posted on 30 December 2015
Written by Derryl Hermanutz
Within a commercial bank balance sheet money system like the whole world uses today, all of the money savers "have", is the same money debtors "owe" to their banks as debt repayments. This we have discussed in Part 1 and Part 2 of this series.
If savers do not spend the money back into circulation, debtors cannot earn their money back and use it to pay their bank debts.
Boom and Bust
But savers "save", not "spend".
So debtors default en masse, and the commercial bank-issued 'money' is exposed for what it really is: credits owed by debtors. If the debtors can't pay, the credits are uncollectable. The credits are owed to banks. Without payments, banks can't pay their deposit liabilities. Depositors' savings evaporate as uncollectable credits owed to them by bankrupt banks. And the whole balance sheet charade collapses back to $0 from whence it began.
Austrian School economists like Andrew Mellon call it a "return to sound footings". Ludwig von Mises chimes agreement.
Credit expansion had inflated asset prices and fostered flourishing economic activity: producing stuff for sale, and buying and selling that stuff. Everybody felt rich, so credit was created and spent (and earned) freely. Lots of new stuff was produced and sold and purchased. There was plenty of work and income for everyone. The economy "boomed" with a plentiful supply of money to spend and earn. Happy times.
Banks do not lend mainly to consumers. Bank credit creation primarily funds borrower purchases of real economic assets like real estate and corporate shares. Bank credit adds demand to the buy side, which inflates the prices of the supply of assets that are for sale.
Sellers of price-inflated assets get the money, and their spending adds demand to consumer goods prices, which causes CPI inflation as they convert their money riches into material luxuries.
Commercial bank balance sheet expansion -- creation of new credit to purchase mortgageable assets -- inflates asset prices. CPI inflation is a secondary effect at best.
But economists and policymakers and the financial media focus myopically on CPI prices, as if the price of Corn Flakes is a reliable indicator of the state and direction of the economy. Real estate and stock prices can be inflating into the stratosphere. Van Goghs can be selling for $40 million a pop. But as long as the price of Corn Flakes only increased by 2%, "inflation is within policy range".
Asset prices and economic activity can collapse into deflationary Depression. But if the price of Corn Flakes is stable, then "inflation" is stable.
Debt deflation collapses the asset prices that credit expansion had inflated. Irrational exuberance to debt-finance purchases of price-inflating assets to cash in on "rationally expected" capital gains, becomes panic to sell price-deflating assets to get money to payout debts.
Credit expansion increases the economy's supply of spendable money. Debt repayment reduces the money supply. A dollar is created as a new loan and a new debt: a commercial bank balance sheet expansion. The dollar remains in existence until the loan is repaid, and the dollar of money is used to extinguish the dollar of debt: a commercial bank balance sheet contraction that reduces both total money and total debt.
Credit contraction deflates the money supply and reduces money-spending, which reduces demand for production of stuff "for sale", so businesses lay off workers and reduce production, which bankrupts newly unemployed debtors and their banks. The bankrupt banks' deposits become worthless, which bankrupts depositors who thought they had "money in the bank". But then discover to their dismay that all they really had was uncollectable credits that were owed by flat broke debtors.
Anybody who still has money after one of these collapses finds their money is on very sound footings indeed. Still-standing banks buy up bankrupt banks' debt-assets for pennies on the dollar at receivership sales, then foreclose on the indebted real assets. The banks can then sell ("liquidate") those real assets to anybody who still has money, at debt-deflation Depression prices.
This is one of the ways ownership of the world's real and productive assets -- which were built up and developed by the combined efforts of humanity -- is "consolidated" into the hands of a few human owners.
Within the world's commercial bank balance sheet money monopoly, the mountain of some people's money savings is exactly offset by the canyon of other people's money debts. Excavating the debt-hole built the money mountain, and the money is owed as the debt. If you bulldozed all the money into the debt hole, you would be back to level ground: $0 money and $0 debt.
