Effect of bank loan defaults on the money supply

[William Hummel]

When a bank issues a loan, it creates a liability (a deposit for the borrower) and gains an asset (a loan contract for a stream of interest payments and a promised return of principal at maturity).  The money supply increases by the amount of the deposit. 

When the borrower writes a check against that deposit, the bank must transfer that much of its reserves to the seller's bank for the check to clear.  It still has a loan contract with the borrower, but its deposit liability has vanished.  The seller's bank has gained those reserves and an equal deposit liability. Since total bank deposits remain unchanged, the money supply does not change when loans are spent.

Now assume the borrower defaults on the loan contract, and the lending bank cannot collect anything against the principal. It must write off the entire loan as an asset.  It has lost an equal amount of its capital (the reserves) so its capital/asset ratio will have fallen.  Since its deposit liability has simply been transferred to another bank, the money supply does not change as a result of the default.

Depending on the amount of capital lost, the bank may have to shrink its loan portfolio or sell new bank shares to remain in compliance with the capital adequacy rules.  It may also have to acquire additional reserves to meet the reserve ratio requirement.  However as long as it remains solvent, it can normally borrow the required reserves in the Fed funds market or from the Fed's discount window.

William Hummel

[Joe Leote]

William,

 

I am still authoring and revising a write-up (a cheat sheet for my own understanding) of a simplified monetary system. I envision the aggregate creation of new bank credit as money-debt pairs D*: 

  

Borrowers                    Banks
  Assets |  Liabilities      Assets |  Liabilities
   D*          D*                 D*         D*

where D* is aggregate new cash asset on the books of the borrowers (money) and a liability to repay principal amounts to the banks (debt), the money supply expands or contracts over some period as delta-D = D* - D#, where D# is the aggregate loan repayment during the same period, so bank credit component of money supply expands or contracts as money-debt pairs are created or destroyed via bank lending activity.

 

One thing I noticed is that accounting for interest payments as liabilities of the borrowers and assets of the banks (arising from contractual obligations) would lead to unbalanced entries in the books, which violates the basic practice of double-entry accounting. It appears from reading my old accounting textbook that interest payments are not logged as receivables and payables until they become due and payable over time. So although the long term assets and liabilities appear on the collective balance sheets, it appears that long term interest payment commitments are curiously absent from the aggregate books of account.

 

Also as you've noted before interest payments to banks converted to retained earning (bank capital) rather than spent as expenses to the non-bank sector tend to drain the money supply and are replenished by Fed via open market operations.

 

Joe 

[Joe Leote]

If repayment rate in my model is D#, and defaults occur in this rate of repayment, what happens is that banks are losing capital and becoming less solvent, they are less likely to expand loan rates D* as new money-debt pairs in these conditions, so the impact on money supply in terms of bank manager perceptions (not merely accounting practice) is to contract bank credit during periods of high default rates, which explains a debt-deflation.

 

Joe

[William Hummel]

On 5/12/2011 9:57 AM, Joe Leote wrote:

William,

 

I am still authoring and revising a write-up (a cheat sheet for my own understanding) of a simplified monetary system. I envision the aggregate creation of new bank credit as money-debt pairs D*: 

  

Borrowers                    Banks
  Assets |  Liabilities      Assets |  Liabilities
   D*          D*                 D*         D*

where D* is aggregate new cash asset on the books of the borrowers (money) and a liability to repay principal amounts to the banks (debt), the money supply expands or contracts over some period as delta-D = D* - D#, where D# is the aggregate loan repayment during the same period, so bank credit component of money supply expands or contracts as money-debt pairs are created or destroyed via bank lending activity.

 

One thing I noticed is that accounting for interest payments as liabilities of the borrowers and assets of the banks (arising from contractual obligations) would lead to unbalanced entries in the books, which violates the basic practice of double-entry accounting. It appears from reading my old accounting textbook that interest payments are not logged as receivables and payables until they become due and payable over time. So although the long term assets and liabilities appear on the collective balance sheets, it appears that long term interest payment commitments are curiously absent from the aggregate books of account.

 

Also as you've noted before interest payments to banks converted to retained earning (bank capital) rather than spent as expenses to the non-bank sector tend to drain the money supply and are replenished by Fed via open market operations.

Joe,

The Fed is not a significant factor in replenishing the money supply lost to retained earnings of banks. Then how is that loss covered?  The answer is that economic growth creates a demand for additional money, and banks support that with new loans. Thus interest on old loans are covered by the money that becomes available from a net increase in loans.

Then what happens if the economy reaches a plateau in growth or even declines?  Under those circumstances, fewer new loans would be issued and little or no new money would be created. Any increase in defaults on loans would leave more old money in the non-bank sector at the expense of the banking system. Thus the gain in net worth of banks at the expense of the non-bank sector is self-limiting. In the long run, banks do well only if their borrowers to well, and lose if their borrowers lose.

William

[Joe Leote]

William,

 

I clearly see your point that new or ongoing bank credit expansion provides the interest payments for old bank credit in a normal growth economy. Fed need not increase the money supply to create the interest payments in a growing economy because banks as a whole tend to do so.

 

So when little or no new bank credit (money) is being created, and old loans are defaulting, in my defined terms the old loans remain as deposit liabilities D on the books of the banks which are never cancelled since repayment and cancellation of these liabilities in aggregate D# process never occurs.

 

It seems to me there should be further implications to this fact although I am at a loss to articulate what they might be at this point.

 

Joe

 

----- Original Message -----

From: William Hummel

To: understan...@googlegroups.com

[John Hermann]

Absolutely right Joe.  However my survey of commercial banking institutions within Australia has revealed that the amount of interest income kept as "retained earnings" amounts to an average of 2-3 percent of their overall interest income (and we are talking here about commercial banking operations, not investment banking).  I suspect that a similar figure applies for other banks around the world.  It is to this extent (i.e., 2-3 percent) that the debt-virus hypothesis has any degree of validity, by contrast with the loopy idea pushed by some debt-virus theorists that all bank interest income is somehow withheld from the economy.  A classic example of confusing stocks and flows.  
  John Hermann.

[William Hummel]

Joe,

The net growth of the credit money supply (ignoring QE) during a given period should equal net loans (new issues minus redemptions) less the net bank inflows from operations.  The latter includes net earnings on investments after accounting for all operating expenses and dividend payouts. Taxes go to the government and reduce net profits but don't directly affect the credit money supply.

The question then is what effect do bank loan defaults have on the money supply growth in the current period?  If the defaulting loans were issued in a prior period, the defaults would have no effect. The issuing banks however would suffer a possibly large loss of capital.  Assuming the issuing banks remain solvent, they would probably throttle back on their rate of lending until they had largely recovered through retained earnings. Bank loan defaults in the aggregate could therefore reduce the amount of credit available and cause the money supply to shrink or at least grow at a slower rate.

There should be some rate of defaulting loans that allow banks to earn a satisfactory return on equity on average while the money supply grows at a rate that meets the money demand of the economy at large. However that may be dependent on the short-term interest rate set by the Fed.  Otherwise the economy would probably veer off toward inflation or dis-inflation.

