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Subject: I accept MMT but think that they should rethink some points. rss

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Steve
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I think that the economists who are pushing MMT {Modern Money Theory, Google "Wray and MMT"} are making some mistakes. Don't get me wrong here, I mean in order to convince those who need to be convinced MMT should make a few changes.

1] MMT claims that it has proven that tax collections “destroy money” as soon as they are received and that there is no need to keep track of them in an account, so that they can be spent later. MMT also claims that it has proven that all Fed. Gov. spending is done with new money that has just been created as the Gov. spends it.
. . a] It seems to me that these statements are not necessary to the rest of the theory. If they are not necessary then it doesn't matter if expert X or Congressman Y agrees that these statements are proven.
. . b] Therefore, when some experts and Congressmen don't think they have been proven and get hung up on that “fact”; their ability to accept the rest of MMT's points is undermined.
. . c] Therefore, MMT ought to reformulate its arguments without these hard to grasp and unnecessary points.
. . d] I personally can see MMT's point. When I get an IOU back from someone, I don't need to keep it to be able to issue a new IOU later. When I get it, I should destroy it. But, this point is not necessary to the rest of MMT's policy points.

2] For example, MMT needs to convince the experts and Congressmen that Fed. Gov. deficit spending will always automatically provide the cash for the people and banks to buy the T-Bonds that are used to “finance” the deficit spending. That therefore, the need of the Fed. Gov. to sell bonds to finance the deficit spending will not crowd out private lending by sucking up the savings of the people. Selling T-Bonds just moves the people's [here including banks and all other companies] money from their checking accounts into their “savings accounts”.
. . a] Actually, far from sucking up their savings, the opposite is true. A Fed. Gov. deficit adds to the savings of the non-gov. sector of the economy, that is the savings of the people.
. . b] It seems to me that it is not necessary to get the experts and Congressmen to accept that Fed. Gov. taxes destroy money and that Fed. Gov. spending money creates it. The point is that deficit spending does not do what many economists says that it does. It does the opposite. This is why interest rates have not gone up under Bush II and Obama despite their huge deficit spending. Many economic theories are just plain wrong, so most economists are just plain wrong when they use wrong theories. The facts on the ground prove the theories to be wrong.
. . c] Further, it isn't even necessary to show or prove that banks do not in fact lend only the money that has been previously deposited in the bank.
. . d] It was experimentally shown in 2013 that a German bank does not make sure it has the cash on hand to make a loan before or after it makes the loan. Nor does it deduct the loan amount from some figure in its books. This proves that banks create new money when they make a “bank loan”.
. . e] Therefore, banks can always make loans. If they are not making loans it is not because they lack the cash to do so.
. . f] This link will take you to the article about this:

http://www.sciencedirect.com/science/article/pii/S1057521914...

. . It says that in 1905 economists were right and believed that bank loans created new money. Around 1920 economists began to doubt this and by 1930 had moved to thinking that a bank couldn't but all banks together did create new money. Then they began to doubt that and by 1965 had moved to rejecting the idea that bank loans created new money. And that the experiment done in 2013 by the authors proved that banks do create new money.

.......................................................................

Another small error that MMT is making is:
. . MMT points out that the US Gov. has run a surplus about 7 times in the past and that every single time this only stopped when there was a Bank Panic, Depression, or Recession. They say this to “prove” that the surpluses were the cause of the Bank Panic, etc. They really need to prove this separately because “correlation does not prove causation”. In this case, the people and the Gov. would be perfectly happy to run a surplus and pay down the debt. This seems like a good idea. As long as everything is going good or OK the Gov. will not cut taxes [while holding spending more or less constant] to wipe out the surplus. It is only when the $h-t hits the fan and tax revenue falls through the floor that the surplus stops being collected. So, whatever is its cause, a Bank Panic (etc.) will cause the surplus to end. Looking at the figures in the “historical records” only tells you that tax collections fell. It doesn't tell you why the Bank Panic happened.
 
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Steve1501 wrote:
Koldfoot wrote:
MAN MAN TRANSEXUAL?

What does this even mean?

I mean really, I do not understand your point.

MMT needs to be defined.
 
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Steve
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jmilum wrote:
Steve1501 wrote:
Koldfoot wrote:
MAN MAN TRANSEXUAL?

