Re: Why do governments borrow money?
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No individual Bank can just "create" money, but the banking system as a whole can.
This can be easily evinced by looking at the following example:
Suppose that any one bank can lend 90% of its deposits. Now imagine that 10K is deposited at Bank A which then lends 9K, that is deposited at bank B which then lends 8100K which is then deposited at bank C which lends 7290 and so on.
10000> 9000
9000 > 8100
8100 > 7290
7290 > 6561
6561 > 5904
5904 > 5314
5314 > 4782
4682 > 4304
4304 > 3874
3874 > 3486
So you can see how from an original deposit of only 10K over 55K of loans can originate through the banking system, but at the same time each component will be able to show that deposits>loans or assets>liabilities.
The banking system can create debt backed by debt backed by debt and thus create money and in fact manages a currency system whereby debt=money.
The sleight of hand of the system is achieved by fostering the illusion that all the components are independent, therefore money can leave the doors of one bank as a liability and then arrive through the doors of another bank as an asset, where as in reality that money has just passed through components of a unified system. It is this alchemy of transforming liability into asset upon which are whole financial system depends.
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But the original investors can deposit an initial reserve into the bank.
If initial this reserve is $1000 and the required reserve ratio is 9:1, then the bank can lend $9000 on this initial high-powered money. This money is essentially new money created by the bank.
This new commercial bank money can then be deposited at another bank and be used to create further credit by dividing it by the fractional reserve ratio, and not multiplying it.
This process repeats:
$1000 initial reserve deposit
$9000 loan > $8100
$8100 > $7290
and so on as in your example.
If repeated 50 times, this initial $1000 deposit can be used to create approximately $90000 - 90:1 ratio
The banks can lend this money they have created at interest.
Suppose all the money in this example were loaned out as a mortgage. The house buyer's signature on the mortgage agreement acts as a guarantee that he/she will pay back the loan (+ interest) or risk forfeiture of the property to the bank.
If the home owner fails to meet their repayment obligations, then the bank can repossess their property. This means that banks can acquire assets using money they create themselves.
It is inevitable that a certain proprtion of people will fail on their obligations to meet their loan agreements and lose the assets they bought to the bank since the only way they can pay back the principal plus the interest is by someone else taking out a loan and injecting further money into the economy. At the time the loan was initially issued, only the money needed to pay back the principal existed and the money needed to pay the interest had yet to be created by the bank.
The time-lag between issuing the credit and the settlement of the debt (usually years) offers an opportunity for the banks to create the additional money needed to pay the interest.
And so the cycle of exponentially increasing debt continues...but by definition - cannot continue for ever.
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it can't go on forever, but it can go on for a long long long time.
i'm currently building a dataset from which i expect to be able to get rudimentary predictions of GDP. from it i mostly hope to learn about the economy via time series analysis.
in it, i will eventually get bank reserves, total credit outstanding (i have that already) and total money in the system. your hypothesis of "exponentially increasing credit" can then be tested.
i don't think there will be an exponentially increasing credit as a % of GDP.
the point is that you've made, again, some very strong simplifying assumptions and i'm not even sure what exactly you're saying about the money to pay interest not being created yet...b/c now we live in a time period prior to which the money was created and the system now functions on (relatively small) changes in the amount of money as a % of GDP out there.
i just am commenting on the exponentially increasing credit hypothesis.
Barron
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