Money is debt
Out of context: Reply #28
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- Arkadeas0
The Money As Debt theory is fallacious.
According to the Money As Debt theory, commercial banks create money whenever they loan out money. But this is very misleading, because this so-called created money does not increase the amount of money buyers are able and willing to spend! Here is why.
Let’s say Ms. A has a job that provides her with a net income of $2,500 a month, all of which she is able and willing to spend on goods and services. This means that over the next year she will have $30,000 to spend on purchases. She decides to buy a car for $12,000 for which she is willing to pay $1,000 a month for 12 months. So she goes into a bank to borrow $12,000 to buy a car from Co. B. The bank approves the loan and makes out a check for $12,000 payable to Co. B.
Let’s stop here for a moment and ask where does the bank get the $12,000 to enable it to write the check. The answer is that it doesn’t! The bank has the legal authority to just write the check with little or nothing to back it. Thus the “illusion” of creating money. To see why this is only an illusion of money creation, let’s go back to the story.
Ms. A takes the check and gives it to Co. B in exchange for the car. Co. B deposits the check into its checking account. This increases Co. B’s ability to purchase goods and services. HOWEVER, Ms. A’s ability to purchase goods and services has just gone down!!! She is no longer able to spend $2,500 a month because she must now give the bank $1,000 a month to repay the principle on her loan, which leaves her with just $1,500 a month (or $18,000 over the next year) to buy additional goods and services.
The net results are the same whether Ms. A takes out a loan for the car or pays cash for the car. In both scenarios, Ms. A ends up with the car and has only $18,000 left to buy additional goods and services, and Co. B has the $12,000 to spend on goods and services. Therefore, the amount of money society in total (Ms. A + Co. B) is able and willing to spend on goods and services is exactly the same whether Ms. A borrows the money or pays cash for the car!
In other words, when a bank makes a loan, it is only creating money according to the Fed’s definition of the money supply (M1, M2, or M3). It is not creating money in the sense of increasing the amount of money society is able and willing to spend on goods and services.
This means that the money “created” by banks writing loans is non-inflationary, because it doesn’t increase society’s ability and willingness to spend.
If the bank had just given Ms. A the $12,000 to buy the car without any obligation to repay the loan, then that would be true inflationary money creation. Now we can see why governments choose to borrow money instead of just printing it. Borrowing is non-inflationary, but printing is inflationary.
But let’s not forget about the interest. The video makes a big deal about the interest. It says that banks don’t create the money to pay the interest, it only creates the money to pay the principle. It says the money to pay the interest doesn’t exist. Therefore the only way to get the money to pay the interest (on a society basis, not an individual basis) is to take out more loans, which in turn will require more interest to be paid, which requires more loans, etc., etc. To sustain this, the video claims, requires exponential growth in trade.
But the video’s claims about interest are totally inaccurate. A payment for interest is a payment for a service. And the economic effect of a payment for servicing a loan (interest) is no different than payment for any other kind of service, such as for a haircut or a taxi ride.
When a bank receives an interest payment it is no different than income by any other company or individual. Bank people are just like other people, they too need to buy homes, cars, TV sets, groceries, etc. Therefore, the money just gets circulated back through the economy over and over again. No exponential growth is required to pay the interest.
The video also claims that with a stable money supply, the banks, because they are charging interest, will end up with all of the money. But this is only true if the banks never spend the interest (income) payments they receive. But the same can be said for any service industry. If they never spend their income, but could keep selling their services, they too would, eventually, end up with all the money.
We now have enough to conclude that the Money As Debt theory is false.