Claims didn’t fall, they went up some.

So dollar still weak/commodities and stocks still moving up, and bonds only a touch off their recent highs.

With the large output gap and unit labor costs well contained, it can be said it’s not so much the dollar is weak but the other currencies strong, particularly the euro, where it looks like they are trying to force deflation with their austerity measures during a time of high unemployment. And the yen, too, is still struggling with deflation.

If I recall 1980 correctly silver has been lagging and ‘caught up’ with gold just before it all came apart? Silver peaked at maybe $60 while gold peaked at maybe $880?

The Reagan expansion that followed the end of the oil shock was not a good time for gold and silver.

And today they are going up for the ‘wrong’ reason- market participants believe and are shifting portfolios as if the Fed and other central banks were ‘printing money’ when they are not. And this can persist for a considerable period of time.

30 Responses

  1. Sorry to ask this here as it’s OT, but I have been unable to find the explanation elsewhere and I’m a bit stuck.

    When a secured loan (e.g. a mortgage) goes “bad” and the property is auctioned off for less than the amount of the loan, it would seem that this would create money because the initial deposit is still in the banking system while the loan has been retired.

    I assume this does not, in fact happen. So how is this avoided? Is the bank’s Fed account debited the difference between the loan amount and the collected amount? Is the remaining liability just converted into an unsecured loan? Something else?

    Thanks in advance for help with this question that I feel I should have been able to answer on my own.


    1. My guess is that the initial loan ‘created money’ , i.e. loans create deposits, but it did not create ‘net financial assets'(NFA). Upon default NFA is created in the amount of the default -at least theoretically. But then bank capital (destruction of the loan )is reduced by defaulting amount + the value of the house.

    2. A loan creates a deposit. The loan is a bank asset (receivable) and the deposit is a bank liability (payable). They net to zero. Correspondingly, the deposit is the borrower’s asset and the loan obligation is the borrower’s liability. Again, net zero. No increase in net financial assets.

      You are asking for an explanation of the accounting in the case of full or partial default. In a loan default, all or part of a bank asset and borrower obligation is cancelled. What is the corresponding double entry, and how does this affect net financial assets?

      Perhaps one of the accountants or bankers here will enlighten us about the correct way to state this.

      1. Not contradicting to JKH but I will try to make it a bit more simple and short.

        When MMT says loans create deposits it is a balance sheet entry. When you say that a house is auctioned and sold at a loss then it is an entry on profit and loss statement. Every accounting period (annually) the result of p&l is integrated into balance sheer under the capital position. This is how the loss is accounted for.

    3. This turned out to be more difficult than I expected. Hope it makes at least a bit of sense.

      SIMPLIFIED example:

      Assume the lending bank’s books were originally set up as follows for this loan:

      Loan 100
      Deposit 100 (created with the loan)
      Capital 10 (already on the books, previously unallocated, now allocated to this deal)
      Treasury bills 10 (assume capital is invested or stored in risk free treasury bills of 10 for the time being. This ISN’T EXACTLY how banks manage their capital books, but it is a harmless operational simplification here.)

      So the balance sheet “dedicated” to this deal is 110 each side, including the capital and treasury bills.

      Assume that the deposit which was created with this loan actually stayed with the same bank – i.e. the payee for the initial house purchase was a customer at the same bank. This simplifies the accounting rather than dealing with deposit and reserve flows among different participating banks all the way through.

      Assume for simplicity, the 100 loan goes bad and the house goes to auction, but the loan isn’t “written down” and losses taken until the auction is completed. Again, a simplification, but only with respect to the timing and sequence of expected losses and final loss recognition – makes no real difference to the story.


      Bank sells house
      Auction proceeds 60
      Loan repaid to the point of 60
      The rest of the loan i.e. 40 is “written off”
      Net bank loss 40
      Bank capital down 40 (corresponding to loss)

      Bank now has net capital shortfall of 30, AT THE MARGIN, due to this particular deal
      (May be made up for the bank as a whole by excess capital elsewhere, not yet allocated to risk – but that’s another story)

      These are ALL non-cash items and entries, EXCEPT for the auction proceeds of 60, which is a cash transaction from the customer perspective.

      Assume the auction buyer has deposit account with the same bank, again to simplify.


