Creating money out of nothing

[Hud955]

 

ALB wrote:

You keep saying that the scheme you are thinking about (where banks all extend credit at the same rate) has nothing in common with what happens today but I think it has. See if you can spot the error in this explanation by Positive Money of why Northern Rock went bust. According to them, it was because it extended credit too much and too quickly and so ended up with a continuing negative balance when the clearings with the other banks were over.

Cheers Gnome!
Hi Adam
I guess, in this instance, they had forgotten that all the other banks were going down at the same time. So the argument is all very well in theory…!  And in any case, this is not what most commentators think happened.  Most seemed to think that Northern Rock went gung ho for secruitising its loans to raise money to – presumably – make more loans against.
Yes, surely, this does happen in the real world with individual banks.  What I doubt is that the whole banking system could keep up a massive overselling of loans indefinitely while maintaining  the system in balance.  

[Hud955]

Young Master Smeet wrote:

Hud955 wrote:

 They can do it because every loan creates a deposit. (So far so good). 

And herein, like says law, is the Achilles heal.  Why does a loan create a deposit?  What if I draw my loan out as cash?  A certain percentage of loans will go out into cash and will not come back into the banks but will continue to circulate.

Well yes, but we can suppose that there is a statistical adjustment that banks can make for this possibility and probably do.  That, after all, is partly what the reserve rate is about.
These days most transactions of any size are made digitally.  And even if I draw cash I will in all probability spend it quite quickly and it will be redeposited in the banking system by a shopkeeper etc who is then likely to use digital means for his own transactions.  But in any case the banks have reserves of cash which they can use, in the knowledge that much of it will come back as a deposit ready for the next transaction.  Though you are right that some of it will not come back much of it will as well as some cash currently circulating.   Any cash spent in a shop etc is likely to come back into the shop’s bank account.

[ALB]

Hud955 wrote:

What I doubt is that the whole banking system could keep up a massive overselling of loans indefinitely while maintaining  the system in balance.

Isn’t that the answer to your original question?Positive Money says that Northern Rock went bust because it expanded its loans faster than the other banks (so violating one of the assumptions of your ideal scenario). If you think that banks “create money” from thin air rather than from funds they already have this is the only logical explanation you can give. But since banks do make loans from funds they have it is perfectly possible for one bank to expand its loans faster than others, as long as it gets the extra funds. Northern Rock did so by borrowing heavily from the money market. It got into trouble when the interest rates at which it could borrow from here rose. What has been called “funding strains arising from reliance on short-term wholesale funds”. Positive Money of course deny that this could happen or would be a problem because they don’t accept that banks need funds to make loans.

[Hud955]

ALB wrote:

Hud955 wrote:

What I doubt is that the whole banking system could keep up a massive overselling of loans indefinitely while maintaining  the system in balance.

Isn’t that the answer to your original question?

Hi Adam
Well, not really.  I doubt it.  Demonstrating it is a different matter.
The problem I have with your reply (and all the replies I’ve been getting here and elsewhere) is that the evidence you give will support both the ‘intemediary’ scenario AND Positive Money’s.  I still haven’t seen anything yet that shows conclusively that  Positive Money is wrong about this and the ‘intemediary’ claim is correct.
What percentage of banks either went down, got into trouble or needed rescuing?  I don’t really know.  If a high percentage of the industry was affected, then I think that provides a prima facie argument against Positive Money, for although their explanation might work for one or two banks it won’t work for the whole industry.  Banks can’t all be lending more heavily than each other.  Again, I’m hampered by lack of detailed historical knowledge on this.

[DJP]

Hud955 wrote:

Well, not really.  I doubt it.  Demonstrating it is a different matter.The problem I have with your reply (and all the replies I’ve been getting here and elsewhere) is that the evidence you give will support both the ‘intemediary’ scenario AND Positive Money’s.  I still haven’t seen anything yet that shows conclusively that  Positive Money is wrong about this and the ‘intemediary’ claim is correct.

Wouldn’t a cursory glance at a Banks balance sheet do this? If there assetts (loans) and liabilities (deposists) are equal we are right, if there assetts are 90% greater than there liabilties then they are right. Not sure where you’d get the data, maybe here http://www.statistics.gov.uk/hub/index.html

[DJP]

I’m talking about a single bank, not the banking system as a whole. What is true for the system as a whole is not true for an individual bank. Perhaps that’s where the confusion comes in? Haven’t read all the previous posts properly.

