Since bank money (what MR would call "inside money") is the primary form of money in our fiat monetary system it's perfectly normal for loans to increase as economic activity increases.That thought again, at the end of the post:
The bottom line to me is, you can't even begin to understand the current economic machine without understanding this basic fact - we live in a fiat monetary system in which bank issued "inside money" is the primary form of money. Access to credit can exacerbate the boom as we just saw during the recent period of lax lending and unusual optimism. And the more credit the more potential for a boom (and a bust).The posts are from 2012, Sumner's and Roche's and mawillits's. If the focus on credit booms and lax lending standards seems a little odd, it's because the posts are old. And yet, if you can't even begin to understand the current economic machine without understanding that bank issued "inside money" is the primary form of money, then it is necessary to to say so at every opportunity.
How does this apply to our world? Jim points out that if a saver "had a lick of sense he would figure out that he has no savings at all. All he has is IOUs from destitute people who can never pay and the process is making them even more destitute."
Most of the money in our economy was created by people borrowing and spending it. If somebody saves that money, the saver earns interest on money that the borrower is still paying interest on. And the money the borrower put into circulation is no longer in circulation. So the situation has not improved.
If the borrower needed to borrow before, he's going to need to borrow again. That means debt is going to increase. And savers are going to save more of it, again. And borrowers will be putting money into circulation that doesn't stay in circulation. The borrowers bear the cost of keeping that money in circulation, without getting the benefit. It's insanity. You can't run an economy that way.
We tried.
4 comments:
Here's what I'm thinking. Borrowing money (and spending it) increases the quantity of circulating money. This is true when the government does it. And it is equally true when ordinary people do it.
Everybody needs a little extra money once in a while, and borrowing fills the need.
We don't usually think of it this way, but borrowing (and spending) increases the funds that are readily accessible for spending. But this is exactly what Cullen Roche was saying: bank money is the primary form of money in our monetary system.
Borrowing money also makes debt increase. But things remain in proportion: The amount of newly created money and the amount of newly created debt are equal. That can be a sustainable situation.
But suppose the money starts leaking away: a trade imbalance takes money out of our economy... or the Federal Reserve, worried about inflation, reduces the growth of the money supply... or people just naturally save something out of income. Now there is less money that is "readily accessible for spending". There is less money that can be used to generate income.
The debt comes to grow all out of proportion to the money. And having less money available makes it more difficult to repay the debt. That's not the best situation to be in.
The better situation might be to repay our debts at a faster rate. This might not fix trade imbalances. And it might not stop people from saving. But at least it would stop the Fed from having to reduce the growth of the money supply. Because repaying debt at a faster rate is also a way to reduce the growth of the money supply and fight inflation. A more natural way, in my view.
Repaying debt at a faster rate also reduces debt, and can reduce debt enough to keep debt in proportion to the money supply. Or maybe, in our situation, to reduce debt relative to the money supply.
And yet, if you can't even begin to understand the current economic machine without understanding that bank issued "inside money" is the primary form of money,
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Is that always a correct statement?
The reckless lending that occurred before 2008 was not financed by banks creating deposits. it
was funded by savers through private mortgage funding channels. That lending did not create new deposits.
The effect of all the extra borrowing was pretty much the same as if it was creating new deposits (i.e. more spending) but then it all came to a crashing halt and all the extra spending that the non-bank lending created also came to a sudden stop. So the bubble and burst of the bubble was all about money that was not "bank issued"
One shouldn't confuse all debt with bank
debt. The fact is before 2008 bank liabilities were becoming a smaller and smaller in relation to total debt
https://fred.stlouisfed.org/graph/fredgraph.png?g=okDh
Hey Jim. I think you are using a technical definition for "bank" and I'm just wingin it.
Would you still object if we replace all occurrences of the word "bank" with "depository institution"? This would probably still leave out funding "by savers through private mortgage funding channels." But I don't know.
You point out that much of the lending "before 2008 was not financed by banks" but that "The effect of all the extra borrowing was pretty much the same". So I'm not sure why you make the distinction. I guess, because you would see how banks and non-banks behaved differently, and regulate the non-banks accordingly.
I'm thinkin it is still all "inside money" even if it comes from non-banks. Yes?
I was talking about about the same thing Cullen Roche was talking about. The lending where loans create deposits which of course can only be loans made by depository institutions.
The fundamental difference that is little talked about is loans that had govt backing (and thus were regulated) and loans that had no govt backing (and thus had zero imposed standards)
Prior to 2008 the market participants were convinced that funding thru private channels was
as good as funding thru govt backed channels.
The process is very much the same as far as money
creation goes. The problem is that without govt backing money created out of thin air can quickly disappear back into thin air.
http://si.wsj.net/public/resources/images/BN-DW279_RMBS_E_20140728130506.jpg
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