Read of the Day: The People Versus the Bankers

I like this piece by Matthew Klein in the Economist today.  His first paragraph is particularly MRish:

“MOST of what we call money is actually short-term debt created by banks when they make loans. This means that banks are the stewards of our savings and manage the payments system. As a result, they have a privileged place in our society: governments never deliberately choose to liquidate the banking system. It always appears preferable, in the short term at least, to preserve the incumbent institutions and personnel through bail-outs. (Lending to “solvent but illiquid” firms at below-market rates is another kind of bail-out, even if it is not always called one by the authorities.)”

I think it’s incredibly important to understand that first point.  Almost all of what we call “money” today is created by banks out of thin air.  The government has essentially outsourced money creation to an oligopoly of private entities.  This might sound ludicrous, but it’s largely in keeping with the capitalist nature and democratic foundings of the American system.  That is, the money supply is controlled not by the government, but by the private sector.  And the entities that distribute this money must compete for our business.  The alternative is having the government distribute all money in some fashion.

Of course, the problem with this design is that private banks are driven purely by the profit motive.  So, this capitalist design can be both beneficial, but inherently unstable as banks have a tendency to reach out on the risk curve.  It’s the old Hyman Minsky “stability creates instability” thing.  So you have a serious conflict of interests here.  The banks issue and dominate the social construct that is OUR money.  And their involvement in the stability of that social construct is essential as they maintain the payments system.  But the profit motive leads them to do silly things at times which leads to systemic instability.

Matt’s article discusses the need for higher capital requirements and reining in the ability of banks to take massive risks.  I’ll stop blathering and let you read it….

See here.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • SS

    It seems like a no-brainer. If our politicians understood MR they’d just put a better regulatory hold on the bankers so they can’t repeat 2008. But the economic advisers in DC don’t even understand that debt is money.

  • dis737


    Isn’t deficit spending essentially money creation as well? Although typically not as significant as private bank’s ability to create money, with 7-8% deficits, it is pretty significant right now is it?

  • Cullen Roche

    Deficit spending is the redistribution of money and the creation of a net financial asset in the bond. So, deficit spending involves taking from Peter to pay Paul and giving Peter a t-bond.

  • ji1824

    I think I’ve seen this question asked before on this site, but not sure I ever saw the answer. I know Bernanke and others have defined (and defended) QE as an asset swap that will eventually be reversed. These two actions taken together (the purchase and eventual resale of assets) do not in fact constitute “money printing.”

    But what if the Fed doesn’t sell those bonds back into the markets, but instead allows them to mature? Isn’t that the same thing as a the Fed lending directly to the government? And constitute “printing money” in the same sense that a bank lending to “Peter” is creating new money?

    I think about it this way. Peter borrows $100 from Bank A ($100 is “created out of thin air”). Peter uses the $100 to buy a government bond. Bank B buys the government bond from Peter. The Fed buys the government bond from Bank B. Net everything out and the Fed has created a loan ($100 to the government) and the related deposit ends up somewhere in the system when the government spends the $100 on Paul (who deposits it at at Bank).

    Would love to hear your thoughts Cullen. Much appreciated.

  • Cullen Roche

    I don’t call it monetization because monetization implies that there aren’t buyers for the bonds. That’s silly in our system. The banks are required to make a market in govt debt. So, if there was no QE the banks would still be buying and selling their inventory on to other people. The whole concept of the Fed funding the govt implies that the banks wouldn’t do their normal buying. All the evidence from pre-QE and smaller examples like the end of QE2 prove this thesis wrong. So I don’t think it’s right to say that the govt is being funded by the Fed. The Fed’s just doing its regular old monetary policy. This is really not that different than how it has always enacted policy.

  • ji1824

    Perhaps the actions themselves are just “regular old monetary policy” but the magnitude of their actions is markedly different. See the size of the Fed’s balance sheet.

    I’m not saying the banks aren’t playing their normal role in making a market in government debt – I fully understand (and agree with) the role they play in the market. My specific question is if the Fed does not sell these bonds back into the market, does that “create money” in the same way that a bank loaning money to Peter “creates money”?

