Money and value
- Thread starter littlebabyjesus
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ItWillNeverWork
Messy Crimbobs, fellow humans.
littlebabyjesus
one of Maxwell's demons
I need to do more than that, and I am planning on doing it when I work out how to - I need to find a way to take a long-ish period, say 50 years, in a particular economy and calculate how much interest was paid on loans over that period, how much growth there was and how much inflation. If I'm right (and this wouldn't in itself prove I was right, but it is a prediction of my theory), then inflation should equal interest paid minus growth. If it doesn't show this to a reasonable accuracy, then I am wrong.
But to take post-war UK as the example, growth has been 2-3 percent per year for most of the post-war period. In that time, the bank base rate has until very very recently never dipped below about 4 percent, and of course most loans are taken out at a higher rate than the bank of england base rate. Even now, you can't take out a secured loan for less than about 3 percent even with massive equity, and growth is around zero at the moment - and most loans are made at much more than that.
littlebabyjesus
one of Maxwell's demons
No. It has to be rates actually charged by lenders. It's the actual activity that matters here rather than theoretical rates. You'd have to subtract defaults, but then defaults are an integral part of the game - they are the means by which the banks take possession of real things.
ymu
Niall Ferguson's deep-cover sock-puppet
Inflation fills in the gap, doesn't it? Interest rates have to cover inflation + risk + admin costs (+ profit) or the bank goes under. If growth is lower than inflation, fortunes trickle away. Which is why Osborne is on seriously borrowed time. His base are getting twitchy.
littlebabyjesus
one of Maxwell's demons
ItWillNeverWork
Messy Crimbobs, fellow humans.
I don't think it is circular logic, more that this demonstrates the circularity of causation within the economy. There are many interconnected variables impacting on each other simultaneously. Both positive and negative feedbacks exist, some cancelling each other out and others acting as self-reinforcing loops.
So it may well be that interest rates drive inflation, but just as real is the idea that inflation rates determine interest rates. Similarly, a raising of interest rates lowers the volume of people demanding loans and so creates a tendency for growth to decline which in turn decreases inflationary pressures.
Put simply, the economy cannot be viewed linearly with x -> y as a direct cause. It has to be analysed holistically and dynamically.
littlebabyjesus
one of Maxwell's demons
Yes. Very true. That's a good way of thinking about it. I may in fact be trying to oversimplify here. Certainly if inflation is running at 10 percent, banks are going to want to charge at least 11 percent for any loan. Charging interest sets up an expectation that the money supply will grow - but that expectation will then feed back into the process of setting interest rates - yes, I can see that.
love detective
there's no love too small
where do you get this idea that money is actually created to pay interest (and that this 'extra' money is the 'fundamental' driver of inflation)? this crude mis-analysis is at the root of a lot of your misunderstanding about some very basic things
I'll have one last go at trying to show you where you are wrong - using the most simple of terms and examples to demonstrate it:-
Pretend I get paid £105 a week and I normally spend all of it consuming things. If i borrow £100 from you, and promise to pay you back £105 tomorrow when I get paid - a loan situation develops between us in the intervening period
Normally when I get paid i'd spent £105 on consumption, but when I get your loan I spend £100 on consumption and when I get paid my £105 I have to hand it all over to you. So at this point instead of £105 chasing goods in the economy, only £100 is (a potential deflationary, not inflationary, situation) - however that additional £5 that i'd normally spend on consumption goes to you and represents your gain on the loan, you now spend this and in total we're back to the £105 chasing goods in the economy.
The loan and the interest have been repaid in full - no money has been created while doing so (as i've paid you back from my wages which I would have been getting anyway), no trace of either the loan or interest is left - they have both been obliterated, no increase in the amount of money chasing goods has come about and no inflation has occurred. The only thing that has changed, at all the different points of the loan transaction, is the distribution of existing goods/money between you and I - at the total level nothing has changed
Can you try and explain to me why you see the need for additional money to come into the system in the above example?
ItWillNeverWork
Messy Crimbobs, fellow humans.
Expanding on this view of the economy as a system in which feedbacks exist, one of the problems with neoclassical economics is that it only analyses negative feedbacks - i.e. tendencies that cancel each other out and so lead a system to 'equilibrium'. The problem with this is that it is based on naive 19th century concepts found in physics.
Nowadays it is understood that even physical systems do not always reach a static equilibrium. For example, watch how chemical reaction oscillates back and forth between different colours. There is no reason to think that capitalism does not operate in the same sort of way with oscillations being a natural consequence of it's internal dynamics.
Anyway, that was a bit of a digression. You got me all excited.
Nowadays it is understood that even physical systems do not always reach a static equilibrium. For example, watch how chemical reaction oscillates back and forth between different colours. There is no reason to think that capitalism does not operate in the same sort of way with oscillations being a natural consequence of it's internal dynamics.