William

[Jean Erick]

    My post here would be the same as to Hummel.  I'm seeing the confusion as the conflating of real money with debt.  You trying to build a house on economic sand.

 

James

----- Original Message -----

From: Joe Leote

To: understan...@googlegroups.com

[Jean Erick]

     But isn't this whole thing based on the fallacy of money creation?  Money is money.  Any alteration of its drawing power on real goods must be appropriately maintained.  Debt is what is DONE with money.  But both money and debt are conflated into one as the "money supply".  So "money supply" is a misnomer.

It does not designate the supply, the tally, of "money".  It's actually a tally of debt, because debt is the only thing that changes in amount.  The amount of money stays the same.  It's very confusing and I don't understand it yet.

 

James

----- Original Message -----

From: William Hummel

To: Google Group

Sent: Wednesday, May 11, 2011 3:36 PM

Subject: Effect of bank loan defaults on the money supply

[John Hermann]

James, my comments are interposed in brown font.  John.

At 03:20 AM 14/05/2011, James wrote:

But isn't this whole thing based on the fallacy of money creation?  Money is money.

Money is anything (tangible or not) which is accepted by a sufficiently large section of society as a medium of exchange, and by the government for the payment of taxes.

Any alteration of its drawing power on real goods must be appropriately maintained.  Debt is what is DONE with money.  But both money and debt are conflated into one as the "money supply".  So "money supply" is a misnomer.

The "money supply" is not a misnomer, it is a term recognized and used by the central bank (in the U.S., the FED) when compiling its monetary statistics. The money supply is simply that form of money which is accessible to and used by the non-bank community (i.e. by individuals and by non-bank businesses). It consists of creditary deposits within commercial banking institutions (i.e. bank credit money) together with currency in the hands of the public.

While it is true that debt is something carried out with money, I feel that you also should recognize that all bank credit money was created as debt. The net debt of society is nothing other than debt to the banking system, and is roughly equal to the magnitude of the money supply. And the magnitude of gross debt is usually several times larger than the magnitude of net debt. 

It does not designate the supply, the tally, of "money".  It's actually a tally of debt, because debt is the only thing that changes in amount.  The amount of money stays the same.  It's very confusing and I don't understand it yet.

There is no law of conservation of money. The money supply fluctuates on an ongoing basis -- every time a bank loan is advanced or repaid, every time a bank spends, and every time a customer creates a deposit using currency or makes a currency withdrawal.

Neither is there a law of conservation of reserves (exchange settlement funds plus currency held by commercial banks).

[John Hermann]

There is no law of conservation of money. The money supply fluctuates on an ongoing basis -- every time a bank loan is advanced or repaid, every time a bank spends, and every time a customer creates a deposit using currency or makes a currency withdrawal.

Neither is there a law of conservation of reserves (exchange settlement funds plus currency held by commercial banks).

Oops, sorry  ..  that was wrong.  Creating a deposit or withdrawing currency does not change the money supply, it only changes the stock of reserves.   John.

[John Hermann]

From: William Hummel

On 5/12/2011 9:57 AM, Joe Leote wrote:

      William,  I am still authoring and revising a write-up (a cheat sheet for my own understanding) of a simplified monetary system. I envision the aggregate creation of new bank credit as money-debt pairs D*:

Borrowers                    Banks

  Assets |  Liabilities      Assets |  Liabilities

   D*          D*                 D*         D*

where D* is aggregate new cash asset on the books of the borrowers (money) and a liability to repay principal amounts to the banks (debt), the money supply expands or contracts over some period as delta-D = D* - D#, where D# is the aggregate loan repayment during the same period, so bank credit component of money supply expands or contracts as money-debt pairs are created or destroyed via bank lending activity.

      One thing I noticed is that accounting for interest payments as liabilities of the borrowers and assets of the banks (arising from contractual obligations) would lead to unbalanced entries in the books, which violates the basic practice of double-entry accounting. It appears from reading my old accounting textbook that interest payments are not logged as receivables and payables until they become due and payable over time. So although the long term assets and liabilities appear on the collective balance sheets, it appears that long term interest payment commitments are curiously absent from the aggregate books of account.

      Also as you've noted before interest payments to banks converted to retained earning (bank capital) rather than spent as expenses to the non-bank sector tend to drain the money supply and are replenished by Fed via open market operations.

Joe,  The Fed is not a significant factor in replenishing the money supply lost to retained earnings of banks. Then how is that loss covered?  The answer is that economic growth creates a demand for additional money, and banks support that with new loans. Thus interest on old loans are covered by the money that becomes available from a net increase in loans.  Then what happens if the economy reaches a plateau in growth or even declines?  Under those circumstances, fewer new loans would be issued and little or no new money would be created. Any increase in defaults on loans would leave more old money in the non-bank sector at the expense of the banking system. Thus the gain in net worth of banks at the expense of the non-bank sector is self-limiting. In the long run, banks do well only if their borrowers to well, and lose if their borrowers lose.    William

William, 

This is a plausible endogenous mechanism for covering the cost, in a self-limiting manner -- although the argument seems somewhat hand-waving.  I would like to see a mathematical model of a growing economy with a proper treatment of banking operations (including credit creation and debt), which would allow us to ascertain the conditions (the parameter regime) under which the long-term limiting behavior you are describing can take place. 

I also understand why those who think the monetary system operates in an exogenous manner might come to the conclusion that retained bank earnings create a monetary growth imperative.

Incidentally, even if the mechanism for monetary growth happens to be fully endogenous, is it not true to say that the monetary increase is "covered" by decisions taken by the central bank?

John.

[William Hummel]

John, here is a little more rigorous argument:

We assume the Treasury balances its inflows against outflows with taxes and the sale of bonds.  That means on average there is no change in bank deposit liabilities due to government spending.  Cash in circulation remains constant is therefore ignored.

The entire money supply consists of bank deposit (D) created through bank loans (L) plus net injections (I) by the central bank to add reserves as needed to maintain control of the interbank lending rate.

 We assume the income of the banking system is derived entirely from its loans at an average interest rate i per year, before accounting for loan defaults.

At the start, assume I = 0, so D₀ = L₀.  At the end of the first period, the private sector must pay iL₀ to banks.  Assuming it wants to keep its total deposits fixed at D₀ , it must borrow iL₀ from banks.  That results in
L₁ = L₀ (1+ i). Continuing this through n periods results in L_n = L₀ (1+i)ⁿ  That is, the debt of the private sector to banks and the interest costs increases exponentially at the rate i.  Since the money supply (D) remains constant, we can ignore injections I because there is no reason for the CB to add additional reserves.

Now suppose the increasing debt service causes the private sector to begin defaulting on its loans.  In the above scenario, the defaults would increase as debt service grows and will ultimately cancel out the interest earnings.  I’ll leave it to you to show this mathematically,  but I think it is self-evident.

In reality retained earnings of a banks is nowhere near the average interest rate charged on loans because of operating costs and dividends.  The typical return on assets for a bank, including loan losses, is about 1.0% to 1.5%, while the average interest rate is five to ten times greater.

