Peter Praet, ECB board member, shows his ignorance about money (1 graph, 1 image)
At least it made me read Herodotus. But the recent Peter Praet Speech about the history of ‘money’ is a shocker. What’s wrong with it? A few points:
1. The speech is inconsistent with core ECB monetary philosophy
Peter admits that the so-called Money Multiplier can be affected by changes in liquidity preference and cash hoarding. But he still believes in the concept, which states that the central bank controls bank reserves (“base money”) and therewith the amount of money banks can and do lend and therewith the amount of money in circulation and therewith inflation. This idea is not only very wrong (look here) but it’s also not the official ECB view. The empirically based ECB-vision can be found in the second issue of the Monthly Bulletin (February 1999). And it too rejects the idea that base money is important for monetary policy:
Base money is, however, very volatile in the short-term and not a reliable indicator of future inflation. The focus of monetary policy is therefore typically on broader aggregates. In the case of the euro area these consist of currency in circulation and certain liabilities of Monetary Financial Institutions (M-3 money, M.K.)
For an in-depth rejection of the idea that “base money” or even the stock of M-3 money are important policy variables for a central bank one can consult the work of the ECB economist Ulrich Bindseil. Money in circulation is created by borrowers and banks, not (not even indirectly) by central banks: loans create deposits. In the case of Ireland, such money/debt creation led not only to 15% of GDP increases of household debt a year as well as 30% increases of money in circulation but also to the housing bubble (see graph, ‘household investments’ are mainly purchases of existing or new houses). A development which the ECB couldn’t control at all (the ECB Eurozone money growth target is 4,5%, by the way). Sources: Eurostat and the Excel-sheet related links at the end of the pdf behind this link to the statistics of the Irish Central Bank).
2. Peter Praet is not aware of the high costs of using money
Using money has costs. Think about all the women and men behind the cash registers, all the accountants in all the offices in all the world, bankers, whatever. A recent ECB study “The social and private costs of retail payment instruments“, estimates these costs to be about 1% of GDP for retail sales alone. A conservative estimate of the total private and social costs would be the size of the FIRE sector (Finance, Insurance, Real Estate), which can be as high as 8% of GDP. These (high) costs of course mean that we do not just use money because it’s efficient. But also because we’re living in a historical monetary economy with ever evolving but deeply monetary institutions like wage labour, insurance, markets and bankers.
3. Peter Preat still believes the romantic ‘traders developed commodity money and invented the unit of account’ fairy tale
A large part of the speech consists of the neo-classical story that, once upon a time, there were traders who did not use money but who, gradually but increasingly, started to use one of the commodities they bartered as a kind of ‘intermediate’ commodity as this reduced transaction costs and price setting frictions. In due time, this led to the development of (metal) coins. This story is wrong, see Wray, see Graeber. But the myth still lingers, so, let’s at least take care that we know what we are actually talking about and take a look at these first coins. Be in for some surprises. A transferable ‘unit of account’ existed long before commodity money nominated in units of account (like golden coins or paper money). It came into existence, probably in Mesopotamia, to account for debts, and might be traced back to multiples of ‘one barleycorn’, or ‘one chick pea’; 1 shekel being 180 ‘barleycorn’ and 40 ‘chick peas’. Herodotus tells us that, reasonably close to this area, the Lydians were the first people to use metal coins, a statement which is corroborated by archeological finds. These first coins were made from electrum, a natural gold/silver alloy. The gold content of these first coins, probably issued by the Lydian rulers, is however lower than the gold content of natural electrum… Errr, yes, the hypothesis that the first coins were made to enable debasement can not be rejected. And the awareness of Herodotus and his interest in the precise weight of famous precious golden and silver objects (as well as of the artists who made them and the whereabouts of the objects, often the British museum Coryinthian treasure trove) lends credibility to the idea that these very first coins were deliberately debased. The work of Herodotus also shows that this society had the arithmetical and metrical skills necessary for the use of a monetary standard and trade. Interestingly, Herodotus also state that the Lydians were the first to have retail shops. The 64.000 shekel question: did the easy transferability of the kind of money lead to trade, instead of the other way around? Was money just a kind of grease – or a Schumpeterian invention which caused (and causes) massive changes in society? The answer seems clear.