What does this even mean?

I mean really, I do not understand your point.

MMT needs to be defined.

OK, I did with an edit. MMT = Modern Money Theory.

 
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How to put this delicately?

Modern Money Theory is utter tripe.
 
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wifwendell wrote:
How to put this delicately?

Modern Money Theory is utter tripe.


Care to elaborate?
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Too Big to Fail was bailed out through Quantitative Easing which is a real world example of MMT. QE helped the wrong people, but that's a different argument.
 
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odie73 wrote:
wifwendell wrote:
How to put this delicately?

Modern Money Theory is utter tripe.


Care to elaborate?

Well for one, you're not attempting to call it actual economics.
 
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Oliver Dienz
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whac3 wrote:
odie73 wrote:
wifwendell wrote:
How to put this delicately?

Modern Money Theory is utter tripe.


Care to elaborate?

Well for one, you're not attempting to call it actual economics.


You mean the "actual economics" of the marginalist type that has been shown wrong in the capital debates 50 years ago?
 
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Brian S.
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whac3 wrote:
odie73 wrote:
wifwendell wrote:
How to put this delicately?

Modern Money Theory is utter tripe.


Care to elaborate?

Well for one, you're not attempting to call it actual economics.
Economics are schools of thought. "Theory" doesn't make it inferior, nor does "Modern" make it new.
 
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Vrooman wrote:
Economics are schools of thought. "Theory" doesn't make it inferior, nor does "Modern" make it new.

Is it an actual accepted school of economic thought which would appear in a peer-reviewed economics journal?

I probably know what theory means better than you do.
 
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Steve
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whac3 wrote:
Vrooman wrote:
Economics are schools of thought. "Theory" doesn't make it inferior, nor does "Modern" make it new.

Is it an actual accepted school of economic thought which would appear in a peer-reviewed economics journal?

I probably know what theory means better than you do.

Short answer is, yes it is by actual Economics Professors and they do publish in peer reviewed journals. Google MMT.
 
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whac3 wrote:
Vrooman wrote:
Economics are schools of thought. "Theory" doesn't make it inferior, nor does "Modern" make it new.

Is it an actual accepted school of economic thought which would appear in a peer-reviewed economics journal?
It wasn't created by elves.
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Steve1501 wrote:
whac3 wrote:
Vrooman wrote:
Economics are schools of thought. "Theory" doesn't make it inferior, nor does "Modern" make it new.

Is it an actual accepted school of economic thought which would appear in a peer-reviewed economics journal?

I probably know what theory means better than you do.

Short answer is, yes it is by actual Economics Professors and they do publish in peer reviewed journals. Google MMT.
Then my fundamental objection is withdrawn.
 
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Steve
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I watched a debate between Dr. Mossler [for MMT] and Dr. Murphy [an Austrian] at Columbia Univ. In it Mossler claimed that MMT was a description of the way things are in the US, but Murphy made a good point that MMT insists on combining the Treasury Dept. and the Fed. Reserve Bank. They are not now 1 thing, they are separate.

MMT should stick to being descriptive of how things currently are. Therefore, it should separate the Fed. Res. Bank from the Treasury Dept. in its analysis. This would also deal to some extent with my issue above, because dollars are IOUs issued by the Fed. Res. Bank and not by the US Gov. Therefore, they are not destroyed as soon as they reach the Treasury Dept. If they are destroyed, it is as soon as they reach the Fed. Res. Bank's account. This would eliminate the road block in people's minds who just can't “get” that IOUs are destroyed as soon as the issuer gets them back.

Dr. Randell Wray [another important MMTer] has said that combining them makes the analysis easier to understand. It is true that MMT must be understood before MMT can be implemented by the Gov. But, continuing to stress that dollars are destroyed by taxes (not collected) also makes it harder for people to accept MMT's view of economics. And acceptance is what needs to happen before MMT will be implemented by the Gov.


 
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Having a debate between Austrian economics and MMTers is a bit like having an argument between Biblical literalists and Richard Dawkins about religion: One is closer to the truth than the other, but they are both pretty wrong.

Neither side's idea of how the Fed affects interest rates really makes any sense.
 
