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http://www.abc.net.au/news/stories/2...27/2044638.htm
Deeper in debt: irresponsible lending takes over
By Steve Keen
Posted Thu Sep 27, 2007 8:59am AEST
Updated Thu Sep 27, 2007 11:53am AEST
Understanding the dynamics of debt creation necessitates an excursion into economic theory - both conventional and unconventional.
For those who would prefer to avoid such suffering, the conclusion of this essay is that lenders are primarily responsible for the explosion in debt and credit: a deregulated credit system will provide as much debt as it can up until such a time - as now - that the level of debt causes a financial crisis.
For those who'd like to know more about how lenders actually create money through their loans, read on!
The standard explanation of how money is generated argues that banks can only create credit if the government "kick starts" the system, effectively by creating cash that a citizen then takes to a bank for safe-keeping. Once the citizen has deposited that government-created "fiat" money, the banking system can create additional credit-based money via what is known as the "money multiplier".
This story has the banker sitting anxiously, waiting for a customer to walk in the door and make a deposit of government-created cash, before the banker can then begin the credit money creation process. Once the essential deposit has been made, the banking system can weave its money multiplier magic; but without the deposit, the banker - and the banking system - is impotent.
Would you like credit with that?
Does that sound like banking to you? It barely has credence as a description of the 1960s, let alone today's "would you like a $25,000 credit limit with that?" world of banking.
A relatively new school of thought in economics argues instead that banks have the power to create money, even in the complete absence of government money. In this "endogenous money" vision of how the financial system operates, rather than "deposits create loans, it is "loans create deposits", and the mechanism is far more straightforward than the "money multiplier" story.
Think of your own credit card. If your balance is sufficiently below your limit, then you are completely at liberty to go to an electronics shop and buy a new widescreen TV.
When you do, your debt to the bank is increased by the cost of the TV - and an equivalent amount of money is simultaneously created and deposited in the shop's bank account.
There is absolutely nothing stopping you from doing that, right out to your credit limit (apart from personal financial prudence!), and the same observation applies to every other credit card holder in Australia.
If we all went out and did something similar tomorrow, we would increase the money supply by over 7 per cent overnight.
Taking advantage of the loans that we have every right to take out (the gap between our credit card balances and card limits) instantly and simultaneously creates both new debt and equivalent deposits in the accounts of the lucky retailers who swiped our cards.
Loans create deposits
The same mechanism applies to the financial system in general: loan-issuing entities grant their customers the capacity to create both money and debt simultaneously, without the need for a prior deposit of money to set the process off. That capacity exists in the contracts it ordinarily writes with borrowers to supply credit on demand.
If a small business expands its overdraft, it expands its debt to the bank and simultaneously creates an equivalent deposit in the account of whoever it made a payment to.
Ditto at the "Big End of Town", where most major corporations have a "Line of Credit" (normally with consortiums of banks). If a company expands its use of this facility, it increases its own debt to the bank(s) while simultaneously creating deposits in the accounts of those to whom it made payments.
Loans thus create deposits, and the process is instantaneous - unlike the time-lagged process described in the conventional "deposits create loans" story.
Of course, the "deposits create loans" process co-exists besides this "loans create deposits" mechanism, in that banks can use deposits of government-generated money to generate even more credit.
But government-created money simply plays second-fiddle to the private money creation process - and it has clearly been a laggard as well, given the drift in the ratio over time.
Therefore the "money multiplier", rather than being something the government has any influence over, is simply a measure of the extent to which credit-money creation dominates the fiat money system.
For better or for worse
For better or for worse then, the private financial system is predominantly in control of the amount of credit money in the system, and the amount of credit it will create depends on the contracts it is willing to write, to provide credit to those who request it.
The better side of this - perhaps - is the degree of innovation this inspires credit providers to undertake.
The worse side is that nothing short of a systemic crisis will limit the amount of credit money and debt that the financial system is willing to generate - if only it can find borrowers willing to bind themselves to pay the interest bill the debt commits them to.
If you define responsible corporate behaviour as that which is sustainable over the long term for both the finance sector and its customers then most lenders are, by definition, irresponsible.
The answer to the "who's to blame" question is thus "irresponsible lenders", rather than "profligate borrowers".
But that's only half the story: a crisis can only eventuate if irresponsible lenders meet gullible borrowers.
Unfortunately history gives us no reason to be confident that individual borrowers understand the system and their part in it well enough to make sensible and sustainable decisions.
The fact that the financial system will lend as much as borrowers demand means that we can't rely - as we have been doing - upon deregulation and self-regulation to control the financial system.
But the system itself can't get out of control unless there are other factors that entice borrowers to indulge in levels of debt that, ultimately, turn out to be ill-advised.
Fortunately for the fraudulent and shonky operators who exist in any financial system, but unfortunately for the rest of us, those factors exist, and they're at the very core of our modern economic system.
Steve Keen is associate professor at the School of Economics and Finance at the University of Western Sydney. This is an extract from his paper Deeper in Debt: Australia's addiction to borrowed money.