Image 1. One of the first Lydian coins, with the symbol of the king (the rising sun). This coin consisted of electrum debased with silver and copper. These coins probably date from about 600 BC. At that time, ‘virtual’, non-commodity money already existed for at least a thousand years. Interestingly, this coin is 1/3 ‘unit’.
This all matters. The romantic view is conservative to its core, assumes ‘market behaviour’ as entirely natural and sees money as a benign, cost-lowering invention which is only used and not created by market participants. The credit crisis is, in this view, in the end not about money and banks and markets but about irresponsible governments, sticky wages and mooching Greek pensioners. Money is neutral in a multidimensional sense: it just enables market behaviour, it does not really change markets, or society. Problems are therefore in the end not caused by money itself – but by problems with the market system. How do you solve a financial crisis? Change the labour market, according to the ECB! The scientific view (elements of which are part of the official philosophy of the ECB, as shown) to the contrary sees central banks as less powerful, admits that lenders and borrowers together create money – as well as debts. This can be a benign process but it can also lead to all kinds of bubbles while the asymmetry between the anonimity and easy transferability of money on one hand and the personal and sticky character of debts on the other, combined with the asymmetries between the flexibility of asset prices on one hand and the utter rigidity of debt on the other can lead to a severe mismatches between borrowers and lenders as well as the value of collateral (houses) and debts (mortgages). Also, according to the scientific view money, monetary thinking and behaviour and monetary institutions are evolving all the time which enables the view that for instance the Troika policies are not aimed at restoring some kind of natural order – but at squeezing entire countries in the interest of panicking creditors.
Money is dynamite. And Peter Praet is working with it – without knowledge of the manual. Beware.
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Real-World Economics Review Blog 
“How do you solve a financial crisis?” Economists are ALL in the dark. Peter Praet is just MORE in the dark than others, for instance Steve Keen.
Find the REAL cause and then you might find the real solution.
Not one of the economists on this list has answered my repeated challenge to refute my theorem, and Steve Keen (Mr. “endogenous money”) has been personally invited to do so repeatedly for the past 10 months, but refuses to give it a try. As always the invitation is open.
The math and logic involved are accessible to a 5th grade elementary school child.
What are you economists afraid of? The TRUTH?
Click to access Incorrect_Diagnosis.pdf
http://paulgrignon.netfirms.com/MoneyasDebt/twicelentanimated.html
Paul, Steve Keen may not have a replied because he has already refuted one of the key elements of your argument that the interest payments on debt create a vicious circle where more debt has to be created to pay of the interest on existing. It is to do with conceiving of money as stock or flow. The velocity of money flowing from banks takes care of the interest (assuming of course that banks have fair rates of interest).
Also he’s already in dispute with 99% of his profession, I don’t suppose he is inclined to start a fight on another front.
Want also to say thanks for your film as it was my first introduction to the monetary system and I was shocked at how ignorant I was. It was a personal epiphany at the time and galvanized me into a learning more about money and economics.
Nell, I am happy that my first movie provided you with an epiphany.
But even in my first movie I stated that IF ALL INTEREST PAYMENTS WERE RECYCLED AS SPENDING available to the general public, there would be no problem paying interest. So the idea that interest is unpayable because the money to pay it was not created has NEVER been my argument.
In fact debunking the P<P+I fallacy is a big part of my campaign as so many otherwise intelligent "reformers" like Ellen Brown, Chris Martenson, Charles Eisenstein, Marc Gauvin and many others all fall for it and claim it is the cause of the "growth imperative".
You cannot have read my proof at all. Nor could you have seen Money as Debt II. Certainly you have not read my Banking Analysis in which the first thing I do is prove that it is essentially IMPOSSIBLE FOR INTEREST TO BE AN INSOLUBLE MATHEMATICAL PROBLEM.
http://paulgrignon.netfirms.com/MoneyasDebt/Analysis_of_Banking.html
Here's an excerpt.
"However, proof that ALL of the Interest can be supplied from the original Principal is not even necessary.
WHY? Because at any moment you need to pay Interest, THERE IS ALL THE MONEY IN THE WORLD TO DRAW FROM TO PAY THE INTEREST.
The idea of some inevitable real shortage of money IN EXISTENCE to pay the interest because P < P + I is a total illusion!!
