The get­ting of wis­dom part two

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This is the sec­ond part in a two-part series. To read the first part, click here.

In my arti­cle yes­ter­day I showed how Paul Krug­man had used the views of a young James Tobin to dis­miss the rel­e­vance of banks to macro­eco­nom­ics – even though those views were later dras­ti­cally revised by James Tobin him­self. The con­trast between the the­o­ries advanced by the young James Tobin and Tobin the Elder were stark, and a salu­tary les­son in the ben­e­fits of always remain­ing open-minded to new infor­ma­tion. But the ques­tion remains, which Tobin should you believe?

I sug­gest you believe nei­ther, but con­sider sim­ple logic, and also con­sider which per­spec­tive makes sense of the empir­i­cal data. On both fronts, the ‘banks don’t mat­ter’ view is a total loser – as Tobin the Elder came to appre­ci­ate.

Read the remain­der of this post here. I also rec­om­mend read­ing Nick Rowe’s post “What Steve Keen is maybe try­ing to say”, which is the first con­certed (and very accu­rate) attempt to put my endoge­nous money approach in a form that Neo­clas­si­cally trained econ­o­mists can under­stand. This could be the start of a real dia­logue in eco­nom­ics.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • This will be Aus­tralia in 4 years just change the name.
    https://www.youtube.com/watch?v=vsoUMggVp-s
    I look for­ward to pur­chas­ing homes for around half today’s price then.
    Buy GOLD & SILVER NOW.

  • Bhaskara II

    Some might be inter­ested in this:

    The­ory of Abyssal Abi­otic Petro­leum Ori­gin: Chal­lenge for Petro­leum Indus­try”
    Vladimir G. Kutcherov Royal Insti­tute of Tech­nol­ogy, Stock­holm, Swe­den
    (Or, an alter­na­tive the­ory to fos­sil fuels, with evi­dence.)

    http://www.aapg.org/europe/newsletters/2008/06jun/techAbyssalAbioticPetrol.cfm
    pdf ver­sion:
    http://www.aapg.org/europe/newsletters/2008/06jun/06jun08europe.pdf

    *This is related to eco­nom­ics because it is related to energy, a large part of the econ­omy.

  • Harry

    This dis­cus­sion about the cre­ation of money by banks has been run­ning for a long time, and I for one am con­vinced by the endoge­nous money argu­ment. What the dis­cus­sion seems to be miss­ing is the other half of the process — DOES THE BANKING SYSTEM DESTROY MONEY WHEN LOANS ARE REPAID? While this would seem to be the log­i­cal corol­lary, I have not seen any­body lay out the rel­e­vant account­ing pro­ce­dure. Have I just missed it? Is there any­body (prefer­ably an accoun­tant) out there who actu­ally KNOWS?

  • Bhaskara II

    Any accoun­tants out there? Who know?

  • I was a critic of that atti­tude when I first started mon­e­tary mod­el­ing Harry, but I have to con­fess that I now think that it is valid to say that repay­ing loans destroys money.

    There are still nuances here: since money can also be in cash form, I cer­tainly don’t think that bankers tear up dol­lar notes when they’re used to repay loans–they would go into stor­age for reis­sue instead. But cer­tainly it would be the case that repay­ment of a loan takes money out of cir­cu­la­tion, and that’s the expres­sion that I pre­fer to use. Whether money (notes or binary entries in a com­puter data­base) is actu­ally destroyed or not, the amount in cir­cu­la­tion in the hands of the non-bank pub­lic falls, and that’s what affects eco­nomic activ­ity.

  • Harry

    Thanks for the reply Steve. It seems to me that when a loan is repaid, the money to repay it comes out of a deposit account some­where in the bank­ing sys­tem, so is, in your terms, with­drawn from cir­cu­la­tion. The key ques­tion is what account­ing pro­ce­dure does the bank go through at this point? The asset that the loan rep­re­sented ceases to exist, so there must be a Credit (i.e. decrease) to the Asset side of the bal­ance sheet, but what is the bal­anc­ing entry? It has to be either a Debit (increase) to another account on the Asset side, or a Debit (decrease) to the Lia­bil­i­ties side. Because the Lia­bil­i­ties side is where cus­tomers’ deposits are kept, a decrease to that side means that the money is no longer there to back up new loans. In other words it really does just “dis­ap­pear”.
    BUT, I am no accoun­tant, and I’m sure there are many more com­pli­ca­tions to the process than this sim­plis­tic out­line. Which is why I plead for a real live bank­ing-sec­tor accoun­tant to tell us what really hap­pens. Surely it must be a mat­ter of com­mon knowl­edge and prac­tice, rather than all this spec­u­la­tion we out­siders indulge in?

