Do you think in aggregate all banks purchase enough assets or services etc… to provide enough deposits to pay all of the interest on all of the loans made ? Mortgages, personal loans, credit cards, corporate loans etc? It seems unlikely to me but I don’t know for sure. If they don’t what implications do you think this has ?
Thanks for some very interesting questions - I need to think about this more.
If they refused to spend, I think you'd see their equity skyrocketing. I'm far more focused on theory than markets, so all I'll say is I don't *think* that's happening. There will be times when banks spend at a slower rate than than their interest income, and times when they spend at a higher rate. As long as there's enough liquidity in the system to deal with the imbalances in the back and forth flow, it should be ok.
If the banks decided as a cartel to refuse to create enough deposits for borrowers to pay interest, you might have a problem. I'll see if I can work out whether it could be overcome.
When a bank creates a deposit to purchase an asset the banks equity will reduce as a proportion of total assets, so the banks net worth will reduce. I also assume the amount of deposits created in this way (buying non loan assets) is insufficient to cover *all* outstanding interest on loans created ?
(Please consider your comments 'like'd. For some reason, substack isn't responding to me clicking 'like').
Let's use some specific figures. Suppose the bank started with $1m cash (and $1m equity). If it makes a 1-year 5% loan for $100K, it charges $5K interest.
[A] +$100K {loan}; +$5K {interest}.
[L] +$100K {deposit}.
[E] +$5K.
So charging interest increased the bank's equity by $5K. Then it can pay $5K to have its windows washed for a year as follows:
[L] +$5K {deposit}.
[E] -$5K {window cleaner}.
Essentially the interest on the loan funded the bank to get its windows cleaned for a year. Its equity is back at $1m, because assets and liabilities each increased by $105K.
If instead of paying for a service with the $5K, it bought a corporate bond, its equity would have actually increased (by the bond).
It's possible that the bank could deliberately not create enough deposits for the borrower to pay the interest, but unless it has a monopoly, I don't think it would gain much advantage from doing that. An interesting thought experiment I should do though.
The quick answer is that banks also create deposits (without an increase in the public's debt to banks) when they:
- pay wages to employees
- pay suppliers (e.g. people who wash the bank's windows)
- buy assets (e.g. bonds) from the public
- pay dividends to shareholders
So if you borrow from the bank, you can earn the money to pay the interest by selling something to the bank (or to a bank's employee, supplier or shareholder, or to someone who sold something to one of them, etc.).
I wrote a short series on money and banking, which I hope you'll find helpful.
Definitely both! I have been interested in understanding economics for a long time and have been aware of Steve's ideas since 2008 when he was one of the few economists who understood and foresaw the problems to come. I recently came across your work and hope to find some time soon to look through it in more detail.
Great thankyou for the responses
Also, really great substack, great content, very informative and well written.
Thank you! I'm glad you've found it informative. Please do recommend it to anyone you think might appreciate it!
Do you think in aggregate all banks purchase enough assets or services etc… to provide enough deposits to pay all of the interest on all of the loans made ? Mortgages, personal loans, credit cards, corporate loans etc? It seems unlikely to me but I don’t know for sure. If they don’t what implications do you think this has ?
Thanks for some very interesting questions - I need to think about this more.
If they refused to spend, I think you'd see their equity skyrocketing. I'm far more focused on theory than markets, so all I'll say is I don't *think* that's happening. There will be times when banks spend at a slower rate than than their interest income, and times when they spend at a higher rate. As long as there's enough liquidity in the system to deal with the imbalances in the back and forth flow, it should be ok.
If the banks decided as a cartel to refuse to create enough deposits for borrowers to pay interest, you might have a problem. I'll see if I can work out whether it could be overcome.
Thanks for the answer!
When a bank creates a deposit to purchase an asset the banks equity will reduce as a proportion of total assets, so the banks net worth will reduce. I also assume the amount of deposits created in this way (buying non loan assets) is insufficient to cover *all* outstanding interest on loans created ?
(Please consider your comments 'like'd. For some reason, substack isn't responding to me clicking 'like').
Let's use some specific figures. Suppose the bank started with $1m cash (and $1m equity). If it makes a 1-year 5% loan for $100K, it charges $5K interest.
[A] +$100K {loan}; +$5K {interest}.
[L] +$100K {deposit}.
[E] +$5K.
So charging interest increased the bank's equity by $5K. Then it can pay $5K to have its windows washed for a year as follows:
[L] +$5K {deposit}.
[E] -$5K {window cleaner}.
Essentially the interest on the loan funded the bank to get its windows cleaned for a year. Its equity is back at $1m, because assets and liabilities each increased by $105K.
If instead of paying for a service with the $5K, it bought a corporate bond, its equity would have actually increased (by the bond).
It's possible that the bank could deliberately not create enough deposits for the borrower to pay the interest, but unless it has a monopoly, I don't think it would gain much advantage from doing that. An interesting thought experiment I should do though.
Can you explain how private debt plus interest can be repaid. It’s my understanding private debt plus interest > deposits
Thanks for the question!
The quick answer is that banks also create deposits (without an increase in the public's debt to banks) when they:
- pay wages to employees
- pay suppliers (e.g. people who wash the bank's windows)
- buy assets (e.g. bonds) from the public
- pay dividends to shareholders
So if you borrow from the bank, you can earn the money to pay the interest by selling something to the bank (or to a bank's employee, supplier or shareholder, or to someone who sold something to one of them, etc.).
I wrote a short series on money and banking, which I hope you'll find helpful.
https://economics21st.substack.com/p/money-and-banking-1
https://economics21st.substack.com/p/money-and-banking-2
https://economics21st.substack.com/p/money-and-banking-3
If it's not clear after that and what I wrote above, let me know, and I'll be more than happy to answer any follow-up questions you have.
Definitely a good person to talk to.
Do you mean I was a good person for him to talk to, or he was a good person for me to talk to? ;-)
Definitely both! I have been interested in understanding economics for a long time and have been aware of Steve's ideas since 2008 when he was one of the few economists who understood and foresaw the problems to come. I recently came across your work and hope to find some time soon to look through it in more detail.
Thanks! I don't have many people contacting me at the moment, so if you want to ask any questions or discuss anything, I'm more than happy to engage.
That's exciting news! I will look out for the podcast episode when it comes out.