critique of loon theories around banking/money creation/the federal reserve

[equationgirl]

I've just opened a spreadsheet up and I'm gonna start creating some money - does anyone want to borrow a few grand?

Yeah, count me in

 

[Jazzz]

Its been explained to you. Interbank lending.

consider we have four high street banks:

Bank A lends Alf £1000
Bank B lends Bert £1000
Bank C lends Charlie £1000
Bank D lends Dan £1000

interbank lending concerning these loans - must be zero! (symmetry)

So either the loans have been created from nothing, or are being 'funded' some other way. What's happening?

Response to LBJ tomorrow.

 

[Jazzz]

I've just opened a spreadsheet up and I'm gonna start creating some money

Anyone can create money. It's easy. If you have ever written an IOU you have created money (promissory note). The question is, do people believe you can honour your promises?

 

[Blagsta]

consider we have four high street banks:

Bank A lends Alf £1000
Bank B lends Bert £1000
Bank C lends Charlie £1000
Bank D lends Dan £1000

interbank lending concerning these loans - must be zero! (symmetry)

So either the loans have been created from nothing, or are being 'funded' some other way. What's happening?

Response to LBJ tomorrow.

You're an idiot.

 

[littlebabyjesus]

consider we have four high street banks:

Bank A lends Alf £1000
Bank B lends Bert £1000
Bank C lends Charlie £1000
Bank D lends Dan £1000

interbank lending concerning these loans - must be zero! (symmetry)

So either the loans have been created from nothing, or are being 'funded' some other way. What's happening?

Alright, I think I get where you're coming from here. The sum total of all the money in the world is zero - subtracting all debts from all credit. Or at least it would be zero without interest. Interest charges complicate matters somewhat by making a debt larger than the deposit it created.

And for the banking system in its entirety, it is fairly indifferent even as to whether or not debts are repaid, because repaying the debt destroys the deposit the debt created.

And that is money's function. A person does some work that is of value to another. That other gives the person money, which can then be reimbursed for someone else's work. Initially, that note was produced by someone getting into debt, and in the case of initial seed money for currencies, that debt is never repaid. You'd destroy the currency if you repaid it. The person who has got into debt will have to do some work of value to another at some point to repay the debt - to get back to zero.

In that sense, you're right that money is a promissory note - one that has the general confidence of the population, meaning that it can be passed around.

But, the point others are making here is that an individual bank within the system cannot act with indifference towards the loans it makes because there is no guarantee that the deposit created by the loan will be put back in the same bank. It does need to fund the loan. It needs to balance its books so that the sum total of loan/deposit is zero. It has to finance its assets with liabilities.

 

[Blagsta]

Jazzz is attempting to look at banks in isolation from the rest of the economy. Which is why i called him an idiot.

 

[love detective]

I'd like to hear LD define 'funding' for himself.

The process of how banks have to fund their loans have been done hundreds of times on threads like these, you've been pointed to the threads, you've been pointed to the posts and you have been unable to counter them. I've explained it you. LBJ has explained it you (and it's worth noting that a year or two ago he had a fairly similar position to you on this, but unlike you he is actually genuinely interested in finding out how things do work and over the last couple of years has changed his outlook on this quite considerably, largely I would say as a result of discussions had on here about it), yet you are unable to engage with these, and instead just keeping repeating the same questions that you don't even realise you've had the answers to, as you don't understand them

Fuck knows why I bother with this, but pages 4 & 5 of this thread from March 2012 talk exactly about how banks have to fund their loans (regardless of whether you subscribe to an exogenous deposit first approach or endogenous loan first approach - for what it's worth I find talking about these things in these two extreme terms doesn't shine much light on what actually happens, exogenous relies on endogenous and endogenous relies on exogenous)

