100% reserve banking
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The idea that banks can create money/credit out of thin air and then charge interest on it is more widespread than ever, eg Zeitgeist, the Occupiers but not just them. Here, then, are a couple of counter-quotes to theirs.The first is from Paul Samuelson whose textbook Economics has been and still is widely used all over the world:
Quote:Most people have heard that in some mysterious manner banks can create money out of thin air, but few really understand how the process works.Actually, there is nothing magical or incomprehensible about the creation of bank deposits. At every step of the way, one can follow what is happening to the banks’ accounts. The true explanation of deposit creation is simple. What is hard to grasp are the false explanations that still circulate.According to these false explanations, the managers of an ordinary bank are able, by some use of their fountain pens, to lend several dollars for each dollar deposited with them. No wonder practical bankers see red when such power is attributed to them. They only wish they could do so. As every banker knows, he cannot invest money that he does not have; and money that he invests in buying a security or making a loan soon leaves his bank. (chapter 16, 5th edition, 1961)The second is from Keynes:
Quote:The notion that the creation of credit by the banking system allows investment to take place to which ‘no genuine saving’ corresponds can only be the result of isolating one of the consequences of the increased bank-credit to the exclusion of the others.(…) it is impossible that the intention of the entrepreneur who has borrowed in order to increase investment can become effective (except in substitution for investment by other entrepreneurs which would have occurred otherwise) at a faster rate than the public decide to increase their savings. (General Theory of Employment, Interest and Money, Chapter 7, section V)China has said it will cut the limit on the amount of cash the country’s banks have to hold in reserve, a move designed to encourage more lending. China’s central bank said it would reduce the reserve limit from its record high of 21.5% to 21% on 5 December. The bank had been increasing the rate to reduce lending by banks in order to dampen demand and tackle rising prices.http://www.bbc.co.uk/news/business-15962630 Some commentators also suggested the move could be part of a wider effort by Chinese authorities to combat underground lending. China Banking Regulatory Commission said it was looking to curb the rise of shadow banking and private lending in the country. Some estimates put private loans, where rich individuals and businesses rather than banks lend money, at 4 trillion yuan ($627bn; £402bn). The loans often come with exorbitant interest rates of up to 70%.
Good point. Question for currency cranks: do rich individuals and loan sharks also create the money they lend out of thin air? Of course not. They have to have the money to lend in the first place. Banks are no different.The Times (23 November), reporting on the situation in the northern Chinese city of Ordos, clearly explained where the money for “underground lending” had come from:
Quote:Money made from the region’s huge coal reserves or land compensation has made many residents rich, people who, instinctively, have looked for ways to invest that money as real interest rates from bank savings have slipped into negative territory. By way of loan sharks and other methods of underground financing, that money has been churned back into property investment and more building.This year the official figure for real estate development loans in Ordos was 597 million yuan (£60 million), while the true scale of property investment was closer to 40 billion yuan. More than 85 per cent of the money came from the underground lending market.Banking reformism seems to be rampant at the moment. Here’s what was proposed in yesterday’s Mourning Star (handed out for free at the trade union rallies) by Jerry Jones, their economic expert (and also that of the Communist Party of Britain). He’s talking about how to re-impose the sort of credit controls that existed in the 1950s and 1960s:
Quote:This could be achieved by restricting bank lending to, say, 80 per cent of savers’ deposits plus what the Bank of England was prepared to lend banks at an interest rate that it decided depending on the economic circumstances.This amounts to calling for banks to maintain a cash reserve of 20 percent of deposits. Not quite as economically illiterate as calling for them to hold a cash reserve of 100 percent. But just as irrelevant.
well, what fractional reserve banking does is create more risk in the economy. A miscalculation of the risk factor of a large enough portion of credit could end up in bankruptcy and run to the bank. Another big problem is these financial products which make it possible for banks to throw risk management out of the window and lend out as much as they can while letting other people take the risk, which further increases the chance of a bubble forming. Other than that the real issue is the interest asked on these loans because they add up and create an enormous demand for exponential growth in the economy which is obviously gonna end up in the “weaker” players (including governments) going bankrupt leading to mass unemployment, austerity measures and a continuing vicious cycle which can only be delayed by lending out more.But these problems are minor in comparison to what the inherent motive for profit does every day.
dogmatic wrote:Other than that the real issue is the interest asked on these loans because they add up and create an enormous demand for exponential growth in the economy which is obviously gonna end up in the “weaker” players (including governments) going bankrupt leading to mass unemployment, austerity measures and a continuing vicious cycle which can only be delayed by lending out more.I’m not sure I agree. It seems to be putting the cart before the horse. Surely it is not the need to pay interest that drives the capitalist economy, but the need to make profits.Banks make loans to capitalist businesses only if they judge that that the business will make a profit of which they can obtain a share as interest (and businesses will only take out a loan if they judge they can make a profit larger than the amount of interest they will have to pay). If banks don’t consider this to be the case then they won’t make a loan even if they have the money. Which is what is happening now. Profit is the problem and not interest as such.The imperative to grow that you mention and which is indeed built-in to capitalism results from capitalist firms competing for profits and having to invest in more and more productive machinery and methods, ie accumulate capital, to remain competitive and stay in the race for profits. What causes unemployment and austerity to increase from time to time is when this competition leads to overproduction (in relation to the market) and a fall in profits. When this happens banks (who had expected to get interest out of future profits, which have now not materialised) and governments (who had expected more tax revenues from the same future profits) find themselves with a “debt problem” but this has been caused not by the need to pay interest but by the fact that profits out of which to pay it have not materialised.But, as you say, whatever causes booms and slumps, the need is to get rid of the profit system and replace it by production for use which is only possible on the basis of the world’s natural and industrial resources becoming the common heritage of all under democratic control.
