Three theories of banking

[William F Hummel]

Joe Leote brought the following paper by Professor Werner to my attention, and I think it would be of interest to the group.

http://www.sciencedirect.com/science/article/pii/S1057521914001070

The author identifies three theories of banking which he claims are mutually exclusive, each of which has dominated macroeconomic thinking at different times in the past century. They are (1) the credit creation theory until about 1930, (2) the fractional reserve theory until about 1970, and (3) the financial intermediation theory since then.  

According to the author, banks are currently viewed as mere financial intermediaries that gather resources and re-allocate them, just like other non-bank financial institutions, and without any special powers. Any differences between banks and non-bank financial institutions are seen as being due to regulation and effectively so minimal that they are immaterial for modeling or for policy-makers. Thus it is thought to be permissible to model the economy without featuring banks directly.

In the fractional reserve theory, the dominant view was that the banking system is unique, since banks unlike other financial intermediaries can collectively create money, based on the fractional reserve or ‘money multiplier’ model of banking. Despite their collective power, however, each individual bank is considered to be a mere financial intermediary, gathering deposits and lending these out, without the ability to create money.

The credit creation theory, in line with the fractional reserve theory, maintains that the banking system creates new money. However, it goes further than the latter and differs from it in a number of respects. It argues that each individual bank is not a financial intermediary that passes on deposits, or reserves from the central bank in its lending, but instead creates the entire loan amount out of nothing.

The author’s intent is to prove empirically that banks create money out of thin air, a point

that MMTers have always taken as axiomatic. Since this supports the credit creation theory of banking, he eliminates the competing theories as unrealistic.

However the three are not mutually exclusive as the author claims. And banks are not as free to create deposits through lending as the author implies. Banks can only lend to willing borrowers. When the public is deleveraging as it has been for several years, finding creditworthy borrowers can be a limiting factor on bank lending. Unless banks can sell off their loans, they are not going to lend freely as they did during the recent housing bubble.

Monetary policy set by the Fed influences the demand for loans and thus limits aggregate bank lending. Banks must hold reserves sufficient to cover the loans they make. That means their creditworthiness must be excellent or they cannot borrow reserves when needed.

There are important ways that set banks apart from non-bank financial institutions. Banks play a central role in the payment system and lend by crediting transaction accounts. Non-banks play no direct role in the payment system and can only lend their own funds. However they are a major source of credit in the economy, mainly with funds borrowed in the bond market rather than from banks.

William

[helge nome]

The banks and financial system operators have found a way of getting around the obstacle of finding credit worthy borrowers by creating a market for increasingly complex IOUs amongst themselves.

This has facilitated the creation of monstrous amounts of "money" in the system, skimming from which has generated record profits

for banks and financial institutions in the last number of years.

Thus, banks are able to make record profits for their shareholders in spite of depressed economic activity in the overall economy world wide.

Good economic indicators for world wide economic activity are the Baltic Dry Index and the Harper Peterson Index giving shipping quotes for bulk goods and finished good respectively.

Helge

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Date: Sun, 21 Dec 2014 11:03:09 -0800
Subject: Three theories of banking
From: wfhu...@gmail.com
To: understan...@googlegroups.com

[Jean Erick]

     With respects:  As usual the question is derived from the comtemporary neo-con culture and therefore

allows no valid answer.  It functions to keep the discussion within the neo-con context so guestioning that

context is implicitly discouraged.

     We live in a money medium extant age, exemplified by capitalism.  Previous ages of long standing had markets where

either usary was not allowed (Islam) or capital accumulation by merchants was heavily regulated and discouraged (China).

     The classic elements are a state, merchants, and the population, and how they have alligned themselves as partners.

Currently we have a captialistc corporate mercantile-banking partnership which has captured the state.  The populace is on

their own as per usual.

     The market needs a state to issue money so a market can then function.  From then on it's symbiotic.  Interestingly,

a human psychological symbiotic relationship is now termed a "shared psychosis"  But in the human psychosis, the recessive

takes on the dominants fantasy out of sympathy.  In the money rules psychosis, the dominant forces the recessive to take

on the fanstasy.

 

     What do the questions below have to do with the Kontratieff wave of a greatly enlarged banking industry at the time of great

financial structural crisis, the current being To Big To Fail?  Nothing.  TBTF is a political issue that uses money so that the

cohort in power maintains their wealth and the order of things.  Roubini has echoed that banking is supposed to be a very

boring business.  And Roubini, Keen, Hudson, (and Jesus) have accapellaed "wipe out the debt".

 

    I have posted my view that the banks lend some money and then create drawing rights on money.  I think my reading

about debt history of late has supported that view.  The opposing discussion does not get into the details of the differences

in "real money" and "credit money".

