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Deposits, Loans and Inequality

by Metatone
Sat Aug 20th, 2011 at 05:19:23 AM EST

When I was young and trying to get my mind around how the world works, I was told that bank loans come from deposits.

As such:

  1. If you want business investment, you have to have savings - typically the savings of ordinary people.

  2. It doesn't matter how rich someone gets, even if they don't spend their money, it remains in the system because their savings enable loans.


ATinNM has threatened to write about the difference between a million people earning about a billion euros and a single person earning 999 million and the rest earning 1 euro.

Part of the foundation in mainstream economics is the idea that money cannot be removed from the system by this redistribution.

The uncontroversial point in the global age is that money can be removed from the local system. This may result in adjustments of things like wage level/interest rates/exchange rates which should even things out - but we know that all of these things are not free variables in our world.

So the simple part of the inequality problem is that (for example) if the rich person gains wealth in Europe and invests it in China, it's going to be a long time before that money comes back into Europe via trade - which implies a contraction of demand in Europe.

The harder part is that (as discussed quite a bit here recently) bank lending isn't actually tied to deposits.

There's also a question about the effect of fixed asset (for example, land) price inflation... as it's only little people who really use banks in the simple way.

Can this help us further trace the mechanism by which inequality leads to "magneto trouble"?

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Magneto trouble - NYTimes.com

One of my favorite Keynes quotes comes from Essays in Persuasion, in which he tried to explain the nature of the Great Depression, which was still in its early stages, and declared that "we have magneto [alternator] trouble." The economic engine was as powerful as ever -- but one crucial part was malfunctioning, and needed to be fixed.

That's about where we are now. The defective alternator is the financial system. We replaced the old, bank-centered system with a high-tech gizmo that was supposed to be more efficient -- but it relied on fancy computer chips to function, and it turns out that there were some fatal errors in the programming.

Anybody know a good mechanic?

by afew (afew(a in a circle)eurotrib_dot_com) on Sat Aug 20th, 2011 at 05:29:31 AM EST
When I was young and trying to get my mind around how the world works, I was told that bank loans come from deposits.

As such:

  1. If you want business investment, you have to have savings - typically the savings of ordinary people.

  2. It doesn't matter how rich someone gets, even if they don't spend their money, it remains in the system because their savings enable loans.

That's called the loanable funds fallacy. As the astute reader may have guessed from the name, it's not true.

We had an extensive discussion of the subject here, and in the comment thread that spawned that diary. And since I need to attend to other matters presently, I shan't repeat what I and others wrote there.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Aug 20th, 2011 at 05:45:17 AM EST
My intention was not that we repeat the discussion about the loanable funds fallacy, but given that it is a fallacy, then it could be useful to clarify what the effect of rising inequality is...
by Metatone (metatone [a|t] gmail (dot) com) on Sat Aug 20th, 2011 at 09:55:59 AM EST
[ Parent ]
Lower and less stable demand, because the wealthy stockpile money and either put it into their pillows or put it into more or less creative speculation, which blows up every once in a while. And the government is blocked from correcting this demand shortfall and volatility through full employment fiscal policy, because this would reduce inequality.

And since investments are made only when there is adequate and adequately stable demand, it also slows the capital accumulation of a country.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Aug 21st, 2011 at 08:30:01 AM EST
[ Parent ]
First is the inequality of wealth. Wealth is a source of power, and so the greater the inequality of wealth, the greater the inequality of power. Without an equal and roughly offsetting alternative source of power, that means that decisions in a society are increasingly geared to the immediate interests of the wealthiest.

However, one of the interests of the wealthiest is the creation of financial games which the wealthy can use to increase their share of national income, and since the pursuit of an ever increasing share of the income distribution by any one segment of society is impossible over an indefinite period, that necessarily leads to the playing of unsustainable financial games.

The second is the inequality of income. A primary contribution of that inequality to economic instability would seem to be precisely as JakeS details ~ a much larger share of effective demand by high income individuals is luxury demand that can be postponed or eliminated if required to maintain their wealth position.

Add in the economic instability from catering to the wealthiest, from the first factor, and there certainly will be, sooner or later, a financial crisis in which the wealthiest need to cut back on their spending in order to maintain their wealth status, and in that situation an overdependence on demand from the incomes of the wealthiest acts as an amplifier of the financial crisis.

