In it, I argue that if bank loans create money, then repaying those loans destroys money. The money in question literally ceases to exist. That is one of the hardest economic truths to get our heads around.
If we use the correct words – money and credit – then it’s blindingly obvious. Repaying a loan destroys credit. And?
And, it should be noted, destroying credit does not, one iota, destroy any goods, services, stocks or works-in-progress. Nothing materially changes. The way the Sage appears to fixate on the mechanisms of money creation & destruction is so much horse-radish – he’s just looking for a snake oil excuse to justify an ever-increasing State share of those goods and services.
If I lend you £10 I don’t create £10. If you pay me back I that doesn’t destroy £10.
But if I call myself a bank the same transactions create and destroy money? How would that make sense in any sane universe?
I thought only the State could create money because the only use of money is to pay taxes to the State. Or is that just on Thursdays?
@FrankH
“If I lend you £10 I don’t create £10. If you pay me back I that doesn’t destroy £10.
But if I call myself a bank the same transactions create and destroy money? How would that make sense in any sane universe?”
It does not make sense to me either.
So every time I pay £x to the bank for my mortgage there is £x less in existence.
Again, think of money and credit as being different but related things. You pay back a loan of course there’s less credit. Obvious, innit?
“Again, think of money and credit as being different but related things. You pay back a loan of course there’s less credit. Obvious, innit?”
This is why I’m having such a problem with the ‘banks do/do not create money’ argument. As far as I see (and you’ve just stated it) banks create credit, but not money. And credit without money is pointless – I can say ‘I will loan you £10’ but unless I actually give you a £10 note, that credit is of no use to you. For credit to exist, I have to pass something of value to you, either cash, or give you an asset or perform a service for you. Without that passing of value (with accompanying promise to repay) credit does not exist.
Ergo when a bank creates a loan for a person, until they give that person something of value nothing has happened. Thus my point is still – when banks create lots of extra credit (in a boom time for example) where does the value come from that they must have in order to make those loans reality? If I borrow £100k to buy a house, at 4:30 on the day I sign the agreement they must have to find whatever is their reserve ratio, 10% (?) so £10k in new deposits or loans of cash from another bank. Then at some point the bank has to put £100k in cash in my account so I can pay it to the vendor. If net bank credit has gone up by (say) £100m in a day, where has the extra money/value come from to balance that over the entire banking system at 4:30pm?
OK, so you take a loan for £100k. The banks now got an asset, you owe it £100k. It also hsa a debit, it’s agreed to let you have £100k when you want to buy something. We’ve not created any money but we clearly have credit. If you don;t buy anything then both sit in hte same bank and the b ooks balance.
Now you spend the £100k. Buy that house. Someone else in the banking system now has that £100k. Cash doesn’t come into this. Nor does the reserve ration (that matters for how often the bank can do this dependent upon its capital base. But it doesn’t for the money supply. Well. OK, the total size of the money supply – the credit exansion – will depend upon the reserves but not for an individual transaction).
OK, so now the bank has an asset – you owe it £100k. But it has a hole on the other side of the books, the £100k payment. But that £100k payment is now out there floating around the banking system, somewhere. The bank’s got to attract that £100k back as a deposit to balance those books.
We’ve not increased cash at all. We have increased credit. The creation of the loan does indeed create both sides of the book entry, the credit and the debit. But it’s the “banking system” that balances these all, not the individual bank.
Of course, every bank is doing this millions of times a day. They tot up all their transactions and only have to go borrow – or lend – to balance the nett effect upon their overall books. Which is what hte overnight market is.
Tim. The important thing is not fantasy numbers created by book-keepers. It’s who is consuming the created value in the economy? That’s the only thing that actually matters.
The original idea of the banking system was that it expedited commerce. What we have now is everything else being subordinated to supporting the banking system. And government money cannot be separated from the banking system. They are two cheeks of the same arse.
@Jim – “And credit without money is pointless – I can say ‘I will loan you £10’ but unless I actually give you a £10 note, that credit is of no use to you.”
