And with the words “Magical lawsuit” I take my leave of this thread and I strongly urge that the rest of you do so as well.
Let’s try putting some real numbers in your example.
Time 1:
Bank A
Assets $1 (what B owes them)
Liabilities to B $1
Net worth: $1 - $1 = $0
Bank B
Assets $1 (what A owes to B)
Liabilities to A $1
Net worth: $1 - $1 = $0
Combined net worth: $0
Time 2:
Your “magical lawsuit” gives $10 of artificial liabilities to A from B, which also creates a new asset for B
Bank A
Assets $1 (the amount B owes them)
Liabilities $1 + $10 = $11 (the $1 they originally owed plus another $10)
Net worth: $1 - $11 = -$10
Bank B
Assets $1 + $10 = $11 (the original $1 plus the new $10 debt from A)
Liabilities: $1 (they still owe A the original amount)
Net worth: $11 - $1 = $10
Combined net worth: $0 (-$10 + $10)
A is poorer and B is richer than when we started, but the combined net worth of the two institutions is still the same.
Time 3:
Liabilities cancel out
Bank A
Assets: $0 (B’s debt to them has been cancelled out)
Liabilities: $10
Net worth: -$10
Bank B
Assets: $10
Liabilities: $0
Net worth: $10
Combined net worth is still $0
It appears to me that in Time 3 you are still trying to count an asset that no longer exists: once the debts are offset, A has no further claim to repayment from B, so has no asset to list on their balance sheet. This is an error on your part.
It looks like we’re working on X - X = 0. It might help to start with simpler examples, e.g. 2 - 2 = 0.
1 - 0 = 0.9999999999999999999… … Now, there’s a good one!
Technically, money supply is created by bank deposits, not bank loans. This technicality is largely immaterial as bank loans are generally paid into bank accounts as deposits, rather than as a direct loan of currency notes. However, I’m raising this point because you are conflating bank loans, debt, and liabilities as the same items, which they are not. A liability is an accounting of an owed amount. In that respect, it is similar to a loan, but includes many things that are not loans. For example, a business may pay its salesmen annual bonuses such that the business calculates the current value of the bonus every month. If the salesman leaves before the end of the year, he forgoes his bonus. Therefore the calculated bonus, aka the accrual, is not a debt. It is however, a liability because it is accounted for on the business’s balance sheet.
A business may also borrow from another business. This is generally referred to as credit and is a debt. It’s not optional (under general circumstances) for the business to decide not to pay the credit it’s been extended. Conceptually credit and loans are the same thing. However, business-to-business credit and bank loans fall outside of that concept. Business-to-business credit may have a tiny amount of exchangability, but is not considered money supply in any modern economy. A judgment from a lawsuit should be accounted for as a debt. But, again, this is separate from a bank loan.
A bank loan is actually a financial instrument which the prior two examples are not. It has a legal definition and regulatory standing. If I’m understanding your ascertain, and I’m not confident that I am, you’re claiming that one bank can sue another bank, account for the expected judgment, and record it as an equivalent to a deposit. (BTW that would be an asset, not a liability, but then so is the cash side of money loaned into a bank, so I’ll ignore the term-hopping.) That’s simply not allowed. I doubt such a lawsuit would make it into a bank’s financial statements as anything other than a footnote if it chose to undertake such an endeavour. It certainly wouldn’t be included in a banks reports to its regulators on whether it was meeting its capital requirements.
Funnily enough, you’re capturing the point that Askreddit is trying to make. (I think it’s her point. She’s doing a poor job of actually making it.) If Bank A is able to be dissolved with no consequences, Bank B is left with $10 in assets. In the real world, there are structures set up to prevent this. However, regulated banks are intertwined with non-regulated financial institutions which hold a huge amounts of assets. https://www.cnbc.com/2019/04/11/shadow-banking-is-now-a-52-trillion-industry-and-posing-risks.html#:~:text=“The%20exposure%20of%20the%20global,or%20exacerbate%20financial%20market%20stress.”
It’s quite possible that schemes exist to overvalue bank assets based on transactional exchanges between regulated banks and shadow banks. Intentional bankruptcy of a shadow banking institution, obscured by a network of intermediaries, is possible, even if it sound like a plot from a conspiracy threat novel. Other threats are more likely, including the overvaluing of assets used to meet capital requirements, but there is an actual risk, although it’s probably not a catastrophic risk.
No, there aren’t any structures to prevent this. People are just too lazy to do this. But yes those are both problems.
That doesnt solve the problem.
It doesnt have to be. It is just there to cancel liabilties.
It is obvious that debt creates money. Any debt. That is how fractional reserves work. If debt cancels out then money is freed up. This is not hard to understand, you’re simply trying to ignore it.
Here is an actual empirical study proving banks create money out of nothing, and if this process was repeated rapidly enough hyperinflation would occur.
It’s accurate that there’s no hyperinflation threat at the moment, but people who believe that the US will always be a reserve currency no matter how bad our macroeconomic, tax, fed, and treasury policies may be, are seriously drinking some powerful American exceptionalism kool-aid.
We’ve had two decades-long foreign wars costing trillions and trillions of dollars, and we’re on massive recession number two with no end in sight, having just wiped out our very modest gains from the last economic rout, and there’s still no serious discussion about raising taxes on the wealthiest Americans. Anyone who seriously believes we can just keep kicking cans down the road are delusional. Just like investors in a Ponzi scheme, the world’s central banks that do business with us will eventually start asking questions. Even before this historic downturn, the interest on the debt was almost 9% of all outlays - that number has probably increased dramatically.
