Critisticuffs on Inflation
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“Do you perhaps mean the following? When Barlcays gives Alice a loan of £100 then Alice can dispose over £100 to spend. If Alice spends these £100 in cash, then Barclays cannot spend these £100 in cash, too. If that is what you mean, then we are back at the start. It is not correct to say that to spend £100 from your bank account £100 in cash are needed: within the same bank transfers are just ledger updates, between banks (at most) differences are settled in central bank money.”
That is not what is meant. If Alice spends the £100 to buy from someone or some shop that has a bank account with Barclays, what this means is that Barclays can record having a further £100 deposited with it from outside.
If she spends it — by cheque, card or bank transfer — to buy something from someone banking with a different bank then Barclays has to transfer £100 to that bank whose deposits therefore go up by £100.
To maintain its previous position Barclays has to get an incoming payment of this amount (there is no reason why this would have to be in cash; it could equally be, in fact, would be more likely to be a transfer from another bank). It may well get this, but if by the end of the day it hasn’t, then it will have to borrow £100 on the interbank landing market.
However it does it, Barclays has to have an incoming payment to cover the loan.
In the olden days — two hundred years ago — Barclays would have probably given a loan in the form of a bag of gold coins. Then it would be quite obvious what a bank loan was and that it did not involve the “creation” of any additional purchasing power (even if it did result in more things being bought).
The form in which a bank loan is made — gold coins, the bank’s own notes, Bank of England notes, an account with a cheque book, an account with a plastic card — makes no difference to the principle that a loan is a transfer of already existing purchasing power and not the creation of new purchasing power. It is a loan of the use of money no different in principle from the loan of a book or a car.
Once this basic fact is grasped it is easy to see why bank lending does not and cannot cause the currency to depreciate (however high finance might become).
“In the olden days — two hundred years ago — Barclays would have probably given a loan in the form of a bag of gold coins.”
I think here is one of the key misunderstandings in this thread, that money in the modern world is not the same as a bag of gold coins. To make use of Alice and Bob again:
Alice buys £1000 of beans from Bob. Alice banks with Bank A, Bob with bank B. Bob supplies Alice with the beans, and Bank A transfers £1000 to Bank B, who credit Bob’s account with £1000.
At the end of the day, by a weird quirk of fate, the mutual transfers between the two banks equal each other. No money needs to change hands between them. £1m of purchasing may have gone on, all with broad money initially created as a deposit.
A more likely scenario is that after cancelling out mutual transfers between the two banks, Bank A has to transfer a balance to bank B. This might be, say, 10% of the total value of payments from A to B.
Clearly Bank A has to ensure that it is able to meet such obligations. It might borrow from other banks, or the central bank – meaning new base money is created – but it does not need to cover its deposits on a 1:1 basis, and when new base money is created this follows rather than leads broad money (i.e. there is no money multiplier up from the amount of central bank money that is created – the reverse is true, banks seek to ensure that they can lay their hands on an adequate amount of base money, which will always be a percentage of their obligations, not the full amount).
Can I draw people’s attention to this earlier exchange on banking
It is a very long discussion but worth viewing
That’s the conventional way of putting it but it doesn’t follow from it that bank lending could cause the currency to depreciate, as claimed in the pamphlet under discussion here.
I would just make two points. The conventional view is not using the word “deposit” in a the way most people would understand it — as a sum of money deposited (whether in cash or by bank transfer) in a bank from outside; in effect a loan to a bank, something the bank owes to the depositor. In your exposition of the conventional view you use the word in the opposite sense of a loan from a bank, in the form of an account created by the bank in which it has “deposited” an amount that the borrower can draw on.
To use the sane word for two different and opposite things can only cause confusion (besides, is also not an accurate description of what happens; normally the borrower already has an account and is given a loan as an overdraft facility, so nothing is actually “deposited” and no loan is given until the borrower uses that facility).