William

[Joe Leote]

William,

 

So banks in aggregate during an accounting period convert net income to retained earnings per this formula:

 

Income = Revenues - Expenses

 

where revenue comes primarily from interest payments on loans and investments. The expenses return to the pool of bank deposits D, and the income is a drain on deposits D?

 

But now if banks purchase financial investments in the next period from retained earnings (the increase in owner's equity is no longer held in cash on the books of the bank) this investment transaction (if done with a non-bank) would return such funds back to aggregate pool of bank deposits D, correct?

 

Thus in aggregate banks drain the money supply whenever they increase holdings of cash assets, and they increase the money supply when they decrease holdings of cash assets, during dealings with non-banks.

[Joe Leote]

If a bank loans me money to buy something from you, will your bank accept the payment from my bank? The answer is usually yes, and that makes bank credit = money between you and me. The debt I owe to the bank is a side agreement which is typically of no concern to anyone other than inflation hawks and monetary economists. But you are correct there is money distinct from money-credit, however, I am not conflating the two.

[William Hummel]

Joe,

That's correct.  More generally, payments by banks which go to non-bank entities increase the money supply. Payments by non-bank entities to banks decrease the money supply.  Bank assets are not counted as part of the money supply.  Thus a bank-owned deposit is not counted as part of the money supply.    

William

[Joe Leote]

John,

 

Apart from doing the math one can identify (recognize) the human causes of bank credit expansion at periodically unstable and unsustainable rates. This formula, called the Affordable Growth Rate (from book 101 Business Ratios, Sheldon Gates), applies to non-bank managers:

 

AGR = (Retained Earnings)/(Equity Last Year)

 

where growth of a firm must be financed from increased equity, increased debt, or retained earnings from operations (ignoring sale of assets which may not be necessary for growth), when the firm grows at this rate it generally can maintain a constant leverage or debt/equity ratio. If investors are risk-averse, they look for high growth companies converting sales to retained earnings now and in the future, with low debt, and with high return on equity. The stock in these companies can go up in a trend to Price/Earnings ratios that make one's eyes pop!

 

Company managers with stock options have an incentive to make comparables better than competitors in the market (to capture capital gains in stock options increasing in price). The same motivation to get rich via stock options occurs in growth companies, financial firms, and banks. Hyman Minsky explains how a banker seeks to convert profits to retained earnings to increase bank capital and Return on Equity:

 

% Return on Equity = ( % Return on Assets / Total Assets ) x ( Total Assets / Capital )

 

where capital equals equity in a bank.

 

To increase the first term ( % Return on Assets / Total Assets ) the bank managers make longer term loans and investments (held as higher yield assets) and borrow shorter term when issuing liabilities, thus taking more risk to earn greater interest rate spread on total assets. If a competitor bank does this, the other competitor banks feel pressure to do it to, to maintain a comparable position in the eyes of investors.

 

To increase the second term ( Total Assets / Capital ) bank managers lend more creating increased leverage.

 

The net result is greater risk taking by bankers as a cohort group when bankers attempt to beat the other banks on comparable Return on Equity, and the motive of the cohort group is to improve price of stock options owned by bank managers. Same motive as every other manager who seeks to cash in on capital gains from stock options.

 

Periodically all the stars line up. Bank managers as a cohort are creating credit aggressively and increasing leverage, typically then banks and non-banks enjoy profit growth for a while as cohort action is like the rising tide that raises all boats. However at some point the leverage increase in banks and non-bank balance sheets will cause these very same managers to "blink" as they wake up and smell the fundamentals, and then the game of musical chairs (credit expansion) naturally reverses to greater or lesser degree.

 

I do not think there is a pure math model for this process but maybe someone smarter than me can build a reasonable stock-flow model with the human action feedbacks integrated in the simulation.

 

Joe

 

----- Original Message -----

From: William Hummel

To: understan...@googlegroups.com

Sent: Saturday, May 14, 2011 1:37 PM

Subject: Re: Effect of bank loan defaults on the money supply

[John Hermann]

At 03:07 AM 15/05/2011, William wrote:

On 5/14/2011 6:35 AM, John Hermann wrote:
From: William Hummel On 5/12/2011 9:57 AM, Joe Leote wrote:

      William,  I am still authoring and revising a write-up (a cheat sheet for my own understanding) of a simplified monetary system. I envision the aggregate creation of new bank credit as money-debt pairs D*:

Borrowers                    Banks

  Assets |  Liabilities      Assets |  Liabilities

   D*          D*                 D*         D*

where D* is aggregate new cash asset on the books of the borrowers (money) and a liability to repay principal amounts to the banks (debt), the money supply expands or contracts over some period as delta-D = D* - D#, where D# is the aggregate loan repayment during the same period, so bank credit component of money supply expands or contracts as money-debt pairs are created or destroyed via bank lending activity.

      One thing I noticed is that accounting for interest payments as liabilities of the borrowers and assets of the banks (arising from contractual obligations) would lead to unbalanced entries in the books, which violates the basic practice of double-entry accounting. It appears from reading my old accounting textbook that interest payments are not logged as receivables and payables until they become due and payable over time. So although the long term assets and liabilities appear on the collective balance sheets, it appears that long term interest payment commitments are curiously absent from the aggregate books of account.

      Also as you've noted before interest payments to banks converted to retained earning (bank capital) rather than spent as expenses to the non-bank sector tend to drain the money supply and are replenished by Fed via open market operations.

Joe,  The Fed is not a significant factor in replenishing the money supply lost to retained earnings of banks. Then how is that loss covered?  The answer is that economic growth creates a demand for additional money, and banks support that with new loans. Thus interest on old loans are covered by the money that becomes available from a net increase in loans.  Then what happens if the economy reaches a plateau in growth or even declines?  Under those circumstances, fewer new loans would be issued and little or no new money would be created. Any increase in defaults on loans would leave more old money in the non-bank sector at the expense of the banking system. Thus the gain in net worth of banks at the expense of the non-bank sector is self-limiting. In the long run, banks do well only if their borrowers to well, and lose if their borrowers lose.    William

William, 

This is a plausible endogenous mechanism for covering the cost, in a self-limiting manner -- although the argument seems somewhat hand-waving.  I would like to see a mathematical model of a growing economy with a proper treatment of banking operations (including credit creation and debt), which would allow us to ascertain the conditions (the parameter regime) under which the long-term limiting behavior you are describing can take place. 

I also understand why those who think the monetary system operates in an exogenous manner might come to the conclusion that retained bank earnings create a monetary growth imperative.

Incidentally, even if the mechanism for monetary growth happens to be fully endogenous, is it not true to say that the monetary increase is "covered" by decisions taken by the central bank?

John.

John, here is a little more rigorous argument:

We assume the Treasury balances its inflows against outflows with taxes and the sale of bonds.  That means on average there is no change in bank deposit liabilities due to government spending.  Cash in circulation remains constant is therefore ignored.

The entire money supply consists of bank deposit (D) created through bank loans (L) plus net injections (I) by the central bank to add reserves as needed to maintain control of the interbank lending rate.

I don't understand this statement William.  The money supply consists of public deposits (created through commercial bank loans) plus currency in public circulation.  Are you saying that the net reserves created by the central bank (which, in this simplified model, are needed to maintain control of the interbank lending rate) is equal to currency in public circulation?