    If a banks assets (i.e. loans to “Peter”) are growing, and that is essentially creating money, isn’t it also true the Fed’s assets (i.e. loans to the government) is also creating money to the extent the “asset swap” never takes place and instead remains on the Fed’s balance sheet?

  • Johnny Evers

    How much ‘money’ in the system has an obligation attached to it? In other words, how much is ‘short-term debt created by banks when they make loans.’

    If paying a loan back ‘destroys’ the money, isn’t deleveraging always bad for the economy (but good for the individual) So would a limited debt jubilee get around that problem? I know Tom Brown is looking for ways to spur inflation — that could be a way.

  • Mountaineer

    Cullen, if you haven’t seen it yet, you need to go over to the FT and read Martin Wolf’s latest, “The case for helicopter money.” Krugman might be slow to come around, but Wolf is absolutely on point right now.

  • Boston Larry

    Cullen, I concur with Mountaineer. “The case for helicopter money” by Martin Wolf in FT is a must read, and it makes sense to me. See:

  • brent

    Hi Cullen and sorry in advance for the dumb questions…….I’ve taken an interest in MR more on the government spending side of things and am only now looking at banking.

    I wonder if you could perhaps direct me to the best article you’ve written/referenced on banking and the way private money is created .

    Here in Australia there’s constant talk in the bank reporting about funding costs , how the banks have moved to address their over-reliance on wholesale funding by increasing their deposit based funding for loans (deposits presumably being weighted according to their stickiness) etc…..

    The banks tell us they cannot pass on RBA rate cuts because their funding costs are increasing etc..

    All this leads to the conclusion in the public that banks can only fund loans via deposits and wholesale funding and that the cost of these funds determine the lending rate.

    if banks create money out of thin air then this , to me anyway , makes a nonsense of the way the banks communicate their business activities.

  • Cullen Roche

    I’ll have a read at some point tonight. Still crawling out from the vacation hole….Thanks.

  • Tom Brown

    Just curious, what do you mean by “wholesale funding” and “stickiness” of deposits? Is the wholesale funding when a bank takes a loan from the central bank? It’s usually to a bank’s advantage to attract transfer deposits since the deposit liability is usually very cheap, and of course it comes “packaged” with an equal measure of reserve assets, which can be used for meeting reserve requirements (if there are any), or for clearing payments (essentially deposit transfers OUT of the bank by customers purchasing items, e.g. by writing checks), or any number of ways. So perhaps this is a sloppy way of pointing out the difference between acquiring two kinds of cheap liabilities (both coming with reserve assets to back them up): Borrowings (liabilities) from the CB vs from depositors: neither should have anything to do with making loans directly, though, since loans create deposits, and thus deposits in and of themselves are not required prior to making a loan. Perhaps the reserve assets which come along with these liabilities help meet Basel requirements or some kind of liquidity requirements indirectly associated with making a loan? Do you suppose that might be it?

  • brent

    Hi Tom – not sure about all this but the banks certainly frame the conversation in terms of “cost of funds” rising and therefore their inability to pass on RBA rate cuts. The banks not set their own rates and only take limited notice of RBA rate cuts , which was never the case up until recently.

    The banks talk about their funding in terms of deposits and wholesale funds with “wholesale” meaning 3-5 year money from institutions , whether that be insurance companies, large investment companies etc…

    By “stickiness” of deposits I meant the terms on which the deposit is taken. If , as they say , they fund loans with deposits then I would assume a higher weighting/security would be attached to a 3 year term deposit as against money sitting in an at-call account …………the sort of low/no interest free money the banks love to hold but it can also disappear rapidly.

    I suppose your last point is what I’m trying to get my head around. The banks frame it as funding loans which doesn’t make sense in terms of the idea of banks creating money.

    The funny thing from my point of view is that in this case it sounds like the banks themselves don’t understand what they’re doing, just like the government/Fed in the US LOL. Very confusing.

  • Tom Brown

    What? Why not?

