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At the Telegraph again.

Can you tell that a mate got a job there*?

Getting back to US banking, Dimon may well be right and it would be nice if he were. But the truth or not of his proposition is not based on any objective facts about the world out there. It depends purely upon whether we believe him. Or not.

For all banking, everywhere and everywhen, is a con: and like any con it only works if we have confidence in it.

*Not quite how it works, a commissioning editor is like a capo, he has his consigliere. When the comed gets a new gig then the cons get pulled along….

3 thoughts on “Elsewhere”

  1. Richard G Brown

    Re the ‘loans/deposits – which creates which?’ question, I fear your (usually correct) arguments are being weakened by your laudable desire to to prove Mr Murphy wrong at every opportunity. Where I think you go wrong is by merging two distinct steps of the argument. So I wince whenever you raise this point… ‘if Worstall’s wrong about this, maybe he’s wrong about other things where he’s equally confident?’ I’m pretty sure you know what follows way better than me and are simplifying for brevity’s sake, but for completeness:

    The key insight is that a deposit is a *liability*. And there are two distinct ways they can arise. I can create a deposit by paying in some cash/transferring money from another bank (“making a deposit”) OR by taking out a loan from the bank. In both cases, my ‘balance’ (ie their liability to me) goes up, and the ‘size’ of the bank’s balance sheet has increased slightly (both assets and liabilities are slightly higher the instant after the loan is made than the instant before). But there are two important points we need to immediately make:

    1) the asset side of the balance sheet clearly looks completely different in each case. In the first case, the bank now has some more cash in the vault or increased reserves at the central bank. In the second case, the bank now has an IOU from me, promising to pay back the loan in the future.

    2) the deposit is just a liability at this instant. It’s a promise to disgorge cash or central bank reserves on demand in the future. But, at the instant of making the loan, that cash has *not* been disgorged and the probability that it will in any given time horizon is less than 1 (but greater than 0).

    To the extent that the value of outstanding mortgages and loans exceeds the sum of “cash in circulation + central bank reserves” then it’s just a statement of fact that ‘loans create deposits’ is the dominant mechanism for how bank balance sheets expand.

    But we always need to remember that deposits are liabilities, and the world of common sense hasn’t broken down completely. In particular, people often want to *do* something with their ‘deposits’. Either withdraw them as cash or use them to pay for things. To the extent they are paying somebody at the same bank, it’s just a book exercise. But, in the other cases, then yes.. the bank really does need some cash or reserves hanging around on the asset side of the balance sheet to hand over. So yes… banks obviously have to worry about what happens _after_ the instant of loan creation. Your point about magic money trees is well made.

    And this, of course, is where things like liquidity ratios come in: if you go round making gazillions of loans without limit then you’ll wake up one day with some angry customers yelling at empty ATMs realising that those illiquid mortgages on your balance sheet are very much not the same as cash.

    Hence why you also need to worry about how likely your ‘depositors’ are to demand all their money back without warning or run at the first sign of trouble, etc, etc… and making sure that the mix of *assets* on your balance sheet is appropriate for the possible outflows that the *liability* side of your balance sheet could generate – on normal or stressed days.

    So I suspect the ‘loans create deposits’ thing is an interesting insight that’s a useful way to test if somebody actually understands balance sheets, etc… and maybe it does have limited real world utility… since the need for liquidity ratios and a capital cushion, etc., is there irrespective of the mental model of banking one uses.

    But this ‘blind spot’ of yours has been nagging me for some time now and I figured your Telegraph piece was as good a trigger as any to try to get you to see sense 🙂

  2. I’ve no problem with any of that. Probably a better description than I usually give too.

    My argument here is with the next leap that people make. Murphy, for example, has claimed, flat out, that banks do not need deposits. Because they just invent the money they lend. And this is something that lots of people (Positive Money, some parts of MMT) really do believe. Banks just create all the money they lend. But this cannot be true if losing deposits makes a bank go bust. And as losing deposits can make a bank go bust therefore Postive M, Murphy and parts of MMT are wrong.

    Your point about it all being an interesting insight. Sure. But it’s that next leap which is so dangerous. As with the other MMT insistence, govts create money so they can spend what they like – as long as they tax back the inflation. Well, the problem here is that while that is a useful insight it’s only a marginal one. That argument entirely forgets that it is resources that matter, not the chitties we use to keep track of them. If we use more resources to do this thing over here – the NHS say – then we cannot use those resources to do this other thing over there – Sky footie perhaps. We always face opportunity costs that is. The cost of something is what we have to give up to get it. This is what MMT fails upon. It’s not possible for government spending to be costless. Because it’s the direction of resources. The cost is whatever else would have been done with those resources instead. They’ve got hung up on tracking the chitties, not the resources.

    This is something that Murphy especially does repeatedly. He gets his teeth into some marginal point which should really be used in moderation as a small illumination and then declares that this is the one final truth. Therefore and whatever. He’s actually doing what he accuses the neoclassicals of doing – using an extreme modelling assumption as the definition of reality.

  3. Thanks Tim. Yes – very good point re resources-versus-chitties. Easy to overlook if one is not paying attention, and easy to use it mendaciously when seeking to confuse or misdirect.

    Maybe the ‘banks do not need deposits’ thing is another example of his using language to create confusion. It’s technically true that banks can indeed ‘create’ all the money they lend… lending is the act of creating assets (the loans on the asset side of the bank’s balance sheet) and recording matching liabilities in the form of ‘deposits’. That part is just fine. The money that has been created is just a commercial bank liability at this point. Book entry. ‘Deposit’ here simply means ‘liability’ or maybe ‘demand liability’

    What is not fine is what comes next: some proportion of the people you’ve lent to will want to *withdraw* some cash! And if the only thing on the asset side of your balance sheet is loans then you need an answer for where that cash is coming from. And if the customers get skittish, you need an answer for how you can convert large amounts of your illiquid assets into cash sharpish.

    But note: it does *not* follow that *any* of the cash needs to have come from customers who have actually ‘deposited’ it (in the sense of paying in cash or transferring from elsewhere). The bank could, instead, have simply sold some of the loans, raised some equity (and held the proceeds as cash), or borrowed against other assets on the balance sheet. I mean: isn’t this how investment banks used to work? They *couldn’t* ‘take’ deposits.

    But… historically, by far the *cheapest* way to fund the liquid assets on the balance sheet was from deposits – in the sense of ‘cash paid in by somebody’ – because consumers are surprisingly willing to tolerate crappy interest rates.

    Hence why I say this is perhaps all a trick of language…. using one word – ‘deposit’ – to mean different things at different times.

    Banks don’t need the cash on the asset side of their balance sheet to have arisen from people ‘paying it in’. But they do nevertheless need to have some!!

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