The “money as debt” fallacy.

Google the phrase “money as debt”, and you’ll find numerous claims that the money created by commercial banks is a form of debt, or that for every pound of such money, there is a corresponding pound of debt.

This idea is seems very plausible because whenever the commercial bank system creates £X of new money the recipient of the new money seems to be “in debt” to their bank to the tune of £X.

But dig a little deeper, and the latter “in debt” idea falls to pieces.

We’ll start with a barter economy.

When trying to solve a problem, it’s a good idea to take the simplest possible case of the problem and solve that. Then add the complexities later.

So let’s start with a simple barter economy where citizens decide that barter is inefficient and that instead, they’ll allow commercial banks to set up and do what such banks normally do: accept collateral from anyone wanting a stock of money and crediting the accounts of those people with money produced from thin air. So banks set up and embark on their “thin air” trick.

Now at that stage, there isn’t just one debt, namely the obligation on the “collateral supplier” to pay back the thin air money to the bank: there are two others.

Debt No. 2: there is an obligation on the bank to give back the collateral to the collateral provider when the latter has paid back the thin air money. So that, so to speak, cancels out debt No. 1.

Debt No 3: thin air money actually consists of an entirely artificial debt owed by the bank to the customer. And the basic promise made by the bank to the customer is that the bank will transfer the debt to someone else when instructed to do so by the customer: an instruction that can be conveyed to the bank with a cheque, debt card or by other means.

Having said that the latter debt is “artificial”, it is actually very real in the sense of being legally binding. That is, when someone writes a cheque for £X drawn on bank A and it’s deposited in bank B, bank B at the end of the working day will want £X worth of central bank money from bank A. And if bank A cannot come up the money, then bank A is on the path to bankruptcy.

To summarise, there are two debts worth £X owed by the bank to the customer, and one debt worth £X owed by the customer to the bank. And that nets out to £X owed by the bank to the customer: quite the reverse of what we hear from the “money is debt” brigade!!!!

So at this stage, i.e. where banks have credited thin air money to customers accounts, but before customers have spent any of the money, banks are in debt to customers.

Interest.

The interest paid or not paid on a debt is absolutely crucial, because if no interest is paid, the debt really doesn’t matter. To illustrate, if the Bank of England plonked a billion pounds worth of freshly printed £50 notes in my garage, I’d then owe the BoE a billion. But that would be no problem for me as long as I don’t have to pay interest!!

So is any interest paid in respect of any of the above three debts? Well the quick answer is “no”. But let’s run thru those debts just to verify that.

Re debt No.1, the thin air money owed by the customer to the bank, the question as to whether interest is charged here is a bit complex. You have been warned!

On initially crediting a customers account with thin air money, the initial charge/s made by banks varies widely from bank to bank. In particular some banks structure their charges in very deceptive ways so as to draw in customers, in much the same ways as supermarkets have so called “loss leaders”.

But let’s assume that bank charges strictly reflects costs.

So . . . on initially accepting collateral and crediting a customer’s account, a bank will incur administration costs: e.g. the cost of checking up on the value of the collateral, other staff costs, bank building maintenance costs, etc etc. So the bank will charge customers for those costs.

Of course some banks CALL THAT CHARGE “interest”. But it’s not interest at all!!! (In contrast, other banks call the relevant charge an “overdraft arrangement fee” or something like that).

What is interest?

In view of the obvious need to distinguish between genuine interest and other charges, let’s clarify exactly what “interest” is.

Interest arises even in barter economies. That is, if in such an economy one person lends a house or any other asset to a second person, the former will normally want some sort of payment. The first person will have forgone the use of, and enjoyment of the asset, and will want a reward for that sacrifice.

The payment made by the second person may well include something for items OTHER THAN  interest. For example the above house owner may pay the insurance or any number of other costs involved in maintaining a house, and the owner will want those costs reimbursed by the tenant. But that doesn’t detract from the basic point here, namely that asset owners normally want a reward simply for forgoing the use or enjoyment of the asset. And that is what’s called “interest”.

Now in crediting the accounts of customers, does a bank transfer any sort of real asset to the customer? The answer is “no”: all the bank has done is to write numbers in a ledger – or as is the case since the advent of computers, type numbers into a computer. So at that stage, there is no reason to charge interest. Administration costs – yes. But interest  - no.

Debt No.2.

This is the obligation on the bank to give collateral back to the customer, and a typical house owner certainly does not charge their bank interest here. (Things are a little different in the World’s financial centres where interest or some other charge is often made for lending out collateral, but  we’ll ignore that.)

Debt No.3.

This is the fact that thin air money is an artificial debt owed by banks to customers. Again, it is unheard of for customers to charge their banks interest on that so called “debt”.

To summarise, none of the above three debts are of any significance because no interest is paid in respect of them.

The customer spends their thin air money.

The next step is that a customer spends some of their thin air money. And “spending” means giving money to someone in exchange for  REAL ASSETS or REAL goods and services. Now let’s stop the clock again.

The recipient of the money has forgone the use of real assets or goods. And as explained above, people who make that sacrifice normally want interest.

