Understanding where money comes from and applying credit creation analysis to portfolio management
Submitting InstitutionUniversity of Southampton
Unit of AssessmentBusiness and Management Studies
Summary Impact TypeEconomic
Research Subject Area(s)
Economics: Applied Economics, Econometrics
Commerce, Management, Tourism and Services: Banking, Finance and Investment
Summary of the impact
Research carried out at the University of Southampton into banking,
economic growth and development has made Professor Richard Werner a
trusted source of advice for economic policy-makers at the highest level,
for example for the Financial Services Authority, the Independent Banking
Commission, the International Monetary Fund and the Bank of England.
Through articles, books and many media contributions, he has promoted a
greater public understanding of economics and the financial crisis. His
credit creation analysis has also been adopted by two investment funds in
their portfolio management, leading to financial gains for investors,
outperforming the FTSE100.
The financial crisis has given a jolt to policy-makers and researchers,
triggering a new consensus that it is necessary to include the banking
sector in macroeconomic models. Developing such a macroeconomic model —
that distinguishes between the type of credit that boosts GDP and credit
that is associated with asset prices and banking crises — has been the
focus of the research conducted by Richard Werner, since 2004 at the
University of Southampton Management School (since 2005 as Professor of
International Banking) [3.1, 3.2, 3.7]. The research has led to
the development of Werner's "credit creation approach" to banking policy,
as well as asset allocation and portfolio management [3.8, 3.3].
Werner's research at Southampton has focused on the link between the
financial sector, in particular the banking system, and economic growth
and development, and has been framed by his Quantity Theory of Credit
(QTC) [3.1]. Based on a combination of analytical and empirical
research (financial data gathered from international banks, formal and
informal interviews with bankers and investors) Werner's theory posited
that banks are not merely financial intermediaries that allocate
pre-existing financial means, but operate as creators and allocators of
new money, producing about 97% of the money supply. Werner's findings
include the insight that when a `bank loan' is granted, banks credit the
asset side of their balance sheet with the value of the loan contract and
credit the borrower's account with the loaned money — while in fact not
transferring any existing money to the borrower's account. The deposit in
the borrower's account is a `fictitious deposit', but indistinguishable
from genuine deposits that are used to settle transactions [3.2]
This bank credit creation may increase overall market risk and volatility
[3.4, 3.8], depending on the use the funds are put to (productive
real credit vs. unproductive financial credit) [3.1, 3.5, 3.6].
This research resulted in many important policy implications, including in
banking policy, regulation, monetary and fiscal policy, as articulated in
Based on QTC, Werner applied his credit creation approach to portfolio
management, by linking credit creation data from 38 countries to the
future direction of equity, bond and currency markets [3.3].
Werner then combined the strength of each signal with the past track
record of the model in each asset class and country. This information was
then applied to obtain concrete portfolio weights for each position in a
diversified international portfolio (equities, bonds and currencies).
These were then implemented and monitored as part of Werner's research.
During 2007-08 Werner fine-tuned this approach (to include shorting) and
has since 2008 employed this method in the management of UCITS
(Undertakings for Collective Investment in Transferable Securities) funds.
Werner found that the credit creation approach is effective in improving
models that aim to forecast nominal GDP, equity markets, long-term
interest rates (bond markets) and exchange rates. An examination of the
fund management track record revealed that funds using this credit
creation approach produced competitive returns at lower risk [3.3].
References to the research
3.1 Richard A. Werner (1997). Towards a New Monetary Paradigm: A
Quantity Theorem of Disaggregated Credit, with Evidence from Japan. Kredit
und Kapital (Credit and Capital Markets), vol. 30, no. 2, pp.
3.2 Richard A. Werner (2005). New Paradigm in Macroeconomics:
Solving the Riddle of Japanese Macroeconomic Performance,
Basingstoke: Palgrave Macmillan, 2005 (print run 1,950 in the UK and
15,000 in Japan).
3.3 Richard A. Werner (2008). Credit Creation: Its Role in Asset
Allocation/ Alpha Generation and Implications for Risk Management, paper
presented at the Nomura Global Quantitative Strategy Seminar, 28 January
2008, Nomura House, London (Evidence of quality: Commissioned seminar paid
for on a commercial basis by one of the largest investment houses in the
3.4 Richard A. Werner (2009). Understanding and Forecasting the
Credit Cycle — Why the Mainstream Paradigm in Economics and Finance has
Collapsed, QFinance, London: Bloomsbury. Available at
(Book with online free version; high impact, record downloads)
3.5 Richard A. Werner (2011). Economics as if Banks Mattered — A
Contribution Based on the Inductive Methodology, Manchester School,
vol. 79, September, pp. 25-35. DOI: 10.1111/j.1467-9957.2011.02265_5.x (3*
journal in the ABS quality guide).
