As far as I know, all fiat (Credit) money is loaned into existence as PRINCIPAL. When repaid, or written off, the entire amount of money that was loaned into existence as principal is destroyed.
Since all of the money that is loaned into existence is eventually destroyed, the only way for there to be additional money in existence for the lending bank to receive INTEREST or FEES is that the pool of Credit Money was expanded, thus diverting some of that money into the repayment of Interest or Fees.
This problem is only solved by the continual expansion of the credit money supply. If Eve's bank is the only bank, there is NO EQUITY in the bank, and the only way for Eve to get that £25 is for the bank to Loan it into Existence as Principal to Eve, which does not solve the problem of the missing interest payment money.
"If Eve's bank is the only bank, there is NO EQUITY in the bank, and the only way for Eve to get that £25 is for the bank to Loan it into Existence as Principal to Eve, which does not solve the problem of the missing interest payment money."
How familiar are you with accounting? At the point where Alice has repaid the principal, here is how everyone's balance sheets would appear:
Bank
[A] £25 (interest due)
[E] £25 (retained earnings)
[RNW] 0
Alice
[A] 19,000 bushels of wheat
[L] £25 (interest owed)
[RNW] 19,000 bushels of wheat - £25
Eve
[A] £25 (equity stake in bank)
[RNW] £25
So the bank *does* have £25 equity. You have to understand that equity is not a pile of money. It's just what would be left of its assets if its liabilities were all paid, and so it's how much is left to be distributed to the shareholders if it were liquidated.
"As far as I know, all fiat (Credit) money is loaned into existence as PRINCIPAL."
Would you mind telling me where you acquired this belief. What I'm trying to do here is to show that it's actually not true. When a bank pays a dividend, it creates new money. Here are the bank's and Eve's balance sheets after the bank pays the dividend:
Bank
[A] £25 (interest due)
[L] £25 (deposit - Eve)
[E] 0
[RNW] 0
Eve
[A] £25 (deposit in bank)
[RNW] £25
Notice that the bank's equity is now 0 because it has a new liability: the money it created in Eve's current account.
You begin your "Pay interest" segment with, "By this point, the bank has a £25 profit, ...".
But 'profit' is typically recognized when the payment is made and the interest is collected. While "accrued interest" may indicate future earnings, it is not classified as profit until the borrower has paid it.
It can’t pay out what it has not collected, except out of … what - its capital??
Common Law: Nemo dat quod non habet! “Nobody can give what s/he has not!”
I'm using profit in the "One Lesson" sense - that its RNW has increased. The only constraint on it paying a dividend is legal, not logical. It can always credit someone's current account and debit equity.
As I say elsewhere, to overcome the legal hurdle, Eve could capitalise the bank with a large quantity of a valuable tangible asset (e.g. a tonne of gold). Or in a more realistic scenario, there would be lots of other people around, some of whom would borrow and could buy something from Alice.
The whole point of this exercise is to find the *simplest* scenario where Alice borrows for a sensible purpose, and repays the debt with interest, and everyone ends up unambiguously better off than they were at the start. To disprove a general claim, we only need a single counter-example, so we may as well make it as simple as possible.
I agree with your previous description [19 Jan], where you showed the Bank’s RNW = 0 as follows:
“Bank
[A] £25 [interest due]
[E] £25 [retained earnings] or “accrued interest”
[RNW] 0”
That was after £25 interest had been recorded. But [A] and [E] would be £25 lower than you show here before interest became due, so RNW would still be zero before the interest accrued. This follows from your “Equity vs Net Worth” article, which shows that “RNW = 0” is a permanent condition in a corporation.
So, if the “increase in RNW” will always be zero for the bank, surely, it follows logically that “profit in the "One Lesson" sense” is, therefore, also always zero.
This means Eve’s dividend can’t be paid out of that non-existent “profit”, by your definition, and you’ve just added a new hurdle to the legal one for Eve to overcome.
"That was after £25 interest had been recorded. But [A] and [E] would be £25 lower than you show here before interest became due, so RNW would still be zero before the interest accrued."
That's fine. The question of when an accounting entry should be recognised is one of judgement, but that an interest debt appears at some point is a fact. At this point, the bank can pay the dividend to Eve, who can buy something from Alice, who can clear her interest debt to the bank.
"So, if the “increase in RNW” will always be zero for the bank, surely, it follows logically that “profit in the "One Lesson" sense” is, therefore, also always zero. "
That's an interesting observation. And yes, I'd say that's true. The bank doesn't accumulate profit for itself: it's passed on to the shareholders via the increase in equity.
