In their working paper Assessing UK money supply measures in the light of the credit crunch, Toby Baxendale and Anthony J. Evans provide a better measure of the money supply. In this article, Steven Baker explores the background to the paper and indicates some key findings.
This article was originally published in October 2009.
Many people know the Bank of England is creating new money through quantitative easing but if the quantity of money is being increased, how is that quantity being measured? What is counted as money?
As the Bank of England explains:
When the Bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero.
So if they are almost at zero, and there is still a significant risk of very low inflation, the Bank can increase the quantity of money – in other words, inject money directly into the economy. That process is sometimes known as ‘quantitative easing’.
But when I consider quantitative easing, I am concerned with the following problems:
- It is not clear that the Bank of England has a useful definition of the money supply. The present measures do not correspond to economic activity — which is what the Bank is trying to increase with new money — and this crisis was famously not foreseen.
- As commentators have reported, “the Bank’s Governor, Mervyn King, seemed pretty confident that QE could work. But even he would admit he has no idea how long it will take – or how much money he will have to print to get there.” This uncertainty seems less than ideal given the risk of price inflation.
- As the end of the present round of QE approached, it appeared it was not working.
- According to Austrian-School economic scholars including Hayek and Huerta de Soto, injecting new money can create only a harmful illusion of prosperity1.
As my colleagues point out in their working paper, the fact that the monetary authorities have turned to increasing the quantity of money will focus attention on how that quantity is measured. This article provides some background information and indicates Baxendale and Evans’ key findings.
Conventional measures of the money supply
Today, the Bank of England publishes two measures of the money supply: “narrow money”, which is notes and coins (M0), and “broad money”, which is money in bank and building society accounts (M4).
Look a little further and you soon find that at least three different measures of the quantity of money are — or have been — used by various monetary authorities (M1, M2 and M3). Look back at the Bank of England in more detail and, confusingly, you find “M4”, “M4 excluding intermediate OFCs”, “M4Lx” and “M4Lx excluding intermediate OFCs”; these measures give quite different results, particularly during the recent crisis:
You might wonder if money can be counted at all or which measure is meaningful. You might wonder if the monetary authorities can effectively monitor the quantity of money in the economy as they add more.
Studying the history of the various conventional measures of the money supply is dispiriting. We find that the Federal Reserve abandoned M1 in 1987, M2 in 1992 and M3 in 2006. The Bank of England abandoned M0 in 2006. We have to ask not just whether those measures were useful, but whether they were the right measures at all.
So what is money?
A barter economy can only take society so far. A software engineer, marketing consultant or economist would have to look a long way indeed to find a cobbler who would swap a pair of shoes for their services.
In The Theory of Money and Credit, Mises writes:
Where the free2 exchange of goods and services is unknown, money is not wanted. In a state of society in which the division of labor was a purely domestic matter and production and consumption were consummated within the single household it would be just as useless as it would be for an isolated man. But even in an economic order based on division of labor, money would still be unnecessary if the means of production were socialized, the control of production and the distribution of the finished product were in the hands of a central body, and individuals were not allowed to exchange the consumption goods allotted to them for the consumption goods allotted to others.
That is, we find we have a choice between a tribal society, communism or a system based on money.
Money emerged to support a growing market economy, to enable individuals to cooperate to fulfill their wants. Rothbard defined money as follows:
Money is the general medium of exchange, the thing that all other goods and services are traded for, the final payment for such goods on the market.
But more specifically, these Northern Rock customers knew what they wanted; they wanted notes and coins:
Northern Rock, originally uploaded by ewanmcdowall
However, most of the time, we buy goods and services using debit and credit cards or even cheques. As Mises writes:
When an indirect exchange is transacted with the aid of money, it is not necessary for the money to change hands physically; a perfectly secure claim to an equivalent sum, payable on demand, may be transferred instead of the actual coins. In this by itself there is nothing remarkable or peculiar to money. What is peculiar, and only to be explained by reference to the special characteristics of money; is the extraordinary frequency of this way of completing monetary transactions.
So, as members of the public, we can be quite clear: money is notes3 and coins, plus your bank balance, which you transfer in various ways.
The Bank of England’s definition of money
The Bank of England defines broad money — the measure which is more than just notes and coins — as follows:
M4 comprises:
The M4 private sector’s (i.e. the UK private sector other than monetary financial institutions (MFIs)) holdings of:
- sterling notes and coin;
- sterling deposits, including certificates of deposit;
- commercial paper, bonds, FRNs and other instruments of up to and including five years’ original maturity issued by UK MFIs;
- claims on UK MFIs arising from repos (from December 1995);
- estimated holdings of sterling bank bills;
and
from end-1986, 95% of the domestic sterling interbank (now inter-MFI) difference (allocated to wholesale deposits/other financial corporations, the remaining 5% being allocated to transits). This followed a review of its causes (see page 101 of the June 1992 Economic Trends).
