We Are Already In Depression (If Borrowing Money Is Not Income)

Tyler Durden's picture

Via Baker & Company Advisory Group,

  • The U.S. economy is not as solid as it appears.
  • Statistical anomalies hide profound weakness.
  • I will examine actual GDP and actual employment.
  • Warning: not for the faint of heart.

Do you consider debt as income? Before you answer that, let’s perform a thought experiment. Imagine that you had taken a long cruise last fall and charged $10,000 to an American Express card. When you did your taxes this year, would have told the IRS that you had $10,000 income from American Express? Of course you wouldn’t. Suppose a major oil company issues $800 million worth of bonds to develop a new old field. Would the company report that as income to the stockholders or the IRS? Of course they wouldn’t. I am sure those sound like silly questions as the answer is a self evident “NO!” We do not consider borrowed money as income. It is a liability that must be paid back. Then why do we count Federal Government debt when measuring national income? I will leave speculation as to the “why” to the readers and focus on the fact that we do count new Treasury Debt as income.

The modern concept of GDP was first developed by the Department of Commerce in 1934. Commerce commissioned Nobel Laureate Simon Kuznets of the National Bureau of Economic Research to develop a set of national economic accounts. Professor Kuznets headed a small group within the Bureau of Foreign and Domestic Commerce’s Division of Economic Research. I picture them meeting to develop statistical measures that would help the government to determine if the economy was recovering from the Depression. They are debating on how to measure all of the various sources of income. One economist suggests that regardless of the source of his income, there are only two things he can do… Spend it or invest it and we know how to measure consumption and investment (& savings). This was the foundation of the expenditure approach to measure GDP. I can imagine another one of the economists suggesting that when we sell more to other countries, the excess should be added to national income and subtracted if we buy more than we sell (Balance of Trade). Then another economist suggests that there is a third alternative to the idea that he will either spend or invest his income and that is paying taxes. Since the government takes a portion of National Income and spends it, they decided to add Government spending into the GDP calculations. While each component of this basic formula for GDP breaks down into hundreds or thousands of sub-components, the final calculation is:

GDP= PI + BT + GS

Where PI is private income (measured as consumption or investment)

Where BT is balance of trade

Where GS is government spending

So the final formula for GDP includes Government Spending. Notice that the government spending component does not take into account whether or not the government spent money taken out of private income (taxes) or borrowed it. When measuring National Income, we are giving equal weight to spending taxes on actual Private Income and money the Treasury borrows.

I suggest that government debt is not part of “ National Income” because it is not income. It is borrowed (often from sovereigns that are not our friends) and must be paid back eventually. We do not consider borrowed money as income anywhere else and it shouldn’t be considered as National Income. Debt is artificial stimulus not National Income! Governments must pay back debt either through higher taxes, inflation/depreciated currency, reduced services or some combination thereof. If we want an accurate picture of whether or not the economy is self sustaining, then we need to consider a measure I would like to introduce as “Actual National Income”which does not count artificial stimulus. Therefore to accurately measure the health of the economy, government debt must be subtracted from the formula. Please consider the GDP formula with the following modification.

Actual GDP = PI + BT + (GS – GB)

Where GB is government borrowing

So, if you acknowledge for the sake of argument that government debt is not actual national income, the following graph is how the U.S. economy looks like excluding stimulus. This is Actual GDP excluding artificial stimulus.

The data and chart comes from the Federal Reserve Economic Data base (FRED.) It is Gross domestic Product minus Treasury Debt. If you download them to a spread sheet GDP is expressed in billions so 1,000,000,000 is expressed as 1, while Federal Debt is expressed in millions so 1,000,000,000 is expressed as 1,000. That is why the chart is (Gross Domestic Product * 1000.)

The government has always borrowed and spent money but actual GDP has grown as far back as the Fed has data. That is until 2008. Then something in our economy broke. Since then it appears the economy has been in what would be considered a depression but masked by huge Federal Government stimulus borrowing. Have we reached a level of economic activity that could sustain itself without this artificial stimulus? What would happen if the Government was forced to balance the budget? You decide for yourself, but remember that would remove 5-7% of our GDP. An economic depression is generally defined as a severe downturn that lasts several years. Does this look like a severe downturn that is still lasting several years? This is what our GDP minus artificial stimulus looks like.

