derryl

How Much Longer Must This Deleveraging Process Go On?

jlounsbury59,
You are talking about production of real economic wealth: goods, services and physical capital (machinery, etc.). There is no doubt that investing money in productive processes increases supplies of real wealth. You input $1 million worth of capital, material and labor and you output $1.2 million of goods-for-sale.

The problem is that producing real wealth does not produce "money". It produces economic values that are denominated in monetary values, but the industrial economy does not produce any "money" at all (aside from the banknotes and coins--the physical forms of money--that are printed or minted on behalf of the central bank: printing and minting are "industrial" activities).

The creation of financial credit--"money"--is an entirely separate process from the production of real wealth and from the availability of real credit. In our system only banks are allowed to literally "make money". Banks create money as loans. That's where money comes from in the first place. That's where ALL money comes from in the first place.

When a bank makes a loan it creates a deposit in the account of the borrower and an asset in the account of the bank. A bank's "assets" are its loans customers' "debts". When the principal balance of the loan is repaid both the asset and the deposit are written down to zero.

The "money" was created out of nothing and after it went into the economy and activated economic activity the money returns to the bank and ceases to exist. That's just the simple truth about the life cycle of money which is clearly explained in any introductory financial economics textbook. Incredible as that might seem to people who are used to thinking of money as something "real". But money is essentially just numbers.

The institution of "banking" creates and manages an economy's financial credit. Banking is called an "industry" because it is operated as private-for-profit, but I think it is more properly recognized as an institution along with government, the courts, etc. because bankers decide what kinds of economic potentials will be actualized and what kinds will not; and they decide who will be given the privilege of buying something they have not earned yet.

These are "fiduciary" duties. There is a public trust involved. Banks make loans on behalf of "society" and it will be society who has to make good on that money by producing economic efforts or goods that are bought by the person who borrowed from the bank. There are social and moral elements to those decisions as well as purely economic or financial elements.

"We", society, people, provide the real credit to redeem the financial credit that banks give borrowers. If "we" don't respond to offers of bank-money payments, the money is worthless because it cannot "command" real credit. The 1913 Bank Act that made US dollars "legal tender" means that we are legally required to accept those dollars as payment.

We don't necessarily have to accept any particular "form" of the money--we don't have to take checks or debit cards--except for Federal Reserve notes which are "cash", $20 and $100 bills that you put in your wallet and that have "legal tender" printed on them.

A legitimate reason for refusing to accept legal tender is that you lack real credit: "Sorry, we are out of that item." or "I'm too booked up to do your job." When our supply of real credit is fully expended we cannot respond to offers to activate our real credit: it's already activated and fully committed.

There are many opinions about our "methods" of banking (for or against fiat money, fractional reserves, central banking), but nobody is denying that banking as an institution is an essential element of any economy that has evolved much beyond barter.

In the example above the $1 million was "invested", which means it was spent as the "costs" of production. So the company spent $1 million into the economy, but the company created $1.2 million worth of economic values which it charges as the "prices" of the goods it made for sale.

Every other company is in the same boat. They all spend an amount of money into the economy as their costs "C", but they all need to take out of the economy a greater amount of money to make profits "P". They put in C of money and they need to take out C + P of money.

Where does the "money"--not the economic value but the "money"-- come from to make P possible?

Industrial activity only distributes an amount of money C into the economy. Knowing as we do that the only source of money is bank loans, the only possible source of new money to make P is from somebody else taking out loans and distributing the money into the economy.

But loans have to be repaid, and a borrower can't repay his loan with money he already spent buying goods from our industrial producer. He no longer owns that money. The producer now owns the money.

The borrower must earn income by working for some other industrial producer and this borrower's "income" is part of his employer's "costs". His income is part of somebody's C. The ONLY money that is put into this system is C.

Bank's can make "consumer loans". Money is created to finance consumption, not production. But you can't earn money to repay your consumer loan just by consuming something. You need to earn the money so you "own" it. You must repay "owed" money with "owned" money. You must repay borrowed money with earned money.

This is the main fiduciary duty of banking, to ensure that those to whom we lent our real credit have paid it back in kind, by "earning" the repayment money.

We are seeing what ends up happening if you pay one credit card with another; if you try to repay owed money with more owed money. Eventually the jig is up. The banks want their money (which, properly understood as the activator of "our" real credit, is "our" money) and they won't lend you any more.

In order for companies to make P there must be an escalating increase in new money coming into the system. The only source of this money is new loans. To the borrowers, these loans are their debts. P is only possible with escalating debt.

Eventually the music stops and there aren't enough chairs for everyone and we see widespread defaults, foreclosures and bankruptcies that result in the kind of large scale asset/debt writedowns that are happening now. This had to happen. There was never enough "owned" money in the system for everyone to pay all their monetary debts.

That's because loan money is created at interest. Just like industrial producers who put C of money into the economy and need to collect C + P back out of it, banks put C into the economy as their loan principal but have to get C + I (interest) back out of the economy. Bankers are in business to earn money so just like the business who needs to earn profits, banks' interest is their P.

But the banks, alone or collectively, never created the money to pay I, the interest. They only created the money to pay C, the loan principal.

It is argued, by people who don't want to accept this arithmetic absurdity of our financial system, that because loan terms cover different timeframes there will always be enough money in the system for borrowers to repay principal plus interest.

So okay, let's take all money that was created by banks as loans from 1913 when the Bank Act made US dollars the only legal tender up until now.

The arithmetic doesn't change by adjusting the timeframe.

ALL banks over ALL that time created an amount of money C as loan principal, and an additional amount of monetary debt I as interest on all those loans. If every borrower has repaid all of their principal the amount of money left in the system today would be zero: C - C = 0. You put in C as loans, you take out C as loan repayments. There is no "money" left in the system.

In our G10 central banking system governments don't get "free" money from the Fed either. It must all be accounted and charged interest. Like a private bank manages its customers' accounts, the Fed manages the "country" account according to basically the same rules as private bank accounts.

There is no "external" source of MONEY to resolve the arithmetic impossibility of paying principal plus interest when the only money that can exist is the principal.

The same arithmetic applies to stock markets and financial markets. You can increase "economic" values all you want. But you cannot increase "money" because money is just numbers and numbers don't multiply themselves to become bigger numbers. Whatever number you put in, that's the number that is available to take out. Everything else is smoke and mirrors and confusion, escalating debt and financial meltdown with asset/debt writedowns, and start all over again.