Introduction to Deposit Deflation

Does money disappear entirely when we spend it, or does it merely change owners? Surprisingly, the answer depends on the form of the money, and what we spend it on.

Example: A customer determines that she has written and mailed a check in error, and places a Stop Payment Order with her bank, to cancel that check. The bank performs the SPO successfully, and the customer sees that the fee of $35 has been debited from her checking account. A costly transaction, but well worth it, by the customer’s choice.

But who got the $35 bank fee? Does that seem an obvious, trivial question? Is there any reason to believe that those funds were not conveyed to the bank?

They weren’t. A bank account represents money the bank owes you — the depositor — not money it’s holding for you. So when it charges a fee directly to your account, it doesn’t obtain that amount of money from you; rather it ceases to owe it to you. The bank has extinguished a portion of its own liability — its debt — but has no more money than it had before debiting your balance. It has no more physical cash, no more reserves, no more of any other party’s liabilities than it had before. The bank gains in the transaction by owing you $35 less, not by obtaining $35 from you. (It cannot be doing both simultaneously, or its balance sheet gain would be $70, not $35.)

By the bank’s owing you $35 less, certainly its equity goes up by that amount. Its assets, such as real estate, artwork, car notes and goodwill, are that much less encumbered by debt. But equity isn’t money and isn’t a true account; it’s a guesswork estimate of net valuation, assets minus liabilities. Moreover, equity was a wash in this transaction; the customer’s equity diminished with the reduction of her deposit, while the bank’s equity was augmented by the cancellation of a portion of its debt. But money well and truly vanished in the transaction — both from the customer’s point of view and from the community’s. The customer had less money, while the bank had no more.

Deposit Deflation concerns itself with the macro effects of this transaction and others like it.

The national money aggregate M2 has dropped by $35 merely by one customer’s decision to spend that amount on a stop payment rather than at the hardware store. No other money aggregate was augmented to balance it.

To be sure, the bank has expenses, and creates new checkable bank liabilities — new money — in the course of meeting them. Some may even be linked to the processing of the stop payment. But there is no contractual relationship between such creation and the money destruction that accompanies the customer’s payments of principal, interest and fees to the banks.

By engineering our money in this manner, we assure that individuals, governments and businesses will be immersed in ever-compounding bank debt. Someone will have to borrow anew to create the money to pay down the debt, money that will be extinguished in the periodic act of repayment, even as the debt continues to accrue.

And yet this is not an inherent characteristic of money. The US Government’s coins, for example, are accounted as the assets of their lawful owner of the moment, and as no party’s liability. We can spend them or lend them at interest without adding to or diminishing the quantity. When USG obtains its own issued coins at a toll booth or park office, it augments the assets in its account; it does not reduce its own liabilities as the bank did when it marked down its customer’s account for the stop payment fee. The accounting of coins is stock-flow consistent — unlike that of bank deposit currency. And the accounting works just as well for either transaction.

Money that disappears with debt repayment destabilizes economies. Thus the argument for “100% money” where bank credit money would merely apportion reserve balances. Or for public banking, or for an evolution to new forms of money issued by producers of commodity-style services, with tax policies and government backstopping policies to influence which forms will prevail, just as we have today.

But there are excellent arguments for bank credit money as well, with its remarkable safety, accountability and transactional ease. Deposit Deflation does not for now propose a radical overhaul of our money system. The site is intended primarily to enhance our mutual understanding of the system we have.

We’ll announce ourselves around, and open the site to evidence-founded comments, after we have a few more articles up.

EconCCX — February, 2020