The world advances by those in error being educated out of it. So, this Substack is already making the world a better place. This is also just a short note on the point.
A couple of days back I talked about MMT and banking. With special and specific reference to the misunderstandings - the being in error - of Professor Richard J Murphy.
Every bank faces, every day, at 4.30 that basic test. Do deposits plus capital equal loans out? If not it’s bust. And we have seen examples, in living memory, of this not being true and of banks being bust as a result.
This is what makes “lending by a bank is unrelated to the deposits it takes from savers” the purest and most unmitigated tosh.
Sure, banks lend then go finance that loan. But they do, absolutely, have to finance that loan. By attracting deposits sufficient to cover that loan that has been made. And they’ve got to do that in an Action This Day sense. Which is why banks have a Treasury Department which manages this process.
Murphy has simply got the entirety of banking wrong here. He’s claiming that banks don’t even need deposits. Their loans, their balance sheets, deposits simply do not matter. When they do - because if you’ve not the deposits plus capital to finance your loans then you’re bust.
This couple of days later we get this from Professor Richard J Murphy:
As all central bankers agree, commercial banks always make loans using newly created money.
And then, as Clive pointed out, banking regulation forces those banks to borrow to cover the loan that they have created as if the funds to make the loan were not newly created money.
What is obvious is that if banks can create money from nothing (and that is a universally true fact and always the funding mechanism for loans made), then banks never need to borrow to cover those loans. And yet, regulation apparently imposes that wholly unnecessary requirement.
The questions to be asked are:
Why does regulation do that?
How does it do that?
Who benefits from it doing so?
How do they benefit?
What can be done to resolve this situation, which is obviously absurd?
I am not saying I have answers as yet. What I do know is that the regulatory requirement is obviously absurd.
So, we now have agreement that yes, banks create money through the act of lending. But by 4.30 pm that day they must balance their books. Deposits fund the loan book that is. In effect they do at least.
Good, we advance. The world - or at least one of the more absurd corners of it - is now better informed. The world is better by that dawning of knowledge.
Yes, this admission is as a result of this Substack - those who read here started to pop up in his comments section which prompted the rethought. I’m not allowed to comment there because I’m a neoliberal, d’ye see?
Now, no doubt we will now be treated to extensive ruminations on who is imposing and why that regulation. I’ve no doubt at all that neoliberalism will be blamed, at least one solution proposed will be higher taxation and so on.
But yes. Deposits fund the loan book at a bank. Glad we’ve got that part sorted at least.
We might even offer a little hint to get those ruminations winning along the right path. Adam Smith, in Wealth of Nations, discusses what happens when loan issuance runs ahead of deposits plus capital. True, he was thinking more of private bank notes but it’s the same underlying effect. He also thought that, in moderation, it might well be a good enough idea. Or at least one with not too much harm to it, despite the regular run of bank failures it engendered.
The subsequent quarter of a millennium has thought differently about this. Maybe right and maybe wrong too. But it is something that has been chewed over for 250 years and Prof Murphy might like to consider that before leaping into the next position of error on the subject.
And, also and obviously, we can all enjoy this proof, once again, that all economics is simply footnotes to Smith or wrong.