Does that chart look like the data on a self sustaining recovery? If it were self sustaining the slope would be rising as it was prior to 2008. It continues to decline and is therefore anything but self-sustaining. In economics, deficit spending has long been called “Fiscal Stimulus.” Since 2008, this artificial stimulus has averaged 7.45% of GDP. The arithmetic (GDP-GB) is quite simple; without the artificial stimulus created by spending the proceeds of newly issued Treasury bonds, our GDP has declined an average of 7.45% each year since 2007! The following data/proof is downloaded from the source of the previous chart.

From 1929 to the end of the Great Depression and WWII, the Fed increased its balance sheet from 6% of GDP to 16% of GDP. From 2008 to 2014 the Fed grew its balance sheet from 6% of GDP to over 22% of GDP. The effective FED Funds target rate sank to 0-¼% band at the end of 2008 and stayed there until the end of 2015, when they went to 1/4-1/2% and stayed there a year. In fact, the Fed did not start serially raising rates until the end of 2016. Essentially, the Fed sat at the zero boundary for 8 years. Many wonder why they took so long to start the process of normalizing rates.

The FED has given us 8 years of “0” rates and almost twice as much of an increase in balance sheet expansion as they used in the Great Depression and WWII. Why? Did they see something that was more dangerous than the dual threats to the U.S.’s actual existence than the Great Depression and WWII combined? Or perhaps they were just engaged in a reckless and potentially dangerous monetary experiment? I have been asking those questions since the Fed’s balance sheet expansion exceeded that of the Great Depression & WWII. I believe what I have been describing as “ Actual GDP” may provide the answer. The Fed & the Government may have seen a depression that had the potential to be more threatening, deeper and longer than that of the 1930’s. If that assumption is correct, then the Fed & the Government have successfully masked a depression, avoiding a negative feedback loop and giving the economy time to heal. Has it healed? Please refer to the first graph “GDP minus Federal Debt” chart and tell me if you think the actual economy has healed. It is still heading down so I believe an informed and rational answer would be NO. If it has not healed one wonders what the Fed is doing.

In a report published on Wednesday August 30, 2017, titled “With A Shutdown, There Will Be Blood”, U.S. chief economist at S&P, Beth Ann Bovino, writes that “failure to raise the debt limit would likely be more catastrophic to the economy than the 2008 failure of Lehman Brothers and would erase any of the gains of the subsequent recovery.” I believe Bivino is on to something, even though we now have a temporary extension of the debt ceiling. With the Federal Government borrowing and spending over 6-7% of GDP, then it stands to reason that without the Government’s ability to borrow new money, GDP would collapse 6-7% before a negative feedback loop type mechanism is engaged making it worse. It is just arithmetic. Since 2010 the amount of net new Treasury Bonds issued has averaged 6.5% of GDP. If the Federal Government were unable to issue new bonds then that amount would no longer be in GDP. Again, It is just arithmetic.

The labor market is reported as having created millions of jobs, but what kind of jobs? We often hear that we have full employment and a very tight labor market, that we have created so many jobs the Fed must raise rates. Since no one wants to raise a family working multiple part time jobs, let’s examine U.S. employment in terms of full time jobs,

The Federal Reserve data base (drawing on U.S. Bureau of Labor Statics) tells us there were 121,875,000 people employed with full time jobs in November of 2007 (just before the 2008 crises). As of August 2017 there were 125,755,000 people with full time jobs. That means our economy has added a paltry 3,880,000 full time jobs in almost 10 years as the population grew by about 23 million.

According to the National Center for Educational statistics there were 3,897,000 people who received a college degree including associates, bachelors, masters and PHDs in the school year 2016-2017.

The good news is that most of the people who graduated from college in the 2016/2017 school year can have full time jobs. The bad news is that in the 2016/2017 school year, those who dropped out of college, graduated from high school or dropped out of high school do not have a full time job. The really bad news is that everyone who graduated from college, who dropped out of college, graduated from high school or dropped out of high school from 2007 through 2016 do not have a full time job. There have not been enough full time jobs created in our economy for anyone out of high school or college in the last 9 out of 10 years. If the creation of enough full time jobs to employ only 1 year of college graduates out of 10 years sounds like a tight labor market to you and not a depression, then perhaps some of the readers would like you to share some of whatever you are smoking .

