Back then, most of what the financial sector did was simple credit intermediation and risk management: banks took deposits from households and corporations and loaned those funds to homebuyers and business.
While this is the accepted perception of how banks function, it hasn’t been true since we left the gold standard domestically in ’34 to fund FDR’s New Deal and the later war mobilization. Loans made by member banks of the Federal Reserve system are now balanced by new money creation to facilitate interbank transfers and the loaning bank does little more than make value judgments of borrowers’ ability to repay. Only loans that go into default would require the bank to dip into deposit reserves as the borrower’s contract serves as an asset to offset the liability of new money created by the Fed.
This also gives the Fed complete control over interest rates as it is always the gorilla in the room providing capitalization of bank lending via its shared balance sheet with Treasury. However, the retirement of bank loans still requires US dollars created by Congress via deficit spending into the economy. (Neither taxation or borrowing are, or have ever been, “funding” mechanisms for our government and all spending is new money creation.) As Congress became reluctant to spend on the public purpose after Reagan convinced voters it was “their” money being spent, the retirement of private debt has been largely relegated to increased demand to “roll it over” with GDP growth.
This growth funded economy works well until it doesn’t, as we saw demonstrated in the late ’90s- 2008 when Clinton’s budget surpluses and an extreme trade deficit strained it beyond its limits. As we continue to drain the economy to service a mostly meaningless budget number and cut automatic stabilizers to the bone our economy becomes more dependent upon growth and more fragile. As always, the wealthy will save, hell or high water, leaving the middle class and poor to suffer the ravages of market capitalism on steroids with no funding they aren’t committed to repaying, even from their own wages.