[Hud955]

Well, I thought that, Darren, but no it wouldn’t, at least if we presume that every loan creates a deposit.  (And I can’t at present see why that wouldn’t happen today, at least in the medium term.)  If the banking system (presume one bank for now for simpicity’s sake) makes a loan of £1,000 without having a deposit or start up cash or whatever to back it, that money will still come back into the system and sit on the bank’s books as a £1,000 deposit.  Loans (plus reserves) will always balance deposits whether Positive Money or the intermediate theory of banking is correct. 
As far as I can see, this whole debate revolves around whether deposits create loans or loans create deposits.  The logic is the same for both.  I think of only two ways to counter the positive money argument.  The first would be to provide empirical evidence that this is not actual banking practice.  But where would that evidence come from? Beats me!  The other approach would be to collect evidence of large-scale bank failure and demonstrate that it was caused by excess lending.
I’m very willing to be proved incorrect here.

[Hud955]

True but I’m not sure what demonstrating this for a single bank would mean, except that it is either lending more heavily than other banks or failing to attract an equal market share of depositors.   But Positive Money accepts this scenario and uses it as an explanation of why Northern Rock failed (or any bank might fail.)  They claim that banks can create loans out of nothing so long as they do it together at the same rate (at least over time).  If they don’t then they start having negative BACS balances, and unless they do something to correct that they will go down.
Once again the same evidence will support both scenarios.
(And that suggests a third possible approach to the proble; the one I started with.  You could attempt to demonstrate that the competitive nature of banking and of the market would ultimately prevent them from maintaining an equal rate of lending.  But again, I have no idea how you would go about that.)

[DJP]

Hud955 wrote:

True but I’m not sure what demonstrating this for a single bank would mean, except that it is either lending more heavily than other banks or failing to attract an equal market share of depositors.   

Here’s a balance sheet for hsbchttp://finance.yahoo.com/q/bs?s=HBC+Balance+Sheet&annualDoesn’t this prove that banks do not make loans of 900 for every 100 deposited with them, as that guy in the green party video claims. Wouldn’t you expect their assetts to be 90% greater than there liabilities if that were the case?

[DJP]

…Maybe Hardy can help us out:http://libcom.org/library/banking-credit-myths-socialist-view” If it is bank loans which create bank deposits then deposits ought to increase in parallel with bank loans. Instead of this happening, Walter Leaf’s figures showed that bank deposits fell when bank loans increased.”

[Hud955]

Again, no it doesn’t.  Assume a single bank for now and assume a bank rate of 10%.  If the bank receives a deposit of £100 and lends 900% of that or £900 as your green party guy claims, it will in due course receive a deposit of £900.  Its books will then show £1000 in deposits (£100 and £900) and a £900 loan.  There would be no obvious way of distinguishing between this situation and another where it recieved an initial deposit of £1000 and loaned 90% of that or £900.  Again, its books would show deposits of £1000 and a loan of £900.  The only difference here would be in a slight time delay.  In the first instance the bank’s balance would show a slight preponderance of loans over deposits, in the second a preponderance of deposits over loans -everything else being equal.  (Everything would depend on the speed at which the bank made new loans on the basis of new deposits, and received new deposits on the basis of making of new loans).  You might be able to identify the difference statistically though.  But again, how would you go about that?  
In the banking system of course there is more than one bank and so the system relies on a distribution of new deposits.  A loan bank A makes might go to bank B as a future deposit, but then a loan bank B makes might come back to bank A.  If a bank is getting fewer deposits than it is making loans this will show up in negative BACS balances every evening signalling to it that it needs to reduce its rate of lending or start marketing itself more heavily to get a greater ‘market share’ of depositors. Its own commercial needs would encourage it to do that and so the system would be kept in balance.

[ALB]

Hud955 wrote:

I think of only two ways to counter the positive money argument.  The first would be to provide empirical evidence that this is not actual banking practice.  But where would that evidence come from?