More than enough money exists to pay the Interest. The pertinent (and limiting) issue is… is it available to YOU to be EARNED?
Debt money is someone's Principal. And anyone's Principal can be temporarily and repeatedly used to pay anyone's Interest, because interest is not extinguished. Therefore, successful payment of interest can NEVER produce the only significant mathematical shortage there can ever be, which is a shortage of Principal with which to extinguish Principal Debt."
Last December, Steve Keen told me he read my Analysis of Banking and would refute it. But he hasn't refuted it and given the fundamental misunderstandings in the only reply I did receive from him, I doubt that he read it either.
My proof assumes 100% RECYCLING OF INTEREST throughout. It also assumes that ALL BORROWERS ARE COMPETENT, capable of paying back their loans.
Try it out.
http://paulgrignon.netfirms.com/MoneyasDebt/twicelentanimated.html
Paul, as an example of the same “principal” being used to satisfy multiple private debts, look no further than this old story: http://smokeschool.net/moneycircle.htm
There is no theorem and no proof in these links, as far as I can understand it. I’d suggest to define your concepts and axioms, write down the statement you want to show as a formula in predicate logic, and do the proof (say in a sequent calculus). Then it becomes possible for someone to check your proof and your axioms.
The money circle story is exactly that, a contrived situation involving a perfect circle of debt. Any one of the debtors could have monetized their own debt as a voucher for redemption as all debts were equal and had this been a LETS system, obviously cleared already. They didn’t need a token from outside to represent what was in the end the prostitute’s debt to the hotel owner. Had the complete circle of debt not included a debt to the hotel owner for the full amount, the story wouldn’t work would it? The guest would come back, not get his money back , and call the police.
Should you wish to examine my theorem here’s the link.
http://paulgrignon.netfirms.com/MoneyasDebt/twicelentanimated.html http://paulgrignon.netfirms.com/MoneyasDebt/Analysis_of_Banking.html
Paul Grignon
Or he could have liked the room, stayed, and paid his bill.
Your comment is a non sequiteur. I provided a counterexample to your so-called theorem: any amount of bank money, no matter how small, can be used to extinguish an unlimited amount of private debt, if properly applied and circulated, so you do not need growing amounts of bank money to avoid disaster. Moreover, bank money is fungible, so there needs be no relation between the money that creates a debt and the money that extinguishes it.
Your argument may suffice to show that the world of finance always has the possibility of getting into a pickle, but not that this is an inevitable or even probable outcome. In an actual logic, CTL*, this is the difference between the propositions (AGEF crash) and (AF crash). Besides, as I showed above, there is always a way to get out of the stuck condition.
Paul, you are a victim of three great fallacies. 1. That debt is a bad thing. 2. That our current system overloads us with debt. 3. That the government cannot create effectively ‘debt free’ money if it needs to. All three are wrong.
Debt enables people to borrow money to invest in expensive items like a house, a business, or a university degree. Our current system ensures that debt does not exceed the amount of credit (which is money), so that debt slavery is avoided. Government creates money for spending when it issues bonds and these bonds need only have an interest rate that is the same as or lower than NGDP growth and they are effectively free money. Right now the US government can issue bonds at zero real interest rates.
What you should be calling for in your films is fiscal stimulus to maintain credit growth and thus growth of the economy during this slump.
Why not refute the logical proof as given? Instead you prefer distractions that have nothing to do with the logic I provided.
“Our current system ensures that debt does not exceed the amount of credit (which is money)”. Sorry WRONG! Read my proof.
Banks create money when they lend it but loans of existing money do not. Therefore it is perfectly possible for ALL money created as bank credit to be lent a second and a third, maybe N times by non-bank lenders during its possibly 20 year average circulation time. Estimates are that N = 3 times at least.
Once the bank credit is paid back to the bank and extinguished it leaves the dependent secondary, tertiary and Nth debts STRANDED with no money to pay them.
Unless sufficient new bank credit is created ON TIME to service the N debts dependent on it, there will be mathematically inevitable defaults. Therefore, whenever the creation of new bank credit slows down, people default, lose their homes, the banks crash, the economy goes into a tailspin by MATHEMATICAL CERTAINTY.
The way I see it the logic can’t be refuted. What we need is a quantitative figure for the lending of existing money versus money creation lending, as well as how much new bank credit the banks create to buy equities, to know how significant this dynamic is in the real world.
