Jump to content
House Price Crash Forum
Sign in to follow this  
wonderpup

An Unscientific Survey Re Banking

Recommended Posts

I was just wondering where the consensus now is on where bank loans come from. I recall it used to be quite controversial on this forum to claim that banks created money from thin air, rather than lending out existing deposits- is this still the case?

So two options;

1) Private banks lend money by taking the deposits of savers and lending them out to borrowers

2) Private banks lend money by crediting borrowers accounts with money they create from thin air

Version two seems to be gaining ground with 'insiders' while version one is still widely believed by the public to be the truth.

Where do you stand?

Share this post


Link to post
Share on other sites
The debate was effectively put to rest by the Bank of England last year with the publication of the following article in its Q1 2014 Quarterly Bulletin:

How many people have read this I wonder? I'm fairly certain that if you stood in Threadneedle street tomorrow and asked random passers by how bank lending works most would choose option 1- and that would include some bankers as well I suspect.

The idea that Banks just make money from nothing is really hard for people to accept- not surprising given how painful paying that money back can be.

Share this post


Link to post
Share on other sites

The thing I am still not sure of is government borrowing the same. My take on it is that it isn't,you buy government bonds with existing money.But I am not sure.

Share this post


Link to post
Share on other sites

How many people have read this I wonder? I'm fairly certain that if you stood in Threadneedle street tomorrow and asked random passers by how bank lending works most would choose option 1- and that would include some bankers as well I suspect.

The idea that Banks just make money from nothing is really hard for people to accept- not surprising given how painful paying that money back can be.

Even with this sort of evidence now available, when an article appears on (say) the Telegraph website which tries to articulate the reality, the comments are full of diatribes from readers whose economics education has come via the erroneous economics textbooks that the article mentions.

So when I say the debate has been put to rest, that certainly doesn't mean that this is now the most prevalent, accepted view. However for those who seriously look into the subject I don't see how they can reach any other conclusion.

In January 2012 I gave my rationale for why endogenous money creation was the reality and I challenged Extradry Martini to debate me on the issue (he had started another of his threads on the subject of banking, telling members in his inimitable style that anyone who disagreed with him was a moron).

Share this post


Link to post
Share on other sites

The lending -> deposit part is clear but I still don't get 'created money from thin air'.

A loan asset is balanced with a deposit account liability. Net for both borrower and bank, and total, is zero. Profit exc expenses created from interest rate differentials between loans and deposits, rolling that process forward to create ever more profit and ever greater borrowing so loans can only be repaid with more loans, not deposits.

Is there a real difference between assets-liabilities anywhere beyond the above, or just a 'money' definitional thing - broad money (asset) vs base money (liability) distinction? Quite keen for someone to explain what I'm missing or where totally wrong.

Share this post


Link to post
Share on other sites

I was just wondering where the consensus now is on where bank loans come from. I recall it used to be quite controversial on this forum to claim that banks created money from thin air, rather than lending out existing deposits- is this still the case?

So two options;

1) Private banks lend money by taking the deposits of savers and lending them out to borrowers

2) Private banks lend money by crediting borrowers accounts with money they create from thin air

Version two seems to be gaining ground with 'insiders' while version one is still widely believed by the public to be the truth.

Where do you stand?

As to (1), private banks do accept deposits, and as money is fungible, when they lend they are lending those deposits.

As to (2), I think you need to be careful. Base money and credit money are distinguishable in practice, as some bank depositors have discovered to their cost. I think that by overselling the argument and trying to make it pithy, you create something that is difficult for people to process. When a loan is made credit money is created. For all practical purposes, especially with a £85,000 per banking group FSCS for retail depositors, credit money is essentially the same as base money, and as part of base money is notes and coins and as notes and coins are what people think of as money, that means banks create money.

I also think that (2) is stated in a slightly clever-clever fashion. In a system of more than one bank different customers at different banks need to be extended loans at roughly the same rates. If one bank went bananas and made enormous loans in a way out of keeping with the other clearing banks the net flows as its customers spent their loans would in due course exhaust its reserve account balance with the Bank of England, its crappy lending practices would mean that other bank wouldn't lend to it, it would go bust. Of course, what you have written is consistent with what I have written but what you have written does not preclude the possibility of one bank going nutso, whereas our system does.

Share this post


Link to post
Share on other sites

I learnt about this by doing A-Level economics in the 1990s (although I don't think it was on the syllabus). However, i have learnt a lot more about it subsequently through both this forum and a change of jobs in the financial sector. However, there were a number of incorrect assertions, normally traced back to flashy youtube videos.

