Sunday, 30 April 2017

World Economic Forum article claims private banks don’t create money.

The article is entitled “Do banks really create money out of thin air?” though the WEF do not officially endorse the arguments in the article.

The article starts with the hypothetical example of person S who sells a house to person B. “S” is obviously short for “seller” and “B” is obviously short for “buyer”.

The initial assumption is that B does not have any cash, so after the sale, B simply becomes indebted to S for the value of the house. And that, as the article rightly points out, is an arrangement which will not suit the vast majority of house sellers. Among other things, it involves S in collecting regular repayments and interest in respect of the debt from B for 20 years or so.

Next, the article explains that banks can help with the latter problem: a bank can open an account for B, credit the account with an amount of money equal to the value of the house (produced from thin air), which B then pays to S. S is now relieved of the inconvenience of collecting the debt from B, plus S has money with which to buy an alternative house.

But despite the obvious admission referred to in the latter paragraph that a bank has in fact created money from thin air, the article in the final paragraph then says:

“But this is only the prima facie appearance and not the truth of the matter because the outside observer has neglected to acknowledge that the deposit value records the value-for-value exchange conducted through an underlying transaction.”

Well the cognoscenti (which includes me needless to say) have always been aware that commercial bank created money nearly always RESULTS FROM the desire of people and firms to do business. I.e. if B did not have any need for a large amount of money, there’d be no point in B going along to a bank and asking for a loan, would there? But the fact that that money creation results from something or other does not stop that money creation being money creation, unless I’ve missed something.

The second flaw in the latter final paragraph, is that in fact banks will create money even where there is no immediate desire to do business. This is unusual, but if a particularly credit worthy bank customer went along to a bank and said “I have no immediate business deals in mind, but please lend me a million so that when a profitable looking deal comes my way I can pounce on it.”, the bank might well go along with that (and of course charge for the service provided). 

Friday, 28 April 2017

Private banks do not charge interest in respect of the money they issue.

There is a popular myth to the effect that the above is the case. The myth is promoted by among others, Positive Money, an organisation I actually support because PM gets many things right. Also Bryan Gould (former member of the UK Labour Party shadow cabinet) seems to lend credence to the myth.

The idea that private banks DO CHARGE interest in respect of the money they issue stems from the “loans create deposits” phenomenon: that is, when a bank makes a loan, it does not need to get the relevant money from depositors or from anywhere else. It can simply open an account for the borrower and credit $X to the account – the money comes from thin air. The bank then charges interest on the loan.

Thus banks do two things there: first, create money, and second, charge interest. Ergo, so it might seem, they charge interest on the money they have created.

The flaw in that argument is that banks either charge for the loan or for the money. They cannot charge for both. I.e. if a bank charges 5% interest, is that for the loan or is it the lucky recipient of the money who is charged?

Take the case of a loan for $X which is granted to Y, who then spends the money, which ends up in the bank account of Z. There is no doubt that Y pays interest to the bank. But Z, the recipient of the money doesn’t.!! If anything, Z charges his or her bank interest (or put another way, Z’s bank will pay interest to Z, particularly if the money is put into a term account.)


Double checking the argument.

By way of double checking the above points, consider an economy where there was no borrowing or lending, but people did (understandably) want a form of money. And let’s say that money is supplied by, or at least supplied almost exclusively by private banks.

Those banks would open their doors for business. Customers would ask to open accounts and would ask for some specific sum of money to be credited to those accounts to enable day to day transactions to be done. Banks would demand collateral as appropriate.

Certainly banks would charge for ADMINISTRATION  costs there (e.g. the cost of checking up on the value of collateral). But there would at that stage be no reason to charge INTEREST because no real resources would at that stage have been transferred by banks to customers.

Moreover, even after customers started spending their money, there would still be no very good reason for banks IN THE AGGREGATE to charge customers in the aggregate for interest. Reason is that money leaving one account must arrive in some other account. (To keep things simple, I’ll assume there is no physical cash – a not totally unrealistic assumption, given that it looks like physical cash will disappear in the near future.)

Of course where specific customers ran down their bank balances, and left them in a “run down” state for extended periods, banks would charge interest to those customers. But in that case, real resources would have been transferred to those customers for an extended period. That is, the only way for that “extended run down” to occur is for relevant customers to buy stuff off other customers and leave it at that. I.e. the latter “buyers” would in effect be borrowing from the latter sellers with banks acting as intermediary. Sellers, would understandably want interest, and that interest would be passed on to buyers.



Banks charge interest on loans. They also charge for administration costs when supplying customers with day to day transaction money. But it would not make any sense for banks to charge interest simply for supplying all and sundry with day to day transaction money.

Monday, 24 April 2017

Random charts XX.

Text in pink on the charts below was added by me.