Paul,
There is nothing special about non-bank debts. If you buy a product or service, you owe the seller a debt. You always have to discharge that debt with your available bank deposits.
Unless sufficient new bank credit is created, not all desired transactions in the economy can be completed and there will be recession and unemployment. This is straight Keynes.
The most important type of ‘non-bank’ lending is tri-party repo, which is essentially fractional reserve ‘bank-type’ lending on top of bank credit. But repo creates both an asset and a liability. So repo acts as money too. Just unregulated money.
Unless sufficient new bank credit is created on time, people will default and lose their homes by mathematical certainty which, to me, is an unacceptable design feature of the system.
@BT London You have to discharge this debt of course (though I do know a seventeenth century contract which stipulated that a customer did not have to discharge a sizeable interest free initial debt as long as he (in fact: the married couple, not a trivial detail as this was a kind of risk hedging in a society with high mortality) stayed customer). But the other side of the debt (on the liability side of the balance sheet of the customer) is of course the ‘receivable’ on the asset side of the seller. This is in fact a kind of (temporary) money, used to pay for the transaction and created by the buyer. Nowadays, ‘receivables’ are of course reasonably liquid, as a company can use them as collateral to lend or can sell them to specialized companies.
The point: we are the ones who create the money. Not central banks.
There is ancient Egyptian text that the soldiers that apprehended tomb robbers of a royal grave circa 1750 B.C. were paid in gold. I assume it was in set units/weights, if not in actual coins.
Lydians may have been the first to “coin” it, but “talents” of gold existed way back before the days of the original “Judea” (Itj-tawy region of the northern Egyptian delta) and the original Jerusalem (Urusalim…aka Thebes of Lower/southern Egypt, the original “Israel”), the real “Two Kingdoms” of the Torah/Old Testament.
There was no “Israel” (the first “Israelite King”, Hezekiah, was in fact an Egyptian prince/priest of both Amun/Amen and Aten, proof of which is clay bullae with his name and the winged disk of the Aten on them) …and Shekels are named after the Sea People tribe that invaded that area circa 1120 B.C., called the Shekelish by scribes/historians of that era.
Images of their soldiers, wearing skullcaps and taken captive by Ramses II are carved in stone.
BTW: the builders of the Nile civilizations came from India, passing through Mesopotamia/Ur/Sumer on their way.
All you have to do is read any standard text on ancient Mesopotamia (George Roux, Kramer are both good). Trade long predates coins or standard units of any kind. Credit predates standard units. Standard units denoted obligations for at least a millenium before coins. In what other field would it be possible to get (well-documented) history so wrong?
That’s exactly the thing. I’m a complete dilettante when it comes to pre-1505 AD money. Even then, a quick glance suffices to see the nonsense of the ‘markets without states’ vision of the development of coins.
Ours is a monetary economy not a “money is a veil over barter” orthodoxy affirming reality for DSGE theorists to latch onto, as well as obscuring distraction for Bankers to foment to hide their own monopoly on credit.
Money is a spectacularly useful and accurate tool that will be around for a while yet. You simply have to account for it correctly. That is why it is so vital to recognize that the subset of double entry bookkeeping is where the nexus of finance and economics lies along with the most deeply embedded and dynamic factor of all economics, namely cost is found. Hence the rule of COST accounting that all costs must go into prices underlies and dynamically/continually enforces the economic reality of a scarcity of individual incomes in ratio to costs/prices. Of course there is no theoretical limit to prices on the upside except what the market will bear, but the more underlying price inflationary/individual income deflationary nature of commerce/the economy is the more relevant fact missed by economists as the most fundamental problem causing economic instability.
Here is the rebuttal Paul Grignon claims to seek (mid way through the attached page), the problem is really semantics and a rejection by Paul to understand the finer nuances, etc. This leads him to not understanding what is being said by others that do. Concretely, stability of a money system is not determined by whether or not interest can be paid but rather if the growth is unbounded or not. These fine points are discarded by Paul as unimportant, but they are all too important with regards to system dynamics. He also lacks an understanding of what mathematical proofs consist of and has not to my knowledge provided one so his claim that none have refuted his ‘proof’ is largely because he simply has not provided one. I know that he is convinced and others too but that does prove anything.
http://bibocurrency.com/index.php/downloads-2/19-english-root/learn/194-answering-paul-grignon
‘I know that he is convinced and others too but that does prove anything.’ above should read ‘…does NOT prove anything?