"This means Eve’s dividend can’t be paid out of that non-existent “profit”, by your definition, and you’ve just added a new hurdle to the legal one for Eve to overcome. "
There's no hurdle. The bank isn't paying her out of *its* profit - it's paying her out of *her* profit (in her capacity as shareholder). All it has to do is debit equity £25 and credit Eve's current account £25. (In One Lesson terms, Alice writes off £25 of her equity stake in exchange for the bank creating a new £25 debt to her in the form of an increase in the balance of her current account).
The board of directors won’t authorise breaking the law. They (she) can’t do it legally. That is a hurdle; you mentioned it yourself but dismissed it as of no consequence. Don’t expect me to endorse that. It’s time you dealt with the legal/regulatory hurdle. I can’t see banking regulations changing to accommodate your theory.
As I've pointed out before, the legal issue is trivial to get around by the bank being pre-capitalised with a substantial quantity of valuable tangible assets e.g. gold. This has precisely zero effect on the analysis.
You wrote “Money and Banking (4)” [M&B 4, 1 Jan] to DISPROVE the common hypothesis that “if banks ever charge interest, there’s never enough money in the economy for all borrowers to repay their loans with interest”, and claim your “scenario” provides that DISPROOF. Let’s check that claim.
In today’s “Big Picture” re-hash of M&B 4 (and M&B 5), banker Eve still ends up getting her £25 <dividend> in the form of <wheat> worth £25. As before, Eve purchased that <wheat> with the proceeds of her in-house interest-free £25 <LOAN>, taken out for the specific purpose of providing farmer Alice with the £25 she needed to pay the £25 [interest] on her [interest]-bearing loan, which [interest] she was OTHERWISE UNABLE TO PAY. [Bingo!]
Ironically, your scenario PROVES that Eve’s £25 <LOAN> IS NECESSARY to provide Alice with the means to pay the £25 [interest] on Alice’s [interest]-bearing loan. In fact, without Eve’s special purpose £25 <LOAN>, Alice would have to take out <ANOTHER £25 [interest]-bearing loan> to pay the £25 [interest] she owes Eve.
That’s the exact opposite of your M&B 4 hypothesis, as the £25 [interest] charged on Alice’s loan makes it impossible for her to pay that [interest] without “somebody else” taking out a new £25 <LOAN> which creates that £25 [interest].
Q.E.D.N.D.E. [quod erat demonstrandum non est demonstratum]
Trying to obscure this disastrous result by allowing the bank [Eve] to pay Eve her £25 <dividend entitlement> by “simply increasing the balance in [Eve’s] account” [M&B 5] doesn’t alter the above logic.
Eve’s £25 <dividend entitlement> was ultimately funded by Alice’s payment of £25 [interest] – which contributed to “retained earnings”, from which Eve’s £25 “simple credit” was funded with a matching £25 “simple debit”. As you say in M&B 5, it's “actually just TRANSFERRING some of the shareholders’ RNW to the customer”. As Eve is the only shareholder in your scenario, Eve is “actually just TRANSFERRING some of [shareholder Eve’s] RNW to [customer Eve’s personal] account” [with my added CAPITALS]
That’s not creating “new credit”. You said it yourself; it’s transferring existing credit.
"Ironically, your scenario PROVES that Eve’s £25 <LOAN> IS NECESSARY to provide Alice with the means to pay the £25 [interest] on Alice’s [interest]-bearing loan."
It wasn't a loan, and therefore it can't prove that a loan is necessary. Where do you see Eve paying, or being obliged to pay, anything back to the bank?
"That’s the exact opposite of your M&B 4 hypothesis."
I didn't have a hypothesis in M&B 4. I mentioned that the "Money As Debt" film makes this claim, and I showed that, even if it's true (which it isn't), it still doesn't mean that debt must grow exponentially or that someone will be forced into bankruptcy.
"Eve’s £25 <dividend entitlement> was ultimately funded by Alice’s payment of £25 [interest]"
If by that you mean that the £25 increase in the bank's RNW from Alice agreeing to owe a £25 interest debt to the bank is what allowed Eve to receive a £25 dividend, then I agree.
"As Eve is the only shareholder in your scenario, Eve is “actually just TRANSFERRING some of [shareholder Eve’s] RNW to [customer Eve’s personal] account” [with my added CAPITALS] "
Yes, this is correct. The bank debits equity and credits Eve's current account.
"That’s not creating “new credit”. You said it yourself; it’s transferring existing credit. "
It is creating new money. Eve couldn't spend her equity, but once the dividend payment was made, she could use it to buy things - in this case wheat from Alice - by using a cheque, debit card, etc.
I think it's good to understand exactly when money is created and destroyed -- it's commonly misunderstood. But I hope that the point of the One Lesson isn't lost. What's most important for understanding the economy as a whole is not how much money there is (after all it's easy to create), but how everyone's RNW changes. That's why the arrow diagrams are so useful.