Baxendale and Evans’ definition of money
With reference to the work of other Austrian-School economists, Baxendale and Evans consider an asset to be part of the money supply if:
- The asset is continuously owned by the depositor.
- The asset has a cash value which does not fluctuate.
- The asset is redeemable on demand.
- The asset is commonly agreed to be legal tender.
- The asset is a final means of payment.
Applying these theoretical criteria, the authors show that the money supply consists of:
- Cash.
- Demand deposits with commercial banks and thrift institutions.
- Government deposits with banks and the central bank.
And excludes:
- Savings deposits, which can only be spent via demand deposits.
- Money market mutual funds, retail market funds and other securities, which must be sold for money.
- Certificates of deposit, which have a notice period.
- Retail goods, which must be sold for money.
- Travelers’ cheques, which are a credit transaction.
The authors explain that the conventional measures of the money supply fail to correspond to economic activity not because the problem is intractable, but because the other measures lack a thorough theoretical basis for their composition.
Counting money by these criteria provides some important results.
By charting their actual measure of the UK money supply — MA — against the traditional measures, industrial production, GDP and retail sales, Baxendale and Evans show that MA differs by offering a close approximation to economic activity.
For example, consider this chart which plots, over the past ten years, the rate of change of retail sales and MA offset by 12 months:
We find that, unlike the measures published by the Bank of England, MA provides a useful indicator of economic activity.
Conclusion
It appears the Bank of England’s measure of money is less useful than a measure based on sound Austrian-School economic theory. Interestingly, for all the thousands of pages of theory written over many decades, the Austrian-School definition corresponds quite closely to the common-sense understanding of everyday people cooperating in the economy.
“Money is the general medium of exchange, the thing that all other goods and services are traded for, the final payment for such goods on the market.” This insight provides a better measure of the money supply.
In an era of quantitative easing, we should care how money is measured and, in the light of the usefulness of this Austrian measure of the money supply, we should pay more attention to another area of Austrian theory: the idea that the economic activity produced by new money lasts only as long as the supply of new money and that new money cannot be created forever.
Further reading
- The Bank of England, Quantitative Easing Explained
- Toby Baxendale and Anthony J. Evans, Assessing UK money supply measures in the light of the credit crunch
- Mises, The Theory of Money and Credit
- Mises, The Austrian Theory of the Trade Cycle
- “The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate. What this policy has produced is not so much a level of employment that could not have been brought about in other ways, as a distribution of employment which cannot be indefinitely maintained and which after some time can be maintained only by a rate of inflation which would rapidly lead to a disorganisation of all economic activity.” Hayek, 1974 Nobel Prize Lecture [↩]
- “Free” as in “freedom”. [↩]
- Bank of England notes still have written on them “I promise to pay the bearer on demand the sum of ten pounds”. We might reasonably ask, “Ten pounds of what?” [↩]
Interesting post: congratulations.
Clearly you have identified a monetary measure more in line with reality than the conventional mess.
I see you quote Rothbard:
“Money is the general medium of exchange, the thing that all other goods and services are traded for, the final payment for such goods on the market.”
I think Rothbard’s assumption is in error.
Money is not an object – a thing – it is a relationship.
As John Law put it in 1705 in “Money & Trade Consider’d…”
“Money is not the Value for which Goods are exchanged, but the Value by which they are Exchanged”:
E C Riegel in his “Flight from Inflation” summarises the monetary relationship as follows:
“The purpose of Money is to facilitate barter by splitting the transaction into two parts, the acceptor of Money reserving the power to requisition Value from any trader at any time.
The method of Money is to employ a concept of Value in terms of a
Value Unit dissociated from any object. The monetary unit is any adopted value, which value is the basis relative to which other values may be expressed.”
I prefer to define terms slightly differently.
A monetary system as I see it comprises goods and services circulating with “time to pay” (aka credit) by reference to a Value Standard (Unit of measure) and within a framework of trust.
By way of example there is the Swiss WIR – a trade credit clearing system, which has been operating since 1934 – and where billions of Swiss Francs’ worth of goods and services change hands not FOR fiat Swiss Francs, but by reference to Swiss francs as a Value Standard.
The framework of trust – ie the enforcement mechanism or protocol in respect of debit balances – is provided by charges over WIR members’ property. ie the WIR is a property-backed monetary system.
There are numerous proprietary barter systems all incorporating credit/time to pay – such as Bartercard – and all of them are monetary systems in microcosm.
What the Austrians think of as money, I would define as currency, being the unit of value FOR which people are accustomed to exchange goods and services.
