Wednesday, June 26, 2013

Warren Mosler — Chinese liquidity drill

Warren explains what's happening in Chinese banking.

The Center of the Universe
Chinese liquidity drill
Warren Mosler


JKH said...


This was sort of interesting in that he's describing the current Chinese context for the dual nature of the loan/deposit relationship that I described here:

i.e. that being that loans create deposits, but that banks also compete for deposits after they're created - that's basically what he's saying

its a generic relationship in banking which happens to be working currently in the Chinese context, and helps explain what's going on there

Tom Hickey said...

Thanks, JKH. Your post and the discussion that ensued clarified a lot of the accounting terminology or me especially "funding."

It's straight forward once one gets it, but a lot doen't, so there's a lot of confusion out there.

Anonymous said...

Regarding the question of whether deposits "fund" loans, it's worth reading this article by Scott Fullwiler:

Scott says no, they don't.

Tom Hickey said...

I don't see that in the paper, y.

When a bank creates a loan-depost, it debits its loans account on the asset side (LHS) and credits a deposit account on the liability side (RHS). The deposit is said to "fund" loan. As the customer draws down the deposit, the bank has to seek other funding to maintain the balance of LHS and RHS. Banks do this, either increase liabilities, e.g., taking a deposit from another bank or borrowing from the money market. Banks could also fund the loan by increasing equity.

"Fund" in this sense means balancing the two side of the balance sheet and implies nothing about "loanable funds," which Scott does address in the paper. JKH clarified this use of terminology for me, which I had previously found confusing.

As long as the loan is on the LHS it has to be "funded" on the RHS. That is the work of Asset and Liability Management (ALM). Here we are looking at one transaction, but ALM maintains the balance in aggregate so as to keep the bank at the level of leverage that top management decides to run.

Anonymous said...

"The deposit is said to "fund" loan"

The fact that it is said to doesn't mean that it does.

A bank creates a deposit when it makes a loan. The deposit does not fund the loan.

"As the customer draws down the deposit, the bank has to seek other funding"

The withdrawal (or payment) is distinct from the loan. The bank needs funds to settle withdrawals or payments to other banks. Deposits might be a way to acquire those funds. However, those deposits do not fund the loan itself.

JKH is just trying to bring back mainstream descriptions for some reason. So according to him now, deposits find loans and the government needs borrow our savings. A completely pointless intellectual regression.

Anonymous said...

Don't forget that JKH claims the government has to get funds from taxation and borrowing.

Anyone who claims that either genuinely doesn't understand, or else they have some sort of agenda.

Tom Hickey said...

And don't forget that Warren ways that "deposits create reserves."

That leads some to think that banks create reserves by issuing loans, which is not what it means.

The problem is that the terminology that is used technically is easily misunderstood, since it has other uses in ordinary language.

Tom Hickey said...

Beside the point. The issue is the meaning of "funding" in sources and uses.

If you work in ALM at a bank your job involves "funding" which in turn involves maturity transformation in the sense that banks lend long and borrow short, so there is interest rate risk that has to be considered in funding decisions. You don't want to depend on too much overnight borrowing, for example, since that increases risk. And your don't want to pay any more than necessary iaw bank policy, since that decreases profit.

Anonymous said...

you need to distinguish between withdrawals or payments to other banks/the government, and the loan itself.

In his piece on this subject JKH starts off by doing this but then conflates them for some reason to reach the erroneous conclusion that deposits fund loans.

A lot of what JKH does is just word games. Like S=I+(S-I) for example. It doesn't say anything that the sectoral balances equation doesn't already say. It's the same, just written in a simplified form. But JKH and chums claim it "proves" that private investment is "the backbone of savings" because the (S-I) bit is in brackets. It does no such thing. Putting something in brackets doesn't achieve anything. It's just a meaningless presentational gimmick.

Tom Hickey said...

That's true. It's an algebraic attempt to say that non-govt saving nets to zero and net saving in aggregate comes from (G-T).

Recall this arose of the debate about S=I in the blogosphere going back some time. Saving is identical with investment is as an identity in a closed system owing to accounting rules. When the system is open to govt as an exogenous factor, then S-I needs to be articulated to include it. The external sector also.