  • Tom Brown

    brent, perhaps Cullen knows exactly what you’re talking out and can answer your questions quickly, but I have to confess I’m still a bit confused. If you’re new to MR, and how loans create deposits, etc. and you’re a visual person, as I am, who needs concrete examples to understand, I suggest you read this article by Scott Fullwiler:

    Another resource I like are these tools on econviz:

    The part to pay attention to in Fullwiler’s article are the example balance sheets and how they change when a loan is made, or when a deposit is transferred from one bank to another. After reading that article I stopped thinking of a deposit as “money” from the banks perspective. From the bank’s perspective it’s really just an IOU (liability), such as “We owe Bob $1000.” When Bob decides to do something w/ his “money in the bank,” the bank MAY have to scramble to borrow that money (in the form of reserves) on the interbank market to “clear the payment” (send the reserves to another bank). I wrote “MAY” because if the buyer (Bob) and seller have accounts at the same bank, then no reserves are required: the bank simply debits the buyer’s deposit and credits the seller’s. Scott does a great job of providing simple examples, so I suggest you look at those if that’s the part that’s confusing you.

    “cost of funds” sure sounds like what the bank pays in interest for a liability. The “Wholesale funds” you describe sound like “time deposits,” similar to a certificate of deposit (CD) here. Then the insurance company, for example, would “purchase” one of these deposits, but their money is tied up for 3 to 5 years (i.e. with varying amounts of “stickiness”). The payoff for the insurance company is they receive a higher rate of interest from the bank. The “at-call” deposit you describe is then a “demand deposit” (i.e. a checking account) wherein a customer has immediate access to funds at any time, but on which he receives a very low interest payment from the bank (if any at all!).

    Like I wrote earlier, banks want to attract transfer deposit liabilities because they come in a 1:1 ratio with reserve assets, which the bank can then use for clearing payments, loaning to other banks, or paying off existing loans to other banks, etc. Thus if there are already a lot of these “wholesale” deposits, that implies that the banks are already stuck borrowing the accompanying reserve assets that came with those deposits (for 3 to 5 years) at a higher rate perhaps than what the RBA is now charging. Don’t think of the reserves the bank has borrowed in this way as just sitting on the bank’s balance sheet, they have probably long since been loaned out and re-loaned out to OTHER BANKS, or used to back deposit transfers (e.g. clear payments between customers). I believe Australia does not have reserve requirements, true? In such a case I think the reserves actually sitting on the banks’ balance sheets (BSs) at the end of each day is probably minimal, but they probably all still have substantial borrowings and/or loans of reserves to other banks on their BSs. The CB just needs to create reserves on a temporary basis during the day, but is repaid (or nearly repaid) in full each night. I went through an example of this once here which is very similar to Fullwiler’s examples:

    Cheaper still (perhaps) than the RBA rates are the rates for “at-call” deposit liabilities.

    Banking is all a game of maximizing the difference (spread) between what they get paid in interest for assets and what they must pay in interest for their liabilities. So perhaps when the banks sold those time deposits to the insurance companies, etc., the RBA rates were higher and thus the spread was wider. But now that’s not true, thus they want to attract even cheaper liabilities (demand deposits) to allow them to increase their spread again on their balance sheets. Or maybe they’re just trying to snow you. ;)

    Cullen, how am I doing here? Have I gone off the rails yet? ;)

  • Matthijs

    This is exactly the same question I have. For non-insiders, this stuff is very confusing. People can say “loans create deposits, not the other way around” hundreds of times, but if that is true, why would banks need to atract customers putting money in savings accounts (costing the bank money) at all?

  • Dennis

    I have tried to ask the same exact question. If the Fed keeps the bonds until maturity (in particular those bonds created out of whole cloth by the GSE’s Fannie and Fred e.g. Mortgage backed securities), then the principal paid out by the GSE’s and the moola collected by the Fed would go back to Uncle Sam’s treasury who today has many of those very bonds on its books– correct? It’s a circle that wipes out the debt? Cullen has answered that the bonds are just rolled over. Does this mean that the principal is never paid out or collected? I don’t get this, sorry.