Yes, banks do create money out of nothing. The BOE bulletin also points out that this is not kept in check by fractional reserves. However, it does overlook the FSA/PRA liquidity regime, which has ensured that banks keep a proportion of their liabilities in cash or monetiseable assets,

However, there are important things to remember:

- Banks still need deposits, which explains why there are often ISA adverts at this time of year. These are largely to ensure that the liquidity reserves are maintained.

- Banks must hold sufficient equity capital to support the lending. This will be supported by the "leverage ratio" which ensures that banks can only lend a certain multiple of their capital base.

- A failure to repay a loan results in a financial loss for the shareholders. Once the loan asset is created, it becomes real and failure to repay can result in insolvency.

- Banks cannot generate money to pay out on liabilities (deposits) - if there is a run on the bank and it does not have sufficient reserves put aside, it will collapse.

Share this post


Link to post
Share on other sites

Minsky learnt how private banks create money by going to work for one, unlike the majority of his fellow economists who decades later still continue to dispute the macroeconomic significance of money, debt and banking. The experience transformed his thinking about financial instability.

Share this post


Link to post
Share on other sites

Option 1 is correct - what people miss is that a bank lending money also creates a further bank deposit; which is then lent again and the merry-go-round continues ad-infinitum.

This is basically the same as 2. It really does not matter exactly which way you get to the end point, so I would not argue. However, the Bank of England bulletin described it as option 2.

Share this post


Link to post
Share on other sites

Option 1 is correct - what people miss is that a bank lending money also creates a further bank deposit; which is then lent again and the merry-go-round continues ad-infinitum.

This is basically the same as 2. It really does not matter exactly which way you get to the end point, so I would not argue. However, the Bank of England bulletin described it as option 2.

I actually think that the 'merry go round' idea is incorrect and captures the fractional reserve banking 'toy model' which supposes a small amount of base money being deposited into the banking system then supporting a larger but still fixed amount of credit money. This is the model attributed to elementary Economics texts and the staple of internet comments.

I think it absolutely does matter how you get to the end point, because in the fractional reserve model the central bank has direct control over the total amount of credit money that can exist. If there is always base money held in simple ratio to the amount of loans created, the amount of new credit money that can be created is always anchored to the amount of base money that the central bank creates. After a certain point, no new base money, no new loans

In our system, the bank just needs to ensure that its reserve account with the Bank of England doesn't go to zero. In order to do that it doesn't need to exchange any base money with anyone, it just requires that when it settles with the other banks at the end of the day it receives as much in total as it has to pay out in total.

A stupid example to clarify the point. Mr A lives in South London and Miss B lives in North London. They wish to exchange houses. A goes to Lloyds and gets a loan for £600,000. B goes to RBS and gets a loan for £600,000. They exchange. A now owes Lloyds £600,000 , B owes RBS £600,000. On the day they exchange Lloyds and RBS settle up and there is no net movement in their Bank of England reserve accounts because of our transaction. No depositor is required, no new base money to be lent onward. The new credit money appears out of nowhere and is now owed and interest will be charged. And that's how you get a credit-fuelled asset price bubble and lots of people with lots of debt that they can only service at very low interest rates.

As Ah-so correctly points out in the earlier post there are constraints on the private bank money creation model, though banks went to lots of trouble to subvert them. A market check might have thought to have been the monitoring of leverage by the banks creditors, but with a little help from some clever investment bankers and some conflicted rating agencies it turned out that it didn't work out like that till pretty late in the day.

One important perspective to consider is the possibility that this process has already gone way, way too far and that the powers that be are waiting for a miracle and trying to forestall a debt-deflation death spiral in the meantime. This is the straight-forward counter-narrative to Osborne's celebration of missing the 2% target by 2%. We have already created a massive problem that we cannot fix. The nature of our money creation mechanism was the how, but fixing the money creation mechanism won't fix the problem, because the problem is the what - the problem is the excessive private debts, debts that cannot be paid.

Share this post


Link to post
Share on other sites

The lending -> deposit part is clear but I still don't get 'created money from thin air'.

A loan asset is balanced with a deposit account liability. Net for both borrower and bank, and total, is zero. Profit exc expenses created from interest rate differentials between loans and deposits, rolling that process forward to create ever more profit and ever greater borrowing so loans can only be repaid with more loans, not deposits.

Is there a real difference between assets-liabilities anywhere beyond the above, or just a 'money' definitional thing - broad money (asset) vs base money (liability) distinction? Quite keen for someone to explain what I'm missing or where totally wrong.

Don't know what you are talking about.... Sorry.

The way I see it is...

The banks lend money they don't have. It's created when the loan is taken.

They hope this new money gets deposited (pretty quickly) in their bank to balance out the loan.

If it isn't, they then borrow this difference from the BOE overnight to make their books look sound and hope it's deposited tomorrow.

