As I have explained before*, QE won't work in the UK as numbers on bits of paper are being shuffled between the commercial banks and two departments of HM Treasury (the Debt Management Office and the Bank of England) in a closed loop.
In the USA, the government is actually giving the banks new money, by buying bad and doubtful loans off them for rather more than market value. Karl Denninger has explained at length that this is a massive fraud, pure and simple, but even assuming it were done with the best of intentions and at market value ...
The mainstream belief is based on the erroneous belief that the banks need reserves before they can lend and that quantitative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves.
This is the text-book conception of the world and parades as the money multiplier theory. It is taught – to their disadvantage – to all undergraduate students in economics. It is an exercise in deceptive brainwashing. The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualization suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.
But bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).
The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves. The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached.
Via HPC.
* The comment thread is very lengthy, in which The Fat Bigot, Umbongo and I try to explain to DBC Reed how it works, but none of us managed to formulate it quite this snappily.
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10 comments:
Rather than not so snappily,none of you was putting anything like
Karl Denniger's thesis.Mark Wadsworth was advancing the proposition that bank loans were always backed by deposits with the banks acting as middlemen: the TFB depicted the happiest of all worlds where the banks were but the "little people's" wishes made reality with wonga.
Denniger's "Banks lend to any creditworthy customer they can find and worry about their reserve position afterwards" is precisely the argument I was advancing,albeit I was saying they did n't care about how much they had on deposit at all (let alone in reserve).Denniger is also talking about fraud which must give the resident (or atleast embedded) experts the vapours,since they represent the banks as the people's champions against the State.
DBC, what I said on the previous thread was "For every £1 extra loan to a borrower that a bank 'creates', it must simultaneously 'create' £1 extra in deposits, it always nets off to nil."
I fail to see how that is in any way different to what I posted today.
The fraud to which karl D refers is not some general fraud perpetrated by bonus hungry bank employees (although he is in two minds about if), but the specific collusion between the US Administration and their chums at the big banks, which is a slightly different topic.
I'm not sure this is confusing the issue (or just confusing myself) but I understood (probably from "Our Island Story") the history of the way banks "create" money quite simply as follows:
The first modern bankers were goldsmiths who, by virtue of their profession, were adept at keeping their gold safe. When the public realised this they started to deposit their gold with the goldsmiths in return for a receipt: the receipt stated that the depositor of the gold could get his gold back immediately on submission of the receipt. Two implications became quickly apparent: 1. since gold is fungible, the goldsmith only needed to return "gold" not the depositor's actual gold; 2. if the goldsmith had a good reputation his receipts could be used by the owners of the gold to pay their debts using the receipts rather than going to the goldsmith, withdrawing their gold and handing it over to the creditor (who would, most likely, deposit the gold back with the goldsmith in return for a freshly issued receipt).
I hope you see where we're going here. It became obvious to the goldsmith that he didn't need to hold all the gold deposited with him against the possibility of the depositors wanting their gold back. Accordingly, he - the goldsmith - could lend out a portion of the gold at interest thus getting a return on the gold in his vaults. Of course, the goldsmith soon realised that there was no need to lend actual gold. All he needed to do was issue receipts or, at least, a promise to allow the bearer of the "receipt" to draw gold. If he got it right, he could issue far more receipts than he had gold although he had to have a reserve of gold to give to those who demanded it. In time the receipts became what we know as banknotes. Accordingly, at any time there were far more receipts in circulation (or deposited for safe keeping at other goldsmiths/banks!) than there was gold in the vaults. Hence the goldsmiths had created money since the receipts were "money".
Today money - narrowly defined - consists of cash plus bank deposits. This is one side of a bookkeeping equation: a bank "creates" money by creating a bank account against which the borrower can draw. This is "money" but it is only one side of the bank's books: the borrower's account (as it's drawn down) creates an increasing asset of the bank (a debit) but the balancing credit is the deposit of those who are paid by the borrower and redeposit the money at the bank. In other words, money is created but a balancing liability (actually "anti-money" to the bank) is created at the same time.
