2.4 Credit creation through purchase of assets.
Genuine and interest-borne
NCT and MMT
scholars seem to be the only ones so far to have pointed out that primary credit
and deposit creation does not only take place when banks grant loans and
overdrafts to customers. It equally happens when banks purchase assets.
Asset purchases in question are
- fixed-term bills and bonds originated by government or companies
- stocks or similar securities with no specified maturity
- real estate and other tangible and intangible assets.
To purchase such assets, the sellers do not even need to have a current account at the bank concerned. Payments due from such purchases add to the same stream of payments to be cleared and finally settled as payments on behalf of own customers. It needs to be seen that most of the overnight liabilities in a bank balance sheet do not represent the counterpart of own credit entries (most of these drain away through customer payments), but represent the counterpart of credits written out by other banks and received from a bank through incoming payments which customers of this bank receive from other banks' customers.
/25/ All assets purchased are entered into one or another asset account. This, by the way, does not apply to paying for labour and services, for these have to be entered in the books against their own equity account. All such payments only reduce a bank's liquid assets (reserves, cash) to the fractional extent to which these fall due for final settlement.
A special case in this respect is government bonds if these cannot be transacted via current bank accounts but have to be paid for with reserves onto a central-bank government account. This means that banks have to finance such credits or purchases at a reserve rate of 100%. The same applies in certain countries to large taxpayers who, unlike small taxpayers who transact via government bank accounts, pay their taxes directly to a main government account at the central bank. However, this does not reduce to an important degree the banks' ability to create money. Governments do not save money but immediately spend what they receive. Reserves obtained from the banks are thus immediately transferred back to them. Again, though, this somewhat reduces the banks' profit margin from this type of business.
All of the assets bear the same liquidity and solvency risk with regard to the aforementioned constraints. Equally, most of the assets can generate income (interest, dividend, rent), and they come with a chance of appreciation as well as a risk of depreciation in market value.
Yet there are
significant differences too. These are rooted in maturity:
- Fixed-term bonds basically follow the same mechanism as loans to customers. Upon maturity the reserves or deposits involved flow back so that the principal is cancelled.
- Stocks once were also fixed-term, but over time they mutated into 'eternal credit'. They only cease to exist in bankruptcies, or when paid off or converted into new other stocks in connection with mergers and acquisitions.
- Similarly, real estate, bullion, works of art and other tangible and intangible assets, except patents but including equipment, do not normally have an 'expiry date'. Furniture and equipment, of course, wear out or become obsolete, and are written down over a given period of time. Buildings, artworks and so on, however, can be maintained for a very long time. Real estate possibly combines long-lasting and growing capital value with high use value.
/26/ However, the differences in maturity result in a different 'life expectancy' of the deposits that were created through such purchases. Loans and bonds have a fixed maturity, thus principal and deposits are cancelled upon repayment (reflux). With regard to stocks and real estate, however, there is no maturity and they are not normally redeemed. Thus there is no repayment and extinction of the deposits that were created upon the purchase of stocks and real estate, artworks or similar. This applies as long as a bank concerned continues to hold the assets.
Furniture and equipment are written down over five or ten years; they thus disappear as valuable assets. But the deposits created when they were purchased do not flow back; they stay in circulation. The same holds true when securities depreciate or become worthless. In this case, again, the deposits created continue to exist 'forever'.
Deposits created through a bank purchase of assets without maturity can nevertheless be cancelled, and this happens when a bank sells the assets involved to nonbanks. Nonbanks pay with deposits and these 'disappear' in the clearing process of incoming and outgoing payments.
It thus turns out that the banking privilege of primary credit creation actually involves two different types of extra profit, or so-called seigniorage, which is the special profit which accrues from creating credits and deposits. One is interest-borne seigniorage. It accrues from loans, overdrafts and bills and bonds in the form of interest earned on the principal that is cancelled upon repayment. Financial studies only refer to interest-borne seigniorage of central banks. Interest earned by banks is not considered to be seigniorage – though in fact it is, because bank credit, in contrast to secondary on-lending of already existing deposits, is primary credit created 'almost out of nothing'.
/27/ Interest-borne seigniorage of banks is difficult to calculate because of the 'almost' part. It is an extra margin which derives from the difference between the entire interest a bank would have to pay on taking up 100% of the money it loans or spends, and the interest on the fractional part which it effectively has to refinance. To put it differently, the interest-borne seigniorage of banks equals the financing costs which the banks are able to avoid on the biggest part of created deposits thanks to their privilege of primary credit creation.
One can argue against the existence of such an extra margin profit on the grounds of banking competition. The advantage is basically equal for all banks, even though for large banks it is relatively bigger than for smaller ones. If effective, competition can be expected to pass on the refinancing advantage to customers in the form of lower interest rates than would otherwise result. This, though, needs deeper investigation against the background of oligopolistic power structures in the banking industry. Moreover, banks actually need to pay interest on all deposits in order to prevent customers from removing their deposits, and thus a disproportionate amount of reserves, to other banks. In any case, the extra advantage is not a positively indicated income that could be read out in the profit account. Instead it represents financing costs avoided.
The other type of seigniorage is genuine seigniorage. It dates back to traditional society and the beginnings of modernity when the rulers of a territory – warlords, kings, emperors and other feudal seignieurs – had the sovereign prerogative of minting coin. The difference between the cost of production and the purchasing power of the coin resulted in this genuine type of seigniorage. Coins were not interest-bearing, since they were not loaned but spent into circulation. They kept circulating over all territories as long as they were not hoarded, 'decried' by the rulers (recalled for reprocessing), or, in times closer to ours, hidden in the hay to avoid them being seized by tax collectors.
Today, genuine seigniorage is thought to exist only residually, benefiting a state's treasury that still has the right of coinage and sells the coin on demand to the central bank for reserves. /28/ It is overlooked, however, that central banks as well as banks actually benefit from a modern variant of genuine seigniorage when they buy financial, tangible and intangible assets with no specified maturity. These items are bought with deposits from primary credit creation with no or low production costs and low transaction costs. The banks, though, enjoy an asset advantage of 100% as long as they keep the assets and the asset value can be maintained. Some part of the bank money created is extinguished when such assets are sold to nonbanks, while the remaining part of demand deposits continues to exist 'forever' wherever they happen to flow to, just as was the case with sovereign coin in former times.
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 Mosler 1995 pp18, Ryan-Collins/Greenham/Werner/Jackson 2012 64, 137, Seiffert 2012, Huber 2013.
 Reprocessing meant smelting the coins down and reminting them into more coins of the old face value; thus each coin contained less silver. This can be seen as a kind of taxation in times when taxes in a modern sense did not exist yet in the occidental world – except the tithe to ecclesial landlords, which normally, however, was delivered in kind rather than paid in coin.