Real Savings Are At The Heart Of Lending

After climbing to 12.2 percent in April last year, the yearly growth rate of combined commercial bank real estate and consumer and business loans plunged to –2.6 percent in early March.

loans

For most commentators, an important factor in setting economic prosperity in motion is bank lending. Hence, this sharp decline in the yearly growth rate in bank loans raises the likelihood that US economic activity is under strong downward pressure. Consequently, most commentators are of the view that central authorities must provide the necessary support to strengthen bank-lending growth. However, is it true that bank lending is an important factor in economic prosperity?

For instance, farmer Joe, who produced two kilograms of potatoes. For his own consumption, he requires one kilogram, and the rest he decides to lend for one year to farmer Bob. The unconsumed one kg of potatoes that he agrees to lend is his real savings. This example is necessary in order to illustrate that for lending to take place there must be real savings first. Lending must be fully backed by real savings.

By lending one kilogram of potatoes to Bob, Joe agrees to give up ownership over these potatoes for one year. In return, Bob provides Joe with a written promise that after one year he will repay 1.1 kilograms of potatoes. The 0.1 kilogram constitutes interest.

What we have here is an exchange of one kilogram of present potatoes for 1.1 kilograms of potatoes in a year's time. Both Joe and Bob have entered this transaction voluntarily because they both have reached the conclusion that it would serve their objectives.

The introduction of money does not alter the essence of what lending is all about. Instead of lending one kilogram of potatoes, Joe will first exchange his kilogram of potatoes for money, let us say for $10.

Joe may now decide to lend his money to another farmer, John, for one year at the going interest rate of 10 percent. Observe that the introduction of money did not change the fact that real savings precede the act of lending.

Furthermore, it is not the act of lending as such that strengthens economic growth but real savings that support the borrower while he is busy upgrading his infrastructure. With the help of an enhanced infrastructure, the borrower of real savings can boost the production of his product.

Also, note that when a saver lends money, what he in fact lends to a borrower are final consumer goods that he did not consume.

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