  • Greg

    “…stewards of OUR savings…”

    Sounds a lot like a public purpose element as well.

  • John Wilkins

    Cullen: When you gate a chance I hope you can expand on you comment above. I cannot get my head around why the deposit that government spending creates in not a net financial asset. If it is not, then why does the G in GDP= C=I+G+(X-M) work? I guess what it is the (G-T)= T-bond issuance. So, I think you are saying the rest comes from T which is taking from Peter to pay Paul. Right or wrong??

  • John Wilkins

    Also, I assume the deposits the government spending creates are part of the money supply? And loans are part of the money supply until repaid? If T-bonds are the asset created, what would happen in the theoretical case where the govt stops selling bonds because of IOER. The Treasury just spends and the Fed adds to ER. In that case the deposits created by spending over & above taxes is the NFA?

  • Cullen Roche

    Greg, banks serve private purpose first and public purpose second. Just review the structure of the fed. By definition, the Fed must serve banks in order to be able to serve the public. That’s how monetary policy gets done. This MMT nonsense about banks serving public purpose totally misleads people about how our monetary system works and how the current structure is actually designed. The system is not designed around public purpose. It’s designed around private purpose. Anyone who says otherwise is selling you a political lie.

  • Cullen Roche


    Taxes take from Peter and give straight to Paul. Deficit spending is Peter giving to the govt to give to Paul. BUT, Peter gets NFA in the bond issuance. This “works” for several reasons. Not only does it increase the flow of spending and income in the economy, but it adds a financial asset to the private sector that did not previously exist. That improves balance sheets and can help particularly in a de-leveraging.

    Make sense?

  • Cullen Roche

    Govt spending doesn’t create new deposits. Govt spending redistributes existing deposits. Think of the Tsy Direct process. If you buy a bond via TD you give the govt a deposit, they give it to someone else and the govt gives you a t-bond. All govt spending is a redistribution. Not the creation of new money.

  • Johnny Evers

    This concept is difficult for me. It seems there are three ways to look at the Treasury bond.
    1. It’s a traditional bond note. It’s an asset to the holder, but a debit for the U.S. government.
    2. It’s money. It can do 99.99 percent of what money does. Most critically, investors believe that the U.S. government will always reedeem it. That’s why it’s risk-free.
    3. It’s a net financial asset.

    Calling it a ‘net financial asset’ seems to me to be a clever way of avoiding the accounting problems with the first two methods. If it’s a bond, then you have created a future liability that you may not be able to redeem. If it’s money, then you are printing money.
    Maybe it’s all the same. No matter what you call deficit spending, you will have problems someday unless you can grow the economy faster than you grow the debt. You are adopting a high-risk strategy, sometimes for very little, debatable short-term gains.

  • Cullen Roche

    Let me know when your bank deposits lose 20% in value in a year and then we can start calling t-bonds “money”. Until then, let’s stick to calling them what they are – securities that give you a claim on money.

  • LVG

    If government bonds are money then why aren’t private sector bonds and stocks also money?

  • Luke

    You stated that allowing private banks to issue money is consistent with the capitalist nature of the American system. I do not agree. Capitalism is the system where the government legally protects private ownership of the capital stock, where capital is the human-created factor of production (resources/land and labor are the other two factors in classical economics). Private ownership of the capital stock encourages capital accumulation, which ultimately builds wealth by saving time.

    Money should not be confused with capital. Capital is the source of wealth creation. Money is just the medium of exchange. Describing banks as just another private business ignores the unique privilege banks have to self-fund all of their assets. This privilege exists under the protection of government. The market did not create the banking privilege.

    All of the confusion lies in sloppy word choice. Banks aren’t really “lending” in the sense most people understand the word. A loan implies a credit to a borrower and a debit from the lender. But a bank “loan” does not involve a debit from the lender’s account, which is why the money supply expands. Few people grasp that banks don’t actually “lend”.