In conclusion, I believe the U.S. economy is in a depression masked by debt. I further believe there is no indication we have had an actual recovery of the actual economy.

These observations could inform intermediate and long term strategies. I am not using these observations as a timing tool, but rather as a depth finder for assessing risk when the next crisis unfolds or when market participants realize the emperor, not only has no clothes, he maxed out his credit cards buying them.

 

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nuubee's picture

If borrowing is not income, we're in the worst depression ever. Basically this would be a complete do-over if borrowing is not income.

cossack55's picture

I will use this article when arguing with my brain-dead relatives

Bigly's picture

That one chart illustrates what we feel in our bones.

We are underwater, not rah rah.

UndergroundPost's picture

Until men of good will and honest money are determined, by the force of arms if necessary, to smash the unholy socialist trinity of alchemist money, centralized globalist banking & systemitized theft via confiscatory taxation (ie income tax), we will continue down this path.

peddling-fiction's picture

+666 the unholy dialectical trinity of 1) alchemist money (fractional-reserve money creation), 2) centralized globalist banking & 3) theft via confiscatory taxation (i.e. income tax)

It is more unholy than most could ever imagine.

LawsofPhysics's picture

Correct.  It will be forced upon us by the laws of physics and Nature.  Why? Simple.  Those who actually know how to produce things for real value will have no choice but to produce for THEMSELVES and their tribes.

At that point you better have some tradable skills motherfucker, or control of productive capacity and real resources...

All these "educated" eCONomists still believe in infinite and exponential growth in a biosphere with finite resources...

Good luck with that.

In the meantime...

"Full Faith and Credit"

peddling-fiction's picture

This is much more like the good ZH articles that got me interested in ZeroHedge back in 2010; without mentioning the great comments.

Are (((they))) going to let this truth stand, or is it allowed now, because implosion is imminent?

This is the BOMB.

Bastiat's picture

Consider what GDP would look like if you pulled out the $20 trillion created out of thin air and pumped into the system by the central banks after the 2008 meltdown.

affirmed_78's picture

The moral here is GDP looks good simply because of reckless government spending and keynesian monetary policy.

toady's picture

....and GDP doesn't look good...

Oldwood's picture

Uh, would it be considered trolling to suggest that debt IS income if it's never going to be paid back? I sure know the IRS considered unpaid debts as income.

Does anyone here really think the debts will be repaid? This has been pure money creation, All money is created through debt, this debt going straight to the goevenment's check book.

This entire economy is a non reality construct. It's Monopoly. We play it for keeps and none of us wants to end up bankrupt, but the game has got loose and racy and now noby fears failing as it really isn't real anymore.

Of course consequences are real ultimately, but the way they have played the game, if we try to apply real rules of consequence we will fail. Put everything on the roll of the dice. Why not?

peddling-fiction's picture

If you have skin in the game with collateral, you will lose it.

Your property will be theirs.

Sooner than later, this fiat money will not be worth much.

Only real capital goods, gold and real estate will be worth anything.

This formula has been repeated ad nauseam.

The Weimar Republic comes to mind.

assistedliving's picture

 I believe the U.S. economy is in a depression masked by debt.

I believe I'm in a depression masked by opoids

UndergroundPost's picture

Logic can never overcome ideology. America (majority) irrationally believes money can  be CONjured out of thin air and thereby borrowed at no limit, making it worse than a depression - its the death of a nation & western civilization 

small axe's picture

hopefully your brain-dead relatives can still process logical thought and good information. My brain-dead relatives are too far gone. I've tried, but anything that bursts their bubble is rejected out of hand.

good luck.

sleigher's picture

I finally red-pilled my brother.  Took about a year or so but he finally opened his eyes and realizes we are completely screwed.  I think the hurricane that hit Tampa had a little bit to do with it as well.  Once other people whom I don't know started saying to him the same stuff I was saying, he started asking questions.  Now he sees the need for land, guns, and the skills to use/maintain them. 

toady's picture

You'll find that's the way it happens... you talk to someone about this stuff over and over again, and then one days it's "my buddy told me something the other day.. "

It's happened to me several times. I just shake my head and smile.... I'm just glad some people are finally waking up!

