The next video in the Economic Truths series is out this morning, continuing the theme of discussing money, its creation and its consequences. In this video I argue that it's not true that bank savings fund bank loans. The economic truth is that bank loans create the money in bank savings accounts, however odd that might seem to be.
The audio version is:
The transcript is:
It's an economic truth that bank loans create most bank deposits.
I've already done two videos, one of which says that you've got no money in the bank, if that's what you think your bank statement shows, and another one that talks about how banks do not lend out savers' money. But let's just talk about what happens when the bank does lend out money that it has created as a result of the exchange of promises between the bank and a borrower.
The borrower gets money, and they spend it. And what does the person who receives the money that they have borrowed do with that? Well, of course they deposit it with their bank. They will have very little choice in reality because, of course, the vast majority of transactions that take place in the UK economy are now made with electronic money through bank transfers. So, the bank lends money to a person, and that person then says, “Hey, I've got money in my bank account, that's why I borrowed, I'll go out and buy whatever it is I desire, a car, a new camera, whatever”, and with that new money that they have borrowed, they go along, buy that item, and the person who receives their money pays it back into the bank.
That seems extraordinarily familiar to most of us, and totally obvious. But the fact is that that deposit of the money that the bank lent creates most savings in the UK. Yes, tiny proportions are made out of people's income but that's only because there's already money in existence.
Actually, all money in the UK is made in one of two ways. Either by the government spending it into existence, and we're going to deal with that in separate videos, or, as in this example, with the bank lending somebody new money as a result of an agreement between them and the borrower. And that new money that the bank lends is then deposited back in the banking system, because no wise person holds money in cash.
Therefore, in the UK economy and in the economies of the world at large, most bank deposits, that is money in savings accounts, is created by the banks themselves by lending money into existence.
Now that's really important. Because what that really means is that all the private wealth that is recorded through the mechanism of money is only in existence because banks have lent.
Think about that. We are dependent on this record keeping system of money creation the banks. put into operation for us to actually record basically all of the private wealth that we have.
Now that doesn't mean to say that we couldn't have private wealth without money, but a lot of the forms of private wealth that we have are utterly dependent upon being recorded in that unit of currency that we call money, that is being created by the government as legal tender, and as a consequence we are utterly dependent upon this system to make sure that our economy works and that we enjoy our own well-being.
So, banks have to lend to create money, but when they create that money, they create bank deposits.
There is no great surprise in all of this, I hope, to any accountant watching this because, of course, this is double-entry bookkeeping at work. And when you understand double-entry bookkeeping, you realise that the whole world is all about double-entry bookkeeping.
The bank's loan is somebody else's deposit. That's all I'm saying. It has to be because that is what double-entry bookkeeping requires.
And yet, most people think that the deposit comes before the loan and that's not true. The loan has to come before the deposit or else the money would not exist to be deposited.
So much of what is economically true is the other way around for what most people think. That's my point in making this particular video. Remember that normally, if you think something is obvious, the opposite is true when it comes to economics.
So, savings do not fund loans, loans create savings. It's a simple message, but fundamental to understanding the reality of how the economy works.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
I do get this, but might some figures help?
A ratio of savings in say the UK to actual loans made by the banking sector?
I’m sure that the latter would far outweigh the former?
Just a thought from a not very good at all accountant.
Hmmm….how many hours are there in a day?
Surely, the point Richard is making is that all loans create a deposit. So “Savings = Loans”… except that this does not deal with government created money. So, “Savings = Loans + National Debt”.
Of course, “Savings” here represents economy wide savings – not just households.
Agreed
Or Money = Private and Public Loans
This money then circulates but ultimately gets redeemed. Along this journey it facilitates the use of real resources.
Lesson 101 for honest politicians and journalists!
Thank you Richard, but I’m afraid this raises more questions than it answers.
If banks don’t loan out deposits, how can there ever be a run on a bank.
And I thought money had a strict definition, ie banks create credit not money?
These things still confuse me!
When there is a bank run people with deposits in the bank on which the run takes place try to transfer their money to another bank. If that other bank will not accept the bank making the transfer has the credit available to it to make payment then that bank failes. This is why bank runs take place. The promise to pay is broken by the bank that people think holds their deposit. It is broken because the bank in question has destroyed its own credit worthiness, usually through creating a credit imbalance within its own balance sheet. It is entirely possible for what looks to be an entirely solvent bank to be insolvent for this reason. The availability of central bank reserves created by the Bank of England has virtually eliminated this risk.
A bank run in the modern world is when customers withdraw their deposits more than a bank has access to central bank printed bank notes. In this scenario I believe that whether the central bank is under a sovereign authority or independent is almost irrelevant. The central bank will do whatever it takes. However, politicians can interfere to restrict the central bank providing their printed bank notes.
So a bank run is a political outcome as much as caused by economic forces.
If any readers of this blog have a free evening, the Bank of England quarterly 2014 quarter one, is 114 page document -with diagrams. But the first 30 or so pages are the most relevant to understanding money in the modern economy. It is a while since I read it.
Agreed
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/quarterly-bulletin-2014-q1.pdf
And of course all bank loans must be repaid. The banks giveth, and the banks taketh away.
The net result is that all bank loans are eventually deleted,
Banks also charge interest on their loans, so the bank eventually taketh away more than they loan.
The interest payments enrich the banks at the expense of the consumer.
On the other hand, government spending (e.g. public sector wages) does not need repaying, though the government can remove and delete money through the payment of taxes.
Correct
So….is my thinking correct Richard.
The only source of interest free money that does not have to be repaid is the government. Conversely commercial banks create credit with interest so interest can only ultimately be repaid from government money? With interest repayment currently running at £213million per day that is a direct contribution to the National Debt?
No, I think you are confsued
Babk money does have to be repaid
Interest diverts commercial money from productive use to bank profits
Richard, yes, i understand loans create deposits into the recipient.s bank – but it doesn’t end there surely.The money cycle suggests that the deposits will eventually be spent, rather than permanently remaining in the supplier’s/recipient’s bank account As you have previously said savings destroys money.
Savings don’t destroy money the way loan repayment and tax do
But they do take money out of use
Thanks Richard. I am completely befuddled by “cryptocurrencies”. They are not government backed (although strangely American politicians seem to be increasingly talking about holding them) as government assets. I sense cryptocurrencies may be the next investment bubble to burst. People “invest” in them but they don’t have any intrinsic value. Who is promising who to pay? It all seems smoke – and – mirrors to me. However I am an engineer not an economist. Maybe you could address cryptocurrencies some day as a separate blog?
It is my plans