Friday, April 13, 2012

Neil Wilson — The fixed exchange rate system at the heart of MMT


Systems thinker Neil Wilson gives a very clear exposition of how the exogenous (vertical) and endogenous (horizontal) system interact, with the central bank and its currency powers at the apex of the hierarchy that includes the Treasury and banks as public-private partnerships. This system is at the core of modern economies, all of which use state money as central bank created currency in addition to credit money created by bank loans that presupposes use of currency for final settlement.

Read it at 3spoken
The fixed exchange rate system at the heart of MMT
by Neil Wilson

32 comments:

Anonymous said...

Bank credit money is also created when banks make asset purchases or payments on their own account, not only when they make loans.

Matt Franko said...

Anon,

Look at all the branches as your evidence there imo...

Resp,

Anonymous said...

Matt,

What do you mean?

Matt Franko said...

imo they must be able to buy the property and construction of their branches by crediting bank accounts of the landowners and contractors....

in this way they unfairly compete with small businesses for commercial locations, ie McDonalds, Gas Stations, etc...

Resp,

Anonymous said...

Whenever they spend or lend they do so with their own privately created credit. They only use reserves to settle with each otheror with the central bank and treasury (or when they borrow/lend reserves from/to each other,)or cash when people withdraw it. Everything else is done with the 'inside money' they create themselves. Genius.

Anonymous said...

But the money they create to buy stuff for themselves is just as much a liability as money they create in the process of making a loan. They create an account for the seller of the goods and credit that account. If the seller of the goods then writes a check on that account to someone whose account is at another bank, the first bank will have to make a payment to that other bank that is settled and cleared through the banks' reserve accounts at the central bank. And if the seller comes into the bank and decides to withdraw the total amount in the account, the bank will have to hand him a bunch of vault cash.

Anonymous said...

Agreed. Still pretty bloody clever way of taking over an entire society though, especially if you can succeed in reducing the use of cash and reserves to a miniscule amount.

Anonymous said...

Great post by Neil as usual. He's a smart guy.

Anonymous said...

cont.

That's not to say the government isn't still in control, but the banks have positioned themselves in such a way that they cream off a piece of everything that happens, and the bigger they get, the more they become the defacto issuers of 'money'. If a bank can grow to the such a size that most transactions happen between its own customers (account holders), then it effectively becomes a currency issuer.

Rogue Economist said...

When a bank buys a branch property, it has to be funded by a corresponding liability - its own equity, a loan from somewhere else, or via deposits - and we know banks can't buy stuff using customer's deposits. That would be misappropriation of customer's funds.

But I can see how Matt or you or I can be confused when someone says "Bank credit money is also created when banks make asset purchases or payments on their own account, not only when they make loans." Where did commenter 1 get this? It cant' be MMT.

Ryan Harris said...

Appears to be lingering confusion between capital and reserves

paul meli said...

@Anon

Any transaction that includes profits in a capitalist system is a skimming operation, or as Tom says an extraction process.

That's why I say supply-side is like a perpetual-motion machine - it can't exist because it relies on the extraction of the very thing that an economy needs to run, and hoards it.

Investment always removes more from the economy (profits) than it injects by definition (In the aggregate).

Supply-side must wind down unless it's able to be parasitic upon the work of others.

It follows that causation is the demand-side.

Anonymous said...

"When a bank buys a branch property, it has to be funded by a corresponding liability - its own equity, a loan from somewhere else, or via deposits - and we know banks can't buy stuff using customer's deposits. That would be misappropriation of customer's funds."

The money a bank uses to make purchases or payments (to accounts that are held in the bank) doesn't have to come from anywhere - it is created as an accounting entry by the bank, quite simply. The bank just credits an account. The deposit created is the bank's liability and the account holder's asset.

The bank does have to maintain a ratio of capital to its total assets, as well as required reserves, but that's it. As Dan says, if the deposit created by the bank is transferred to another bank then it will eventually have to settle with reserves.

When a bank 'makes a loan' it is basically buying an asset.

Tom Hickey said...

