[From Bill Powers (2000.04.08.2011 MDT)]
Rick Marken (2000.04.08.1000)--
Transferring money from one person to another doesn't affect
the circular flow. The money still gets spent.
I don't think a loan is the same as a transfer. I agree that
giving the government $100K just transfers my claim on goods
and services to the government which then transfers it to
other people. This, I agree, is why it is silly to speak of
government waste.
But a loan is a _service_ provided by the lender to the debtor.
The cost of that service is the interest on the loan. So the
cost of a 15 year $100K loan might be about $7000/year (that's
the _interest only_ cost; $1000 might be principal so the total
yearly cost of the loan would be $8000). The $7000 is what the
lender (the producer) needs to cover his costs (including
profit). So $7000/year is (in this individual case) equivalent
to aggregate GNP (cost of production for the aggregate producer).
If the debtor defaults (returns $0 to the lender/producer) this
is equivalent to aggregate consumer spending going to $0; that is
100% leakage; the producer/lender gets back none of the costs
of "production" (the cost of providing the loan). If 7% of all
loans default, this might explain why, at the aggregate level,
7% of GNP is _not_ returned to the aggregate producer as consumer
spending.
I think the treatment of the principal of a loan has to depend in part on
whether the lender is legally authorized to create new money (as banks do,
by lending money they do not have). When you borrow from anyone else but a
bank, you are borrowing old money -- money already in circulation. If I
write you a check to lend you $100, I must have $100 in my checking
account. But if you borrow $100 from a bank, the bank simply writes $100 as
a deposit into your account; it does not have to have all of that $100 on
hand. In fact, it must have on hand only a small percentage of that amount,
the legal reserve. The balance is new money, money created out of nothing
when the loan is made. That money can circulate just like any other money,
so it is perfectly real.
I agree with you that if I go into the private lending business, I become
part of the Composite Producer. But because I am not a bank, I can lend you
only money that I already have -- if I write a bad check to you, it will
bounce and I won't end up lending you the money. This is a simple transfer
of funds from one individual to another, and makes no difference in the
circular flow.
What I can do, as you suggest, is charge you for the service of lending you
the money and keeping the books on the loan. I pay my clerks out of this
service charge (interest), use more of the interest income to pay for
advertizing or insurance or legal fees and all that, and pay myself Capital
Income from the rest of it. The people I pay to help me are part of the
Composite Consumer; they spend what I give them as Wages. I am also part of
the Composite Consumer; what I spend is my Capital Income (as well as any
Wages I pay myself for being an officer in the company).
The equation can't really be balanced because I'm talking about one
individual enterprise, and the circular flow applies only to the whole
nation. My employees (and myself) are not my customers, in general (they
don't borrow from me and I don't borrow from myself), but somebody else's
customers. The people for whom I perform the service of lending money pay
me for this service, but I do not turn around and pay them because they
don't work for me; they work for someone else. The circularity in the
circular flow becomes evident only in terms of Composite entities in which
individuals and their microtransactions disappear and only aggregates remain.
So the way I see it working out, it's irrelevant that the particular
service I perform is to lend money. I could give haircuts or sing songs or
mow lawns. My role as part of the Composite Producer depends strictly on my
collection of money in return for my product, and I use that money to pay
someone (who could be me, as part of the Composite Consumer) for producing
that product. The nature of the product doesn't matter.
If that is so, then when I transfer the money to you that is just like
selling a product, and what you do with the money from then on is none of
my business. I can't spend that money for goods and services, but you can,
so the circular flow is completed with respect to the principal that was
lent (the circular flow is indifferent to which individuals spend a given
dollar). I earned it, but you spent it, which is of no interest to the
Composite Producer. If you pay me back, you pay me with dollars which you
can no longer spend, but I can.
Where you and I become part of a local eddy in the circular flow is with
respect to the other part of the transaction, assuming that I charge you
something for lending you the money. The fee you agree to pay me over the
years is my income from selling my service; the money I pay you for doing
the actual work or as rents and royalties completes the circular flow
(although I actually pay out that money not to you but to someone else
completely equivalent to you as far as position in the circular flow is
concerned).
In the Big Picture, what matters about me as a non-bank lender is that I
can never create any new money. I have to have on hand, or close enough to
hand, the money I lend, and when I lend it, the total money supply does not
change. When a bank makes a loan, on the other hand, it puts new money into
circulation, not money it already has (the reserve requirement aside). The
money supply increases. This is why there is more money when people are
encouraged to borrow from banks, and less when people are discouraged from
borrowing.
If you return the loan to me as a private lender, I will have the money to
spend rather than you, but it is spendable and when it is spent the
circular flow will be undisturbed. But if you have borrowed from a bank and
return the money, the money that was created with the loan is now destroyed
-- because it never "really" existed in the first place except as an entry
in a bank account. The bank crosses the loan off the books, but it can't
spend the money that was returned. And neither can anyone else spend it,
because you returned it to the bank to cancel a debt and the account was
closed. You may still have to pay service charges to the bank, but the
principal has disappeared.
Thinking in terms of composite entities, we can consider the rate at which
new loans are taken out and the rate at which old ones are repaid (or
defaulted upon). These processes, in the macroeconomy, are going on
simultaneously, just like saving and withdrawing from savings. The total
money outstanding as loans is the integral of the new-loan rate minus the
loan-closure rate. I expect, as an aside, that the money _actually_ in
savings can be treated the same way.
The integrated amount, for loans, is probably numerically equal to the
total money supply, since new money can be created _only_ by banks -- a
premise which so far nobody I have asked in the banking business (like Bill
Williams, who once taught Money and Banking) has denied.
One glitch in this seemingly neat picture has to do with private credit, as
in the case of credit-card loans and debts. I think we can probably ignore
this fairly safely, for the simple reason that a credit-card debt is not
legal tender. It can't be used to pay "all debts, public and private."
There can be a private market in such private debts, with paper being
traded like a commodity, but this market stands apart from the circular
flow, in its own private universe. The money that Visa pays the retailer is
not new money, but old money, and Visa's checks to the retailer have to be
good (as do yours when you make your monthly payment to Visa). Either you
or Visa can, of course, overdraw your checking account, but if you get away
with it, either of you will probably find that you have actually applied
for and been granted a bank loan, for an elevated service charge.
Indirectly, new money may appear, but as usual it's a bank loan, not a
private loan. Private transactions cannot create new money, as I understand
it.
The main effect of private credit is to shift buying power from one group
within the Composite Consumer (those who owe the debts) to another (those
who work in the field of making private loans). In macroeconomics, that's
the same as having no effect.
Well, all this is pretty much an exercize in logic rather than a true
statement about how things work. I'm guessing, and don't know how much if
any of the above is true. If anyone has any banking or financial friends,
it would be interesting to see what they say about all this guesswork.
Best,
Bill P.