Find an English note. For example a £10 note. And look at it carefully. You’ll find it says “I promise to pay the bearer on demand the sum of ten pounds”. That’s what (some) money is – a promise. If you are sufficiently widely known and trusted, then you can personally create money (though by writing IOUs – not by promising to lend).
Since money is a promise, its value depends critically on the trustworthiness of the issuer – hence runaway inflation when people start to believe that the issuer cannot honour their promise.
BiS : but credit does facilitate commerce.
Those countries with no credit system have moribund economies. No-one can borrow to grow.
The Islamic countries are slowly realising that “usury” is necessary for a good economy.
That’s what (some) money is – a promise.
No it isn’t. Its a token of value widely, readily & confidently exchangeable for goods or services in commerce. No promises required.
The promises date back to when government paper money was exchangeable for gold. They were broken years ago. The promise now is worth less than the paper its printed on.
These days a promissory note could be written by anyone but a government. (ie the IOU) It would be something you could probably rely on.
“The original idea of the banking system was that it expedited commerce”
No, absolutely not. Entirely the other way around. People wanted somewhere secure to save. Goldsmiths had a nice secure safe. So, others would add their gold to that safe. Goldsmiths worked out that you could lend out at interest what you thought no one wsa going to come by for any time soon.
Now, yes, I know you’ve worked with gold. Bit ’tis true, roughly at least.
We’ve seen it again with Mpesa in East Africa. Purely electronic money. Everyone’s been chuntering on about microfinance and the ability to borrow. Sure, interesting. And then perhaps an actual payments system for small sums for poor people would be a good idea? Mpesa. And the real, cracking and unexpected use hsa been as a method of savings. What poor folk – all folk – really want is a secure method of savings.
Banking started from that…..
It’s part of where the banking system comes from Tim. But in commerce it’s about being able to move money without actually moving money. Just the balances of compensating transactions. There were actually people doing that outside the goldsmiths. They were certainly doing it in England because there wasn’t enough silver & gold coinage in circulation to enable the current level of commerce.
Don’t we know what happened to the goldsmith’s lending?. When people wanted their gold they found the king had confiscated the lot & melted it down to fund his foreign wars?
I find the subject amusing because it was the re-coinage & the advent of sound money set Britain on the path to commercial dominance. Now the Master of the Mint (the office still resides with the Treasury doesn’t it?) will proudly tell you how he intends to clip the coinage by 2% in line with his plans & expect you to congratulate him for it. It was far better in the hanging, drawing & quartering days.
I still don’t understand why we have to have inflation. It’s simply stealing from savers to give to borrowers. Suits government because it’s always a net borrower.
And that other bit of book-keeping illusion. Borrowing to pay for Covid furloughs. Let’s try that an an honest conversation:
“Hey Fred! Yes, you the guy’s that’s risking his health working in Tesco ensuring the food distribution system ensures everyone gets fed. I’m going to take some of what you’ve rightly earned & give it to Tarquin here so he can sit safely at home for three months watching TV & twiddling his thumbs. That OK with you?”
No amount of book-keeping flummery will create something doesn’t exist.
“OK, so you take a loan for £100k. The banks now got an asset, you owe it £100k. It also has a debit, it’s agreed to let you have £100k when you want to buy something. We’ve not created any money but we clearly have credit. If you don;t buy anything then both sit in hte same bank and the b ooks balance.”
Yes, and as long as things stay like that, its all just numbers in Bank A’s ledger. Its like me saying ‘I’ll loan you £1000 in cash’ while not having that amount of notes to hand. As long as you don’t want to spend it then no-one is the wiser. The issue comes when Bank A has to transfer £100k to Bank B, into the house vendors bank account, when I spend my loan. Bank A creating a loan account that says ‘£100k’ in it does not create anything that can be transferred to someone else. That has to be something else entirely – money not credit. Otherwise Spud is right – banks create money when they create loans. But you’ve just said they don’t……..
Otherwise a bank in the middle of a bank run just needs to create an account that says ‘£10bn’ in it and start transferring that to all the people who are demanding their money back. We know they can’t do that, they have to get the money to pay existing depositors from somewhere else – new depositors, new loans , new investors putting up capital.
