Why Private Bank Money Creation is Dangerous

The financial cycle refers to a co-movement between asset prices and bank lending. While asset bubbles can definitely emerge themselves (just look at the recent Gamestop and Bitcoin stories), thanks to positive feedback loops that are inherent to these markets, when the banks join in … you better hide because that’s when they can get truly dangerous.

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There are two elements to the financial cycle story:

1) The first is that of rising asset prices, primarily houses, but also stocks.
2) And the second is that of rising debt to GDP. Or increased bank lending.

The biggest and most recent episode of a financial cycle happened in the United States and it started … right around 1996. In this year both the level of debt compared to the size of the economy (also known as credit to GDP) and inflation adjusted house prices started to pick up. And up and up they went. And as they went up… the people were happy, the sky seemed the limit. If you want to get rich, just buy a house.

And the banks? They were more than willing to lend. After all, if a borrower could not repay the loan, he or she could sell the house. Since the price could only go up, the house sale would always yield enough money to repay the loan….

Now at the same time, it so happened that the economy was doing really well. Even a big stock market crash in 2001 could not stop the party. After that stock prices also started to pick up until….. in 2006 house prices started dropping. Then in 2007 stock prices followed, and in 2008 everything came crashing down and the world faced its biggest banking crisis in a hundred years.

Currently banks are far better regulated and are less likely to have pumped up asset prices such as those of stocks like Tesla, and Nvidia, but also about crypto assets like Bitcoin and Ethereum.

This video has been inspired by work from economists at the Bank for International Settlements such as Claudio Borio. I'm also using it in a course that I am teaching at the University of Groningen called International Financial Markets that I teach with prof. Dirk Bezemer.

Narrated and produced by Dr. Joeri Schasfoort (University of Cape Town)

[abhishek.chakraborty]

A really underappreciated channel imparting much needed financial education 🙏
I hope your channel subscription grows exponentially in future 👍

[owennilens]

Considering this video is on asset bubbles I think you've missed the opportunity to do a poll with plenty of relevant keywords to help you in the YouTube algorithm. You could still do it. It is trendy to do so now.

[inferno]

This video has pointed out a concept that 90% of "economists" refuse to talk about: rational behaviors for individuals and rational behaviors for the banks are completely different things

[DanHaiduc]

Thank you for creating your channel and posting these videos! I find it hard to stop watching. Your content is amazing and wellresearched!

[owennilens]

Your channel really deserves more attention 👍 😉 #AssetBubble #ShortSqueeze #WSB #GME #Bitcoin #Housing #Markets

[jaundice]

good quote - "economists are not trained to deal with markets with positive feedback loops"

[ryanconners]

This simple, short video explains such a huge, complex, wide ranging issue, so well! Great stuff!

[ddicin]

The concision with which you convey your concepts is remarkable. You have a gift for teaching, my friend.

[Ausfailia]

Australia is currently heading towards the downswing in my opinion, lending has hit record highs along with record high house prices, yet interest rates are rising next year

[Ikbeneengeit]

Great video, especially interesting to hear about positive feedback loops and recent behavioral economics thinking. Thanks

[whaha]

Zelden zo'n genuanceerde video gezien over de financiële cyclus. You really make very easy to understand videos. If only most people would watch this, there would be more interest in monetary reform.

[Pradosarethenewcommodore]

One of the best channels on YT. Well done! Keep going

[kenmoretoast]

for years I've heard that banks are more heavily regulated after the GFC, but i couldn't tell you what any of those regulations are. might be a good topic for another video

[MstlyHarmless]

One note on central banks and interest rates- the natural overnight bank rate without government action is 0%. This is because the primary source of reserve drain from the banking system is 1) the Treasury selling bonds and 2) the central bank selling Treasury bonds, neither of which are necessary for government spending. Without this, the bank rate drives to 0% (or the support rate paid by the central bank) as the supply of reserves expands via government spending and interest on reserves paid by the central bank.

[antoniocolasnieto]

Absolutely fantastic channel. Love it. Thank you.

[marten]

I think the vast majority of home buyers are aware that prices won't go up forever. Instead it's the renters who consider the housing prices and the (unrealized)profits as unfair and who seem to think that owning a house is financially secure and forget how the housing crisis a decade ago ruined many households, especially when they lost their jobs or got a divorce in that period.

[XaharYoutube]

THANK YOU very much for this video... always thinking about to produce a published paper [requirement for my PhD study] on housing price and credit creation. This video gives me a very good idea on what research can be done on a smaller scale for my upcoming paper.

[shushirakawa]

Wouldn't it be much better to tax the money out of the economy rather than raise interest rates?

Hypothesis: When you are borrowing money, you are basically renting money from the bank. You need some economic growth to cover the fees. Population growth is going down and other factors drive deflation. If you raise interest rates by too much then you have to lower them again. Probably deeply negative.

Thought experiment: EE mentioned "shorting the dollar" through borrowing. If borrowing really is shorting, that would imply that people who accept x% interest loans also expect the value of the dollar to go down by x% each year. Assuming you borrow, interest is directly responsible for creating an inflation expectation if there is no growth to back it up. After all, the economy can only grow nominally (more dollars, same quantity of goods). The other implication is that the profit margin banks put on top the central bank interest rate puts a price floor for inflation if interest rates get stuck at 0%. Inflation has to be at least as high as the profit margin of the bank.

The other interpretation is that shorting the dollar with 5% interest at 2% inflation forever means I expect that interest on the loan goes down over time until it is negative enough to break even or negative enough to be profitable.

Conclusion: Either way high interest eventually ends up with lower real interest rates (interest - inflation) and low real interest rates lead to high real interest rates forming a cycle. It might be better to stay at 0% forever and tax inflation out of the economy which eliminates the need for cycles.

[DonutSurprise]

Very good video, even after watching many other (also well made) explainers on the topic.

[c.j.]

Always interested watching videos from Schiffer’s like yourself!