As far as I know, all fiat (Credit) money is loaned into existence as PRINCIPAL. When repaid, or written off, the entire amount of money that was loaned into existence as principal is destroyed.
Since all of the money that is loaned into existence is eventually destroyed, the only way for there to be additional money in existence for the lending bank to receive INTEREST or FEES is that the pool of Credit Money was expanded, thus diverting some of that money into the repayment of Interest or Fees.
This problem is only solved by the continual expansion of the credit money supply. If Eve's bank is the only bank, there is NO EQUITY in the bank, and the only way for Eve to get that £25 is for the bank to Loan it into Existence as Principal to Eve, which does not solve the problem of the missing interest payment money.
"If Eve's bank is the only bank, there is NO EQUITY in the bank, and the only way for Eve to get that £25 is for the bank to Loan it into Existence as Principal to Eve, which does not solve the problem of the missing interest payment money."
How familiar are you with accounting? At the point where Alice has repaid the principal, here is how everyone's balance sheets would appear:
Bank
[A] £25 (interest due)
[E] £25 (retained earnings)
[RNW] 0
Alice
[A] 19,000 bushels of wheat
[L] £25 (interest owed)
[RNW] 19,000 bushels of wheat - £25
Eve
[A] £25 (equity stake in bank)
[RNW] £25
So the bank *does* have £25 equity. You have to understand that equity is not a pile of money. It's just what would be left of its assets if its liabilities were all paid, and so it's how much is left to be distributed to the shareholders if it were liquidated.
"As far as I know, all fiat (Credit) money is loaned into existence as PRINCIPAL."
Would you mind telling me where you acquired this belief. What I'm trying to do here is to show that it's actually not true. When a bank pays a dividend, it creates new money. Here are the bank's and Eve's balance sheets after the bank pays the dividend:
Bank
[A] £25 (interest due)
[L] £25 (deposit - Eve)
[E] 0
[RNW] 0
Eve
[A] £25 (deposit in bank)
[RNW] £25
Notice that the bank's equity is now 0 because it has a new liability: the money it created in Eve's current account.
You begin your "Pay interest" segment with, "By this point, the bank has a £25 profit, ...".
But 'profit' is typically recognized when the payment is made and the interest is collected. While "accrued interest" may indicate future earnings, it is not classified as profit until the borrower has paid it.
It can’t pay out what it has not collected, except out of … what - its capital??
Common Law: Nemo dat quod non habet! “Nobody can give what s/he has not!”
I'm using profit in the "One Lesson" sense - that its RNW has increased. The only constraint on it paying a dividend is legal, not logical. It can always credit someone's current account and debit equity.
As I say elsewhere, to overcome the legal hurdle, Eve could capitalise the bank with a large quantity of a valuable tangible asset (e.g. a tonne of gold). Or in a more realistic scenario, there would be lots of other people around, some of whom would borrow and could buy something from Alice.
The whole point of this exercise is to find the *simplest* scenario where Alice borrows for a sensible purpose, and repays the debt with interest, and everyone ends up unambiguously better off than they were at the start. To disprove a general claim, we only need a single counter-example, so we may as well make it as simple as possible.
I agree with your previous description [19 Jan], where you showed the Bank’s RNW = 0 as follows:
“Bank
[A] £25 [interest due]
[E] £25 [retained earnings] or “accrued interest”
[RNW] 0”
That was after £25 interest had been recorded. But [A] and [E] would be £25 lower than you show here before interest became due, so RNW would still be zero before the interest accrued. This follows from your “Equity vs Net Worth” article, which shows that “RNW = 0” is a permanent condition in a corporation.
So, if the “increase in RNW” will always be zero for the bank, surely, it follows logically that “profit in the "One Lesson" sense” is, therefore, also always zero.
This means Eve’s dividend can’t be paid out of that non-existent “profit”, by your definition, and you’ve just added a new hurdle to the legal one for Eve to overcome.
"That was after £25 interest had been recorded. But [A] and [E] would be £25 lower than you show here before interest became due, so RNW would still be zero before the interest accrued."
That's fine. The question of when an accounting entry should be recognised is one of judgement, but that an interest debt appears at some point is a fact. At this point, the bank can pay the dividend to Eve, who can buy something from Alice, who can clear her interest debt to the bank.
"So, if the “increase in RNW” will always be zero for the bank, surely, it follows logically that “profit in the "One Lesson" sense” is, therefore, also always zero. "
That's an interesting observation. And yes, I'd say that's true. The bank doesn't accumulate profit for itself: it's passed on to the shareholders via the increase in equity.