3.6 Lyonnet, Victor & Werner, Richard (2012). Lessons from the
Bank of England on `quantitative easing' and other `unconventional'
monetary policies. International Review of Financial Analysis, 25,
94-105. (3* journal in the ABS quality guide).
3.7 Richard A. Werner (2012). Towards a New Research Programme on
`Banking and the Economy' — Implications of the Quantity Theory of Credit
for the Prevention and Resolution of Banking and Debt Crises,
International Review of Financial Analysis, 21, 94-105, doi:
10.1016/j.irfa.2012.06.002 (3* journal in the ABS quality guide).
3.8 Richard A. Werner (2010). Towards Stable and Competitive
Banking in the UK — Evidence for the ICB, Formal response to the Call for
Evidence by the Independent Commission on Banking (ICB), 15 November 2010,
originally published on the ICB website, available as CBFSD Policy
Discussion Paper No. 3/ 1-10, University of Southampton Centre for
Banking, Finance and Sustainable Development, at
Details of the impact
The financial crisis has provoked intense interest in how economies and
financial systems work. Werner's research has actively engaged with this
issue from the highest level of policy-making to the general public.
Werner's book New Paradigm in Macroeconomics (2005) has sold
17,000 copies in its English and Japanese editions. Tobias Hoschka, Head
of Asian Research at McKinsey and Company called it "A must read for
economists and finance professionals." [5.1]
His other book Where Does Money Come From? (first edition 2011,
second edition 2012) has sold 3,300 copies so far and is now
included as a core text on a City University undergraduate banking and
finance course. [5.2] Professor David Miles of the Bank of
England's Monetary Policy Committee said "The way monetary economics and
banking is taught in many — maybe most — universities is very misleading
and what this book does is help people explain how the mechanics of the
system work." [5.2] The book has been widely cited in the press,
including by the Financial Times (20/1/13).
Werner's work has also been used to manage two award-winning UCITS
investment funds. In 2008, Profit Global Macro Fund AGmvK and Global Macro
Trust [5.3] were formed and adopted the latest version of Werner's
credit creation methodology as the core element of their portfolio
management. In terms of cumulative monthly returns, performance for both
funds between June 2008 and December 2012 has been as good or has exceeded
those of FTSE100 and HFRI Fund of Funds Index [5.4]. This has led
to financial benefits for investors — recognised in 2009, when Profit
Global Macro Fund won silver in the 'Global Macro SHF: Germany Hedge Fund
Award' [5.5] and its 2012 naming as a 'Top 10 UCITS Macro Hedge
Fund' [5.6]. In 2013 Global Macro Trust was shortlisted for an
'HFMWeek European Hedge Fund Performance Award' [5.7].
In November 2010, Werner submitted evidence based on his QTC to Britain's
Independent Commission on Banking (ICB), pointing out the need for bank
regulation to reflect the role of banks as creators of the money supply [3.8].
The ICB recommendations formed the basis for UK government policy on
banking reform. HM Treasury has confirmed that ICB Commissioners paid
attention to Werner's evidence and that "the final report was informed by
Mr Werner's submission amongst others" [5.8]. Werner had
previously been in touch with Treasury in order to influence policy [5.9]
Werner's work on credit creation is heavily cited in 'The Chicago Plan
Revisited', the 2012 International Monetary Fund (IMF) report arguing that
banks should no longer be allowed to create new money in the form of
credit in connection with their lending activities [5.10]. This
IMF paper has been much cited in the national and international media,
such as in the Daily Telegraph on 21 October 2012.
Werner organised the first European Conference on Banking and the Economy
(ECOBATE 2011) with Lord Adair Turner, Chairman of the Financial Services
Authority and ECOBATE 2013 with Vince Cable as keynote speakers. Each
conference was attended by over 200 members of the public, local business
and government representatives, policy activists and politicians, and has
called for specific changes to bank regulation policy. Lord Turner has
confirmed that Werner's work has been an important influence on FSA policy
and on the deliberations by the international Financial Stability Board,
both of which Lord Turner chaired from 2008 to 2013. [5.11]
Since 2011 Werner has been a member of Handelsblatt's 'ECB Shadow
Council' — a forum of 15 top European economists whose views on monetary
policy decision are regularly published in the paper, which also nominated
him as one of four `economists of the year' and frequently cites him [5.12].
Leading UK economist Tim Congdon compared Werner and his invention of
`quantitative easing' to Keynes (Economic Affairs, October 2012).
