A Black Hole in Economics: Money Creation and Its Consequences by Jim Brown (Review)

How is money created, who creates it, and what are the economic effects of money creation?

Seneca, SC: Loco-Foco Press, 2024
324 pp. $7.50 (Kindle)

Editor’s note: This review includes a glossary of terms. Readers unfamiliar with economics may wish to familiarize themselves with the glossary before reading the review.

How is money created, who creates it, and what are the economic effects of money creation? In his book A Black Hole in Economics: Money Creation and Its Consequences, Chartered Financial Analyst Jim Brown answers these questions comprehensively. His book is timely considering that the prices of consumer goods have risen nearly 20 percent since 2021. Yet a reader might wonder why we need another book on this topic. Haven’t economists already discussed this issue ad nauseam?

They have. But most economists, according to Brown, subscribe to a wrong theory. “I believe money creation,” he writes, “suffers from a special kind of ignorance. The ‘black holes’ of outer space are poorly understood because we lack the scientific knowledge to explain them. However, money creation is poorly understood because the correct . . . theory, once widely understood, has somehow been forgotten” (25).

Brown discusses three different theories of the banking system and its role in creating brand new money. First, the credit creation theory says that individual banks create new money in the form of credit when they extend loans or buy assets. Second, Paul Samuelson’s fractional reserve theory claims that the interaction of banks, not any single bank, creates money through a “reserve multiplier” process. When one bank extends a loan, the theory goes, this money gets deposited and reloaned by other banks, creating new money. Finally, the financial intermediation theory (the dominant theory today) denies that banks create money; instead, it claims the money that banks lend comes from the customers who have deposited their savings with them.

The financial intermediation theory, Brown observes, correctly describes how many _non_bank financial institutions operate, but not how banks operate. The correct theory, Brown argues, is the credit creation theory: “commercial banks create money ex nihilo, i.e., ‘out of nothing,’ by issuing promises to pay out cash when demanded. . . . The ability to ‘create money’ this way is fundamental to all banks and has not changed over time. What has changed is the nature of the cash” (33–34).

Brown then explains, in great detail, the mechanics of money creation, analyzing how a bank’s balance sheet changes when it extends a loan or buys an asset. He also explains how modern banking evolved from the practices of European goldsmiths in the mid-15th century, indicating the important difference between two types of money: cash (“standard money”) and promises to pay cash (“fiduciary media” such as credit and checks). Brown explains how commercial banks only have the power to create the latter type of money and how the nature of the two types of money changed when the government abandoned the gold standard.

Although commercial banks create money in the form of promises to pay cash the same way today as they did under the gold standard, the key difference between now and then is that, under the gold standard, the supply of cash was limited because only gold (or silver) was considered cash. Under the monetary system today, central banks—not commercial banks—have unlimited legal authority to create cash in the form of paper bills. Brown points out that in the 1930s, “the government seized the power to control the amount of bank reserves away from the gold depositors and gave it to the Federal Reserve [i.e., the ‘Fed,’ the central bank of the United States], which could easily create new cash reserves in any amount” (52).

Although the power of central banks to create money in the form of cash is unlimited, the power of commercial banks to create money in the form of promises to pay cash is not. As Brown explains, “Commercial bankers face numerous market constraints, such as loan demand, interest rates, a limited pool of creditworthy borrowers, and the expenses associated with lending operations” (74).

Brown distinguishes “good money creation” from “bad money creation,” devoting a chapter to each. Commercial banks create money in accordance with the law of supply and demand. This is good money creation, which “results in productive, non-inflationary growth”—increased production without a permanent increase in the amount of money in circulation (98). The reason such growth is “noninflationary” is that, over the life of a loan, no net new money is created. A bank, for example, creates new money (credit) when it extends a loan to a business; when the business pays back the loan, the previously created money no longer exists. But “the new or improved products [that business] created [with the loan] will still be there as an addition to the economy’s reservoir of real wealth” (96). Good money creation in the form of business loans, in other words, fosters prosperity by providing entrepreneurs with the capital they need—not only to create new or improved products, but also to expand production, start new businesses, or devise better ways to serve their customers.

Central banks, on the other hand, are responsible for bad money creation, which is highly destructive. This raises the question: Is bad money creation the same thing as inflation? To answer that, we first must be clear on what exactly inflation is. Brown starts this discussion by analyzing its various definitions. Whereas the most common definition of inflation is a general rise in prices, the Fed defines it more narrowly as a general rise only in consumer prices. The major problem with these definitions, Brown observes, is that they cause all sorts of confusion because they ignore money creation while focusing only on one of its effects (price increases), which can also be caused by other factors.

Brown cites one definition of inflation from the Oxford English Dictionary: an “(undue) increase in the quantity of money circulating,” which he deems essentially correct (110). The implication is that good money creation by private banks is not inflation because it cannot be properly described as undue money creation. So, what is the source of undue money creation? “We are left with the fact that only government intervention in the banking system can enable a prolonged or persistent increase in the quantity of money” (114). Brown concludes with a more specific definition of inflation that he borrows from economist George Reisman: “an increase in the quantity of money caused by the government” (114). Inflation, in other words, is synonymous with bad money creation.

