Last month I spoke at a seminar on the financial crisis organised by The Whitlam Institute, in reply to a speech by Professor John Quiggin. Guy Debelle, the Assistant Governor (for Financial Markets) of the Reserve Bank of Australia, was the other discussant.
The Institute has put together a very professional video of the discussion, which has been picked up by SlowTV, a free internet TV channel run by The Monthly, an Australian magazine of comment and analysis which, amongst many other things, published Australian Prime Minister Kevin Rudd’s lengthy essay on the Global Financial Crisis in which he explicitly critiqued neoliberalism.
The video comes in 4 parts, which are respectively
- John Quiggin’s speech in two parts (One and Two)
- My reply and alternative analysis of the Global Financial Crisis (embedded at the bottom of this post)
- Guy Debelle’s reply
The Question and Answer session with the audience isn’t available at SlowTV, but it is on YouTube in three parts:
The Powerpoint presentation that I gave is available here.
My presentation includes simulations of two dynamic models that are the core of my analysis of the financial crisis:
- The Minsky Model simulates a cyclical economy with debt in the form of both productive borrowing–where the money borrowed finances increases in productive capacity–and “Ponzi” borrowing–which gambles on asset prices (which are not explicitly modelled here as yet) and therefore adds to debt without increasing productive capacity;
- The Circuit Model models the endogenous creation of credit in a pure credit economy, and also simulates a crisis caused by a sudden shift in the willingness to lend and to take on debt–a “credit crunch”. I also model an “exogenous” government rescue one year into the crisis in one of two ways:
- By injecting a $100 billion sum into banks unlent reserves over a one year period; and
- By injecting the same sum into the bank accounts of the debtors (firms in this model) over the same period
The simulations are run in the visual simulation program Vissim; I have embedded a link to download the free Vissim Viewer into the presentation; that embedded link may no longer work, but the one given here should do so after a registration process (I use Vissim mainly to showcase the models; I develop them in the mathematical program Mathcad).
My main research objective for the next year is to combine these two models to develop an explicitly monetary model of financial instability. This will be the bedrock of the book Finance and Economic Breakdown that will be published by Edward Elgar Publishers.
Finally, my speech is embedded below (Reuters will soon start publishing a regular vidcast by me, and I’ll reproduce it on this site.)
August 18th, 2009 at 9:10 am
I don’t think that our democracy is in terminal decline if I read what’s going on in other countries. 5 minutes spent every day with Gazeta Wyborcza makes me feeling happy that I live in Australia. If I feel depressed I can always read about “progriess” of “diemokratia” in Russia. It is much better than Orlov.
In my opinion the bastardisation of public life in Poland (to some extent Central Europe in general) is a direct result of 20% unemployment (and previous historic experiences). This does not affect politicians only – think about your boss at work treating you as his serf (this system was only abolished in 1864).
If this doesn’t convince us we should put our current crisis of democracy in the historical context. WW1, the Soviet Revolution, Stalin, WW2, Nazi camps, genocide of Jews and Gypsies, communism in Eastern Europe.
Of course I share the grave concerns about the impact of humans on the environment and then the impact of environmental damages and diminishing resources on humans. But I believe that the evolution of the current (imperfect) system is the only way to address the issues and that we are not doomed.
I am not for printing money – this is not the solution. Deficits may be a tool to achieve certain social goals and direct investment in the areas normally neglected by the investors. If the tool is abused the only effect will be even more mess. We cannot cure debt with more debt – but for now this seems to be the easiest way out. This won’t work for very long I think.
When our society is “stirred not shaken” by the next phase of the crisis either right-wing morons will seize power or we may actually see our democratic system working better – people may lose certain illusions and request genuine reforms. I am still an optimist to some extent – the awakening may slowly arrive.