Rogue "But I can see how Matt or you or I can be confused when someone says "Bank credit money is also created when banks make asset purchases or payments on their own account, not only when they make loans." Where did commenter 1 get this? It cant' be MMT."

MMT economists are well aware of this. However, the bulk of horizontal money creation comes from credit extension, so it is really a footnote.

Anonymous said...

Do you mean the bulk of horizontal money creation comes from credit extension in the forms of loans? I was saying credit is extended to make payments and purchase assets (extending a loan is purchasing an asset).

Tom Hickey said...

Yes. Banks can and do create bank money for other purposes, but the bulk of bank money creation comes fromm making loans. MMT economists are aware that banks can and do create bank money for other purposes, but that just gets an asterisk.

Clonal said...
This comment has been removed by the author.
Rogue Economist said...

Anonymous, if it were true that banks can just credit the money to buy anything, why haven't they bought everything yet?

When a bank buys a loan, it expects a positive income from the spread between the loan and the cost of the liability that results from it. When a bank buys property for a branch, or a computer printer, there are no income assumptions, they're an expense outlay for the bank.

While it is true that purchases or payments are created as an accounting entry by the bank, if they result in net equity outflow, that outflow cannot be compensated by the bank by printing reserves into existence.

Loans and branch locations are two different animals.

Ryan Harris said...

From Section 3.5 FDIC Premises and Equipment Regulations

"...provides for capitalization of interest costs where construction was financed from general funding sources which, in the case of a bank, is largely its deposit liabilities."

"The interest rate utilized on internally financed projects projects must not exceed the weighted average rate for all of the bank's interest-bearing deposits and liabilities. "


Interesting.

Clonal said...
This comment has been removed by the author.
Tom Hickey said...

Rogue, "Anonymous, if it were true that banks can just credit the money to buy anything, why haven't they bought everything yet?"

When a bank creates bank money to purchase assets other than loans or fund expenses, it is in effect borrowing at the price of reserves, since it is creating deposits that have to clear (after netting). Even if a bak uses its own excess reserves, that's interest it is losing on lending in the interbank market. Banks can create money but not "for nothing." But it is true that banks borrow at a much lower rate than non-banks in the sense that they don't have the spread to deal with.

Matt Franko said...

Rogue,

"why haven't they bought everything yet?"

They only do property (and some cars)... your question should be: why havent they bought all property yet?

believe me they would like to!

They basically have an interest in all property that is financed. all the other property that they do not have their hooks in is not for sale...

Resp,

Clonal said...

I corrected my posts above.

Anonymous is right in one way. When a bank makes a loan say a 30 year mortgage at 8% api, the banks books all of the interest as income IMMEDIATELY on a cash discount basis. See Banking Revenue Recognition<

For a bank, the discount rate is the Fed rate. 8% api interest for 30 years and a 1/2% discount rate gives you net 7 1/2 % rate for 30 years. So for a $100,000 loan, I just booked myself a $152,000 revenue, and that goes straight to my capital account! An interest only loan at the same value and duration would yield an immediate revenue of $252,000

Now you know why the liar loans were made, and how the fraud arises?

Quote:

An entity must recognize a servicing asset or servicing liability, in certain situations, every time it undertakes an obligation to service a financial asset by entering into a servicing contract.

All separately recognized servicing assets and servicing liabilities must be initially measured at fair value, if practicable.

The new standard of fair value at initial acquisition involves measurement based on discounted or future cash flows.

For each class of separately recognized servicing assets and servicing liabilities, an entity may select either the amortization method or the fair value measurement method

Rogue Economist said...

Matt: "They only do property (and some cars)... your question should be: why havent they bought all property yet? believe me they would like to!"

Well, you could be talking about your banks over there in the US. But in the rest of the world, banks are not in the business of owning property. They are in the business of extending loans, and they want to get paid back the loans and earn the interest rather than owning the property. In the rest of the world, capital tied up in property is capital they cannot use to churn new loans and any properties they end up with because of soured loans are immediately disposed of.

Again, you could be right in the US setting though. Who knows anymore.

Anonymous said...