    I believe the government-protected self-funded banking privilege should end. We should allow real loans (where the lender’s account is debited), but not debitless credits that expand the money supply. If we are going to use a credit-based monetary system, the it makes the most sense to have liabilities backed by the debt of a sovereign operational currency issuer. This doesn’t imply any sort of government takeover, although it may imply lower taxes.

  • Luke

    I meant strategic currency issuer, not operational.

  • Cullen Roche

    Capitalism is a system not only of private ownership of production, but also of the MEANS of production. There is no more important element in the means of production than the money we use. I think a system of money managed by private entities is entirely consistent with that thinking.

  • Greg


    No need to lecture me on this. If you re read my comment you’ll see I said “A public purpose ELEMENT….”

    I get the private purpose…. loud and clear…. but any suggestions that there isnt NOR shoudnt be any public purpose to banking is also false.

    Anything the govt supports to the degree it supports banking has public purpose. If there were NO public purpose there would be NO deposit insurance or NO govt backing of mortgages

  • Luke

    Outside of original issuance of money, I agree the distribution of money should be primarily controlled by the private sector. But that’s different than allowing banks to self-fund their assets.

    Most people think the government issues money today. I don’t think the public would scoff at the government doing what they currently believe they already do. I do think they would scoff at the idea that a select group of people protected by government-granted banking licenses get to be the privileged few who get to create money.

  • Johnny Evers

    Again, admitting my failure to understand, but if the bank creates money to lend to me, what does it do when I pay that loan back?
    It destroys the money?
    If the bank lends $10,000, and I turn around a week later and give the bank $10,000 in bills, what does the bank do?

    As the economy grows, it needs more money in circulation; otherwise, prices fall. Is that right?
    So you have to keep creating more money. But if you are also creating more obligations by those who hold the money, doesn’t that create problems such as we are now facing?

  • Cullen Roche

    I am not saying that there is no public purpose, but the MMT thinkers explicitly state the the money system exists entirely for public purpose. Sorry, but that’s total nonsense and it displays a gross misunderstanding of the role of private banking in our monetary system.

  • Luke

    I don’t see a problem with more obligations, provided they can be repaid. The problem comes with backing your financial liabilities with low-quality assets like consumer loans.

  • Johnny Evers

    Luke, don’t you see money as one form of capital, along with traditional types of capital such as land or factories, as well as trade contracts, or even human capital. A newly minted engineering graduate from MIT has enormous capital.
    Money gives you the ability to buy sources of capital, or to borrow more money, or even to make interest-bearing loans.
    Maybe the complication is that money is many things — capital, a medium of exchange, a store of wealth.

  • Luke

    In classical economics, the MIT grad is high-value labor. Capital is the human-created factor of production. The idea of “human capital”, in my opinion, adds more confusion than understanding.

    And rather than “money”, I think you are referring to “wealth”. Money is just the medium of exchange. And no, I don’t think wealth is a form of capital. Take the example of a corn farmer. His harvest all constitutes wealth, but only the portion he uses for the next year’s crop is capital. Only the capital makes us wealthier.

    And I don’t have a problem at all with interest-bearing loans. I have a major problem with debitless credits, masquerading as loans, that expand the money supply.

  • But What Do I Know?

    I agree wholeheartedly with the tenet that money is created by commercial banks when they lend it–but doesn’t the same principle apply when the Federal Reserve *Bank* lends money?

  • Johnny Evers

    Agree with your final point.

    I think the lines have been blurred between labor and management. If I am a mechanic working for the local shop, I’m labor. If I am a mechanic who takes contracting jobs, am I still labor?
    If you define capital as the source of wealth creation, then for somebody like Stephen King, he is the capital.

  • Johnny Evers

    The reason I say it’s ‘money’ is because it’s a ‘risk-free’ asset that is principal guaranteed. And it can be converted for money at any time.
    Since we are describing realities on this blog, the reality is that the Fed will always redeem your bond (with inside money) if you can’t find a buyer. After all, if you can’t find a buyer, then the system collapses.
    Before you say that Treasury can fall in value, yes, I understand that. My dollar bill can also lose purchasing power.
    But, if a Treausry is not money, then it’s a loan, as Cullen just described. It’s a claim on future money.
    If you want to call it a Net Financial Asset, you could just as easily call it a Net Financial Debit, which they are to the future taxpayer.