      Bank deposits down 60 (auction payment)
      Original bank deposits of 100 now 40
      The auction payment is a cash item from the customer perspective.
      The auction payment “destroys” 60 in deposits upon withdrawal and “destroys” 60 in loans on being applied against the loan
      (This is the reverse of “loans create deposits” as per MMT


      The original balance sheet dedicated to this deal was 110 each side. The residual balance sheet after all is settled up from the auction:

      Treasury bill assets 10
      Deposits 40
      Capital (30)

      Long story short – a partial residue of deposits originally created with the loan deal remains with the banking system – where the residue equals the amount of losses and the negative hit to capital. The balance sheet must balance at close. Essentially, the deposit residual after the loan is fully off the books has offset the gross reduction in capital; it’s a wash because both are on the RHS of the balance sheet.

      Apart from that, the resolution of reserve and deposit accounts for different individual banks that might actually participate in the various payments (e.g. borrower’s bank, auction buyer’s bank) is just a matter of shuffling reserves and deposits around, etc. – better to look at it assuming single bank involvement first – which is equivalent to looking at it from a banking system perspective as well.


      I made the balance sheet 110 because that keeps the “loans created deposits” illustration straight forward. In the “real world” of bank risk accounting, the 10 in capital is more likely to show up through internal funds transfers as part of a funding mix for 100 in loans that includes 90 in non-capital funding costs – very complicated via transfer pricing systems.

      Interestingly though, in the “real world”, excess capital is identified as such and is matched up against risk free assets such as treasury bills – pending future deployment against new risk assets.

    4. Ape Man,

      I created a visualizer in part to help answer this type of question. Start with “bank loan” and choose “run operation”:

      Then choose “borrower defaults on bank loan” and again “run operation”.

      By pointing at the “households” or “banks” label under the corresponding balance sheet, you can get a floating popup to compare to the preceding state (though unfortunately the tool doesn’t let you do that yet across two operations at once).

      Bottom line: A loan default is in effect like a “gift” from a bank to the non-bank sector and it reduces bank equity by the amount of the default, and increases the non-bank equity by the same amount. The addition to “broad money” (see orange bar in top right) that was created by the loan is NOT destroyed after the default. This is because the broad money supply counts deposits and currency held by non-banks, but excludes assets held by banks. So the default (quasi-“gift”) creates money simply via transferring bank assets (not counted as money) to non-bank assets (counted as money).

      You may wonder looking at the visualizer, “if a default is like a gift from banks to non-banks, why didn’t the bank balance sheet shrink as a result of the two operations?” Because the newly expanded deposits held by the household are tied to a corresponding deposit liability and reserve asset held on the bank balance sheet. Choose “bank customer withdraws currency” as a third operation and THEN the bank’s balance sheet will shrink to match the size of the quasi-“gift” that the default corresponds to.

      If that’s all too confusing let me know and I’ll add some more “combo” operations (like the existing “Government Spends (Consolidated)”).

      1. I think I got sloppy in some of my wording… read some of the times I say “default” to instead say “bank loan plus subsequent default”.

      2. Hey hbl .. good explanation and you have great graphics to show the same!

        You could include transactions involving two nations as well as another project!

        A digression:

        Its been a while since I saw your website. I noticed one thing this time – you have operations for open market operations but you call them open market operations to increase/decrease rates. Probably you may have to change the wordings since it has the potential to create misinterpretations.

        A few lines from Marc Lavoie’s article “Endogenous Money: An Accomodationist”

        “Some post-Keynesians have pointed out long ago that open market operations had little or nothing to do with monetary policy. For instance,

        It is usually assumed that a change in the Fed’s holdings of government securities will lead to a change, with the same sign attached, in the reserves of the commercial banking system. It was the failure to observe this relationship empirically which led us, in constructing the monetary financial block of our model, to try to find some other way of representing the effect of the Fed’s open market operations on the banking system. (Eichner, 1986, p. 100)

        That other way is that ‘the Fed’s purchases or sales of government securities are intended primarily to offset the flows into or out of the domestic monetary-financial system’ (Eichner, 1987, p. 849)”

        In other words, if the central bank wants to increase/decrease rates, it doesn’t start doing more/less/more open market operations than what it has been doing.

      3. Thanks Ramanan.

        “You could include transactions involving two nations as well as another project!”

        I do in fact have a much-too-ambitious second project going to create a step-by-step flow visualizer/tutorial that aims to walk through most of the major MMT concepts, including interaction with the foreign sector. (Time to work on it is always the challenge.)

