A deposit is an asset for the customer, but a (pending) liability for the bank. The whole thing is a debt relationship – but not a means of payment.
In short: a deposit is an option right to instruct the bank (in the sense of an order) either to make cash withdrawals or to initiate a transfer of funds. The means of payment used for this purpose are on the bank's asset side (cash for withdrawals, reserves for transfers), thus deposits can never be a means of payment:
Although gold cannot be produced alchemically, there was an alchemist who discovered the recipe for so-called "white gold" – the discovery of the porcelain recipe by Johann Friedrich Böttger. This was a valuable discovery because the Chinese kept the recipe secret, and Europeans had to pay gold and other precious metals to acquire the porcelain from the Chinese. Seen in this light, this invention improved the European balance of payments somewhat because they could now produce the porcelain themselves.
The story of the growth imperative is often told, but it doesn't stand up to close scrutiny. It is possible to show theoretically that it can very well lead to a non-explosive trajectory if the interlinkages between investment and consumption are taken into account. While there is a need for "subsequent debtors," this simply means that economic activity is a so-called "ongoing concern" that ultimately ensures survival. Why should one stop economic activity?
Keynes once put it like this:
"If investment is proceeding at a steady rate, the finance (or the commitments to finance) required can be supplied from a revolving fund of a more or less constant amount, one entrepreneur having his finance replenished for the purpose of a projected investment as another exhausts his on paying for his completed investment." Keynes, J.M., (1937)
"The means of payment used for this purpose are on the bank's asset side (cash for withdrawals, reserves for transfers), thus deposits can never be a means of payment."
I think I see what you're saying here, Renée. From the bank's perspective, they're going to credit an asset on their books (and debit the deposit liability mentioned above) ONLY once they receive a payment instruction. You're saying THIS is the moment the money is created, not the moment the loan is issued. Am I picking up what you're putting down?
Additionally, I've heard that quoted Keynes passage used to defend the idea that the VELOCITY of money explains where the money to make interest payments comes from. To my eye, you appear to be making that exact point. Is there any daylight between what you are arguing here and the concept of the velocity of money?
Finally, this anecdote about porcelain is absolutely brilliant. Thank you for sharing it!
A payment instruction doesn't create new money, but rather causes the bank to reduce its liquidity (assets), unless it's an internal bank transfer. The easiest way to remember this is to realize that payments must always be made with assets. Then it also becomes clear that the bank can't transfer a deposit, because it can't pay with its debts – this applies to all economic entities. Therefore, a bank doesn't pay when it credits something, but rather expresses a promise to pay. This is somewhat like an engagement, which is also a promise of marriage, but not the marriage itself. As we know, a lot can happen in between. And a bank's bankruptcy prevents these promises from being honored – it's not even that rare.
Velocity is a concept that exists in a cash economy without claims clearing, but not otherwise. Attempts to estimate velocity have had little success, so economists have agreed to simply assume it to be constant in an act of faith. That didn't work either, which threw all previous analyses out the window. Since then, velocity has become a dummy variable, responsible for everything that cannot be explained. It's that simple in economics. Incidentally, velocity doesn't undermine the consistency condition for monetary economies. The identity of assets and liabilities (the analogue to income and expenditure) is not affected by it—whether the means of payment quickly "changes hands" or not.
"The easiest way to remember this is to realize that payments must always be made with assets."
That's a VERY helpful way for my accounting brain to remember that Bank Deposits are kind of like food orders placed by customers in a restaurant, while Bank Reserves are analogous to the ingredients used to create the ordered meals. Assets vs liabilities.
A good allegory. The joke about the schizophrenic who eats the menu card at a restaurant and complains to the waiter about the bad taste fits perfectly! :-)
I'm looking for FEEDBACK on this essay!
Let me know what you think in the text box above...
A deposit is an asset for the customer, but a (pending) liability for the bank. The whole thing is a debt relationship – but not a means of payment.
In short: a deposit is an option right to instruct the bank (in the sense of an order) either to make cash withdrawals or to initiate a transfer of funds. The means of payment used for this purpose are on the bank's asset side (cash for withdrawals, reserves for transfers), thus deposits can never be a means of payment:
https://substack.com/@reneemenendez/p-136930534
Although gold cannot be produced alchemically, there was an alchemist who discovered the recipe for so-called "white gold" – the discovery of the porcelain recipe by Johann Friedrich Böttger. This was a valuable discovery because the Chinese kept the recipe secret, and Europeans had to pay gold and other precious metals to acquire the porcelain from the Chinese. Seen in this light, this invention improved the European balance of payments somewhat because they could now produce the porcelain themselves.
https://en.wikipedia.org/wiki/Johann_Friedrich_B%C3%B6ttger
The story of the growth imperative is often told, but it doesn't stand up to close scrutiny. It is possible to show theoretically that it can very well lead to a non-explosive trajectory if the interlinkages between investment and consumption are taken into account. While there is a need for "subsequent debtors," this simply means that economic activity is a so-called "ongoing concern" that ultimately ensures survival. Why should one stop economic activity?
Keynes once put it like this:
"If investment is proceeding at a steady rate, the finance (or the commitments to finance) required can be supplied from a revolving fund of a more or less constant amount, one entrepreneur having his finance replenished for the purpose of a projected investment as another exhausts his on paying for his completed investment." Keynes, J.M., (1937)
"The means of payment used for this purpose are on the bank's asset side (cash for withdrawals, reserves for transfers), thus deposits can never be a means of payment."
I think I see what you're saying here, Renée. From the bank's perspective, they're going to credit an asset on their books (and debit the deposit liability mentioned above) ONLY once they receive a payment instruction. You're saying THIS is the moment the money is created, not the moment the loan is issued. Am I picking up what you're putting down?
Additionally, I've heard that quoted Keynes passage used to defend the idea that the VELOCITY of money explains where the money to make interest payments comes from. To my eye, you appear to be making that exact point. Is there any daylight between what you are arguing here and the concept of the velocity of money?
Finally, this anecdote about porcelain is absolutely brilliant. Thank you for sharing it!
A payment instruction doesn't create new money, but rather causes the bank to reduce its liquidity (assets), unless it's an internal bank transfer. The easiest way to remember this is to realize that payments must always be made with assets. Then it also becomes clear that the bank can't transfer a deposit, because it can't pay with its debts – this applies to all economic entities. Therefore, a bank doesn't pay when it credits something, but rather expresses a promise to pay. This is somewhat like an engagement, which is also a promise of marriage, but not the marriage itself. As we know, a lot can happen in between. And a bank's bankruptcy prevents these promises from being honored – it's not even that rare.
Velocity is a concept that exists in a cash economy without claims clearing, but not otherwise. Attempts to estimate velocity have had little success, so economists have agreed to simply assume it to be constant in an act of faith. That didn't work either, which threw all previous analyses out the window. Since then, velocity has become a dummy variable, responsible for everything that cannot be explained. It's that simple in economics. Incidentally, velocity doesn't undermine the consistency condition for monetary economies. The identity of assets and liabilities (the analogue to income and expenditure) is not affected by it—whether the means of payment quickly "changes hands" or not.
"The easiest way to remember this is to realize that payments must always be made with assets."
That's a VERY helpful way for my accounting brain to remember that Bank Deposits are kind of like food orders placed by customers in a restaurant, while Bank Reserves are analogous to the ingredients used to create the ordered meals. Assets vs liabilities.
Thanks for the comment, Renée!
A good allegory. The joke about the schizophrenic who eats the menu card at a restaurant and complains to the waiter about the bad taste fits perfectly! :-)