49. Banks Add Money and Investment.

Banks Add Money and Investment.
Bob Komives
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Would you rather have a thousand dollars worth of stock or a thousand stocks worth of dollars? You might say, "That depends." Would you rather have a thousand potatoes worth of dollars, a thousand potatoes worth of stock, or a thousand stocks worth of other people's promissory notes? I suppose, "It still depends." With some creative logistics you can use any of these assets at the stock exchange to buy stock, at the bank to secure a loan, in your will to endow a university, or, in a pinch, most anywhere to trade for most anything. Why? Because there are secondary markets for potatoes, stock, loans and money. After the first transaction that puts them into the marketplace they can be sold again and again. The secondary markets for potatoes, stock, and loans are giant-but-tiny compared to the fluid markets for money. As the principal means of exchange, money is coveted by one side in most transactions. In modern economies we need a lot of money --so much that even free-spending governments can have trouble keeping up with the demand. They need assistance. While good-old General Motors would never allow anyone else to issue its stock (traders were stuck with the number of stock General Motors chose to issue), the demand for money is so great that most national governments let banks assist them in minting. The economy needs new money as enterprise brings forth new goods and services that the public wants. By choice or by default, governments in countries that emphasize the private marketplace let the banking system issue much of their money. Within the limits imposed on them by government, banks issue new money whenever they borrow from their depositors to issue new loans. If the banking system did not print more money there is no way that most bankers could cover their growing obligations to depositors --to return the deposits, with interest, on demand. Nor could borrowers pay their obligations to the banks.

Bank-printed money is easy to see if we consider the banking system as one bank. One day a man who is known to be reliable and productive takes 100 dollars out of his pocket and deposits them in the bank. A day later he borrows 80 dollars from the bank. The morning of day three he withdraws his initial deposit plus one day of earned interest. Now he has 180-plus real dollars in his pocket and an obligation to pay back his loan. He goes out and spends those dollars at stores that quickly send someone to the bank to deposit their earnings. By close of the business day the bank has assets of more than 180 dollars in deposits and more than $80 in good loans. As the cycle goes on, the amount of money in circulation and deposited in the bank continues to rise. Someone printed money, and, oh yes, during these three days government was on a holiday.

Having once put new money into circulation by lending out money that they have guaranteed to hold for depositors, a bank cannot withdraw that money from the marketplace even when investments turn sour. Borrowers have spent the money. It disappeared into the marketplace --eventually returning to the bank, but with no tag to identify it with the initial loan. Where projects fail borrowers never get enough money back from the marketplace to return what they owe to the bank. New money spent on these bad projects stays out in the marketplace searching for goods and services. Since the projects did not produce their promised economic growth, new money competes with old money for old goods and services --forcing up prices. The value of all money declines. That is inflation. Whether bank or government issues money to finance bad projects the effect is the same: inflation. Whether bank or government issues money to finance good projects the effect is the same: economic growth.

Despite the inflation risk, a banking system can serve its country well. A diverse investment structure that includes banks of various sizes in different locations can develop diverse investment strategies. Local banks can help a nation develop the complex organization at all levels that typifies a robust ecosystem. Because government spending should reflect priorities set by the nation, national government spending is the most direct and understandable way to infuse the private investment market with the money it needs. Centralized investment, however, even if intelligently made, even if made by a giant private bank, tends to over simplify the needs and opportunities of a complex society. A complex system of local and regional banks is a complementary money pump to national investment. It fills investment niches that simpler national strategies cannot find.

:: Bob Komives, Fort Collins © 2006 :: Plum Local IV :: 49 Banks Add Money and Investment ::
With attribution these words may be freely shared, but permission
is required if quoted in an item for sale or rent

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