Sunday, 7 February 2016

Private banks and credit creation: if you make it seem complicated, you just create loopholes.

By Prof. Steve Keen at Forbes:

The great tragedy of the global economic malaise is that it is caused by a shortage of something that is essentially costless to produce: money.

Both banks and governments can produce money at physically trivial costs. Banks create money by creating a loan, and the establishment costs of a loan are miniscule compared to the value of the money created by it—of the order of $3 for every $100 created.

Governments create money by running a deficit—by spending more on the public than they get back from the public in taxes. As inefficient as government might be, that process too costs a tiny amount, compared to the amount of money generated by the deficit itself.

But despite how easy the money creation process is, in the aftermath to the 2008 crisis, both banks and governments are doing a lousy job of producing the money the public needs, for two very different reasons.

Nope. Let's split this up into two separate cycles.

1. His description of how governments create money is broadly correct, but government spending should be judged on its own merits, not on how much 'money' it 'creates'. Government debt is a necessary evil, but it can be put to good use as a) a handy unit of currency and b) somewhere for people to put their savings/surplus => full reserve banking.

2. And there are private banks. Strictly speaking, they hardly create any new money. Most of so-called bank lending is nothing of the sort, they are just glorified debt collectors - they collect debts from buyers of land on behalf of sellers of land.

Simple scenario: Mr B agrees to buy land and buildings from Mr S for £100, which Mr A does not have in ready cash.

If Mr B takes out a mortgage of £100, Mr S gets credited with a deposit of £100. These pop up on opposite sides of the banks' balance sheet. Mr B has to pay that off in instalments over twenty years and Mr S can withdraw up to £100. But all depositors taken together cannot withdraw all their money at once and spend it. Collectively, they cannot withdraw their money any faster than all the mortgage borrowers are paying it in.

But there is no need for a bank. They could agree that Mr B will simply Mr S in instalments over the next twenty years. If Mr B defaults, then Mr S would take him to court, repossess the land and buildings, or employ a debt collection agency/firm of solicitors to enforce payment, by fair means or foul. Pretty much the same as what a mortgage bank would do.

So ultimately, what is the difference between banks and debt collection agencies? Not much. The added extra which banks provide is a risk-pooling exercise/insurance, so if Mr B's loan goes bad, Mr S only has to bear a tiny percentage of it; similarly, Mr S has to bear the same tiny percentage loss if other buyers' loans go bad. No doubt a debt collection agency could offer the same service.


Antisthenes said...

He is wrong on another point. Central banks have expanded money and credit far too much to give the illusion of prosperity which was the object. Of course they have side effects they cause malinvestment and asset inflation. No high street inflation gladly but Corbyn would change that with his helicopter money idea by introducing PQE.

Mark Wadsworth said...

Anti, agreed but it's a game of two halves. Do governments deliberately run deficits in order to create the illusion of private wealth or do they do it as a means of shuffling money to their friends and families (with just enough vote buying to keep them in power)?

I mean, which is more correct a) or b)

a) are debts the aim and bad spending the means to an end, or
b) is bad spending the aim and government debts the inevitable result?

I find it easier to identify bad spending than to discuss the knock on effects of government deficits (these are not entirely bad, just largely bad).

Antisthenes said...

MW. I am not sure about bad spending although that features heavily it was more to do with pushing spending onto to riskier assets. One thing is certain though it is a policy that will cause the next bust when credit and money supply is tightened or some other event triggers it. I am worried though that the next bust will be the last and there will be no subsequent boom as the tools for recovery are in very short supply as they have been largely used up fighting the last bust.

Lola said...

MW. 'Creating money' as the Prof seems to advocate fails absolutely because he is advocating getting something for nothing. He appears to have absolutely no clue at all about what money is and how it works.

Mark Wadsworth said...

Anti, yes, if the government is lending to banks and lending on risky, overpriced or non-productive assets (Help to Buy) at artificially low interest rates, that skews the economy towards gambling and rent seeking => even bigger bust next time.

But even that is looking more at the spending side, i.e. where does the money go. This is a separate topic to deficits - the government could bring the books into balance by slashing sensible spending i.e. shut down the NHS and state schools, while still merrily propping up banks and land prices.

L, I also get that impression :-(

Antisthenes said...