Anyway, that was a bit of a digression. You got me all excited.
littlebabyjesus
one of Maxwell's demons
How did that existing money enter the system? That example starts from the position where there is money already in the system.
I agree with you that your example is zero-sum, but my example involves a third party - a bank of some kind - providing the money, the symbolic entity to which value is attached. Without that third party, how can there be any money in the system at all?
ItWillNeverWork
Messy Crimbobs, fellow humans.
Although this does assume that saving has to take place before a loan can be made - i.e one persons loan is another persons deferred consumption. ymu mentioned Minsky earlier, and he had quite a different take on this idea.
love detective
there's no love too small
but your contention is that lending money at interest causes inflation - if the money was lent at 0% according to you it wouldn't cause inflation - but the question as to where it comes from remains - so for the purposes of looking into your hypothesis it is irrelevant
littlebabyjesus
one of Maxwell's demons
Yes, very good. And not a digression, I don't think - this kind of systems analysis is crucial to understanding complex processes. But in the particular case of inflation/deflation, there isn't an oscillation really - there's pretty much always inflation.
love detective
there's no love too small
I hope you get the significance of my point above - i.e. your claim is that only lending at interest causes a increase in the money supply which in turn causes inflation - this implies that lending money not at interest (i.e. for free) doesn't cause an increase in money supply/inflation - so the investigation into how the original £105 came about can have no relevance to your hypotheses, because according to you, if money is not lent at interest then we don't have the fundamental driver of inflation that you claim it is - so you can't use 'where did the original money come from' to justify your case here (or if you do, then you need to adjust your hypothesis to one which says lending in general causes inflation, but that then blows your plan about proving you are right via reference to interest rates & interest payments)
love detective
there's no love too small
(i wish you'd stop editing in things after i reply as it makes it look like i'm ignoring points)
commercial banks don't introduce money to the system, they circulate existing money (i.e by lending it to people - just like you lent £105 to me) that has been created by the central bank
love detective
there's no love too small
ItWillNeverWork
Messy Crimbobs, fellow humans.
In the 20th Century this was the case for sure (other than the great depression). This is quite an interesting graph though. It shows how in the 19th Century there was just as much deflation as there was inflation, with the severity of the price changes decreasing as the century went on.
I've no idea what to make of this data but it sure is interesting. I'd like to understand what effects Keynesian policy had on altering the behaviour of the economy after the 1930's.
littlebabyjesus
one of Maxwell's demons
Ok, I accept that loans within the system such as you describe don't create inflation. But there is a need to get money into the system in the first place. As itwillneverwork says, your model there assumes that all loans are made through deferred consumption. But in reality is that really what banks do? And in reality, how could money ever enter a system in the first place if that were true?
There is another way in which money can be thought of - the deferred consumption (someone's deposit in the bank, perhaps) may give confidence to the borrower and lender, but the loan is made on the valuation of an asset of the borrower's, or even just on the trust of a firm handshake. You don't actually need the deposit to back that up - the bank can just as easily just create the money out of nothing and give it to the borrower with the asset as collateral - as long as the loan is repaid, the fact there was nothing to back up the bank's loan is irrelevant.
And in order for any money to be in the system at all, this kind of process must have happened, or at least, you have to consider the system as if this were the process that started it off. If you don't do that, you may be ignoring a fundamental aspect of the system.
ymu
Niall Ferguson's deep-cover sock-puppet
But it does, if the money never existed in the first place, doesn't it?
I have no idea what he's going on about, but if a banker makes up an imaginary £90 to add to the tenner he's got, and charges a fiver on the £100 loan, inflation was caused by spending £90 that never existed. The fact that it quickly vanishes in a puff of smoke when profit has been made off it doesn't mean it didn't have an impact.
And this is where I get lost ...
ItWillNeverWork
Messy Crimbobs, fellow humans.
At the risk of repeating myself, I'd point you to Minksy and the theory of endogenous money. I'm not saying that his theories are correct - for sure, they are not part of the mainstream. However, it is still the case that the mainstream understanding of how money is created is not accepted by everyone. Just something to think about
littlebabyjesus
one of Maxwell's demons
Some changes I can think of that might be relevant include the abandoning of the gold standard (which had been fiction for a while anyway) and the beginning of fractional reserve banking as the mechanism for putting money into the economy.
littlebabyjesus
one of Maxwell's demons
I'm going to have a read of that. I may leave this thread alone for a while while I do.