John.

[William Hummel]

On 5/14/2011 8:17 PM, John Hermann wrote:

At 03:07 AM 15/05/2011, William wrote:

John, here is a little more rigorous argument:

We assume the Treasury balances its inflows against outflows with taxes and the sale of bonds.  That means on average there is no change in bank deposit liabilities due to government spending.  Cash in circulation remains constant and is therefore ignored.

The entire money supply consists of bank deposit (D) created through bank loans (L) plus net injections (I) by the central bank to add reserves as needed to maintain control of the interbank lending rate.

I don't understand this statement William.  The money supply consists of public deposits (created through commercial bank loans) plus currency in public circulation.  Are you saying that the net reserves created by the central bank (which, in this simplified model, are needed to maintain control of the interbank lending rate) is equal to currency in public circulation?

John.

My wording was a bit awkward and incomplete.  What I meant was the entire money supply (bank deposits and cash in circulation) is normally created through net bank loans to the public and net injections by the central bank as needed to maintain control of the interbank lending rate. To be complete one must add the effects of QE in which the central bank independently creates deposits (and reserves) in the banking system.

Bank reserves are not a part of the money supply and I mentioned them only in passing. Deposits can be exchanged for currency on demand. However such exchange does not alter the total amount of money.

William

[Joe Leote]

William,

 

I am trying to understand whether deposits D have a static level in the absence of net loan creation L. In other words, is there a measure of money m = D - L that is residual if net loans go to zero and stay there? Repayment of old loans will shrink D, so if D > L then m > 0. I do not know if this is a good question or just a confusing one.

 

Let money M = C + D, currency in circulation C plus bank deposits D. Suppose the net loan rate L goes to zero and stays there indefinitely. This could cause other problems (defaults, bank runs) but imagine for some reason bank customers are able to repay principal + interest on old loans. Where does the money supply reach equilibrium? At the level of base money?

 

Any insight you might offer is appreciated.

 

Joe

----- Original Message -----

From: William Hummel

To: understan...@googlegroups.com

Sent: Sunday, May 15, 2011 12:32 PM

Subject: Re: Effect of bank loan defaults on the money supply

[William Hummel]

Joe,

Hypothetically, if all private bank loans were paid off and no new loans issued, there would remain a residue of bank deposits resulting from the Fed's quantitative easing and from any spending by the Treasury not recaptured through taxes or bond sales.  Aggregate bank deposits would end up being about equal to aggregate bank reserves. Of course this would shrink bank balance sheets and income so much that few would would remain as viable businesses.

William

[Joe Leote]

William,

 

Thanks. Tonight I was re-reading Minsky. I came across a line where he refers to "bank cash (reserve deposits)" and although I understood that banks use reserves like cash to settle interbank payments, it just dawned on me that reserves (currency on hand plus reserve deposits) are basically the cash assets of banks for all transactions with non-banks and with other banks.

 

When banks transact with each other, for example, making interbank deposits or settling payments for customers, reserves stay in the banking sector. When banks transact with non-banks, as you confirmed, reserves flow out as cash deliveries to non-banks, and flow in as cash deliveries from non-banks. This insight is actually very helpful for me at this point.

 

So just to confirm the implications of your answer, there would be a 1 to 1 ratio of reserves to deposits in the absence of bank loans. Therefore bank loans are ultimately the source of all deposits, including interbank deposits, time deposits, and savings deposits in excess of bank reserves.

 

Currency C and non-deposit money market accounts F are leakages from the banking sector (reserve-deposit outflows) although banks may manage money market funds as well as deposits, and other non-bank financial companies may only manage money market funds. 

[William Hummel]

On 5/15/2011 8:49 PM, Joe Leote wrote:

William,

 

Thanks. Tonight I was re-reading Minsky. I came across a line where he refers to "bank cash (reserve deposits)" and although I understood that banks use reserves like cash to settle interbank payments, it just dawned on me that reserves (currency on hand plus reserve deposits) are basically the cash assets of banks for all transactions with non-banks and with other banks.

 

When banks transact with each other, for example, making interbank deposits or settling payments for customers, reserves stay in the banking sector. When banks transact with non-banks, as you confirmed, reserves flow out as cash deliveries to non-banks, and flow in as cash deliveries from non-banks. This insight is actually very helpful for me at this point.

If we ignore bank transactions with the Fed and Treasury, the only way aggregate reserves can change is when the public withdraws or deposits cash.  Even then the Fed will normally add or drain reserves to compensate for such changes in order to maintain the balance of supply  and demand at the target Fed funds rate.  The vast majority of the transactions involve a transfer of reserves from a payer's bank to a payee's bank and have no net effect on aggregate reserves. 

So just to confirm the implications of your answer, there would be a 1 to 1 ratio of reserves to deposits in the absence of bank loans. Therefore bank loans are ultimately the source of all deposits, including interbank deposits, time deposits, and savings deposits in excess of bank reserves.

That's basically correct.  When the Fed or Treasury create deposits in the banking system by their spending, they inject an equal amount of reserves.  Since that would result in an excess of supply over demand, the Fed would normally drain the excess in order maintain control of the Fed funds rate. Under QE, the Fed flooded the banking system with reserves and effectively gave up control of the Fed funds rate.  The only way to raise the Fed funds rate above zero requires paying banks interest on Fed funds, which it is now doing.

Currency C and non-deposit money market accounts F are leakages from the banking sector (reserve-deposit outflows) although banks may manage money market funds as well as deposits, and other non-bank financial companies may only manage money market funds. 

Currency withdrawals are reserve leakages, but that's not true of most money market funds. It depends on whether a bank or non-bank owns the fund, and from whom it buys the short-term debt securities that comprise its portfolio.  For example, if a non-bank creates an MMF and buys its securities from non-bank, non-government entities, then aggregate reserves remain unchanged.  Transactions by clients in such an MMF would have no effect on aggregate reserves.

William

[Joe Leote]

This paper includes a model for profit-driven incentives causing bank instability in modern banking:

 

Unstable banking (13 page pdf):

http://www.economics.harvard.edu/faculty/shleifer/files/unstable_banking_jfe_print.pdf

 

where the math model would take much time to critically analyze but the description of changes in banking practices and systemic risk is a good treatment of the way modern large banks operate. This paper is also relevant to the monetary transmission and capital market banking (securitized banking, shadow banking, parallel banking, unstable banking, wow ... all these names for innovative banking floating around!).

[Jean Erick]

     What is debt virus, please?  Interest as going out of the economy was popularized by the "Money as Debt" video but the maker (Paul Grignon) has accepted that theory is in error.

 

James

----- Original Message -----

From: John Hermann

To: understan...@googlegroups.com

[Jean Erick]

     Thank you for responding.

----- Original Message -----

From: John Hermann

To: understan...@googlegroups.com

Sent: Friday, May 13, 2011 4:52 PM

Subject: Re: Effect of bank loan defaults on the money supply

James, my comments are interposed in brown font.  John.

At 03:20 AM 14/05/2011, James wrote:

But isn't this whole thing based on the fallacy of money creation?  Money is money.

Money is anything (tangible or not) which is accepted by a sufficiently large section of society as a medium of exchange, and by the government for the payment of taxes.