        “In other words, if the central bank wants to increase/decrease rates, it doesn’t start doing more/less/more open market operations than what it has been doing.”

        I’m afraid I don’t completely follow. I think you’re suggesting I have the details on this pair of operations wrong, and if so I’m very happy to get such feedback. Are you just saying that splitting open market operations into two pieces is misleading, as maintaining rates is a single continuous process? If that’s it, I welcome ideas on how to illustrate it in the format of this visualizer, given that balance sheets have to adjust in concrete ways. If I’ve still got it wrong, please point me to a good explanation that I can incorporate. (I know Bill Mitchell has covered it in lots of posts that I may have forgotten the details of… I wish he was less verbose sometimes though 🙂

      4. with excess reserves, rates are adjusted simply by paying interest on those reserves at the target rate

        with a net borrowed reserve position, rates are adjusted by varying what the Fed charges on those ‘overdrafts’

        open market operations are just ways of paying interest on balances or charging interest on overdrafts

        the term structure of rates is altered by altering the maturities of the fed/tsy liabilities.

      5. hbl,

        The operations you have shown in your Balance Sheet Visualizer are right.

        Yes you are correct about maintaining a single interest rate. The Fed announces a target and is defending it. The word defending is appropriate. During the course of a day, reserves can change due to various factors – mainly the operations of the US Treasury. The open market operations are just to offset these changes not to change the target. Interest rate changes are made by “Open Mouth Operations”, not open market.

        So open market operations are to offset changes which may cause the reserves lending rate to deviate from the target rather than changing the target itself.

      6. Ah, I’m clearer on your point now, and I agree that my wording is potentially misleading. When I get a chance, I’ll rename the operations to something along the lines of “open market ops to raise/lower rates toward target“. Thanks!

      7. I do in fact have a much-too-ambitious second project going to create a step-by-step flow visualizer/tutorial that aims to walk through most of the major MMT concepts, including interaction with the foreign sector…

        That sounds great, just don’t reinvent the wheel. :o)

        These web pages contain all EViews macros to replicate results in the book Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth by Wynne Godley and Marc Lavoie…

      8. Beowulf said: “That sounds great, just don’t reinvent the wheel.”

        Thanks for the link, I hadn’t seen that. I even have the book (and really must get around to reading it!)

        However, I think those EViews macros are quite different than what I’ve hoped to create. Anything that requires a $1000+ software license and download of wonkish equations is targeting a very niche audience.

        My goal has been to create something web-based and accessible to a reasonably broad audience, that could hopefully give a decent 5-15 minute overview of core concepts, with visuals as an aid to understanding (but not actual mathematical models underlying them). I know I’m not the only one who has for a long time expressed a desire to see a basic FAQ or MMT wiki, which I can’t believe still don’t exist (AFAIK). As I’ve said before, the topic of MMT as presented in blog format seems accessible only to the most dedicated and time-blessed. (Warren’s 7 Deadly Frauds and Bill’s 101 pages are good but even they require a bigger time investment than I suspect many hesitant newcomers are prepared to give). So that’s the gap (as I see it) that I’ve been hoping to help fill. And the project really isn’t all that big, I’m just frustrated at my own time challenges.

      9. Thanks, JKH! As you can see I’ve resisted putting in “share offering” and “market reprices shares” operations, for now 🙂

    5. the initial deposit was there even before the loan went bad, so that doesn’t change

      the bank’s equity goes down, which is a financial asset.

      think of it this way- if you held all the stock of a bank that lost all its money the value of your stock goes to 0.

      before your loans went bad because the borrowers owed you the money.
      after they default their liability goes away as does your asset.

      If the bank loses more than it’s net worth, and goes to a negative value,
      no additional private sector assets are reduced (the FDIC ‘takes the loss’) and the deposits remain.

    1. Lars, I hope so…

      but the last speech he gave a couple of weeks ago to the “Deficit Terrorist Club of Rhode Island” didnt even address monetary, all he talked about was fiscal and his message was for getting the deficit down, not increasing fiscal at this time….

      If he does do an about face like this I agree with JC, it would be even better for stocks than current policy…fingers crossed.


  2. Lars, False Alarm. In an email response to me, the writer said he was guessing. But it begs the question: who first proposed this? Warren or Bernanke in Japan?

