It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before. On the contrary, the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period.
In a recent, short sequence of Gang8 messages I came upon a PDF by Dirk Bezemer and Geoffrey Gardiner: Innocent Frauds Meet Goodhart's Law in Monetary Policy.
The PDF relates the phrase "innocent frauds" to Warren Mosler and to Charles Goodhart, but connects it ultimately to John Kenneth Gallbraith. Quoting Galbraith to give meaning to the phrase, Bezemer and Gardiner relate it to "versions of the truth". One such would be the version I hold: money is a thing, not a relationship.
In Part 2 of the PDF, Bezemer and Gardiner state:
Three innocent frauds in monetary policy come together in a case study of the recent capital base enhancement by the UK government of Royal Bank of Scotland (RBS), and the wider issue of quantitative easing. The first innocent fraud is that money is a thing, not a relationship. But by lending, banks enter into a contractual relationship and there are limitations to what the newly created liquidity can be used for, as circumscribed by legislation. Liquidity creation by the government is not 'lent on' by banks to the public -- even though the image is that the government 'pumps money into the system' which then unclogs the credit pipelines to the economy.
The immediately next sentence in the PDF is "The second innocent fraud is that the government does this with taxpayer's money." So I'm thinking, what's in the whitebox here is an explanation of the reason that money is a relationship or, rather, the reason Bezemer and Gardiner think money is a relationship.
Short form: By lending, banks enter into a contractual relationship. Ergo, money is a relationship.
First off, I wish they would call it a "relation" rather than a "relationship". Relation refers to some kind of connection, as by blood or contract. "Relationship" suggests some kind of sexual adventure. Every time I read it.
So. By lending, Bezemer says, lenders enter into a relation with borrowers, and this relation, apparently, "is" money.
Nonsense. Let's go back to supply and demand. The potential lender has a supply of available credit. The potential borrower has a desire to put credit to use, a demand for credit. The two meet, perform contractual nookie-nookie, and money is born. Money is the offspring of the relation.
The relation between lender and borrower is this: The lender permits the borrower to put credit to use, in exchange for the promise to return the funds (plus interest) at some future date. The "credit" part is the belief that repayment will be made. The "debt" part is the obligation to repay. The money itself is neither of these.
Let me ask you this: What happens if the contract is broken, and the borrower never repays the lender, and, say, the lender writes it off as a loss. If that happens, the contract is terminated, right? The relation between borrower and lender is terminated. But the money continues to exist.
Is that right? If it is, then the money exists independent of the "relationship". And if the money continues to exist after the relationship is terminated, then the money is not a relationship: The money cannot be a relationship. The money is a thing.
Wow, that was easier than I thought.
Too easy, maybe. Look: The act of lending transforms available credit into credit in use, in exchange for a promise to repay with interest.
The transformation of available credit into credit in use is offset by the promise to repay. And the repayment will transform the credit again, making it again available. The money is a by-product of these arrangements.
Once the borrower spends the money, the money is no longer connected in any way to the borrower. Yet the borrower's obligation to repay remains, and the credit remains in use.
Money is a thing, not a relationship.
6 comments:
Hi Art,
You wrote:
"What happens if the contract is broken, and the borrower never repays the lender, and, say, the lender writes it off as a loss. If that happens, the contract is terminated, right? The relation between borrower and lender is terminated. But the money continues to exist."
I don't think that is correct. What the bank writes off comes from the bank's deposits and the total deposits in the banking system are diminished. Writing off a loan is not much different than paying off a loan. The only difference is who's deposit is erased from the ledgers.
So you may wonder why total deposits in the system are not now falling like a rock. Well the banks are lending to the federal govt which then deposits the loaned amount into the banking system when it spends. Without that extraordinary level of lending to the govt the M2 money supply would be some $2 trillion smaller than it now is. Actually it would be a whole lot smaller than that since vicious cycle of debt deflation would have necessitated a even less private lending and a lot more write-offs of loans.
-jim
Hi jim.
"What the bank writes off comes from the bank's deposits and the total deposits in the banking system are diminished."
Well I'm sure I don't understand that, but thanks for trying :)
This is what I think: If someone "writes off" a "bad loan" it is because the money is not being paid back. If the lender decides to give up and "take the loss" it means they will never get the money back. And when they "write it off" it means that they subtract the amount of the bad loan from their taxable income.
This is all stuff I have figured out for myself, so if you see this & that wrong with it, please do point it out.
I can see that the bank's deposits are diminished because they never got repaid for that loan. But when they write it off, that only affects their taxes, I think, and saves them some money on taxes.
If the borrower spent the money and then the loan went bad, well it looks to me like the money still exists and is in circulation somewhere.
I'm rushing these thoughts because the hamburgers are almost ready. But I hope what I said makes enough sense that you can point out where you think I'm wrong.
Well you are not wrong, but you are also not accurately accounting for what happens.
If the bank pays the janitor his paycheck then the money is written off the bank's deposit account and pops up in the janitor's deposit account. That transaction does not increase or diminish the total deposits in the banking system.
When a loan is paid back the principal comes out of someone's account but it does not reappear in some other deposit account. This is the opposite of what happens when the loan was created and a deposit was created ex nihilo. The bank sometimes can sell
the collateral and apply that to extinguishing the loan. In that case it is the deposit's of the buyer that are destroyed by the loan repayment.
jim: "The bank sometimes can sell the collateral..."
Okay. But if in all of recorded history there is so much as one dollar (created "ex nihilo" by lending) ... If one such dollar continues to exist after the loan goes bad, this dollar disproves the claim that "money is a relationship".
Why does it matter? It matters because it explains why bankruptcy helps to end depressions.It explains why listlessness lingers in Japan.
There is always the possibility that you pick up the monopoly card that says "Bank error in your favor - collect $200"
In theory, the banking system's assets and liabilities always
balance, but I imagine in all of history there must have been some errors.
I am not referring to errors, but to concepts.
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