Money as Debt ... as Fact, or Fiction?
"Money as Debt" by Paul Grignon is an interesting documentary about money, banking and debt creation. It points out some facts about money, but unfortunately, it has a few flaws.
Firstly, I want to commend a couple of points where it quite rightly challenges popularly-held views:
1. "Money", as in a currency in our wallets, is not backed by the equivalent amount of gold held by banks or in places like Fort Knox. This is true. (See Wikipedia article: Representative money).
2. Most of the money in an economy is not the result of governments printing notes, but rather from the money creation activities of banks and other credit providers. This is also true. (See Wikipedia article: Money supply).
The general public should be made aware of these common misconceptions, so that people can be better informed about how the economy really works. However, I cannot entirely accept the description of the money creation process as depicted in the video. Nor can I accept the suggestion that the money (or debt) is conjured completely out of thin air.
According to the example in the documentary, a bank can have only $1,111.12 in reserves and use that to loan $10,000 to a borrower. Huh? How can the borrower use the credit (an asset for the bank) when there is no corresponding deposit (a liability for the bank). This would violate double-entry accounting. That's Enron-style voodoo accounting. How does the bank account for the $8,888.88 that has been conjured out of thin air, as the documentary asserts? For the bank to be able to lend out $10,000 it would need to have initially raised that amount of money from somewhere, as either startup capital from investors or deposits from the general public.
While it is true that banks create money, the ratio of 90:1 suggested by the documentary is plain wrong. $1,111,12 cannot create $100,000 of money. If the required reserve requirement ratio is 1:9, then the credit creation multiplier is 9:1. The bank would need $10,000 of initial capital, not $1,111,12. For a more accurate example of the money creation process, check out the description of the Fractional reserve system in the Wikipedia article: Money creation.
The second major issue I have is the idea that debt (and therefore money) exists independently of the real assets in the economy. Again, double-entry accounting suggests this is not possible. Somewhere along the line, a mortgage of say $100,000 requires equivalent assets as collateral. Otherwise the bank shouldn't hand over its depositors' funds to the borrower. That would be irresponsible.
While I accept that these days the traditional (and rather conservative) credit system of banks has been usurped by all manner of credit providers. These sources of credit have much looser regulatory requirements, and I would argue that here lies a potential problem for the economy.
Another concession I would make is that the total debt in the economy may actually exceed the real value of the assets acquired with the money borrowed. Any such mismatch can cause real problems for the economy. Bubbles can lead to prices that have lost touch with the real value of assets. Remember the Tech bubble, the sub-prime fiasco, and so on? If the bubble bursts, borrowers could be in the unenviable position of holding assets worth less than the debt owed to acquire them. These borrowers may no longer be able to meet their obligations, and so could be forced to sell the assets if, for example, the bank forecloses on their mortgage. The flow-on effects throughout the economy can be disastrous, as many people are experiencing as part of the sub-prime crisis.
I must admit I stopped watching the video about half-way through. Therefore I don't know where the argument was ultimately leading. Unfortunately, the two flaws I've identified make me question the documentary as a whole. A basic requirement of a logical argument is that it must be built on premises that are not false. False premises render any conclusion inferred by those premises to be unsustainable.
If the documentary maker wanted to prove that most money is created by banks and other credit providers (i.e. not by governments), and that out-of-control debt creation can cause economic problems, then I would have to agree. But unfortunately he has sabotaged his efforts by introducing serious flaws in his argument. One day if I get time I might watch the rest of it to see what the conclusions are. In the meantime, I cannot give it an unqualified recommendation. I would suggest viewers interested in the issues raised by the documentary seek more authoritative sources before accepting any conclusions presented.
Firstly, I want to commend a couple of points where it quite rightly challenges popularly-held views:
1. "Money", as in a currency in our wallets, is not backed by the equivalent amount of gold held by banks or in places like Fort Knox. This is true. (See Wikipedia article: Representative money).
2. Most of the money in an economy is not the result of governments printing notes, but rather from the money creation activities of banks and other credit providers. This is also true. (See Wikipedia article: Money supply).
The general public should be made aware of these common misconceptions, so that people can be better informed about how the economy really works. However, I cannot entirely accept the description of the money creation process as depicted in the video. Nor can I accept the suggestion that the money (or debt) is conjured completely out of thin air.
According to the example in the documentary, a bank can have only $1,111.12 in reserves and use that to loan $10,000 to a borrower. Huh? How can the borrower use the credit (an asset for the bank) when there is no corresponding deposit (a liability for the bank). This would violate double-entry accounting. That's Enron-style voodoo accounting. How does the bank account for the $8,888.88 that has been conjured out of thin air, as the documentary asserts? For the bank to be able to lend out $10,000 it would need to have initially raised that amount of money from somewhere, as either startup capital from investors or deposits from the general public.
While it is true that banks create money, the ratio of 90:1 suggested by the documentary is plain wrong. $1,111,12 cannot create $100,000 of money. If the required reserve requirement ratio is 1:9, then the credit creation multiplier is 9:1. The bank would need $10,000 of initial capital, not $1,111,12. For a more accurate example of the money creation process, check out the description of the Fractional reserve system in the Wikipedia article: Money creation.
The second major issue I have is the idea that debt (and therefore money) exists independently of the real assets in the economy. Again, double-entry accounting suggests this is not possible. Somewhere along the line, a mortgage of say $100,000 requires equivalent assets as collateral. Otherwise the bank shouldn't hand over its depositors' funds to the borrower. That would be irresponsible.
While I accept that these days the traditional (and rather conservative) credit system of banks has been usurped by all manner of credit providers. These sources of credit have much looser regulatory requirements, and I would argue that here lies a potential problem for the economy.
Another concession I would make is that the total debt in the economy may actually exceed the real value of the assets acquired with the money borrowed. Any such mismatch can cause real problems for the economy. Bubbles can lead to prices that have lost touch with the real value of assets. Remember the Tech bubble, the sub-prime fiasco, and so on? If the bubble bursts, borrowers could be in the unenviable position of holding assets worth less than the debt owed to acquire them. These borrowers may no longer be able to meet their obligations, and so could be forced to sell the assets if, for example, the bank forecloses on their mortgage. The flow-on effects throughout the economy can be disastrous, as many people are experiencing as part of the sub-prime crisis.
I must admit I stopped watching the video about half-way through. Therefore I don't know where the argument was ultimately leading. Unfortunately, the two flaws I've identified make me question the documentary as a whole. A basic requirement of a logical argument is that it must be built on premises that are not false. False premises render any conclusion inferred by those premises to be unsustainable.
If the documentary maker wanted to prove that most money is created by banks and other credit providers (i.e. not by governments), and that out-of-control debt creation can cause economic problems, then I would have to agree. But unfortunately he has sabotaged his efforts by introducing serious flaws in his argument. One day if I get time I might watch the rest of it to see what the conclusions are. In the meantime, I cannot give it an unqualified recommendation. I would suggest viewers interested in the issues raised by the documentary seek more authoritative sources before accepting any conclusions presented.
Labels: economics, inefficiency
posted by Bruno at 10:55 PM [permalink]
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