Thursday, 2 September 2021

What's wrong with “debt based” money?


 When a private / commercial bank grants a loan, it credits the account of the borrower with the bank's home made money, and at the same time, the borrower is in debt to the bank in that the borrower must repay the debt at some stage. The borrower of course then spends that money, so that money ends up with a variety of other people and firms. It would therefore seem that someone has to go into debt in order for people to have a stock of money.

That idea is promoted in this Positive Money article for example.

Only problem with that idea is that the total amount of debt that the population wants to incur vastly exceeds the amount of money it needs for day to day transactions. Thus money is in effect a free by-product of lending and debt. 

In contrast, if no one in the country, or at least very few wanted to incur debt, then debt based money would certainly be inferior to “non debt based” money, i.e. base money (central bank issued money). But that's not what obtains in the real world.  

To illustrate with some figures, the average mortgage in the UK is just under £140,000 and there are around 11 million mortgages and 30 million households. Average household income is around £30,000 pa, i.e. £2500 a month. So the average household needs a minimum of about £2,500 to tide it over from one salary cheque to the next. Say £4,000 for comfort.

So total amount of money needed for day to day transactions and a bit for rainy days is 30million x £4,000 equals £120bn. In contrast, the total amount of mortgage debt is 11million x £140,000 equals £1.54tr. So the total of all mortgages is a bit over ten times the amount of money needed.


P.S. 3rd Sept 2021.  I omitted the REASON debt based money would be inferior to base money where there was very little desire to incur debt in the above paragraphs. Reason is that (assuming the stock of money people want for day to day purchases is the same) then the only way they'd be able to acquire that money would be to borrow it from a commercial bank. But that involves those banks in checking up on the credit worthiness of borrowers, getting security / collateral off them as necesssary, and those are very real costs. In contrast, if the relevant economy relies just on base money, there are no such costs. As Milton Friedman put it (using rather convoluted language), "It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances."  .

1 comment:

  1. It somewhat boggles the mind to think that our bank accounts, which we call ours and fully owned by us, are really shared claims on money issued by the central bank, yet that is what I describe here:

    I argue that private banks making loans are NOT creating money; they are reusing real fiat money. The multiplication factor between money issued by the CB and 'issued' by private banks is a result of how we like to measure the supply of available money.


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