love detective
there's no love too small
i've already explained to you numerous times how money enters the system and how commercial banks then circulate that money via fractional reserve lending - i.e. £10 of central bank money could be lent & borrowed countless times creating say £100 of loans & deposits
now each time that £10 is circulated by the commercial banks (through lending and recycling back through the system to more lending)- no new money is created, the only thing that happens is that the velocity increases
so the example i gave you, which you now accept doesn't create inflation, is the same thing that happens each time a bank lends through fractional reserve lending i.e. there is no third party that you keep going back to - no additional money comes into the system, it just circulates more (and earlier on you ruled out the possibility of increasing circulation from causing inflation - something i actually disagree with btw)
commercial banks can't create money, they can only circulate existing money
i'm more than happy to discuss how money enters into the system, but i specifically ignored it in the example i gave you because based on the way you had set out your hypothesis it wasn't relevant - because your core claim is that lending money at interest is the fundamental driver of inflation. this implies that lending money at 0% interest does not cause inflation - so the issue to discuss from the point of your theory is not how the money got there, but once it's there - why if it's lent at interest does it cause inflation, but lent at 0% it doesn't. i.e. the issue of the money getting there in the first place you actually dispense with in your hypothesis because what you say is the fundamental driver of inflation is whether it's lent at interest or not - not how it got there
i know i keep saying this, and you will ignore it, but if I were you I would take a few steps back and try and work on your foundations before trying to build anything on them - it will pay dividends in the long run
love detective
there's no love too small
it doesn't, my example of the £100 borrowed from you was blind to where the money come from (for reasons i've already stated, i.e. your hypothesis rendered that fact irrelevant)
my actual model is what happens in reality (i tend to find that helps) which is that loans are made through commercial banks circulating existing central bank money - i.e. fractional reserve lending (which is nothing more than money circulating), something that has pretty much been around since the credit system & money itself, it's nothing new
love detective
there's no love too small
this is pretty much what i'm saying - i.e. banks circulate money within the system to the extent that demand dictates (although it still needs a base of central bank money to happen, but the independent variable is demand for loans, not central bank money - LBJ's theory on the other hand seems to place the importance of central bank money ('a third party') as the key driver here)
people often go on about banks being able to create money out of thin air, which is obviously bollocks - they have the ability to circulate existing central bank money, but only if the demand for loans & deposits in the system is there - i.e. neither the central bank, or the commercial banks are the independent variable, but demand for loan capital is)
anyway - this is all irrelevant to the fundamental reason behind LBJ starting this thread which states that lending at interest (and not lending money at 0%) is the fundamental driver of increased money supply and inflation - i.e. as said a few times already, what lies at the heart of LBJ's theory is not how the money gets there, but whether it's lent at interest or not once it's there. If he wants to admit that his theory (which prompted the creation of this thread) has no legs, then the discussion may move onto something that might actually get us somewhere - until then however we're stuck in a loop of LBJ insisting he's right without ever having proven it (either logically or empirically)
littlebabyjesus
one of Maxwell's demons
I'm not insisting I'm right. It's kind of the opposite, in fact. I can see your point about commercial banks - as long as loans are made on the back of deposits, they are a way of shifting existing money around - any loan is matched by money 'resting' in a bank account somewhere. So whether or not there is an increasing money supply is simply a function of the balance between loans and loan repayments. And at least in modern times, there has always been a bias towards ever greater loans being taken out.
Ok, I accept that. I've got that bit wrong at least.
Ok, I accept that. I've got that bit wrong at least.
love detective
there's no love too small
yep that's correct (although the money isn't resting, far from it in fact, it's speeding/circualting around the system and effectively being in mutliple different places at once) - and fractional reserve lending is purely a function of existing money circulating (i.e. shifting around as you say, and this shifting around/circulating/velocity is the key thing in all of this)
commercial banks can't just create money from nothing (grasping this is absolutely vital here) , and while central banks can create money from nothing, if there's no demand for it (from commercial banks, and in turn their customers) the money created would have no affect - so we're left with demand within the system for loan capital which is the key driver for both existing money circulating and new central bank money being created (which is why things like QE never have anything like the effect most people think it does - because it's money being created and pushed onto a system that doesn't really want it at that particular time)
commercial banks can't just create money from nothing (grasping this is absolutely vital here) , and while central banks can create money from nothing, if there's no demand for it (from commercial banks, and in turn their customers) the money created would have no affect - so we're left with demand within the system for loan capital which is the key driver for both existing money circulating and new central bank money being created (which is why things like QE never have anything like the effect most people think it does - because it's money being created and pushed onto a system that doesn't really want it at that particular time)
love detective
there's no love too small
Do you still have the same level of confidence you initially had about how lending money at interest is the fundamental reason for inflation?
Bearing in mind that the question of the introduction of money into the system can have no bearing on your hypothesis - because if that money was lent at zero interest it would not, per your hypothesis, cause any inflation
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