 

     I do not know if you are talking about the credit theory of money (Notes:" Mitchell-Innes was exponent of the Credit Theory of Money:
Money is an accounting tool, not a commodity. (Unit of A [c] count?)  Money measures debt.") or (Notes:"G. F. Knapp's "State Theory of Money" 1905.  Charlemagnes pounds, shillings, and pense value measuring system remained far after his empire and tokens had expired.
     Hazel wood tally sticks split in half with one holding the "stock" and the other holding the "stub" (ticket)not.") or something else.

 

    I agree with above as money being a unit of a count, but mainly not a commodity.

Somehow the labeling of banks as simply intermediaries does cross my eyes.

 

James

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

From: William F Hummel

To: Money Group

Sent: Sunday, December 21, 2014 11:03 AM

Subject: Three theories of banking

[Joe Leote]

James,

The questions of whether banks create credit and money (yes), operate on a principle of fractional reserves (yes), otherwise behave much like other financial intermediaries (yes), and operate according to the theory of the money multiplier (no), are valid questions posed within the prevailing customs of law, trade, and accounting.

The same author makes an effort to identify the distinction of banks from nonbanks by recognizing the accounting implications which follow from Client Money Rules (UK):

http://www.sciencedirect.com/science/article/pii/S1057521914001434

I agree with this paper on how banks extend credit and create money from "thin air." The discussion of client money rules and accounting implications is excellent but does not capture the complexity of the modern banking system or nonbank financial system. The debit and credit examples would have to be extended significantly to capture the structure and dynamics of banks and nonbank financial firms applying banking accounting customs versus nonbank accounting customs while making credit deals.

Joe

[Jean Erick]

     Your, reiteration only, of the neo-con view does not further the discussion.  Anything talked about within a neo-con

culture is right to the neo-con view.  As I have posted many times before, everything is known about the individual trees,

nothing about how they fit into the forrest.

 

    You are in the postition of accepting "intermediary" as an accurate description of the US banking entity which is $26 Trillion

in debt black while all other sectors are in debt red, and banks have another $8 Trillion in small times savings.  They appear to

be nothing less then both the financial store house of the oligarcahy and the main mechanism of their control.  How much

bigger and more powerful do they have to get before they rise above the appellation of "intermediary"?  And why would anybody

attempt to describe such an entity with such a misdescriptive term?

 

     This narrow thinking of the neo-con mentality is the nearly the exact if not exact thing that Capital Management was engaged in

with their 5 year history.  It works in the short term only for those running the game.

 

       The fact that strong distinctions are not made between the money created by the Fed and the "money" created

by banks is an example of a system that is so misdescriptive that "smoke and mirrors" is the only accurate description.

If banks can make money, why didn't they make money to get themselves out of trouble?  Please explain that to me.

 

     Banks don't create money out of thin air.  They create debt out of thin air.

 

    In fact, the discussion should probably be, as all money is borrowed, is there any real money?

 

     Personally, I am surprised at your, generally neo-con, position (narrow by its nature).  You are the one who turned me on to

Hudson and you are the one who was right about debt existing before money.  I was, on my own, looking more and more at

debt and the book was just a tidal wave pushing me further in the direction I had been moving.  You have such a wonderful

talent in your wording.  If you could see a bigger picture, it woud give you so much to celebrate in your wonderful financial prose.

 

    I thought I was really getting ahead with Chris Hedges interview of Volin wherein "inverted totalianarism" was used to describe

our current culture of make believe (title of Derrick Jensens book but referring to a different aspect of the system) only to find out

this is nothing new.  It's always been done that way.  We live in 3600 BC.

[Joe Leote]

James,

I regard capitalism as the social pattern described by the words "private property with finance." To understand private property with finance I study the customs of law, trade, and accounting with some level of necessary abstraction and generalization.

My views of the purpose of law, private property, and finance are pretty close to the ideas expressed in this paper by Hugh Gibbons:

The Purpose of Law
http://www.biologyoflaw.org/Purpose/PurposeLaw.pdf

To me the role of a financial intermediary is to hold financial assets on one side of the balance sheet and issue liabilities on the other side of the balance sheet as the dominant feature of the unit in the economy. Historically the freedom to contract and right to enforce private property claims leads to firms and governments that operate as financial intermediaries. While a closed domestic economy has an incentive to keep financial intermediaries from getting too big to fail, I think a large economy with international trade has an incentive to allow financial intermediaries to scale up especially if other internationally active nation-states allow their financial intermediaries to scale up.

Joe

[Jean Erick]

     Captitalism is based in compound interest.  It is an approach of competetiveness, extreme violence

to implement it, and the insane in todays world, unquestionable context of permanent growth.  For most

of mankind, it was absolutely forbidden.  It has been a vehicle to install a social system where a tiny,

elitiest minority of the population make the decisions for all of us, those decisions based on what is

good for that minority.  It has led to a facist state masquerading as a democracy.  A charter member

of Davos, himself, posted on the site that today's capitalism is unnsustainable.

 

     Then essential elements of civilization have been slavery-freedom.  There is no ethical acceptence

 slavery.  Debt has classically been used to enslave.

 

BTW  Roubini noted that economies of scale only work with one product.  Not the multitude of financial products.