John Law is relevant again here:
“Every thing receives a Value from its use, and the Value is raised, according to its Quality, Quantity and Demand”.
By that criterion gold is not really much of a currency, because you cannot live in it; heat your home or run your car on it; or type an email with it.
In my view, the three basic factors of production which have a generally acceptable use value are location (ie a Unit redeemable in land rental value); Energy ( eg a Unit redeemable in – say – 10 Kilowatt Hours) and Knowledge (ie the time value of intellectual property and the time value of an individual’s innate knowledge, experience, gumption, contacts and everything else that dies with him).
It is our capacity to carry out unqualified labour (manpower) and our knowledge, individually and collectively, which back the credit we may issue as a soverign individual.
But note that most of the bank created “money” in existence today is in fact based upon the use value of land, having come into existence as interest-bearing loans backed by mortgages. ie our money is largely deficit-based but asset-backed.
In my view, there is a fundamental qualitative distinction between “money” in circulation – which you have successfully isolated – and the vast bulk of money in existence which is what inflated asset prices (particularly land), and is essentially static.
All that QE does is replace this property-based private “static” credit with public credit. This money=credit can only cause inflation if it is lent or spent into circulation.
Since most UK wealth has become concentrated in few hands – which is what always happens when compounding interest combines with private property in land – then the solution to the crisis must necessarily involve systemic fiscal reform
This is in addition to a new approach to re-basing currencies upon Value generated by the issuer; rather than upon a claim over Value issued ex nihilo by a credit intermediary.
Chris Cook,
The first part of your message is a description of the difference between money as the “medium of exchange” and money as the “unit of account”. I agree that both are important.
The last part shows you have been paying too much attention to the Georgists and amateur monetary theorists on the internet, IMO. Read up on the criticism of Georgism.
It all sounds very smart – if only we the mortals would understand it.
Imagine one Monday morning the Great Britain wakes up with the following headline:
The Presses are Running
Below we read:
“Toby’s plan is approved!
The government is printing approx £850 billion in cash and shipping it to banks.
Banks are not giving anything in return. It is a gift from the government so the banks can have cash in their vaults corresponding to every pound deposited in any checking account.”
You guys have one hour before the banks open to stop the panic. What do you tell the crowd?
> Banks are not giving anything in return.
You don’t understand. Toby’s plan is to sieze the assets of the banks, that correspond to demand deposit accounts.
> It is a gift from the government so the banks can have cash in
> their vaults corresponding to every pound deposited in any
> checking account.
No, Toby is proposing to completely change the legal relationship between banks and customers. At present checking accounts are a loan to the bank by the customer. After the reform and the move to 100% reserves checking accounts are a “bailment”, they belong to the customers and not to the bank. None of the extra money that goes into the bank vaults belongs to the banks.
Current, Toby said it is a gift from the government. The government is not getting anything in return – he said that in comments on the original post. Who is seizing the assets of the bank? Nobody in Toby’s plan.
He is just annulling the paperwork without paying the loans back to the people who deposited it.
He said: the government will pass a law that the banks do not owe anything to the people anymore?!?
Unless you are Stalin and the depositors are enemy of the people – a government won’t pass such a law.
Ellie;
You are correct, and this is where Toby’s plan totally falls apart. He states that the government prints money and delivers it to the banks, and also that this is non-inflationary (as he wrongly asumes that because the money already exists as demand deposits, it is not new money).
What happens if those depositors withdraw their demand deposits though? Suddenly the new moeny is in the system, and the bank is left with a government facing liability. Its value only increases because the government is gifting it money, not because of any intrinsic change in it’s structure….it is effectively QE.
Sure, the government can print money via QE and pay of it’s debt, and give us all tax cuts. At the same time though, it will busily be be debasing the currency, promoting inflation and crushing investment. It’s not a solution.
What of course is really happening is that Toby is confusing (and trying to replace) fractioanl reserve banking, where there are limits to the amount of credit created set at two levels (1. reserve requirements 2. availability of short term money market liquidity) with quantative easing, and he gives the control of QE to commercial banks rather than the BoE.
Footnote/example: This is the example I gave to Toby regarding his plan, which he never gave a proper counterexample to.
I set up a bank and another company. I attract depositors to my bank, and then lend the money to my other company at very favourable rates. Let’s say I attract £100m of deposits, and I lend it all to my other company.
The government comes and gives me £100m, to secure all my depositors money in cash. I return this (new) money to my depositors, making them whole and fulfilling my legal obligations to them. I then have my company repay the loan to my bank.
I am left with a situation where I have a company worth nothing, and a bank with no depositors but £100m in equity capital, generated from a gift of government.
Of course, I’m not even going as far as the idea could go….what I really should be doing is recycling the depositors money through several shell companies, after each company in turn becomes a depositor (of it’s loan money) at my bank. That way I could bolster the £100m I was otherwise going to recieve and make it billions – without doing anything technically illegal.
