A while back, Asymptosi observed that "the MMT mantra ... seems to ignore private credit issuance/money creation". Observations like that are valuable to me, because I don't notice such things myself.
But I'm cautious around observations like that because, well, because I don't notice such things myself.
More recently, Winterspeak quoted Steve Keen, who most certainly does not ignore "private credit issuance" and private debt:
I couldn’t convince several of the academics in the audience of the importance of private debt: they kept coming back to “one person’s debt is another person’s asset, therefore the level of debt doesn’t matter”.
Then Greg reinforced the idea for me:
The reason they dont think private debt is a problem Art is that they view it as debt owed to each other as WS said. Ive seen Nick Rowe AND Paul Krugman state as much. They think if I am in debt that someone somewhere is in surplus and therefore that surplus is being invested and not causing a monetary imbalance.
So private debt is ignored. MMT people like Winter and Greg think most academic economists ignore it. And Asymptosi thinks MMT people ignore it.
And me? Come to think of it, I'm just glad I don't notice such things.
At Winterspeak, Greg expressed the view that economists ignore private debt. Recently on this blog, he turned thumbs down to my Debt-per-Dollar graph, saying that debt-to-income is a more relevant measure. I think Greg is ignoring debt.
It sounds like he's not ignoring it. It sounds like he wants to look at debt in a different context than I look at debt. But Greg's context is income, and income can be created by creating debt. You might say income is typically created by creating debt.
When Greg looks at debt-relative-to-income, he is ignoring debt as a source of income.
We get money two ways. If I have a dollar in my pocket, it is either because I earned it, or because I borrowed it. Either way, when I spend it, the dollar becomes income for somebody. Circulating money is one source of income. Private-sector debt is another.
But how many of our dollars of income exist because somebody borrowed the money? Today, most of our dollars of income exist because somebody borrowed the money. Fifty years ago, that was much less the case. The portion of income that is created out of debt is a variable. It is a variable that Greg ignores, and that economists ignore.
You cannot measure this variable by looking at debt relative to income. You can only measure it by looking at debt relative to the quantity of money in circulation.
27 comments:
Art
Its kind of an eerie feeling seeing your name in a post like this. It makes one feel so UNanonymous ; )
A couple thoughts come to mind.
First, technically all money is debt. Its either govt debt (currency, coin or a bond)or its private debt (a bank loan). So yes all income is debt because all money is debt, but Im not sure thats really news if one thinks about money correctly.
Second, regardless of whether my income comes via a private sector loan (to my employer) or a govt expenditure, I can only service a certain amount of debt from that income. The amount I can service depends on the interest rate and term of the loan. That income is the limiting factor in how much debt I can take on. Now of course if I have savings those can be tapped into to pay back a loan as well but most people take out loans as a way to preserve their savings. If they didnt wish to do that they would simply liquidate their savings and make the purchase, why borrow at all if you are going to do that ?
So I dont really think Im ignoring debt as a source of income because all income is money and all money is debt.
Where I think we went wrong in this crisis is that our lending institutions did not do due diligence and make sure the incomes of borrowers could service their loans AND our system ignored the fact that a certain level of income guarantees are necessary for a smooth credit system. You cant make people dependent on bank credit AND have the possibility of complete loss of income. Those two conditions do not coexist well.
The important thing about my comment at Winterspeaks was the paragraph you left out.
"They fail to see that virtually all of us are indebted to the banking system, which is really a third party outside the economy so to speak. A banking systems surplus is of no more use than a govts budget surplus. Banks dont "spend" their surpluses. They exist only on their books as "outstanding loans" owed to them. But when we cant pay them back they freeze up. Most academic economists do not understand banking. They think a bank is just an intermediary between savers and borrowers."
Seeing the banking system as connecting savers and borrowers is simply wrong. The banking system is like the govt in that it is outside the system so to speak. It creates money at will. It does NOT take Arts savings and lend them to Greg. It is doing something entirely different and getting that wrong is why we cant get the fix right.
Virtually all of us, individuals and corporations owe money to the banking sector. Just like we all owe money to the govt in the form of taxes. The banking system uses those loans we owe them as assets. But when those assets grow they are of no use to the rest of the economy. Their surplus does not change their capacity or propensity to spend. But when what we owe outstrips what we can earn the system freezes up, like now.
"It does NOT take Arts savings and lend them to Greg."
So, what does it DO with Arts savings?
So, what does it DO with Arts savings?