By Steve Keen
Posted Thu Sep 27, 2007 8:59am AEST
Updated Thu Sep 27, 2007 11:53am AEST
Understanding the dynamics of debt creation necessitates an excursion into economic theory - both conventional and unconventional.
For those who would prefer to avoid such suffering, the conclusion of this essay is that lenders are primarily responsible for the explosion in debt and credit: a deregulated credit system will provide as much debt as it can up until such a time - as now - that the level of debt causes a financial crisis.
For those who'd like to know more about how lenders actually create money through their loans, read on!
The standard explanation of how money is generated argues that banks can only create credit if the government "kick starts" the system, effectively by creating cash that a citizen then takes to a bank for safe-keeping. Once the citizen has deposited that government-created "fiat" money, the banking system can create additional credit-based money via what is known as the "money multiplier".
This story has the banker sitting anxiously, waiting for a customer to walk in the door and make a deposit of government-created cash, before the banker can then begin the credit money creation process. Once the essential deposit has been made, the banking system can weave its money multiplier magic; but without the deposit, the banker - and the banking system - is impotent.
Would you like credit with that?
Does that sound like banking to you? It barely has credence as a description of the 1960s, let alone today's "would you like a $25,000 credit limit with that?" world of banking.
A relatively new school of thought in economics argues instead that banks have the power to create money, even in the complete absence of government money. In this "endogenous money" vision of how the financial system operates, rather than "deposits create loans, it is "loans create deposits", and the mechanism is far more straightforward than the "money multiplier" story.
Think of your own credit card. If your balance is sufficiently below your limit, then you are completely at liberty to go to an electronics shop and buy a new widescreen TV.
When you do, your debt to the bank is increased by the cost of the TV - and an equivalent amount of money is simultaneously created and deposited in the shop's bank account.
There is absolutely nothing stopping you from doing that, right out to your credit limit (apart from personal financial prudence!), and the same observation applies to every other credit card holder in Australia.
If we all went out and did something similar tomorrow, we would increase the money supply by over 7 per cent overnight.
Taking advantage of the loans that we have every right to take out (the gap between our credit card balances and card limits) instantly and simultaneously creates both new debt and equivalent deposits in the accounts of the lucky retailers who swiped our cards.
Loans create deposits
The same mechanism applies to the financial system in general: loan-issuing entities grant their customers the capacity to create both money and debt simultaneously, without the need for a prior deposit of money to set the process off. That capacity exists in the contracts it ordinarily writes with borrowers to supply credit on demand.
If a small business expands its overdraft, it expands its debt to the bank and simultaneously creates an equivalent deposit in the account of whoever it made a payment to.
Ditto at the "Big End of Town", where most major corporations have a "Line of Credit" (normally with consortiums of banks). If a company expands its use of this facility, it increases its own debt to the bank(s) while simultaneously creating deposits in the accounts of those to whom it made payments.
Loans thus create deposits, and the process is instantaneous - unlike the time-lagged process described in the conventional "deposits create loans" story.
Of course, the "deposits create loans" process co-exists besides this "loans create deposits" mechanism, in that banks can use deposits of government-generated money to generate even more credit.
But government-created money simply plays second-fiddle to the private money creation process - and it has clearly been a laggard as well, given the drift in the ratio over time.
Therefore the "money multiplier", rather than being something the government has any influence over, is simply a measure of the extent to which credit-money creation dominates the fiat money system.
For better or for worse
For better or for worse then, the private financial system is predominantly in control of the amount of credit money in the system, and the amount of credit it will create depends on the contracts it is willing to write, to provide credit to those who request it.
The better side of this - perhaps - is the degree of innovation this inspires credit providers to undertake.
The worse side is that nothing short of a systemic crisis will limit the amount of credit money and debt that the financial system is willing to generate - if only it can find borrowers willing to bind themselves to pay the interest bill the debt commits them to.
If you define responsible corporate behaviour as that which is sustainable over the long term for both the finance sector and its customers then most lenders are, by definition, irresponsible.
The answer to the "who's to blame" question is thus "irresponsible lenders", rather than "profligate borrowers".
But that's only half the story: a crisis can only eventuate if irresponsible lenders meet gullible borrowers.
Unfortunately history gives us no reason to be confident that individual borrowers understand the system and their part in it well enough to make sensible and sustainable decisions.
The fact that the financial system will lend as much as borrowers demand means that we can't rely - as we have been doing - upon deregulation and self-regulation to control the financial system.
But the system itself can't get out of control unless there are other factors that entice borrowers to indulge in levels of debt that, ultimately, turn out to be ill-advised.
Fortunately for the fraudulent and shonky operators who exist in any financial system, but unfortunately for the rest of us, those factors exist, and they're at the very core of our modern economic system.
Steve Keen is associate professor at the School of Economics and Finance at the University of Western Sydney. This is an extract from his paper Deeper in Debt: Australia's addiction to borrowed money.
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