Tyler,
I guess Toby will tell the crowd something like:
– Don’t panic, pick a number in the line – you will get your money as soon as the government prints them and delivers them.
At this moment everybody will try to buy something of value with the UK currency assets they have. But nobody will be accepting sterling. Thus the official UK currency will be destroyed and with it – all the thin air behind it.
Heck of a plan!
Unless government is printing not a UK currency, but some special new currency that will stand for the demand deposits money.
Nobody will want this new currency (because they are used to the IOUs and they think of it as UK pounds – although it is a different kind of money in the philosopher’s mind, where everything is not as it seems to be) but this is a problem for those losers who deposited their money. Although it is the same money – represented by e new currency.
In which case the crowd turns away from the bank and moves in front of 10 Downing street.
What do you tell the crowd before it enters the building?
Ellie,
Present day money is fiat money. After the change it would still be fiat money. There is no real difference.
I agree that if there is widespread price inflation then people will stop accepting it.
Current, you will need a better crowd control than that :)
Do not try this line in front of the crowd waiting for their freshly printed cash or you may end up in a FIAT ambulance.
Just kidding.
Current, where did the money that the people deposited go? Lost, stolen, burned, damaged, hidden? Where did they go?
Why do you need to print those money again?
Clearly it was lent out.
Current, that is a very sane answer! Me like it and understand it! We are making progress.
Now, can the bank collect whatever money they lent so the people can have their deposited money back instead of government printing money?
Can the bank take a loan to pay back the folks with the deposits while waiting for collecting its own lent money – instead of government printing money?
Why is the Gov printing new £850 billion again?
Current, if the money were lent out – that means that the money is not in the bank.
That means that they cannot be swapped for the new printed money? If the money is not there the bank has nothing to swap?
Explain, please, why I am wrong.
A bank deposit is a loan. It is a loan from the customer to the bank. In exchange for the services of the bank the customers lends money to the bank. The bank then lend this money out to others, as mortgages and so on. Each loan is an asset of the bank.
Savings and current account customers loan to the bank. Then the bank loans out to borrowers such as those wanting mortgages. As a result a bank holds a similar amount of assets (loans) to the amount of debt it owes. A bank aims to always charge slightly more for loans than it spends on everything else, that leaves a margin for profit.
The bank keeps a ledger, a database, of how much it owes each customer, that is what a bank account is. As Toby says earlier a bank statement is a statement of how much the bank owes you. Similarly, a mortgage statement is a statement of how much you owe the bank.
Banks are not warehouses for money as some people think. Toby’s proposal however is to make banks into warehouses for money. After his reform for demand deposit accounts banks will be required to hold cash. Rather than a bank account being a loan it will be a “bailment”. It will be like a safety deposit box, the bank will not be able to lend it out or invest it. Like the contents of a safe deposit box it will not appear anywhere on the balance sheet of the bank. The cash will at all times belong to the customer, the bank will only be it’s guardian until the customer wants it.
Toby suggests doing this by using the information banks hold in their databases on how much they owe us. This debt will be wiped out and replaced with a sum of actual cash. As I said above this cash will be held by the bank but not owned by them. If only this were done then it would make the banks extremely rich because a great part of their debts would be wiped clean and they would still have a huge amount of assets. That’s why Toby suggests taking a similar amount of assets from the banks and using them to pay off the national debt.
I think this plan wouldn’t work well, for reasons I haven’t mentioned here. However, it’s quite possible to implement the plan.
Current, you have a talent! I understand most of it. I really appreciate your effort to go to my level.
And here is how it is supposed to be done in my opinion.
When the folks who pay their mortgages make their monthly payments to the bank – the money has to go to the vaults and not being lent. At the same time the new deposit’s money should go to the vault and not being lent.
Keep doing it until you have 100% reserve. After that you can lend the money coming from mortgages and profits.
That way – the bank holds it and no money is printed.
Of course, there will be no lending for some period.
To prevent that – you can do Bush-style TARP government loan to the banks that they can repay when they achieve 100% reserve requirement and start lending and doing profits again.
Where I am wrong?
I’ll reply to several of your questions in one place…
> Current, Toby said it is a gift from the government. The government
> is not getting anything in return – he said that in comments on the
> original post. Who is seizing the assets of the bank? Nobody in
> Toby’s plan.