Fractional reserve banking. They lend it many times over to Greg and Bill and Charley, and to speculators who make 40:1 leveraged bets on financial derivatives that no one can rationally evaluate . . .
No, wait -- we're in a liquidity trap. They hold it in reserve and get a small 0-risk return from the Fed.
No, wait -- that's all the QE money.
I think they pay it out in dividends and executive bonuses.
WASF!
JzB
Banks dont DO anything with Arts savings other than promise to keep them safe (actually the FDIC promises that) and allow him to write a certain amount of checks against them. They might also sell him a CD with them.
The major point is that whether they ever took anybodies savings in they could still make a loan to Greg. The loan to Greg would become a deposit within the banking system.
If on Monday Jazz opens a bank and only Art opens an account with 10,000$, can Jazz make a 10 million dollar loan to Greg on Tuesday morning? The answer is yes. Some would say "But that is 1000:1 leverage!!" No its not. All that needs to happen is reserves need to be purchased by Jazzs bank putting him at the required ratio. There would never be a time he couldnt get the reserves, the fed must make them available to all member banks.
So it should be obvious that Arts savings are not being lent to Greg.
I understand the major point, Greg. I understand that banks can purchase additional reserves (subject to Fed decisions regarding interest rates). That is not the problem.
The problem is the little thing, the pebble in the shoe, the to-me ridiculous claim that banks don't even bother to use the money we deposit with them.
If the banks have deposits enough to make a loan, then why would they bother to not-use those deposits, and go get extra reserves instead? I don't think they would.
"If the banks have deposits enough to make a loan",
I think this is the wrong question again. Banks dont need a certain level of deposits TO make a loan. You are presupposing that that is the reason they are seeking deposits.
As I understand it, when a bank has deposits they can make money off them by having debit card accounts, checking accounts, ATM fees etc etc.. The bulk of their money making is in loans and if they are able to make a lot off loans they can probably charge less on checking fees etc.
So why do they seek depositors? Because depositors become customers for their other services like loaning etc. When people pull their money from deposit accounts its not that they are losing the money to lend, they are losing people who want to do business with them.
"then why would they bother to not-use those deposits, and go get extra reserves instead? I don't think they would."
Use the deposits for what?
Bank assets = Bank liabilities + Bank Capital
Deposits are a liability on the banks balance sheet so the more deposits they have the more capital they need to raise. Their loaning operations ARE capital constrained. Certain forms of collateral count as capital so a loan can provide its own capital if the collateral is right.
I hope I'm not too late to the party. Greg: If all money is debt, what is savings? And, when the system freezes up, like now, the bank may in fact charge Art for storing his savings. This notion that banks consider loans as assets has always seemed perplexing to me. It would seem that loans can only become assets when paid. When does an asset become a liability? Answer: when there isn't the likelihood that it will be repaid. (Think credit default swaps and derivatives.) And yet, banks and financial institutions are still carrying these instruments as assets, at par, on the books. Talk about fiction.
Art: I don't think banks purchase additional reserves. They borrow them. Right now, they are borrowing from the Fed, purchasing gov't bonds, and holding the spread. Get rid of paying interest on reserves, raise capital requirements, and see what happens. It won't be pretty.
First off I need to make it clear that I am not defending the system, I am simply describing it as I understand it from my 3+ yrs exploring the subject.
Yes it seems shady that a loan can be called an asset but if you simply take an accounting perspective and terminology it is less slimy. When a loan is created, say for Greg, a deposit is placed in the banking system attributed to Gregs account number. This isnt at all under dispute I hope. Now this deposit for Greg IS money and can be used to buy stuff. BUT, the other side of that deposit (which IS a bank liability) is the loan, which is an asset by definition because it offsets the deposit liability. Its simply the two sides of the coin.
What a bank is allowed to do with that "asset" is what this crisis is all about in a sense (in my view. The accounting terminology doesnt make the operation shady, its how the bank behaves with that asset that makes it shady. Is that asset "good as gold" so to speak. If its a loan to Greg, who cant find a steady job, probably not, but if its a loan to Art, who has an enormous income stream, it is.
Greg -- if I deposit a dollar in the bank, does that get added to their reserves?
Nanute -- "Art: I don't think banks purchase additional reserves. They borrow them." -- agreed. I saw that too, that after it was too late to change it. Oh, well.
Greg,
I understand the accounting identity, balance of accounts. As you say, it is all a matter of what the bank is allowed to do with the asset is where the problem lies. A lot of what transpired with lending and repackaging questionable assets to shift risk to others without full disclosure, and in some cases then betting that the loans would default should be a crime. (I'm not sure it is.) Attempts at meaningful reform were met with an onslaught of push back by the very same perpetrators.
