Friday, 1 August 2014
Private banks don’t exacerbate debts.
Positive Money, along with many others falls for the superficially plausible argument that private banks create a form of money which is “debt based”, thus the latter activity might seem to exacerbates indebtedness, ergo we should dispose of debt based money. There is actually a very good argument for doing the latter, i.e. disposing of debt based money (and more on that below). But the latter "superficially plausible" argument is not it. The flaw in the "superficial" argument is thus, and we’ll start with day to day transaction money as opposed to long term loans.
If you want £X of transaction money from a bank, the bank credits your account with £X which is an artificial debt owed BY THE BANK TO YOU. And you can force the bank to “owe” that money to someone else, using your cheque book or plastic card. Plus you undertake to eventually recoup the debt / money from the “someone elses’” and repay the £X to the bank. So initially there are two equal and opposite debts there. No net debt exists before you actually start to spend the money the bank credits to your account.
In fact there’s probably a THIRD debt: if you deposited collateral at the bank, the bank owes you that collateral when you repay the bank. So in that scenario, there is initially a net debt OWED BY THE BANK TO YOU!!!!!
Once you start spending your day to day transaction money, then your debt to the bank rises (or if you like, the bank’s debt to you falls). But let’s say everyone else in the economy has done the same as you: got themselves some transaction money which they spend. That money must end up somewhere, and some of it will end up in YOUR ACCOUNT, assuming like 99% of the population you have some sort of income (e.g. from work, benefits, etc). So on balance (to oversimplify the real world a little, but not by all that much) having private banks supply debt based transaction money does not result in increased debts.
Long term loans.
In contrast to day to day transaction money, there are LONG TERM LOANS, of which mortgages are the biggest example. Having got your long term loan from a bank and spent it, that money must again end up in someone else’s account. But the someone else must be willing to leave it there for a longish period, and for the simple reason that if they didn’t, aggregate demand would rise as a result of you spending the money you borrowed. And if the economy is at capacity, a rise in AD is not permissible. (As to where the economy is NOT AT capacity, that’s dealt with below).
In short, private banks cannot create debt based money without willing savers. But in the absence of banks, those willing savers would still be there: they’d just lend direct to those wanting mortgages. Indeed that’s exactly what happens with collateralised debt (CDOs).
In short, disposing of debt based money does not in any DIRECT WAY reduce debts any more than ceasing to use gold coins as money means the World’s stock of gold declines. (There is actually a minor and INDIRECT way in which disposing of debt based money cuts debts, but I won’t go into that here).
As Keynes said, banks don’t do anything that wouldn’t happen anyway. All private banks do, so far as long term loans are concerned, is to intermediate between savers and borrowers: i.e. assuming private banks work efficiently, they just make the lending / borrowing process more efficient.
Moreover, in the case of long term loans, those who have deposited money in banks for longish periods will tend to put the money on “term” or deposit accounts rather than in current or checking accounts. And normal practice round the world tends to be to not count as money sums deposited in term accounts.
Indeed Positive Money itself does not count as money sums placed in the investment accounts proposed by PM. Quite right.
The economy is not at capacity.
As to where the economy is NOT AT capacity, i.e. in a recession, the fact of banks creating money out of thin air and lending it ABSENT THE EXISTENCE of willing savers, well the increased demand stemming from that wouldn’t matter. But it’s very doubtful as to what extent that phenomenon actually takes place. That is, as Keynes pointed out, economies can get stuck in high unemployment equilibria. Put another way, private banks far from ameliorating booms and busts EXACERBATE them, if anything. Certainly prior to the recent crisis, banks in the UK were creating new money like there’s no tomorrow, then come the crunch, far from helping us escape the recesssion, they drastically CUT DOWN on their lending / money creation.
In the case of transaction money, commercial banks do create money, but that does not give rise to debts. And in the case of long term loans, commercial banks just organise lending / debts that would exist anyway, but that tends not to result in money creation.
Ergo, contrary to PM’s claim in the above tweet, commercial bank money creation does not exacerbate indebtedness.
But that’s not to say there isn't a strong argument for disposing of debt based money and switching to a system that involves only debt free money (i.e. base money). The argument for doing the latter are not as suggested in the above tweet; it’s briefly as follows.
Money is a liability of a bank. Or to be more accurate, money appears on the liability side of banks’ balance sheets. (The extent to which that liability really is a liability in the case of central banks is debatable, but let’s gloss over that for the sake of simplicity.)
Next, money is fixed in value (inflation apart). That’s unlike the value of other assets like houses or shares which fluctuate in value. Ergo commercial banks have assets which can fall in value and liabilities that are fixed in value, which is recepie for disaster. And indeed, regular as clockwork over the last few centuries, private banks have gone bust one after another. Ergo they have to be backed or subsidised by a host of different taxpayer funded subsidies: TBTF, depsot insurance, lender of last resort, etc. And subsidies misallocate resources: they reduce GDP.
Ergo commercial bank created money should be disposed of and replaced entirely by central bank or “debt free” money.
As to debts, there is no obvious reason why that switch to debt free money would greatly reduce debts.