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Capital Debt-Based

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Cullen, I want to start with following hypothetical statement:

Capitals are exist because they are having rat-race with debts. Unless they are still in race, they won't exist anymore.

Let's imagine there are only 2 private banks in the world. namely A and B with no money circulated at all. These 2 banks still have zero capital in their balance sheet. Then borrowers comes to Bank A asking for $1000 loan with $10 as interest thus A creates money (deposits) $1000 also at the same time. Bank A records this loan as asset but hopes to get repaid $1000 along with $10 interest.

Now, since no money exist at all prior to Bank's A loan, the borrower need to borrow $110 from Bank B to pay back loan from Bank A. By the time loan is paid, Bank A doesn't have asset anymore. However, since there is $10 interest paid, this will be new capital gained and it is accumulated through new other loans over the time. And, all of these interest could be paid because other bigger loans (to compensate for interest) have to come from other places.

So the question: based on your point of view, is the above statement a reality ?

@dharland,

That's kind of how this works. It sounds like a ponzi scheme when you say there's no capital though and that's not how lending works. The reason we make loans to one another is mainly because there is a capital structure to support the loan. So, for instance, when you get a mortgage there is a real asset supporting the loan value (the house). It's not a ponzi scheme at all. Someone really invested in building a house and there's a real asset to support any potential future purchase.

So yes, future interest to pay off past loans come from new balance sheet expansion for the most part, but that is just saying that future investment pays for balance sheet expansion. So it's not like a ponzi scheme in any meaningful way unless we're all just expanding balance sheets without producing anything, which is not how the economy really works....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Hi Cullen,

It is said by visualcapitalist here that in the world by 2017, total estimation of broad money is $90.4 trillion while the total debt is $215 trillion. Since debt equals to money, why the amount of debt is multiple orders of magnitude from broad money ?

Hi Kev,

Not all debt creates "money". For instance, if a corporation issues debt this doesn't create broad money. The only time broad money is created it when a bank creates loans. Corporate debt is just a contract to obtain deposits and is issued by a non-bank firm. So that's where the discrepancy comes from.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

I still don't understand why there is discrepancy. When corporate issues debts, there must be available deposits in the system to buy the debts. Corporate can't just issue debts without any deposits given to it. Since all debts issued always have available deposits, then total debts must equal to total deposits. Does this make sense ?

If there's $100 in loans in the system and $100 in deposits in the system and a corporation issues a corporate bond for $10 then they issue a new liability and sell it to someone who held some of those $100 in deposits. Now the deposit holder has $90 in deposits and $10 in corporate bonds and the corporation has $10 in deposit assets and $10 in bond liabilities. So, the quantity of deposits in the system is exactly the same as it was before the corporate bond issuance and the amount of "debt" in the system has increased by $10.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Supposed that there's $100 in the system. If there are 5 companies which issue debts for $100 from same source of deposits thereby moving it from one to another which result $500 total of debts issued. Is this what makes the amount of debts are multiple times of deposits ?

Hmmm. I’m not sure that would work. These kinds of examples are super unrealistic because it’s not remotely close to how the system actually works.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Then what's the real examples which cause total of debts is a multitude of total available deposits in the system ?

The reality is that there are lots of different money-like instruments in the world. The reason corporations, governments and households create longer-term forms of debt is because they want to obtain short-term money-like instruments in exchange for the certainty of issuing longer-term money-like instruments. There's no reason why all "debt" has to be super short-term instruments like deposits.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche
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