I agree with every word of the actual verfiable conclusion of Gauvin’s report which simply states the obvious truism that debt at interest left unpaid approaches infinity. I also agree that interest and fees charged for financial services adds to the cost of everything. So does transportation, excess packaging, advertising, retail display and gross wastefulness.
I have thoroughly and repeatedly disproved Marc’s assertions and yet he returns each time as if I hadn’t. Quite incredible actually.
I have a logical proof of instability as defined by ME as mathematically inevitable recessions and foreclosures that are caused by the design of the money system itself. I prove rigorously how this would happen even in the complete absence of interest. Marc has been told of the existence of this proof and challenged to refute it for many years now. He doesn’t because he can’t. Instead, he invalidates it as not fitting his inappropriately limited definition of instability.
paulgrignon.netfirms.com/MoneyasDebt/MAD2014/problem5.htm
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/twicelentanimated.html
Sorry Paul, but pictures and prose do not constitute a mathematical proof, when and if you provide formal mathematical model that I have requested from the start, we can continue. If you know the principle of superposition it is trivial to realise that the following proof is true for any sum of such loans in series or in parallel:
Proof that 100% of P+I of any loan can never be fully satisfied on its own Principal alone.
P = Outstanding Principal
I = Total interest over k periods.
i = interest payment per period
p = principal contributions to payments.
k = remaining periods within the term of the loan.
P also represents all available money in the system, such that all and any paments (p+i) must necessariy come out of outstanding P AT ALL TIMES.
The standard equation for oustanding debt over k periods is:
Debt = P(1+ik)
Because at all times P 0 can P+I be fully satisfied by P.
Because outstanding P (principal) is also equal to all the money in circulation at any point in time, and all p+i payments necessarily come from P, then it is clear that on the last payment k, P = p (now all the remaining Principal in the system)!
Therefore and since on the last payment P = p it follows that not all p+i payments can be satisfied over the term of k payments and therefore not all P+I (sum of all p+i over k payments) can be satisfied over said term.
End of proof.
Just try it, using a page of math no more, that is all that is required. Don’t be afraid to formalise it.
Likewise with your twice lent theory a presentation is not what is required, if you want to prove your theory you have to provide a full representation in math otherwise you cannot call it a proof. I know that you are convinced we all are aware of that, but repeating out loud how much your are in as many ways as you do, is not going to constitute a mathematical proof and won’t help answer the questions i raised.
You have already rejected the formal definition of stability in favour of one based on pay-ability without realising that pay-ability can’t represent the phenomenon as comprehensibly while the formal definition fully accounts for pay-ability or lack thereof.
I look forward to when you provide more detailed and rigorous representations of your theories.
Paul was actually closer to the truth in his first set of videos with his treadmill concept than his current thinking, except instead of interest being the factor that disequilibrates the system it is the actual processes and time delays of commerce itself held in place by the conventions of cost accounting which is the culprit. Debt itself (not interest) has no naturalizing, countervailing paradigm to bring balance to the economic system. As even zero percent loans exact a cost to the individual consumer (and inadequate aggregate individual effective demand is the rock upon which macro-economic policy falters) monetary grace the free gift of credit to the individual…is its solution.
There’s a solution that doesn’t involve government or “monetary grace”.
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/GYCdemos/supplychain.mov
I have to state that the Points raised by Paul are (though he approaches it from the other side) related to the debt deflation ideas of Irving Fisher. See also this article by Mason and Jayadev about Fisher dynamics of household debt: ON AVERAGE people do not borrow to consume – but to SERVE THEIR DEBTS http://repec.umb.edu/RePEc/files/FisherDynamics.pdf
I perused the Fisher document Merijn. My argument is so much simpler!!!!
I want to make it clear that there is no need for any individual consumer to borrow to pay past debts to create “twice-lent” money. The system’s DESIGN is “twice-lent money”.