Recent articles by Werner were published in The Financial Times
(5/3/2013), The Economist (15/06/2013, 1/07/2013, 14/09/2013), The
Guardian (10/2/2012, co-writer Caroline Lucas MP), The Central
Banking Journal (10/5/13, with subscribers in 130 countries, 120
central banks) and Frankfurter Allgemeine (10/9/12 and 4/10/12) [5.13].
His research has been cited, among others, in the Daily Telegraph
(26/10/2012, 17/12/2012, 22/01/2013), profiled in South Korea's JoongAng
llbo daily newspaper (2/12/2009), Greece's Naftemporiki (5/09/2011)
and Boerse Online, one of the largest-circulation German
stock-exchange journals (25/11/09). His contribution to QFinance is the
most widely read in the volume [3.4]. His YouTube interviews have
received over 34,300 hits in total (2011-07/2013) [5.14]. Werner
is regularly asked to comment on economic news including UK Banking and
Regulation (BBC News, 2/8/12 BBC World Service 30/8/11), Quantitative
Easing (The Guardian 12/07/12, Fundweb 13/4/12) and the LIBOR probe
(Bloomberg, 26/6/12, 2/3/12 and 21/2/12). His professional publications
influence thinking in the business world (Chartered Banker, June 2013;
Local Council Review, Summer 2013).
The Bank of England's `Funding for Lending Scheme' of 13 July 2012 was
predicated on a core tenet of QTC, as it aims to "incentivise banks... to
boost their lending to... the `real economy' " (BoE Quarterly Bulletin
2012Q4) [5.15]. Only Werner's work had previously argued for such
a disaggregation of bank credit, and the Bank used the same method to
calculate the data series defined as `credit for the real economy' as
Werner had recommended for the UK [3.5] and submitted to the Bank
in July 2011.
Sources to corroborate the impact
5.1 Comments available at www.palgraveconnect.com/pc/doifinder/10.1057/9780230506077
5.2 Comments by Professor David Mills available at: http://www.neweconomics.org/blog/entry/the-big-questions-on-money-and-banking-we-should-all-be-asking,
and book available from www.academia.edu/2344025/Where_does_money_come_from_A_guide_to_the_UK_monetary_a
5.3 Corroborating contacts: Former MD., Pictet Private Management
Ltd., Tokyo Branch Manager; and Partner, Focus Asset Management, Munich.
5.4 In public domain: data series on portfolio management
performance available at news and data services, including Reuters and
Bloomberg. Bloomberg LLP codes: CSPGMTR AV Equity (Global Macro Trust);
PGLOBMC LE Equity (Profit Global Macro Fund). Available to view on
request: Fund performance charts showing outperformance of Global Macro
Trust, Profit Global Macro Fund and the Bear Stearns Global Alpha funds of
the FTSE 100 index, which adopted the methodology.
5.5 Certificate showing Profit Global Macro Fund won the Silver
award in the "Global Macro SHF" Category; Germany Hedge Fund Award,
5.6 Email: from Partner, ALIX Capital SA confirming Profit Global
Macro Fund appears in the report cited (In addition, the reports
themselves are published at http://www.alternative-ucits.com/page-report.html,
this refers to Q1 2012 which shows outperformance of first fund — in the
first quarter 2012 there were approx. 800 UCITS funds and a total of 120
billion $ in assets under management)
5.7 Email: from Pageant Media, announcing that Profit Global Macro
Fund had been chosen as a top performing fund in the HFM European
Performance Awards 2013.
5.8 Freedom of information request response: from Office of George
Osborne MP, Letter from Chancellor Osborne. www.whatdotheyknow.com/request/93078/response/235294/attach/3/document2011%2012%2012%20182448.pdf
5.9 Letter: from Chancellor of Exchequer
5.10 'The Chicago Plan Revisited' report available at www.stanford.edu/~kumhof/chicago.pdf
5.11 Corroborating Statement: Lord Adair Turner
5.12 Handelsblatt: www.handelsblatt.com/jahreswechsel/jahreswechsel-das-war-2011/oekonomen-des-jahres-die-nominierten-richard-werner-der-krisenexperte/5997422-3.html
5.13 Financial Times: www.samachar.com/Hitchhikers-guide-to-monetary-infrastructure-ndgeNUedcij.html;
Central Banking: www.centralbanking.com/central-banking-journal/feature/2266660/the-case-for-nominal-gdp-targeting-by-central-banks;
5.14 Reference to YouTube hits available at: http://the-free-lunch.blogspot.co.uk
5.15 Bank of England Summary of Quarterly Bulletin 2012 Q4 www.bankofengland.co.uk/publications/Pages/quarterlybulletin/n12.aspx