Posts Tagged ‘deficit’

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It’s a good thing I don’t teach Money and Banking. I wouldn’t be very good at it. That’s because, as Magpie and Bruce remind me, my understanding of money and banking is riddled with myths and bad textbook theories.

But I am willing to learn. . .

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Lesson #1: it is not the case, as countless textbooks and on-line courses teach, that banks collect the deposits of countless small savers and loan them out for investment projects. That image—of banks as useful financial intermediaries, given the existence of money—is simply false. Instead, what banks (commercial banks, that is) do is make interest-earning loans and leases and then, on the opposite side of the ledger, credit deposits—thus creating money.

So, what role do customer deposits play if not to create loans? According to Ellen Brown, “while banks do not need the deposits to create loans, they do need to balance their books; and attracting customer deposits is usually the cheapest way to do it.”

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Lesson #2: quantitative easing has not involved the Fed printing money, and then giving that money (as costless or free cash) to banks in order to encourage lending (much less to buy back government debt). Instead, what the Fed has done is expand bank reserve deposits by purchasing Treasury bonds (and mortgage-backed securities) from banks, thereby increasing both the Fed’s holding of Treasury securities and the excess reserves of depository institutions.

The fact is, however, banks of late have renewed their purchases of government debt instruments (as we can see in line 3 of the latest Assets and Liabilities of Commercial Banks in the United States statement). The question is, why? According to Bloomberg, commercial lenders have increased their holdings of Treasury bonds this year “as loan growth fails to keep up with record deposits and banks prepare for rules that take effect in January requiring them to hold more high-quality assets.”

As I see it, banks are not lending at the pace we (and, for that matter, the Fed) would like not because they don’t have adequate reserves (as Paul Krugman argues today) but because they don’t see enough profitable opportunities among their corporate customers—who are not investing but, instead, hoarding their cash, buying back stock, and finding ways to shelter their income from taxes.

The fact is, the nature and pace of the current recovery are not determined by the savings of individuals and households, but of the profit-seeking investment decisions of large private banks and corporations.

So, thanks to Magpie and Bruce, I’ve learned a few things. But, I’ll admit, I still may be getting some of this wrong—and therefore am still not ready to teach Money and Banking.