MW. Fiat money is the worst medium for voluntary exchanges in society and is next to worthless. The promise to pay written on the bank notes is no promise at all as there are not 100% of assets to cover them. It can be manipulated up or down by government when ever it wants and not when society wants it to be. Governments have no business interfering in markets be it housing, money, credit and all the others that it distorts so brazenly with little benefit to anyone especially ordinary people in the long run.

Slashing spending would be very easy if it removed it's fingers from all the pies it currently has them in and so would not have to affect essential services that it provides. Such as the police and military most other things like the NHS, Network Rail could and should not be provided by government but by the private sector. A whole swath of quangos and public sector bodies could go.

If only we would all wake up to the fact that government as a provider is the worst of all possible solutions. It is useless at nearly everything it does. Unfortunately we cannot do away with government altogether yet(some day I believe it will be possible) some things only they can do as no one else will.

Lola said...

A. What defeats me is why people ever trust any government.

Mark Wadsworth said...

Anti, in practice, fiat money is the best kind of currency. All the theory says it isn't, but it just "works" surprisingly well. The point is that even if there is nothing behind them, you can use them to pay your compulsory tax bill. Practice trumps principle (sadly or otherwise).


Let's assume that I provide a valuable service and instead of charging £100 cash for services worth £100, I demand one sea shell of a certain shape, size and colour. Those sea shells might be inherently worthless, but will suddenly will be worth £100.

Now let's assume the government charges you income tax of one shell for every £500 you earn instead of 20% income tax in cash. The shells are worth £100 each.

See also: rationing vouchers sold on the grey market.

L, because people do, they have no choice and no alternative, and most governments are preferable to anarchy which is usually followed by an even worse government/dictatorship.

Bayard said...

So much for all this wailing about banks creating money by "splitting the zero" and how it should be banned. Are not Messrs B and S doing exactly the same thing?

Bayard said...

"The great tragedy of the global economic malaise is that it is caused by a shortage of something that is essentially costless to produce: money."

I can't see how this could possibly be true.

Dinero said...

All the deposits can be withdrawn and spent at once if they are spent with other deposit account holders in the banking system by cheque or electronic transfer. Transfers by cash would be slightly different but not fundamentally different.

Lola said...

MW. Don't agree. Yes, you need government, a minarchist government being the least worst IMHO, but you don't have to trust it. Not the same argument. In fact better not to trust it. Give anyone, well except me and thee, obviously, the power of coercion and the monopoly of 'legalised' violence and it goes to their dear little heads.

My old man always said to me 'Officers. Don't trust them. They get you killed'. Same principle.

Mark Wadsworth said...

B: "Are not Messrs B and S doing exactly the same thing?"

Yes of course. Mr S is giving Mr B credit, the same as if a bank stepped in as intermediary.

Din: "All the deposits can be withdrawn and spent at once…"

Yes of course. In which case, Mr S is saying to the car manufacturer from whom he just bought a nice new car for £20,000 that the bank will collect £20,000 from Mr B on the car manufacturer's behalf. The car manufacturer cannot withdraw and spend the money any faster than Mr B pays it in.

L, hooray for small government of course. As to 'trusting', that's a philosophical question. Do I trust the weather? No. Do I have to accept that the weather is there and does what it wants? Yes.

DBC Reed said...

Oh dear, the argument that commercial banks don't in fact create money by making loans goes on ,like the Japanese soldiers still sniping from the hills years after the war is over.Steve Keen is right;its time to surrender to reality.

May I suggest a truly libertarian scenario? In my youth working people were free of the banks : the got paid in cash and paid for accommodation in cash to rent collectors or local building societies .Their liberty was eliminated by a conspiratorial, non parliamentary movement, to make everybody be paid by direct credit to a bank account and by abolishing the Truck Acts that enforced payment in cash. Now all their money belonged to the banks, since bank accounts are the bank's property and not the customers'.

Then building societies, with their 100%, not fractional, reserves, were sidelined in favour of banks so all the aggregated money got fed into the vast financial jiggery pokery machine that produced Collateralised Debt Obligations that crashed the international system.

Lola is haunted by American B movies about RED INVASION but the Banks are already in control: they own the means of creating the money supply; they own people's bank accounts ; they own people's mortgaged houses. When banks get into trouble: the proles must pay to bail them out, or else!

The alternative is either to go back to the 1950's when only posh people had back accounts or nationalise the banks ,so that the State Violence at present being visited on the poor by Austerity in aid of the banks is instead visited on the banks in aid of the poor.