I'm still wondering what savings is, if all money is debt.
Actually I dont think its even correct to think of the bank as borrowing reserves. They must pay for the use of them but they also MUST be provided by the system whenever a bank transaction is made. Its not like the bank has a choice or the federal reserve system. Reserves, again as I understand it (AIUI), are simply the way all payments get settled. There has to be reserves in the system to reflect outstanding money so payments can be allocated to different accounts. It seems to me that reserves are just "mirror money". They are what the banking system uses to settle payments. Its just part of the latest evolution of how to settle accounts.
I hope Im not being pedantic here but maybe a little history is in order to explain what I mean. Once upon a time when banks or countries made transactions, someone at sometime had to actually transport the gold to the seller. Ships crossed oceans simply to bring gold to the country they traded with. Then it was agreed that everyone would keep their gold in one place and someone was given the responsibility of moving the gold from Chinas vault to Englands vault at the orders of some Treasurer from each country. So these little vault transfers were a reflection of the payments that were taking place. The reserve system is the computer version of this in a non commodity backed currency, AIUI.
So, to answer Arts question ,AIUI, when you make a deposit in a bank reserves are added to "reflect" that deposit within the system.
To answer Nanutes question about what savings is Im going to ask for further information. Are you asking how do I save a US$? You just want to know what it means to have more financial assets (denominated in US$) than you need at present?
See how this thought experiment works for explaining my thinking.
Imagine a 100 person economy. In period 1 all 100 people are spending all their income (where the income comes from is THE mystery but lets assume it for now) in order to meet their needs. In the next period 1 guy has figured out how to do with less so he actually has a savings accumulating. Everyone else is still consuming everything they earn. So you have one guy accumulating savings, can he start a bank and lend to everyone else his savings? Of course not everyone else is consuming their income maximally so they cannot take on a debt payment as well. What needs to happen? Everyone, or at least a large majority, needs to be able to save in order for a bank to spring up. Its actually the presence of MY OWN savings that allows me to borrow. If I cant save I cant borrow. Regardless of how much Art is saving if I have no savings I cant borrow. So really, if you look at it this way Im really borrowing my OWN savings not anyone elses. Banks simply take a cut of my own future savings.
I clicked too soon. I meant to add to this
" Banks simply take a cut of my own future savings."
BASTARDS!! Im painting this on a sign and heading out to my local "Occupy" gathering. Maybe you'll see me getting arrested on TV.
Ill be the guy that looks like a heavier version of Ollie North
Greg,
All banks are required to have a certain amount of reserves. (Bank vault cash, or deposits on reserve at a Federal reserve bank.) When a bank falls below the requirement, it can either raise capital in the open market, or borrow from the Fed to maintain the requirement level. The recent financial crisis has left many of the TBTF institutions essentially insolvent. Hence, QE1&2, and massive borrowing at the discount rate. The money lent out by the financials is NOT being repaid fast enough to meet regulatory requirements. It is questionable if the money will ever be repaid. Why do you think the Fed purchased a significant amount of questionable assets in QE1 and suspended the rules of mark to market?
What I was asking with regard to savings is, if I have excess money after paying my debts, and save it, how can it be considered debt? (Money is debt?) I thought that money was a method of account, a medium of exchange and a store of value.
Nanute
"All banks are required to have a certain amount of reserves. (Bank vault cash, or deposits on reserve at a Federal reserve bank.) When a bank falls below the requirement, it can either raise capital in the open market, or borrow from the Fed to maintain the requirement level."
I think you are using the terms capital and reserves interchangeably sometimes.
Banks start with capital. People invest money and buy stock in a bank. This capital is what determines the solvency of banks. Reserves are for liquidity mangement, settlements of payments and such. Yes, capital levels are reflected in reserve levels but one can have plenty of reserves but still be deficient in capital.
" The recent financial crisis has left many of the TBTF institutions essentially insolvent. Hence, QE1&2, and massive borrowing at the discount rate. The money lent out by the financials is NOT being repaid fast enough to meet regulatory requirements"
Again, they are insolvent why? Because they lack capital to offset loan losses. Not because they lack reserves. Reserves are easy to get. They MUST be provided. Yes they have a cost but they are easy to get. Banks are struggling because there are not enough people seeking loans. Using my previous post, they are struggling because not enough people are giving them a cut of their future savings.
