How fortunate is Smiling Dave! The whole Keynesian internet has decided to educate him about his total ignorance of how banks function, teaching him some basic accounting at the same time.
They are taught, and are trying unsuccessfully to explain to Dave, that this is how reality works:
Fellow walks in and asks for a loan. Bank writes him a check, and scribble whatever in their account books. Fellow brings in a pile of cash eventually to repay his loan. Banks scribble new whatever in account book. Result: The bank has exactly the same amount of money as if he never repaid the loan at all. That pile of dollars on their desk does not exist. The scribbling made it disappear.
Guys, grow up. Think. There is a pile of money on the table that wasn’t there before. How can some scribbling make it disappear?
Devil’s Advocate: But Dave, what if he repays with a check?
SD: Then the bank presents the check to whoever wrote it, and get cash.
DA: But they scribble in their accounting books that the cash disappears. Of course that must turn on some gizmo that shoots that money straight into the Twilight Zone. How can you not understand that?
SD: I dunno. Maybe if we try it from a different angle.
Let’s pretend the cash really does disappear, for the sake of argument. Fine. Then why do the banks care if they are repaid at all? They cannot spend the money he gives them, because it disappears. Why don’t they just let him keep it?
DA: Because they are not a charity.
SD: What if Krugman and all the other Keynesians are right, that our problem is not enough spending? Why can’t the banks show some good citizenship and let people just keep the loan money the bank gave them, so we can get some spending going? After all, once repaid, the banks can do nothing with it. It’s destroyed the moment it enters their sanctuary.
DA: You are right, that’s a great idea. I guess they just haven’t thought of it.
SD: More to the point, why did Lehman Brothers have to go bankrupt, triggering the Great Recession according to some people? Why didn’t the other banks, as a courtesy, just write Lehman Bros. a check, and tell them not to bother to repay?
DA: For that matter, why do banks ever need bailouts from the govt? Why can’t they just write each other checks, and waive repayment?
SD: Why are there taxes? Why don’t the banks just write checks to the govt, and tell it not to bother to repay? Why all the bitterness about raising the debt ceiling? Forget about debts, just have the banks give gifts of checks to the govt. Problem solved.
DA: OK, I give up. What’s really going on, Smiling Dave?
SD: All they tell you about banks about in the schools is technically true. It’s the interpretation that is lopsided and wrong.
They forget to tell you that when a bank writes you a check, it is writing out an IOU. The bank is saying in that check that they owe someone money. If they write a check for a billion dollars, that means they owe whoever has that check a billion dollars. Whenever they write a check, they get deeply in the red, deeply in debt. And when someone comes along to cash that check, they are in deep trouble, because banks write these IOUs with no regard to their ability to actually cough up the money when presented with the IOUs.
So for every check they write, they are in deep trouble [which is why they don’t handout checks for free]. Someone might try to cash that sucker, and the bank won’t have the money. They write this all up in their books. We owe someone out there a billion bucks. When the person repays his loan, they breath a huge sigh of relief. Now we have the money to cover that check we handed out.
DA: So when Teacher told me the money disappears, what he really meant was that the money doesn’t disappear, but is instantly used to balance the books, to erase that crushing billion dollar debt the bank has?
SD: Yeppers. If you owe the Mob ten grand, and you work and slave and get the money and repay them, would you say your ten grand “disappeared”? Not if you know what you are talking about. The money was used for an important purpose, to pay your debts. It did not disappear.
DA: Dave, this whole discussion was in the context of people repaying loans means there will be less spending. And you said that is not true. That the moment the bank gets repaid, it now has money to spend.
SD: If Bank A is in debt a billion dollars, and Bank B is debt free, who will spend more? Who will lend money to people?
DA: I see your point. But maybe the banks will never find anyone new to lend to. And everyone is saying they aren’t lending anyone anything.
SD: Actually, they are lending the Fed money all the time, every day.
DA: But if the money is given to the Fed, the Fed certainly won’t spend it, will it? I mean, there is no 40 billion a month of QE going on, is there? I mean, they are thinking about deciding to someday taper, or something like that. So of course we are in big trouble.
SD: Uh huh.
DA: Not to mention that all the govt numbers show the money supply is shrinking like a deflated balloon. Help!
SD: I don’t believe it. Govt stats are all lies anyway.
DA: Watch out Dave, that just turned a lot of people off.
SD: Not my fault.
ADDED May 26, 2015:
Thinking about it again, I have a scenario where money disappears.
Smith wants a loan of $100. Bank A gives him a check. He uses the check as money to buy a lot of hamburgers. Then he repays his loan to the bank in cash. Nothing has disappeared yet, because the bank has $100 of cash to spend, and the burger store has a $100 check it can also use as money and buy things with. But if the burger store, instead of using the check to buy things, goes to the bank, presents the check, and says it wants cash for it, then money has disappeared. The check, which is the newly created money, is no longer out there. Come to think of it, this is true whether Smith repays or not.
Bottom line, the money disappears, not when Smith repays his loan, but when someone, either Smith or someone else, presents the check to the bank and wants money for it.
And even then, it has not totally disappeared. The bank, although it will rip up that check, can go ahead and write a new one to somebody. And they will. That’s what they do. It’s why they are in business, to write checks.