  • Tom Brown

    … you mean lends reserves (outside money)? Yes, I believe that’s true. Same goes for when they purchase something with reserves. Conversely it’s destroyed when the Fed sells assets or when it’s repaid from a loan. That’s my understanding anyway!

  • John Wilkins

    Cullen: Yes. it makes sense to me and I think I finally caught it. Thanks for your kind help.

  • Tom Brown

    I think there’s a bit of abuse of language here that sews confusion. It’s never the liability itself that’s attractive, it’s the combination of the liability paired with the asset it comes with. If the asset/liability pair in question can increase the risk adjusted return of the bank, then it’s to the bank’s advantage to acquire it. That’s why it’s a game of spreads: spreads between the interest the bank collects for the asset and the interest it must pay for the liability. If banks could acquire the assets unencumbered by liabilities, they would! (that would be like you walking into a bank, depositing your money, and then telling them to erase your deposit from their list of liabilities.)

    Thus “cheap” liabilities (i.e. those requiring payments of a low interest rate) are only attractive insofar as they come packaged with an asset which offers an overall attractive spread. An “expensive” liability could also be attractive if paired with a high risk adjusted rate of return asset.

    In the case of banks in a no-required-reserve system, where banks endeavor to keep their overnight central bank (CB) reserve balances at $0, in the normal course of deposits being transferred and people purchasing things (payments being cleared), some individual banks will acquire net reserve borrowings (liabilities) they owe other banks (even though there are not actually any reserves left in the system by the end of each day). Thus attracting a transfer deposit may be attractive if the rate the bank must pay the depositor is less than the rate the bank currently pays on its reserve borrowings. In other words the reserve-assets that come with the cheap deposit-liability could be used to pay down a more expensive reserve borrowing liability. Even if the bank did not have net reserve-borrowing liabilities, those reserve assets will almost certainly be put to work immediately by being lent out (at a higher rate than the rate the bank pays the depositor) to other banks which need them.

    Any BTW, by “liability” and “asset” I’m not counting equity: To me equity is an abstraction calculated after all the real assets and real liabilities have been accounted for. If positive (assets exceed liabilities) it’s placed on the right under “liabilities,” if negative (liabilities exceed assets) it’s placed on the left under “assets” on the balance sheet, in order to make the two sides of the balance sheet equal (in order to balance it). When positive, it can be viewed as a liability in the sense that it represents what’s “owed” to the shareholders. Since equity is usually positive, many balance sheets are helpfully labeled on the right “Liabilities & Equity” to make a clear distinction between the two. Sometimes this is augmented with a horizontal line to divide them as well.

  • Tom Brown

    I made a longish response here to Matthijs, and then hit the wrong key or something before I added it and the page reloaded with it gone! .. Thus I did it again, and my post still didn’t appear… so now I suspect that BOTH will eventually appear some hours later! Sorry in advance for all the resultant redundancy and doubling down on the long responses!

  • Tom Brown

    BTW, expanding on this idea, it could even be the case that it’s desirable for the bank (or any entity for that matter) to acquire an asset/liability pair where the asset has a negative rate of return; as long as the liability has a negative rate of expense, and it’s more negative than the rate of return on the asset, the spread is still positive; e.g. asset = non-interest bearing reserves in an inflationary environment, liability = customer deposit that pays no interest and instead charges fees). Ah! you might say, “In that case, why not endeavor to obtain the liability by itself w/o the asset?” The answer is because there’s still the case of the principal. All else being equal, an increase in liabilities decreases equity, whereas all else being equal an increase in assets increases equity. Thus if the bank were to acquire money-making liabilities w/o assets to offset the principal amount, there’d be an immediate loss of equity… even if in the long run this were to be reversed (e.g. by collecting enough fees, etc.).