"Why do you think the Fed purchased a significant amount of questionable assets in QE1 and suspended the rules of mark to market?"
Because they mistakenly think if they make a banks balance sheet healthy they will be able to start loaning again! (Yippeeeee!!!)
"What I was asking with regard to savings is, if I have excess money after paying my debts, and save it, how can it be considered debt? (Money is debt?) I thought that money was a method of account, a medium of exchange and a store of value."
Go to this site for the best explanation of this. I cant outdo Calgacus (Arts been there, youll see his excellent comment in the comment section)
http://calgacus1.blogspot.com/
SCroll down and find the post ;
"Economics ( aka MMT) in Three Words"
Greg,
I'm going to respond tomorrow. I'm going off line for the night. If you want to send me an e mail: tony.daniel@thotmail.com
Greg
I don't like to harp on it but I have a LOT of trouble with the "money is debt" concept. When I ask about it I am told that ALL money is credit slash debt.
That doesn't help.
It is necessary to distinguish money that I earn from money that I borrow. It is necessary to be aware of how much I owe.
Debt is a measure of money owed. If anybody wants to expand the meaning of "debt" to include non-monetary obligations or guilt, well, that just ain't economics. Economics is the study of monetary balances. For that study, "debt" cannot be equated with "money".
By the way, I thought Nanute's question was really good: If all money is debt, what is savings?
Greg,
"I think you are using the terms capital and reserves interchangeably sometimes." Perhaps. When I think of capital and reserve requirements, banks are subject to rules established by the BIS (Bank of International Settlements), in 89':
The BIS rules set requirements on two categories of capital, Tier 1 capital and Total capital:
Tier 1 capital is the book value of its stock plus retained earnings. Tier 2 capital is loan-loss reserves plus subordinated debt.** Total capital is the sum of Tier 1 and Tier 2 capital.
Tier 1 capital must be at least 4% of total risk-weighted assets. Total capital must be at least 8% of total risk-weighted assets.
(**Subordinated debt is long term debt that, in case of insolvency, is paid off only after depositors and other creditors have been paid. Thus it can be used like equity to provide those creditors some protection against insolvency.)
I'm focusing on Tier 1 capital. The TBTF entities are having extreme difficulty raising Tier 1 capital. (Look at BOA, for example.) As you say,"banks can have plenty of reserves and still be deficient in capital." This is not only true, it is a big concern for the big boys in light of signals from the BIS to raise Tier 1 requirements under Basel II. Jamie Dimon has gone as far as calling the proposal "unAmerican." The requiring of the banks to have more skin in the game to offset questionable, risky behavior going forward, should be seen as good banking practice.
Hi Art,
Bank lending creates money. If a Bank has a $1 million in customer deposits and gives a loan to one of its customers by putting $100,000 into that deposit account then the total deposits becomes $1.1 million. The bank does not take money from one account and put it in another when it makes a loan.
Technically, it is the borrower that creates the new money. The borrowers promissory note is the new money. The bank exchanges the borrowers IOU for another promise-to-pay (the deposit)
This of course is the crux of the current situation. When debt repayment exceeds lending then the total sum of bank deposits shrinks.
jim..
"Technically, it is the borrower that creates the new money."
unTechnically, without fractional reserve banking, no money would be created by borrowing.
unTechnically, without lenders, no borrowing would be done.
unTechnically, borrowing and lending is the same event.
I remain unconvinced.
"Bank lending creates money. If a Bank has a $1 million in customer deposits and gives a loan to one of its customers by putting $100,000 into that deposit account then the total deposits becomes $1.1 million. The bank does not take money from one account and put it in another when it makes a loan."
This is good, except you left out the part about reserves. It is a good example, starting with $1 million in customer deposits.
Perhaps you would do this example again for me, and assume no additional reserves added to the system, and show me what happens? That would be perfect. Thanks jim.
Art
Lets look at it this way. Would you agree that everything which is used as money involves some sort of accounting? I think you would and here is why. Money has value and anything with value we keep track of. We cant help it I think but we intuitively keep track of things that matter. When it doesnt matter we can ignore it. So accounting is how we keep track of meaningful things. Accounting usually involves a + - type nomenclature. When Art gets something from Greg of value he's plus one and Greg is negative one. One what is the numeraire and of course that changes. All these plus minus things become money' of some form
Say I gave you a sheet of paper that said the bearer of this gets a back rub. Now, it would have some value and you might actually sell it to someone else whom you know really like back rubs. I'm going to keep track of how many of those I issue because that is debt for me, I owe a back rub. I can issue all I want but I will keep up.
