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.