But the people who now have the money are not the same people as the ones who owe the debts. We looked at two guys: one who has +$1 million, the other who owes $600k. This is the financial condition of real people who do not exist as zero sum corporate accounting identities.
Savings Glut is an Excess of Debt
At present, global savers have 100s of trillions of money savings: the accursed "savings glut" whose existence moneyed-up investors fear to acknowledge, because the glut of investible money inflates the prices of investment assets and inversely reduces their yields. Global debtors -- government and private sector -- owe equal 100s of trillions of money debts.
Not counting the additional trillions or quadrillions of derivative debt, the world's debtors are presently about $200 trillion in debt. All those debts are owed to the world's creditors, primarily to commercial banks that created all the credits in the first place. The banks, in turn, owe all that money to their depositors and other creditors.
Banks created and loaned -- and debtors borrowed and spent -- the trillions into the money supply. Other parties earned and saved the money that borrowers spent. Spenders now owe the debts. Earners now have the money.
All of the money and debt were created on zero sum corporate (bank) balance sheets, where total money = total debt. The debts are the banks' interest-earning Assets. The savings are the banks' deposit Liabilities and other debts owed to the banks' creditors.
Commercial bank balance sheet expansion created $200 trillion of brand new credit to purchase $200 trillion of brand new debt. That's how money is "created", within the commercial bank balance sheet money-issuing monopoly.
The money that debtors owe is the same money that savers have. If savers do not spend their money, debtors cannot earn the money back and use it to pay their bank debts. Total debt cannot be reduced without an equal reduction of total savings. When debtors cannot pay banks, banks cannot pay their depositors, and the massively imbalanced commercial banking system comes crashing down. Like 1929. And 2008.
The mountain of money savings is really a mountain of commercial bank-issued credits that are owed by debtors. If debtors cannot pay, the credits are uncollectable. The mountain of uncollectable credits slides into the pit of unpayable debts, and the balance sheet rebalances to $0.
Back to "sound money".
The credits repaid the debts. The debts absorbed the credits. There is no more credit-money and there is no more debt that is owed in credit-money. The banking system balance sheet has contracted back to where it began, with $0 Assets and $0 Liabilities. No more debts. No more money.
It cannot be otherwise, within a zero sum balance sheet paradigm, where all of the money supply is issued as credits that are owed as debts to the credit-issuer.
Creating Wealth out of Nothing - Balance Sheet Tyranny
But after the Collapse some debts were simply written off as uncollectable, so some people ended up with credit-money that was created as debt, but which the people who now have don't personally owe as debt. These people now own debt-free money, to buy whatever is for sale.
Meanwhile, the world's debtors had pledged real assets like real estate and corporate shares and future tax revenues and public infrastructure, as collateral security against their promises to repay bank loans and bond-debt, plus interest. When debtors default on payment, creditors take possession of the real assets. Creditors then sell those assets at liquidation sales, and anybody who has money can buy them, cheap. Creditors get the money; investors get the real assets.
"The economy" built all those real assets with real resources and real work. But creditors who create credit out of nothing end up owning those real assets, because a zero sum money system is arithmetically guaranteed to end in mass defaults and creditor foreclosure on "mortgaged" real assets.
As a system for systematically debt-financing the development of a productive economic infrastructure by the collective efforts of literally billions of people, then seizing ownership of that infrastructure when debtors default as they must, the commercial bank credit/debt monopoly is pretty much tailor made.
I would characterize a system like that as a balance sheet tyranny.
One might see government issuance of positive sum debt-free fiat money as a democratic alternative.
Debt-free money worked for Franklin.
It can work for us.
Not necessarily a wholesale replacement of bank-issued credit with government-issued money, as some reformers seek. But as a positive sum supplement, to at least partially offset the catastrophic savings-debts imbalances that periodically crash the commercial bank balance sheet equation.
Illiquidity-cum-insolvency, then economic Depression for want of money demand for everything the moribund economy is able to produce "for sale", is not an inevitable feature of reality.
But it is an inevitable feature of a world that is saddled with a credit/debt balance sheet money monopoly.
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