In fact in the real world, it is normal practice when one firm supplies goods to another the expect payment within a month, and to charge interest if payment is not forthcoming after a month or two.

Reverting to our hypothetical economy, if someone who supplies goods and gets paid has no intention of doing anything more (e.g. spending the money they got) they’d just lodge the money in a bank deposit account and would try to get interest on it. And you cannot blame them: they’ve lost REAL ASSETS OR GOODS, and got nothing REAL in return. So they’ll want interest.

To summarise, once our original bank customer makes some sort of PERMANENT withdrawal of their thin air money by spending it, that means someone else has sacrificed real goods or assets and will want interest as a reward.

In short, people who deposit money in banks for a significant period normally try to get interest on that money, which in turn means banks have to pass on that interest to . . . well, to the people who have so speak helped themselves to goods or assets belonging to others.

In other words, when a bank charges genuine interest (as opposed to administration charges or admin charges which are CALLED “interest”), the bank is simply acting as a go-between and between two people, one of whom has supplied goods or assets to another (just as they might have done in a barter economy). And as is the case in a barter economy, the person conferring said assets or goods will try to get interest.

To summarise, where a bank charges genuine interest, that  is not a charge for creating money: it simply reflects the fact that one person has supplied assets or goods to another, and quite understandably wants interest. And the bank is simply acting as go-between.

Is money in a deposit account really money?

The above arguments are supported by a procedure adopted by those charged with measuring the money supply of countries round the world. That is, while money in current or checking accounts is almost invariably counted as money, money in deposit accounts tends not to be so counted. And the longer the “term” of the deposit account, the less likely the so called money in that account is to be actually counted as money. Plus, the longer the “term” of a deposit account, the more interest it tends to pay.

Put another way, as regards so called money which is quite clearly money (i.e. money in current accounts) interest just doesn’t enter the picture – little or no interest is earned normally on current accounts. So if anyone wants to claim there is a debt here, or that for every pound of money there is a pound of debt, then IN A SENSE they are right. But the real flaw in the latter claim is that no interest is paid in respect of the debt.

So just as where I’m in debt to the tune of a trillion trillion, the debt is immaterial because no interest is paid.

Established banking systems.

To recap, we’ve considered the scenario where there is initially no money, and commercial banks create money and that money is spent. Another and more realistic scenario is where a commercial bank system has been going for decades or centuries, and that system effects a money supply increase (as it was doing like there’s no tomorrow just prior to the recent crisis).

In fact, much the same reasoning applies. To illustrate, a bank will charge for ADMINISTRATION costs, but will not charge genuine interest for initially creating money. Interest payments only arise where one entity has lodged money in a bank for a significant period with a view to getting interest, which means the bank has to pass that interest on to entities that have WITHDRAWN money for significant periods from the bank.

But banning “debt money” WOULD reduce debts.

Having argued that commercial banks “debt money” does not increase debts, there is actually one transmission mechanism via which a ban on commercial bank money creation WOULD reduce debts. It’s as follows.

The above ban would obviously constrain lending by commercial banks, and the effect would be deflationary. But that could easily be countered by having the government / central bank machine create and spend new money into the economy. The net result would be that all participants in the economy would have more money and would thus not need to incur so much debt.

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A trust deed or a debt management plan could be just the ticket to your journey to financial freedom. It might seem unlikely right now that you will ever pay off your debts but with a little help from a debt management company and a little careful planning on your part, it could happen sooner that you might think.

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Take action against problem debt today and take better control of your money. If you are spending more each month than you have coming in it is definitely time to take immediate action. You could be debt free a lot quicker than you thought if you get in touch with your local debt management company today.

Nonsense from Dijsselbloem and Zero Hedge on Cyprus.

Dijsselbloem has claimed in respect of Cyprus that a “levy on wealth is defendable in principle”. And Zero Hedge has chipped in with some inconclusive verbiage which lends mild support to Dijsselbloem (if I’ve interpreted the verbiage correctly).

Well banking apart, we’re all agreed that a “levy on wealth is defendable in principle”. Likewise about 95% of the population approve in principle of other taxes on the rich.

However, grabbing a portion of depositors’ money in a bank is NOT A LEVY ON WEALTH!!!!!

It’s a levy on a PARTICULAR ASSET. That is , if it’s supposed to be a levy on wealth, it’s the daftest levy on wealth ever thought of.

To illustrate, on the date of the levy some not desperately wealthy people will have large amounts deposited in their bank for a variety of possible reasons. For example they may have sold their house and haven’t yet bought another. Or they may have just received a lump sum payment from their pension provider.  In contrast, there are plenty of millionaires who far from having large amounts deposited in banks, are heavily in debt to their bank.

It’s amazing that I even need to spell out the latter point.

It’s should be blindingly obvious that the Cyprus levy was a panic and badly thought out move. But it DOES HAVE a limited amount of sense in that it is a move towards full reserve banking: that’s a system under which, first, it’s almost impossible for commercial banks to fail, and second, bank subsidies are removed, and third, the tendency of banks to lend money into existence during a boom (exactly when a money supply is not needed) is constrained.