Banks create money as a debt of legal tender on demand on a schedule (lent once). Depositors lend the same back to the banking system INDEFINITELY (lent twice). Therefore, all bank deposits, except new unspent loans, are “twice-lent money”. Savings are the indefinite (in real life permanent) INTERRUPTION of timed credit cycles. Therefore savings (exacerbated by income disparity) are the cause of system instability.
If I borrow (create) $1000 from a bank on a schedule for repayment, and $750 of it is tucked away in someone else’s savings indefinitely, how do I pay off my debt? If only $250 of it is available to be earned debt-free, then the remaining $750 I paid my debt off with must have been borrowed into circulation by someone else.
Once I extinguish it, and the $750 remains in savings, that loan will be short $750 of Principal just as mine was. And thus is created the Perpetual Debt Level of $750. If the next necessary borrower from a bank creates less than $750 and the savings remain the same, someone somewhere must default by mathematical certainty not by any fault of their own. If a borrower from a non-bank borrows the $750 of existing savings into circulation, that $750 will be extinguished when paid to the originating bank leaving a $750 shortage.
Either way, the Perpetual Debt of $750 must be maintained ON TIME to prevent default. In practice, debt to banks must increase at all times or mathematically certain defaults will happen. I contend that this is the real root of the growth imperative because it happens even in the complete absence of interest.
Once viewed in this perspective, is this not what is clearly happening in this familiar graph?
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/problem5.htm
M2 (total scheduled debt) rises constantly while M1, spending money rises and falls. Whenever M2 and M1 diverge for 4 years, meaning new debt-on-a-schedule money was created and all or most of it went into savings, a peak of foreclosures, a recession or both occur. It’s readable directly from the graph
I offer a very simple logical causation and real world evidence to back it up!!!
The scientific approach demands that I invite refutation from anyone and everyone capable of doing so, which I have now been doing for 5 years. Economists don’t seem to like the scientific approach. Only one economist/mathematician/physicist has made the attempt and he conceded he could not refute it.
Merijn invited me to write a paper on it but hasn’t attempted to refute it. It think economists find the utter simplicity below them somehow. To me this argument is irrefutable and so simple that , if true, hari kiri of the entire economics profession would be appropriate. Perhaps that’s why no one will take the challenge?
http://peemconference2013.worldeconomicsassociation.org/?paper=proposed-new-metric-the-perpetual-debt-level
Incorrect. The system’s design is the rate of flow of costs/prices will always tend to be greater than the rate of flow of individual incomes simultaneously produced. “Twice lent money” as savings was identified as one of several factors creating the chronic and continual gap between aggregate individual incomes and aggregate costs/prices almost 100 years ago by C. H. Douglas.
Calculus alone is never going to get one to a convincing economic Valhalla, not because the numbers may not identify the actual problem as above, but because there is too much blue smoke and too many mirrors along the way to get a crowd as erudite and committed to erudition as economists are…..to agree upon. Now calculus AND Wisdom being an integration of Man’s dual mental nature might actually get you there. If this is true, and if the economy is actually monetary as opposed to being “a veil over barter” as DSGE economists have intoned, then the questions to ask are what is the missing and ultimate policy Wisdom (monetary gifting directly to the individual both as a dividend and as a discount to prices) and what are the mathematical ever changing monetary calculations to be made and distributed in the dividend and the discount that will result in a sustained equilibrium?
Calculus and Wisdom. Both of these things. Numbers and where to apply those numbers for an actual transformational effect on the economy and the most optimally ethical result as well.
Thanks for providing a concrete scenario. However, your claim that someone necessarily must default is false.
As an axiom, financial assets net to zero (NFA=0) – each person’s financial asset is someone’s liability. In your scenario, the saver has a claim on the bank for $750, the bank has the corresponding debt to the saver, and the NFA of the rest of the world is zero.
Assume that each individual (not counting the saver) has NFA 0, and that the single bank will lend money interest-free at par against other financial assets.
Then there exists a simple sequence of transactions that turns the gross financial assets of the rest of the world to zero, i.e., distinguishes all other debt:
1) All individuals borrow against all their non-money financial assets (claims on other individuals).
2) All individuals repay all their debts with money.
If you relax the condition of lending at par, and do not permit other lending, then the sequence of transactions may be infinite, although debt will monotonically decrease with time. If you relax the condition of interest-freeness, then banks will accumulate claims over time, of course. If there are individuals with NFA < 0, they will not magically become debt-free.