Escrava Isaura's picture

cossack55: I will use this article when arguing with my brain-dead relatives

Try this in yourself: What do you think will happen if the debt is wiped off tomorrow?

 

peddling-fiction's picture

"What do you think will happen if the debt is wiped off tomorrow?"

Is this scenario with the bankers resting peacefully as fertilizer, as well as their minions, or NOT?

Meanwhile you think about your K-Street buddies, I would re-invest the freed debt-servicing money, towards reestablishng a manufacturing base in the U.S.

This is not rocket science Isaura.

Escrava Isaura's picture

invest the freed debt-servicing money, towards reestablishing a manufacturing base in the U.S. 

Great. I am with you here.

a) Now tell us who issues the money.

b) And how will they distribute this debt-free money?

 

 

peddling-fiction's picture

Once they are resting peacefully, Executive Order 11110 would solve your first question.

The second question is more complex, but I can assure you that they must be US single-passport citizens, with skin in the game, right back at home.

I would open a government tender (with 1% fixed-interest loans) with the aforementioned pre-requisites.

You see, it is not that hard.

Escrava Isaura's picture

Sorry, debt-free money can’t carry interest. Just a fee to cover the bank expenditures.

Again,

Who issues the money?

And how will they channel it?

Need a hand?

Sorry, you can’t use the US, because this answer won’t be there.

Try Japan and Canada before the neoclassical economists arrived there.

 

striped-pad's picture

If "debt-free" paper money is nobody's liability, it's also nobody's asset.

cossack55's picture

Silver and gold certificates. I have a few around here somewhere

striped-pad's picture

Silver and gold certificates are debts. The issuer promises to exchange the note for a stated weight of precious metals.

Edit: s/bank/issuer/

Edit2: s/They're/Silver and gold certificates are/

Escrava Isaura's picture

Bank of North Dakota is a great blueprint. A Great way for other states to imitate.

But, Bank of Dakota cannot issue money.

Again,

Who issues the money?

And who allocates the money.

 

striped-pad's picture

Anyone who writes an IOU which is generally accepted in exchange for goods and services is issuing money. Most people's IOUs aren't accepted by traders, so if they want to buy before selling, they go to a bank, and write an IOU to the bank in exchange for the bank's IOU to them. The bank is issuing money, because traders generally accept its IOUs in exchange for goods and services. (Although they shouldn't if the bank is insolvent, because the bank won't be able to honour all its IOUs).

Money is allocated by borrowers asking banks for loans and banks agreeing to lend to them – it's an agreement for mutual benefit. If someone who has good credit can't get a loan at one bank, and they live in a free society, they should be able to find another bank which will lend to them.

Escrava Isaura's picture

You need to step outside of your comfort zone or you’re not going to connect the dots.

How do you think US economy grew in 1950’s and 1960’s? Free market nonsense? Gold?

No. US economy grew the 50’s and 60’s by creating money and going to Europe to buy assets.

The same way Japan did in the 80’s and 90’s.

And China is doing now.

 

Please, watch these 3 minutes:

Capital Flows:

https://www.youtube.com/watch?v=p5Ac7ap_MAY.“#t=32m56s

End game: Bankrupt small banks and firms and move the money to the Stock Market —Wall Street.

https://www.youtube.com/watch?v=p5Ac7ap_MAY#t=1h02m15s

 

striped-pad's picture

You need to step outside of your comfort zone or you’re not going to connect the dots.

I stepped out of my comfort zone long ago, but thanks for your concern. :-)

How do you think US economy grew in 1950’s and 1960’s? (...) US economy grew the 50’s and 60’s by creating money and going to Europe to buy assets.

The same way Japan did in the 80’s and 90’s.

Economies don't grow by people buying existing golf courses, notable buildings and works of art. (At least not in the long run). Buying government bonds with money which is then spent instead of invested is even worse. You can't make yourself a bigger producer just by buying stuff. You do it by finding better, more efficient ways to produce goods and services. And you don't need money to do that – you need saved physical capital and innovation. Any fool can write an IOU, but producing more than you consume actually takes some skill, devotion and sacrifice.

