Chapter 3 - First they lend. Then they stop.

In Australia, about 4% of the money supply is Cash Currency. The 96% is credit in bank accounts. This 96% is monetized credit which is transferred from account to account to effect money transactions. The Money Supply is totally reliant on this money that is lent by banks. If the banks cut back on lending, the money supply falls. When the banks lend plentifully, the money supply increases. When they fail to lend, the money supply falls. For steady state economy, it is essential that the banks lend at a similar rate to the rate at which they collect repayments. Banks can be operated by private corporations or they can be operated by the government. When operated by the government they are called public banks. Without public banks, the magnitude of our money supply relies on the lending habits of banks. Private banks have a habit of being erratic with their lending as shown in the graphs below.

Graph of Bank Lending as a percentage of GDP for Australia. Creative Commons Attribute - Andy Chalkley.

The banks issue fresh money and cancel money without regard to the magnitude of the money supply. They arbitrarily cease to issue credit. The largest part of the Money Supply is the credit issued by banks. Their unscientific over-creation of money causes an inappropriate expansion of the Money Supply. Their cutbacks on lending decrease the Money Supply causing deflation and depression. Here is the same graph with some nasty consequences added.

Graph of Australia Bank Lending causing Depressions. Private banks are not capable of maintaining a stable Money Supply. Creative Commons Attribute - Andy Chalkley.

This next graph shows the annual change in the value of private lending for Iceland. [I have averaged the figures over a three-year period to smooth the graphs.] [1] Notice the violent changes in the volume of loans in Iceland. Iceland locked up some bankers for their despicable treatment of the Icelandic people.

A graph of domestic credit provided by the financial sector (% of GDP) for Iceland. Creative Commons Attribute - Andy Chalkley.

This next graph shows the annual change in the value of private lending for the United Kingdom. How is anyone to maintain a steady economy when the lending varies so dramatically? [I accidentally did not put the x-axis shift in these graphs. 1980 means the figures for 1980-12-31. I usually record 1980-12-31 as 1980.99. 1980 sometimes means the figures for the last of December whence it would be 1980.99. 1980 sometimes refers to the figures for the whole year whence 1980.5 is more appropriate. Problems can occur when annual figures are plotted with monthly figures.]:

Graph of Domestic credit provided by the financial sector (% of GDP) for the United Kingdom. Creative Commons Attribute - Andy Chalkley.

How my good Irish friends put up with this, I do not know. They are a tough lot:

Graph of Domestic credit provided by the financial sector (% of GDP) for the United Kingdom. Creative Commons Attribute - Andy Chalkley.
Graph of Greece Loans Change. Creative Commons Attribute - Andy Chalkley.
Graph of All Other Loans for the USA during the Great Depression. Creative Commons Attribute - Andy Chalkley.
Graph of Loans for Greece. Creative Commons Attribute - Andy Chalkley.

In this graph for the good people of Spain, I have shown the M3 and M2 money supply in light green. As the banks cut the lending the M3, M2, and M1 money supply falls. Most of the fall in M3, M2, and M1 is taken from Circulating Money because Hoarded Money avoids taxation. The result is a partial destruction of the GDP. Because most tax depends on transactions, the government revenue is badly wounded.

Graph of Loans for Spain. Creative Commons Attribute - Andy Chalkley.
Graph of Loans for Spain. Creative Commons Attribute - Andy Chalkley.

This graph from Italy shows Loans to the Private Sector

Italy Loans to the Private Sector. Graph by Andy Chalkley. Creative Commons Attribute

Credit is needed for two reasons:

  1. Commerce and industry only thrive when credit is available. Businesses need money before they can make money. Business starved of credit cannot thrive.
  2. Fresh credit is needed to maintain the level of the Money Supply. In Italy, 86% of the Money Supply is credit supplied by banks when they make loans. [6] Only 13% of the Money Supply is Cash Currency issued by the European Central Bank. If the volume of credit falls by 1%, the Money Supply falls by 0.87%.

Citizens do not freely lend their money, so business needs an organised availability of credit at a fair rate of interest. Credit is not going to be made available without some profit to the lender. Even if the lender is creating the money out of thin air, the lender does not wish to be out of pocket from the lending process. Commerce cannot exist without this lending. Mohamed was aware of this and made rules about the lending of money. When the church had a complete ban on the lending of money, commerce was at a low level. It was the relaxation of the rules of lending by the church that has allowed the last three centuries of development. Unfortunately, little heed was paid to the wording of the Quran and immense quantities of unpayable debt have built up. Business relies on the availability of credit. When the credit dries up, so does commerce.

In the aftermath of a financial crisis, the banks were reluctant to lend. They stored excess reserves in case a ‘liquidity problem’ occurred. They had the reserves and backing to lend but did not do so to protect themselves. This basically means that they ceased to lend which caused a damaged economy. When there is a falling Money Supply or a Money Supply that is sluggish to expand the economy suffers enormously. Banks keep a reserve of money to cover demand. During and after a crisis they like to keep a higher level of reserve. This inhibits their lending behaviour. This is the opposite to what is required to lift and economy out of a recession. The banks are operating for their own benefit without any consideration for the economy. The economy needs a mildly expanding Money Supply. If the private banks are to be the only entity supplying credit, they need to have a consideration for the needs of the national economy. At exactly the time a boost is needed to the volume of credit in society they go on a lending freeze and cutback for their own internal operational reasons. This is entirely inappropriate. Absolutely no consideration is given to the volume of credit required by an operational economy. The banks are ignoring the needs and their responsibility to society for their own ends. They are entirely focused on their profitability and financial well-being with a total disregard for the responsibility to society bestowed on them by the granting of the exclusive right to create the credit for the nation.