Rinse and repeat until the world explodes.

That's it. In full. Unbelievable!

Share this post


Link to post
Share on other sites

Don't know what you are talking about.... Sorry.

The way I see it is...

The banks lend money they don't have. It's created when the loan is taken.

They hope this new money gets deposited (pretty quickly) in their bank to balance out the loan.

If it isn't, they then borrow this difference from the BOE overnight to make their books look sound and hope it's deposited tomorrow.

Rinse and repeat until the world explodes.

That's it. In full. Unbelievable!

+1

Exactly

Share this post


Link to post
Share on other sites

The debate was effectively put to rest by the Bank of England last year with the publication of the following article in its Q1 2014 Quarterly Bulletin:

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

If the inflation target is 2% what is the growth rate of new debt? If it exceeds inflation what then?

House price growth?

Share this post


Link to post
Share on other sites

The debate was effectively put to rest by the Bank of England last year with the publication of the following article in its Q1 2014 Quarterly Bulletin:

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

Only skim read this but does it tell you where the individual who got the money from the bank via the loan actually gets the money to pay the interest on the principle?

Share this post


Link to post
Share on other sites

Oh my God, how long have you been here?

The interest is added to the banks' revenue line and typically leaves the bank by the back door as wages, dividends etc. Effectively the borrower has simply gifted that money to them and it has reentered the economy and the borrower must work out how to grab a share to repay his loan and its interest.

The system always balances. Credit means just that, two equal but opposite parts created from nothing.

If the system always balances you would never have a crisis. Banks would never collapse.

Share this post


Link to post
Share on other sites

"While economic textbooks claim that people and corporations are competing for markets and resources, I claim that in reality they are competing for money - using markets and resources to do so. Greed and fear of scarcity are being continuously created and amplified as a direct result of the kind of money we are using. For example, we can produce more than enough food to feed everybody, and there is definitely not enough work for everybody in the world, but there is clearly not enough money to pay for it all. In fact, the job of central banks is to create and maintain that currency scarcity. Money is created when banks lend it into existence When a bank provides you with a $100,000 mortgage, it creates only the principal, which you spend and which then circulates in the economy. The bank expects you to pay back $200,000 over the next 20 years, but it doesn't create the second $100,000 - the interest. Instead, the bank sends you out into the tough world to battle against everybody else to bring back the second $100,000."- Bernard Lietaer, Former Central Banker

Share this post


Link to post
Share on other sites

Don't know what you are talking about.... Sorry.

The way I see it is...

The banks lend money they don't have. It's created when the loan is taken.

They hope this new money gets deposited (pretty quickly) in their bank to balance out the loan.

If it isn't, they then borrow this difference from the BOE overnight to make their books look sound and hope it's deposited tomorrow.

Rinse and repeat until the world explodes.

That's it. In full. Unbelievable!

Don't apologise I don't understand either - that's why I asked.

I get the new loan (bank asset) new deposit (bank liability) part, and that lending begets ever more lending. But for what you say to be true would mean that the liability is not real. The idea of borrowing from the BoE only cements that it's real otherwise why do it, and itself would just create another asset/liability along the chain. But that still doesn't explain the money from thin air, only that banks sell loans and milk interest rate differentials as their balance sheets grow with more loans and deposits.

If you accept that the deposit liability is real, that a deposit offsets a loan, and the loan repaid with a deposit means no more loan or deposit - then where is and was the extra money in the system, and where was the extra money for banks beyond interest while the opportunity lasted? That's the part I don't get.

Edit:clarifying confusion...

Edited by northshore

Share this post


Link to post
Share on other sites

If the system always balances you would never have a crisis. Banks would never collapse.

What if you don't repay the original loan. How can the bank have your loan deposited in it's bank (to balance it's books). It can't. You might buy drugs and hookers with the money. Or invest in a £1,000,000 gem stone that's only worth 50p. What then? What if you do that for 30 years? What if your bad loans (of manufactured money) drive the price up of gem stones to £2,000,000 and you then loan against it's new value? If, what and buts... That's a lot of money the bank has to find to cover all the bad loans (of manufactured money), and then there's the interest that should have been paid on the loan. Who's going to pay that.... We've already taken it as bonuses and profit. We've even paid tax on it! (not much). And that was only last week, what about all the bad loans we've made this week. Who's going to pay for them....

And so on and so forth....

Share this post


Link to post
Share on other sites

@northshore

We drive money creation. We create it.

I stand in a bank and say... 'With my labour and hard work I will create £250,000 to buy this house. By my own sweat and tears, by god I will do it!" and so it is created.

And why not? I can't think of a better way of creating money, can you?

What's wrong with that?