I've copied some posts from it below, but it would be better to read the actual thread to get all the context

money can circulate, creating the loans/obligations/'new money' that it leaves in its trace, without increases in central bank money. this is a very basic fact of the monetary system (something that has also been discussed in detail in the earlier pages of this thread). So to show that empirically the money supply races ahead of (proportionally) existing base central bank money, doesn't prove anything near the assertion that money is created out of thin air by a few taps on the keyboard (as you suggest) - all it proves is the a priori fact that at times of increased circulation/activity the supply of money increases, and that supply is not dependent on central bank money to do so. The regulatory aspect of what or how much reserve needs to be held back is not the important thing here in terms of getting to the fundamentals of how things work - the regulatory aspect can hamper/intervene the fundamentals of how it works but it doesn't create those fundamentals

If there was no requirement to keep any reserves (i.e. the 10% referred to above) this wouldn't magically allow banks to create money out of thin air - all it would mean is that they could lend out £100 for every £100 they got in - if they wanted to lend out £110 for every £100 they got in, then there's no amount of tweaking with regulatory/legal things that could make this happen - no more than you or I could magically lend £10 to someone that we don't have

Sorry, but you are simply wrong on this. Here's the written evidence to parliament on how the banks did it:

i'm not wrong on this at all i'm afraid

this research only compares one part of a bank's funding streams (customer deposits) to its total extension of credit (loans)

it doesn't take into account, wholesale funding (which makes up a substantial part of a lot of bank's funding - and is really just commercial deposits but is not included in that analysis), central bank funding, equity capital, subordinated debt and all manner of other types of ways that banks fund their balance sheet. For the purposes of this discussion (to simplify terminology) i've lumped all of these into one category and called them deposits because in the wider sense they are all 'deposits' of money with the bank, they are just different in their nature - but what they all have in common is that they all form part of a bank's overall funding which allows it to lend money out. the research which you quote (which is based on an article that the bbc and times wrote) - purely looks at the relationship between bank lending and customer deposits, it excludes these other important components of bank funding)

The 322% figure quoted for Northern Rock shows exactly why it failed - because the bulk of it's lending was funded from wholesale markets and not from straightfoward more stable customer deposits - so when the wholesale market freezed up it was caught totally exposed. This research does not show that Northern Rock created money equivalent to 222% of the money it had lent out - it merely shows what proportion of it's customer lending was funded through wholesale borrowing (which is effectively the same as a deposit as it's a commercial bank 'depositing' money with another bank for a given time at a given rate)

(i'll quite happily walk through a bank's balance sheet with you and talk through the various categories/components and point out which parts are included in that analysis and which aren't - it will be dull as fuck mind, but it will prove the point)

my central point still remains, if a bank wants to lend out £110 but has only got £100 'deposited' with it (deposit in the wider sense, not the sense used in that report - i.e. if it only has funded itself to the tune of £100 through the variety of ways possible i.e., customer deposits, wholesale funding, equity capital, subordinated debt, etc..), the extra £10 can't be magiced into existence or created just because some regulations have changed - it has to be funded from somewhere before it can be circulated onwards - this is what i've been saying from post one on this thread

edit: and in fact looking back at my post you quoted, I didn't even talk about deposits in it, i referred to things like banks only being able to lend out what they got in - the parliament report doesn't contradict this in any way, as it only focuses on one part of what banks 'get in' to enable them to lend

/Ctd

 

[love detective]

Ctd

YMU - here's a snapshot of Northern Rock's balance sheet prior to it's crash (this is a very summarised/condensed down version of it)



If you look at the 2006 year - you will see that loans to customers (the 87) is 322% of customer deposits (27) - this is what the parliament report refers to

All this shows is that the differences between customer lending and customer deposits, is funded by means other than customer deposits - i.e. other kind of funding that the bank has obtained, in this case mortgage securities which represented money that they had borrowed from the wholesale markets which was secured/collaterised on future income streams from their mortgage book and other borrowings plus a little bit of equity capital. It's nothing to do with the bank creating money out of thin air or lending out more than it has got in

