As a general way of illustrating the effects of changes in supply or demand, or taxes thereon, on the price and quantity of goods and services, which have to be produced before they are consumed, the graphic representation is most useful. But as far as "money" is concerned, it is complete hokum, unless you accept that it is an abstraction of an abstraction.
Facts are:
1. Any economy is and always will be a barter economy.
2. "Money" is a useful unit of measurement, in the same way as tonness and kilograms are useful units of measurement for agriculture. You could say a farmer produces X tonnes of potatoes, or he produces £Y's worth of potatoes, and the shopper buys X kilograms or potatoes or £Y's worth of potatoes. But tonnes and kilograms are not things in themselves, they are merely units of measurement, and "money" is just a useful measure of relative value. You can't easily convert a new car to its potato equivalent, but you can easily say what a new car costs and what a pound of potatoes goes and divide one by the other.
3. To the extent that "money" actually exists, it is merely an expression of who owes whom how much "money" (i.e. future goods and services to the value of…). All banks do is a glorified bookkeeping exercise saying who owes whom how much and running the debt-collection service on behalf of the people owed money (i.e. who have produced more than they have consumed in any time period). This last bit is also a simplification - if a land goes up in value and a landowner sells, he has not, in practice, produced anything or deferred consumption, he has in fact produced nothing and brought forward his ability to consume, but there you go.
4. You can't have "savings" or a positive bank balance without somebody else having taken out a loan or mortgage first. It is actually the borrower who creates credit or prints money.
So it is more useful to look at the demand curve, which is a distinct curve and not a straight line:
But this is also hokum - if "money" were actually produced had a cost of production in itself, then there would be no such thing as debt/credit bubbles, it would choke itself off at a certain stage. For example, I'm sure most people would love to drive round in a brand new Bentley, but we don't, for obvious reasons. So the total number of Bentleys produced is a fairly low and stable figure.
We can actually ignore the supply curve entirely for the time being because it is derived from the demand curve and focus on the demand curve. Why is is curved and how can we plot this?
It is curved because there is no demand for "money" in itself, there is demand for what you can buy with it, i.e. consume.
The interest rate you are prepared to pay is higher, the more that the following apply:
- small amount of money/expenditure required,
- how urgently you need to consume that thing NOW as opposed to later,
- for how many years you will benefit from spending money today.
So
- pay-day loans have an interest rate of 50-plus% (if you can't pay the £100 gas bill, you get cut off for weeks; if you don't buy £50 of food this week, you will starve)
- credit cards have an interest rate of 25%. If you are in the shop and overcome with an urge to buy new clothes or an electronic gadget for a couple of hundred pounds NOW, you are happy to pay fifty quid interest over the next year.
- if you need a van or a car for work, costing thousands of pounds but which will last you a few years, you are happy to take out a personal loan or an HP loan at 15%, because the £1,000 a year it will cost you in interest is less than the extra income you can earn for the next few years.
- if you are renting an average house with a build cost of £80,000 and paying £10,000 a year rent, you are happy to take out an £80,000 mortgage at 8%, pay £6,400 a year in rent and gamble on the repair and maintenance costs being less than £3,400 a year.
- if interest rates are lower than this, or if rents are higher than this, the money borrowed will be spent on land (which includes land speculation and credit bubbles, see last chart).
We also now that from the lender's point of view, those loans for which he can charge a higher interest rate have higher collection costs and higher write-offs for irrecoverable amounts, and that these tend to reduce the overall profit/return down to about 5%, for example:
- pay-day loans. Interest rate 50% minus collection costs 15%, minus write-offs 30% = net profit 5%.
- credit card loans. Interest rate 25%, minus collection costs 10%, minus write-offs 10% = net profit 5%.
- personal/HP loans. Interest rate 15%, minus collection costs 5% minus write-offs 5% = net profit 5%.
- house purchase loans. Interest rate 10%, minus collection costs 3% minus write offs 2% = net profit 5%.
With land purchase/speculation and credit bubbles, these rules no longer hold and the real return to the lender is negative.
So what does the demand curve look like from the point of view of the lender, once we deduct collection costs and write-offs?
It's fairly flat, of course:
And that dashed red line becomes, to all intents and purposes the "supply" curve as well. A saver (or a somebody who supplies goods on credit, however indirectly) is indifferent whether the customer's debts are collected by a pay-day lender, a credit card company, a personal loan/HP company or a mortgage bank:
Employees of such a company might be blissfully aware that this is how their wages are paid, but that is exactly how it works. The car worker gets £x thousand paid into his bank account each month. The car salesman sells the car on HP, and the bank (the HP provider) credits the car manufacturer and assume liability for collecting the debt.
So the car worker/manufacturer produce a car and somebody buys the car. All the bank does is debit "HP loans" and credit "car manufacturer"; there is then another entry "debit car manufacturer" and "credit car worker" at the end of the month when the wages fall due.
This is a nice simple real-world model which we can hopefully understand. And it works, in real life, there is an overall benefit to mankind and the economy from running things like this. The existence of "money" and the banking system oil the wheels and enable specialisation, spreading monthly income against daily or irregular expenditure etc.
Where the model becomes a bit fragile and breaks down is once rents are high, interest rates are low, there is an expectation that land prices will rise faster than interest rates and when bankers are paid according to the value of loans they make/deposits they take (regardless of whether the bank itself will make a profit on the deal).
I'll return to that phenomenon next week, suffice to say, over half of all lending by volume relates purely to land purchase and speculation:
