Highlighting what I think is an important distinction - viewing this through the lens of the Perry Mehrling money view / balance sheet framework (all money is someone else’s liability etc) we think about bank lending as money creation insofar as a loan and deposit are simultaneously created “by the stroke of a bookkeeper’s pen.” This balance sheet expansion (and resultant money creation) stands in contrast to the notion of a financial intermediary simply channeling already-existing savings to borrowers.
How do you think about this in capital markets? I.e in order for capital market lending to function as money creation, there needs to be a balance sheet expansion somewhere , right ? E.g. if a high net worth individual funds capital markets issuance with their existing saved income, no money was created.
Obviously if this capital market issuance is funded in repo , and the repo system effectively expands its balance sheet, then that indeed could be seen as money creation.
I guess the main point here is - if bank balance sheets are not expanding, then whose balance sheet is expanding ? Given that we need balance sheet expansion in order for this to qualify as “money creations
I can't speak to anyone else's framework, but I can tell you how I understand the concepts personally.
Banks can create new deposits through lending. This is only "money creation" to the extent that you define "deposits" as money. No new base money is created through the process - i.e. no new dollars have entered circulation. Rather, banks - as liquidity managers - have allowed multiple entities to share access to the same single dollar, expanding the effective purchasing power of the population in the process.
The key point here is that the depositor does not lose access to his money when the bank lends it out. This is really the magic of how you turn $1->$2.
But its not really magic. It only works because not everyone wants their dollars at the same time. If they do, then you have a bank run, and the bank fails! If banks truly created new money, then bank failures shouldn't happen right?
A similar thing happens in liquid capital markets. I might lend a dollar to the US Treasury, who can spend my money. But I can also easily access my money at any time I want because I can sell my Treasury in the liquid market or borrow against it. Similar to banks, no new money is being created here, and if everyone decides they want their money right now, then the charade crashes down.
A bank run, like a capital market run, both highlight that "money creation" is always somewhat of an illusion - unless it comes from the Fed.
By contrast, loans that don't have some liquidity component don't expand money in the same way. If I lend you $1 for a year, then you have my dollar for a year, and I don't. I have no way to access liquidity for this unique loan, and our collective purchasing power has not expanded as a result.
This has been a long a convoluted way to say that the core of money expansion is "sharing", "stretching", or "leveraging" base money through shared liquidity pools, rather than true "creation".
Thanks for the clarification - I guess the way I’m thinking about it here (and apologies if this comes across as me retrofitting a specific framework upon your post), is the distinction between (1) banks funding loans with deposits (which seems implied by your statement “depositor does not lose access to his money when the bank lends it out”) and (2) banks simply expanding their balance sheet symmetrically, simultaneously creating a loan on the asset side of their balance sheet and a corresponding deposit on the liability side, regardless of their deposit base - they haven’t had to fund this expansion in anyway - although obviously it is constrained by any capital or reserve requirements, hence your point around “leveraging base money.”
So my understanding is that you’re focused on the multiplicative money expansion upon a given level of base money, whereas I’m focusing more on endogenous balance sheet expansion, regardless of base money supply. And in a world with zero reserve requirements (and ample reserves) I would think the latter is more relevant than a money multiplier type view ?
“If banks truly created new money, then bank failures shouldn't happen right?”- relating to the point I believe you made in the original article, banks vis balance sheet expansion create something that is money-like for some and effectively contributes to money supply growth, but at some point if they lose their “money-ness,” then there’s a sudden contraction in money supply, and coincidently banking balance sheets contract.
Similarly , UST issuance does effectively increase money supply given that that the govt has effectively expanded its balance sheet , and USTs (someone else’s liability i.e. the federal govts liability) function as money for the private sector who can easily liquidate and or use to obtain repo financing.
Agree with your last paragraph here although I think it’s important to note that, without reserve requirements , it is theoretically possible for bank balance sheets to expand without limit and effectively increase money supply endogenously so long as the liabilities involved in that balance sheet expansion are accepted as “good” - in the vein of the expansion of the offshore Eurodollar credit system in the 1960s 1970s etc. Obviously though there is a limit and if the perception of that “money” shifts , the whole thing comes crashing down. But the broader point is that base money is not necessary without reserve requirements , and that balance sheets (and therefore the money supply) can expand endogenously without any central bank involvement.
I think we are saying a lot of similar things, and part of the reason why this post is called "money on the spectrum" is because these topics are really hard to pin down - and there is a legitimate range of money-like instruments that we need to consider including the balance sheet of the US Govt.
But I actually disagree with your final point around whether a bank could lend to an unlimited degree with out reserve requirements. I say they can't.
Reserve requirements (or other regulatory requirements) are not the reason why base money has to exist. They are regulations that try to make sure that banks don't fail.
If you had no regulatory oversight whatsoever, a bank still needs base money because that's how everything is settled. Bank to bank transfers are settled in reserves. Consumers pull cash from ATMs reducing the bank's base money. Base money is the money.