(Its actually in the Banks' interest to support LVT because this will prevent recurrent crashes caused by their overinvestment in real estate. But they can't be bothered.)

Lola said...

DBCR. Bit muddled, old mate. I'm with you on getting paid in cash money. The demonisation of cash by the state and the banks is precisely for their convenience. Viz, if the police for whatever reason stop you and find you're holding lots of cash they will likely confiscate it until you can prove where you got it. Eh? Why?

We also agree about the banks owning the money supply and all that follows on from that.

But not trusting governments is the practical realistic attitude to have. The Bible agrees - 'Put not your trust in princes'; Psalm 146:3-5

DBC Reed said...

@L The Bible is full of unhelpful advice as, in "Render unto the Banks those things that are the Banks" (This is not necessarily an exact quotation).
Anyway, the Princes nowadays are the banks:I am calling for a return to Adamic innocence where people keep their own money to spend unseduced by the banking serpents.And what happened when they were bunged out of Eden? We were all damned to work miserably from here to eternity.

Lola said...

DBCR "Render unto Caesar the things that are Caesar's, and unto God the things that are God's" is the line. That's about God and Man. I think it is quite helpful advice. Another goody is 'My yes is my yes and my no is my no'. which I quote it to the FCA and all the other bureaucrats that inflict themselves on me and my customers in regards to their fatuous 'loyalty oaths' ( ). The yes is my yes meme is what the Quakers use about oaths.

You know full well that I (we on here?) all consider that the Government/Central Bank/Nationalised Mint/fiat money/commercial banks nexus is the foundation of pretty well all our ills. It's just that I hold that a free market solution is the best and you (I think) hold that a central planned socialist solution is the best.

DBC Reed said...

@L I do know the quote: was just taking the piss (What is the Bible for but to reinforce sketchy arguments?)

Anyway the instruction to pay taxes to a foreign Imperial power which the Son of God is proposing here, does not accord with his generally liberalising mission.Does rather suggest that we should cheerfully pay taxes to be enslaved by colonialists and take comfort in the greater riches of being on good terms with God on a "You'll get pie in the sky when you die" basis.

I do not see anything conducing to more wealth and freedom in the onward march of free markets: since Thatcher and the boy genius started pushing back the frontiers of the State things have gone from bad to worse. We now have a centrally planned bankers' solution to everything with wholesale bribery of the electorate through land price inflation.

I admit free markets plus LVT could work but free market economists and politicians are more hostile to LVT than Socialism, it would appear.

NeilW said...

"But all depositors taken together cannot withdraw all their money at once and spend it."

Yes they can. Because when you spend money, all that happens is that the ownership tag changes on the deposit. It doesn't actually move on the bank's balance sheet, and certainly not on the aggregate balance sheet of all banks.

You're confusing a stock and a flow. It is the flow that creates economic activity. The creation of bank loans - whether against existing collateral or against potentially new collateral of a new business stream - just increases the amount of deposits that can be in flow concurrently. It saves us all stalling waiting for the same £10 note to reach us so we can clear all the payments.

The two sides of a bank's balance sheet flow independently and are dynamically stable in their own right.

Similarly the idea that you can stop banks creating money or for that matter anybody else in the economy is based entirely upon a misunderstanding of how credit works. It cannot be done, and attempts to do it control nothing. Hence why bankers chuckle quietly to themselves at sovereign money fanatics:

Lola said...

DBCR. Thatcher was about 'free markets' - to a greater degree than the Tories and Labour. But what she started has morphed in crony corporatism all sitting under an bureaucratic central planning interventionist proto-nationalising agenda. It's all of a piece. What we do not and have not had, certainly since 1997, is 'free markets'. It's is precisely the lack of liberty, markets, sound money (the crony 'bankster' bit we agree on) and the unremitting failed interventions of central planning bureaucracies that is in large part why we are in the mess we now find ourselves.

Andy Blatchford said...

'Free markets' Never has been never will be (bit like communists saying the Soviet Union wasn't pure communism...the same thing argument really, utopian nonsense) the so called 'self regulating markets' which is what you really mean failed in the late 19th/early 20th Century.I refer you to the excellent The Great Transformation by Karl Polyani.

Lola said...

@AB. well, no. For a start it's not really 'free markets'. it's freedom and markets. Which arrangement has delivered more wealth to more people than any other arrangement, ever.

As far as I know there was no 'market failure' in the period you quote. What screwed markets in that period was things like the creation of the Fed and WW1 - neither being the work of 'markets.