     My poiint is that this is not a sufficient deffintion of money.  I am not comfortable with my position because I seem to be alone it it, but, as this time, I am questioning the validity of the whole basis for deffining money.  The conflation of money and debt.

Any alteration of its drawing power on real goods must be appropriately maintained.  Debt is what is DONE with money.  But both money and debt are conflated into one as the "money supply".  So "money supply" is a misnomer.

The "money supply" is not a misnomer, it is a term recognized and used by the central bank (in the U.S., the FED) when compiling its monetary statistics. The money supply is simply that form of money which is accessible to and used by the non-bank community (i.e. by individuals and by non-bank businesses). It consists of creditary deposits within commercial banking institutions (i.e. bank credit money) together with currency in the hands of the public. 

     As per above.

          
While it is true that debt is something carried out with money, I feel that you also should recognize that all bank credit money was created as debt. The net debt of society is nothing other than debt to the banking system, and is roughly equal to the magnitude of the money supply. And the magnitude of gross debt is usually several times larger than the magnitude of net debt.  

     Yes, I think I do understand that.  I have mentioned how, over time, no new money is created, only debt.  From the issuance of Treasuries onward.

But, again, when the "money supply" is talked about, it is actually the "debt supply".  Again, if all debt was paid off, there would be the "real money' supply.

I'm beginning to suspect that the "real money" is reserves.  But it is the one thing that is not listed as part of the money supply.

 

It does not designate the supply, the tally, of "money".  It's actually a tally of debt, because debt is the only thing that changes in amount.  The amount of money stays the same.  It's very confusing and I don't understand it yet.

There is no law of conservation of money. The money supply fluctuates on an ongoing basis -- every time a bank loan is advanced or repaid, every time a bank spends, and every time a customer creates a deposit using currency or makes a currency withdrawal.  Neither is there a law of conservation of reserves (exchange settlement funds plus currency held by commercial banks).

 

     Oh, I love this.  I spent some time on the reply below before I read your next post in which you retracted.  I've left it in just because of all the effort I put in to it.  ;)

     There is the law of the conservation of value.  And the importance of this law has been expressed in revolutions, and all the booms and busts throughout history, right up to the present one.  Money is financial value.  Social unrest is the price of the lack of it's conservation.

       And, yes, the money supply fluctuates but the "money" does not.  the "money supply" is debt supply but it is conflated with money and value conservation lost.

 

Back to basics:   BY DEFFINTION   A = B.  1 unit of A = 1 unit of B.  Now double A.  Now 2 units of A equal 1 unit of B.  That is called, according to which  time or deffinition, inflation.  In one deffinition, is is called inflation of the money supply.  In another, it is called inflation of prices.  This is primary.  The secondary is arguments that this formula does or does not apply in the real world, hopelfully the arguemnts will contain specifics.

     Now, in our case, I think we are close to agreeing that only debt is created over the long term.  If all debt were paid off, there would be money, but no more than before the debt started (Mosler's night of glory ;-).  Doesn't this suggest the whole 60 year cycle  of inflation/deflation might be caused by pressures to deal with the deflationary aspect of money not keeping pace with goods?

 

James

 

 

From: William

[Jean Erick]

     I'm not sure if I'm missing some thing here or not.  In the cases of home mortgages, I think the big issue has been the "bucket".  That is, that loan gone bad that is not written off the books for a while.   I think the normal time is 90 days but that "bucket" was extended during the crash and banks have needed time to clear the bucket.  Also, the unwillingness of banks to say how big their bucket is has led to an information vacuum form banks.

 

James

[Jean Erick]

     Well then, don't you see something odd about calling a bunch of debt the "money supply".

[Jean Erick]

     I don't suppose you're willing to recognize that a more accurate description of the money supply would be debt supply, at this time?

 

James

----- Original Message -----

From: William Hummel

To: understan...@googlegroups.com

Sent: Sunday, May 15, 2011 9:32 AM

Subject: Re: Effect of bank loan defaults on the money supply

[Jean Erick]

 

     There was money before Treasuries.  In any functional system, there will be money left after Treasuries and all debt is paid off.

     As there is an arrow of time, there is an arrow of debt, that is not being recognized.  The Treasury only borrows money.  It does not lend money.

Banks, as we talk about the multiplier, lends money.  Both are debt but are opposite arrows of debt.

     The FED does not create money or anything.  It acts as an early redemption mechanism for Treasuries.  Any financial value, in the form of reserves, that it credits to the banks, is matched by a withdrawal of securities from that bank.  No difference in individual bank or aggregate financial value.

     The multiplier serves as a mechansim to lend out an entity that is accurately described as a combination of money and letter of credit. "letter of credit", of course, refers to that part that is the result of multiplication over the amount of the original money.  The explnaations are futher confusing in that they don't distinguish between loan demand deposits that are immediately spent, as in house loans, to those business type oans that are more gradually brought down.

In one case, reserves are transferred, through check clearing.  In the latter, not quite so quick.

     I don't have an answer yet.  I thought I'd find answers here.  It seems that I have to make up the whole damn thing myself.

     I'm suggesting that you are conflating because I don't see you (or others) distinguishing between the intermediate money lending part of the multiplier and the "letter of credit" part of it.  And, of course, talking about how money is created when it is debt that is created, not money.

 

James

[Joe Leote]

Federal government has loan or loan guarantee programs:

 

http://www.govloans.gov/about-us

 

You need answers? Start with the basic principles of double-entry accounting schemes. Next inspect the components of money as cash assets of non-banks:

 

Cash Assets

C - currency

Ds   - bank deposits

MMFs - money market funds

 

Matching Liabilities

C - central bank

Ds - banks

MMFs - bank and non-bank firms

 

For every cash asset, used as money to settle payments by society, their is a matching liability on the books of a counter-party. The thing you prefer to call "money" is the currency component C which is created in our society when Fed issues more of its own liabilities. Otherwise it would have to be defined as $1 = so many ounces of gold, so many ounces of silver, a pigs eye and a chicken foot, etc.

 

People use money to support transactions and save for the future. The savings which is not held as static money under a mattress or in a deposit box or safe, is given to others to operate their business, government, household, etc in exchange for a security stipulating the conditional or fixed terms for repayment of the money. Treasuries are the most reliable of all forms of securitized saving since a loan to the government is backed by the Central Banks ability to print the money of the nation as a liability against itself as agent of the nation.

 

Black Elk's people were not so foolish, they knew the buffalo on the hoof (the nation of buffalo) were the "bank account" that supported the Lakota way of life for generations. The nation of peoples who accept dollar denominated liabilities persists for generations and this is the source of the power of Fed to issue money as a liability without any obligation to do anything but stabilize the purchasing power value of these liabilities, and it also gives Treasury the power to borrow from individuals within the nation and virtually guarantee repayment if Congress does not impose a default decree. 