This is what Toby wrote as his point 6:
# As for the banks, not having you the depositor as a liability
# anymore, they will suddenly be £850 billion better off, with no
# current liabilities and only assets (loans to business etc), post
# reform. The government can now put those assets into Mutuals, which
# would then immediately pay off the national debt, and leave the
# banks in exactly the same position net worth wise as they were
# prior to the reform, owned by their existing shareholders. As the
# national debt is still just under the £850 billion, which would be
# available as surplus assets of the banks, this could still be
# achieved.
By “The government can now put these assets into Mutuals” Toby means “the government will take these assets from the banks and put them into mutuals”. There are other slightly ways this could be done. But, what all of them would effectively mean is that the government would sieze some of the assets of the commercial banks.
> Current, the information database about the demand deposits is
> not part of the money supply. The money that people deposited is
> part of the money supply.
No. The “Money supply” includes notes and coins and balances in demand deposit accounts.
Demand deposits are called “money substitutes” because they perform the same tasks as money. They are acceptable as payment just as normal note money is.
This is how economists look at things. On the one hand we have notes and coins, these are called “base money”, “money in the narrower sense” or “outside money”. On the other hand we have “money in the broader sense”, that’s given by the equation below.
Money in the broader sense = Money in the narrow sense + demand deposits.
When we talk about money supply we mean the stock of “Money in the broader sense”.
> If the bank lent the money – that means the money is no longer
> in the bank.
>
> Toby is swapping cash for paperwork.
Yep, that’s exactly what he’s suggesting. The intention is that after the reform:
Money in the broader sense = Money in the narrower sense.
After the reform there will be no demand deposits based on debt. For every demand deposit the bank will hold the same number of notes. The banks will be a sort of warehouse service that holds notes on behalf of it’s customers.
The bond banking business will continue as normal though.
> Is he adding to the bank’s assets £850 billion or not?
>
> Is the UK government so rich it can gift £850 billion to the fat
> cats in the banks?
The addition isn’t to the bank’s assets. Two things are happening at once. At present a bank account is a debt from the bank to the customer. Toby’s plan aims to change this so that a bank account is a “bailment”. After it is implemented for demand deposit accounts the bank will be like “warehouse”. When you take things to a warehouse the value of your possessions are not included in the accounts of the warehouse. Your possession aren’t *lent* to the warehouse, rather you keep possession of them all the time. The warehouse is only a guardian.
That’s why Toby writes:
# Thus, if you deposited £100 once thinking it was “yours,” it
# now really exists in cash, with the bank acting as custodian of
# your money.
> What is this money? Tax-payer money? Whose money is it?
>
> Is this money or just worthless paper? If it is paper why it is
> turning into money?
Toby’s proposal is to *print* £850 billion. However, doing so will not alter the money supply because it will be cancelled out.
Here is the situation before reform:
Money in the Broader sense = Money in the Narrower sense + Demand Deposits
Money in the Narrower sense = £49.8 billion
Demand Deposits = £1042.4 billion
Money in the Broader sense = £49.8b + £1042.4b = £1092.2 billion
I think my numbers are slightly different than Toby’s because they are newer.
Then, after the reform all of the £1042.4b of demand deposits is converted into notes and becomes the possession of the account holders. So we have:
Money in the Broader sense = Money in the Narrower sense = £1092.2 billion
The old “demand deposit” contribution no longer exists.
> And here is how it is supposed to be done in my opinion.
>
> When the folks who pay their mortgages make their monthly payments
> to the bank – the money has to go to the vaults and not being lent.
> At the same time the new deposit’s money should go to the vault and
> not being lent.
>
> Keep doing it until you have 100% reserve. After that you can lend
> the money coming from mortgages and profits.
>
> That way – the bank holds it and no money is printed.
>
> Of course, there will be no lending for some period.
The problem with that is that there is only £49.8b of cash. Prices and wages would have to fall by a factor of ~20.
Deflation of that magnitude would cause huge problems for the economy.
Current:
C: The “Money supply” includes notes and coins and balances in demand deposit accounts.
E:
If Tobi is swapping cash for balances – he should consider the whole bank balance sheet. If it is negative – the bank doesn’t need any cash, because the bank has no money.
If it is positive: Let’s say the bank has L100 million surplus.Then Tobi needs to subtract the cash that is already available in the bank from the surplus. The rest is the “substitute money” part of the surplus. Toby can have cash printed for those.I can live with that.
By the way: after I deposit a L10 bill or L2 coin to a bank – is this be considered narrow money or demand deposit balance?
Current,
Demand Deposits are negative balances for the banks. However in the money supply formula they are used in they absolute value:
[-1]=1 and
That way:
money supply= cash + [-L850 billion]= cash + L850 billion.
This means there are L850b in the system, but they do not belong to the banks, because they are negative balance for the banks.
Depositors have L850 and when Cameron prints the cash and gives it to the depositors – he is doubling their money, because the bank still owes them.
They did not move their deposits to the Cameron bank – so Cameron can be repaying their deposits. They still have deposits in the original bank.
