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Lending Existing Money

Hi Cullen,

I am thinking about the problem of lending existing money. For instance, if I get loan from bank, I can lend the money over another borrower. The same borrower could repeat the process again and again. It is not fictional though. There might be case of 2 or 3 step loans, for example shark loan and it is very common in society. Another example is I can use my loaned money to buy money market fund shares and the manager uses my loaned money to buy corporate bonds. Thus, that's also case of lending existing money.

Eventually those will lead into multiple principle debts with just single money available. Simply said, when the money is earned by initial borrower and paid back to bank, the other borrowers are left with debts in which there is no money available anymore since money has been destroyed through repayment. Borrowing money from existing deposits is not increasing aggregate deposits, but increasing aggregate debts.

Actually there is no problem with high ratio between total debt vs total money available, so long as the banks still keep giving new loan. The existing loan can be just paid off with new loan. The problem comes in when banks are not giving loan anymore for some of reasons. This will result some borrowers inevitably have to be default because there is no new money (debt) anymore in the system to pay off their previous debts.

If I am not mistaken, you once said saving account can be thought of "corporate bond". I agree in this sense. However, I would argue that we as deposit holders have the freedom to "securitize" these assets by lending over other borrowers. Asset securitization is not necessarily pooling loan assets into mortgage backed securities. Lending existing money is the simplest form of it. When the ratio is too high and banks tops lending, crash is about to happen.

So what do you think ?


When you lend existing money you're creating a new private IOU. So, let's pretend you have $100 in deposits and you lend that $100 to me. I have your $100 deposit and your NEW $100 loan liability. You have the new $100 loan asset. The problem with this arrangement is that your new $100 loan asset is functionally worthless unless I give you back the actual deposits. You can't take the Kevlar Paper IOU and go spend it. It's only good between the two of us. No one else would use it.

This is what makes banks different from the rest of us. When they create loans they create deposits that ANYONE is willing to use. So, when they create new IOUs those IOUs are trusted, unlike the Kevlar IOU that we created.

I hope that helps.

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