  3. Warren, if I understand your two Oct 16th comments correctly, the OMO operations I had were potentially misleading, but not wrong. If you (or anyone) think they were wrong, I am happy to be corrected.

    I have updated the econviz OMO text to hopefully be clearer, for example regarding OMO as just one tool central banks use. Thanks.

    “with a net borrowed reserve position, rates are adjusted by varying what the Fed charges on those ‘overdrafts’”

    If you are referring to the discount rate, isn’t it true that the discount window is very rarely used in practice?

    “open market operations are just ways of paying interest on balances or charging interest on overdrafts”

    As I understood it, open market operations are about affecting supply and demand and the rates banks charge each other for overnight loans (though as you say targeting rates not quantities), and that open market operations don’t involve any interest paid by the central bank. Isn’t interest paid on reserves (which is relatively new in the US, and I thought distinct from OMO) the only primary tool for which the central bank is making interest payments itself?

    1. if banks are in ‘overdraft’ in the reserve accounts, they can either 1) do nothing and be charged the discount rate, or 2) try to get the funds cheaper.

      since the fed doesn’t want banks paying up for $ they use open market operations, for example, to offer funds to the banking system at or near their target rate for fed funds.
      open market operations are all about the cb pricing the funds they add (or subtract). When they do repo’s for example, the banks ‘bid’ for the funds and the CB determines the ‘stop’ which is the highest rate they make the banks pay.

      so yes, the discount window is rarely used as it involves banks paying up for funds and a higher marginal cost of funds for banks that the fed doesn’t want.

      it’s always about price (interest rates) and not quantities.

      1. Okay, thanks for explaining. That seems to be consistent with my understanding (someone call me out if I’m missing something), with the exception of the repos, which I haven’t known as much about. This seems like a good explanation:

        So I think I was correct that the “System Open Market Operations” don’t involve any interest paid from banks to Fed or vica versa, but the repo operations seemingly do. And regarding price vs quantity, of course influencing the price is the goal, but I don’t think it’s incorrect to say the quantity matters as a means to an end. As the articles says “Through this adjustment to the supply of reserve balances, open market operations influence the federal funds rate”. So since what I have right now is only a “stock” (quantity) visualizer, I’ll stick with what’s there for now, subject to revision as I get further feedback.

  4. I wanted to ask what I think is Ape Man’s question again.

    I am probably just confused but I think you have made the assumption that the financial sector is solvent when giving your answers. I hope people are still looking at this thread and that I am clear enough in in asking the question so that it is understandable and answerable.

    If in this example I’m a bank with $10 in capital and am allowed to be leveraged 10x so I lend $100 to customers to buy houses that post/pre bubble would sell for $50. Let’s assume $50 sellers has 100ltv. The loans go bad. Bank insolvent. Equity holders wiped out. Deposit insurance makes original home seller whole.
    We started with $10 dollars now there are $50 dollars with no debt to service.

    please explain to me how this is not inflationary to get rid of debt that cannot be serviced.

    If i’m leveraged 30x and I’m more than 3% wrong about the asset value and am liquidated while the money created by the credit extended by the bank remains, how would this not be inflationary once we return to pre bubble asset prices.

    $100 loan created to buy houses
    $50 mortgages retired
    $50 created (deposit insured)
    Loans default, bank is insolvent, homes are sold in forclosure for $50 costs, $10 costs to complete forclosure process, $50 goes to deposit insured sellers.
    Started with $10 capital, ended up with $40 after original capital wiped out by bank insolvency.

    So we started with $50 in private debt ended up with $50 in private debt but there was $40 dollars created that are now private debt free how is this not inflationary stating from the post bubble prices.

    If assets were priced appropriately and didn’t result in bank being ridiculously insolvent I understand how this would not be inflationary because it would be eaten by bank capital. However, If the bank creates $100 and its opposite the $100 debt and is leveraged 40x but it turns out that that the collateral was only worth $50 and therefore $50 of debt is destroyed but the created money still remains how is this not inflationary? Its no like I get to say sorry I need that extra $50 back because it turns out i don’t know how to underwrite a loan and am a moron. Its already out there. but there’s $50 less debt to service relative to the money in existence.

    1. spending more than one’s income is an inflationary bias, and lending facilitates that. So all that money getting spent was the inflationary bias, not the loss of private capital when the loans default.

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