Some people are confusing bank deposit creation (loan growth) as saving..this misses the point

Some people seem to think bank loans and savings are one and the same other words if a bank lends someone $10,000, some believe that this instantly becomes savings in someone’s hands.  I do not believe it does.  They seem to think that excess savings is synonymous with too much debt…I find this incredible…

Savings are what are left over from income, not what you borrowed at the bank.  Yes, if what was loaned was spent and all of that became someone’s income and all of it was saved, then it would become savings…or if the residual was passed multiple times between various hands in exchange for goods and services and all of it was ultimately saved.   But new money created via a loan has to pass through the production, consumption or investment function in order to enter savings territory..ultimately and this is the problem.

For example a loan is spent on an additional car and raises the demand for cars…the manufacturer may need to invest in spare capacity or more working capital and will therefore spend more of its revenue on production..this expenditure therefore moves into revenue, investment and wages and savings and profits…the loan is translated into economic collateral and from that collateral comes saving.. 

Savings should come from the revenue generated from production of goods and services in order to be classified as savings.  Savings are that product of capital which is unconsumed and are the means by which additional productive capital is accumulated via reinvestment, thereby increasing future consumption, production, saving and investment.  This way the relationship between asset supply and price and the capital (debt/equity) related to production and consumption dynamics, is a direct one.  This way the value of debt and equity assets have a direct relationship with current and future growth in output.  

Otherwise, if money created by new loans bypasses consumption and investment and merely focuses on bidding up the price of existing assets, the rising value of assets effectively depresses the expected returns on those assets at the same times as raising debt.  Not only that, but debt has not increased the productive output capacity of the economy, meaning that returns available to repay and fund debt remain the same for increasing levels of debt.   So we can have increasing levels of loan debt and asset prices for a constant economic return.  This imbalance between economic growth and the ability to fund debt and justify asset prices builds up a latent demand and asset price shock that ultimately ripples through financial markets, the banking system and the economy.  This is why excess asset focussed money supply growth (loan debt) becomes intractable… it is not excess savings but excess debt and the impact on asset prices of increasing levels of asset focussed money supply growth.

Money is a funny thing and it is possible for significant components of money supply growth to become increasingly asset focussed.  Increasing amounts of money allocated towards portfolio functions as opposed to the consumption functions will create imbalances between the valuation of assets and the production, consumption and investment capacity of the economy.  Indeed, even savings from current production may be reallocated away from investment and to assets: note share buybacks, falling wage growth and increasing profits.  So where we have imbalances that skew the allocation of savings (unspent income or corporate profits) towards existing assets, even the traditional saving function will result in an impairment in the capital of production, and an excess allocation of savings from investment per se towards assets. 

Therefore, if money raised from a loan has been applied to the purchase of an existing asset, it has not entered the P/C/I/S chain and all it may have done is to raise the price of existing assets.  In other words there is no saving and no investment from this particular asset focussed money supply growth.  The new loan cannot possibly = saving, for there is no saving, only a bidding up of the price of an existing asset and no addition to the productive capacity and hence future wealth of a nation.

So a new loan from a bank does not immediately become saving, and if the money created becomes asset focussed and remains portfolio focussed within the wider market place, the increase in the value of assets do not become savings, and the loan does not in itself receive an identifiable income stream from economic output against which to ascertain its current value.  We arrive at excess debt, not excess saving, and we have excess asset values generated by excess money supply growth and not necessarily excess savings.

While I agree that the rise in corporate profits, a fall in wages as a % of national income and declines in capital investment may give rise to an excess supply of savings relative to investment opportunities and hence an excess valuation of assets as money supply once consumption focussed becomes asset focussed, this does not appear to have been the only force in debt and asset markets.  

Likewise, as some have suggested, getting people to swap debt for equity is not going to solve the excess debt problem.  It is the underinvestment and under consumption on one hand and the increased focus of new loan growth, particularly pre 2007, on assets that is the problem.   

Leave a Reply