Any deposit money created by the bank is it's liability. It has to hold a ratio of capital and or reserves against it. That's why banks don't go around hoovering up everything in sight.

Rogue Economist said...

Anonymous, that why it's inaccurate to say that "Bank credit money is also created when banks make asset purchases or payments on their own account, not only when they make loans."

You have to distinguish whether that payment is for an expense or for a loan. Anything that is considered an expense outlay is not new money created by the bank. And any net cost that results from that purchase is not funded with new money, as is the case with capital that has to be raised to maintain the ratio. That's why, as Tom said, the bulk of horizontal money creation comes from credit extension, not asset purchases or payments on their own account.

Anonymous said...

When a bank purchases something or pays someone they credit an account, as they do when they make a loan. The credit is typed into existence through a computer keyboard.

This adds to the bank's overall liabilities. Banks have to maintain a *ratio* of capital and or reserves. That ratio has to "come from somewhere" in the case of said purchases/payments, but it's only a fraction of the overall credit/deposit money credited by the bank.

If the created deposit is then transferred to another bank then of course settlement takes place with reserves, as always.

Could you explain in more detail what you mean as I don't fully get your point.

Rogue Economist said...

Anonymous, not all liabilities created by the bank are new money. Not all payments it makes, though they're paid as credits to accounts, are new money. Often that credit results in a debit, and the debit is from their equity.

For example, if they buy their office supplies, pay their workers, or settle their utility bills, it does not add new money to the economy. It uses its earnings (part of its equity) which is money received from elsewhere, it is not money created at the point of credit.

A bank that has no earnings or no equity cannot continue spending just because it can create money out of thin air by crediting an account.

Clonal said...

Rogue,

See the revenue recognition post above. I believe the fact that revenue is recognized immediately on making the loan is where all the problems are coming from. More money than the amount of the loan is created at the time of the inception of the loan. The excess money is then capitalized after accounting for things like provisions for loan losses etc.

This is what allowed for the banking control fraud described so well by Bill Black -- problematic accounting rules.

Rogue Economist said...

Clonal, as I acknowledge previously, I could be thinking of an outmoded banking model, and things may actually be different there in the US. As far as I know, if a bank keeps the loan in its books, revenue is recognized as and when it receives interest income, not when the loan is made. Of course, if a bank securitizes everything or most of the loans it makes, revenue will be recognized when the loan is sold, even if it's at the point the loan is made.

Clonal said...

Rogue,

You are correct in your view.

Securitization is what made one of the frauds possible. You sell the loan to "investors", but collect servicing fees. Now you are profitable on two fronts!

Also "recognition of phantom revenues" in option ARM's also led to a similar problems

Quote:
Phantom Revenues

Some commercial banks have created a mortgage for homeowners and investors that has raised concerns in the banking industry and the investment community. It is the option adjustable rate mortgage or “ARM.” In an option ARM, the mortgagor has four monthly payment options; for example:

minimum payment, which doesn’t cover interest changes (resulting in the principal growing each period and creating negative amortization);

interest only, with no interest added to the principal balance;

regular (interest plus principal) payments on a fully amortizable 30-year loan; and

regular (interest plus principal) payments on a fully amortizable 15-year loan.

Because the option ARM is attractive to cash-strapped home buyers and investment-return buyers, most mortgagors chose the minimum payment option. Under that option, the interest rate (which is growing each month) adjusts the loan balance. At some point, the loan principal is reset and a new amortizable balance is set over the 30-year term, resulting in a revised mandatory repayment amount that can readily be three or four times the original monthly payment.

Of concern to bank regulators and those investing in commercial bank stocks is the treatment of such loans by the mortgagees. Under existing GAAP, the mortgagee may book revenue on the option ARM at the fully amortized amount, despite the fact that the mortgagor is only paying the minimum amount (the negative amortization case). This booking of “phantom” future revenues is the disturbing result of option ARMs.

Anonymous said...

Rogue Economist:

Yeah I think you're right about that. However it would seem that money is created by banks when they buy other types of financial assets (other than loans) rather than real assets like buildings.