While on the topic of this, balance sheets always balance, i.e. total assets equals total liabilities (something that was also discussed earlier on this thread) - anyone who claims that banks can create money out of the thin air would see a situation where the banks assets increase but not their liabilities. This is just absurd really - every asset on that balance sheet above, is funded by a liability for the exact same amount. So in 2006 northern rock had assets of 101bn which in turn were funded by liabiliites of 101bn - the component part of that 101bn that is made up of customer deposits is important from a point of view about how the bank funds it's operations (i.e. it's over reliance on a particular stream/type of funding), but just because customer deposits in this case doesn't equal 101bn, it doesn't mean the bank has created money out of nothing, or lent out more than it has 'got in'.

edit: also if you look at the end of year 2007 position - the reduction in customer deposits represents the run on the bank, meaning it's overall assets were even less funded from customer deposits and things like the state funding from the bank of england begin to take it's place - again this is just funding from different sources, it's not them creating money out of thin air or magicing it into existence

AFAIK the problem was that some of the things that they counted as equivalent to cash deposits for the purposes of lending were nothing like cash deposits in practice.

the problem was what i referred to above - that northern rock depended upon the wholesale funding markets far too much in relation to its customer lending - this got it into trouble then those markets froze up and as such a big component of its lending was funded in this way, along with the run on the bank which removed another slice of its funding in the shape of reduced customer deposits , leading first to emergency state funding and then it going down the pan

I think I can see what ymu's getting at. If you make a loan which will be repaid in 10 years' time, say, and fund that loan with a 'deposit' that you have to repay in 1 year's time, these are not equivalent. You have not funded your 10-year loan at the start of the process, merely a small part of it: ie the idea that the size of a loan is money plus time.

yes, but that's completely different from saying you can create money out of thin air or you can lend out more than you have already borrowed

you can only lend out that original loan for ten years, if you have the money in the first place to pass on to the borrower - so it has to be funded initially, and then over the course of the loan, refinanced if the borrowing to fund it didn't exactly match the maturity profile of the loan itself. This is exactly what got Northern Rock into trouble, it borrowed short term on the wholesale markets and lent long term in the mortgage markets - so when the wholesale markets froze up it was left with a huge financing gap when it's shorter term borrowing came up for payment and it wasn't able to renew it and it also wasn't able to liquidise its assets as they were tied up in long term mortgage deals

this is liquidity risk (and was the cause of a lot of the bank's failures), and it's important to bank's survivial - but it doesn't change the simple fact that if you want to lend something, you have to first fund it - this was the central point being contested earlier - and one which both of you suggested I was wrong about - i'm 100% right on this i'm afraid

You could also learn something from reading these two posts here (1 & 2)

And remember your original assertion on all this was that banks didn't need to fund loans at all, that circulation is not required, you said:-

circulation is simply not necessary. To give a simple example, if someone deposits £1000 hard cash, the bank doesn't have to pass that £1000 around with other banks or itself making loans that eventually add to credit creation of maybe 30 times. It can simply make thirty loans of £1000 straight off the bat.

I'll admit i'm more of a loon now than you for indulging in this as I know you will not read any of the above (just like you didn't read it when previously referred to it) and continue to claim I've never addressed any of this. - utter loon (you and I!)

 

[TruXta]

Just... let it go man. Let it go.

 

[littlebabyjesus]

Well he's right, I think, that the sum total of interbank lending must equal zero. But that doesn't change the fact that individual banks within the system can reach a situation where confidence that their assets will be realised (loans repaid) collapses and other banks will no longer lend to them.

In that sense, yes, you're right that you can't look at banks in isolation. The confidence in the assets comes from the state of the real economy. If a bank lends me money to start a business, they do so believing that my business will be a success. When my business fails, that loan has not proved to be productive. If the house I put up as collateral on the debt halves in value after a house price crash, the bank may take possession of it, sell it, and still be left with a shortfall. They may have to write off a loss. But they can only write a loss off against cash reserves. They can't write a loss off against a liability.

Meanwhile, that money they loaned and have now lost remains out there in circulation, but this kind of business failure/loan default puts a dent in the confidence in the currency and must act as an inflationary pressure.

ETa:

Actually, this last bit isn't really true. The bank basically repays the debt itself from its cash reserves, so destroys the deposit it created.

