Saturday, December 8, 2012

Paul Grignon’s flawed videos.

Grignon’s videos do a good job of introducing people to the basics of banking and money creation. But after those introductions, the videos go astray.
At least that’s true of the two videos of his that I’ve watched. I don’t have time to wade thru them all.
One of Grignon’s videos goes wrong (at around 24.00) where it claims that interest cannot be repaid because only enough money has been lent into the economy to supply loans: not enough has been loaned out to pay interest as well. That answer to that is as follows.
Commercial banks in the aggregate do not make loans and then ask for the whole lot to be repaid plus interest (as Grignon implies). What actually happens is that borrowers are CONTINUOUSLY taking out loans and repaying them. Thus IN THE AGGREGATE loans are never repaid. Plus of course borrowers pay interest to banks: indeed, the latter is banks’ main source of income.
But what do banks do with that income? Well just like firms in any other sector of the economy, they don’t just sit on the money! They SPEND IT – on staff costs, office building costs, computers, payments to shareholders: the list is endless.
In short, banks’ income (i.e. interest) is re-cycled into the economy in general. So that disposes of Grignon’s claim that bank lending leads to bankruptcy or similar for the population as a whole.

Without lending there’d be no money?
A second myth pushed in one of Grignon’s videos is the idea that since private banks lend money into existence, it follows that without lending and debt there’s be no money. That idea appears about 20 minutes into this video.
One answer to the above idea is: what about central banks?
In other words if there WERE A significant drop in the amount borrowed, there would indeed be a decline in the money supply, the effect of which would be deflationary: unemployment would rise. But there is a simple solution: commercial banks are not the only institutions that create money – central banks do as well.
Indeed, at the time of writing we are in the middle of a scenario of very much the above sort. That is, commercial banks have cut lending over the last two years or so (or, same thing, the private sector is paying off debts). As a result, central banks have stepped in and boosted the money supply big time under the guise of quantitative easing.
And I’m not suggesting that QE is good way of countering the above caution in the private sector, but it’s better than nothing.

Let’s ignore central banks.
Ignoring central banks and concentrating on commercial banks, is it true to say that that money creation by the latter results in debt? Well the latter idea is EXTREMELY debatable, and for the following reasons.
Let’s assume that no one wants to borrow anything but that the population (unsurprisingly) DOES WANT a supply of money with which to conduct normal commercial and day to day transactions. Indeed, without that money, there’s be a drastic contraction in economic activity. Or at least people would be reduced to barter: a method of exchanging goods and services which is alright in very simple economies, but which is useless in sophisticated economies which have several million different products on offer.
So let’s say (to keep things simple) that everyone opens an account at a bank, deposits collateral, and as a result has their account credited. Now at that stage, what debt exists?
Banks would owe collateral to depositors, which is a sort of debt. While depositors would not owe anything to banks because they have not yet made use of their overdraft facilities.
Thus far from ordinary, hard done by people owing anything to banks, it’s actually the other way round: banks owe people!

People start spending money.
But of course people and firms arrange overdraft facilities so as to SPEND some or all the relevant money.  Now there is a problem here for the Grignon theory, which is that money spent by one person for firm must be received by another. Thus if where one person uses their overdraft facility and goes into debt to their bank, someone else must do the opposite, that is deposit money in their account. And that means the relevant bank is in debt to the depositor!!!!
So overall, people and firms (i.e. private sector non-bank entities) are never in debt to banks.

Distinguishing administration costs from interest.
Next, to the extent that money creation DOES RESULT in debt, what’s the problem? I don’t mind being a TRILLION DOLLARS in debt, just as long as I don’t pay any interest on the debt.
So when it comes to money creation, do commercial banks charge interest? The answer (surprisingly) is “no”. Banks certainly charge for the ADMINISTRATION COSTS involved in money creation and they charge something to cover bad debts, and that is perfectly reasonable.  But they’ve no reason to charge interest. (I’m assuming that “interest” is a payment made by a debtor (who wants to spend money and consume real resources) to a creditor (who charges said “interest” for the pain involved in abstaining from consuming resources, or “forgoing consumption”).
Where a bank simply supplies money or “monetises an asset” there is no foregone consumption and thus no reason to charge interest.
Of course in the real world, the so called interest charged by banks INCLUDES enough to cover administration costs: staff costs, the costs of equipment, printing costs, the costs of maintaining branch buildings, etc. Plus banks have to charge for RISK (i.e. for bad debts). Thus the word “interest” as used by banks is misleading. Put another way, if banks were to be strictly accurate, they’d split the so called interest they charge into “real interest” and “other costs”. But borrowers are not interested in details like that, so banks don’t bother.

Loans and forgone consumption.
I said above that when supplying money rather than making a loan, no one has to forgo consumption. That might seem questionable given that  the only purpose of obtaining a loan is to spend the relevant money, i.e. consume resources. 
But remember that the whole purpose of having a form of money is (as pointed out above) to avoid the inefficiencies of barter.
Thus on the subject of consuming resources, as long as any extra demand stemming from money creation is matched by bringing into productive use resources which are waiting there to be used, no inflation will ensue. That is, as long as the extra demand that results from money creation is matched by the increased efficiency that comes from converting to a money economy from a barter economy, no inflation will ensue.
To be accurate, there are actually circumstances in which money creation by private banks IS INFLATOINARY. Those circumstances are set out by George Selgin.  But let’s just say, and with a view to keeping things simple, that I’ve assumed a “non-Selgin” scenario.

There is a sense in which money creation by commercial banks (as distinct from extending loans) results in no net debt. But even if you want to argue that money creation gives rise to a debt, there is no reason for a commercial bank to charge interest (as distinct from charging for administration costs). So what’s the problem? Darned if I know.

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