People have to withdraw their deposits from the bank and deposit it in the government bank so the Cameron have any ground to pay them any money.
They don’t have deposit with the government – so the government can’t pay them back money. Unless their bank is bankrupt and the government is paying off insurance.
C: The balance sheets of the banks aren’t negative, if they were then they would be bankrupt fairly quickly.
E: Not if Cameron prints cash for their demand deposits.
> If Tobi is swapping cash for balances – he should consider the
> whole bank balance sheet. If it is negative – the bank doesn’t
> need any cash, because the bank has no money.
The balance sheets of the banks aren’t negative, if they were then they would be bankrupt fairly quickly.
There is a confusion here in Toby’s explanation and that used by many Rothbardians. On the liabilities side of a bank’s balance sheet there are a set of demand deposits. On the assets side of the bank’s balance sheet there are reserves, loans and mortgages. Toby is comparing here the quantity of reserves to the demand deposits. So, there are 33 times more demand deposits than reserves, that means the reserve ratio is 33:1. However, the reserves aren’t the only assets, there are also the mortgages and loans. In terms of total assets the demand deposits are backed greater than 100%.
> If it is positive: Let’s say the bank has L100 million
> surplus.Then Tobi needs to subtract the cash that is already
> available in the bank from the surplus. The rest is the
> “substitute money” part of the surplus.
Yes. Toby confirmed to me in another discussion that the detailed plan is to do that.
Let’s say a bank owns £5M of assets in loans and mortgages and £1M in reserves of cash. It has £4.5M of demand deposits.
In that case £3.5M of new money would be printed. The resulting £4.5M of money would become the property of the bank’s customers. £4.5M of the bank’s assets would become property of the “mutuals” setup to clear the national debt, and the remaining £0.5M would go to the bank shareholders.
> By the way: after I deposit a L10 bill or L2 coin to a bank
> – is this be considered narrow money or demand deposit
> balance?
After you deposit and L2 coin your account balance goes up by L2. That is money in the broader sense. The coin becomes a part of the reserves of the bank.
This sort of thing is said to “create new” money-in-the-broader-sense because you have and extra L2 and so does the bank.
That may sound like “getting something from nothing”, but really it isn’t. Because, the quantity of money doesn’t measure any resource.
In that case £3.5M of new money would be printed. The resulting £4.5M of money would become the property of the bank’s customers. £4.5M of the bank’s assets would become property of the “mutuals” setup to clear the national debt, and the remaining £0.5M would go to the bank shareholders.
That’s interesting. I had assumed that only £3.5M worth of assets (corresponding to the new money) would be moved to the mutuals.
MRG
That is correct, only the exact amount of new positive net worth created needs to be moved to the Mutuals.
> That is correct, only the exact amount of new positive net worth
> created needs to be moved to the Mutuals.
Yes. I got the example I gave wrong above.
As I understand it the idea is to leave the banks with the same asset surplus that they had previously.
This bank begins with an asset surplus of £0.5M and that’s the figure after the reform.
Current,
You say:
“Let’s say a bank owns £5M of assets in loans and mortgages and £1M in reserves of cash. It has £4.5M of demand deposits.
The bank can repay the L4.5m with its assets – it does not need new money. The bank has enough assets to repay the clients.
It does not need money from the gov.
The government is just laundering money.
Printing 4.5 and give it to the people? BS. People did not lend money to the gov and the gov does not owe money to the people unless the bank is bankrupt and the gov is paying insurance).
The gov does not owe $4.5 to the bank, because the bank did not deposit 4.5 in the government.
There is no ground for the government to print 4.5 either for the bank or for the people.
Toby is doubling the money – either for the people or for the bank.
If the gov gives 4.5 to the people – people will have 4.5 from the gov and 4.5 in the bank.New money.
If the gov gives 4.5 to the bank – the bank has no more liabilities and is 4.5 richer. New money.
The mutuals later does not matter.The new money stay money. Follow the money!
In the first step the government creates 4.5 new money.
And they continue to be new money till the end of the world.
There is no step in the plan where the 4.5 is deemed to be money no more. They are deemed to be money from the moment they are printed till the moment they pay the gov debt.
It is new money – inflation… inflation…
MRG, you say:
That’s interesting. I had assumed that only £3.5M worth of assets (corresponding to the new money) would be moved to the mutuals.
You are wrong and Current is right.
When the gov gives 4.5 to the people – the 4.5 demand deposits in the bank still exists.
Toby said that the gov will pass a law that says the bank no longer owes the people 4.5.
At this moment 4.5 of the bank’s liabilities turn into 4.5 of bank’s assets.
I call this the bank stealing people’s money facilitated by a law.
This is why the the bank has 4.5 new assets – the new 4.5 printed money went to the people – so they don’t scream that the bank stole their money.