  • Cullen Roche

    I’ll post something on all of this next week. It’s obviously a source of serious confusion.

  • Tom Brown

    … and I guess in that case (my above comment) the focus should be on the liability, language wise (as in “the bank desires to acquire liability x”), since that’s what’s providing the income. However, it really only makes sense when the principal amount of the liability is offset with an asset, otherwise the acquisition of the liability just digs a hole in equity that the rate of return has to eventually make up for before it can actually start to make money for the bank. Whereas acquiring an unencumbered asset with the same spread, starts the bank off w/ a boost in equity that the return just adds to. A great example of that is the interest payments made to the bank: Those are pure asset with no accompanying liability (except for taxes).

  • Tom Brown

    Iluvatar, I can always tell your comments, even when just scrolling by quickly… I don’t have to read the name. Yours always have a certain look to them! ha!

  • Tom Brown

    Great! … will it include an answer for brent’s original question?:

    Wherein he states, that in Australia:

    “The banks tell us they cannot pass on RBA rate cuts because their funding costs are increasing etc..”

    I was trying to reason that through above, imagining that the issue was that the banks perhaps acquired “Wholesale” deposit-liabilities (they sold time deposits) at a time when RBA rates where high, but now RBA rates are perhaps lower. So the banks are stuck with these wholesale deposit-liabilities for a number of years (“stickiness” of this kind of deposit) and the asset they originally received with it (reserves) probably used to pay a higher rate, giving the banks a better spread, but now they don’t. Thus the banks can’t “pass along” the new lower RBA rates because they still have to charge enough to make up for the spread deficit they’re already locked into with the “wholesale” deposits. Sound plausible?

    Let me see if I can work out a two person / two bank mini example here. Say we start with persons x & y and their banks, bx & by resp., and a central bank (CB) and all w/ clean balance sheets. Say the CB rate is 3% and x borrows from bx at 1% above CB (4%) to buy something from y. Now y takes his deposit from by and moves it to bx because they offer a “wholesale”/time deposit at 2% for 3 years, whereas by only paid 1% for their “at-call”/demand deposit.

    bx was making money off the spread between the RBA rate it had to pay bank by (to borrow back reserves after the payment clearance to repay their CB overdraft) and the 4% it gets paid by x: 4% – 3% = 1%. But by attracting y’s transfer time deposit, they were able to bring their profit margin up to 4% – 2% = 2%.

    Bank by was making 3% – 1% = 2%, but after y transferred his deposit, they make nothing (clean balance sheet again).

    Now let’s say the CB lowers rates to 0%, and x wants to take another loan (of the same size) to buy something else from y. Well now bx’s BS is a money loser for the bank since it only get’s 0% + 1% = 1% from x but is still paying y 2%, so instead of being able to offer x a loan at 1% (1% above the prime/CB rate of 0%) as they did previously, they must charge instead 3% (3% above prime) if they want to bring their overall spread (between assets and liabilities) back up to an average of 1%.

    So of course x goes to bank by instead, who can offer a 1% loan to x since it’s got nothing on its BS and is glad to have the business. But since bx is desperate to stop losing money, they might still compete with bank by.

    OK, silly example perhaps, but I think I see how the “Wholesale” deposit commitments could disincentivize banks from passing along CB rate cuts…. but at the same time, if they’re actually losing money I think competition could be fierce!

    However, if the loans to x in my example had been at fixed rates instead of adjustable, the example falls apart, since x is locked in at the higher rate (say for the same amount of time, 3 years, as y’s time deposit) and thus bx continues to make their spread, and thus they’re able to pass along rate cuts from the CB w/o losing money.

  • Tom Brown

    I’m having a hard time with your introduction of MBSs into the game. Is it important? Specifically this sentence:

    “then the principal paid out by the GSE’s and the moola collected by the Fed would go back to Uncle Sam’s treasury who today has many of those very bonds on its books– correct?”

    I don’t see “Uncle Sam” with the MBSs on it’s books, unless you’re counting the Fed as Uncle Sam. The principal goes to the Fed and is retired (the principal doesn’t get sent on to Treasury).

