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((Tread 2)) On money creation
[Again, I just can't resist. I think I might even have gone overboard this time but you've been a great sport about it.]
My sincerest apologies for any misrepresentation of your views. I tried to impart your positions as fairly as possible. https://twitter.com/TroyDPresley/status/1304564095421612032
[Again, I just can't resist. I think I might even have gone overboard this time but you've been a great sport about it.]
My sincerest apologies for any misrepresentation of your views. I tried to impart your positions as fairly as possible. https://twitter.com/TroyDPresley/status/1304564095421612032
You have been defending the all too common view, yet not particularly convincing I might add, that banks are not reserve constrained, only capital constrained; that supply is perfectly elastic (or close enough) with quantity supplied dependent on demand. 1/20
Ditto, I believe you are still being incongruous in your reasoning. First, you have yet to concede on the most basic of points, virtually admitted by all sides: that a depository institution growing their loan book will be faced with an increased level of adverse clearings. 2/
Your description just now of "rivals competing for reserves" completely misses the point; the problem I was first pointing to is not one of increased funding costs (though you are also making pretty unfounded claims there) but of primary and secondary reserve depletion. 3/
Imagine bank A with a deposit base of 10.000$ and primary and secondary reserves amounting to 30% (very typical) of said base (equally divided for the sake of simplicity). Assume further that the bank can perfectly discern "100% trustable borrowers with 0% default risk" 4/
Following your advice, it extends (perfectly secure) loans by an extra 20.000$ (with a significant interest rate markup in their contracts compared to commonly practiced market prices!). Fantastic, say you! It nonetheless just exposed itself to an extra 20.000$ reserve drain. 5/
With reserve buffers of 3.000$, this certainly seems like an overly ambitious expansion, but let us further assume that we are in the midst of a serious depression— and the velocity of money is remarkably depressed— allowing A to massively (yet safely) increase its liabilities 6/
This is a cashless society, hence A merely needs to guarantee its reserves are sufficient to cover interbank settlements. The main point is: even if not catastrophic, A's average level of adverse clearings will have necessarily increased following its credit expansion! 7/
Now imagine A's primary reserves getting wiped out unexpectedly. Perhaps it sells some of its assets and converts secondary reserves into more liquid form. If it wishes to expand further, it will rely more heavily on wholesale funding and overnight/terminal loan arrangements 8/
Perhaps it resorts to the discount window and, due to its very public nature, compromises its access to other vital sources of funding. Now, you might say this need not be the case [if only troublesome "Austrians" would cease describing such reliance in unsavoury tones!] 9/
You might even say it's principally a "soft constraint"! This is playing fast and loosely with words. It is empirically a very hard constraint— explaining why no institution relies heavily on said funding (and is only sporadically tolerated by other providers of liquidity). 10/
This is where you go wrong: even advocates of your position will admit that banks can still be price-constrained! It is obvious in my description that Bank A's rising dependence on more volatile funding means it will face increasing marginal costs if it insists on expanding 11/
You might continue to suggest that extending credit will not deplete reserves (somehow), only depress net interest margins to a point. But why should one accept even the latter, unsubstantiated claim that the cost of providing additional loans will never exceed its return? 12/
Indeed, even introducing a lender of last resort effectively capable of instantaneously clearing all interbank settlements, there is still a possible backstop mechanism to credit expansion: namely, when the benchmark rate enforced by CB is too high a hurdle rate! 13/
Alas, the following inconsistency: granting that reserve balances can always be attained at some interest rate, why should one assume that this rate of interest is one at which the bank can always make a profit that imparts a sufficiently high return on equity? 14/
I already covered why individual banks are reluctant to extend their operations to a point of relying too profoundly upon the privileged bank of issue. I have not pressed you here anticipating the objection: "but it need not be so," already a significant concession. 15/
So let me extend another olive branch. Yes, the central bank can always intervene in the system and provide emergency liquidity. However, let me run this final scenario [sorry, just a bit more to go!] and you let me know what you think. 16/
Bank A has expanded and depleted its liquid holdings (through adverse clearings) to such a degree that no market actor is willing to lend to it anymore— or, if you consider this an unreasonable scenario, not willing to lend at rates that make further expansions profitable 17/
Granted, the CB can always provide enough reserve balances. Let's even assume that it can impart them to A at a reasonable price, facilitating its expansion! Here lies the predicament: if A does not contract its liabilities, it will permanently rely on the CB to expand. 18/
If you are still not convinced this is a binding backstop to credit expansion, let's bump it up a notch. Let's assume the CB accepts this new role as the lender of default! Question: what are the implications, not for any individual bank, but the overall banking system? 19/
I submit this entails a complete dissolution of private funding markets. Also, CB's inability to manage the supply of money. Either way, your story isn't a "realistic description of operational realities," as it is often claimed, nor a road particularly worth traveling. 20/20