S = I + (S - I) seems to be only to be useful when the derivation is shown, but JKH does that. I think he believes that they is clearer than the MMT explanation in terms of NFA, which hadn't made much of dent in the debate on the blogs.

I think that this issue of far from clear at this point in the minds of the people that both MMT and MR are addressing.

As far as system funding goes, the private sector as a closed system funds itself, loans and deposits netting to zero systemwide. As open system, the private sector funds itself and govt also funds itself (with deficits offset with tsys issuance), and when govt runs a balanced budget. When govt runs a surplus, it is funded by the private sector drawing down previously accumulated $NFA, and ultimately through private borrowing, both of which are fiscal drags, respectively increasing.

The problem is that most of this requires thinking in accounting terms and the DBE model, which most people, even many economists, don't or can't do. So they get confused, mixing up stocks and flows, and misinterpreting technical terms, for example.

I have yet to see JKH and Scott Fullwiler disagree on the accounting, for example. But MMT economists and some circuits draw different implications from it.

Anonymous said...

S=I+(S-I) is simply a weak attempt to "prove" that private investment is more "important" than government deficits by simply rearranging the sectoral balances equation and then writing some clever-sounding but empty rhetoric about it.

Anonymous said...

Here's Cullen Roche, in his idiotic 'primer':

"Private sector saving can be decomposed into the amount of saving created by investment “I” and the amount of net financial assets transferred from other sectors (S – I). That is the focus of the equation S = I + (S – I) as it highlights the fact that the private sector is the primary driver of economic prosperity while government is a powerful facilitator".

S=I+(S-I) does no such thing.

This is a perfect example of the sort of sophistry that some of MR embodies.

If JKH and chums occasionally corrected or contradicted the confused nonsense written by Cullen then I might give them the benefit of the doubt. But they never do.

Tom Hickey said...

it highlights the fact that the private sector is the primary driver of economic prosperity while government is a powerful facilitator

MMT economists agree with that statement.

Modern developed economies are capitalist and therefore investment-driven. A great deal of that investment is provided by bank lending. The purpose of banking in a capitalist economy is risk management (not risk-taking). Government delegates the power of creating credit-based money and risk management to banks, as well as depositor guarantees, with the cb as the lender of last resort. This is government facilitating modern banking.

Some argue that this is government controlling banking due to the requirements that governments may impose for the franchise, but that is to ensure stability of the system and to prevent gaming. Clearly, govts have not done an adequate job in this regard rather than exerting control.

The economic question is over a supply side or a demand side economics. Conventional economics is supply side, and economic theories based on old Keynesianism are demand side, but non one argues over whether investment is the primary driver.

The role of government in old Keynesian and contemporary theories reflecting it is not primary but secondary, acting as a complement to private activity. In MMT this involves offsetting demand leakage as needed and using fiscal policy to stabilize employment and prices simultaneously.

Opponents mispresent this as "big government' running everything, i.e., central planning. Where the central planning actually occurs is at the level of the central bank with monetary policy determined by a small group of technocrates that are "politically independent," i.e., unelected and unaccountable to the people.

The position that the private sector is the primary driver of economic prosperity while government is a powerful facilitator is compatible with demand side and old Keynesianism. Keynes's objective was to save capitalism from itself since the neoclassical viewpoint was politically unsustainable.

It was not the objective of Keynes, nor is it of MMT, for govt to replace the financial sector. The purpose of govt wrt to the economy and finance is to facilitate and complement.

Anonymous said...

Tom, the point is that S=I+(S-I) proves, highlights or demonstrates nothing that isn't already demonstrated by the sectoral balances equation used by MMT.

Tom Hickey said...

Since the expression "S = I + (S - I)" is derived from the sectoral balance identity that follows from double entry accounting, "S = I + (S - I)" is an articulation of the sectoral balance identity.

It is the MR explanation of consolidated non-government net financial assets in MMT-speak. Some people apparently have found that confusing and S = I + (S - I) is an attempt to clarify the issue.