So when you write “all with broad money initially created as a deposit”, it would be clearer to have said “all created as a bank loan”. Again, when you write that a bank “does not need to cover its deposits on a 1:1 basis”, to say “does not need to cover its loans on a 1:1 basis”.
But this is a matter of semantics that should be able to be sorted out.
The second point is one of fact. Is it the case that “when new base money [central bank money]is created this follows rather than leads broad money [bank loans]”? Does the central bank issue more money simply because a bank asks them to? I thought the process of introducing new money into the system starts with the central bank selling bonds or Treasury bills, ie that the initiative lies with the central bank.
I am not sure that it is wise to move on to the question of whether “bank lending could cause the currency to depreciate” at this stage given there is no agreement on whether banks can create purchasing power. That is a necessary part of the argument to understand and agree to get to the conclusion.
What I am struggling with in the disagreement about whether commercial banks granting credit creates purchasing power, is that I feel my comrades from critisticuffs have given possible examples where financial instruments have created purchasing power that was not backed by base money. I don’t see that those examples have been shown to be wrong.
I also think the easiest example to set up is just one with bills of exchange:
1. Archibald wants £10 worth of chicken feed. He doesn’t have £10 but writes Belinda a promise to pay her £10 in a week and gets the chicken feed in return.
2. Belinda, wanting to eat an omelette, visits Cuthbert’s cafe. Belinda, persuades Cuthbert to accept Archibald’s promise to pay which she signs over to Cuthbert.
3. Cuthbert, needing eggs, which Archibald supplies, was actually happy to accept Belinda “paying” in this way, because he then presents Archibald with his own promise to pay (causing it to disappear) in return for more eggs.
In this example, none of A,B or C need actually have ever had the £10. Yet the promise to pay was able to effect the transactions i.e create purchasing power (obviously a single £10 note could have achieved the same had Archibald not been skint but it turns out it wasn’t needed).
For the moment, maybe the best thing to do in an attempt to move the debate forward would be if someone who has this view could explain why in the A, B, C example above, the promise to pay is not itself what creates the purchasing power? It seems to me that it is functioning absolutely as money in the sense that it was what facilitated the transactions as means of purchase and means of circulation.
Once we introduce banks, with 1000s of depositors and 1000s of loans extended, what in the above example is a rather contrived circle where no cash was needed becomes a routine phenomena. They are able to create book money which they successfully calculate will never be required to be backed by base money routinely. Therefore they are not mere clearing houses for unused money but turn their role in taking hold of unused money into the opportunity to create further purchasing power not matched by the money deposited with them, by granting credit which they calculate will not be called for in cash. But we don’t need to go there as it seems to me the disagreement should be capable of resolution at the level just of working out the bill of exchange point.
On a final (separate) note: the German Central Bank explains that this is how it works (I know in the SPGB text the critisticuffs piece disagrees with the Bank of England piece to the same effect is referred to)- the German Central Bank one is worth a read and is here in English: https://www.bundesbank.de/resource/blob/667334/de28e82ef38090619f3af34e1442d269/mL/2017-04-monatsbericht-data.pdf Obviously, although I agree, I don’t do so because they are Central Bankers. They do a reasonable argument and explanation of how they see it working.
As it happens, we published an article at the time on what the German Central Bank said:
Archibald, Belinda and Cuthbert reminds me of this story that I am sure you all have heard a version of.
A rich tourist stops at a hotel and puts a $100 bill on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night.
As soon as the man walks upstairs, the owner grabs the bill and runs next door to pay his debt to the butcher.
The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.
The pig farmer takes the $100 and heads off to pay his bill at the feed store.
The guy at the Farmer’s Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her services on credit.
She rushes to the hotel and pays off her room bill with the hotel owner.
The hotelier now places the $100 back on the counter so the rich tourist will not suspect anything.
At that moment the tourist comes down the stairs, picks up the $100 bill, states that the rooms are not satisfactory, pockets the money and departs.