Now a system that has the latter three merits definitely has something going for it. Thus a movement in the direction of full reserve, even if it’s done in a chaotic Cyrus fashion, has some merit.

For more details on why a levy on depositors is part and parcel of full reserve, see this Positive Money article.

Bank shareholders are pointless.

The traditional view of banks is as follows.

Banks have shareholders, bondholders and depositors. Shareholders allegedly perform a function: they foot the bill when things go seriously wrong. In contrast, depositors and bondholders supply funds on which they expect interest – a reward for forgoing consumption. But they don’t expect to be first in line for a hair cut when things go badly wrong: indeed, depositors don’t expect to take a hair cut at all (though of course recent events in Cyprus have dented faith in the latter idea).

And that “division of labour” as between shareholders and depositors seems to make sense: it seems to give people FLEXIBILITY as regards what risks they want to accept and what costs they want to bear.

But there is a catch in the latter argument, and as follows. There is already a HUGE VARIETY of different forms of saving and investment available. For example in Britain people can put their money into the ultra safe and government run “National Savings and Investments”. While at the other end of the scale, savers can buy shares in a dodgy gold mine in a developing country.

So why would anyone want to put their money into anything other than an ultra safe form of saving, while at the same time demanding 100% safety? Well it can only be because interest rates paid by the more risky savings institutions are better – and precisely because of the additional risk. In short, depositors who put their money into anything other than the ultra-safe are demanding the right to the rewards of taking a risk at the same time as being insulated against the downside of that risk.

IT’S NONSENSE !!!!

Put another way, wherever there is a risk over and above the risk involved in an ultra-safe forms of saving, ALL ADDITIONAL INTEREST should go to shareholders because they are the ones carrying the additional risk.

So savers are being illogical when they lodge their money in anything other than a 100% safe manner. But that raises the question as to why savers ACTUALLY DO put their savings into commercial banks – i.e. less than 100% safe types of saving.

Well the explanation is that they’ve found a “mug insurer” who is prepared to cover the risks those depositors are taking, and at an artificially low premium. The insurer is the taxpayer.

In short, the whole “shareholder / depositor” symbiotic relationship is nothing more than an organised raid on the public purse.

The raid has arisen because of various political and populist forces: the corrupt banker / politician nexus, for example. Plus there are well orchestrated mobs of depositors crying wolf when ever their savings are threatened – or crying: “we want to have our cake and eat it”. Or crying “We’re little old ladies relying on our pitifully small deposits to keep body and soul together.”

Conclusion.

If there is little sense in having different types of bank creditor (shareholders, depositors, etc), then that supports the case for full reserve banking: the latter being a system in which depositors who want their money loaned on by their bank have to foot the bill if those loans go badly wrong. Put another way, full reserve is a system under which those depositors are in effect shareholders.

And that ties up with the recent statement by Mervyn King that British building societies are entities in which depositors “are in effect the shareholders”. 

Bank capital ratio nonsense.

Here is an emperor with no clothes. He’s stark bollocking naked. But as is always the case with naked emperors, no one believes emperors, presidents etc could possibly parade in public with no clothes on.  So everyone sees clothes where there are no clothes. Anyway the naked emperor is as follows.

Thousands of person hours and tons of ink and paper have been devoted by Basel III / Dodd –Frank / Vickersetc to the question as to what capital ratios banks should have. Allegedly a higher ratio imposes additional costs on banks and Basel III has settled for a 3% ratio.

Funding a bank from capital is allegedly more expensive than funding via depositors, so everyone agonises over the cost benefit ratio here: lower capital ratios allegedly cut bank funding costs, but involve a bigger risk – agonise, agonise, agonise.

But wait a moment . . . as Mervyn King rightly pointed out, the depositors at British building societies (roughly equivalent to US savings and loan) “are in effect the shareholders”.

So in effect, the capital ratio with building societies is 100%. Yet they compete very effectively with banks!!!!!

So the whole “capital ratio” so called dilemma is nonsense. And the reason it is nonsense was of course pointed out by Messers Modigliani and Miller. That is, the risk of a particular bank going bust is a given, thus the reward demanded by those accepting that risk is a given. Thus the total number of shareholders amongst whom that risk is divided has no effect on the total amount of risk. That is, if you up the capital ratio, the risk per shareholder or per dollar of shares is reduced.

And if you go the extreme of making ALL THE CREDITORS of a bank shareholders, as is the case with building societies, that in no way hinders the ability of the relevant bank or similar entity to compete.

Actually the latter couple of paragraphs understate the point. That is, given a very small capital ratio, the risk of a bank failing is INCREASED. For example if the ratio is 3%, then the value of loans or investments made by the bank only needs to decline by about 3% and the bank is technically insolvent.

In contrast, if a bank’s only creditors are shareholders (as per British building societies), it’s virtually impossible for the building society / bank to become insolvent.

For another attack on the whole bank capital ratio shambles, see this article in the Financial Times entitled “Why bankers are intellectually naked” by Martin Wolf.