While we’re talking about banks, here’s a good criticism of the “nationalisation of the banks” put forward by many leftists and why it has nothing to do with socialism (the blogger calls it “communism” while we prefer “socialism” but anyway the two words mean the same).Here’s an extract:
Quote:Communist relations preclude the existence of banks and the exchange value they express. Communist relations constitute the antithesis to bank relations whether private or public. The former are directly visible relations while the later are relations of reification. Consequently commodities cannot exist under communism. Products cannot assume the form of commodities under communist relations. They are just products. Consequently money and banks are superfluous.ALB wrote:dogmatic wrote:Other than that the real issue is the interest asked on these loans because they add up and create an enormous demand for exponential growth in the economy which is obviously gonna end up in the “weaker” players (including governments) going bankrupt leading to mass unemployment, austerity measures and a continuing vicious cycle which can only be delayed by lending out more.I’m not sure I agree. It seems to be putting the cart before the horse. Surely it is not the need to pay interest that drives the capitalist economy, but the need to make profits.Banks make loans to capitalist businesses only if they judge that that the business will make a profit of which they can obtain a share as interest (and businesses will only take out a loan if they judge they can make a profit larger than the amount of interest they will have to pay). If banks don’t consider this to be the case then they won’t make a loan even if they have the money. Which is what is happening now. Profit is the problem and not interest as such.The imperative to grow that you mention and which is indeed built-in to capitalism results from capitalist firms competing for profits and having to invest in more and more productive machinery and methods, ie accumulate capital, to remain competitive and stay in the race for profits. What causes unemployment and austerity to increase from time to time is when this competition leads to overproduction (in relation to the market) and a fall in profits. When this happens banks (who had expected to get interest out of future profits, which have now not materialised) and governments (who had expected more tax revenues from the same future profits) find themselves with a “debt problem” but this has been caused not by the need to pay interest but by the fact that profits out of which to pay it have not materialised.But, as you say, whatever causes booms and slumps, the need is to get rid of the profit system and replace it by production for use which is only possible on the basis of the world’s natural and industrial resources becoming the common heritage of all under democratic control.
I agree with you on everything except the bold part which has been proven wrong : Okishio’s theorem is a mathematical theorem formulated by Japanese economist Nobuo Okishio. It has had a major impact on debates about Marx’s theory of value. Intuitively, it can be understood as saying that if one capitalist raises his profits by introducing a new technique that cuts his costs, the collective or general rate of profit in society – for all capitalists – goes up.Okishio [1961] establishes this theorem under the assumption that the real wage – the price of the commodity basket which workers consume – remains constant. Thus, the theorem isolates the effect of ‘pure’ innovation from any consequent changes in the wage.
dogmatic wrote:I agree with you on everything except the bold part which has been proven wrong : Okishio’s theorem is a mathematical theorem formulated by Japanese economist Nobuo Okishio. It has had a major impact on debates about Marx’s theory of value. Intuitively, it can be understood as saying that if one capitalist raises his profits by introducing a new technique that cuts his costs, the collective or general rate of profit in society – for all capitalists – goes up.Okishio [1961] establishes this theorem under the assumption that the real wage – the price of the commodity basket which workers consume – remains constant. Thus, the theorem isolates the effect of ‘pure’ innovation from any consequent changes in the wage.Actually Okishio’s ‘proof’ is not as strong as you might think and is actually logically inconsistent and so has been junked several times. I don’t have the time to write a full response just yet but will refer you to chapter 7 of Andrew Kliman’s ‘Reclaiming Marx’s Capital’
A lot more labour will be replaced because those companies who do not will not profit as much as those who do, so they will copy the methods or go bust.the state will have to take on more loans because of their decreasing rate of profit and will depend more on the capitalist class just so it can still provide some basic services especially services that benefit the capitalists like police and roadsthe new unemployed class will have to become more and more self-reliant for their basic needs in local communities whilst the capitalist class will become even richer but increasingly provide goods and services for the capitalists (thats where the money is). Yachts, Space travels, luxury cars, extravagant jewelry, decadent parties, etcThe capitalists will invest more in protection of property and keeping the poor at bay as they become more desperate, ultimately replacing police with robots and turning the production facilities into fortresses.That’s how I see things evolving. The vast majority living in self-sustaining local communities a lot of which will struggle to get by as water scarcity increases, whilst the privileged rape the planet at an increasing rate and come up with new products to advertise to the richest.