Share this post


Link to post
Share on other sites

Don't apologise I don't understand either - that's why I asked.

I get the new loan (bank asset) new deposit (bank liability) part, and that lending begets ever more lending. But for what you say to be true would mean that the liability is not real. The idea of borrowing from the BoE only cements that it's real otherwise why do it, and itself would just create another asset/liability along the chain. But that still doesn't explain the money from thin air, only that banks sell loans and milk interest rate differentials as their balance sheets grow with more loans and deposits.

If you accept that the deposit liability is real, that a deposit offsets a loan, and the loan repaid with a deposit means no more loan or deposit - then where is and was the extra money in the system, and where was the extra money for banks beyond interest while the opportunity lasted? That's the part I don't get.

Edit:clarifying confusion...

The debt does disappear as does the created money. However, these debts tend to get replaced by new ones so the money supply is ever growing.

In reality, the money supply tends to grow a little faster than inflation.

Share this post


Link to post
Share on other sites

Don't apologise I don't understand either - that's why I asked.

I get the new loan (bank asset) new deposit (bank liability) part, and that lending begets ever more lending. But for what you say to be true would mean that the liability is not real. The idea of borrowing from the BoE only cements that it's real otherwise why do it, and itself would just create another asset/liability along the chain. But that still doesn't explain the money from thin air, only that banks sell loans and milk interest rate differentials as their balance sheets grow with more loans and deposits.

If you accept that the deposit liability is real, that a deposit offsets a loan, and the loan repaid with a deposit means no more loan or deposit - then where is and was the extra money in the system, and where was the extra money for banks beyond interest while the opportunity lasted? That's the part I don't get.

Edit:clarifying confusion...

In what sense is the bank's liability, i.e. credit money deposited in the customers account when the loan is made, not real?

You borrow £200,000 and use it to buy my BTL. I now have £200,000 credit money. You have a £200,000 debt and a claim on the asset (the house). The bank has a loan asset and a liability to me in the form of the credit money in that is now in my account. I take the £200,000 and buy £200,000 worth of shares in a blue chip company, or a lot of beer. How is the money "not real"?

Edited by bland unsight

Share this post


Link to post
Share on other sites

Don't know what you are talking about.... Sorry.

The way I see it is...

The banks lend money they don't have. It's created when the loan is taken.

They hope this new money gets deposited (pretty quickly) in their bank to balance out the loan.

If it isn't, they then borrow this difference from the BOE overnight to make their books look sound and hope it's deposited tomorrow.

Rinse and repeat until the world explodes.

That's it. In full. Unbelievable!

this works as long as their is proportional growth (due to the young needing debt to create value) within the closed system, hence why globalization in the eu must happen for the 1%ers to stay in power because industrialized nations only average a 1.7 children to 2 adults, so in Britain we get the unindustrialized people to help offset that curve and continue the Marxist regime, similar to how we create labour voters by stopping productivity by giving wealth to the rich and creating a socialist paradox in my opinion seeing as a conservative republic is best. (my example old America)

the problem with Britain today is that babies add more wealth to society rather than cheap labour which are usually poor and hit the welfare state harder (referring to recent British immigration) creating a coming crash or a eussr dictatorship which is why the conservatives are trying to rewrite the magna carter before hand so the inalienable rights as persons given to us as British citizens and supposedly defended by the royalty are taken away before hand, ready for a dictatorship by a mafia cartel which resides under the name government. but i digress...

Share this post


Link to post
Share on other sites

@northshore

We drive money creation. We create it.

I stand in a bank and say... 'With my labour and hard work I will create £250,000 to buy this house. By my own sweat and tears, by god I will do it!" and so it is created.

And why not? I can't think of a better way of creating money, can you?

What's wrong with that?

I hope you're being sarcastic.

Surely what's wrong with that is that Fergus Wilson could come along and say "I think that the bloke who is about to come in and want £250,000 can service that mortgage on a repayment basis. I think that his earnings could easily service a £300,000 loan on an interest-only basis, so why don't you offer us both loans. I'll outbid him for the house and then you, Mr Banker, can have more interest, and I can make a little bit too!"

The problem is that the banker's motivations regarding how much money should be created, to whom it should be allocated and for what purpose may not be aligned with the kind of society that you want to live in.

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

  • Recently Browsing   0 members

    No registered users viewing this page.

  • The Prime Minister stated that there were three Brexit options available to the UK:   58 members have voted

    1. 1. Which of the Prime Minister's options would you choose?


      • Leave with the negotiated deal
      • Remain
      • Leave with no deal

    Please sign in or register to vote in this poll. View topic


×

Important Information

We have placed cookies on your device to help make this website better. You can adjust your cookie settings, otherwise we'll assume you're okay to continue.