No one produced anything and no one earned anything. However, the whole village is now out of debt
“As it happens, we published an article at the time on what the German Central Bank said:”
….hadn’t seen that thanks. Will have a read and a think.
all methods which save on medium of circulation are based upon credit. On the other hand, however, take, for example, a 500-pound note. A gives it to B on a certain day in payment for a bill of exchange; B deposits it on the same day with his banker; the latter discounts a bill of exchange with it on the very same day for C; C pays it to his bank, the bank gives it to the bill-broker as an advance, etc. The velocity with which the note circulates here, to serve for purchases and payments, is effected by the velocity with which it repeatedly returns to someone in the form of a deposit and passes over to someone else again in the form of a loan. The pure economy in medium of circulation appears most highly developed in the clearing house — in the simple exchange of bills of exchange that are due — and in the preponderant function of money as a means of payment for merely settling balances. But the very existence of these bills of exchange depends in turn on credit, which the industrialists and merchants mutually give one another. If this credit declines, so does the number of bills, particularly long-term ones, and consequently also the effectiveness of this method of balancing accounts. And this economy, which consists in eliminating money from transactions and rests entirely upon the function of money as a means of payment, which in turn is based upon credit, can only be of two kinds (aside from the more or less developed technique in the concentration of these payments): mutual claims, represented by bills of exchange or cheques, are balanced out either by the same banker, who merely transcribes the claim from the account of one to that of another, or by the various bankers among themselves.[11] The concentration of 8 to 40 million bills of exchange in the hands of one bill-broker, such as the firm of Overend, Gurney & Co., was one of the principal means of expanding the scale of such balancing locally. The effectiveness of the medium of circulation is increased through this economy in so far as a smaller quantity of it is required simply to balance accounts. On the other hand the velocity of the money flowing as medium of circulation (by which it is also economised) depends entirely upon the flow of purchases and sales, and on the chain of payments, in so far as they occur successively in money. But credit effects and thereby increases the velocity of circulation. A single piece of money, for instance, can effect only five moves, and remains longer in the hands of each individual as mere medium of circulation without credit mediating — when A, its original owner, buys from B, B from C, C from D, D from E, and E from F, that is, when its transition from one hand to another is due only to actual purchases and sales. But when B deposits the money received in payment from A with his banker and the latter uses it in discounting bills of exchange for C, C in turn buys from D, D deposits it with his banker and the latter lends it to E, who buys from F, then even its velocity as mere medium of circulation (means of purchase) is effected by several credit operations: B’s depositing with his banker and the latter’s discounting for C, D’s depositing with his banker, and the latter’s discounting for E; in other words through four credit operations. Without these credit operations, the same piece of money would not have performed five purchases successively in the given period of time. The fact that it changed bands without mediation of actual sales and purchases, through depositing and discounting, has here accelerated its change of hands in the series of actual transactions.
And
“The quantity of circulating bills of exchange, therefore, like that of bank-notes, is determined solely by the requirements of commerce; in ordinary times, there circulated in the fifties in the United Kingdom, in addition to 39 million in bank-notes, about 300 million in bills of exchange — of which 100-120 million were made out on London alone. The volume of circulating bills of exchange has no influence on note circulation and is influenced by the latter only in times of money tightness, when the quantity of hills increases and their quality deteriorates. Finally, in a period of crisis, the circulation of bills collapses completely; nobody can make use of a promise to pay since everyone will accept only cash payment; only the bank-note retains, at least thus far in England, its ability to circulate, because the nation with its total wealth backs up the Bank of England.”
> I thought the process of introducing new money into the system starts with the central bank selling bonds or Treasury bills to the banks, ie that the initiative lies with the central bank.
Ah, no, the central bank does not sell sovereign bonds. The government sells the bonds (gilts in the UK, treasury bills in the US) to private investors like banks. These can use these as collateral to borrow from the central bank, which then creates new central bank money (or at least account balances with the central ban that entitle the holder to get central bank money notes from the central bank, but that’s a minor technical detail).
