Money and Debt: “joined at the hip” (ECB edition)
from Merijn Knibbe
According to IMF economist Manmohan Singh and consultant Peter Stella, money and debt are “joined at the hip’:
In the simple textbook view, savers deposit their money with banks and banks make loans to investors (Mankiw 2010). The textbook view, however, is no longer a sufficient description of the credit creation process. A great deal of credit is created through so-called ‘collateral chains’. We start from two principles: credit creation is money creation, and short-term credit is generally extended by private agents against collateral. Money creation and collateral are thus joined at the hip, so to speak. In the traditional money creation process, collateral consists of central bank reserves; in the modern private money creation process, collateral is in the eye of the beholder.
And yes – once upon a time the billion or so lend by Icelandic bank A to Icelandic bank B was considered very beautiful collateral, just like the reciprocal lending of one billion or so by bank B to bank A. Well, times change, don’t they?!
Anyway, one can’t indeed find this real life ‘loans create deposits’ view of money in the textbook of Ben Bernanke e.a. or the textbook of Olivier Blanchard e.a.. But you can find it in the monthly ‘monetary developments in the Euro area‘ press release of the ECB. It spells out the changes in loans (like new mortgages or consumer loans) on one side (of the balance sheet) as well as the corresponding changes in the amount of M-3 money on the other side (of the balance sheet) and I have used these these stats (on a national level) repeatedly in blogposts. Time to be a little more specific about these statistics. Graph 1 shows the entire balance sheet of the banks (called MFI’s in the press releases), april 2012.
This graph shows the next things:
* An increase in lending by the banks can increase M-3 money (i.e., currency, overnight deposits or “Deposits redeemable at notice up to 3 months”, which are part of the items included in M-3, but it might also increase ‘debt to others’, like “Deposits redeemable at notice longer than 3 months”.
* Money might also be created (or destructed) by shifts between “Debts to others” and M-3
* But in reality the main message is that an increase in lending (loans to households and companies) lead to increases in M-3 money.
* Be aware that this is an Eurozone balance sheet. The asset/liability identity does not hold for individual countries. When money is transferred from an Italian account to a German account the Italian amount of money dwindles – without an ofsetting decline of debt. The Eurozone amount of money of course stays the same.
(Singh and Stella pay a lot of attention to interbank lending and balance sheets like this one indeed only show net results of very complicated financial flows. However – Singh and Stella also show that these increasingly complicated financial flows in the end only resulted in higher borrowing costs (their graph 3), of setting much of the lower rates of the ECB and the Fed (and where is all that money going to?)).