Tuesday, 18 April 2017

Steve Keen and Mish make a fallacy of composition error?

I agree with Steve Keen and Mike Shedlock (“Mish” for short) about 90% of the time. But they’ve slipped up on the subject of bank reserves, unless I’ve missed something. I’ll use the word “bank” to refer to commercial banks (as distinct from central banks)

Mish challenges the conventional wisdom on interest on reserves (IOR), which is that IOR is an incentive for banks not to lend. The conventional wisdom is that if a bank gets say 5% on its reserves, and given that lending $X means the bank loses about $X of reserves, it won’t lend unless it gets at least 5% after expenses from the potential borrower.

Mish challenges that by pointing out that the decision by an individual bank (or indeed the bank industry as a whole) to lend more has no effect on the industry’s stock of reserves. He concludes from that that interest on reserves does not provide banks with an incentive not to lend.

Well it’s true that the decision by a bank or the bank industry as a whole to lend more has no effect on the industry’s stock of reserves. However, the flaw in the latter “Mish” argument is that “incentives” as seen by an INDIVIDUAL bank are not the same as “incentives” as seen by the commercial bank system as a whole. That is, if an individual bank (to repeat and over-simplify a bit) gets say 5% on its reserves, it has no incentive to lend unless it gets MORE THAN 5% from the potential borrower after expenses.

The fact that IF IT DID LEND, there would be no effect on the TOTAL AMOUNT the bank industry gets by way of interest on reserves is irrelevant because banks just don’t collude when it comes to the decision by an INDIVIDUAL bank to lend – they couldn’t collude if they tried. To illustrate…

Suppose that bank A is contemplating a loan of $Y to a customer, and suppose that in the event of the loan taking place, relevant monies will be deposited at bank B. It is plain impossible for both banks to get together and work out the effect on their combined incomes as a result of making that loan: reason is that each bank will be making thousands of loans per day. Moreover, in the latter example, relevant monies will not necessarily be deposited at just one bank (i.e. bank B): chances are they’ll be deposited at several banks. And worse still: relevant monies will not stay at recipient banks for long. Those monies will be re-spent and deposited at yet another set of banks.

Thus the idea that banks can somehow collude with a view to working out the effect on their total income as a result of one bank making a loan is wholly, completely and totally unrealistic.

Thursday, 13 April 2017

Random charts IXX.

Text in pink is added by me to the original charts.

Wednesday, 12 April 2017

Do Job Guarantee enthusiasts want the entire workforce raking leaves rather than doing something useful?

Reason I ask is that it’s not entirely clear where JG enthusiasts stand on this one. For example Pavlina Tcherneva is one of the more vociferous advocates of JG, but in the opening paragraphs of an article of hers (Levy Economics Institute Policy Note 2012/2) she criticises conventional stimulus and sings the praises of JG type employment.

So how far does she want to take that point: abolish all forms of conventional employment, and instead have the entire workforce raking leaves, planting trees and doing the other assortment of jobs normally given as examples of what JG / make work scheme employees can do?

Strikes me as pretty obvious that the optimum policy here is to boost demand as far as possible, and get as much of the workforce as possible into conventional types of employment (public and private), and then use JG to deal with the remaining and unemployed members of the workforce. But there is no hint in her article of the latter idea.

More evidence of the dim view she takes of conventional forms of employment comes in this tweet of hers where she castigates dangerous car factories. Well the solution to that is proper and properly enforced health and safety laws, not closing down every car factory in the country and putting redundant employees onto raking leaves and planting trees.

Amazing that it is even necessary to explain this, isn't it?

Factories that produce cars and other items produce what people actually want and are prepared to pay for (shock horror). JG work is inevitably less productive because if a given JG job really was more productive than the less productive regular jobs, market forces would bring the former into existence and dispense with the latter, all else equal, i.e. assuming a constant level of aggregate employment.

Moreover, it’s not as if there is a total absence of injury and death on JG projects: a significant proportion of the JG scheme which operated in the 1930s, namely the WPA, involved constructing buildings, roads, bridges and so on. That sort of work is inevitably quite dangerous.

In contrast to today’s deluded JG advocates who will get precisely nowhere under the current Republican administration, the JG ideas I was advocating about 20 years ago have actually been put into effect, albeit in a small way.  One idea I advocated was that JG type work should be with EXISTING employers rather than on specially set up projects, as per WPA. Second I advocated that there should be no preference for public sector employers as compared to private sector employers (or vice-versa).

Those two ideas are in fact inherent to the only JG type scheme up and running in the UK, i.e. the Work Programme.

For my latest ideas on this subject, which have not changed substantially from 20 years ago, see my recent paper in the journal below. This is an exercise in tidying up and bringing things up to date.

Sunday, 9 April 2017

Random charts XVIII

Text in pink is added to original charts by me.