A bank could not survive without base money because when someone asked for money, the bank would not have any to give them. And saying, "take this loan which is as good as money" does not work.
I do think that there is a general abstraction on the banking system that I find interesting, but frankly unpractical. Bank failures aren't a theoretical phenomenon - they happen regularly and we know why. Its when a bank runs out of base money.
“I think we are saying a lot of similar things.... these topics are really hard to pin down” - yep completely agree here. And understood on your base money point, basically base money is needed to satisfy settlement constraints. I think that’s generally right as well, however I think technically settlement constraints could be satisfied by unsecured interbank borrowing to meet those settlement constraints, i.e. a bank can continue to meet payments deficits so long as some other entity has adequate trust in the health of that institution to lend to it unsecured (although to be honest this is where I feel my understanding is a bit unclear myself - could a bank settle a payments deficit using a deposit created by another bank extending credit to it and expanding its balance sheet? Or do those payments deficits specifically need to be settled by reserves themselves?) - anyway, post-2008 obviously the unsecured interbank market has largely given way to secured borrowing against collateral. Definitely need to refine this thinking on my end further.
Appreciate your insight/perspective here, take care
Thank you for this thread. It's all a bit above my pay grade, but I sense its importance. There is chaos in this system, lurking, and waiting for its opportunity.
I would say that the system is constantly evolving and its important for us to continue to keep our mind open to that evolution! It doesn't necessarily have to be a good or bad, but static models go out of date quickly! Thanks for reading!
So if money is effectively being forced out of banks and into capital markets - would this explain the great YTD % so far in the stock market is likely to continue? Or is that too much of a reach and simplification?
I'm not sure one is driving the other per se. I think it's more likely that buoyant equity and debt markets are both expressions of loosening financial conditions broadly. Cross asset volatility has come down substantially since late last year, as terminal rates have become more clear, the economy has outlasted many expectations, inflation has come down etc...
Going forward I expect they will continue to work in tandem and help reinforce each other. If there is a breakdown in equity markets, it will likely also bleed into debt markets.
Very interesting take that makes a lot of sense. certainly, there is some mystery as to why the economy continues to overperform so many estimates. the idea that there is enough quasi-money to continue to turn the wheels is a very interesting and plausible theory. thanks for this
Highlighting what I think is an important distinction - viewing this through the lens of the Perry Mehrling money view / balance sheet framework (all money is someone else’s liability etc) we think about bank lending as money creation insofar as a loan and deposit are simultaneously created “by the stroke of a bookkeeper’s pen.” This balance sheet expansion (and resultant money creation) stands in contrast to the notion of a financial intermediary simply channeling already-existing savings to borrowers.
How do you think about this in capital markets? I.e in order for capital market lending to function as money creation, there needs to be a balance sheet expansion somewhere , right ? E.g. if a high net worth individual funds capital markets issuance with their existing saved income, no money was created.
Obviously if this capital market issuance is funded in repo , and the repo system effectively expands its balance sheet, then that indeed could be seen as money creation.
I guess the main point here is - if bank balance sheets are not expanding, then whose balance sheet is expanding ? Given that we need balance sheet expansion in order for this to qualify as “money creations
Thanks v much
I can't speak to anyone else's framework, but I can tell you how I understand the concepts personally.
Banks can create new deposits through lending. This is only "money creation" to the extent that you define "deposits" as money. No new base money is created through the process - i.e. no new dollars have entered circulation. Rather, banks - as liquidity managers - have allowed multiple entities to share access to the same single dollar, expanding the effective purchasing power of the population in the process.
The key point here is that the depositor does not lose access to his money when the bank lends it out. This is really the magic of how you turn $1->$2.
But its not really magic. It only works because not everyone wants their dollars at the same time. If they do, then you have a bank run, and the bank fails! If banks truly created new money, then bank failures shouldn't happen right?
A similar thing happens in liquid capital markets. I might lend a dollar to the US Treasury, who can spend my money. But I can also easily access my money at any time I want because I can sell my Treasury in the liquid market or borrow against it. Similar to banks, no new money is being created here, and if everyone decides they want their money right now, then the charade crashes down.
A bank run, like a capital market run, both highlight that "money creation" is always somewhat of an illusion - unless it comes from the Fed.
By contrast, loans that don't have some liquidity component don't expand money in the same way. If I lend you $1 for a year, then you have my dollar for a year, and I don't. I have no way to access liquidity for this unique loan, and our collective purchasing power has not expanded as a result.
This has been a long a convoluted way to say that the core of money expansion is "sharing", "stretching", or "leveraging" base money through shared liquidity pools, rather than true "creation".
