This essay defends the supposedly naïve “Intermediation” theory of banking against its lately de rigueur “Thin Air” rival. It holds that the Intermediary theory of banking comes much closer to describing the workings of actual banking systems than the Thin Air alternative.
In making this case, there are several points about the Intermediary theory I find it especially necessary to stress. They are:
- That the difference between it and the Thin Air theory is not a matter of “mere semantics”: both theories rely upon essentially the same understanding of what it means to say that banks are intermediaries, so that the difference between them is substantive;
- that the Intermediary theory doesn’t suppose that banks must receive deposits of “physical” stuff (e.g., commodity money or fiat currency) to make loans, or (for that matter) that they ever have to deal in physical stuff at all, whether by taking it in or by handing it out;
- that it is not contradicted by the fact that banks can “create” money in the form of their own transferable IOUs, and specifically in the form of current deposit account balances, or by the fact that the quantity of bank‐created money at any time tends to be much larger than the quantity of base or high‐powered money;
- that it doesn’t require that banks rely exclusively upon retail deposits for funding;
- that it doesn’t require that banks have sufficient funds of any sort on hand before they arrange loans;
- that it is not the same thing as the textbook “multiplier” account of bank lending and deposit creation;
- that it does not apply to fiat‐money issuing central banks, the powers of which are more or less those that the Thin Air theory wrongly assigns to ordinary (commercial) banks.
