The last post looked at the cost to the bank of creating new bank credit in exchange for a promissory note when it makes a loan. While the bank at first simply notes an entry in the borrower's account, what that actually does is to give the borrower control over that amount of the bank's money — he can then either withdraw cash (reducing the amount of money owned by the bank), or can write a cheque to someone who banks with another bank, directing the bank to transfer money to the bank of the recipient of the cheque.
What about if the borrower writes a cheque to someone who has an account with the same bank? Does that disadvantage the bank in any way, or is that a free meal ticket? Let's examine the accounts of that scenario. First, the bank before any loan is made:
| Assets | shillings | Liabilities | shillings |
|---|---|---|---|
| Deposit at BoS | 100,000 | Money owed to bank owners | 100,000 |
| Total | 100,000 | Total | 100,000 |
The bank has 100,000 shillings on deposit at the BoS. That is how much the bank is worth, and so that is how much is owed to the owners because, well, they own the bank.
Now after a loan of 10,000 shillings is made to Mr Smith:
| Assets | shillings | Liabilities | shillings |
|---|---|---|---|
| Deposit at BoS | 100,000 | Money owed to bank owners | 100,000 |
| Promissory note (Mr Smith) | 10,000 | Deposit (Mr Smith) | 10,000 |
| Total | 110,000 | Total | 110,000 |
The bank has a new asset – it is owed 10,000 shillings by Mr Smith. At some point in the future, assuming Mr Smith keeps his promise, he will give 10,000 shillings to the bank. However, the bank also owes 10,000 shillings to Mr Smith — he can take 10,000 shillings in cash (or transfer the amount) from the bank whenever he likes.
And finally, after Mr Smith writes a cheque to Mrs Apricot in exchange for a car:
| Assets | shillings | Liabilities | shillings |
|---|---|---|---|
| Deposit at BoS | 100,000 | Money owed to bank owners | 100,000 |
| Promissory note (Mr Smith) | 10,000 | Deposit (Mrs Apricot) | 10,000 |
| Total | 110,000 | Total | 110,000 |
Note that there is very little difference between this situation and the previous one. All that has changed is that Mrs Apricot has the bank credit instead of Mr Smith. The bank still has as much money as it had before – 100,000 shillings, so at first glance, it might appear that the bank is not disadvantaged in any way. But in fact the bank still has a liability to Mrs Apricot, who could withdraw the bank credit as cash or pay it to someone who has an account with another bank. The bank still has given up control of some of its money to another person, and that control could be exercised at any time. If Mrs Apricot decides to withdraw her entire bank credit as cash, the bank ends up in the same situation as in the last post where Mr Smith paid a cheque to Mrs Jones who had an account with another bank:
| Assets | shillings | Liabilities | shillings |
|---|---|---|---|
| Deposit at BoS | 90,000 | Money owed to bank owners | 100,000 |
| Promissory note (Mr Smith) | 10,000 | ||
| Total | 100,000 | Total | 100,000 |
Once again, the bank has only 90,000 shillings in money. It is entirely reliant upon Mr Smith paying back his debt in order to break even, and his interest in order to meet its costs and make a profit.
Summary
The creation of bank credit in exchange for a promise to repay is not a costless operation for a bank. It involves giving control of money to the borrower. We saw in an earlier post that if Mr Smith pays someone with an account at a different bank and then fails to pay back the loan, the bank owners lose money. Above we saw that the bank owners would lose money even if the borrower pays someone who banks with the same bank.
One major argument of "Money as Debt" is thus shown to be deeply flawed. The fact that banks can trivially create bank credit by writing an entry in a book or putting an entry in a computer database does not mean that bankers are evil top-hatted thieves who get something for nothing, steal wealth from others and force others to become indebted to them.
There is still the film's assertion that the existence of interest requires exponential growth in the economy. This argument will be discredited in a forthcoming post...
"One major argument of "Money as Debt" is thus shown to be deeply flawed. The fact that banks can trivially create bank credit by writing an entry in a book or putting an entry in a computer database does not mean that bankers are evil top-hatted thieves who get something for nothing, steal wealth from others and force others to become indebted to them".
ReplyDeleteYes it does.
As before you've completely missed the point, by looking only at the situation of one bank in total isolation. (I won't repeat the comments I already made earlier).
The private banks collectively are issuing 97% of the nation's money, in the form of interest-bearing debt.
Collectively, they have succeeded in fighting-off every attempt by elected governments - on the citizen's behalf - to take back this power (which is totally unconstitutional) from them. hardly surprisingly, considering what untold riches its continued possession has yielded to that small segment of society in a position to profit from it.
They have been incalculably aided in doing that by the almost complete ignorance of most of us who are its victims.
I'm sorry to say it but I don't think your blog is helping to dispel that ignorance - rather the reverse - although I don't doubt your good faith and praiseworthy intentions.
"The creation of bank credit in exchange for a promise to repay is not a costless operation for a bank. It involves giving control of money to the borrower. We saw in an earlier post that if Mr Smith pays someone with an account at a different bank and then fails to pay back the loan, the bank owners lose money. Above we saw that the bank owners would lose money even if the borrower pays someone who banks with the same bank".
ReplyDeleteThis is nonsense. A bank can't lose money that never existed in the first place except as a book-keeping entry.