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Oliver Dienz
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Steve1501 wrote:
I watched a debate between Dr. Mossler [for MMT] and Dr. Murphy [an Austrian] at Columbia Univ. In it Mossler claimed that MMT was a description of the way things are in the US, but Murphy made a good point that MMT insists on combining the Treasury Dept. and the Fed. Reserve Bank. They are not now 1 thing, they are separate.

Officially they are separate but with the Fed willing to buy any amount of government debt at its interest rate target that distinction is rather meaningless. I am sure MMTers know well the difference but have to slim down the exact mechanics for the lay audience. There are already enough macroeconomists around who do not know the intricacies of federal reserve operations or bank lending. (http://www.cyniconomics.com/2014/05/20/buffoonery/) In the end, it is about how the treasury/government accommodates any changes in the Fed rate target. The Reagan deficits were mostly due to the higher interest rates as the primary balance (excluding capital payments) was almost unchanged compared with the 70ies. (http://jwmason.org/slackwire/the-myth-of-the-reagan-deficits...) The government's will to allow those deficits probably played a big part in the economic recovery from the 82/83 recession.

Quote:
MMT should stick to being descriptive of how things currently are. Therefore, it should separate the Fed. Res. Bank from the Treasury Dept. in its analysis. This would also deal to some extent with my issue above, because dollars are IOUs issued by the Fed. Res. Bank and not by the US Gov. Therefore, they are not destroyed as soon as they reach the Treasury Dept. If they are destroyed, it is as soon as they reach the Fed. Res. Bank's account. This would eliminate the road block in people's minds who just can't “get” that IOUs are destroyed as soon as the issuer gets them back.

So what? Then they get destroyed when the treasury retires a T-bill. I really do not see how that changes much when most people have not heard of MMT and even more are clueless how banking and lending really work.

Quote:
Dr. Randell Wray [another important MMTer] has said that combining them makes the analysis easier to understand. It is true that MMT must be understood before MMT can be implemented by the Gov. But, continuing to stress that dollars are destroyed by taxes (not collected) also makes it harder for people to accept MMT's view of economics. And acceptance is what needs to happen before MMT will be implemented by the Gov.

I do not keep my hopes up that MMT policies (even a "light" version) will be happening in my lifetime. The interests of the capital owners are too strong against anything that would reduce their influence. And when the public suddenly realizes that it can create and spend $ ex nihilo the value of financial capital will just plummet.

There are problems with MMT (e. g. external trade balances/capital flows; future role of the private banking sector; underestimation of the private sector's influence on money creation and economic activity) but misrepresenting the actual state of affairs is not really one of them. As long as mainstream economists can give policy advice based on their general equilibrium models populated by "a single immortal consumer-worker-owner [who] maximizes a perfectly conventional time-additive utility function over an infinite horizon, under perfect foresight or rational expectations, and in an institutional and technological environment that favors universal price-taking behavior.." (Robert Solow) MMT is a vast improvement towards more real world economics.
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Steve
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hibikir wrote:
Having a debate between Austrian economics and MMTers is a bit like having an argument between Biblical literalists and Richard Dawkins about religion: One is closer to the truth than the other, but they are both pretty wrong.

Neither side's idea of how the Fed affects interest rates really makes any sense.

It seems to me that MMT is right when it says that the Gov. could tell banks with money to buy T-Bonds what interest rate the Treasury is willing to pay. If there are no buyers at that rate the Gov. could [with an act of Congress] say, OK we will let you hold those dollars which pay you no interest or you can buy the T-Bond that pays something. And that the banks would cave-in because something is better than nothing.* [The Bonds may have to be short term though.]

Interest rates that comp. and people pay are different.

I'm not clear what "interest rates" you were referring to. How does the Fed. "set" or "effect" the interest rates that the public must pay? I can see how the Fed. sets a floor, because given a choice of lending to the Gov. at 4% with no risk and to a Prime rate comp. at the same 4% with some risk; obviously the loan to the Gov. is the better deal. This sets a floor at 4%.


. * . If the holders of the cash invest it outside the US, then in a sense "who cares?" If they go to Thailand [where I live now] and invest in a comp. there then, either that comp. buys machinery from a comp. in the US which helps the US economy or it buys the machinery from a German comp. which accepts the dollars. So, who cares?
. . Like MMTers say, if China wants to make deals where they ship the US real stuff (like T-shirts) and we pay with US dollars that are converted into T-Bonds that they hold; then how is this bad for the US? We got stuff and they got pieces of paper.
 