 

Joe

----- Original Message -----

From: Jean Erick

To: understan...@googlegroups.com

[John Hermann]

I feel impelled to intrude on the discussion because clearly James has been troubled by this matter for a long time. Bank credit money takes the form or computer entries in the accounts of commercial bank customers. And for most people this is perfectly acceptable as a medium of exchange. The overwhelming majority of customers are probably quite unaware of the fact that reserves tag along (in principle) with all transactions involving bank credit money. Consider also that exchange settlement funds (bank reserve deposits in the central bank) are also credit money, and are intangible in precisely the same way that bank credit money is intangible. From my perspective, money is anything which is acceptable to a sufficient number of people as a medium of exchange, whether it takes a tangible form or not. The monetary aggregate known as the "money supply" is nothing other than money which is accessible to, acceptable to, and used by the general public and non-bank businesses. Primarily that consists of creditary deposits in commercial banking institutions. The term "money supply" is also recognized by the central bank (the FED in the U.S.), which compiles money supply statistics on a regular basis.

John.

At 04:18 AM 19/05/2011, James wrote:

     Well then, don't you see something odd about calling a bunch of debt the "money supply".
 

[William Hummel]

On 5/19/2011 7:40 PM, John Hermann wrote:

I feel impelled to intrude on the discussion because clearly James has been troubled by this matter for a long time. Bank credit money takes the form or computer entries in the accounts of commercial bank customers. And for most people this is perfectly acceptable as a medium of exchange. The overwhelming majority of customers are probably quite unaware of the fact that reserves tag along (in principle) with all transactions involving bank credit money. Consider also that exchange settlement funds (bank reserve deposits in the central bank) are also credit money, and are intangible in precisely the same way that bank credit money is intangible. From my perspective, money is anything which is acceptable to a sufficient number of people as a medium of exchange, whether it takes a tangible form or not. The monetary aggregate known as the "money supply" is nothing other than money which is accessible to, acceptable to, and used by the general public and non-bank businesses. Primarily that consists of creditary deposits in commercial banking institutions. The term "money supply" is also recognized by the central bank (the FED in the U.S.), which compiles money supply statistics on a regular basis.

John.

I think the most general definition of money is "whatever is widely accepted as a medium of exchange." Credit money refers to money backed by the full faith and credit of the country or institution that issues it, as opposed to hard money which depends on the perceived exchange value of some commodity like gold.

There is a hierarchy of credit money which depends on its degree of acceptability as a medium of exchange.  At the top of the hierarchy is fiat money, issued by the government and required in the payment of taxes.  Next are bank deposits which are actually claims on government fiat money.  And next are money market funds which are actually claims on short-term debt securities against which checks (actually drafts) can be written.

Reserves are fiat money owned by banks that must be surrendered when a depositor writes a check against his account or withdraws cash.  A check is the payer's order to the bank to transfer some of his claims on fiat money to the payee.  I wouldn't refer to reserves "tagging along" because that suggests reserves are incidental in the payment.  It is hard to imagine how bank credit money could retain widespread acceptability as a medium of exchange unless it was acting as a proxy for government fiat money.

William

[Joe Leote]

In this video Perry Mehrling gives a very brief overview of the hierarchy of money:

 

http://ineteconomics.org/blog/money-view

 

where the basic concept is explained between minutes 4 and 6. Also he says modern financial theory and economic theory have abstracted away from the older understanding of how dealers in money and credit provide market and funding liquidity to each other by cohort behavior patterns, or alternatively how markets "freeze" when dealmakers collectively hit the panic mode. Hyman Minsky describes these dealings as the position-making activity of financial and non-financial firms in Chapter 4 of stabilizing an unstable economy. This requires a network of dealers in the capital markets and money markets who exchange money for credit and credit for money.

 

Credit in this context means a financial claim to future cash flow (security) and money in this context means a cash asset sufficient to settle payment obligations in some sector or subsector of the economy. I am still trying to understand how MMFs both resemble and do not resemble banks, since only a portion of the MMF funds were used with Conduits to float Asset-Backed Commercial Paper with long term receivables as the ultimate collateral against short term liabilities, whereas MMFs that kept mostly short term receivables against short term liabilities were and should be more stable than traditional banks.

 

Joe 

 

----- Original Message -----

From: William Hummel

To: understan...@googlegroups.com

Sent: Friday, May 20, 2011 1:38 PM

Subject: Re: Effect of bank loan defaults on the money supply

[William Hummel]

Mehrling has a very important message, namely that the shadow banking system has overtaken the classical banking system in finance and is now the big elephant in the room.  His book "The New Lombard Street" explains this well.  He argues that not until the Fed assumed the role of dealer of last resort starting in Sept 2008 was the financial system saved from a complete meltdown.  Highly-leveraged broker-dealers had previously maintained two-way markets in a number of asset classes.  However as the quality of their assets came into question, they began failing because they could no longer roll over their short-term debt which was essential in financing their own portfolios. 

Mehrling points out that the shadow banking system is not really understood by most economists and policy makers.  The Dodd-Frank bill is directed primarily at problems in the classical banking system, and is of little value in protecting against another financial meltdown. One would hope that the Fed does not have to remain the dealer of last resort as a permanent role.

William

[Joe Leote]

This is another short video where Mehrling discusses the hierarchy of money in a domestic and international context:

 

http://www.youtube.com/watch?v=3S3I3JWqhs8&feature=relmfu

 

where as William said below he places MMMF dollars and Eurodollars below bank deposits in the hierarchy of money, but I think the reason is that bank deposits are "enhanced" as dollar equivalent liabilities because of FDIC insurance, not merely because they are more acceptable as payment settlement. The reasoning for the proposed reforms in making MMMF funds or Eurodollars on equal footing with reserves and currency is not explained here, unfortunately.

[William Hummel]

Here is the abstract of an interesting paper in pdf, titled "Regulating the Shadow Banking System" which can be one-click downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1676947&rec=1&srcabs=1735008

The “shadow” banking system played a major role in the financial crisis, but was not a central focus of the recent Dodd-Frank Law and thus remains largely unregulated. This paper proposes principles for the regulation of shadow banking and describes a specific proposal to implement those principles. We first document the rise of shadow banking over the last three decades, helped by regulatory and legal changes that gave advantages to three main institutions of shadow banking: money-market mutual funds (MMMFs) to capture retail deposits from traditional banks; securitization to move assets of traditional banks off their balance sheets; and repurchase agreements (“repo”) that facilitated the use of securitized bonds in financial transactions as a form of money.

A central idea of this paper is that the evolution of a bankruptcy “safe harbor” for repo has been a crucial feature in the growth and efficiency of shadow banking, and so regulators can use access to this safe harbor as the lever to enforce new rules. As for the rules themselves, history has demonstrated two successful methods for the regulation of privately created money: strict guidelines on collateral (used to stabilize national bank notes in the 19th century); and government-guaranteed insurance (used to stabilize demand deposits in the 20th century). We propose the use of insurance for MMMFs combined with strict guidelines on collateral for both securitization and repo as the best approach for shadow banking, with regulatory control established by chartering new forms of narrow banks for MMMFs and securitization and using the bankruptcy safe harbor to incentivize compliance on repo.