dogmatic wrote:I agree with you on everything except the bold part which has been proven wrong :Okishio’s theorem is a mathematical theorem formulated by Japanese economist Nobuo Okishio. It has had a major impact on debates about Marx’s theory of value. Intuitively, it can be understood as saying that if one capitalist raises his profits by introducing a new technique that cuts his costs, the collective or general rate of profit in society – for all capitalists – goes up.But the part in bold did not say that competition forcing capitalist firms to innovate so accumulating capital leads to the overall rate of profit in society going down. It just said that it led to capital accumulation (“economic growth”).Maybe your are jumping to the conclusion that because we regard ourselve as Marxists we’re committed to the view that crises are caused by the rate of profit falling as a result of labour-saving capital accumulation. In the debates on this question we have not taken this position. Admittedly, others in these debates have argued this but not us. We’ve argued that because there are counteracting tendency it is not possible to predict how the rate of profit will move, up or down, in the short or even medium run. See for instance this and this.
ALB wrote:Maybe your are jumping to the conclusion that because we regard ourselve as Marxists we’re committed to the view that crises are caused by the rate of profit falling as a result of labour-saving capital accumulation. In the debates on this question we have not taken this position. Admittedly, others in these debates have argued this but not us. We’ve argued that because there are counteracting tendency it is not possible to predict how the rate of profit will move, up or down, in the short or even medium run. See for instance this and this.thanks for the links and you were right on me assuming that.It seems i was too fast to judge looking back at the wiki article as their seems to be quite some criticism:The problem with these examples is that they are based on comparative statics. The comparison is between different economies each on an equilibrium growth path. Models of dis-equilibrium lead to other results. If capitalists raise the technical composition of capital because thereby the rate of profit is raised, this might lead to an ongoing process in which the economy has not enough time to reach a new equlilibrium growth path. There is a continuing process of increasing the technical composition of capital to the detriment of job creation resulting at least on the labour market in stagnation. The law of the tendency of the rate of profit to fall nowadays usually is interpreted in terms of disequilibrium analysis, not the least in reaction to the Okishio critique. It does seem a lot more sane to assume that there are many factors at play on whether the rate of profit will rise or fall, especially in a global interconnected economy with stock markets and financial products.
Just heard Robert Peston commenting on the BBC on Lloyds Bank’s annual report. Here’s the matter-of-fact way he takes it for granted that banks are financial intermediaries that borrow at one rate and lend at a higher one, and how they can only lend what they have got the funds for, and how their profits are squeezed if they find these harder to get:
Quote:Perhaps the most striking trend is that what’s called the interest margin – the difference between the interest Lloyds charges for loans and what it pays out in interest – has shrunk and will shrink again this year. The interest margin fell from 2.21% to 2.07% and is expected to fall by a similar amount in 2012.One of the main reasons for this income squeeze is the rising cost for banks of borrowing money on wholesale markets, or from other financial institutions, at a time when what banks can charge for loans to customers remains under pressure – partly because central banks, and in its case the Bank of England, are keeping official rates at record lows, and partly because the demand for credit is subdued.Lloyds is becoming less dependent on these less reliable wholesale sources of funding – as part of a strategic effort to make itself safer. And there has been considerable progress in that regard: its more dependable retail deposits represent 62% of all its funding today, compared with 56% a year ago.But the price of wholesale funds is still a big influence on Lloyds’ profits.So much for those who think that banks can create money to lend out of thin air.
Every week brings refutation of the view that banks can create money out of thin air and confirmation that they can only lend money they have got (whether from savers or what they have themselves borrowed). We may as well record them here as anywhere. So, here’s a BBC report on Halifax’s decision to raise the rate of interest on their loans to housebuyers:
Quote:The UK’s biggest mortgage lender, the Halifax, has confirmed it is raising its standard variable mortgage rate (SVR) from 1 May.The Halifax said the rise – from 3.5% to 3.99% – was due to the higher cost of raising funds for mortgages from both savers and the financial markets.(…)It argued that its hand had been forced by market conditions.”The change acknowledges that the cost of funding a mortgage in today’s market remains significantly higher than the longer term average,” the Halifax said.”The increase to the rate reflects the fact that raising money through retail savings and in the wholesale markets is currently very expensive by historical standards.”The report said other banks were doing the same and for the same reason:
Quote:On Friday, RBS raised the rate on two of its mortgages from 3.75% to 4%. (…) An RBS spokesman said the rises were down to the higher costs they were incurring borrowing money, which they had absorbed for some time before opting to pass it on to some of their customers.Banks are essentially financial intermediaries whose main income comes from borrowing money at one rate of interest and lending it at a higher rate. They can’t simply conjure money up out of thin air and then charge interest on it, as numerous currency cranks claim.
Another news item for the file (from today’s Times):
Quote:Mr Osborne will begin next week the Government’s so-called credit-easing programme under which the Treasury will underwrite £20 billion of bank borrowing to fund cheaper lending to small businesses.If banks can create money out of thin air why would they need to borrow money to fund loans to small businesses ? I can see why, in this case, they’d like their loans to be underwritten by the government but not why they would need to borrow the money to make the loans. Answer: banks can’t create money to lend out of thin air.
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