August 18th, 2009 at 10:09 am
Aak,
People I know say (certainly immigrants) that Australia is the best place in the world to live, one says it one the few systems worth fighting and dying for. I believe him. I have done very well in Australia, despite the faults I point out I have a great standard of living and many opportunities. What concerns me is that is not a sustainable system. I believe democracy is likely to survive because with our history and culture we will accept nothing less, however, I believe that democracy in the future, if we are to be sustainable, must be localised, people must be faced with the consequences of their actions/decisions (not just everyday people but also those that seek to exploit others for their own gain). Then people will act responsibly. What worries me is what is going to happen in the transition. We can nationally recognise the massive problems we are facing and start moving towards local, sustainable communities now with a national effort, in this case would could probably even maintain our federal system (possibly not our state system). I also believe there are significant benefits to localisation that make it worthwhile in itself. Alternatively, I believe we will continue down our current path until we can go no further, and then our democracy will be truly challenged, because the alternatives for an unprepared, oil-dependent (for food and transport) nation are either military rule or anarchy. Hopefully democracy would revive, but it is this transition that will threaten everything, not to menation all the suffering involved in either case. I am not just being cantankerous, I have a child and I am seriously afraid of this.
August 18th, 2009 at 11:35 am
Steve
some of the inflationists in the US argue that the dollars overseas will come flooding back, but as I understand it government borrowing like non-bank lending doesn’t create new money just new debt, therefore overseas there’s likely to be a lot of debt held but not nearly as much actual cash. Is there any way that this debt coming back could cause inflation as I wouldn’t have thought so?
Also with governments just creating new bonds to meet old serving requirements, this seems highly unsustainable, surely the only options if continuing down this path are default or printing. Why would people keep giving their money to the governemnt if its not being spent productively and they can’t expect a return on their money, in the case of government the spending has to increase growth so tax base rises. Surely its as simple as productive investment equals debt servicable and vice versa.
August 18th, 2009 at 11:48 am
Hi Steve,
Thanks for another very interesting and persuasive presentation. I’m a big fan of your innovative analysis which has certainly contributed enormously to my understanding of how credit-driven economies actually work.
I do have a few questions on the model however: firstly, what eventually happens to all the excess reserves that accumulate in banks during the deleveraging? I have read your cavaliers of credit piece, and can see how the cessation of growth in PSC contribues to a sharp reduction in aggegate demand. However, when people attempt to deleverage, the repayment of loans, if they are not relent out by banks (which in aggregate needs to happen if deleveraring is to occur), become excess reserves (although obviously some are needed merely to replenish equity against bad loans). I note in your modelling outcomes, unemployment rises, debt/GDP declines over time, and also back reserves increase materially.
I can see how when new credit growth occurs, new “money” and aggregate demand is created. but when the debt is paid back, that “money” does not disappear – it just gets pulled temporarily out of circulation but remains very much real on the balance sheet of banks. this would seem to imply a massive excess of capital and ultimately very low interest rates for a long time. I guess my question is, what are the implicaitons of this? Seems unrealistic to think banks are going to have equity/asset ratios of 20-30%??
Thanks in advance,
Rgds,
August 18th, 2009 at 12:41 pm
When a loan is repaid the balance is netted and the virtual (credit) money is destroyed. For example the bank removes mortgage from your house. This process led to the decrease in the amount of M2 during the Great Depression.
August 18th, 2009 at 3:01 pm
Not my analysis ak,
I argue that the money is taken out of circulation by being transferred from active deposits to unlent reserves; but it is not destroyed.
LT, I’m flat out now for lecture writing but I’ll answer your post tomorrow sometime.
August 18th, 2009 at 4:12 pm
Small business: “What recovery?”
http://www.news.com.au/business/story/0,27753,25946946-31037,00.html
August 18th, 2009 at 4:20 pm
Steve,
I thought that the original question referred to the principal of the loan.
“I can see how when new credit growth occurs, new “money” and aggregate demand is created. but when the debt is paid back, that “money” does not disappear – it just gets pulled temporarily out of circulation but remains very much real on the balance sheet of banks”
Obviously I didn’t refer to the interests accrued.
This is what I’ve found on the Wikipedia:
“When the loan is repaid, with interest, the credit money of the loan is destroyed, but reserves (equal to the interest) are created – the profit from the loan.”
http://en.wikipedia.org/wiki/Circuitist
If I am wrong could you please explain what I have misunderstood as this may have far reaching consequences.
