether "real" or newly created) have migrated. Banks can borrow from each other at very low rates (in the US, the Fed funds rate is 0.25%). They keep the difference in rates as their profit.
The central bank, which has the power to print money, is the ultimate backstop in this money-creating scheme. If there is leakage in the system from cash withdrawals or transfers to foreign banks, the central bank supplies the liquidity, again at very low bankers' rates.
That is the way the system should work. But in the Eurozone, the national central banks of member countries have relinquished their critical credit power to the European Central Bank. And the ECB, like the US Federal Reserve, marches to the drums of large international banks. The central bank can flick the credit switch on or off at its whim. Any country that resists going along with the creditors' austerity program may find that its banks have been cut off from this critical liquidity, being branded no longer "good credit risks." That damning judgment becomes a self-fulfilling prophecy, as is now happening in Greece.
Turning the Credit Spigots Back On
The problem now for Greece is how to restore bank liquidity without the help of the ECB. One way would be to leave the Eurozone and return to its own national currency, as many pundits have urged. Its central bank could then issue all the drachmas needed to fund the government and provide cash for the banks.
But that alternative comes with other major downsides, including that the drachma would probably plummet against the euro. Greek leaders have therefore sought to stay in the Eurozone, but that means dealing with the bank runs that are bleeding the banks of euros. It also means bowing to ECB regulation, something the ECB is attempting to impose on all Eurozone banks.
Assuming, however, that Greece stays in the EU, might there be a way that the government could restore the liquidity necessary to keep its banks and the economy afloat, without the help of the ECB and while continuing to use the euro?
Consider again the Bank of England's bombshell 2014 report called "Money Creation in the Modern Economy." According to the BOE, 97% of the money supply is now created by banks when they make loans. British banks create digital pounds. US banks create digital dollars. And Greek banks create digital euros.
How it all works is explained by Kumhof and Jakab in an IMF paper called "Banks Are Not Intermediaries of Loanable Funds -- And Why This Matters." They note that the chief practical limit to the digital creation of money is simply the willingness of banks to make loans. The central bank can create massive "excess reserves" (as the Fed did with "quantitative easing"), but bank lending to local businesses will not increase if the banks do not see a profit in it. The problem is called "pushing on a string": there is no mechanism for forcing banks to make loans.
That is true in a private commercial system, but in a nationalized system, the government can "pull" on the string. It can manage the lending of its state-owned banks, as China and Japan have done for decades. Loans to local businesses can be guaranteed with government letters of credit in lieu of capital; and if some loans turn out to be "non-performing," they can be written off or just carried on the books, as China has also done for decades. The money was created as accounting entries and can be carried on the books as accounting entries.
The Greek government could follow China's lead and nationalize its private banks, all of which are insolvent. It could then use their digital money machines to pump liquidity back into the economy, by making loans to all those once-viable businesses now starved of funds. Restoring their credit lines would allow them to pay for workers and materials, generating purchasing power and sales, increasing employment and the tax base, and generally reversing the economic death spiral induced by insufficient money in the system to keep the wheels of production turning.
In an All-digital System, the Books Are Always Balanced.
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