None of this has much to do with the supply of money: money is a very small portion of the total amount of financial assets held by the wealthy in a modern monetary production economy and, after all, banks can always make more money as long as the financial system is not experiencing a crisis. So deep seated problems in meeting liquidity needs of the economy is more a symptom than a cause of the problem.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue Aug 23rd, 2011 at 04:37:16 PM EST
[ Parent ]
I would hypothesise that even in the absence of gross disparities of wealth and power, gross disparities of income would themselves lead to financial legerdemain. Because, well, there are only so many Veblen goods you can plausibly buy to show off your income. Sooner or later, people who take home obscenely high incomes are going to start putting a substantial fraction of those incomes into various "investments" of which they have only the most cursory of knowledge.

An important byproduct of financial markets is that they separate people who have more money than sense from said money. Often messily. So the existence of people who have more money than they can plausibly spend on real goods and services would, I should think, tend to encourage the casino aspect of financial markets.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Aug 23rd, 2011 at 06:36:20 PM EST
[ Parent ]
If you've got a system with massive disparities in income without massive disparities in wealth, that's sufficiently unlike our institutions that I'm not going to speculate on how it would play out ... the tendency in those cases is to project our own institutions onto the blank page, yet you've assumed massive chunks of our own institutions away.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Wed Aug 24th, 2011 at 04:07:43 AM EST
[ Parent ]
This sounds like a 60s/70s economy where tax on high earners was much higher and wealth differentials were much lower.

The problem is that if there is any feedback loop that rewards power or wealth differentials, both will always increase.

The practical(ish) answer is to monitor both closely and set rigid limits on them - the progressive equivalent of an (inverse) flat tax. Beyond a certain point it should be impossible to become richer or more powerful.

Which is fine in theory, but pretty damn impossible to implement in practice.

So the best you can hope for is a creaky structure with plenty of mutual monitoring and explicit constitutionally enshrined feedback loops that attempt to enforce basic equality of opportunity while still rewarding useful innovation and dis-rewarding plunder, naked power grabs, and institutionalised family wealth.

The other problem is that criminals will always get rich through the usual illegal 'business' opportunities. So you also need a solid social policy that can successfully manage drugs, prostitution, racketeering, extortion, and the other usual suspects.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Aug 24th, 2011 at 05:00:00 AM EST
[ Parent ]
But the flip side of that in most of the Anglosphere, at least, was separation between merchant banking and commercial banking, merchant banking being carried out by partnerships rather than corporations, and a range of other safeguards against a repeat of massive unsustainable private sector debt leading to a Depression economy.

And while wealth inequality was lower than today, wealth inequality was still greater than income inequality, and the inheritance tax structure was not sufficient to prevent establishment of a permanent aristocracy of wealth.

Like the Koch Bros. Daddy, one of the original radical reactionary Texas Millionaire funding the radical reactionary movement in the United States.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Aug 24th, 2011 at 07:15:55 AM EST
[ Parent ]
See under any feedback loop.

All economic and political systems with obvious power disparities are inherently unstable, and will always explode.

You can mitigate the danger with negative feedback, but you have to make sure it can't be threatened, debated or disassembled by would-be aristos.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Aug 24th, 2011 at 11:30:48 AM EST
[ Parent ]
I'm skeptical of the premise ~ susceptible to an explosion and certain to eventually explode are not the same thing in historical time, so the premise sounds to me to be overly mechanistic.

And of course, these are not always simple positive feedback loops ~ there are ambitious people whose ambitions are best served by some change in the intrinsically past bound institutional rules, and all institutional rules have ambiguous boundary cases that generate conflict and must be decided by sovereign authority. The outcome of the fight in terms of which rule changes or extensions are advanced by which interests, and which rule change or extension is implemented is inherently unpredictable, and the consequence of the rule change will always entail unexpected side-effects.

So a system which seems traveling inexorably to crisis and collapse could find its path unexpectedly diverted into a more favorable future, and a system which seems as stable as a rock could find itself faced with an unexpected explosion.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Aug 25th, 2011 at 12:56:49 PM EST
[ Parent ]
by afew (afew(a in a circle)eurotrib_dot_com) on Tue Aug 23rd, 2011 at 11:00:40 AM EST


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