 

[love detective]

Well he's right, I think, that the sum total of interbank lending must equal zero

Of course it's right, but this is just a banal truism. The sum total of all financial transactions (in terms of risks, flows, profits/losses, interest etc) between all parties sums to zero, but this gives no informational content in itself other than the banality that all financial (and non financial) transactions have two parties/sides to them, each of which conducts the equal and opposite of the other. This is something that is predicated in the very notion of a financial transaction (loan, deposit, swap, option, whatever) itself. It's just repeating back what is already predicated in the thing being talked about

 

[littlebabyjesus]

Yes, you're right. It is a truism. I think Jazzz is stuck on that truism, though.

 

[SpineyNorman]

Anyone can create money. It's easy. If you have ever written an IOU you have created money (promissory note). The question is, do people believe you can honour your promises?

Well given your willingness to believe any old paranoid crap, I reckon that I'd be able to get you to believe I could if I could somehow show that it is necessary to believe I can act on my promises if you also want to believe that teh jooz Rothschild Zionists international bankers control the world through finance.

But here's the thing - banks don't just write IOUs when a loan is taken out - at that stage the 'money they've created' has no relevance to the wider economy. It doesn't matter until the money is withdrawn and put into circulation. And for that to happen they have to have the money to pay you.

Just like if I write out an IOU to you, you can't spend it if I don't have the money to give to you.

You've still never explained why the financial crisis happened and that link I 'liked' that you claim supports your lunatic theories doesn't support your lunatic theories.

 

[Jazzz]

The process of how banks have to fund their loans have been done hundreds of times on threads like these, you've been pointed to the threads, you've been pointed to the posts and you have been unable to counter them. I've explained it you. LBJ has explained it you (and it's worth noting that a year or two ago he had a fairly similar position to you on this, but unlike you he is actually genuinely interested in finding out how things do work and over the last couple of years has changed his outlook on this quite considerably, largely I would say as a result of discussions had on here about it), yet you are unable to engage with these, and instead just keeping repeating the same questions that you don't even realise you've had the answers to, as you don't understand them

<snip>

LD, you've put up HUGE posts of absolute waffle.

I'm looking for the simple answer. What is the form of 'funding' which bank uses for loans, if they aren't creating them out of thin air?

A mathematical description please.

 

[Jazzz]

I may be wrong here, but I don't think so. As I understand it, interbank lending takes the form of digits on computers, allowing banks to balance their books overnight. That makes borrowing from another bank overnight a liability, not a cash reserve, because the loan has to be repaid. Money on deposit at the Bank of England might be considered a cash reserve, perhaps.

Cash plus money on deposit at the BofE plus liabilities in the form of deposits from savers and loans from other banks.

And all assets (loans made by the bank) must be fully matched by the sum of the above. If the bank fails to do this, it's dead. To repeat, this is what happened to Northern Rock, which was heavily reliant on borrowing from money markets and had been taking massive risks by borrowing too short in an attempt to make even more money. Interesting reading about the culture at NR. Employees who warned that they were borrowing too short were marginalised. Large bonuses were on offer for those who boosted short-term profits through very short borrowing.

'cash reserves' are indeed hard cash (notes in vaults) plus demand deposits at the bank of england. The latter is just a bookkeeping entry, it is a Bank of England liability account to the bank. It is just like the bank accounts we hold. Our deposits are demand liabilities of of our high st bank.

When interbank lending takes place, the money is transferred by the lending bank having their BofE account debited, and the destination bank's BofE account credited. So the 'money' being transferred is a transfer of cash reserves. When the loan is repaid, of course, it goes the other way.

When a customer makes a deposit at a bank, the deposit is a change in the bank's cash reserve. That's because it is either a transfer in of hard cash, or it is a transfer in from another bank ('cleared' exactly as interbank lending above).

So when a bank has to be able to cover a withdrawal, it does so from it's 'cash reserves'. This can be thought of as 'bank of england money'.

The key point is this. It is not the case that a fractional-reserve bank must have cash reserves to meet its demand liabilities. This is precisely the meaning of 'fractional reserve'. The cash reserves of a fractional-reserve bank are only a fraction of its demand liabilites.