Here’s what Glen Arnold (described as “a businessman, investor and a professor of investment at Salford University.”) says in an FT Guide to Financial Markets published earlier this year. After describing the classic way in which, with a required cash reserve, the banks collectively (but not one on its own) can use the money from an initial deposit to make loans many times that amount, through the loans, after being spent, being deposited in one or other bank, he comments:

Quote:

The central bank is the only player here which can create money out of thin air and pump it into the system if the system is at equilibrium.Thus, despite the commercial banks’ ability to create money on the way to equilibrium, there is a limit to the amount that the system can go up to, because for every dollar, pound, euro, etc created there has to be a fraction held as a cash reserve. It is the central bank which controls the total volume of monetary base (reserves at the central bank plus cash in circulation and at deposit-taking institutions) and so the broader aggregates of money have an upper limit. (p. 126)

Creationists oppose this “deposit multiplier” theory because they realise that it is based on each new loan being preceded by a new deposit.The sub-plot here is that there is a disagreement amongst economists about the way banks and the central bank (in the UK, the Bank of England) interact. Some say that commercial banks take the initiative and make loans without having the funding in the knowledge that the central bank will always create the funds needed to cover these loans (which still acknowledges that loans do need to be funded). Others challenge this view (such as Arnold above and Paul Krugman), pointing out that there are limits to the amount both an individual bank and the banking system can make.Positive Money relies on quotes from the first school of economists, especially as some of them do talk the language of “creating money from thin air”, even though none of them think that a single bank can do this on its own or that banks collectively can either without the intervention of the central bank (which, as a State institution) can create money out of thin air (if you want to put it that way).But surely the main argument against the Positive Money position is that banks do seek outside deposits and do borrow wholesale from the money market.? If they could create the money to lend from thin air why would they need to do this? For someone expressing the view that “banks do not (and never have) needed depositors for enable them to make loans” and “deposits play no part in that process” (his emphasis) on the Positive Money website and endorsed there as “an excellent comment” see this. Surely there is enough “empirical evidence” to show that this is not actual banking practice? 

[DJP]

It would seem that the bank in your first example would go bankrupt the first time a single withdrawal of £100 or more was made, quite likely since the bank has to account for £1000. That’s why the situation doesn’t hold in real life.I think this can be solved by getting balance sheets for all the major UK retail banks totalling them up and seeing if deposits increase in parallel with loans.

[Hud955]

DJP wrote:

…Maybe Hardy can help us out:
http://libcom.org/library/banking-credit-myths-socialist-view
” If it is bank loans which create bank deposits then deposits ought to increase in parallel with bank loans. Instead of this happening, Walter Leafs figures showed that bank deposits fell when bank loans increased.”

Now that is interesting.  But…  and here I’m being cautious again because I’m aware that I lack an understanding of the banking system and therefore of many factors that could be influencing what happens.  …but ploughing on regardless, the puzzle for me here is that though it may be true that “if it is bank loans which create bank deposits then deposits ought to increase in parallel with bank loans” isn’t it also true that if it is bank deposits that encourage banks to make bank loans (which I presume is the case because after all is what banks are there for on the intemediary theory) then loans ought to increase in parallel with deposits, so Walter Leaf’s figures fail to answer the case either way.   I think I remember this article by Hardy, but as I’m cooking supper right now I haven’t had time to read it again yet.

[Hud955]

ALB wrote:

Hud955 wrote:

I think of only two ways to counter the positive money argument.  The first would be to provide empirical evidence that this is not actual banking practice.  But where would that evidence come from?

  Surely there is enough “empirical evidence” to show that this is not actual banking practice?

LOL, well there may be (and I sincerely hope there is.)  But right now I am off to slob out, eat supper and watch a couple of episodes of ‘Northern Exposure’ (I’ve just discovered this amazing, whimsical, gently comic TV series.)
I’ve skimmed your post quickly.  I’ll read it more carefully later and respond.  What I hope is that we can make an argument that is based on something more substantial than just quotes from authorities.  It seems that more and more bankers are coming round to the creationist view these days (if the quotes that get bandied around are real and accurate) so a reliance on ‘authorities’ might just end up as a playground battle of my authority is more authoritative than your authority. 
Thanks for engaging with this.  I was feeling left a bit high a dry with it for a while.
 
See you at the meeting.

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