So I still don’t understand where the ‘stuff that can be electronically transferred from bank to bank’ (whatever you call that) comes from, and how it increases in aggregate to match the amount of aggregate credit created by banks. I know I probably sound dumb, but it makes no sense to me at all.
My take on this is that the only thing that ultimately matters is that money is sloshing around the economy.
This is where Tim’s beloved MV=PQ equation comes in. Money spent equals crap being bought.
It doesn’t really matter if most of the M is a scam conjured out of thin air by the banks, so long as there is plenty of V and PQ going on.
My take on this is that the only thing that ultimately matters is that money is sloshing around the economy.
What actually matters is created value is sloshing round the economy. Government money is just a method of ensuring the value ends up with the people the government wants it to. Think about it. If you didn’t use government money you’d be able to keep all the value you had created. Government would have no way of collecting taxes because it would have no way of knowing how much you’d been paid for the work you do.
“Otherwise Spud is right – banks create money when they create loans. But you’ve just said they don’t……”
No, I’ve said the trick, the difficulty, is in the definitions.
We’ve got different sorts of money. There’s cash money, government money. Notes, coins (and what the central bank makes). Technically this is M0. OK, that’s one definition of money. We’ve also got credit and bonds and bank loans and all that. Technically, that plus M0 is M4 (and M1, M2 etc are different variations on the theme).
Now, we can say that M4 is “money”. That’s one sense of the word money. Or, we can insist that “money” is just M0. All the other stuff is “credit.” So, M0 is money, M0 plus credit is M4.
Which we really use is largely a matter of taste.
What Murphy keeps insisting is that M4 is money. So, when a loan is made credit expands, but credit is a part of money so that’s money being created. So too when a loan is repaid, that’s money being destroyed.
I say that it’s better to think of “money” as being only the central bank stuff and the rest is credit. That means that it’s obvious that if a bank makes a loan then credit has expanded and if one is paid off then credit has contracted. I mean, obvs, right?
By making the distinction between money and credit clear – or the types of money even – then we can see that banks don’t create money but they do create credit. Yes?
Now, of course, there’s a complication. Because when we talk about the money supply and inflation then I’m likely to say that M4 – the notes plus all hte credit – is the type of money we’ve got to be wary of. But Spud will, at exactly the same time, say that it’s M0 that matters. Because the distinctions between the type of money matter for his version of the explanation and don’t for mine. Or – to get really complex – if we go a level down then I too would insist upon the distinction.
Which is one of the difficulties here. “What is money?” is a question we can only usefully answer after we’ve also asked why you want to know? What’s the question you want illuminated?
“So I still don’t understand where the ‘stuff that can be electronically transferred from bank to bank’ (whatever you call that) comes from, and how it increases in aggregate to match the amount of aggregate credit created by banks. I know I probably sound dumb, but it makes no sense to me at all.”
This is credit, not money. And banks create credit.
“This is credit, not money. And banks create credit.”
So if credit money (which you’ve just said banks create) can be transferred between banks, why can’t a bank just create enough credit money to pay off its depositors in a bank run then?
This is what actually happened at Northern Rock.
So, the banks suffering a bank run. Shrug. So, there’s enough “credit money” out there to be lent to NR. Yep, there is. But the other banks won’t lend it to NR. Because NR “might” be bankrupt. Not just illiquid, but actually have lost all its capital and a good chunk of deposits. Maybe. So, who is going to lend to a bank if you might lose some or all of what you lend to that bank? Don’t forget deposit insurance only goes to £85k.
This is exactly what did happen to NR. They went around asking other banks to lend them money. Just a normal part of operations, that “overnight” market. And the other banks went “LOL, no!”. So, NR is illiquid and so bust. As it turned out NR was not insolvent, it hadn’t lost all the money. But that it might have been was enough.
The other way to describe this is that NR suffered a wholesale bank run. Other banks wouldn’t lend to it.
Tim. This is all imaginary book-keeping. It has tenuous connection with the value created in commerce in the economy, if any. If a bank creates credit, where do the goods & services it is exchangeable for come from? This all happening in real time. The money is in the bank account now. It’s not a call on some future production may or may not happen. The only place I can see the receiver getting anything is if some other consumers forego consumption. In other words they’ve devalued the existing tokens of value in circulation. The banks haven’t created anything. They’ve just moved around who gets what.