What this means is that the banks can loan out far more money than they hold in 'cash'.

They can do this because
1) We only want a small percentage of the money we hold to be in notes
2) Just as the customer of one bank might draw on his loan to another bank, customers of the other banks transfer the other way - largely balancing out
3) Where (2) doesn't balance out, interbank lending can smooth over the issues

Generally banks hold 3% of their demand liabilities in cash. That means that the other 97% has been created by them when they make loans. They make the money out of thin air!

 

[Jazzz]

Just like if I write out an IOU to you, you can't spend it if I don't have the money to give to you.

You haven't understood that the IOU * is * money. Not long ago I was in a local coffee shop and didn't have the cash for my hot chocolate. So I wrote an IOU for the hot chocolate, signed with my wet signature, which was put in the till. This piece of paper facilitated the transaction of the hot chocolate. That's what money is, and what money does.

Now if my IOU was made payable to 'the bearer', then the coffee shop owner could have traded it with someone else, and then when they came to me with the note, I would have to honour them instead.

[If you have some cash in your pocket, have a look at it. You'll see that the Bank of England is promising to pay you £10 (or whatever your note is) and it has the Chief Cashier's signature on it]

Now just suppose that my IOUs became accepted as general currency - based on a long history of my being able to honour them when presented. I could start lending, at interest, more IOUs than I had cash to honour them with, because as at any time, a large percentage would be out there!

This is precisely how the goldsmiths created fractional-reserve banking (their IOUs represented gold on deposit). And it is precisely what the High St banks do now.

 

[littlebabyjesus]

Generally banks hold 3% of their demand liabilities in cash. That means that the other 97% has been created by them when they make loans. They make the money out of thin air!

Because that's their business - making loans. I agree with you that the making of a loan is the creation of money. But the money they create in that process has two parts - the asset and the liability. A bank holds only a fraction of its demand liabilities in cash, and holds the rest of it in the form of assets - its loans.

So, for instance, a bank will not be able to borrow from another bank if that bank thinks its loans are junk. Because the bank will only be able to honour its loan from another bank if its customers also honour their loans from it. And that takes us back to Northern Rock, because this is exactly what happened to them. Where banks lose confidence in each other the system collapses.

It's very revealing to look at the figures for interbank lending in the UK during the madness years of 2002 to 2007. Having been very steady for a long time, creeping up each year to around 200 bn, they zoomed up in those five years to 600 bn. An enormous amount of money was created through loans in this period, created not to represent real added value in the real economy but a house price bubble. As soon as confidence in that bubble was burst, interbank lending collapsed right back down to its previous level of 200 bn, which is more or less where it remains today. This creation of illusory value through the inflation of the price of ownership rights to stocks, shares and indeed houses is what Marx called fictitious capital. It exists purely due to confidence that the price of the assets will continue to rise. Once that confidence disappears, the fictitious value represented by the fictitious capital is wiped out, leaving a whole lot of losers and winners in its wake. David Harvey says something very pertinent about what happens next - pertinent for what is happening now, and written before the credit crunch: "the capitalist class appears to have a choice between devaluing money or commodities, between inflation or depression. In the event that monetary policy is dedicated to avoiding both, it will merely end up incurring both." We are seeing this played out right now.

It is almost as if the shortage in social housing in the UK had been engineered with the purpose of manipulating supply and demand in the private housing market in order to create fictitious capital... Who'd have thunk. The list of evils that Blair/Brown did is a long one, with Iraq at the top, but that they played a key role in making this happen is high on the list. And surprise surprise, Blair made himself a property millionaire out of it.

 

[Jazzz]

This is just absurd really - every asset on that balance sheet above, is funded by a liability for the exact same amount

I can't quite believe I've read this. It's grade A nonsense. Assets are things you have, or are owed to you. Liabilities are what you owe to others. ['equity' is the difference].

Saying that liabilities 'fund' assets is bizarre.

 

[littlebabyjesus]

I can't quite believe I've read this. It's grade A nonsense. Assets are things you have, or are owed to you. Liabilities are what you owe to others. ['equity' is the difference].