The bank has 4.5 that were stolen from the people and is giving some of it into mutuals.
Imagine the gov passes a law: the banks no longer owe you money – riots begin.
Instead they say: The bank will no longer owe you money, but the gov will give you all the money the you lost because of the new law. People are happy – their money are stolen, the gov is repaying the debt with laundering 4.5 printed cash.
I got this example I gave above wrong, MRG is right.
Current, you say: “Toby suggests doing this by using the information banks hold in their databases on how much they owe us. This debt will be wiped out and replaced with a sum of actual cash.”
This is where you and Toby are losing the attention of the crowd. 98% of we the people are not economists.
Is he adding to the bank’s assets £850 billion or not?
What is this money? Tax-payer money? Whose money is it?
Is this money or just worthless paper? If it is paper why it is turning into money?
Is the UK government so rich it can gift £850 billion to the fat cats in the banks?
Fat Cats are not popular with the crowds. Folks are looking for pitchforks.
Current, the information database about the demand deposits is not part of the money supply. The money that people deposited is part of the money supply.
If the bank lent the money – that means the money is no longer in the bank.
Toby is swapping cash for paperwork.
The posts by Ellie Velinska and John Moore point to a confusion in Rothbard and De Soto’s case.
Rothbard sometimes confuses a bailment contract and 100% reserves, they are not the same thing.
Consider a Rothbardian warehouse bank that uses bailments, say “Goodhand Bank”. It has 1000 ounces of gold in it’s vaults which it is storing for it’s customers. It charges a combined total of 100 ounces of gold per year in storage feeds.
The bank is also a savings & loans bank of the sort Toby mentions. It’s customer have bought 10 bonds from the bank, and the bank must pay 400 ounces of gold per year in interest on those bonds. The bank also has 10 mortgages that provide a combined income of 500 ounces of gold per year. That means the bank makes 100 ounces of gold in profit per year on it’s bond business.
So, the bank makes a total of 200 ounces income. It’s cost per year are 100 ounces, so it makes 100 ounces profit.
There is another identical bank across the street, “Thorpe Bank”. It has 100% reserves, but it’s contracts are not bailments in the legal sense. It has exactly the same finances as Goodhand Bank.
Now, think about what happens if some of the loans turn out to be bad. Suppose that due to defaults the income from mortgages falls from 500 ounces to 300 ounces. Both banks are therefore making a loss because they must pay more to bondholders than they can. Let’s suppose that both go bankrupt.
At Goodhand Bank the liquidators instruct that depositors get their 1000 ounces of gold back because it never belonged to the bank in the first place. At Thorpe Bank however the liquidators notice that all the banks has is debts which have equal seniority. So, the combined assets of Thorpe bank are distributed to the bondholders and the depositors. In this case the depositors will get less than 100%.
This was pointed out in Austrian Economic literature some time ago, but I can’t remember where.
It has historical relevancy too. There was a continental Bank-of-issue (it may have been the Bank of Amsterdam) that kept close to 100% reserves. What caused it to fail was a bad loan to some colonisation project in the 18th century.
BR,
Rob
To All Involved in this Debate – Thank you for your time.
The intention of the reform is to leave the existing owners of the banking system in exactly the same position as they were on the day of the reform., this means their net worth stays the same.
The government does not have to confiscate the excess assets created. What I have suggested is that it passes a law that compels the banks to forward assets into the mutuals that will need to be set up that mirror image the shareholding of the current banking system. These mutuals to be only mandated to pay off the national debt then wind themselves up. Job done.
Current, you may be implying I am a Rothbardian, I may jump to a wrong conclusion here, much as he was a great man, I am not an anarcho capitalist but a limited state liberal with small “c” conservative leanings. I understand that if a 100% reserve bank “Door 2” style savings and loan style bank makes bad loans, shareholders will not get paid out in full on a liquidation. This is just like any 100% reserved company, which all of us in business have to run. The point being, if I go bust as a fishmonger, there is no “fish run,” I just go bust. If Lehman, one bank goes bust, the whole world spins off into the “credit crunch.” As the governments around the world nationalised our banking problem, we now have a massive sovereign debt default problem.
Current, I am very careful to make the distinction between a balance sheet like mine which requires no legal privilege and a lender of last resort to stay solvently together. Mine has current liabilities and a bank does not distinguish between it s current liabilities and its long term liabilities. Here lies the problem. Anyone who supports fractional reserve free banking acknowledges that they require a grant of legal privilege for their system to stay afloat. So I am right in comparing current liabilities of my company and that of all other companies except banks and banks who do not make this distinction.
100% reserve banks like 100% reserve companies can go bust as they can do bad loans to shoddy entrepreneurs and lose money. A Bailment only bank can even go bust if it does not charge the right amount for storage and or have enough customers. The point being is there could never be a bank run and system wide catastrophe like we have today!
