Re: Aggregate debt

From: Michael Vilkin (mikevilkin_at_mail.com)
Date: 06/14/04 

Date: 13 Jun 2004 21:24:24 -0700

William F Hummel <wfhummel@comcast.net> wrote in message news:<9ofpc0t55d9jk3ioga61jeibg43q8kpd9q@4ax.com>...
> On 13 Jun 2004 11:49:10 -0700, mikevilkin@mail.com (Michael Vilkin)
> wrote:
>
> <snip>
>
> >Here is a theoretical question.
> >Suppose, the banking system lends total of $100 B at 20% interest per
> >year and collects $20 B in interest. So, $20 B is taken out of the
> >economy. Now $20 B sits in banks' own accounts.
> >
> >Banks have certain expenses, so banks return back to the economy $10 B
> >per year out of those $20 B.
> >In this case $10 B will be taken out of circulation, and money supply
> >will fall by $10 B.
> >I don't say that the banking system really does this every year. This
> >is just an example.
> >
> >Do we agree that money supply may increase or fall depending on the
> >amount of interest earned - $20 B in this case - and the amount of
> >money banks return to the economy, which is $10 B in this case?
> >
> >To keep money supply from falling, the banking system has to create
> >new money with new debt. If the banking system will not create $10 B
> >of new money, money supply will fall by $10 B in this case.
>
> As I explained earlier, credit money is endogenous which means the
> amount ultimately depends on the demand for bank credit. The amount
> will increase or decrease as economic conditions change, and thus vary
> the demand for credit. There is nothing unusual about a decrease in
> credit money in the short term. However on average over the long
> term, the amount will increase because the real economy has a growth
> bias.
>
> Banks need to grow their capital in order to back the ever-increasing
> demand for credit money. They return most of their earnings to the
> non-bank sector in operating costs, dividends, and bad loan writeoffs.
> A typical return on equity is about 10% if the bank is well-managed.
> They need about half of that just to stay even with the growing demand
> for credit.
>
> You are arguing that interest on bank loans is a positive feedback
> which _forces_ banks to lend still more so the borrowers can pay the
> interest on those loans. I claim that applies only to a decaying
> economy, in which banks themselves would fail. If borrowers can't
> service their loans, including paying back the principal, banks cannot
> survive.
>
> A sort of equilibrium could exist if bank capital remained constant,
> which implies all of their earnings are returned to the non-bank
> sector in various ways. In that case borrowers in the aggregate could
> cover the interest on their loans out of income they earn off of
> banks.
>
> Normally however the economy is growing. In that case banks could
> grow their capital along with the borrowers who would be able to cover
> the interest on their loans mainly from income earned from banks. A
> bank might lend to cover interest payments if that is seen as only a
> temporary cash flow problem. However if the business is failing, the
> bank will normally take a hit along with the entrepreneurs.
>
> Your simple scenario is a case of not seeing the forest for the trees.
> One can always argue along those lines, but it doesn't bear much
> relation to the real world. I presented data on growth in the
> aggregate capital of banks relative to the growth in national income
> as evidence against the debt virus thesis, which you seem to ignore.
> I think it is up to you to reconcile your analysis with the evidence.

Thank you, William, for the explanation.
I agree with everything you say. No, I never said that debt virus will
cause a depression. I said our banking system has to create new money
with new debt.
Otherwise, debt can not be paid. It's simple math, unless you prove
otherwise.

You don't address one point.
What will happen with money supply if the banking system collects $20
B in interest and return $10 B to the non-bank sector?
I assume you agree that money supply will fall by $10 B.

M3 money supply does not fall. In the period from '60s to the last
year it increased every year from zero percent to more than 10
percent.
Whenever M3 money supply rises slow, our economy is in trouble.
Invariably, there is a credit crunch.
I'm not one of those who argue against "bank money" or credit.
Just opposite, I argue that we do need steady bank credit.

In the example above I've described that we can create bank credit
without inflation. Money loaned to build a new house will not increase
inflation.
The same amount of money loaned to buy an old house will contribute to
the increase of inflation, because new money will be created, but not
a new house will be built. I think you will agree with me on this.

The only point we disagree is...what?
Why the banking system has to create new money?
I believe the Fed has an obligation to keep money supply slowly
rising.
I believe also that without that our economy will fall into a
depression.

To prove it, I'd suggest to calculate how we will pay off $40 Trillion
of aggregate debt given that M3 money supply is only $9 Trillion.

It's simple math. Drop trillions. Imagine that we have to pay $30 over
30 years - $1 per year - but we have only $9 of money in circulation.
  Suppose also that we don't increase money in circulation, but 50
cents is returned to the non-bank sector.

 Money supply will fall by 50 cents every year.
After the first year we will have $8.50 circulating in the economy,
after a second year there will be $8 circulating, and so on.

Once again, I'm not saying it will happen.
I'm saying that the Fed has to keep credit flowing, so that money
supply does not fall on a year-to-year basis.
If M3 is allowed to fall even a fraction of a percent, we will have
another recession.

You are saying that "credit money is endogenous which means the
 amount ultimately depends on the demand for bank credit."
Of course, I agree. We can not force anyone to borrow money, no more
than we can push on a string. But we can do something. Here is an
example.

In 2003 the banking system made loans to buy 6 million resale homes,
but only 1 million new homes. It's a shame. In '70s we built close to
2 million homes per year for a few years.
So, we have demand for housing, but there is no government regulation
to make more loans to build new communities. Supply of housing is low,
prices are high.
People are getting very deep into debt. How they will pay it back?
Let's solve that problem, how to pay $30 with $9 in circulation.
Mortgages are for 30 years, so it's the same problem.

--Michael Vilkin

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