An example: UK Government sells a gilt worth £1000, Barclays buys it for £1000, Barclays then borrows £1000 in cash from the BoE when it wants it, e.g. to satisfy some outgoing payments, this creates £1000 of central bank money.
The central bank might also proactively go out on the market and buy gilts, i.e. initiate purchases of gilts: quantitive easing. Finally, they may also want to wind down their gilt positions, i.e. sell gilts which they previously purchased, which would reduce the amount of central bank money in society: they sell the gilts and effectively destroy the money they receive.
References:
– Section 3 of https://critisticuffs.org/texts/inflation.pdf
– https://gegen-kapital-und-nation.org/media/sovereign-debt.pdf
– https://critisticuffs.org/economic-crisis-june-2020.pdfOk, it’s not now the Bank of England but another government department but that doesn’t undermine the fact that it is the government, or if you like the state, that takes the initiative that leads to more fiat money being issued and not the commercial banks. The state’s role is not passive as suggested but, as you put it, pro-active.
That passage from Marx is pointing out how bills of exchange (private IOUs) economise on the use of cash as a means of payment. Nobody is denying that. The point at issue is not this but whether they can cause money to depreciate (inflation in its original sense). If you think they can or could you need to explain why they didn’t in Marx’s day.
Incidentally, while it is possible to imagine all sorts of scenarios where private IOUs serve as means of payment (and so economise on the use of cash) in practice historically this wasn’t so easy and involved the emergence of specialised bodies such as discount houses and acceptance houses.
Anyway, nobody is arguing that private IOUs cannot be used as means of payment and/or economise on the use of cash or that bank transfers can’t either. It’s about whether or not bank loans can lead to inflation.
[Replying to ALB’s post #234912, the link to an SPGB article on the Bundesbank paper]
The article linked to contains the same misunderstanding we’ve seen here:
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SPGB: “Banks are profit-seeking financial intermediaries that borrow money at one rate of interest (either ‘retail’ from individuals or ‘wholesale’ from the money market) and relend the money to borrowers at a higher rate. The spread between the two rates is the source of a bank’s income; after it has paid its operating costs, including staff wages, what remains is the bank’s profits.
Banks’ ‘inherent interest in profit maximisation’ affects how what the article describes as ‘the need for banks to find the loans they create’ is met. It means that they are going to seek to obtain the needed funding as cheaply as possible, i.e., at the lowest possible rate of interest:
‘Deposits play a major role in this regard, for while banks have the ability to create money – that is, to accumulate a stock of assets by originating liabilities themselves in the form of sight deposits – they need funding in the form of reserves.’[quoting the Bundesbank article]”
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This quote from the Bundesbank paper is not stating that banks must immediately seek to cover the full value of a loan that has been made from other deposits, interbank lending or the central bank. The sentence after the above quote reads: ‘This need for funding exists because, as outlined above, banks are always at risk of losing at least some of the deposits they have created by granting loans as a result of cashless payments or cash withdrawals’. What is necessary is the ability to cover the likely payments (after clearing) and cash withdrawals, not to cover the entire amount of each loan.
The Bundesbank makes this clear earlier in their paper:
‘But the central bank nonetheless has an important role to play as a producer of reserves. That is because bank A has to assume that customer X will use the loan amount for payment transactions, and these normally result in at least some of the sight deposits created by bank A being transferred to different banks with which the recipients of those payments have an account. If this occurs, bank A will usually need to have reserves with the central bank to settle the outflow of deposits, because a large proportion of cashless payments between banks are netted via the accounts they hold with the central bank’
That is, they do need to be able to cover transactions, but this is not the same as covering the full value of each loan they make, given these are ‘netted’.
“This quote from the Bundesbank paper is not stating that banks must immediately seek to cover the full value of a loan”
Maybe I’ve been missing the point, but I never thought that any of the SPGB texts suggested that banks must *immediately* do this? Nobody has been claiming this, or that banks must have 100% reserves. Have they?
Is the confusion because a process that happens across time, has been described using words that make it seem like it is something that happens in an instant?
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