I recently came across this comment by Steve Keen.
“This is a point on which I happily differ from most modern Post-Keynesian economists and instead concur with Keynes: credit money circulates, it is not destroyed by loan repayment. The argument that repayment destroys money made no logical sense to me when I first heard it, and was treated as absurd when I discussed it with bank accountants as well. I’ll elaborate more fully on this in future lectures.”
So is this correct?
Say, I borrow £10k to buy a car. The commercial bank creates £10k of new money simply by editing my account upwards. In other words, bank IOUs are issued. The vendor has an account at the same bank. The IOUs are transferred from my account to his, so he now has £10k of new money in his account. Later, I walk into the bank with £10k of real government BoE printed notes . I hand that over to the bank. My loan is repaid. The bank puts the government money into its reserves. The vendor still has £10k of bank created money in his account.
So the bank created credit money hasn’t been destroyed. Is this what Steve means?
Say the vendor then wants to use the £10k to pay his tax bill or pay an overseas bill for £10k. The taxman or the overseas bank won’t want bank IOUs. They’ll want real government money. So the bank will use the £10k that it now has in reserves to settle either of those payments and the IOUs created, the credit money, will then be destroyed. Alternatively he could just settle another payment with yet another customer at the same bank. In this case the newly created £10k continues to circulate.
It is important to distinguish between the IOU of the borrower held by the bank when the loan is issued, which is indeed destroyed on repayment of the loan and the credit money issued by the bank, which is not destroyed.
So Steve raises an interesting point and has to be correct. (IMO !)