Thursday, 27 May 2021

How come depositors ever managed to get interest on instant access accounts?


Interest is a reward earned by a borrower for performing two functions. One is to abstain from spending a sum of money so that the borrower can spend that money. The second is accepting the risk that the borrower may not repay the loan.

Now where people deposit money at a bank under fractional reserve, they do not abstain from spending any money: the bank lends out depositors’ money while telling depositors their money is still available to said depositors, and indeed it is still available.

Now at this point, some readers may object by citing the currently fashionable idea that banks create money rather than intermediate between lenders and borrowers.

Well the reality is that a bank cannot simply create and lend out money willy nilly without money coming in from depositors, bond holders and shareholders: why else have bank over the decades dished out billions by way of interest and dividends to the latter three funders so as to attract their money? If a bank WERE TO “lend willy nilly”, it would run short of reserves: not a good position to be in for any length of time.

Moreover, as the second sentence of a Bank of England article entitled “Money creation in the modern economy” says, banks BOTH create money and intermediate between lenders and borrowers.

To summarise so far, depositors manage to have their money loaned out WITHOUT abstaining from the freedom to spend such money.



As regards risk, depositors do not endure any sort of risk because the relevant risk is carried by the deposit insurance system.

So the big question is this: how come depositors with instant access accounts ever managed to earn interest? There is clearly something fishy here.

And as to the idea that instant access accounts currently pay almost no interest, that’s not actually true: interest earned by banks helps defray the cost of administering instant access accounts. Thus those with such accounts, even in today’s low interest rate environment in effect get interest.


David Hume.

What I think explains the latter “fishy smell” is a point made by David Hume over two hundred years ago in his essay “Of Money” when he said “It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government.”

In short, politicians are always tempted to pay for public spending via borrowing rather than via tax. Of course it might be argued that public sector INVESTMENTS should be funded by borrowing. But that’s not what happens at the moment. I.e. at the moment government borrowing funds a large amount of CURRENT spending. And that’s a gift to lenders, i.e. the cash rich: it results in a general and artificial rise in interest rates. And that in turn means those borrowing from banks have to pay an artificially high rate of interest – or at least for most of the time since David Hume’s day (and possibly long before that) they have had to.

And if you don’t think David Hume’s point explains why depositors with instant access accounts have for decades managed to earn interest, I’m always happy to listen to alternative explanations for the above “fishy smell”.

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