  • F. Beard

    We should use the now accepted fact that bank loan repay­ment destroys pur­chas­ing power to struc­ture a metered, uni­ver­sal bailout (Steve’s “A Mod­ern Debt Jubilee”) with a ban on fur­ther bank credit cre­ation such that total pur­chas­ing remains con­stant and thus blow the Aus­te­ri­ans out the water with regard to an infla­tion scare.

  • F. Beard

    cor­rec­tion: “such that total pur­chas­ing power remains con­stant”

  • Econ­CCX

    S.Keen: I have to con­fess that I now think that it is valid to say that repay­ing loans destroys money. There are still nuances here: since money can also be in cash form, I cer­tainly don’t think that bankers tear up dol­lar notes when they’re used to repay loans

    Steve, destruc­tion of deposit cur­rency is the very mech­a­nism of debt defla­tion. But you’re look­ing for that destruc­tion at the wrong bank.

    A deposit is the amount the bank owes you as depos­i­tor, not the amount it is hold­ing for you. So when you pay a $10 check­ing fee, with­drawn from your account, the bank doesn’t “get” the $10; instead, it ceases to owe it to you. An asset has not been assigned; rather, a lia­bil­ity has been extin­guished. And that much deposit cur­rency ceases to exist, with no off­set in the money sys­tem. The bank’s own “vault” is not aug­mented by that $10 in any form, con­tra your model. 

    Sim­i­larly, when you write a check against another bank to pay down a loan: your check­ing account is drawn down (aggre­gate M1 dimin­ished), reserves are con­veyed (aggre­gate M0 unchanged). Net result: deposit cur­rency destroyed with no off­set­ting gain. When you obtain cash at the sec­ond bank to make a pay­ment at the first, M1 is like­wise dimin­ished, while aggre­gate M0 is drawn down at the ATM and restored when you hand a cash pay­ment to the teller. And when you write a check for loan repay­ment against an account at the lend­ing bank, that amount is sim­ply can­celled in your account with no move­ment of reserves or vault activ­ity at all. 

    The bank is cer­tainly worth more in the last case because of its dimin­ished lia­bil­ity to you; but the gain is equity value, whereas the aggre­gate loss is medium of exchange. 

    And it’s prin­ci­pal, inter­est and fees that are destroyed. That’s why I exhorted you to read Soddy when you vis­ited NYC two years ago. His most use­ful pas­sages are com­piled here:

    http://monetaryrealism.com/frederick-soddy-on-endogenous-money-debt-deflation/

    And yes, the bank has expenses, and cre­ates some deposit money in the process, but with no con­trac­tual rela­tion­ship to the amount destroyed via debt defla­tion. Which is thus a con­se­quence of deposit math­e­mat­ics rather than of con­sumer psy­chol­ogy as in Minsky’s depic­tion.

    Warmest Regards
    Econ­CCX

  • Econ­CCX

    Steve, you’d be inter­ested to know that no less than the Fed­eral Reserve Bank of New York con­sid­ers the repay­ment of debt to be dis­si­pa­tive of broad money. Note they’re not rely­ing on sec­toral, behav­ioral or dis­trib­u­tive chan­nels, but on pure deposit math iden­ti­ties.

    Quoth the FRBNY (emphases mine): 

    When the Fed buys an asset, the effect on the broad money sup­ply depends on who sold the assets and what they do with the funds they receive. If the seller is a bank, reserves go up, but broad money only increases if the bank responds to the increase in its reserves by lend­ing more to house­holds and busi­nesses. If the seller is an investor other than a bank, reserves go up, and broad money also goes up in the first instance as the seller’s bank puts a sum equal to the amount it receives from the Fed into the seller’s bank account. But if the seller uses the money to pay down debt, the broad money sup­ply declines again by the amount of the debt repay­ment. As of early 2011, the behav­ior of the broad money sup­ply, eco­nomic activ­ity and infla­tion all sug­gested that recent money growth had not been exces­sive.

    http://www.newyorkfed.org/education/lsap/

    (Expand sec­tions:
    Money and Infla­tion
    What effect do asset pur­chases have on the money sup­ply?)

    Again, here’s the test case. A bank charges its cus­tomer a $10 monthly fee for a check­ing account, with­drawn directly from the account. Aggre­gate M1 is dimin­ished at that moment by $10. Is there a rec­og­nized mon­e­tary aggre­gate that increases by $10 to bal­ance it?