The crunch issue for all banks, wherever they are, is that they do have, from time to time, to back up the money they have created supposedly “out of thin air” with real government money. The mistake which I think many are making is to assume that bank created money, created when loans are issued, stays in the economy until that loan is repaid. It doesn’t....Modern Monetary Theory: Real Economics
A more usual scenario would be that a bank would lend money to a business, say a builder, who would hire bricklayers, joiners, buy raw materials etc for his building project. Every transaction would attract the usual government taxes. Income tax. VAT, NI contributions, Corporation tax etc. As the newly created money is spent and respent it rapidly dwindles until there is nothing left. It has nearly all gone to the government’s taxman who doesn’t want the money as it was originally created. He insists that banks convert their IOUs to government IOUs....
“Positive Money” : A Fallacy built on a Little known Truth.
Peter Martin
12 comments:
I agree.
the loan proceeds are used to pay taxes as the govt does not spend more than it taxes in the current period and requires a non-govt entity to save an equivalent amount of previously issued USD balances for a period of time before the govt will spend more than it taxes....
Analyzed in time domain, this means that much of the balances that banks create via loans ends up going to pay current period taxes...
so banks operate a business where they risk their investors capital on the hope that either the net liability cohort in the non-govt will dis-save in the future or govt will raise the collateral value of future items financed in such a way as the net liability cohort in the non-govt has the balances available to repay the P&I on the loans they make....
They are morons to be in this business and they never make "money" over the long term and require periodic bailouts because of this...
A couple of mistakes in Peter Martin's article.
First re the idea that government gradually withdraws newly created commercial bank money, government does not accept that sort of money in payment of taxes: it only accepts central bank or base money.
Second, even if government did accept commercial bank money, governments only collect money in order to spend it (assuming government is not deliberately running a surplus or deficit) so there’s no net withdrawal.
I find it irritating when people make mathematical arguments without showing the math. OC, this is only part 1, but it gives what appears to be a misleading impression. Yes, banks create money by lending. Yes, governments destroy money by taxing. But that is only half, or less than half, of the picture. Because governments also create money by spending and banks destroy money when loans are repaid. Plus, there is interest.
If bank loans were not paid off, more or less, with interest, then the system would collapse and we would be in worse shape than we are. But the system works, more or less, and there is a general flow of money from creation by bank loans to repayment of those loans. The story Martin tells obscures that fact. Still, it might be worth telling if the flow of money through an economy had four different phases: 1) banks create money; 2) the government destroys money; 3) the government creates money; 4) banks destroy money. But in fact, all four of these things are happening all the time. It does not really matter whether the money in my checking account was created by a bank or by the government.
We could apportion part of that money to the banks and part to the government, in which case we would say that most of it was created by banks. That means that Martin is wrong when he claims, "As the newly created money is spent and respent it rapidly dwindles until there is nothing left. It has nearly all gone to the government’s taxman". If the bank money disappeared so quickly, then most of the money in circulation at any time would not be bank money. But it is. (Am I wrong? If so, Mr. Martin, please do the math and show us that your claim about the disappearing bank money is true.)
It makes just as much sense to conceptually separate the two flows of money created by banks and money created by the government as it does to say that the government destroys the money created by the banks and then the banks destroy the money created by the government. In fact, it makes more sense to conceive of the two flows as distinct.
That does not mean, however, that they are independent. For instance, if the banks are destroying too much money, then the government should create more money to keep money from draining out of the economy. We can reach that conclusion without creating a confusing and misleading picture of the flow of money.
Bill,
All IOUs will be valuable to you -except your own. If you are offered one of mine you can choose to accept it or demand someone else's. If you get one of your own back you tear it up as security precaution. You actually want your own created money destroyed as it removes that liability from you.
Therefore it is not correct to say "government destroys the money created by the banks and then the banks destroy the money created by the government"
It is that Banks destroy their own created money. Government destroys money created by government.
But Bank X wouldn't destroy money created by Bank Y. They would probably refuse to hold it permanently though. Through the contra system banks swap IOUs with each other so they can get back their own, and destroy them. If there is any imbalance the difference is made up from their own reserve funds using government money.
So why so little government money in circulation? First of the use of cash is declining. For some strange reason people seem to think that the process of paying a £20 grocery bill electronically which takes longer than handing over cash ( I've timed it) is some kind of progress!