Saying that liabilities 'fund' assets is bizarre.

It's true, though. That asset cannot exist without a liability or cash to back it up - precisely because the bank itself created the asset. I think I'm right in saying that any bank attempting to create assets without backing them with liabilities/cash would be committing criminal fraud.

That's the thing with creating money out of nothing. In order for it to remain a net 'nothing', there have to be two parts that add up to zero. Just as a vacuum can temporarily create a virtual pair of particles - particle and antiparticle - 'out of nothing' - in reality it is simply another way of expressing nothing. Like the two sides of the equation '4 - 4 = 0' are equal. To create the '4' from 0, you also have to create '-4'. When a bank creates money from nothing, it has to be able to account for both the 'money' and the 'antimoney'. The liability is the 'antimoney'.

 

[Jazzz]

Because that's their business - making loans. I agree with you that the making of a loan is the creation of money. But the money they create in that process has two parts - the asset and the liability. A bank holds only a fraction of its demand liabilities in cash, and holds the rest of it in the form of assets - its loans.

Well I think I nearly agree. Most importantly, fractional reserve banks only get to create money (increasing the amount in circulation) because the practise is not outlawed. Were we to require them to be solvent like any other business - i.e. have reserves to meet their demand liabilities at any time, i.e. full-reserve banking, then they could be said to be simply lending money that they already had. And thus the madness well described in the rest of your post would not be possible.

"[Banks] can lend simply by expanding the two sides of their balance sheet simultaneously, creating (broad) money."
Paul Tucker, Deputy Governor for Financial Stability, Bank of England. Speech: ‘Shadow Banking: thoughts for a possible policy agenda’

 

[Jazzz]

It's true, though. That asset cannot exist without a liability or cash to back it up - precisely because the bank itself created the asset. I think I'm right in saying that any bank attempting to create assets without backing them with liabilities/cash would be committing criminal fraud.

That's the thing with creating money out of nothing. In order for it to remain a net 'nothing', there have to be two parts that add up to zero. Just as a vacuum can temporarily create a virtual pair of particles - particle and antiparticle - 'out of nothing' - in reality it is simply another way of expressing nothing. Like the two sides of the equation '4 - 4 = 0' are equal. To create the '4' from 0, you also have to create '-4'. When a bank creates money from nothing, it has to be able to account for both the 'money' and the 'antimoney'. The liability is the 'antimoney'.

Well this isn't entirely incorrect but I think muddled.

My biggest asset is a piano. It's got a financial value. On my books, it's an asset worth £x. There's no 'anti-piano' anywhere. There's no corresponding liability on my books.

If I have £300 in the bank, then that's an asset for me, but not a liability for me. It's a liability for the bank.

Yes when a loan is taken out, it takes the form of an asset and a liability on the bank's books. But what happens is that the asset, representing the repayments to come, is just an accounting entry, it doesn't really do much except vanish as the loan is repaid: however, the liability - first taking the form of digits in the customer's account - circulates. Let me say again that this what 97% of our money is: it's a credit in a liability account of the bank.

So while you can say that where money is concerned there's matching assets and liabilities, that may be true, but the mirroring is with other entities. Cash reserves are an asset for the bank, matched by a liability for the BofE. Credit accounts are a liability for the bank, an asset for the customer. Etc.

What all businesses are (in general!) trying to do is have more assets and less liabilities. The 'balance sheet' is there as an equity calculation. Equity (net worth) = Assets - Liabilities.

Saying that assets correspond to liabilities in a balance sheet is a bit silly. Even in the case where a bank makes a loan, the asset (total to be repaid) is going to be greater than the liability (the credit in the customer's account). The difference is the bank's equity.

 

[love detective]

LD, you've put up HUGE posts of absolute waffle.

I'm looking for the simple answer. What is the form of 'funding' which bank uses for loans, if they aren't creating them out of thin air?

A mathematical description please.

