Wednesday 8 April 2009

Simple Maths

Aneurin's new Platform is off to a wonderful start, while trying to mock the Deputy First Minister for knocking the banks they claim that Banks create money - here's how apparently:
Someone - let's call them Ieuan Wyn – gets £1000. He puts it in the bank. Someone else, let's call them Plaid Cymru, wants to borrow £500, the bank lends them the £500. Plaid Cymru then give Ieuan Wyn £500 to set up his office. Iuean Wyns pays £200 to his mate Elfyn, who promptly puts it in the bank, and sticks the other £300 in the bank. So the bank now has now turned that initial £1000 into a £2000 balance sheet – in other words it has created £1000. Just like that.
Does Aneurin and his friends know what a balance sheet is? The answer is not-so-subtly included in the name. The clue is in the word balance. Think that paragraph through and it makes no sense.

We start with £1,000, which Ieuan has and puts in bank
That gives the Bank £1,000 in assets and £1,000 in liabilities. Ieuan is owed £1,000 by bank
Bank loans £500 to Plaid
That gives Bank £500 in assets, £1,000 in liabilities and £500 owing to them. Plaid has £500
Plaid give their £500 to Ieuan, Ieuan gives £200 to Elfyn
That gives Bank £500 in assets, £1,000 in liabilities, £500 owed by Plaid. Ieuan has £300, Elfyn £500
Ieuan and Elfyn puts money into bank

We end up with the Bank having £1,000 in assets, they owe £1,300 to Ieuan and £200 to Elfyn (plus interest). Plaid owe £500 to the bank (plus interest).

So on the Bank's credit side they have £1,000 assets and £500 owed plus interest on the £500. On their debit side is £1,500 plus interest on Ieuan and Elfyn's savings.

So the bank's balance sheet is the difference between the interest owed by Plaid and owed to Ieuan and Elfyn (i.e. pennies)

So, um, where's this additional thousand they're supposed to have created on their balance sheet? And these people are supposed to be in charge of our economy?

8 comments:

  1. christ, do you not realise how stupid you are?

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  2. The banks do actually 'create' money this way. In the above example, £1,000 is actually created. The problem is what happens next, but Aneurin Glyndwr is actually partly correct here.

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  3. Two articles, by Peter Hain and Newport Chartist, have just shown up on Aneurin Glyndwr, and they show just how badly Labour fail to understand the economy and finance.

    Peter Hain's rubbish is just what we expect from the clueless former Welsh Secretary who forgot £100,000 in donations to his failed deputy leadership campaign. He starts off praising Gordon Brown's G20 conference as 'saving the world'. The reality: it failed. The IMF has more money to do what it was doing anyway, quite badly, and otherwise... nothing. That's right, there was no agreement or consensus on any action at all regarding fiscal stimulus, and very little on regulation or tax havens. Brown has been spinning like a top but doing very little, although little else can be expected of a Labour leader when his underlings are people like Peter.

    As the article turns to the Budget, you do wonder where Peter left his brain when he wrote it. He is right that Cameron's proposed slash-and-burn of public spending must be opposed, but it is madness to think that spending can be increased to combat recession, even after the hundreds of billions wasted on the failed banking bail-out. Where does Peter think the money will come from? Not borrowing, that's for certain - as I have blogged before, with the national debt rising out of control, who is willing to lend to the government so that they can raise borrowing? The government has already had problems selling long-term, unguaranteed debt at auction - no investor wants the risk of backing a government deep in debt. Idealogically, I may call for relatively high public spending, but that is impossible if there is no money there. The only way to raise public spending is to fund it by much higher taxation of those earning well above the higher rate of tax, as I have blogged before. But this is far too socialist for New Labour to consider.

    The second article is worse, describing Ieuan Wŷn Jones as populist for daring to criticize the banks that New Labour spent billions of our pounds to save. Because banks create money, see? So they must be good. But the article fails to mention one detail. It gives a pretty little example of how a £1000 is 'created', and this example is technically correct. The problem is what happens next. The extra £1000 pounds does not exist in hard cash in a bank's vault somewhere in London, but as digits in a computer system. Now that £1000 pounds can be lent out and deposited, over and over again, so out of the initial deposit, the bank can 'create' £9,000 pounds through continuing to lend. This process is called over-leveraging. Once a few borrowers get into trouble with their repayments, the banks are toast.

    This is because £9,000 of transactions don't really exist, and once a few borrowers default on their loans, the whole system tumbles down. This is what happened to the big banks with the 'sub-prime' mortgage crisis. All the main banks, in the UK, Iceland and the US, and elsewhere, were hugely over-leveraged. When this 'creation' of money cam tumbling dow the worled economy saw a trillion pounds - yes, £1,000,000,000,000 - wiped out of existence. Aneurin Glyndwr fails to mention that money created can be uncreated very easily. This system is something of a problem and needs serious work to fix it, but the article fails to mention that because it doesn't fit the narrative of Labour as saviours of the world. The banks should have been allowed to fail or nationalized outright and restructured from there.

    New Labour chose their third way of confusion, aand threw away our money. That is the truth. When people like David Taylor can grow up and face this, maybe the Welsh blogosphere can respect them.

    Rhydian Fôn James

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  4. Rhydian, do explain the £1,000 figure.

    I can see an additional £500 created but that's not been "created" in anyway, it's simply a debt.

    We need the banks to loan money for our economy to recover, but there's a difference between loaning money and making money. When a bank loans out money it is not making any new money, simply releasing it to a different person - moving the money around to keep the economy going.

    It does nothing to the bank's balance sheet as all debits are matched by credits. What created this whole collapse in the first place was that the banks lent out money they didn't have hand over fist. As you say, it only needs enough people to default on their loans and suddenly everyone realises that this money was never there.

    Moving around money does NOT "create" new money, it creates the appearence of money - exactly what dumped us in this hole.

    Good comment though i must say!

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  5. Hen Ferchetan, you are spot on in your analysis, especially the final sentence - moving money is not the same as creating it.

    The problem is that the banks can, and do, claim that £1,000 has been created, even though the money doesn't really exist. This is completely legitimate too, and actively encouraged by the government.

    As you point out, hat's why the recent credit 'write downs' really do mean that a lot of money has vanished and left us in this mess. They just forget to say that it never really existed in the first place.

    The system needs changing so that banks can't 'create' so much money in this way, and thus leave us in the same mess in a few years time. That's what New Labour don't get, and that's why Plaid Cymru, and especially Adam Price, are suspicious of the banking bailout.

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  6. BTW Hen Ferchetan, I posted the above on Aneurin Glyndŵr - and it has disappeared, presumed deleted...

    Please expose Labour's 'Debate' platform for what it is!

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  7. "Technically correct" - that's a way of saying the OP here is a load of innumerate rubbish without bring yourself to admit that AG was right, yes?

    Of course banks can over leverage, but surely the issue is whether IWJ was simply talking rubbish when he suggested that the government was wrong to bail out the banks?

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  8. ‘Intuitively, I have a chemical analogy that “evenness” is a molecule some numbers have, and cannot be removed by multiplication.’ help me with maths

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