[John Hermann]

At 03:08 AM 21/05/2011, William Hummel wrote:

On 5/19/2011 7:40 PM, John Hermann wrote:

I feel impelled to intrude on the discussion because clearly James has been troubled by this matter for a long time. Bank credit money takes the form or computer entries in the accounts of commercial bank customers. And for most people this is perfectly acceptable as a medium of exchange. The overwhelming majority of customers are probably quite unaware of the fact that reserves tag along (in principle) with all transactions involving bank credit money. Consider also that exchange settlement funds (bank reserve deposits in the central bank) are also credit money, and are intangible in precisely the same way that bank credit money is intangible. From my perspective, money is anything which is acceptable to a sufficient number of people as a medium of exchange, whether it takes a tangible form or not. The monetary aggregate known as the "money supply" is nothing other than money which is accessible to, acceptable to, and used by the general public and non-bank businesses. Primarily that consists of creditary deposits in commercial banking institutions. The term "money supply" is also recognized by the central bank (the FED in the U.S.), which compiles money supply statistics on a regular basis.

      I think the most general definition of money is "whatever is widely accepted as a medium of exchange." Credit money refers to money backed by the full faith and credit of the country or institution that issues it, as opposed to hard money which depends on the perceived exchange value of some commodity like gold.

      There is a hierarchy of credit money which depends on its degree of acceptability as a medium of exchange.  At the top of the hierarchy is fiat money, issued by the government and required in the payment of taxes.  Next are bank deposits which are actually claims on government fiat money.  And next are money market funds which are actually claims on short-term debt securities against which checks (actually drafts) can be written.
      Reserves are fiat money owned by banks that must be surrendered when a depositor writes a check against his account or withdraws cash.  A check is the payer's order to the bank to transfer some of his claims on fiat money to the payee.  I wouldn't refer to reserves "tagging along" because that suggests reserves are incidental in the payment.  It is hard to imagine how bank credit money could retain widespread acceptability as a medium of exchange unless it was acting as a proxy for government fiat money.

The "degree of acceptability" is something which would be hard to quantify, however clearly it bears a inverse relationship with the degree of (perceived) risk of failure to provide legal tender on demand. 

In regard to the point raised in William's last sentence, is it not true to say that - in the early history of banking - credit money acted as a sort of proxy for gold held in bank vaults?  I'm not sure of the extent to which governments in those times issued their own credit money, in place of any gold or silver which they either laid claim to or minted and issued in the form of coins.  However in such circumstances it would not seem to be correct to say that bank credit money necessarily acted as a proxy for government issued credit money.  Query: Did governments in those times accept any form of precious metal for the payment of taxes?

John

 

[Jean Erick]

----- Original Message -----

From: Joe Leote

To: understan...@googlegroups.com

Sent: Thursday, May 19, 2011 12:34 PM

Subject: Re: Effect of bank loan defaults on the money supply

Federal government has loan or loan guarantee programs:

 

http://www.govloans.gov/about-us

 

You need answers? Start with the basic principles of double-entry accounting schemes. Next inspect the components of money as cash assets of non-banks:

 

Cash Assets

C - currency

Ds   - bank deposits

MMFs - money market funds

 

Matching Liabilities

C - central bank

Ds - banks

MMFs - bank and non-bank firms

 

For every cash asset, used as money to settle payments by society, their is a matching liability on the books of a counter-party. The thing you prefer to call "money" is the currency component C which is created in our society when Fed issues more of its own liabilities. Otherwise it would have to be defined as $1 = so many ounces of gold, so many ounces of silver, a pigs eye and a chicken foot, etc.

 

     How do I make sence out of non sence?  The above, while right down the line of how it is talked about simply does not cover it.  May I say that it does sound fine but fails to stand a scutiny born of due diligence?  ;-)    First, there is no matching liability of the cash in my wallet.    Once a bank converts it's account reserves to cash, FED liability is gone.  Remember?  Base money(MB) is FED reserve liability (bank credit at FED) PLUS non FED currency(M0). 

     Second "created ......", no.  When the FED buys securities (as I stated in my previous post)  reserve credits are EXCHANGED for securities.  No FINANCIAL VALUE is added to the economy.  No FINANCIAL VALUE is added to keep up with real VALUE created.  The FED is functioning as an early redemption mechansim.  At some point, taxes will be transferred to the holder.

     The thing that I call money is "generic good" which relates it to real goods and labor.

     NOTE: (and third)  Isn't it odd that the entity which is directly convertable to cash, is the most essential cash substitute there is, and is called "money" when it is "created" is NOT counted as part of the money supply?  That which is most like money is not counted as money when the money is counted.  Whose confused here?

 

People use money to support transactions and save for the future. The savings which is not held as static money under a mattress or in a deposit box or safe, is given to others to operate their business, government, household, etc in exchange for a security stipulating the conditional or fixed terms for repayment of the money. Treasuries are the most reliable of all forms of securitized saving since a loan to the government is backed by the Central Banks ability to print the money of the nation as a liability against itself as agent of the nation.

 

     I have no problem with this.  Well stated.  Treasuries, in a sence, beyond cash, is the "realist" money we have because of the greatest integrity of repayment.  Classically, people "mattress" money (save) for the future.  But not lately.  The common people have not saved while the rich have saved, but only to rent out those savings.  Remember.  The whole thing started when I noticed that, in spite of a low savings rate, gross savings were the part of M2 that had grown exponentially, while the other components just went along as usual.

 

Black Elk's people were not so foolish, they knew the buffalo on the hoof (the nation of buffalo) were the "bank account" that supported the Lakota way of life for generations. The nation of peoples who accept dollar denominated liabilities persists for generations and this is the source of the power of Fed to issue money as a liability without any obligation to do anything but stabilize the purchasing power value of these liabilities, and it also gives Treasury the power to borrow from individuals within the nation and virtually guarantee repayment if Congress does not impose a default decree. 

 

     Considering that the African velt supports more beef than our fenced ranges, we certainly would have been better off to have kept those buffalo and harvested them.  But, again.  Once a bank turns its reserves into cash, where is the liability?  That is where the rubber meets el camino and cash meets the stabilization of purchasing power.  (((As in the price of housing.)))

 

     

James

[Jean Erick]

     LOL.  Thank you for recognizing my concern. 

(1) the conflation of both bank liability deposits and bank asset loan deposits into the same entity, demand deposits.

    I resolved this a bit by accepting that deposits are lent out + "letter of credit" quality money.and that, at a 2-2.5 multiplier (in "normal" times), it

    ain't all so bad.

(2) But then there's an even hotter pan when I see that the "creation" of money is an entire mischaractrerization. because it implies that there is

     new financial value injected into the economy.  There's not. 

(3) And there is yet a hotter pan when you see that with no (2), where's the money to keep the proportion of money (in play) to goods maitained?

     Now that's three strikes and I begin to feel like #2.   ;-) 

 

James

 

   

----- Original Message -----

From: John Hermann

To: understan...@googlegroups.com

[Joe Leote]

This paper is not an official source, but it shows and describes Federal Reserve Notes as the largest liability of Central Bank on pages 1 and 2:

 

http://wps.aw.com/wps/media/objects/2095/2146070/Ch08App.pdf

 

as to the other parts of your response I do not have inclination to engage in "debate-club" at this time.

[John Hermann]

Further comments in blue font..  John.