In other words, the bank's created what is effectively money but the "anti-money" is not brought into consideration in the definition of money. Has this squared the circle?
Mark, perhaps you could explain who benefits from QE. Then things might be clearer. Or is it simply a case of "something must be done; this is something: let's do it"?
U, excellent summary, especially the point about money and anti-money.
B, in the UK, the banks make a small margin on it (but a small margin on a colossally huge sum is still a lot of money) and presumably govt ministers are hoping to "do a Tony" and retire on a nice non-exec job with a bank next summer*. Apart from that, it is sheer blind stupidity** and a desperate desire to keep the house-price bubble inflated.
* The corruption is far more rampant in the US.
** Anybody who knows anything about Japan ought to know it be ineffectual at best and damaging at worst.
@umbongo
Can't imagine what anti-money is,but the standard account of bankers holding gold for people,issuing promissory notes so depositors could pick up gold in distant cities without the dangers of carrying it,then these notes being exchanged as money and then the bankers issing more notes than they had gold is precisely the argument Marshall Auerback is developing (dunno where MW picked up the name Karl Denninger).He's saying that things have now got so bad that the banks do n't check whether they've got any reserves (or "gold in the bank") whatsoever; they just issue cheques as loans and scrabble round the LIBOR market to get a bit of reserve money together (2%)at the end of the day.
I have been saying that the banks have been creating money( which they call loans but are entirely new sums ) and throwing it around minimally constrained by a 2% reserve ratio.Now Auerback is saying that they are not even constrained by that.Fair enough.
(He is not right because they did have to borrow the money interbank every day but the system collapsed because banks suspected their colleague banks could n't pay it back.Remember the concern about the high Libor rate?)
Mark and his supporters seem blissfully unconcerned that the banks control the money supply and increase it ad lib unconcerned even by the laughably low reserve ratio (which is not legally compulsory in the UK :what a surprise).
There is not much point continuing this discussion because it cannot develop on a thesis, antithesis, synthesis basis when the defenders of the banking status quo cannot see that there is an antithesis or that there is anything systemically wrong with the perfect system we have been blessed with.
QE was never about increasing the amount of money in the economy, or increasing credit, it was designed to endure that Labour could run an unprecidented peacetime budget deficit without running into the bond market/sterling crisis that would otherwise have ensued.
The final amount of QE will be approximately the same as the budget deficit for 2009/10, and will ensure that any crisis will fall outside Labour's term of govt, thereby allowing them to blame someone else.
Simple as that. Pure party political self interest, ahead of the national interest. Or treason, as I call it.
DBC "Can't imagine what anti-money". If you owe me a tenner (and we assume you will pay it) then I have £10 in 'money' and you have £10 in 'negative money'. Equal and nearly opposite (the debt weighs more heavily on you than the benefit to me). When you repay me the tenner, both 'money' and 'anti-money' cease to exist.
I am puzzled why you would include me among the "the defenders of the banking status quo" as the system is clearly quite shit. That has nothing to do with the fact that I understand how it works in non-emotive terms.
Sobers, that is only true at the margins. Lunatic government borrowing is a quite separate issue to QE, and something which has major, negative impact. I have never disputed that either, before somebody accuses me of being a "defender of the lunatic government deficit spending status quo".
"B, in the UK, the banks make a small margin on it (but a small margin on a colossally huge sum is still a lot of money)"
So it's just another way for the gov't to put lots of public money into their friends' pockets and sod the consequences. That would explain it perfectly as far as I am concerned.
Despite Mr Reed's insulting parody of the position I put forward towards the end of the other thread, I am happy to see that Mr Denninger supports what I said.
Banks can only lend if there are willing borrowers. Whether banks lend to them is only a consideration once the borrower comes along and says "please lend". It is a process driven from the bottom up.
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