August 18th, 2009 at 4:24 pm
http://economicedge.blogspot.com/2009/08/week-in-charts-buckle-heck-up.html
This article should interest those who think we have inflation to worry about. Good chart porn.
August 18th, 2009 at 9:10 pm
Hi MMitchell, I like your question about how wealth in the west is defined. Westerners have accepted the definition bankers want us to believe–”the number of electronic digits you have in your bank accounts.” Humans instinctively know that’s not wealth…no child I know feels more inner joy, delight, rest, beauty by having an account somewhere with digits in it which would really only show how much time they’ve spent trying to collect more purchasing power, or how much they’ve borrowed as they put themselves into debt. Westerners need to be taught this definition over the course of a career in public schools and public media so we can be good debt slaves and corporate wage slaves and national tax slaves and consumption addicts…all to fuel the system the banking oligarchy created. And now surveys indicate the more “wealthy” developed world is the least joyful population. Hmm…puts the lie to the definition of wealth.
Native tribes knew what real wealth was. They knew what sustainable life was…they didn’t create unsustainable banking models with debt-based money which required unsustainable corporate debt laundering machines. That’s why the anglo-banking empires had to exterminate them…they weren’t corruptible and capable of being taught to be debt slaves. Now isn’t it interesting that a few hundred years later we’re struggling to answer the questions you ask about wealth and sustainability, but they knew it all along? If only we had listened to them rather than killing them.
August 18th, 2009 at 9:21 pm
ak, I suggest we don’t live in democracies. We’re made to think so, but we’re in something far more akin to the Roman Empire. Empires need mass democracy (mob rule) to manipulate with fear/entertainment and maintain control. I don’t know how Australia was originally constructed, but the US was constructed as a republic specifically to prevent the danger of empire and mass democracy. Unfortunately the republic failed and we now live in the biggest empire in history. The empire is crumbling now, which means a renaissance may follow, but the transitional collapse to get there is going to be horrific. The equivalent of the Roman praetorian guard in the US has put in place a police state to protect itself from the masses. I think there’s a high probability we will be seeing in the US some of the stuff we saw in the periods you mention (WW1, WW2, Nazis, Communists, etc).
By the way, the “emperor” of today’s empire is the banking elite…they are transnational…they have conquered all developed territories via the US dollar. They are also some of the same interests that funded Hitler after the banks collapsed the German economy.
August 19th, 2009 at 2:44 am
ak,
Regarding what happens when bank loans are repayed, Steve discusses the topic in much more detail here:
http://www.debtdeflation.com/blogs/2007/03/30/dynamics-of-endogenous-money/
and in the linked paper:
http://www.debtdeflation.com/blogs/wp-content/uploads/2007/03/KeenKeynesCircuit.pdf
However, I’m also a bit unclear as to the meaning of his distinction here. Page 17 of the PDF in particular shows the effects of loan repayment — the bank’s assets (loan balance) and liabilities (deposit balance of the loan recipient) are both reduced by the amount of the repayment. This part seems to agree with the idea that repaying the loan reverses the original money creation and contracts the bank balance sheet.
I haven’t read the whole paper yet, but where Steve loses me so far is in the justification for how/why this process adds to the reserves of the bank. He shows those reserves in a seemingly separate table from the bank balance sheet itself. Are they off balance sheet? If they are on the bank’s balance sheet, what happens on the liabilities side to match the reserve assets? (i.e., so that loan repayment doesn’t shrink the liabilities side of the bank balance sheet while leaving the asset side at the same size). Is a special type of capital created that is distinct from share capital / equity? Perhaps (just guessing) that’s what the “loan capital” example refers to in this wikipedia example?