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Steve1501 wrote:

. . d] It was experimentally shown in 2013 that a German bank does not make sure it has the cash on hand to make a loan before or after it makes the loan. Nor does it deduct the loan amount from some figure in its books. This proves that banks create new money when they make a “bank loan”.
. . e] Therefore, banks can always make loans. If they are not making loans it is not because they lack the cash to do so.
. . f] This link will take you to the article about this:

http://www.sciencedirect.com/science/article/pii/S1057521914...

. . It says that in 1905 economists were right and believed that bank loans created new money. Around 1920 economists began to doubt this and by 1930 had moved to thinking that a bank couldn't but all banks together did create new money. Then they began to doubt that and by 1965 had moved to rejecting the idea that bank loans created new money. And that the experiment done in 2013 by the authors proved that banks do create new money.


I think there is many other points wrong in the OP but this paper was brought up in RSP before but I was too busy at the time to respond for a while and thread died soon afterwards.

It is an interesting paper - but Steve here - as well as the poster in that thread few weeks back - hang much too much on it.

'Experiment' in question was observation of the accounting practices of a very small German bank dealing with a loan of a relatively negligible size. At best - what such an experiment may provide is a modest reason to doubt the currently established theory of bank role in money creation. Claiming that it *proves* that banks create new money goes *way* beyond what the authors of the paper could reasonably claim (and well beyond what they actually do claim).
Without studying the accounts of dozens or hundreds of major banks and their fluctuation with regard to substantial loans over long time one can not possibly speak about empirical proof of anything - at best we may have an indication of money creation - at worst (and most likely) simply an instance of cavalier accounting practice.

From where I stand, premise of the paper - that the banks can create money/credit ab nihilo - fails at the most basic level, that of the motivation for the most typical bank behaviour.

The most dangerous part of the business of retail bank is acceptance of the short-term deposits. Unless such deposits are insured by the third party (which can be costly, even with government provided insurance schemes) existence of such deposits represents constant risk for the bank because of the possibility of a run which can ruin even a perfectly solvent bank.
Despite this fact, from the beginning of modern banking to the present day, retail banks, large and small, continue to assiduously court short-term depositors.

If banks were some sort of magical institutions that can create money (as the paper seems to argue) question is - why would they bother with the cost and risk of collecting deposits in the first place ?

If a bank can create credit on the thin air and charge interest on that credit, why not make that its sole, safe and profitable, line of work ?
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Steve
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bramadan wrote:
Steve1501 wrote:

. . d] It was experimentally shown in 2013 that a German bank does not make sure it has the cash on hand to make a loan before or after it makes the loan. Nor does it deduct the loan amount from some figure in its books. This proves that banks create new money when they make a “bank loan”.
. . e] Therefore, banks can always make loans. If they are not making loans it is not because they lack the cash to do so.
. . f] This link will take you to the article about this:

http://www.sciencedirect.com/science/article/pii/S1057521914...

. . It says that in 1905 economists were right and believed that bank loans created new money. Around 1920 economists began to doubt this and by 1930 had moved to thinking that a bank couldn't but all banks together did create new money. Then they began to doubt that and by 1965 had moved to rejecting the idea that bank loans created new money. And that the experiment done in 2013 by the authors proved that banks do create new money.


I think there is many other points wrong in the OP but this paper was brought up in RSP before but I was too busy at the time to respond for a while and thread died soon afterwards.

It is an interesting paper - but Steve here - as well as the poster in that thread few weeks back - hang much too much on it.

'Experiment' in question was observation of the accounting practices of a very small German bank dealing with a loan of a relatively negligible size. At best - what such an experiment may provide is a modest reason to doubt the currently established theory of bank role in money creation. Claiming that it *proves* that banks create new money goes *way* beyond what the authors of the paper could reasonably claim (and well beyond what they actually do claim).
Without studying the accounts of dozens or hundreds of major banks and their fluctuation with regard to substantial loans over long time one can not possibly speak about empirical proof of anything - at best we may have an indication of money creation - at worst (and most likely) simply an instance of cavalier accounting practice.