At 04:58 AM 22/05/2011, James wrote:

     LOL.  Thank you for recognizing my concern. 
(1) the conflation of both bank liability deposits and bank asset loan deposits into the same entity, demand deposits.

That's because they necessarily ARE the same entity.  I don't see a problem here.

    I resolved this a bit by accepting that deposits are lent out + "letter of credit" quality money.and that, at a 2-2.5 multiplier (in "normal" times), it
    ain't all so bad.

What you persistently fail to recognize is that the retail deposits of commercial banking institutions are NEVER loaned out.  Wholesale borrowings might be loaned out (to other players within the financial system, not to retail customers), however this is a quite different category of bank liability. 

(2) But then there's an even hotter pan when I see that the "creation" of money is an entire mischaractrerization. because it implies that there is
     new financial value injected into the economy.  There's not.

The meaning of this statement is unclear.  You seem to be saying that newly injected "financial value" (definition?) is unrelated to the real monetary requirements of the economy.  However under a modern fractional reserve system of banking, bank credit money is created endogenously according to the needs of the growing economy.  Of course one can legitimately criticise the distribution of money and the purposes for which new money happens to be created, however it seems obvious to me that - when banks advance loans - new "financial value" is injected into the economy.

(3) And there is yet a hotter pan when you see that with no (2), where's the money to keep the proportion of money (in play) to goods maitained?

The system works because credit money is created (or destroyed) endogenously, according to the actual needs of the economy as a whole.

     Now that's three strikes and I begin to feel like #2.   ;-)

From: John Hermann

I feel impelled to intrude on the discussion because clearly James has been troubled by this matter for a long time. Bank credit money takes the form or computer entries in the accounts of commercial bank customers. And for most people this is perfectly acceptable as a medium of exchange. The overwhelming majority of customers are probably quite unaware of the fact that reserves tag along (in principle) with all transactions involving bank credit money. Consider also that exchange settlement funds (bank reserve deposits in the central bank) are also credit money, and are intangible in precisely the same way that bank credit money is intangible. From my perspective, money is anything which is acceptable to a sufficient number of people as a medium of exchange, whether it takes a tangible form or not. The monetary aggregate known as the "money supply" is nothing other than money which is accessible to, acceptable to, and used by the general public and non-bank businesses. Primarily that consists of creditary deposits in commercial banking institutions. The term "money supply" is also recognized by the central bank (the FED in the U.S.), which compiles money supply statistics on a regular basis.

[Jean Erick]

         Oh, gee.  Allright boss.  I will stand corrected and thank you for the citation you provided.  But your post did not apply to what I am confused by.   What I am confused by is what people have been saying about how the FED creates money when it buys securities.  Now it does.  But that is not the point.

     The point is that the transaction is an exchange of financial value in which there seems to be no net financial input to the market.  The FED conveys the financial value of reserve credits to the banks in EXCHANGE for financial value in the form of securities.  Asset - liability = 0 profit.  No new  financial value is created.  But, in the way people talk about it, it sounds like they are saying there is more net permenent financial value injected.  That is what I see and that is what I'm trying to discuss and see what other people think.

    In reading your post about Schumpeter, I think he was trying to get at the same thing so I don't think I'm totally alone on this.

[Jean Erick]

----- Original Message -----

From: John Hermann

To: understan...@googlegroups.com

Sent: Saturday, May 21, 2011 8:47 PM

Subject: Re: Effect of bank loan defaults on the money supply

Further comments in blue font..  John.

At 04:58 AM 22/05/2011, James wrote:

     LOL.  Thank you for recognizing my concern. 
(1) the conflation of both bank liability deposits and bank asset loan deposits into the same entity, demand deposits.

That's because they necessarily ARE the same entity.  I don't see a problem here.

 

     So you are seeing a demand deposit that is created by making a house loan, with multiplier money going  out of the bank to the public,  as the same as a demand deposit made from money that comes into the bank from wages and salaries?

    If I loan base money to a bank as a demand deposit, whether I leave it there or spend it out, it remains in existance.  But demand deposit money that is created by the loan process is destroyed when it is paid back.  There is no money then.  And yet both are added together in the "money supply".  And you find that acceptable?

    I resolved this a bit by accepting that deposits are lent out + "letter of credit" quality money.and that, at a 2-2.5 multiplier (in "normal" times), it
    ain't all so bad.

What you persistently fail to recognize is that the retail deposits of commercial banking institutions are NEVER loaned out.  Wholesale borrowings might be loaned out (to other players within the financial system, not to retail customers), however this is a quite different category of bank liability. 

 

        But I'm not talking about commerical banks.  I'm talking about banks that take part in multiplier lending, commercial, retail, it doesn't matter. I was talking about demand deposits and the difference in how they are created  The context is multiplier lending. 

     When I write a check written on and equal to my demand account created by my deposition of money, reserves are moved from my bank to the bank which holds the account that the check is written to.  If I write a check equal to my demand deposit account created by a loan, a reserve amount equal to that demand deposit PLUS multiplier "created" money is transferred.   Both money and debt is added up to transfer reserves.  But debt is not "money".  In the basic.

(2) But then there's an even hotter pan when I see that the "creation" of money is an entire mischaractrerization. because it implies that there is
     new financial value injected into the economy.  There's not.

The meaning of this statement is unclear.  You seem to be saying that newly injected "financial value" (definition?) is unrelated to the real monetary requirements of the economy.  However under a modern fractional reserve system of banking, bank credit money is created endogenously according to the needs of the growing economy.  Of course one can legitimately criticise the distribution of money and the purposes for which new money happens to be created, however it seems obvious to me that - when banks advance loans - new "financial value" is injected into the economy.

 

    Yes.  Bank credit money is created.  But bank credit money is not money.  It is DEBT.  I guess financial value is not a good term to use.  I should just go to "real money".    "Real money" is that money that is owned with equity title that superceeds legal title.   "Real money" is moved around as debt in an intermediary fashion, and more debt is created through the multiplier.  But no "real money" is created, either by the banks nor the FED.  Only debt is created because it is all based on the fact that the Treasury only issues debt.  The Treasury only BORROWS money.  It's an intermediary.  It does not lend it.  Okay, it also lends it directly to banks but then again, banks repay it.  But the FED doesn't deal in money lent to the banks by Treasury.  The FED deals in Treasuries with everybody EXCEPT the FED (redemption excepted).   In buy mode, it credits reserve accounts in exchange for Treauries the banks have.  Financial value in, financial value out.  Assets - liabilities = 0 profit.  And then, eventually, the money is paid back to whom it was borrowed from.  Paid back from future taxes.  Deficit spending is borrowing.  But that doesn't make it "more" money.  Just more debt.  This is what I'm seeing and it's troubling because it is so different then I think people are describing it.

(3) And there is yet a hotter pan when you see that with no (2), where's the money to keep the proportion of money (in play) to goods maitained?

The system works because credit money is created (or destroyed) endogenously, according to the actual needs of the economy as a whole.

 

      As  above.  Debt, not "real money" is created.  So, GDP has grown but the amount of "real money" has not grown.

     And, I don't know if you noticed lately, but it DIDN'T work.  The whole thing just about went off a cliff.

 

James