Perhaps quoting one of Steve’s statements could help clarify:
“The repayment of loans therefore does not “destroy” money, but transfers it out of income accounts—where it can be used for expenditure—to a reserve account. The proposition that money is destroyed when loans are repaid in part reflects economic conventions that money is the sum of active bank balances. If money is defined that way, then it is indeed destroyed; but I feel that the dynamics of endogenous money creation are more clearly illuminated if we define money in the fundamental Circuitist sense as a token whose transfer settles all commitments between trading parties. That token can then reside in active accounts (deposits) or inactive accounts (reserves). Repayment of loans alters the balance between active and inactive accounts, and thus alters the amount of money in circulation, but it does not destroy the token itself.”
The whole topic seems like something that should be black and white — i.e., don’t bank accountants (or computer systems) have to handle this every day? Or maybe I’m the only one confused
August 19th, 2009 at 9:14 am
hbl,
I have an idea how the part of the system (a bank, a debtor and their immediate neighbourhood) can be described but I will probably have enough time to write about it on the weekend. I would be extremely happy to see Steve’s response to my initial post because I may be missing something.
August 19th, 2009 at 9:26 am
Have to wait till Friday ak–too much work for tomorrow’s lecture right now.
August 19th, 2009 at 11:58 am
Ak, what you describe makes sense to me. Also I’m not really sure it matters in effect if the capital repayment goes into a reserve or is destroyed as the bank, when it wants to make a new loan, can either draw down on the reserve account or just create it out of thin air if it originally cancelled it. It doesn’t matter it seems to me.
August 19th, 2009 at 12:39 pm
I have a few thoughts on Australia’s position in the global mayhem.
I remember late 2007 and early 2008 the RBA was raising rates. They were very late in the trend. The herd had already changed course, the RBA was only just catching the trend. Many borrowers started to go into arrears and suffer stress. Since then rates fell to 3% and PAYG borrowers began finding a way to pay again (businesses are a different story, due to crashing demand).
The MSM assumption is that we are in recovery and interest rates will have to rise again so that bubbles and inflation can be headed off at the pass. I suspect though that rates can’t be raised much going forward, because too much mortgage stress will be evident too quickly. Since 2007 mortgage debt levels have risen and wages have stagnated and hours worked have fallen. Meaning that borrowers are even more sensitive to rising interest rates now.
The downside problem that the RBA faces, is that all up rates (lending rates) cannot go much lower, due to cost of funds constraints. In other words. The RBA may lower the cash rate, but can banks follow? So if sentiment turns negative again, what power will lowing rates have in “saving” borrowers?
As Steve has identified before. Monetary policy is getting pretty blunt in Australia. If it every did anything other than follow the trend in the first place!
The second observation is a comment on how quickly and sharply Australians became negative last year, even before unemployment started rising. I take that as an omen. Australians are very nervous. They have flipped back to extreme optimism at the moment. But what if that flips straight back to negativity? What will save the Australian asset bubbles next time?
August 19th, 2009 at 12:40 pm
Strabes,
Thanks for your comments. I agree with almost everything you say. Except I would like to separate the idea of wealth and democracy. Our system has traditionally excelled at providing personal freedom and the freedom of ideas. This I think is worth fighting for and retaining. In Australia we, at least in public, are very accepting of multi-culturalism, this is worth retaining, however, I suspect this only works while everyone is well off, under stress racial tensions (which are probably already present) may arise. What has been corrupted is our entire economic existence, and in turn the aspects of society that are related to economics ie: everything that can be marketed; education; mass-media (which is driven by marketing). These are the domains in which empire reigns as you say. Mob rule need not be bad, as long as the fate of everyone in the mob is linked. In this case, stupid mobs will not prosper or survive, eventually all mobs must wise up. In our massive system the linking of everyone’s fate does not hold, and one group can benefit by exploiting or dominating another, perhaps weaker group – this is the failing of democracy, and perhaps the mechanism by which the native peoples you refer to have been extinguished. To make my point yet-again (sorry to everyone) smaller masses will more likely have linked fates. These seems possible if we have localised communities with the final say over any decision making. Large projects, such as nationwide railways will still be possible, but would need to be done with much more sensitivity (who cares how long it takes if it is done properly and sustainably and fairly. Stealing land (called compulsory acquisition) for unsustainable projects should not be possible. In the case of water allocations such as we face now where one state or community takes more than its share, that state is actually protected by our current national structures. Under a regional arrangement it is far more likely that an equitable arrangement would eventually be reached, either by co-ordinated sanctions against the offending communities, or, immigration to the areas that are appropriating the resources (so that they are in effect are shared equitably) or, in the very worst case, the threat of armed conflict.