You've asked for and been given comprehensive answers to all your questions so far

The only response you've been able to give to them is that they are 'waffle'

You've been unable to respond to them other than by insults

I'm not sure whether this is because you don't actually understand them or because you do but engaging with them would pull the rug away from your loon theories

Either way, you've had what you asked for and you've been unable to engage with any of it

I'll also take your continued and dogmatic refusal to answer the various questions that have been posed to you as an admittance that you not only don't have answers for them, but are unable to answer them without pulling the rug away from underneath the very shaky foundations of your loon theories

I'm going to respond to your post about the matching of assets with liabilities in the next post however, as I think you could do with some basic tuition on how businesses (including banks) account for their activities in their balance sheet (as your previous posts show a gross misunderstanding of this)

 

[love detective]

This is just absurd really - every asset on that balance sheet above, is funded by a liability for the exact same amount

I can't quite believe I've read this. It's grade A nonsense. Assets are things you have, or are owed to you. Liabilities are what you owe to others. ['equity' is the difference].

Saying that liabilities 'fund' assets is bizarre.

It's quite revealing that you made such a major slip up in your reply there Jazz - it really does show that you have a very poor understanding of not only money and credit, but even the simple mechanics of accounting and company balance sheets. It' nothing but a truism that all assets of a business (including banks) are funded by an equivalent amount of liabilities (equity is the ultimate liability of a business to its owners, so is included within the wider category of liabilities). That you don't understand or can even comprehend this gives an indication as to why you are having so many problems understanding some of the more complicated things.

Firstly though, as you correctly say liabilities are what you owe others - think for a moment why would you owe something to another party? You owe something to another party because you've done a transaction with them where you have received something from them in exchange for an obligation from you to do something for them.

In essence the asset (or obligation due from someone else or benefit in some other sense) that you receive from that transaction has been funded by the obligation that you have now undertaken in relation to them. i.e. the liability has funded the acquisition of the asset (your IOU in the coffee shop is a liability which funded the acquisition of your hot chocolate)

You appear to have a very weak understanding and comprehension of what a balance sheet actually is though, both in relation to the interaction between assets & liabilities and also between liabilities and equity. You are correct that the difference between Assets and normal Liabilities is Equity. However Equity is nothing but the ultimate liability of the company to the owners of the company. It's a differernt form of liability as it's not immediately payable, but what it represents is the accumulated amount of money put into the company by its owners/shareholders plus the accumulated amount of profits/losses made by that company. The sum of all this is the equity of the company (or shareholders' funds as it's usually called in the balance sheet) and represents the ultimate liability of the company, that of its net worth to its owners/shareholders

Now, for some basic accounting tuition for you as you clearly are in need of some instruction on the basics. And there is little point in you trying to take part in more complicated topics if you don't even understand the very basics of company accounting and what balances sheets actually represent. We'll use an example of you setting up a Limited company in relation to your piano paying.

---------------------------------------------------------------------------------------------
Step 1 - Initial Setup of Company
---------------------------------------------------------------------------------------------
You set up a Limited Company called Jazzz Ltd and put in £1,000 of your own money to the company.

The accounting entries at this stage in the company

Dr Bank £1,000
Cr Share Capital £1,000

Your balance sheet at this stage shows an asset of £1,000 in the bank and an equity amount of £1,000 in the form of share capital.

This £1,000 in the bank of the Limited Company has been funded by the injection of share capital by the shareholder into the company. If you were to wind up the company at this stage, the £1,000 would be returned to you as the sole shareholder in the company. The share capital represents the ultimate liability of the company to that of it's owner.

The value of all assets in the company are funded by liabilities

---------------------------------------------------------------------------------------------
Step 2 - Purchase of Asset
---------------------------------------------------------------------------------------------
The company uses £900 in its bank to buy a Piano.

The accounting entries for this transaction are

Dr Fixed Assets (Piano) £900
Cr Bank £900

Your balance sheet at this stage shows:-

Fixed Assets £900
Bank £100
Share Capital (£1,000)

So again like above, the company's asset of the Piano worth £900 and the £100 left in the bank have been funded by injection of share capital by the shareholder into the company.