In any event markets do not generally fail. What people think of as failure is mostly because markets have not yet or cannot ever work out how to price something - the 'externalities thingy.

I have not red Mr Polyani. But I will look him up.

Lola said...

AB. I have just read this
If Mr Zaman's precis is accurate then Polyani's work reminds me most of the Nutrimatic Drinks Dispenser ( ) which, whatever drink you select, always delivers something that is almost. but not entirely, quite unlike tea. Polyani's ideas are similar in that they almost, but not entirely quite unlike economics.

It's mostly twaddle, but interesting in itself to help others develop their arguments.

Andy Blatchford said...

I suggest instead of a blog try actually reading the thing eh? Is that really the depth of your research "I read a blog"

'But not entirely quite unlike economics'
Funny that as Polyani was an Anthropologist so of course not 'entirely'like economics, but just shows the total arrogance of economists who ignore the other social sciences even though the economists are mostly wrong and quite obvious from anyone who actually works in a real business that it is nonsense. They have no idea how prices are set (and Austrian econ is even worse!) The gubmint did it...if you spend 5 mins in a large company then you will find equally as bad, those pesky people get in the way of your theology.

Bayard said...

@Neil Wilson "But all depositors taken together cannot withdraw all their money at once and spend it."

I think what is behind this sort of remark is a confusion between money and cash. Yes, if all the depositors in a bank wanted to withdraw their deposits as cash, then the bank would run out of cash, but that's not the same as running out of money.

You can't have a run on a bank without cash, which is another reason why abolishing cash is attractive to the plutocracy.

Dinero said...

Cash is central bank deposits written on a loose note.If a bank can borrow central bank deposits, it can get cash.

Lola said...

AB. I qualified my remark by saying that if the precis I read was accurate - you will recall. Are you saying that the synopsis was in error?

Nevertheless it is you and Polyanna that have no idea how prices are set. Economists do not ignore other social sciences at all. If you'd read anything else you'd know that. Or rather as you probably have read other stuff, how did you miss it?

And I beg to differ. It is exactly working in (or running) a real business - as I do - that is a practical test of not Polyanna.

As I said, the good thing about stuff like this is it helps refine one's arguments. Piketty, Mazzucato, Keynes (?) etc etc come up with all this stuff to try and find something else and when you start looking at it it's either contradictory, or confused, or selective or whatever. And then it trends into a cult.

I am sorry, son, but your man (assuming the precis is reasonably accurate) if just another semi nut job.

Andy Blatchford said...

"Have no idea how prices are set"

Well as I am a branch manager at a freight forwarder do think I have a good idea how they are set 'sunshine' cost + mark up do YOU set prices? It isn't an auction market mostly you know.

Andy Blatchford said...

If you do run your own business don't you find your model of how prices set runs against how you do it in real life? Your 'free market' stuff just runs into a wall with how things really work, mind you I don't expect an Austrian to have any grip on reality.

Lola said...

AB. Nope. That remark tells me that you absolutely do not know how 'prices' are 'set'.

Try again?

Andy Blatchford said...

Oh dear Lola busted...explain this link.

Lola said...

AB @ 23.11. Eh? What? (first sentence). Second sentence is just self contradictory. Free markets is precisely how things really work.

Lola said...

AB @ 23.14. OK. Explain how you derive mark up and discount percentages.

Andy Blatchford said...

Most prices are set by working out your costs and adding a mark up for profit. I generally add around 10% but it does depend on the customer, what they give me, how quickly they pay. What you don't realise is that completely destroys the laws of demand & supply, without that where does your 'free market' is best hold doesn't.

Lola said...

AB. And the 'discount' factor?

Andy Blatchford said...

Discounts come in for reasons I stated above, it 'depends' on what biz they give me, pay etc.
If you want an example ask for a tariff from DHL, UPS etc they have a general tariff but depending on amount of biz you give them they discount from that tariff. No market clearing price, so if no market clearing price where does that leave you? Well nowhere in the real world.

Lola said...

AB@ 23:36 Hahhahhahahahahaha. Market forces. Good night sweet dreams.

Andy Blatchford said...

"Market forces" lol off to ride free market unicorns eh...enjoy your fairy tales and I do hope they keep you comfy, meanwhile in the real world the adults will get on with it.

Dinero said...

The fact that "cost plus" pricing is used does not exclude market forces. Market forces establish the plus part and go towards part or all of the cost part.