From where I stand, premise of the paper - that the banks can create money/credit ab nihilo - fails at the most basic level, that of the motivation for the most typical bank behaviour.

The most dangerous part of the business of retail bank is acceptance of the short-term deposits. Unless such deposits are insured by the third party (which can be costly, even with government provided insurance schemes) existence of such deposits represents constant risk for the bank because of the possibility of a run which can ruin even a perfectly solvent bank.
Despite this fact, from the beginning of modern banking to the present day, retail banks, large and small, continue to assiduously court short-term depositors.

If banks were some sort of magical institutions that can create money (as the paper seems to argue) question is - why would they bother with the cost and risk of collecting deposits in the first place ?

If a bank can create credit on the thin air and charge interest on that credit, why not make that its sole, safe and profitable, line of work ?

I wondered how the authors could be sure that they were not being "punked" by the bankers. The bankers could decide that since the loan was for 24 to 48 hours only, they could just "kite" it. Write the check [when the money was moved out of that bank the next day], and don't put it on the books properly, knowing that it would be re-deposited after 48 hours.
. . OTOH, the German banking authorities could have read the paper and decided that it was evidence of sloppy bookkeeping and audited the bank. Apparently they didn't. And apparently the bankers were not worried about that either.


Maybe, banks need to get deposits so that they can disguise their money creation. If they had no money on deposit or in other assets, then why would other banks accept their checks? And they need to have a Reserve account with the Fed., right?

Why is it even a question? Can't economists just look at old books from some banks from a few years ago and see if they are deducting loans from their assets or some other figure on their balance sheet?

Edit for typo.
 
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Steve
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I have a very strong feeling that many Repuds in Congress know that MMT's conclusions are true. I base this on their actions more than their words. Politicians lie all the time. As long as a Dem. is President the Repuds are all for a balanced budget, but as soon as a Repud is Pres. suddenly spending is just fine. Not taxes yet, but spending. This vastly increases the deficit. Repuds want the Dem. Pres. to be unable to pass any good new program that the voters will thank them for by continuing to vote for the Dems. and to keep the economy going poorly, again so the voters will blame the Dems. I'm informed enough to see through this and put the blame where it belongs, mostly on the Repuds in Congress who control the “purse strings” of Gov. spending.

 
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bramadan wrote:
Steve1501 wrote:

. . d] It was experimentally shown in 2013 that a German bank does not make sure it has the cash on hand to make a loan before or after it makes the loan. Nor does it deduct the loan amount from some figure in its books. This proves that banks create new money when they make a “bank loan”.
. . e] Therefore, banks can always make loans. If they are not making loans it is not because they lack the cash to do so.
. . f] This link will take you to the article about this:

http://www.sciencedirect.com/science/article/pii/S1057521914...

. . It says that in 1905 economists were right and believed that bank loans created new money. Around 1920 economists began to doubt this and by 1930 had moved to thinking that a bank couldn't but all banks together did create new money. Then they began to doubt that and by 1965 had moved to rejecting the idea that bank loans created new money. And that the experiment done in 2013 by the authors proved that banks do create new money.


I think there is many other points wrong in the OP but this paper was brought up in RSP before but I was too busy at the time to respond for a while and thread died soon afterwards.

It is an interesting paper - but Steve here - as well as the poster in that thread few weeks back - hang much too much on it.

'Experiment' in question was observation of the accounting practices of a very small German bank dealing with a loan of a relatively negligible size. At best - what such an experiment may provide is a modest reason to doubt the currently established theory of bank role in money creation. Claiming that it *proves* that banks create new money goes *way* beyond what the authors of the paper could reasonably claim (and well beyond what they actually do claim).
Without studying the accounts of dozens or hundreds of major banks and their fluctuation with regard to substantial loans over long time one can not possibly speak about empirical proof of anything - at best we may have an indication of money creation - at worst (and most likely) simply an instance of cavalier accounting practice.

From where I stand, premise of the paper - that the banks can create money/credit ab nihilo - fails at the most basic level, that of the motivation for the most typical bank behaviour.

The most dangerous part of the business of retail bank is acceptance of the short-term deposits. Unless such deposits are insured by the third party (which can be costly, even with government provided insurance schemes) existence of such deposits represents constant risk for the bank because of the possibility of a run which can ruin even a perfectly solvent bank.
Despite this fact, from the beginning of modern banking to the present day, retail banks, large and small, continue to assiduously court short-term depositors.