August 19th, 2009 at 12:59 pm
I see that an international consortium has signed a deal with China to sell Australian Natural Gas to China for the next 30 years. This is a big POSITIVE story this morning.
No where did I read that natural gas is now trading at $3 per mmBTU. This is approaching a multi decade low. One year ago gas sold for $13+ mm BTU and in 2006 the price hit $17.
Great positive story! A consortium of ExxonMobil, Shell and Chevron will sell our gas to China and virtually give it away. Why is this good? I read that the government will get $40B tax over the next 30 years. Maybe that’s the good bit.
By the way the price of gas is falling into a multi-decade low as mentioned. A possible target I have is $2.50. But if wave 5 down extends the target will be in the mid to high $1s. That’s insane! Natural gas looks like it will be one of the first commodities to register a long long term low. Some time next year. Natural gas may be the buy of the decade. This is not advice, only opinion.
August 19th, 2009 at 7:17 pm
MMitchell,
I would agree with Strabes that we don’t live in a genuine democracy. If one looks at the institutions in our society: governments (federal, state & local), capitalist firms, educational institutions (universities, TAFEs & schools), churches, non-profit foundations, etc., the only one that has formal democratic mechanisms is the government. All others are based upon authoritarian internal structures whose leaders are unelected and can serve potential life terms (a pathology found in fascist and Bolshevist states). Some may be more moderate but all are based upon top-down hierarchical structures. We don’t accept totalitarianism in the political sphere of life, so why do we accept it in the workplace?
Describing Australia as a democracy defiles its very meaning. Just because one institution (the government) out of many in our society has formal democratic mechanisms, in this case voting rights, this hardly means that Australia can be defined as a democracy in any substantive fashion.
Theoretically, in a democracy, the people rule. However, decision-making power over many aspects of life reside in private, unaccountable hands, generating large-scale effects throughout society. The best way to resolve this problem is to extend democracy throughout the economy so that decisions relating to investment, saving, planning, organization of work, etc. is firmly within the control of people and democratic grassroots organizations. There is no natural law which states that our economy has to be largely managed by unelected and unaccountable corporate central planners and barely accountable state central planners. Reforming this disastrous system would constitute a major social revolution.
“Our system has traditionally excelled at providing personal freedom and the freedom of ideas.”
With the caveat that rights and freedoms are always won, never given.
August 19th, 2009 at 8:54 pm
Philip,
I agree with you because of course you are right. I was talking, and thinking, about democracy in a governmental sense, in all those other areas you mention we have little or no democracy. However, I think our lack of democracy in these other areas comes from our economic history, which in turn probably evolved from our feudal history. However, I was not claiming the best possible political system, just the best existing system beyond tribe size. Compared to many other countries we are relatively very well off.
Rights and freedoms are never given, because those in power use the usurption of rights and freedoms to stay in power. In a truly democratic system I don’t think this would be a problem. In any case, if the following discussion with Monbiot is any indication, I don’t think we should be worrying about that just now, but rather how we can get our existing system to mobilise to deal with the problems we are facing, otherwise their might be no system to talk of:
http://www.monbiot.com/archives/2009/08/18/should-we-seek-to-save-industrial-civilisation/
August 20th, 2009 at 11:39 am
I would dispute that the govt sector is democratic either. Just because the media puts on an election show every once in a while doesn’t mean it’s a democracy. At least in the US we have 2 establishment parties controlled by the banking/corporate elite. They give us 2 to fool us into thinking we have a choice. They debate the irrelevant issues, but neither party would ever cross the Federal Reserve or the rule of Wall St. It doesn’t matter to the elite which one wins…both of them appoint the same Wall Streeters to run the economy and CFR members to run Defense, State, CIA, NSA, Justice.