Brown analyzes two major bad money creation episodes, notably the Fed’s “Quantitative Easing” (QE) program from 2009 to 2022. Under QE, the Fed monetized trillions of dollars of government debt (i.e., it created money out of thin air to buy Treasury bonds) while aggressively suppressing interest rates following the 2008 financial crisis. The stated purpose of this policy was to avoid deflation while “stimulating” the economy, but this came with harmful consequences. Because this new money was funneled into the financial markets, QE unjustly favored investors by artificially inflating the prices of stocks, bonds, and real estate. Savers, by contrast, were “the most obvious victims of ultra-low interest rates,” as the rate of interest earned on their savings fell short of the inflation rate, reducing the real value of those savings (134). Brown explains how QE and repressed interest rates have also led to nonproductive investments and stagnant real (inflation-adjusted) wages.

During the pandemic, the Fed launched QE into overdrive, igniting a sharp rise in consumer goods prices. The question is: Why didn’t QE lead to significant consumer price increases before the pandemic? The first rounds of QE, Brown explains, were directed to Wall Street (investors), which inflated only asset prices, but “the Pandemic QE money surge was directed to both Wall Street and Main Street [ordinary consumers]. Thus asset prices continued rising, but now the inflation included the items Main Street spends money on: eggs, cars, rents, and everything else in the consumer price index” (143).

In addition to asset and consumer price inflation, the Fed’s bad money creation has enabled massive growth of the national debt. “By monetizing much of the new debt and sending interest rates to rock-bottom levels,” Brown observes, “the Fed dissolved the customary link between taxing and spending, making the new debt feel painless” (148). Brown examines not only the government’s current debt but also its unfunded liabilities. He concludes that it is simply impossible for the government to meet all its future financial obligations. A sound path forward must include cutting entitlements, such as Medicare and Social Security, as these programs, absent any changes, will comprise an ever-growing share of the federal budget in the future. But this is unlikely to happen for political reasons. Brown quotes former European Commission President and Luxembourg Prime Minister Jean Claude Juncker: “We all know what to do. We just don’t know how to get re-elected after we do it” (174).

The federal government, according to Brown, will most likely impose a mix of policies that result in “financial repression,” which Brown defines as a “combination of high inflation and low ‘real’ [inflation-adjusted] interest rates” (171). Along with higher taxes, these policies will directly and indirectly transfer wealth from individuals to the government. High inflation will reduce the real value of the government’s debt, but it also reduces the purchasing power of everyone who holds dollars. Given this bleak prospect, Brown devotes the last chapter to discussing investment strategies for defending oneself from financial repression.

The book also has three appendixes, the last of which is particularly important. Brown explains that economist Richard Werner conducted an experiment in 2014. This experiment, according to Brown, “proved the credit creation theory empirically and inductively” (275). Werner simply took out a large loan from a small bank, then analyzed the bank’s balance sheet before and after the loan. Surprisingly, no economist had ever done this before. The result of this experiment, Brown shows, “match only the credit creation theory, and do not match either the fractional reserve theory or the intermediation theory” (290).

I found it odd that Brown relegates this discussion to an appendix. Considering that most people, as he points out, strongly resist the credit creation theory when they first hear it, I think it would have made more sense to include the purported proof of the theory in or right after chapter 2, where he explains the theory in detail.

Another quibble I have is that, when discussing the problems of QE, Brown refers to “unjust economic inequality.” In using this phrase, he says that he is “not referring to the normal differences in income and wealth that occur in a free market due to differing preferences, ambitions, and abilities”; rather, he is referring to the “injustices that occurred due to the central bank’s policy of funneling free money specifically to the investor class” (134). Although Brown correctly identifies the winners and losers from QE, framing this in terms of economic inequality is a distraction. QE isunjust because it coercively benefits some people at the expense of others, violating their rights. Whether this happens to increase or decrease economic inequality is irrelevant.

Despite these minor criticisms, A Black Hole in Economics: Money Creation and Its Consequences is a superb book. Brown cogently explains the various theories of money and banking in a way that is accessible to intelligent nonexperts. Although some readers might struggle with the technical passages regarding bank balance sheets, I think Brown explains this material in the simplest way possible. If you want to learn more about how money is created, its economic effects, the national debt, financial repression, and more, this book is for you.

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Glossary of Terms

• Cash (standard money) is the primary form of money. It is accepted as full and final payment and is not a claim to anything further. Under the current monetary system, physical dollar bills and coins are cash.

• A central bank is a government-privileged bank that is granted the exclusive authority to create cash, the primary form of money. The central bank of the United States is the Federal Reserve.

• A commercial bank is a private financial institution that creates new money, not in the form of cash but in the form of promises to pay cash (fiduciary media).

• Fiduciary media are secondary forms of money. Created in commercial banks, fiduciary media are promises to pay cash, such as checks and credit.

• Money is a commonly used medium of exchange, which includes both cash and promises to pay cash.

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This article appears in the Summer 2025 issue of The Objective Standard.