So as long as banks provide enough liquidity, it is possible to net out all debt.
ferridder wrote: “Thanks for providing a concrete scenario. However, your claim that someone necessarily must default is false.
As an axiom, financial assets net to zero (NFA=0) – each person’s financial asset is someone’s liability. In your scenario, the saver has a claim on the bank for $750, the bank has the corresponding debt to the saver, and the NFA of the rest of the world is zero… Assume that each individual (not counting the saver) has NFA 0,”
STOP right there.
You can only assume that by forgetting where the $750 came from!
The borrower who created the $750 is in debt for it to the bank that created it and actually has a NFA of -$1000 (plus interest that will grow exponentially if unpaid).
Here’s how I explain it to normal people. People who need money create it by borrowing it and then people who don’t need money keep it and collect interest on it, making it necessary for the people who don’t have money to borrow more debt-money into existence to pay off their past debts. If the banks won’t lend or borrowers won’t borrow enough on time, people lose their homes.
I’ll restate my proof in your terms:
Bank 1 NFA (only the interest) creates bank credit for
Borrower 1 NFA -$1000
This is DEBT payable in itself ONLY. There is no corresponding principal asset to the bank as it creates the money from the borrower’s debt and it is extinguished by repayment. The bank cannot spend it . Therefore it is not an asset. Only the interest and fees are spendable.
Banks 2,3,4 etc NFA – ($1000 + interest)
owe their
Depositors 2, 3, 4 etc. NFA + ($1000 + interest)
This is the money needed for repayment.
According to this Federal Reserve graph:
http://paulgrignon.netfirms.com/MoneyasDebt/MAD2014/problem5.htm
At ALL POINTS IN TIME, an average of 75% of all money in existence is locked away in various forms of savings, UNAVAILABLE to be earned, only borrowed.
Therefore only 25% of the existing scheduled debt can be extinguished from the principal it created. Therefore, all principal payments must on average be 75% drawn from NEW DEBT and sufficient new debt MUST be created ON TIME to satisfy the previous debt schedule. Otherwise there will be mathematically certain defaults in which borrowers default simply because the principal they created is in someone else’s possession.
When savings reached 81% the Great Crash of 2008 happened. In fact, on the linked-to graph above, mathematically caused debt-clearing events happen every time that new money goes straight into savings for 4 years in a row.
ALSO…
In that highly contrived banknote at the hotel mind trick there was a perfect circle of debts at the beginning, netting out to ZERO. There was NEVER ANY DEBT TO CLEAR.
Proof: If the prostitute didn’t owe the hotel owner, she would keep the banknote. Everyone else would be paid off but the hotel owner would have an NFA of exactly MINUS ONE banknote to the angry visitor.
Your main issue seems to be whether money becomes available to be earned again. In countries where banks issue CDOs, the principal payments are typically passed on to the CDO holders, so the money becomes available to be earned again. Then the question arises what banks do with the money paid in by savers: they typically buy financial assets, also here making the money available to be earned again.
So your description of how the financial system works is at odds with reality, and there is a distinct lack of a mathematical proof in anything I have seen of your writings. I would suggest that you refrain from using the terms “mathematically” or “proof”, until you actually have set up a model and made a formal proof. I would be very interested to see that.
Another thing. You state that
“This is DEBT payable in itself ONLY. There is no corresponding principal asset to the bank as it creates the money from the borrower’s debt and it is extinguished by repayment. The bank cannot spend it . Therefore it is not an asset. Only the interest and fees are spendable.”
You seem to be using a different definition of financial asset from the rest of the world. Using the standard definition, the IOU of the lender is an asset to the bank. The repackaging of borrowers’ IOUs into CDOs was a major player in the financial crisis, for instance.
To restate the point of my post: if banks are willing to lend (temporarily, against financial assets only), then it is always possible to net out debts, irrespective of savers’ balances. Recall the banknote at the hotel: there the guest basically acts as a bank. Of course, if somebody has negative NFA, then they will still be in debt after netting.
Sorry, “IOU of the lender” should be “IOU of the borrower” (and in my previous post, “distinguishes” should be “extinguishes”).
“The intuitive mind is a sacred gift and the rational mind is a faithful servant. We have created a society that honors the servant and has forgotten the gift.” Albert Einstein