The value of all assets in the company are funded by liabilities

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Step 3 - Earning some Revenue
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You play some shows and earn a net revenue of £200

The accounting entries for this transaction are:-

Dr Bank £200
Cr P&L Account £200

Your balance sheet at this stage shows:-

Fixed Assets £900
Bank £300
Share Capital (£1,000)
Accumulated P&L (£200)

The combined assets of the company of £1,200 are still being funded by the ultimate liability of the company to its shareholder in the shape of the £1,000 initial injection into the company and the £200 in accumulated P&L (which could then be paid out to the shareholders in the shape of dividends)

The value of all assets in the company are funded by liabilities

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Step 4 - Expansion and More Asset Purchases
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You want to expand, so you take out a loan for £2,000 to buy a Van

The accounting entries for this transaction are:-

Dr Bank £2,000
Cr Amount due to bank £2,000
Representing the initial recording of the loan

Dr Fixed Assets £2,000
Cr Bank £2,000
Representing the usage of loan funds to buy the van

Your balance sheet at this stage shows:-

Fixed Assets - Van £2,000
Fixed Assets - Piano £900
Bank £300
Amount due to bank (£2,000)
Share Capital (£1,000)
Accumulated P&L (£200)

Once again, just like before and just like it will always be, all assets are funded by liabilities. The only difference this time is that some of the assets (The Piano and bank account balance) are funded by the equity/shareholders's funds (which represents the ultimate liability of the company to its owners) and some of the assets (the van) is funded by the liability of the bank loan.

The value of all assets in the company are funded by liabilities

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Step 5 - Write Down of Value of Asset
---------------------------------------------------------------------------------------------
At the end of the year, your Van has been valued at only £1,500 so you are forced to write down the value of this asset in your year end accounts

The accounting entries for this transaction are:-

Dr P&L £500
Cr Fixed Assets - Van £500
Representing the write down of the value of the Van

Your balance sheet at this stage shows:-

Fixed Assets - Van £1,500
Fixed Assets - Piano £900
Bank £300
Amount due to bank (£2,000)
Share Capital (£1,000)
Accumulated P&L £300

At this stage the total asset values of the company are stil being funded by a mixture of liabilities to others (the bank loan) and liabilities to shareholders (equity). If the company was to be wound up at this stage, the Van & Piano would be sold off for a total of £2,400 (or whatever value it achieved) with £2,000 of that being used to pay back the loan, leaving a net of £700 cash which would be distributed to the shareholder of the company.

At every stage, at every time above - any asset in the company has been funded by a combination of different types of liabilities of the company

The value of all assets in the company are funded by liabilities

 

[killer b]

it's a bank holiday, loves. let's all go outside. x

 

[love detective]

banks create holidays out of thin air

 

[yield]

Very good post love detective.

Yes when a loan is taken out, it takes the form of an asset and a liability on the bank's books. But what happens is that the asset, representing the repayments to come, is just an accounting entry, it doesn't really do much except vanish as the loan is repaid: however, the liability - first taking the form of digits in the customer's account - circulates. Let me say again that this what 97% of our money is: it's a credit in a liability account of the bank.

I think you're getting confused here between cash, the creation of credit and the velocity of money?

 

[8ball]

Jazzz is attempting to look at banks in isolation from the rest of the economy. Which is why i called him an idiot.

Is this the same kind elementary George Osborne makes when he thinks the country's economy can be run like a single household's?

If so, Jazzz is in good company, I suppose.

 

[ItWillNeverWork]

consider we have four high street banks:

Bank A lends Alf £1000
Bank B lends Bert £1000
Bank C lends Charlie £1000
Bank D lends Dan £1000

interbank lending concerning these loans - must be zero! (symmetry)

So either the loans have been created from nothing, or are being 'funded' some other way. What's happening?

Response to LBJ tomorrow.

Why is it that gold-bug types always try to explain themselves using Enid Blyton characters?

 

[DotCommunist]

Aunt Fanny lol

 

[8ball]

Why is it that gold-bug types always try to explain themselves using Enid Blyton characters?

Could have been worse...

Silverstein lends Charlie £1000 etc.