This reform does not stop banks going bust through bad business, just system wide bank runs.
> Current, you may be implying I am a Rothbardian, I may jump to a
> wrong conclusion here, much as he was a great man, I am not an
> anarcho capitalist but a limited state liberal with small “c”
> conservative leanings.
I should have clarified that. What I means is that you tend towards Rothbard’s view on banking and money matters.
> I understand that if a 100% reserve bank “Door 2” style savings
> and loan style bank makes bad loans, shareholders will not get
> paid out in full on a liquidation.
The problem here though is that insolvency is generally the reason for bank failure. If there is a run then the reason is generally because the bank is judged insolvent by it’s customers.
100% reserves don’t protect against insolvency at all. If my 100% reserve Thorpe bank were to be insolvent then there would be a run on it just like a fractional reserve bank. That’s why to really provide protection a bailment contract would be needed.
(It’s likely that there would be a run on a bailment bank also because of lack of trust that it would act legally.)
> I am very careful to make the distinction between a balance sheet
> like mine which requires no legal privilege and a lender of last
> resort to stay solvently together. Mine has current liabilities
> and a bank does not distinguish between it s current liabilities
> and its long term liabilities. Here lies the problem. Anyone who
> supports fractional reserve free banking acknowledges that they
> require a grant of legal privilege for their system to stay afloat.
> So I am right in comparing current liabilities of my company and
> that of all other companies except banks and banks who do not make
> this distinction.
This issue was discussed at the Mises blog recently. It’s debatable whether a demand deposit is a current liability. A current liability is a debt that’s due in cash in the companies operating cycle. A demand deposit is only like this if the option to redeem it is applied.
The main reason this comes up in any case is the ban on option clauses. If option clauses were not banned then banks could put time limits on their liabilities.
In my view, if option clauses were legalised they would help prevent bank runs. If a bank got into trouble it could exercise the option and turn it’s demand liabilities into timed debts. It could then reorganise itself and pay off those debts. Such a system would mean that no bank would go bankrupt because of a random rush of demand for liquidity. Because, if that happened it could exercise the clauses and make good on them. The only threat a bank would face is insolvency, which is the same situation any business is in.
However, I don’t think it would make that much difference. As I said earlier, random surges in demand for redemptions don’t really occur in practice. A run generally occurs because the market fears the bank is insolvent. Option clauses would only help in the case where the market is wrong.
Does it mean you consider this a serious plan?
All these politicians – whose names are showing on this blog – MPs, MEPs – are they endorsing it?
You guys are too smart and know so much abstract terms that you fail to see the obvious:
1. the people lent L850b to the bank – the bank owes them L850b
2. the gov prints L850b and gives them to the people
3. the bank still owes L850b to the people
4. the government makes a law: the bank does not owe L850b to the people
5. the bank liabilities turn into bank assets. The bank now has L850b more assets.
I call this stealing people’s money, because the bank never paid back the money to the people (instead the government gifted money to the people).
The bank just kept the deposited money to itself and got L850 richer – by not paying back to the people.
It is important part to understand in Toby’s plan.
The people are not complaining that the bank stole their money and never returned it back, because the government reimbursed them for their loss.
Toby says – it is not stealing – it is turning liability into assets – it is a swap: L850b to the people – and the L850b demand deposit are gone.
However, the proper way to close the demand deposits is for the bank to pay back the money to the people. But the people already have the money from the gov. If the bank pays them back too – the people will have double the money.
6. the bank has the extra L850b that the bank did not return to depositors – the bank gives it to the government to repay debt.
At the end the government is paying the debt with the money that the bank stole from the people having demand deposits in the bank.
The money supply before the operation: cash (means the currency in circulation – the bank’s assets are part of this cash) + L850 demand deposit
The money supply after the operation: Cash (original cash + L850b(that is no longer demand deposit, but is turned into bank assets) + L850 cash that the government printed = original cash + 2xL850b
Please, don’t dismiss my brain like I am an amoeba, because I am not an economist.
Read this again and try to understand my point. It is important – if this is a real plan – it is crookery – robbery and it is inflationary.
I hope it is just a L1000 logic exercise.
The street smarts win and get the prize!
Special thanks to Current, John Moor and mrg for teaching me terminology and for all the attention and advice!
I will be going to the ocean for the weekend! Beautiful Carolina Beach. Hope you have a great weekend.
The crux of your writing while sounding agreeable initially, did not really work perfectly with me personally after some time. Somewhere within the sentences you actually were able to make me a believer unfortunately only for a very short while. I nevertheless have got a problem with your jumps in assumptions and you might do well to help fill in all those gaps. In the event that you can accomplish that, I could surely be amazed.