Credit creation comes first Spinnerman....

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Credit creation comes first Spinnerman....

Postby Indaswamp » Thu Mar 20, 2014 10:25 am

RE: your chicken and egg question on another thread:
Bank of England Admits that Loans Come FIRST … and Deposits FOLLOW

Credit is created first, then economic activity follows from that credit being spent into the economy. Period.
Specifically, Bernanke and Krugman assume that huge levels of household debt don’t hurt the economy because more debt among households just means that savers have loaned them money … i.e. that it is a net wash to the economy.

To make this assumption, they rely on the myth that banks can only loan as much money out as they have in deposits. In other words, they assume that if bank customer John Doe has $100 in the bank, then the bank can loan that $100 to someone else.

But Keen points out – as the Bank of England is now finally doing as well – that banks actually loan out money whether or not they have enough in deposits … and then borrow the shortfall from the central bank.

Keen therefore says that it is not a wash … and that high levels of private debt are the cause of economic crises.


And that is the rub....

Why Is The Myth About Banks So Dangerous?

Even if banks don’t really loan based on their deposits and reserves, who cares? Why is this such a dangerous myth?

Because, if banks don’t make loans based on available deposits or reserves, that means:

(1) This was never a liquidity crisis, but rather a solvency crisis. In other words, it was not a lack of available liquid funds which got the banks in trouble, it was the fact that they speculated and committed fraud, so that their liabilities far exceeded their assets. The government has been fighting the wrong battle, and has made the economic situation worse.



(2) The giant banks are not needed, as the federal, state or local governments or small local banks and credit unions can create the credit instead, if the near-monopoly power the too big to fails are enjoying is taken away, and others are allowed to fill the vacuum.

Indeed, the big banks do very little traditional banking. Most of their business is from financial speculation. For example, less than 10% of Bank of America’s assets come from traditional banking deposits.
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Re: Credit creation comes first Spinnerman....

Postby Indaswamp » Thu Mar 20, 2014 10:42 am

This is what Kurgmanites do not understand....
In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt, with the change in debt spending new money into existence in the economy. This is then spent not only goods and services, but on financial assets as well—shares and property. Changes in the level of debt therefore have direct and potentially enormous impacts on the macroeconomy and asset markets, as the GFC [global financial crisis] — which was predicted only by a handful of credit-aware economists (Bezemer 2009)—made abundantly clear.

If the change in debt is roughly equivalent to the growth in income—as applied in Australia from 1945 to 1965, when the private debt to GDP ratio fluctuated around 25 per cent (see Figure 1)—then nothing is amiss: the increase in debt mainly finances investment, investment causes incomes to grow, and the economy moves forward in a virtuous feedback cycle. But when debt rises faster than income, and finances not just investment but also speculation on asset prices, the virtuous cycle gives way to a vicious positive feedback process: asset prices rise when debt rises faster than income, and this encourages more borrowing still.

The result is a superficial economic boom driven by a debt-financed bubble in asset prices. To sustain a rise in asset prices relative to consumer prices, debt has to grow more rapidly than income—in other words, if asset prices are to rise faster than consumer prices, then rather than merely rising, debt has to accelerate. This in turn guarantees that the asset price bubble will burst at some point, because debt can’t accelerate forever. When debt growth slows, a boom can turn into a slump even if the rate of growth of GDP remains constant.
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Re: Credit creation comes first Spinnerman....

Postby Indaswamp » Thu Mar 20, 2014 10:58 am

I have said for years that the banks do not NEED your deposits to make loans. Hell-Bernanke even floated the idea to remove the reserve requirements to make loans.

We live in a Credit driven economy, yet most people have no idea how it works.....
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Re: Credit creation comes first Spinnerman....

Postby Indaswamp » Thu Mar 20, 2014 2:56 pm

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Re: Credit creation comes first Spinnerman....

Postby Indaswamp » Thu Mar 20, 2014 3:00 pm

**See China's Credit implosion for a real-time example**
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Re: Credit creation comes first Spinnerman....

Postby Indaswamp » Thu Mar 20, 2014 3:11 pm

This is why the shift from the Age of Leverage to the Age of Deleveraging was so dramatic, and yet so unforeseen by conventional economists: it was caused by a huge reduction in aggregate demand from a factor they ignore. This debt-induced reduction in aggregate demand will persist as long as private debt levels are falling—as they still are in the USA, though at a much reduced rate from the peak rate of fall in early 2010.

Until private debt levels are substantially reduced, the economy will always tend towards what Richard Koo called a “balance sheet recession” (Koo 2009), where the desire of the private sector to reduce its leverage will suppress aggregate demand, causing both recessions and falling asset prices. The Western OECD is thus “turning Japanese”—replicating the crisis that led to Japan’s “Lost Decade”, which is now two decades old.
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Re: Credit creation comes first Spinnerman....

Postby Indaswamp » Sun Mar 23, 2014 6:01 am

So no comment Spinnerman?
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Re: Credit creation comes first Spinnerman....

Postby Indaswamp » Sun Mar 23, 2014 6:15 am

Read the paper noted in the article at the link:
http://market-ticker.org/akcs-www?post=228868
Here We Go (BOE Paper)


Hoh hoh look what the cat dragged in.... (p11, top of second column)

Far more important for the creation of bank deposits is the act of making new loans by banks. When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created.

Banks can create new money because bank deposits are just IOUs of the bank; banks’ ability to create IOUs is no different to anyone else in the economy. When the bank makes a loan, the borrower has also created an IOU of their own to the bank. The only difference is that for the reasons discussed earlier, the bank’s IOU (the deposit) is widely accepted as a medium of exchange — it is money.


Ah, an admission. More than that, a statement of fact, and one clearly intended to stick a big fat pin in the oft-repeated nonsense in economics textbooks and in college courses (never mind High Schools.)

I went through the standard rubric in Leverage, and noted at the end that while this is a convenient means of explaining how the banks balance transactions out and such in reality banks create the loans first, not the other way around, and then those funds are deposited back to satisfy reserve requirements.

Now let's look at this objectively.

The size of the economy is stated in units of "money"; we call that GDP.

Yet there is a statement right here, by the Bank of England, that banks create "money" out of literal nothing by making a new loan.

It is a basic principle of mathematics that when you have an equation and modify a term that exists on both sides of the equal sign that adjustment must be made to both sides!

If the economy produces 100 bushels of corn (and only that) and there are 100 "dollars" (units of currency), and those are the only two items in the economy, the natural clearing price of a bushel of corn will be approximately one of the dollars.

Now here's the problem -- if a bank comes along and issues 100 new dollars that are indistinguishable from the old ones, simply because someone asked for a loan, how much is a bushel of corn assuming the same 100 exist?

That ought to be obvious.

That would be where the problem lies with so-called "mainstream" economics when it comes to monetary mechanics, and it is a central point I made both in Leverage and in calling for a One Dollar of Capital standard for lending.

I find this paper ground-breaking and surprisingly frank. I wonder exactly why the BOE decided to "come clean" with it at this time, but no matter -- the fact is that they did so and once you are given to understand this then you also wind up understanding how both commercial banks and central banks (when they engage in "QE" and similar schemes) are in fact robbing you.

And that, my friends, becomes a problem for the apologists of these programs.
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