“There are many things that might happen to a firm making it unable to pay off its liabilities. For BP, no one being willing to buy its gas, no one being willing to buy is existing assets (current or not) would do the trick.” i.e. make it go bust.

So you then say

“Your view about BP is absurd. If BP’s sales fell to zero, it would fail. Nearly all of its assets would have next to no value. The balance sheet is conditional on that not happening.”

In the real world, if BP went down, the current creditors, in the absence of any secured creditors would get the collection in of the debtors book (cash owed) which makes up the vast majority of the BP current debtors. This is a cash payout.

The interesting thought that you have given me is that the law should be changed to allow current debt to be secured on current assets and not let long term lenders secure on short term assets, which they do. Thank you for that inspiration Bill.

I think you have made a mistake here as well..

“transactions deposits are only a small fraction of the total liabilities.”

A deposit is not a liability, but an asset. Our Chancellor Alistair Darling makes this mistake as well.

You say…

“the system will collapse if 3% of depositors remove their money,” ignores that possibility that the banks might convince the other 97% of the population to put more money into banks.

“That is why bank capital, rather than reserves, determines the possibility of loss to depositors.”

I think not. The banks found it very hard to raise capital and some even failed last year to raise anything. My bank, RBS moved from 2% capital to 8% I believe. That capital would be lost, period, in an administration, shareholder funds in this situation are zero as the Administrator owns the Bank not the shareholders! Capital of the bank would never pay current creditors!

You are wrong about banks as well. Why do you think that the payoff value would be equal to its current reserves?

You misuse the word solvency.

Generally, the sorts of errors you are making happen when people determine that excess money creation is bad because it is inflationary. They learn that banks create money, and then get all focused on the relationship between bank reserves and the money created by banks. Then they ball up the various sorts of bank liabilities and treat them all as if they are money.

For U.S. banks (I don’t know about Barclays) transactions deposits are only a small fraction of the total liabilities. Savings accounts, which are generally payable on demand are the biggest part. And CD’s are intermediate.

If a bank defaults, then depositors of all sorts don’t get paid in full. How much they get paid depends on the value of assets less liabilities. That is why bank capital, rather than reserves, determines the possibility of loss to depositors.

The people who get to the bank first, at least, before it closes its doors, get paid in full. Then, after it is closed, no one gets anything until the bank is liquidated. The assets are sold off. Whatever reserves rain in the bank, plus the liquidation value of all the other assets–loans and the like, determine what all the depositors get.

The whole “the system will collapse if 3% of depositors remove their money,” ignores that possibility that the banks might convince the other 97% of the population to put more money into banks.

And, of course, it assumes the quantity of the monetary base is constant. Why should it be?

If the quantity of base money is constant, and their is an increase in the demand for it, then its price must rise. But it serves as unit of account, this requires other prices, including wages, to fall. And so, increases in the demand for the monetary base are very disruptive to the economy. Many businesses will fail if the disruption is large enough. Including banks.

“This would suggest that BP has current liabilities marginally greater than their current assets. No doubt the timing of the payment to suppliers is carefully balanced off otherwise their auditors could not sign off the accounts if they thought the company could not pay off its assets as and when they fall due.”

So Bill, it does not say what you imply.

I presume the word creditors should be swapped with debtors when you say “For a bank, if none of its creditors could pay off its existing loans, it would fail.”

On average , if more than 1 person in 33 in the UK banking system walks into a bank to get “their” money, the whole system collapses.

If BP stops selling petrol etc as their is no demand, its current creditors are virtually fully paid out, in fact 95% paid out in days according to their balance sheet. Happy days – assuming their are no secured creditors ranking before them. The sale of some fixed assets would mean all current creditors are made whole again.

If Barclays bank customers go in and demand “their” money, then on average , if they are the average in the UK banking system, they will get a 3% recovery. Like the Northern Rock creditors, absent a government gaurantee and they will have to wait years!

So, I rest my case. Normal commercial law on the whole protects creditors. The special status of banks and the legal protections they have , gives them a unique position that no other commercial instittion has in society. This is antithetical to Liberty.

Perhaps, but BP can borrow to pay off current liabilities replacing one set of current liabilities with a new set coming due in the future. As long as BP’s total assets are greater than its total liabilities (current or not) then the creditors may be willing to lend. The longer term assets will gradually become current.

There is, of course, a risk that no one will lend to BP. And so, it will not be able to pay off its current liabilities. It will default and become bankrupt. And all of its liabilities will be paid off only partially. One of the reason why those lending to BP earn interest is to compensate them for the risk this might happen. Another reason, of course, is the risk that no one will buy BP products.

To me it seems like British accounting rules involve massive government intervention in business. While a firm may choose to organize on the basis of personal liability for directors if one set of assets was less than one set of liabilities, and then there is a default (though it would seem to me this would always happen when there is a default,) other firms may wish to operation on another basis.

As for banks, deposits are loans from the depositor to the bank. The represent liabilities of the bank. It is true that the assets of the bank (such as loans, securities, and reserves) are assets of the bank.

Banks are solvent if the assets are greater than the liabilities. The notion that a bank, or any other firm, is insolvent because something might happen is absurd. There are many things that might happen to a firm making it unable to pay off its liabilities. For BP, no one being willing to buy its gas, no one being willing to buy is existing assets (current or not) would do the trick. For a bank, if none of its creditors could pay off its existing loans, it would fail. It could happen.

The scenario where many depositors want payment now and the bank cannot borrow new money now, and it cannot sell off enough of its assets (current or not) at high enough prices now, so that the bank defaults, is possible. A bank could operation to make this scenario impossible. (Charging people to store cash and for payments services,) but failing to do so doesn’t make the bank insolvent.

That’s why credit expansion is normally not inflationary. But in your scheme, the demand deposits don’t go back into thin air – they’re converted into newly-printed cash.

Note, a demand deposit is created out of thin air, so when the money gets paid back i.e. the £200m or £250m recovered, it goes back to thin air, that is why it is not inflationary!

Note in Administrators report how much cash actually existed in the PMS. The rest are bank IOU’s or call it a bank statement or call it a demand depoit. NOT CASH. All the former do count as money.

Banks keep saying they are lending like mad, but their lending is going down. Are they telling porky pies? No, people are paying back credit faster than it is being lent out, the worst situation for a bank. Salient point, when credit is paid back, it does not sit in a bank vault, so you will not have £300m plus £200m. It goes back into thin air.

M4(before) = 300M demand deposits + 200M recoverable assets + 100M unrecoverable assets + 200M tax revenues + (rest of economy) = 600M + rest

Scenario A (money is not printed, investors redeem demand deposits taking haircut, taxation used to pay national debt)

M4(after) = 0 demand deposits + 200M recovered assets + 100M unrecoverable assets + 0 tax revenue + (rest of economy) = 300M + rest

Scenario B (money is printed, state redeems demand deposits taking haircut, recoverable assets used to pay debt)

M4(after) = 0 demand deposits + 300M newly printed money + 100M unrecoverable assets + 200M tax revenues + (rest of economy) = 600M + rest

The difference between the two “after” scenarios is 300M, the exact amount of cash printed.