“So, the banks suffering a bank run. Shrug. So, there’s enough “credit money” out there to be lent to NR. Yep, there is. But the other banks won’t lend it to NR. Because NR “might” be bankrupt. Not just illiquid, but actually have lost all its capital and a good chunk of deposits. Maybe. So, who is going to lend to a bank if you might lose some or all of what you lend to that bank? Don’t forget deposit insurance only goes to £85k.
This is exactly what did happen to NR. They went around asking other banks to lend them money. Just a normal part of operations, that “overnight” market. And the other banks went “LOL, no!”. So, NR is illiquid and so bust. As it turned out NR was not insolvent, it hadn’t lost all the money. But that it might have been was enough.”
Not my point at all.
Lets start again. I go into Barclays and sign loan agreement for £100k to buy a house. Barclays credit my current account with £100k for me to pay for my house. According to their books they have a liability (the £100k in my account they may have to pay out at any point) and an equal asset (my loan agreement to repay £100k + interest). So far so good. At the moment thats all just book keeping. As long as I never spend the £100k the whole thing is moot. Even if I start making repayments the value of asset (loan) goes down, and their cash holdings go up, which offsets against what I’m still owed (the £100k), so the whole thing still balances.
So at 4:30 on the day I sign the loan agreement and they credit my current account with £100k, how much exterior money (deposits from individuals or loans from other banks) must my bank have attracted during the day in order to balance their books? £100k? Or less than that?
Use the housing market as an example. Forget new build, it’s trivial. Just the existing stock. Banks will advance credit to people want to buy houses. The more credit they advance the more house prices rise. There’s no value being created. The house was worth £100k is the same house worth £200k. It’s a simple transfer of wealth from those aspire to buy houses to those managed to benefit from bank credit in the past. With the banks taking a bloody great rake off on the way through.
On that day? Nothing.
The day you exchange and pay? £100k. Unless, by chance, the seller also banks with Barclays.
“On that day? Nothing.
The day you exchange and pay? £100k. Unless, by chance, the seller also banks with Barclays.”
Aha! Now we see my question. The bank has not created anything by crediting my account with £100k. Its just a number in their ledger. They cannot transfer that number to an account in another bank unless they get a matching deposit the same day from someone else. Ergo they have created no money at all. They’ve just borrowed some from someone to lend it on to me. Its akin to me saying ‘I’ll loan you £100 cash’ but not having £100 in notes to hand, and having to borrow it from a third party to make the loan to you. Only in the bank’s case they can loan the money first and get it off someone else by 4:30 the same day.
So I can’t see how a bank (or banking system) creates money at all, given it always needs a deposit to match what its shelling out to loanees each and every banking day. If each payment out to a loanee needs a matching deposit, how do deposits rise to match loans?
Again, it makes much more sense if we distinguish between money (M0, the central bank stuff plus cash and coins) and credit.
So, two banks in the system. Each issues a 100k loan on the same day. Each loan stays with the same bank (because it’s not used, or the recipient of the payment banks with the same bank). The banks don’t have to find anything to make thir books balance. They’ve both got a 100k loan out and a 100k deposit.
Option two, both issue the same loans. But the one made by Bank 1 is used, and the recipient banks with Bank 2. So, now Bank 1 has a loan out (an asset) of 100k but no matching liability, the deposit. Bank 2 has one loan out, asset, 100k. But two liabilities, two 100 k deposits. Both books are unbalanced. The solution is for Bank 2 to lend 100k to Bank 1. Which it does, through the overnight market. Now all books balance.
Credit has clearly been created – 200k of it. The amount of cash money hasn’t changed in the slightest.
Which is why it’s confusing if we use the wide definition of money – M4, or cash plus credit. M4 has risen, because it includes the change in credit. But M0 – cash money – hasn’t changed at all. Or, to make it easier for us all to understand it, banks create credit, not banks create money.