I've watched Princes of the Yen before, and I've read Richard Werner's theory of banking (posted on ZH, no less). He makes the mistake of claiming that there is no cost to a bank of creating money. In reality, when a bank creates a new debt to a depositor, the bank's shareholder equity, and therefore the owners' net worth, decreases by the amount of the new debt.

What point were you trying to make by the clips from Princes of the Yen? Here's another point of Richard Werner's from the film with which I disagree:

The value of individual currencies is set by currency dealers.

Exchange rates, not values, are set by currency dealers. The actual value of these debts comes from what the holder can obtain from the issuer in settlement of the debt. In the case of an insolvent issuer, the answer is: not as much as it promised.

striped-pad's picture

If a government issues "debt-free money", what makes it valuable to the people as a whole?

What can they, as a group, exchange it for? If they can't get anything in exchange for it, it's literally worthless.

If you don't agree, I'll write you some meaningless pieces of paper with big numbers on if you give me your house in exchange.

"Debt-free money" which isn't inherently valuable (in the way that, say, salted fish or precious metals are) is just a phoney claim that you can increase the world's net worth by fiat.

DjangoCat's picture

Great questions.  Here is an off the cuff response, with apologies to Jim Ricards, probably needs a lot of work:

The state cancels the currency, as India has recently partially achieved.  A new currency is issued cash for cash, treasury based carrying no debt.

Gold becomes the value base, as it really is already, and crypto is used for the transfer the ledger.  The state crypto is controlled by the state and is freely convertible to gold at a market determined rate.

A non-state system like Bitcoin can serve in the place of the SDR, which is the bankster global roll up solution.  When the crisis hits, there will be a move to bail out the central banks into the IMF.  Under their plan, the debt based fiat system will continue and they will have us by the shorts.  I believe we need to be prepared with Bitcoin and gold and ignore them when they try to palm off their "new and improved" version of the same old ponzi scheme.

Everyone revalues their assets in gold and all debt measured in the cancelled currency no longer has any value.

This can be achieved in one reset event and is an event that they will kick off.  If we are ready, they can be toppled at the crisis point.

 

Reginald Blome's picture

bankers resting peacefully as fertilizer

 

Haha +1000 for this!

striped-pad's picture

If the debts owed by individual and corporate (including government) borrowers are wiped off tomorrow, an equal quantity of assets are simultaneously wiped out.

Example: US Federal government debt is written off. Then the Federal Reserve Banks are all insolvent, as are many commercial banks and insurers. That means that the banks have no way to pay their depositors, and annuity providers have no way to pay pensioners.

It's all about the net worth (assets minus liabilities). Production adds to net worth. Consumption subtracts from it. Everything else just shifts it around.

Escrava Isaura's picture

Correct.

All savings go to zero. Unemployment will be 100 percent, meaning, the government will never let it happen.

So, having a conversation about having no new money injected into the economy can only be done abstractedly, in a academic seminar, or by politicians that are trying to screw somebody else’s state, because, in reality, should never happen.

However, I can see no money be injected into some sections of the economy, especially when you hear “give it back to the state”. So, make sure your state is not in that list or you and your state fellows will be screwed.

 

striped-pad's picture

You don't need new money "injected into the economy". It's all false demand – the government buying stuff with IOUs which it has no intention and no realistic prospect of honouring.

How about the government reducing the outstanding stock of debt to, say, $3 trillion – $10,000 per person? How much does everyone really need to be indebted?

Radical Marijuana's picture

Yes!

That is an important point.

Inside a MAD Money As Debt system,

to have no debt is to have no money.

 

Although the article above was well-presented, I did not detect any radical critique of the underlying MADNESS.

"Did they see something that was more dangerous than the dual threats to the U.S.’s actual existence than the Great Depression and WWII combined? Or perhaps they were just engaged in a reckless and potentially dangerous monetary experiment?"

The currently existing political economy, based on the powers of public governments enforcing frauds by private banks, has NECESSARILY become exponentially more fraudulent. Since that "money" made out of nothing was used to "pay" for strip-mining the natural resources of the planet as fast as possible, which was done AS IF those resources were infinite, the underlying MADNESS is too completely crazy and corrupt to comprehend.

The threats presented by excessively successful organized crime manifesting runaway criminal insanities are "more dangerous" than anything that existed in previous history, such as considering both "the Great Depression and WWII combined."