If banks were some sort of magical institutions that can create money (as the paper seems to argue) question is - why would they bother with the cost and risk of collecting deposits in the first place ?

If a bank can create credit on the thin air and charge interest on that credit, why not make that its sole, safe and profitable, line of work ?


Not much time but your objections are wrong. The paper is correct that banks create deposits (aka money) out of nothing when they have a willing borrower. See this Bank of England publication: http://www.bankofengland.co.uk/publications/Documents/quarte...
And look here how central banks manage reserve requirements:
https://www.imf.org/external/pubs/ft/wp/2011/wp1136.pdf (Especially points 88+)

There are plenty more publications. Banks create the deposits when someone takes out a loan and then look for the required reserves. The central bank will always accommodate the reserve need of of the banking sector at the interest rates it has set or it would risk crashing the payment system when suddenly money transfers are not working anymore. Of course, if those newly created deposits lead to increased spending which may cause inflation then a CB will raise their target interest rate(s) to maintain price stability. However, this all happens in response to the private sector (banks/borrowers) activity; it is not causing it as the usual money multiplier/ISLM theory suggests.

To the motivation of the banking system I may respond later.
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Oliver Dienz
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Shelburne
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bramadan wrote:

I think there is many other points wrong in the OP but this paper was brought up in RSP before but I was too busy at the time to respond for a while and thread died soon afterwards.

It is an interesting paper - but Steve here - as well as the poster in that thread few weeks back - hang much too much on it.

'Experiment' in question was observation of the accounting practices of a very small German bank dealing with a loan of a relatively negligible size. At best - what such an experiment may provide is a modest reason to doubt the currently established theory of bank role in money creation. Claiming that it *proves* that banks create new money goes *way* beyond what the authors of the paper could reasonably claim (and well beyond what they actually do claim).
Without studying the accounts of dozens or hundreds of major banks and their fluctuation with regard to substantial loans over long time one can not possibly speak about empirical proof of anything - at best we may have an indication of money creation - at worst (and most likely) simply an instance of cavalier accounting practice.

From where I stand, premise of the paper - that the banks can create money/credit ab nihilo - fails at the most basic level, that of the motivation for the most typical bank behaviour.

The most dangerous part of the business of retail bank is acceptance of the short-term deposits. Unless such deposits are insured by the third party (which can be costly, even with government provided insurance schemes) existence of such deposits represents constant risk for the bank because of the possibility of a run which can ruin even a perfectly solvent bank.
Despite this fact, from the beginning of modern banking to the present day, retail banks, large and small, continue to assiduously court short-term depositors.

If banks were some sort of magical institutions that can create money (as the paper seems to argue) question is - why would they bother with the cost and risk of collecting deposits in the first place ?

If a bank can create credit on the thin air and charge interest on that credit, why not make that its sole, safe and profitable, line of work ?


First, to show that this is not some funky accounting from banks in Europe here is another paper from the Fed that essentially says the same as the previously cited BoE paper although in more technical terms: https://www.federalreserve.gov/pubs/feds/2010/201041/201041p... As said, there are more.

Now to the question, what motivates banks when creating deposits during the loan process. And I apologize in advance that the necessary accounting will look quite boring.

As any company banks want to make profits. They do that mainly by earning more in interest on their assets than what they pay in interest on their liabilities. In its most simplified version a bank’s balance sheet is composed of the following entries:

Assets: loans (e. g. mortgages, T-bonds, commercial bonds etc.) and reserves (reserve account at the Fed and vault cash)
Liabilities: reservable deposits (usually checking accounts), other customer liabilities (savings accounts, CODs etc.)
Net equity (“capital”) = assets minus liabilities

The Federal Reserve serves as the bank of the other banks. Think of a bank’s reserve account as the checking account that you have with your bank. Reservable deposits are those that require a minimum reserve (reserve requirement) with the Fed (in the US usually 10 %). Assets minus liabilities is the net equity (or capital) position of the bank. When that falls below zero the bank is insolvent and will be liquidated.