I don't really know where to start trying to criticize it because it is fundamentally misconceived. For some reason, you seem not to have grasped the fundamental difference between 100% reserve banking and fractional reserve banking. Without that understanding, pretty-well every assertion you make about the workings of the banking system we actually have is foreordained to be - like this one - based on a misconception.
"One major argument of "Money as Debt" is thus shown to be deeply flawed".
You're perfectly at liberty to go bissfully on believing that if you choose. However, as well as deceiving yourself you may be misleading others and I find that worrying.
"This is nonsense. A bank can't lose money that never existed in the first place except as a book-keeping entry."
ReplyDeleteIt's not nonsense at all. It is very clearly demonstrated by the final balance sheet of the post. The bank created some bank credit for Mr Smith in exchange for the promise to repay. It then transferred that bank credit to Mrs Apricot. Finally, Mrs Apricot withdrew her 10,000 shilling deposit, so the bank credit (liability) was destroyed but also the bank's balance of money at the BoS was reduced by the same amount.
It is now very clear that the bank is reliant on Mr Smith to pay back his loan. If Mr Smith defaults, and the bank were wound up in an orderly way, the owners who originally put in 100,000 shillings would only get 90,000 shillings back.
The fact that writing off a loan is done through a book keeping does not alter in the slightest the fact that the bank owners now have less wealth than the had before. Book keeping records promises made. Writing off the loan records that the bank has accepted that it has lost money - acknowledged by the reduction of shareholder equity (money owed to bank owners).
"I don't really know where to start trying to criticize it because it is fundamentally misconceived."
How about giving a worked example, showing balance sheets? You can try to demonstrate how the bank's owners have as much money as they had before, even though they have written off a loan. Or you can tell me specifically where you believe I have made a mistake in the sequence of balance sheets which I included in the posts describing bank loans and losses.
I concede the point.
ReplyDeleteHowever, in no way does that lessen my objection to fractional reserve banking, which I hold (in common with many others much more eminent than me) to be fundamentally unethical and in its effects wholly destructive,
Had a judge in 1848 not misdirected himself, money deposited in a bank would have remained the property of the depositor, in exactly the same way as does the contents of a safe-deposit box in the bank's vault, instead of becoming a debt owed by the bank. It would then never have been entered on the bank's balance-sheet at all (as an asset) with a corresponding liability (to repay it on demand).
robert.horwood said...
ReplyDelete"I concede the point."
Spoken like a gentleman, sir.
"However, in no way does that lessen my objection to fractional reserve banking, which I hold (in common with many others much more eminent than me) to be fundamentally unethical and in its effects wholly destructive,"
That's certainly your prerogative. I personally don't see the lack of ethics, or the destruction caused *as a direct result of a FRB system*, as long as bank customers know what they are getting themselves into when they borrow. I'm happy to concede that debt-based fiat currency with a debt-based bank credit system on top of it is quite an abstract system, and it is not at all obvious when you start to look at it in depth that it is above board. On reflection, I'd also have to admit that as the fraction of reserve required decreases, the amount of vigilance required by regulators increases - fraudulent lending combined with FRB can lead to a bank becoming balance sheet insolvent fairly quickly (over just a few years, it appears).
The other problem with FRB seems to me to be that it gives banks a competitive advantage over credit unions and traditional building societies, in that the fractional reserve requirement allows them to "gear up" higher than their competitors. On the other hand, it does expose them to bigger losses as well as bigger gains.
"Had a judge in 1848 not misdirected himself, money deposited in a bank would have remained the property of the depositor, in exactly the same way as does the contents of a safe-deposit box in the bank's vault, instead of becoming a debt owed by the bank."
Wouldn't it then be something other than a bank? Just a secure storage facility? It couldn't lend anything, because it wouldn't own anything to lend apart from fees charged for the service of providing secure storage.
One major benefit of our banking system (in common with the stock and bond markets) is that it provides an efficient mechanism by which capital can be lent from someone who is not using it to someone who doesn't have capital but does have an idea for putting it to good use to create more wealth than it consumes. Furthermore, everyone benefits - the lender gets a return, the borrower gets to implement their great business idea to make a profit, the bank takes a cut, and more wealth is created for society's benefit. It doesn't have to be a bank with gearing of 10:1 or 33:1 (as per insane EU "stress tests") - a credit union or traditional building society with 1:1 gearing (i.e. it can lend as much as it takes in deposits) relies on the ability to exchange money for a promise to repay, and it is performing a much more useful function for society than a secure storage facility. I can't see how the judge could have come to any other decision.
"Wouldn't it then be something other than a bank? Just a secure storage facility? It couldn't lend anything, because it wouldn't own anything to lend apart from fees charged for the service of providing secure storage".
ReplyDeleteExactly so. It is not and cannot be a source of loan capital or a vehicle for investment.
Separately, however investment banks - an umbrella term - can exist whose business it is to do just that. They attract investment funds which are seeking a return (the return offered reflecting the relative degree of riskiness of the investment involved, and other factors such as the time for which the funds are tied-up).
So long as the deposit-banking activity can be impregnably ring-fenced there would be no reason why the same banking company should not carry-out both sorts of activity. Attracting depositors could then even become a loss-leader for the opportunity to sell investment products. All associated risks of such business would be borne by the investors and shareholders and they would never be bailed-out. But if they went bust the depositors' money would still be there - 100% of it.
"I can't see how the judge could have come to any other decision".
ReplyDeleteAnd there we differ.