"This means Eve’s dividend can’t be paid out of that non-existent “profit”, by your definition, and you’ve just added a new hurdle to the legal one for Eve to overcome. "
There's no hurdle. The bank isn't paying her out of *its* profit - it's paying her out of *her* profit (in her capacity as shareholder). All it has to do is debit equity £25 and credit Eve's current account £25. (In One Lesson terms, Alice writes off £25 of her equity stake in exchange for the bank creating a new £25 debt to her in the form of an increase in the balance of her current account).
The board of directors won’t authorise breaking the law. They (she) can’t do it legally. That is a hurdle; you mentioned it yourself but dismissed it as of no consequence. Don’t expect me to endorse that. It’s time you dealt with the legal/regulatory hurdle. I can’t see banking regulations changing to accommodate your theory.
As I've pointed out before, the legal issue is trivial to get around by the bank being pre-capitalised with a substantial quantity of valuable tangible assets e.g. gold. This has precisely zero effect on the analysis.
You wrote “Money and Banking (4)” [M&B 4, 1 Jan] to DISPROVE the common hypothesis that “if banks ever charge interest, there’s never enough money in the economy for all borrowers to repay their loans with interest”, and claim your “scenario” provides that DISPROOF. Let’s check that claim.
In today’s “Big Picture” re-hash of M&B 4 (and M&B 5), banker Eve still ends up getting her £25 <dividend> in the form of <wheat> worth £25. As before, Eve purchased that <wheat> with the proceeds of her in-house interest-free £25 <LOAN>, taken out for the specific purpose of providing farmer Alice with the £25 she needed to pay the £25 [interest] on her [interest]-bearing loan, which [interest] she was OTHERWISE UNABLE TO PAY. [Bingo!]
Ironically, your scenario PROVES that Eve’s £25 <LOAN> IS NECESSARY to provide Alice with the means to pay the £25 [interest] on Alice’s [interest]-bearing loan. In fact, without Eve’s special purpose £25 <LOAN>, Alice would have to take out <ANOTHER £25 [interest]-bearing loan> to pay the £25 [interest] she owes Eve.
That’s the exact opposite of your M&B 4 hypothesis, as the £25 [interest] charged on Alice’s loan makes it impossible for her to pay that [interest] without “somebody else” taking out a new £25 <LOAN> which creates that £25 [interest].
Q.E.D.N.D.E. [quod erat demonstrandum non est demonstratum]
Trying to obscure this disastrous result by allowing the bank [Eve] to pay Eve her £25 <dividend entitlement> by “simply increasing the balance in [Eve’s] account” [M&B 5] doesn’t alter the above logic.
Eve’s £25 <dividend entitlement> was ultimately funded by Alice’s payment of £25 [interest] – which contributed to “retained earnings”, from which Eve’s £25 “simple credit” was funded with a matching £25 “simple debit”. As you say in M&B 5, it's “actually just TRANSFERRING some of the shareholders’ RNW to the customer”. As Eve is the only shareholder in your scenario, Eve is “actually just TRANSFERRING some of [shareholder Eve’s] RNW to [customer Eve’s personal] account” [with my added CAPITALS]
That’s not creating “new credit”. You said it yourself; it’s transferring existing credit.
"Ironically, your scenario PROVES that Eve’s £25 <LOAN> IS NECESSARY to provide Alice with the means to pay the £25 [interest] on Alice’s [interest]-bearing loan."
It wasn't a loan, and therefore it can't prove that a loan is necessary. Where do you see Eve paying, or being obliged to pay, anything back to the bank?
"That’s the exact opposite of your M&B 4 hypothesis."
I didn't have a hypothesis in M&B 4. I mentioned that the "Money As Debt" film makes this claim, and I showed that, even if it's true (which it isn't), it still doesn't mean that debt must grow exponentially or that someone will be forced into bankruptcy.
"Eve’s £25 <dividend entitlement> was ultimately funded by Alice’s payment of £25 [interest]"
If by that you mean that the £25 increase in the bank's RNW from Alice agreeing to owe a £25 interest debt to the bank is what allowed Eve to receive a £25 dividend, then I agree.
"As Eve is the only shareholder in your scenario, Eve is “actually just TRANSFERRING some of [shareholder Eve’s] RNW to [customer Eve’s personal] account” [with my added CAPITALS] "
Yes, this is correct. The bank debits equity and credits Eve's current account.
"That’s not creating “new credit”. You said it yourself; it’s transferring existing credit. "
It is creating new money. Eve couldn't spend her equity, but once the dividend payment was made, she could use it to buy things - in this case wheat from Alice - by using a cheque, debit card, etc.
I think it's good to understand exactly when money is created and destroyed -- it's commonly misunderstood. But I hope that the point of the One Lesson isn't lost. What's most important for understanding the economy as a whole is not how much money there is (after all it's easy to create), but how everyone's RNW changes. That's why the arrow diagrams are so useful.
Nice analysis.