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June 12, 2018 | Do Commercial Banks Need Deposits Prior To Making A Loan?

Donald B. Swenson: Born January 24, 1943, Roseau, Minnesota. Graduated H.S. 1961, Moorhead High, Minnesota. Graduated College 1968, Moorhead State University, Minnesota. Designated member of Appraisal Institute (MAI), 1974. Employed with Western Life Insurance Company, 1968 – 71; Iowa Securities Company, 1971 – 73; American Appraisal Company, 1974 – 81. Part-time teacher/valuation consultant/bartender, 1979 – 2008 (taught workshops at Waukesha County Technical Institute, Wi. and Madison Area Technical College, Wi.). Retired 2008 (part time teacher/blogger), AZ. Self educated economist/philosopher/theologian:

Loans create deposits when no reserve is required!

The United States also has ‘no reserve’ for lower level lending (see reg. D above).

Commercial banks via their loan policies create trillions of units ($$$$$) for pumping up our asset markets! No-one knows where the money goes until AFTER a borrower acts! All this magic has kept our economy from correcting. Can it continue? When might the crash/correction arrive?


Recently, during one of my teaching workshops, a dispute arose over the issue of lending rules governing our banks. The dispute arose because my student (a retired executive type) said that banks must have deposits prior to making a loan. His point was that banks can not make a loan without having deposits backing up the loan. Is this a valid argument today? Let’s explore.


The recent referendum over in Switzerland involved the issue of how banks can now create digital money without any prior deposits. In fact, what happens is that a banker just ‘types’ the loan amount into a client’s account and the electronic funds appear magically in the account. The bank can simultaneously increase its deposits merely by making a new loan to a client. This happens as ‘no reserve’ funds are necessary for most loans today.


Banks (those that are members within a central bank system) can create electronic money out-of-nothing. We all knew that a Central Bank could create money out-of-nothing (thin air/QE money) but many did not know that all member banks can also create money out-of-nothing (just by typing the loan amount into a client’s account and then calling the result a liability and an asset). Money emerges from the mind of the banker and gets revealed in the client’s account.


This feature of creating money out-of-nothing (essentially the thinking of a banker) could be one reason why our economy has not crashed to date. Borrowers can borrow at a low-interest rate (near zero in many countries) and then invest the loan funds in our stock/bond/real estate markets to earn profits. All this lending can be done without any regulator being aware of the process and all the new funds merely seek out assets for financial growth.


Large companies can also borrow at a low-interest rate and buy back their stock to increase earnings on their books. These buy backs have helped to pump up our electronic stock markets all around the planet. Bank lending and company buy backs are continuing and this may be why our asset markets continue to grow. It is now some 111 months of asset growth for stocks, bonds, real estate with no real correction. How long can this continue? Is there a limit or time horizon when the game changes?


It appears that this trend of asset growth may continue for a few more months. The gradual increase in interest rates may slow activity but it is doubtful if a serious crash will happen in the next few months. Personally, I sense that markets are slowing some and the affordability issue for real estate buyers could be a big issue later this year. If interest rates continue to increase the next few months, we could witness a financial crash later in 2018. It all depends on the concept called ‘confidence’.


Since we now live with electronic money and central bank trading within our markets, I doubt that a major crash will happen until the stress level grows substantially. As I write, the stress level is modest and the availability of cheap money for expansion continues. Watch the real estate market for signs of serious stress later this fall. This market could lead in a correction or a crash. A correction, to me, is 20% or more. So far, we have experienced some 111 months of growth without a 20% or more correction.


Money creation is now digital/electronic and banks can increase their deposits merely by making new loans. All this lending which requires no reserves as backing (for many loans) is what has allowed our markets to expand these past 111 months. Consumers also have been allowed to lower their debt service payments via various zero rate loan transfer options. Borrowing at zero or near zero could continue for a few more months. My view today is that we will not witness a serious financial correction/crash until the stress level increases substantially.


Our markets are fragile, however. Digital money and electronic trading does allow for changes in a moment’s time. Traders could lose confidence rapidly as our markets slow and this is when a crash scenario could develop. Our money today is inner and this means that when a crash occurs, sentiment will change instantaneously. A good model for all this change is the Venezuela stock market. This market crashed 99.9% in 2017 and is now reflated to levels where another crash could happen in 2018.


Electronic markets operate at the speed of light and today our money consists of mere inner digits which evaporate instantaneously as traders short a market. Take a look at the Caracas General stock market for evidence of what has happened and what could happen to all these electronic markets. The Caracas General is currently at 42,000 (up some 3211% in 2018). In 2017 this market crashed to near zero in a matter of seconds. This is what happens in today’s electronic marketplace. Our money is now mostly an ‘inner’ digit.


Our stock markets are managed with circuit breakers today so it is not possible for a full crash to zero. But a crash of 20% could happen in one day. A 50% crash could happen in a week. Money is inner and this means that any crash is silent and without sound. We live in interesting times as the entire planet is now wired electronically. What happens in a major market can spread system wide in a matter of seconds. So far all looks quiet and stable. But all could change in a moment’s time. Think for yourself and prepare for change at some point in 2018 or 2019. ! I am:

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June 12th, 2018

Posted In: Kingdom Economics

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