Lola said...

AB. Son, you have a serious knowledge and logic problem. But, I have enjoyed learning about Polyanna of whom I was unaware.

Bayard said...

"If a bank can borrow central bank deposits, it can get cash."

Din, I think the problem is physical, not financial.

Bayard said...

"Most prices are set by working out your costs and adding a mark up for profit."

They may be in the business in which you work, but that does not mean that this practice is universal. Consider this, if all prices are set by "cost plus", what happens when the cost goes up? Does the price go up or the "plus" come down? If the price goes up and the customer is willing to pay the higher price for the same thing, why were you not looking after the owners of the business by charging that higher price in the first place?

The idea that all businesses work on a cost-plus basis and that all cost increases can be passed on as higher prices is a persistent myth. A widely-believed myth, it is true, but still a myth, for all that.

DBC Reed said...

Lola : Patronising or what? Andy Blatchford is giving examples from the harder, more physical, end of the spectrum of business activities
and you accuse him of subscribing to airy fairy theory.
The whole of the Austrian cult of market forces ( a totally abstract entity) is dependent on price discovery when ,in practice, prices are set by guesswork about what the market will bear.This is dressed up in any amount of theory by hired gun economists (Have Degree Will Travel) who follow the money by devising equations and algorithms which frighten people, whose minds were altered at an early age by an education system that taught them that numbers were incomprehensible .

Lola said...

DBCR. Yes. Unworthy of me. Knackered but that's no excuse.

Lola said...

DBCR. Also. "The whole of the Austrian cult of market forces ( a totally abstract entity) is dependent on price discovery when ,in practice, prices are set by guesswork about what the market will bear Precisely. And when the market won't 'bear those prices' what happens? They adjust. It's market forces. Price discovery. End of.

Dinero said...

the businessman exerts market forces on the supplier and thus upon the costs, when he chooses the supplier and his customers exert market forces on him , and thus upon the eventual markup, when they choose him.

MikeW said...

Andy B, DBCR above,

Looks like Lola has back tracked so I won't drone on. I agree Karl Polanyi is as important as you suggest. In some circles, there is a battle about who was the greatest intellect: historians say brother Karl, philosopers and scientists say brother Michael. Just Google this time!

I have dusted down my copy of the GT(2001) and Stiglitz gives a first class introduction for economists if you need one.

Rather than pretend that I have got every aspect of the book; for the folks here, I would suggest a modern text that can be seen to be 'embedding' economics in wider social and historical events that follows from a clear understanding of Polanyi's GT. Please read/ dust down, Debt: The First 5,000 Years by David Graeber!!! You will find 'Polanna' in his notes.


DBC Reed said...

Guessing a price at what the market will put up with does not begin to cover the complexity of price discovery.Things immediately get tricky when you have to guess future prices on the futures markets.Some poor souls have futures contracts to take delivery of crude oil now, on prices guessed many months ago.Likely outcome: wipe out.Price discovery is also a big feature of the securities game.How many price factors have to be taken into account with these slippery customers ? Too many for comfort.
No wonder there is alleged political, and hence State, interference in the evolution of future price levels.
BTW the generally "Georgist/ geolibertarian" cast of this site is based on cost plus profit. All we say, following Ricardo, is simply that costs when they include inflationary rents capture profits.

Lola said...

DBCR - Ricardo - 'all profits return to rents' - sigh. (Not meaning you. Just generally, 'sigh')

Random said...

The key point that everybody misses in this debate is that the fractional system and intermediation system both are trying to introduce a serialisation requirement into the banking system.

But *removing* serialisations from business processes happens because that allows things to operate in parallel in different departments. It is much more efficient to operate in that manner.

Banks are always fully funded and they maintain their deposits sufficient to cover their loans. But, importantly, they don't do that in any particular order. The lending and treasury functions are asynchronous and operate via a slush buffer and a price determination.

Since lending takes longer than obtaining deposits, treasury have information about roughly how much funding they need at any particular point in time via the normal sales pipeline information that demonstrates how many loan requests generally turn into loans advanced.

And that's before you take into account the fact that time deposits do not stop anybody spending anyway. I still have an asset - wealth. And I know when it matures. Therefore I can alter the expectations of people selling things by making enquiries and purchase orders to *settle* at the maturity date.

Somebody who is deprived of assets via taxation (say) cannot do that with certainty.

The whole concept of there being any restriction in the system is flawed at the most basic of levels.