The banks only keep a bare minimum
of government money in normal times. The rest they convert to treasury securities which aren't counted in the 3%, or whatever it is, of supposed government money in circulation. The 97% would include all the money that everyone has saved in term and other interest bearing deposits. So PM aren't really comparing like with like.
Mr. Martin,
Thank you for your response. :)
But now I am confused. You say that banks destroy their own money. I have trouble squaring that with your statement: "As the newly created money is spent and respent it rapidly dwindles until there is nothing left." But if the banks destroy their own money, then taxation has not destroyed it (pace Mosler, et al.). It must, then, persist.
Bill,
I think everything still follows logically.
Think of the bank giving me a bank cheque for £1000, payable to anyone , when I borrow money from them. In turn I owe the bank £1000 so I'm all square when I hold it.
That Banck-cheque is,of course, the money created by the private bank.
So I use that bank-cheque to pay my taxes. The taxman takes it and presents it to my bank who are duty bound to honour their IOU and so swap the bank-cheque for £1000 of real government money. Crisp new BoE notes.
That bank get back their bank-cheque and tear it up, so destroying the money they had created when they issued it.
That is the process, and it is the same whether the transaction is electronic or based on pieces of paper.
Now, if I had used that bankcheque to buy a car the chances are that the seller, unlike the taxman, would have been happy to hold the bankcheque or just pay it into his account. So the money created by the bank would have lived on as the Positive Money group say it does.
But it is also possible that the buyer could have done the same as the taxman and demanded the bank change it to government money. Or just pay it into his account and draw out government money from the ATM.
Whichever way you look at it, bank created money, created when banks issue loans, would only exist for the duration of the loan very rarely and perhaps for short 'payday' type loans.
Ralph,
"government does not accept that sort of money [bank issued money] in payment of taxes: it only accepts central bank or base money."
Yes. Agreed. Govt forces the bank to honour its obligation to pay from its reserves. Then it destroys the govt money received in taxation.
"governments only collect money in order to spend it"
Ralph , you really should know better than to say things like this on a MMT website!
Peter Martin: "So I use that bank-cheque to pay my taxes. The taxman takes it and presents it to my bank who are duty bound to honour their IOU and so swap the bank-cheque for £1000 of real government money. Crisp new BoE notes.
"That bank get back their bank-cheque and tear it up, so destroying the money they had created when they issued it."
That is one way of looking at it. However, in our debt/money system, they have not destroyed the IOU in any meaningful sense, because you still owe the bank.
Let me clarify a bit. As long as the bank loan is not paid off, in the normal course of affairs the bank destroys money as the debt is paid off. Simply honoring their check is not sufficient. Otherwise, the money they created would typically be destroyed quickly, leaving only the debt behind. The system would quickly break down.
Yes of course I still owe the bank. That's the whole point! The bank issued money has been torn up and no longer exists and the the private domestic sector are left in debt.
That's why credit booms are very dangerous and the PM group are correct to identify the boom bust cycle as being cause by excessive bank lending.
By where they get it wrong is failing to appreciate that the govt then drains the created money out of circulation and makes itself look good in the process as they boast about their created surpluses!
Govt should hand their heads in shame when they run a surplus- unless they are running an economy like Germany's with a large influx of export money.
If the PM group accepted the concept of sectoral balances they'd understand all this. I'm intending to write this up as Part2.
Peter Martin: "Yes of course I still owe the bank. That's the whole point! The bank issued money has been torn up and no longer exists and the the private domestic sector are left in debt."
OK, it seems that I have gotten your point. :)
But as I said in my first post, you need to back it up with the math. Because what you have described so far is the normal operation of a debt/money system. If the normal operation of that system rapidly drains the money and leaves the debt, then won't the system quickly fail? Certainly we have observed periodic crises, but that is not the same as rapid collapse. You are making a strong claim that undermines the very basis for debt/money systems.
Strong claims need strong evidence. Where is the evidence that money regularly and rapidly drains from the system, leaving debt? You need more than just saying that banks cash checks. There must be a plethora of facts and figures to back up that claim. Where are they?
Second, if a debt/money system intrinsically become a debt system, why does it last? How does it even work? That question may be a tall order for a simple blog, but such systems have been around for a long, long time. They have had periodic crises, but they come through. There are recessions and depressions, but if what you say is so there should be one long recession. You really need to show how such a debt system works.
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