The US$ is a promise to extinguish a tax liability
Its probably more accurate to say that all credit/debt
is a form of money but I cant think of anything we have used as money historically that wasnt a credit debt relationship of some form. Some might argue that gold wasnt but I think if you really look at how gold was used as money it would look more like a type of credit debt relationship.
"It is necessary to distinguish money that I earn from money that I borrow. It is necessary to be aware of how much I owe."
Yes that is part of accounting
" Economics is the study of monetary balances."
I would say accounting is the study of monetary balances. Economics can be a field even in a barter economy
"By the way, I thought Nanute's question was really good: If all money is debt, what is savings?"
Theres more to this question, real savings or monetary savings? Im pretty sure he means monetary savings. So I would answer like this. You have savings if the level of dollars in your accounts + the liquidation value(in dollars) of your real assets is greater than the amount of money you owe. If not, you really dont have any savings.
Getting back to differentiating between money earned and money borrowed, I think those are the metrics to compare money earned (income) money borrowed (debt).
Art
You cant see how when I go to a bank, my loan is against MY future income and potential savings and no one elses. I am not borrowing other depositors money. The loan is a result of MY assets, MY income, MY worth. No one elses.
In that thought experiment I did earlier if only 1 guy out of 100 has figured a way to not consume all his income he's the only one who can save and borrow (and pay back). Everyone who is consuming all their income is incapable of borrowing. What do they have left over to pay a loan with?
Hi Art
I'm not understanding what your point is about reserves.
You seem to agree that the total bank deposits increase by the loaned amount when a bank makes a loan.
That seems like the only salient fact to me.
When banks are lending more each period than borrowers are repaying, that adds to the money supply.
When banks lend out less than the repayment of loans that subtract from the supply of money.
The latter in a nutshell describes the underlying cause of the current economic problems. If it were not for extraordinary efforts by the govt, the fall in the money supply would lead to debt-deflation as described by Fisher.
http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf
Hi jim, sorry for the delay in responding.
I don't really have a "point about reserves" except I probably don't understand it well enough. But I do think that
1. when a bank makes a loan, something happens to deposits AND something happens to reserves. And simply dismissing reserves as not a salient fact is not something that my lack of knowledge can accept. And
2. reserve requirements have tended downward for a long time. Let's say that is a fact. But that does not mean that the downward trend was the right thing to do. Maybe it is the source of the problem... Some people call for 100% reserves. I think that's unnecessary and unrealistic. But there's a lot of numbers between zero and a hundred.
Hi Art,
I'm pretty sure that today when a bank makes a loan nothing happens to reserves. The banking system has quite a lot of
excess reserves and few loans.
The point I was making (the salient one) was that when lending is rampant that expands the supply of money in the banking system. When loans are being repaid and total debt is shrinking then so is the quantity of deposits. Whether requiring more reserves would have prevented the current situation is not going to change anything now.
This is an interesting article
from an unusual perspective on these topics:
http://libertarianpapers.org/articles/2010/lp-2-43.pdf
Hi jim.
The banking system has quite a lot of excess reserves and few loans...
Whether requiring more reserves would have prevented the current situation is not going to change anything now.
I notice this difference between us quite often. You are very focused on where we have got to. I am very focused on how we got here.
Probably not salient...
Greg, thanks for the compliment. I appreciate it. I have a bit of free time so I will put up another post or two at my blog trying to clarify things for Arthur (& for myself of course) & post here too.
My goal is basically to change good honest old Arthur's (& Jazzbumpa's & Nanute's?) mind. If I haven't, I haven't succeeded in making things as clear as I want, as clear as they should be.
To answer Nanute's question:If all money is debt, what is savings?
...
What I was asking with regard to savings is, if I have excess money after paying my debts, and save it, how can it be considered debt? (Money is debt?) I thought that money was a method of account, a medium of exchange and a store of value.
The (excess) money you have after paying debts is debts that are OWED to you. You are the creditor. You owN somebody else's debt. If the excess money is a bank account, it is the bank's debt to you. If it is dollar bills in your pocket, or treasury bonds recorded in a computer, it is debt that the government owes you. That's how people pay their debts to others- with money - which is debts that yet other people & entities owe to them.
"Money is debt" is a deeper, simpler, more trivial, more fundamental, more childish analysis than thinking of money as a "method of account, a medium of exchange and a store of value". Money is the kind of debt which has all those properties.
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