Thanks for the clarification - I guess the way I’m thinking about it here (and apologies if this comes across as me retrofitting a specific framework upon your post), is the distinction between (1) banks funding loans with deposits (which seems implied by your statement “depositor does not lose access to his money when the bank lends it out”) and (2) banks simply expanding their balance sheet symmetrically, simultaneously creating a loan on the asset side of their balance sheet and a corresponding deposit on the liability side, regardless of their deposit base - they haven’t had to fund this expansion in anyway - although obviously it is constrained by any capital or reserve requirements, hence your point around “leveraging base money.”
So my understanding is that you’re focused on the multiplicative money expansion upon a given level of base money, whereas I’m focusing more on endogenous balance sheet expansion, regardless of base money supply. And in a world with zero reserve requirements (and ample reserves) I would think the latter is more relevant than a money multiplier type view ?
“If banks truly created new money, then bank failures shouldn't happen right?”- relating to the point I believe you made in the original article, banks vis balance sheet expansion create something that is money-like for some and effectively contributes to money supply growth, but at some point if they lose their “money-ness,” then there’s a sudden contraction in money supply, and coincidently banking balance sheets contract.
Similarly , UST issuance does effectively increase money supply given that that the govt has effectively expanded its balance sheet , and USTs (someone else’s liability i.e. the federal govts liability) function as money for the private sector who can easily liquidate and or use to obtain repo financing.
Agree with your last paragraph here although I think it’s important to note that, without reserve requirements , it is theoretically possible for bank balance sheets to expand without limit and effectively increase money supply endogenously so long as the liabilities involved in that balance sheet expansion are accepted as “good” - in the vein of the expansion of the offshore Eurodollar credit system in the 1960s 1970s etc. Obviously though there is a limit and if the perception of that “money” shifts , the whole thing comes crashing down. But the broader point is that base money is not necessary without reserve requirements , and that balance sheets (and therefore the money supply) can expand endogenously without any central bank involvement.
Apologies as I missed this reply earlier.
I think we are saying a lot of similar things, and part of the reason why this post is called "money on the spectrum" is because these topics are really hard to pin down - and there is a legitimate range of money-like instruments that we need to consider including the balance sheet of the US Govt.
But I actually disagree with your final point around whether a bank could lend to an unlimited degree with out reserve requirements. I say they can't.
Reserve requirements (or other regulatory requirements) are not the reason why base money has to exist. They are regulations that try to make sure that banks don't fail.
If you had no regulatory oversight whatsoever, a bank still needs base money because that's how everything is settled. Bank to bank transfers are settled in reserves. Consumers pull cash from ATMs reducing the bank's base money. Base money is the money.
A bank could not survive without base money because when someone asked for money, the bank would not have any to give them. And saying, "take this loan which is as good as money" does not work.
I do think that there is a general abstraction on the banking system that I find interesting, but frankly unpractical. Bank failures aren't a theoretical phenomenon - they happen regularly and we know why. Its when a bank runs out of base money.
“I think we are saying a lot of similar things.... these topics are really hard to pin down” - yep completely agree here. And understood on your base money point, basically base money is needed to satisfy settlement constraints. I think that’s generally right as well, however I think technically settlement constraints could be satisfied by unsecured interbank borrowing to meet those settlement constraints, i.e. a bank can continue to meet payments deficits so long as some other entity has adequate trust in the health of that institution to lend to it unsecured (although to be honest this is where I feel my understanding is a bit unclear myself - could a bank settle a payments deficit using a deposit created by another bank extending credit to it and expanding its balance sheet? Or do those payments deficits specifically need to be settled by reserves themselves?) - anyway, post-2008 obviously the unsecured interbank market has largely given way to secured borrowing against collateral. Definitely need to refine this thinking on my end further.
Appreciate your insight/perspective here, take care
Thank you for this thread. It's all a bit above my pay grade, but I sense its importance. There is chaos in this system, lurking, and waiting for its opportunity.
I would say that the system is constantly evolving and its important for us to continue to keep our mind open to that evolution! It doesn't necessarily have to be a good or bad, but static models go out of date quickly! Thanks for reading!
So if money is effectively being forced out of banks and into capital markets - would this explain the great YTD % so far in the stock market is likely to continue? Or is that too much of a reach and simplification?
I'm not sure one is driving the other per se. I think it's more likely that buoyant equity and debt markets are both expressions of loosening financial conditions broadly. Cross asset volatility has come down substantially since late last year, as terminal rates have become more clear, the economy has outlasted many expectations, inflation has come down etc...
Going forward I expect they will continue to work in tandem and help reinforce each other. If there is a breakdown in equity markets, it will likely also bleed into debt markets.
Very interesting take that makes a lot of sense. certainly, there is some mystery as to why the economy continues to overperform so many estimates. the idea that there is enough quasi-money to continue to turn the wheels is a very interesting and plausible theory. thanks for this
Glad you found some use for it, and thanks for reading!
What an article... OMG I enjoyed it a lot, thank you Mr. Bear!!