    Let’s go back to ji1824’s example with just Treasury bonds. Again, if these eventually end up on the Fed’s balance sheet and are held there until maturity, I believe that the gov still has to pay the principal to the Fed, even though the interest payments they pay are (mostly) remitted back. So in that sense when Cullen says “rolled over” it makes perfect sense: in order for the gov to pay off the principal to the Fed, it must issue new debt (assuming it still is not bringing in enough revenue and must deficit spend). What happens to that principal? The Fed in effect “destroys” that money, correct? Just like when they perform OMSs, or when they are repaid from covering overdrafts, or when they are repaid for discount window loans,… the reserves they collect in these cases are essentially destroyed.

    Now I’m not arguing that you don’t have a point… to the extent that the Fed actually does hold Treasuries, then the gov is benefiting from (nearly) interest free debt.

  • Tom Brown

    Hi Johnny,

    Just to be clear, I’m “looking for ways to spur inflation” to understand how that could be made to happen, not necessarily because I advocate it.

    In regards to a debt jubilee, that’s also deleveraging and destruction of inside money (at least the part of it that’s used to repay debts), but I don’t see that (the jubilee) as necessarily bad for the economy. It may, overall, be bad for the banks (and the pension funds which invest in them) because it will shrink their balance sheets (even though, on the other hand, it may also retire some toxic assets they’re hiding).

    Deleveraging w/o a jubilee does seem like it subtracts from aggregate demand (like Steve Keen would argue). However, to me it seems like it’s a necessary 1st step to releveraging, and thus growing AD again (hopefully at a non-ponzi lending [in Minsky's sense] rate this time). The jubilee is just a mechanism for escaping this long painful step… but it’s not the destruction of money per se that’s the problem in either case. In fact the faster that money can be destroyed the better, because the faster that happens (the faster principal is paid down), then the quicker we get out from under having to divert large amounts of money into useless interest payments (from loans made on terrible terms to the consumer — remember that underwater homeowners can’t refinance, and thus can’t take advantage of the better terms which exit right now) which serve to grow the financial sector, but don’t add much to the real economy (except through bank shareholder dividends). Government deficit spending during times of deleveraging I think helps hasten this deleveraging process, and at the same time improves the sentiment for purchasing real goods and services. That’s all a debt jubilee would be (gov deficit spending) only over a much shorter time frame. Leave the gov tightening (through tax increases & spending cuts) for when that would be useful (an overheated economy).

    But I can see it the other way too… if people felt confident enough to stop deleveraging and start borrowing again right now, then yes AD would increase. I guess it’s just a matter of when we get to that magic tipping point. If we get there “prematurely” (before we’ve deleveraged sufficiently) then panic might occur again as people “realize” that the bubble still wasn’t fully deflated. What I’m saying is that there’s a lot of hindsight in determining what was a bubble, and how much deleveraging is enough.

    I think Scott Sumner takes that kind of view to an extreme by saying the EMH proves there’s no such thing as a bubble. He’s convinced that the whole problem was that the Fed was too tight with money during a critical few months starting in 2007. Seriously! He even identifies one critical Fed meeting in particular: He argues that if only the Fed had dropped rates a 1/4% more (by 0.5% instead of just 0.25%) at this critical time this would have sent the proper message to the markets, and the recession would have been brief and mild and there would have been no financial crisis and furthermore no housing bubble would have deflated, because, of course, in his mind it didn’t exit in the first place.

    I just can’t see Sumner’s view: I think when literally millions of questionable speculative or ponzi type loans (again in Minsky’s sense of these words) were being made on sky high real-estate, there’s no way we could have avoided a crash. But again I’m looking at it in hindsight!

  • Johnny Evers

    Hi, Tom. Thanks for the response. My sense is that you are not necessarily advocating particular points so much as examing ideas and playing around with them. I think we need more of that, especially in the public sphere, because it will help us implement solutiosn faster. Also, and I think you really convey this with your posts, it’s a lot of fun.