The ways that GDP are measured are far more absurdly backwards than as presented in the article above. Generally wasting natural resources as fast as possible is treated AS IF that was being "productive."  I agree that "the U.S. economy is in a depression masked by debt. ... there is no indication we have had an actual recovery of the actual economy." However, the situation is way worse than that, because the U.S. is currently the leading component of the Globalized Neolithic Civilization, which is based on being able to back up lies with violence, which does not stop those lies from still being fundamentally false.

It is barely possible to exaggerate the degree to which the dominate ways of perceiving the political economy have become as absurdly backwards as humanly possible, due to the intensifying paradoxes that ENFORCED FRAUDS ARE SYMBOLIC ROBBERIES, whose social successfulness requires THAT being buried under the maximum possible bullshit.

For the ruling classes "Borrowing Money Is Income."

Those who are ruled over are stuck inside of a system where they can NOT legally make money out of nothing as debts. However, within that system as a whole, there are those who HAVE that astonishing privilege to make the public money out of nothing as debts, where that money does not exist until it is borrowed. Those who have first access to the largest amounts of that new money made out of nothing as debts are those who are next in line to benefit from the ways that those enforced frauds are symbolic robberies. But still, that MAD Money As Debt system demands that there must be exponentially more of that money made out of nothing as debts, in order to pay the interest on the previous debts, due to previous money being made out of nothing as debts. 

The entrenched systems are DEBT ENGINE TREADMILLS which are wearing themselves out, by driving runaway social polarization and destruction of the natural world. The political economy based on that MADNESS is not merely a "reckless and potentially dangerous monetary experiment." Those entrenched systems are like a terminal cancer, or a parasite that is killing its host. Furthermore, that situation has become too extreme for anything within those entrenched systems to be able to change enough to recover from.

Paying off debts within that MADNESS automatically becomes self-destructive, because the less debts, then the less money. In general, it is politically impossible to have any relatively rational debates regarding political economy issues, especially because sanely doing so must recognize that the political economy operates inside the human ecology. What has actually happened during the development of Globalized Neolithic Civilization, with the U.S. having recently been "leading" the way, has been that the human ecology became as deceitful as possible, while the human economy became as fraudulent as possible. Both trends are endeavouring to become exponentially more deceitful and fraudulent. There is no doubt that the current situation is way worse than both the Great Depression and WWII combined.

At the present time, it is inconceivable how there could ever be any good "recovery" from the degree to which Globalized Neolithic Civilization has become too terminally sick and insane to "recover" from the degree to which that is so. In general, articles like the one above, which provide superficially sensible analysis of the U.S. economy, continue to mostly take for granted operating inside the context of runaway MADNESS.

 

striped-pad's picture

But still, that MAD Money As Debt system demands that there must be exponentially more of that money made out of nothing as debts, in order to pay the interest on the previous debts, due to previous money being made out of nothing as debts.

This is a common fallacy, propagated by Paul Grignon's Money as Debt and Peter Joseph's Zeitgeist, which assumes that new money is only created when someone borrows at interest.

In fact, money is also created when:

  1. A bank pays salaries and wages.
  2. A bank pays its suppliers.
  3. A bank pays dividends to its owners.

By the way, never forget that money is a debt from a bank to the holder, not the other way round.

By the way 2, what's the big problem with there being no money when everyone has paid their debts? I thought everyone agreed that it was really easy to create some new debt money when it's needed, say if someone wants to buy something now and sell something a bit later.

Radical Marijuana's picture

striped-pad:

I was NOT previously aware of your points:

"In fact, money is also created when:

  1. A bank pays salaries and wages.
  2. A bank pays its suppliers.
  3. A bank pays dividends to its owners."

I will presume you are correct.

Those points sound plausible.

However, overall, I would expect that amounts of that kind of money created by the banks' bookkeeping tricks would be relatively small compared to their other bookkeeping tricks.

All of the mainstream notions regarding what money should be continue to be possible ideals regarding some different kind of money that was not made out of nothing as debts by private banks. It was the covert privatization of the public money supplies which makes those most problematic!

striped-pad's picture

Radical Marijuana – I appreciate your openness to new information. It took me a long time to discover this myself (probably 2-3 years after starting to study money and banking).