And as I’ve said before, I’m far from being Ron Paul, “ZOMFG! Hyperinflation!” wingnut.
Meat prices are growing 40% monthly despite reopening. This is borderline hyperinflation. Hyperinflation is defined as a 50% monthly price increase.
Yes, but doesn’t this assume that the lending industry as a whole is losing money?
Sure, Capital One might let me run up $20k on my credit card, then I declare Chapter 7 bankruptcy and they never get repaid, thereby creating $20k worth of money where none existed.
But we would assume that overall Cap One makes a profit, right? So for every bad loan of $20k there are tens of thousands if not hundreds of thousands or millions of others that are repaid in full with interest so that, in essence, those who pay their 18.9% dutifully are paying for my bankruptcy and therefore no money is created by a bad loan.
Am I missing something?
Say you take money off that card to deposit it. Then when your debt gets written off due to statute of limitations 20k is created. Also, as I cited, the bank does not consider consumer loans as a liability so it never loses money.
In the US, the structure with the most authority to prevent banking malfeasance such as a dump and run is the Federal Reserve System. Underneath it are many other regulatory agencies that banks have to report to and are governed by.
In the UK, the primary authority is the Bank of England, although the regulatory duties are distributed out to the Prudential Regulatory Agency and the Financial Conduct Authority.
In Canada, the main authority is the Office of the Superintendent of Financial Institutions (OSFI)
https://www.osfi-bsif.gc.ca/Eng/osfi-bsif/Pages/default.aspx
If you’re curious about any other countries, here’s a list:
To conduct a fraudulent enterprise within a bank that evades the bank regulators requires cunning, substantial knowledge of the bank’s internal processes and controls, knowledge of how the bank’s activities are reported to the regulators and substantial effort - the exact opposite of laziness.
Are you saying that a bank could sue another bank in order to create an asset on its books that it could then use to meet its capital requirements in order to issue further loans or make other investments? It can’t. Banks are able to manipulate their balance sheets in order to meet their capital requirements by creating complex financial instruments such as repurchase agreements and swaps, but a lawsuit absolutely isn’t one of those instruments.
If that is your contention, then please offer an example of when that has occurred, or an explanation of how it would work.
If you’re contending something else, then please provide details of what this supposed scheme is, how it would be accounted for, and how the accounting would evade the bank’s regulators.
Prices fluctuate. The latest BLS report (end of May) shows a 12-month decline in apparel prices of 8%, and a 12-month decline in gasoline prices of 34%. Yes, it also shows a 5% rise for ‘food at home.’ I’ll wait for next month’s BLS report before commenting on a 40% rise. (Even if true, it’s disingenuous to call it a “monthly” rise.)
Individual prices fluctuate. Published inflation figures are averages. If you ignore that and just focus on the scariest number in the latest report, of course you can claim inflation. Why don’t you rewrite your paragraph focusing on the price of gasoline instead of meat? 
(The BLS website has charts showing average prices in many categories — food is broken down into meat, eggs, etc. — going back several years. But it’s a badly organized site and I can’t find those charts just now.)
Will the dollar’s value fall sharply at some point? Almost certainly. Sooner, rather than later? Maybe. But it ain’t happening yet.
U.K. has debt problems at least as bad as U.S. Some other major European countries are even worse. U.S. stocks and bonds (and the U.S. dollars needed to buy them) are still in high demand simply because opportunities elsewhere look even less appealing.
That study discusses the credit creation theory of banking. It investigates whether there is a strict correlation between a bank’s deposits and it’s loans, or whether the correlation is theoretical. Its conclusion is that banks can make loans in the form of electronic payments with capital they don’t actually possess.
It’s already been noted in this thread that the actual activities of banks are far more complex than a simple model of how fractional reserves increase the money supply. That study provides history and detail for how the actual system works, rather than the simple model. It discusses no flaws in the banking system, not does it have any discussion of inflation beyond a single paragraph that mentions it.
Which part of the study supports your concept?
That is not a structure. Those are ad hoc arbitrary stopgaps. And in the study I gave all those failed.
The last sentence of the abstract which literally says that money is created magically from nothing. The way that consumer loans are accounted for isnt accurately reflected as a reserve loss. Since the banks just hit a button and create loans they don’t actually account for it as a reserve loss. Since money in a bank account is notional, it’s a value on a computer screen they dont have an obligation to actually account for it properly as far as regulators are concerned apparently.
Capital One has your $20k credit card debt on their book as an asset. Suppose they swap that debt with another organisation in exchange for an IOU. Capital One now has the IOU on their book as an asset. You default on the credit card debt, leaving the second organisation with a problem. The question then is whether the IOU from the second organisation has any value. If Capital One is making additional “loans” on the basis that your debt, filtered through a third party, is valid when it should be recognised as a bad debt, then they’re falsifying their loan book. Your individual $20k debt doesn’t matter. But if Capital One has lots of irresponsible credit card holders and expects 20% of its customers to default on their debt, but is hiding that debt by moving it to another company who also won’t pay it back, then it’s heading for a crisis. It sounds like a stupid business practice, but they’re probably also generating revenue from credit card fees and other forms of short-term revenue. The idea is to take all that short-term money, and then hope that the bad debt is never recognised.
In terms of money supply, consider the IOU to be a deposit enabling further loans, which are then redeposited. That’s what’s creating the additional “money”. This is pretty simplistic, but I’m trying to be brief. I don’t think anyone, including me, is interested in a detailed debits and credits walkthrough.