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Friday, July 13, 2012 12:30 PM

Notes From Steve Keen on "Lending Reserves" and "Debt Jubilees"; Mish Proposed Starting Point For Real Solution to Debt Crisis

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In response to Can Bernanke Force Banks to Lend by Halting Interest on Excess Reserves?, Australian economist Steve Keen pinged me with the following ... 

Cheers Mate

That "increase reserves to increase lending" argument is so hard to shake, but reserves can't be lent from simply from a double-entry bookkeeping point of view.

The way that accountants keep track of the "assets equals liabilities plus equity" rule is to record an increase in assets as a positive and an increase in liabilities as a negative (your liabilities rise, so a negative gets bigger). Reserves are an asset, as are loans, and shown as a positive. Deposits--which are created by a loan--are a liability and shown as a negative

So to lend to a customer, a bank has to show a negative on that customer's accounts. This can be matched by a positive on the loans entry--because the loan has increased in size. No problem.

But if banks were to lend from reserves, they would need to record a minus there--reserves have fallen. And on the liabilities side, they want to ... also show a negative. Whoops! No can do.

The end result of this logic is that reserves are there for settlement of accounts between banks, and for the government's interface with the private banking sector, but not for lending from.

Banks themselves may (if they are allowed--I simply don't know the rules here) swap those assets for other forms of assets that are income-yielding, but they are not able to lend from them.

Cheers, Steve

P.S. On my debt jubilee idea, I'd welcome a debate with you over it. There is an issue, whether you support a "strong money" gold-backed currency system or a reformed credit system, of dealing with the mess left by this one we currently have. My idea is a way to cancel the impact of debt that should never have been lent in the first place (and to prevent speculation taking off again on the other side by reforms to asset markets that make debt much less attractive).

It would be good to have a back-and-forth with you on the dilemma we're in and the alternative ways out of it, whatever our desired end-system might be.
Debt Jubilee Revisited

Steve Keen is looking to discuss what to do about excess debt.

I knocked his "debt jubilee" idea in Steve Keen Goes Off the Deep End With a "Debt Jubilee" (Free Money to Consumers) Proposal.

It's easy enough to tear down ideas without presenting an alternative. So let's take a look at issues that I think need to be addressed.

Structural Issues

Giving money away will not cure any structural issues such as the high cost of education, pension underfunding, medical costs, prevailing wages, student loans, etc., etc.

Indeed, I think it would compound those problems.

Likewise, I think the second part of Keen's idea about controlling debt in the future tied to GDP growth (or anything else for that matter) would fail miserably.

A free market, not government mandated fiat money is the solution. We certainly do not have a free market now. Instead, we have fiat mandate, compounded by fraudulent fractional reserve banking.

It is the fractional reserve banking system that is the very root of the credit expansion problem.

Fractional Reserve Lending Is Fraud

By lending out more money or gold than exists, asset prices reach unsustainably high levels before they crash. Sound familiar?

Greenspan compounded the problem in 1994 by allowing banks to "sweep" checking accounts (unknown to customers) into savings accounts (via accounting entry).

Savings accounts have no reserve requirements. Effectively, money that people think is in their checking accounts is not really there at all. In fact, it has been lent out multiple times over.

This fact exacerbated the run-on-the-bank problems we saw in 2008. As a side note, FDIC insurance is another form of fraud.

Housing Bubble Lending

In the housing bubble, banks lent because they thought they had credit-worthy customers and/or because they thought asset price appreciation would have them covered in case of losses. Banks did not lend because they had excess reserves to lend from.

It turns out that banks did not have credit-worthy customers. It also turns out that asset prices did not cover losses when the housing bubble burst.

Not Just A Duration Mismatch Problem

On March 24, 2011 I wrote a detailed rebuttal to FRL: Central Bank Authorized Fraud; Fractional Reserve Lending Problems Go Far Beyond "Duration Mismatch"
Reflections on "Legitimate" Right-To-Use

Some argue that as long as customers agree to these various banking schemes it is OK. That line of thinking says as long as it's in the agreement for banks to sweep money from checking accounts to savings accounts and lend it out, then it's OK for banks to do so.

However, it's not OK because such lending is nothing more than a gigantic kiting scheme. Moreover, it affects others by cheapening the value of money, pushing up asset prices for the benefit of those with first access to money, the banks and the wealthy.

Logically, two people cannot have the right to use the same money at the same time, whether they agree to such a scheme or not!
Please read that above article if you have not done so. It will open your eyes as to what is happening and why.

Rothbard Chimes In

For more on the case against Fractional Reserve Lending please see

On page 46 of the book Case Against The Fed Rothbard says "By the very nature of fractional Reserve Lending, banks cannot honor all its contracts".

Since that is known upfront, in advance, how is that not fraud?


Before we can address solutions to the debt problem, we have to understand what caused the debt problem in the first place. In this case, FRL is at the heart of it.

Since FRL is at the heart of it, any permanent solution must address that problem.

I welcome further discussion from Steve Keen on these ideas, and I have a follow-up post in mind on student loans, showing just how distorted the system is when government gets in the way of the free market.

Regardless of what the solutions are, the notion that $1.5 trillion in excess reserves is about to come pouring into the economy 10 times over in the form of $15 trillion in new credit is complete economic silliness, a point on which Steve Keen and I are in complete agreement.

Actually, Steve and I are in agreement on many things, just not solutions.

Final Comments

I appreciate these discussions with Steve Keen. He has taught me a lot. I welcome the opportunity to present views to the public about what needs to be done. It's easy enough to tear down ideas without presenting an alternative.

I propose we start by addressing the root cause of the debt problem which I state is fractional reserve lending.

Mike "Mish" Shedlock
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