This is a comment in a report from the Federal Reserve:

“Bank liquidity hoarding is not a new phenomenon. For example, in the aftermath of the Great Depression, and particularly during the late 1930s, U.S. commercial banks accumulated substantial amounts of voluntary excess reserves. As Ramos (1996) points out, during and immediately after a severe liquidity crisis, banks hoard excess cash to self-insure against further drains of cash and to send markets a strong message that their solvency is not at risk and that bank runs are not justifiable. The situation during the banking crisis of the 1930s clearly resembles the bank behaviour during the most recent financial crisis. As suggested at that time, banks sought to build up liquidity buffers to reduce their risk exposure on the asset side of their balance sheets at times when capital and debt was very expensive.”[2]

They were protecting their own backsides at the expense of the nation’s economy.

Here is another comment from the same report:

“In line with earlier effects of disruptions in interbank markets, my results suggest that the same factors leading to precautionary liquidity hoarding also contributed to the sharp decline in bank lending.”[3]

The banks were hoarding money that was needed as a backing for the issuance of credit. The Federal Reserve bank had made the funds available but the banks simply hoarded the money with a total disregard for the well-being of the nation. Another sentence from the same report:

“Moreover, the considerable fear associated with the riskiness of banks’ portfolios further limits the ability of policy actions to revamp credit growth and stimulate the real economy” [4]

The Federal Reserve were well aware of what was causing the shortage of credit. The Federal Reserve had made funds available. Thus a central bank is incapable of controlling the magnitude of the Money Supply because it is incapable of influencing the credit creation of private banks. The solution is thus to ensure that there is a government owned public bank that will ensure that credit is available to enable business to function and to maintain the level of the Money Supply. Efforts by the Federal Reserve to ensure that excess reserves were available to banks to encourage lending did not work because the banks simply hoarded the reserves. The central bank had little influence over the banks lending habits. The central bank was totally useless at maintaining the level of the Money Supply. The banks were hoarding funds rather than lending out money. This demonstrates that a private banking monopoly with a ghost control entity is totally incapable of controlling the level of credit. What we have is a totally unworkable system. The banks and central banks appear to be creating the problems that they are supposed to prevent.

Here is the starting sentence of another report. This time by the New York Federal Reserve Bank:

“The build-up of reserves in the U.S. banking system during the financial crisis has fuelled concerns that the Federal Reserve’s policies may have failed to stimulate the flow of credit in the economy: banks, it appears, are amassing funds rather than lending them out. ...” [5]

Why is control over the money supply in the hands of an entity that is totally incapable of controlling the level of credit in society? Our society is totally reliant on tokens. These tokens need to be available and moving. When the banks cease to lend, there is an inadequate supply of tokens. The common buzzword used by the banking industry and groomed politicians is: “keep the central bank free from political influence”. Thus it falls entirely on the banking industry and the central bank to maintain the level of tokens.

This situation needs to be corrected. The solution can be one of the following or a combination of the following:

There is a simplistic assumption that the control of the nation’s economy is a matter of controlling the money supply. The magnitude of the money supply is somewhat irrelevant in comparison to the management of the magnitude of the volume of money that is actually circulating. Money that is hoarded is taking no part in the economy. The item that needs to be controlled is the magnitude of the Circulating Money. There is little point in presiding over a rise in money supply, if the money becomes hoarded and plays no part in the economy. Management of the economy requires a steady volume of money that actually circulates. To the unwise, this means monitoring the money supply and its velocity. Velocity should never be allowed to fall. A fall in velocity is exceedingly detrimental to the economy.

The stop-start of the lending by private banks alters the money supply in a damaging manner. ‘Stops’ cause businesses to downsize or close. ‘Starts’ lift the money supply but not in a manner to allow business growth and so the increase in the money supply becomes hoarded. This is witnessed by a fall in the velocity. It is impossible to maintain a money supply when the credit is created in a stop-start manner.

Italy Loans to the Private Sector. Graph by Andy Chalkley. Creative Commons Attribute

Your Assets are Used as Collateral.

When a bank lends you money to buy a house, it uses your house as collateral. The backing for the loan is your house as well as the promise to repay that you signed. The bank creates fresh credit in registers and you have to repay with interest. If the bank fails to supply a continuous drip of fresh credit, the following occurs:

Italy Loans to the Private Sector, M3, M2, and GDP. Graph by Andy Chalkley. Creative Commons Attribute

The whole economy starts to wind back. The assets used as collateral diminish in value and the business of the businesses starts to collapse. The debts that were unpayable at the time of creation, are not paid. The debts go bad because the banks cease to create fresh credit to pay previous debts. The Banca d’Italia writes reports with statements like this:

“Italy’s banks are continuing to repair their balance sheets. The default rate has fallen to its lowest level since 2008 and is expected to continue to decline next year as economic growth proceeds. The stock of non-performing loans is also diminishing, in part thanks to some bad-debt sales, while further disposals have been announced” [7]

There are reports that a full ten percent of Italian loans are ‘sour’. It is to be expected when the Money Supply is depleted by the inadequate supply of credit and an inadequate supply of credit for business operation.

The IMF reports that:

“Italian NPLs account for about a third of those in the entire euro area.” [8]

These businesses would not be in trouble if the banks had not cut back on credit. The solution here is the create a public bank. The public bank would maintain the level of credit in Italy during the downturns created by fluctuations in their lending habits.


China does not suffer from the lending lunacy of Europe:

Lending in China. Graph by Andy Chalkley. Creative Commons Attribute

China operates a network of public banks that ensure that credit is available at all levels of commerce right down to the single person entrepreneur.