Let’s put some numbers to it, e. g. Bank A holds:

Assets: Total $10 mill.: $100K reserve account, $100K cash, $9.8 mill. bonds
Liabilities: Total $9 mill.: $2 mill. deposits, $7 mill. other liabilities
Net equity: $1 mill.

This bank has just enough required reserves ($200K) at the reserve ratio of 10 % to back up the $2 mill. in deposits. Assume now a customer comes in the bank and wants to borrow $100K to purchase a condo. The bank determines based on his credit history and steady income that this is a creditworthy borrower and happily lends him the money. It now credits the customer’s account with the $100K and records the signed mortgage papers as assets. The balance sheet will look like this:

Assets: Total $10.1 mill.: $200K reserves+cash, $9.9 mill. bonds
Liabilities: Total $9.1 mill.: $2.1 mill. deposits, $7 mill. liabilities

However, this is just a virtual snapshot as the money will be immediately transferred at closing to the bank of the condo seller. After that transfer we have the following situation:

Buyer’s bank (Bank A):
Assets: Total $10 mill.: $100K reserves (cash), $9.9 mill. bonds
Liabilities: Total $9 mill.: $2 mill. deposits, $7 mill. liabilities

Seller’s bank (Bank B) (only showing the net changes):
Assets: +$100K reserve account
Liabilities: +$100K deposit (in the condo-seller’s account)

What happened is that Bank A debited the $100K from the buyer’s account, initiated a payment transfer from its reserve account to the reserve account of Bank B. Bank B then credited the seller’s account with the $100K it received from Bank A. Bank A still holds the mortgage bond from the buyer on which it will earn interest over the coming years. Furthermore, Bank A has now a balance of zero in its reserve account. Thus, it would be unable to initiate any further transfers to other banks on behalf of its customers. Remember also that I said earlier that banks are required to have a certain percentage of its deposits available as reserves. Right now, Bank A would need $200K in reserves but has only $100K (the cash it has in its vault which counts as reserve). It is now $100K short which it will need to acquire to fulfill its reserve obligation. On the other hand, Bank B received $100K in additional reserves but only needs $10K to back up the additional $100K it credited its customer. Thus, Bank B would be happy to lend Bank A the $90K it is over the reserve requirement as it will charge interest for those. Bank A could also sell or lend some of its others assets to shore up its reserve balance. For example, the Fed is always willing to buy short-term government debt at the Fed Fund rate it announces in regular intervals. If all else fails a bank can also always go to the Fed’s discount window and for less favorable conditions (= worse interest rate) borrow some money. As a security it can put up the mortgage it just granted to the condo buyer. In any case, the Fed will ensure the bank gets their required reserves or suddenly money transfer begin to stall which can threaten the entire banking system.

So why do banks court deposit holders to do their business with them? Look at Bank B who received the transfer from Bank A. You can as easily image that the customer first banked with A and then due to some incentive switched to B. Now B received as an asset the reserve balance while it gets the deposit as a liability. For the $90K it does not need to hold as a reserve it can buy an interest-bearing asset while it does not pay interest on the deposit. (Even if it would, it would make sure that the interest rate it receives is higher than the interest it pays.) More interest-bearing assets mean more income for the bank.

Can a bank simply print money by crediting an account? Yes, it can but you look at it from the perspective of a bank’s customer. You need to take the view of the bank. When it credits an account it creates a liability which means it owns the owner of the account that amount. What the bank desires instead is a bond from the borrower which will then pay back the principal plus interest. Since it does not acquire a bond when just crediting an account it will not earn anything. In fact, if the account holder goes on to “spend” that deposit (= it gets transferred to another bank) the bank may need to pay additional interest when it has to shore up its reserve position. When doing those changes on the balance sheet you will notice that only adding a liability but no asset means the bank has less equity available. Thus, by crediting an account it spends from its capital.

In summary:
- Banks create money by making loans. (And likewise money gets destroyed when loans are paid back.)
- Bank lending can precede the addition of reserves by the Fed.
- Hence, lending is not constrained by the reserve position of a bank but by its ability to find creditworthy borrowers.
- Banks earn income through the interest spread between its assets and liabilities.
- Bank spending results in a reduction of its capital position.
- Banks try to exchange low-interest bearing assets into high-interest bearing assets to maximize income. (e.g reserve balances into bonds)
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