The elite giving people 2 very limited choices is hardly freedom.
Not to mention the simple evidence that 75% of people were strongly opposed to the US govt bailout program, yet Congress passed it in flying colors. This is not democracy.
I think we’re going to have revealed to us over the next 10 years how un-free we are. The elite allowed us for a few generations to play the bankers’ game because they needed us as good little borrowers/interest payers to ensure we kept the velocity of money screaming so they were propped up as the wealthiest elite on the planet. We’re no longer needed. Our debt bondage, lack of freedom, will soon become obvious to everyone.
August 20th, 2009 at 12:14 pm
The global financial system plays a game of “pass the parcel” to avoid proper regulation, including mortgage securitisation, mortgage insurance etc. Here is a useful health warning from Kris Sayce:
http://www.moneymorning.com.au/20090819/australias-mortgage-insurance-time-bomb.html
August 20th, 2009 at 1:05 pm
strabes,
I would agree that government doesn’t tend to be very democratic and responsive to the will of the population. However, despite its internal bureaucratic problems, the greatest impediment to democracy comes from outside the government, namely the business class or more specifically, the corporate sector.
Citizens turn up to vote once every four years but the business class spends every day and night subverting democracy and market principles. As the Founding Fathers in the US created a separation of church and state, a separation of corporation and state needs to occur.
August 20th, 2009 at 3:27 pm
Strabes and Philip,
As I KBH and I discussed in a previous thread: it is almost inevitable that vested interests will take control of any system. I think the system put in place in the US, like ours, was in fact very good (to begin with). The fact is that over time vested interests subvert whatever democratic processes and checks that are in place. It seems the only way we have any hope of avoiding this is to have as close to direct democracy as possible, no corporations that can use their enormous resources to out-gun anyone using systems of law, EOI, etc that were set up for individual PEOPLE. I do not believe this can be done successfully on a large scale. The temptation to let some group or organisation do our thinking and look after things for us is too great and the rationale that it is more effecient or effective to have some group of so-called experts do this is too tempting for policy makers. We then get a situation like now where the instruments (eg: Financial instruments) used are so arcane that only trained experts can understand them (if even they do) and the everyday person is excluded from participating even if he/she wants to. Having small localised economies (locally produced goods and local control over all resources, laws and decision making) will allow higher levels of accountability, and even if many do get corrupted over time, the scale will not be catastrophic as we seem to be experiencing now.
August 24th, 2009 at 8:39 pm
[...] of many slides from the accompanying Powerpoint presentation. You can download the presentation on Steve Keen’s Debtwatch Blog. You will need to listen to the video to understand some of the [...]
August 25th, 2009 at 12:02 am
[...] of many slides from the accompanying Powerpoint presentation. You can download the presentation on Steve Keen’s Debtwatch Blog. You will need to listen to the video to understand some of the [...]
August 25th, 2009 at 5:53 am
[...] of many slides from the accompanying Powerpoint presentation. You can download the presentation on Steve Keen’s Debtwatch Blog. You will need to listen to the video to understand some of the [...]
August 25th, 2009 at 7:49 am
[...] of many slides from the accompanying Powerpoint presentation. You can download the presentation on Steve Keen’s Debtwatch Blog. You will need to listen to the video to understand some of the [...]
August 25th, 2009 at 8:40 am
I don’t often recommend a Peter Hartcher piece–while I generally find him OK on international issues, he’s just standard MSM on economics–but the jokes he relays in this report of a talk are well worth reading:
http://www.smh.com.au/opinion/friendly-banter-in-the-back-channels-that-nurture-an-alliance-20090824-ewg5.html?page=-1
September 14th, 2009 at 6:50 pm
Hi Steve,
I’m still very interested in any thoughts you had on my original query re the implications of increased bank reserve ratios if you had time?
Thanks very much,
Lyall
September 15th, 2009 at 12:07 am
Hi LT,
It’s easily sidestepped by banks’ innate ability to create credit independently of government money creation. Check the Roving Cavaliers on that front–the reserve ratio and money multiplier are the tail wgged by the private sector lending dog.
