Macro Economics – Encourage People To Save Part I

(Note: I actually started writing this post back in early December. I notice now that several talking heads on major news and “research” agencies are starting to think that banks keeping large amounts of savers’ money on hand, rather than shoveling it out the door in bad loans, might actually be a good idea. Be warned – this is a long post. Really long.)

Please consider the following information that I have gathered over the last ten years:

  • Basic economics: Money in exchange for goods or services.
  • The Federal Reserve, in cooperation with banks and other financial institutions, has been punishing savers for years. Just look at your savings account APY.
  • As a nation, our population is now referred to as “consumers”, even in casual conversation. Consumers don’t produce. They consume – resources, money, air, space.
  • The basic pile of rocks bank savings account doesn’t even keep up with inflation. In effect, savers lose money continually. Online banks, CDs, and the “very safe” vehicles often offer only a little better than inflation.

This is bad because those savers are the fundamental source of banking and investment assets. Yet those assets, those ultra-safe and reliable sources of money to loan out or invest, are constantly de-valued.

So banks (and other institutions) are fundamentally slitting their own throats.

Here’s why:

If you’re a bank with $1000 of savers’ money in your accounts, then you have $1000 that you can loan out. To encourage those savers to keep their money in your bank (so you can loan it out), you offer them %1 per year. That means that you add $10 to those savers’ accounts the first year, and compound it in the following years — effectively increasing the bank’s assets by the same amount each year.

Where does that $10 come from? Let’s keep this example very simple.

The bank lends a portion of that $1000 to other people or businesses, after checking to make sure the recipient is capable and willing to repay the loan plus interest. The bank conservatively sets a limit of lending out no more than %30 of its assets ($300 in this case) and charges %8 interest, for a gross profit of $24.

If the bank is destroyed, the FDIC will reimburse the savers. Nice and safe.

If the loan doesn’t get repaid, the bank covers itself by a) requiring some up-front payment, say %10 of the loan; b) seizing the property/business goods for itself and auctioning them off; or c) pursuing other legal means to recover the money plus expenses.

Still pretty safe so far.

So what we have is this:

Assets                                       Debits
Year 1    $1000 savers’ deposit        -$270 loan
$30 up-front for loans        -$10 savers’ payment
$20 loan interest                  -$10 business expenses
=========================================
$1084.02                                -$290

Assets                                           Debits
Year 2    $1084.02 savers’ deposit    -$240 loan
$30 loan repayment             -$10 savers’ payment
$19.20 loan interest              -$10 business expenses

==========================================

$1133.22                                    -$260

etc…

Until Year 10

With me so far? Everybody is making a tidy profit, right? Now, let’s add in the effects of inflation. We’ll assume %3 inflation per year, as a penalty, because everyone’s purchasing power has gone down (your money buys less food).

Now everybody’s hurting some, right?

Wrong.

And you’ll find out why in Part II.

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