The MMT crowd insist that because the banks don’t need the deposit first to make the loan therefore deposits don’t matter. I go well, yeah, OK, sorta. But they do have to find the deposit by 4.30. Therefore deposits do matter. The daily requirement to balance the books makes deposits matter.
“If each payment out to a loanee needs a matching deposit, how do deposits rise to match loans?”
Every loan createsits own deposit. Just not necessarily in hte same bank. Which is why then deposits do matter again.
“Option two, both issue the same loans. But the one made by Bank 1 is used, and the recipient banks with Bank 2. So, now Bank 1 has a loan out (an asset) of 100k but no matching liability, the deposit. Bank 2 has one loan out, asset, 100k. But two liabilities, two 100 k deposits. Both books are unbalanced. The solution is for Bank 2 to lend 100k to Bank 1. Which it does, through the overnight market. Now all books balance.”
I kind of get it, but I think my brain can only really conceive of actual money flowing around a system like water (or gold coins) when the banking system seemingly doesn’t actually transfer anything at all, just some bytes of information saying ‘We’re reducing our customer Mr Smith’s account by X, you can increase your customer Mr Brown’s by the same amount’. and then at the end of the day doing the reverse with some other bank to make it all add up. And collectively seemingly creating money out of thin air.
Which to my way of thinking is a pure scam, which is what I consider fractional reserve banking to be. If you can’t explain what your business does in a Ladybird Book of Banking manner, then your business is probably fraudulent.
I’m sure you could write the Ladybird Book of Farming (especially if you could leave out the government-created bullshit.)
However, suppose one of the rest of us suddenly inherits a working farm but somehow no farm workers so no institutional memory. Do you think, even if we’ve got your book to hand, we’d survive to even get a first harvest?
Ladybird Book of Farming:
1) Inherit land.
2) Slipper (subsidy) farm the land.
3) Hope for planning permission.
4) Profit.
Note at no part should one actually do anything productive.
“However, suppose one of the rest of us suddenly inherits a working farm but somehow no farm workers so no institutional memory. Do you think, even if we’ve got your book to hand, we’d survive to even get a first harvest?”
Yes, because arable farming is no different to planting seeds in your garden. Its not rocket science. Plant seeds, kill weeds, fertilise, harvest. Nature does the rest. If you literally went out and threw the seed on the ground and harrowed it in you’d get something the next year. Yes there’s a lot more tech about these days, but the principles are no different than they were 10,000 years ago, and you could farm using horses if you were so inclined, or forced to by circumstances.
“1) Inherit land.
2) Slipper (subsidy) farm the land.
3) Hope for planning permission.
4) Profit.”
Or in my case:
1) Inherit land
2) Actively farm it producing things that people want to buy (Crops, hay, firewood)
3) Write a letter to the local council saying ‘I don’t want my farm to be allocated for development in the local plan’ and actively turn away the dozens of unsolicited enquiries I’ve had to cover my farm in solar panels, houses and/or industrial warehouses.
4) Profit quite handsomely from (2) above.
Every loan createsits own deposit. Just not necessarily in hte same bank. Which is why then deposits do matter again.
What you never get around to explaining, Tim, is what happens to money when it gets spent. All money eventually gets exchanged for goods or services.
I’ll ask you again the question you always seem to avoid. When a bank creates credit, where do the goods & services it’s exchangeable for come from?
“I’ll ask you again the question you always seem to avoid. When a bank creates credit, where do the goods & services it’s exchangeable for come from?”
I don’t avoid it, never been asked it.
If there are resourcesunused then they get used to make what is being bought.
An expansion of the money supply stimulates the economy.
If there are none unused – or which can be truned to this task – then the result is inflation. More money chasing the same goods.
Monetary expansion when the economy is already at full capacity leads to inflation.
These are not unusual observations. Standard monetarism. Monetary expansion is stimulatory. If there are no unusued resoiurces then stimulation becomes inflation. And yes, the monetarist targets – M3, M4 – are those measures of money which include bank credit.
We can forget “stimulates the economy”since commerce always happens in the present.
So what I’ve been saying is essentially true. When banks create credit they don’t create anything meaningful. They’re just fantasy numbers. A figment of book-keeping. The actual effect is they change who benefits from resources.