September 15th, 2009 at 8:29 am
Hi Steve,
Sorry I should have been clearer & more specific – I was refering to the question on the implications of bank’s reserve ratios increasing over time as deleveraging ensures. I’ve reproduced the earlier post in full below. You mentioned at the time that you would come back to me on this point.
Cheers,
LT
Original post:
Thanks for another very interesting and persuasive presentation. I’m a big fan of your innovative analysis which has certainly contributed enormously to my understanding of how credit-driven economies actually work.
I do have a few questions on the model however: firstly, what eventually happens to all the excess reserves that accumulate in banks during the deleveraging? I have read your cavaliers of credit piece, and can see how the cessation of growth in PSC contribues to a sharp reduction in aggegate demand. However, when people attempt to deleverage, the repayment of loans, if they are not relent out by banks (which in aggregate needs to happen if deleveraring is to occur), become excess reserves (although obviously some are needed merely to replenish equity against bad loans). I note in your modelling outcomes, unemployment rises, debt/GDP declines over time, and also back reserves increase materially.
I can see how when new credit growth occurs, new “money” and aggregate demand is created. but when the debt is paid back, that “money” does not disappear – it just gets pulled temporarily out of circulation but remains very much real on the balance sheet of banks. this would seem to imply a massive excess of capital and ultimately very low interest rates for a long time. I guess my question is, what are the implicaitons of this? Seems unrealistic to think banks are going to have equity/asset ratios of 20-30%??
Thanks in advance,
Rgds
September 15th, 2009 at 9:47 am
Sorry LT!
Yes, the model does show excess reserves accumulating, and this is also happening in the real world. I think that in the longer term the banks would find themselves having to write off debt on a grand scale, and this raises the question of the mechanics of that process vis a vis their reserves. This is where I would have to defer to my colleagues who have a better knowledge of the rules on such things, but my feeling is that the rise in reserves would to some degree counter the fall in their assets from the debt write-off process. However at some point they would become technically insolvent.
It’ something I’ll consider in full detail when I get into writing the book; at the moment that’s the best I can do. Sorry for an inadequate answer at this stage, as well as a wrong-headed one initially!
September 15th, 2009 at 9:49 am
PS it would seem that the dynamics of credit creation you outline in your caviliers of credit piece result in an expansion of the money supply, as banks lend first and then find reserves later. If I am correct, the latter is facilitated by the RB creating additional money.
However, when the process goes into reverse the credit-created money does not get destroyed through a reversal of the said process, because the excess reserves held at banks do not trigger the RB to destroy money to despose of the excess reserves. In fact to the contrary, global reserve banks are currently inclined towards creating still more reserves to wage a battle against deflation.
So you have all this credit-money created during the great credit expansion which now has to go somewhere. What are the implications of this? Low interst rates and asset price inflation would prima facie seem to be two likely consequences, the beginning of which we are starting to see. And perhaps ultimately we need huge consumer price inflation to effectively effectively “mop up” all the excess money supply, much as a share consolidation reduces the shares outstanding but increases the price?
Very interested in your thoughts on this as I’m still trying to figure out what all this means.
Rgds,
LT
September 15th, 2009 at 9:56 am
Hi Steve,
As I posted the above while you were writing your reply, I had not had the benefit of reading your previous reply.
That was my initial thought too, but ultimately all the bank needs to do is swap out debt for equity to remain solvent, which is what banks have been doing by raising significant equity. From a money supply perspective, giving a bank $1 in the form of equity or debt makes no difference.
This equity is needed to offset the bad loans, but ultimately under a deleveraging scenario there would also be a large cash inflow from the steady repayment of good loans. So this would not seem to resolve the problem of there being a systemic excess money/reserves in the bankign system, which need to be relent. Perhaps the great depression played out differently because the aggregate money supply was shrinking so reserves fell this way?
Cheers,
LT
September 15th, 2009 at 9:59 am
PS no problem re your reply – appreciate you taking the time. Will look forward to hearing more of your thoughts when you have a chance, and will eagerly anticipated the release of your book!!
Rgds,
LT