Consider it this way: if a bank paid its employees, suppliers and owners in cash, and they immediately deposited that cash with the bank, you'd get the exact same outcome: new debts (deposits) from the bank to the employees, suppliers and owners.

I really don't think banks' bookkeeping is a trick. When a bank pays an employee $2,000, for example, it is creating a new debt – the bank owes the employee $2,000 more than it did before. That increases the employee's net worth by $2,000, and reduces the bank's shareholder equity by $2,000, because it has a new $2,000 liability and no new asset. You can think of shareholder equity as a (constantly-changing) debt from a corporation to its owners – it's what would be left over if the corporation were liquidated. $2,000 which previously would have been paid to the shareholders if the bank were liquidated now would be paid to the employee instead, so the shares are now worth $2,000 less to the shareholders.

So a bank paying an employee by creating a $2,000 deposit is a transfer of $2,000 of net worth from the bank's owners to the employee. Creating the deposit in the bank's accounts may be a trivial operation, but it is a transfer of net worth all the same.

When you focus on net worth, and how it changes (production increases it, consumption decreases it, everything else just shifts it around), you start to see that some of the things which economists worry about (e.g. the quantity of money) really aren't all that important. It's easy to create and destroy IOUs, and both are an effective way of paying for something. For any economic transaction, always ask yourself whose net worth changes, and lots of things become much clearer. The only difficulty is that you need to watch out for insolvency, where someone doesn't have enough assets to pay all their liabilities. Insolvent people's economic activity effectively changes their creditors' net worth rather than their own.

DjangoCat's picture

"In fact, money is also created when:

  1. A bank pays salaries and wages.
  2. A bank pays its suppliers.
  3. A bank pays dividends to its owners."

Not so.  The money a bank pays is taken from borrowers and depositors as interest and fees.

Money creation takes place when the bank creates a new debt as an entry in its ledger.

 

striped-pad's picture

If you were to look at the balance sheet of a bank immediately before and immediately after it paid an employee $2,000, the only change you would see is that deposits (which are liabilities of the bank) would have increased by $2,000. That employee can spend that new money using a cheque or debit card, or can exchange it for $2,000 cash. No other money disappeared in the process. New money has been created.

The question of when money is created is a different one from the question of how the bank can fund its liabilities, which is where interest and fees come in. A bank is constantly having to pay employees and suppliers, which it does by creating new liabilities to them. The bank started with a limited stock of assets, and if it doesn't have an income, it eventually gets to the point where it doesn't have enough assets to pay the accumulated liabilities. It must have an income to maintain its assets and liabilities in balance, and it gets this by charging interest and/or fees.

At minimum, a bank must charge enough interest and/or fees to compensate for:

  • The costs of running the bank.
  • Defaults on loans.

For anyone to decide to risk their net worth in offering a banking service, they would expect a reasonable profit on top of this.

Money creation takes place when the bank creates a new debt as an entry in its ledger.

That's absolutely correct. Paying employees is one such example. Making a loan is another. Note that money is a debt from the bank to the deposit holder.

Escrava Isaura's picture

to have no debt is to have no money. 

Correct.

I would like to complement your post with these two quotes that say everything one needs to know about the function of money:

President Trump: Texas & Florida are doing great but Puerto Rico, which was already suffering from broken infrastructure & massive debt, is in deep trouble…Much of the Island was destroyed, with billions of dollars ... owed to Wall Street and the banks which, sadly, must be dealt with.

Now George Carlin: Forget the politicians. The politicians are put there to give you the idea that you have freedom of choice. You don’t. You have no choice. You have owners.

https://en.wikiquote.org/wiki/Critical_thinking

 

Radical Marijuana's picture

Yes, in debt slavery:

"You have owners."

Oldwood's picture

Don't know about anyone else here but I do NOT measure my economic health by how much I spend OR borrow. Usually the opposite.

The one thing I think we could all agree upon is the ONE entity that prospers from VOLUME is government. Why are we looking at THEIR balance sheets for a clue to OUR health? The only item on that spread sheet of relavence directly to many of us is the DEBT that is accumulated in our name.

hongdo's picture

Are any of your assets in US debt?

DjangoCat's picture

I have the same problem.  The issue is, they are braindead and nothing gets through.  The old mind shuts down as soon as the cignitive dissonance begins to scare them.