I didn't understand how commercial bank created money to fund government deficit ?
Moreover, say Bank A lend to Paul $1,000 for which it needed capital of $10. So on asset side bank has $1,000 and on liability side it has $10 of equity. Ain't $990 of deposit or wholesale debt etc required to fund the loan?
When bank A creates the loan, it simultaneously creates the asset and liability. So the loan and the deposit are always created together, and they exist until the loan is repaid and both are extinguished.
How banks create money for the govt isn't as clear, and really depends on the chain of events that occur and where the bond ends up.
Many disagree that this occurs, but it's usually because they end their analysis far too early in the chain of events that allows them to come to that conclusion.
The idea is that no matter who buys the bond, they have to either sell something or reduce a deposit to buy it. Both of these events have flow on effects that result in an asset ending up at a leveraged entity, which borrows in some capacity to hold that asset.
Since every financial asset is matched with a liability on every balance sheet, a new liability has to be created so that new asset (the govt bond) can be accommodated. The banking system (and the Fed) are the only institutions that can do this.
I still didn't get how banks create a deposit. If Bank A has to loan to Paul who is with Bank B, then Bank A has only created an asset i.e. the loan. Doesn't is need deposit or raise wholesale debt to fund this asset?
With Federal debt analysis, when bank buys bonds it end up on asset side for which again doesn't it need deposit or raise debt from wholesale market to buy Treasuries?
Just got around to reading this, thanks Peter. We are facing a (kind of) similar situation in Argentina, where inflation has currently reached 100% YoY, and the CB has net income losses, reaching a point where increasing the benchmark rate only leads to higher inflation. Highly unlikely the US reaches that point though.
Thanks for sharing this with us! Super interesting post. I'm only an amateur in the subject of financial markets and I don't fully understand how the commercial banks create money while funding the gov. You wrote: "The banking system funded the government, as it always does, creating money in the process." I though that when Treasury issues new debt it drains the market from cash as the banks need to have some source of funding to purchase USTs. Could you point me to any good source where I could read about the process in which banks fund gov creating new money? Or maybe you wrote about it somewhere?
Ah I think I might understand. The Treasury spends the money it got from USTs sale so the total amount of deposits in the system does not change yet the amount of USTs increases. Am I correct?
I didn't understand how commercial bank created money to fund government deficit ?
Moreover, say Bank A lend to Paul $1,000 for which it needed capital of $10. So on asset side bank has $1,000 and on liability side it has $10 of equity. Ain't $990 of deposit or wholesale debt etc required to fund the loan?
When bank A creates the loan, it simultaneously creates the asset and liability. So the loan and the deposit are always created together, and they exist until the loan is repaid and both are extinguished.
How banks create money for the govt isn't as clear, and really depends on the chain of events that occur and where the bond ends up.
Many disagree that this occurs, but it's usually because they end their analysis far too early in the chain of events that allows them to come to that conclusion.
The idea is that no matter who buys the bond, they have to either sell something or reduce a deposit to buy it. Both of these events have flow on effects that result in an asset ending up at a leveraged entity, which borrows in some capacity to hold that asset.
Since every financial asset is matched with a liability on every balance sheet, a new liability has to be created so that new asset (the govt bond) can be accommodated. The banking system (and the Fed) are the only institutions that can do this.
I still didn't get how banks create a deposit. If Bank A has to loan to Paul who is with Bank B, then Bank A has only created an asset i.e. the loan. Doesn't is need deposit or raise wholesale debt to fund this asset?
With Federal debt analysis, when bank buys bonds it end up on asset side for which again doesn't it need deposit or raise debt from wholesale market to buy Treasuries?
Can you suggest a book that discusses such topic on money creation, banking system, central bank and their interaction?
Just got around to reading this, thanks Peter. We are facing a (kind of) similar situation in Argentina, where inflation has currently reached 100% YoY, and the CB has net income losses, reaching a point where increasing the benchmark rate only leads to higher inflation. Highly unlikely the US reaches that point though.
Thanks for sharing this with us! Super interesting post. I'm only an amateur in the subject of financial markets and I don't fully understand how the commercial banks create money while funding the gov. You wrote: "The banking system funded the government, as it always does, creating money in the process." I though that when Treasury issues new debt it drains the market from cash as the banks need to have some source of funding to purchase USTs. Could you point me to any good source where I could read about the process in which banks fund gov creating new money? Or maybe you wrote about it somewhere?
Ah I think I might understand. The Treasury spends the money it got from USTs sale so the total amount of deposits in the system does not change yet the amount of USTs increases. Am I correct?