Will paying for Russian Oil and Gas in roubles result in the fall of the dollar as global reserve currency?

 

Will paying for Russian Oil and Gas in roubles result in the fall of the dollar as global reserve currency?

Background on Russia's invasion of Ukraine

For various reasons related to geopolitics, last February, Russia invaded Ukraine.   To avoid potential escalation into World War 3, the United States and its western allies decided to pinch Russia where it hurts, while avoiding launching an outright war with Russia, a nuclear power – its economic lifeline.   They launched economic and financial sanctions with the stated aim of crippling Russian capacity for a protracted war, and to depower Putin and his billionaire supporters. 

The sanctions regime included sanctions on Russia’s largest banks, and freezing of their dollar assets held in western banks. This resulted in Russia being unable to access its vast hoard of dollar and Euro reserves, which it had accumulated through sales of its commodities to the West, and which it had counted on to prop up its economy, its currency, and fund its military campaign.  The goal was precisely that, to cut the source of funds to further its campaign in Ukraine.

Sanctions however stopped short of fully cutting off all trade and economic ties with Russia. Russia after all supplied much of Europe’s oil and gas requirements. Which gave Russia the loophole it needed to get around the sanctions on its banks. 

Russia could therefore continue to earn hard currency while it continues to sell its oil and commodities to Europe. However, as long as these continued to be transacted in dollars and euros, these will be coursed through Western controlled banks and clearing bodies, which are subject to US and European laws and policies, of which the escalating bank sanctions on Russian banks are part. By transacting the sales in roubles, buyers are forced to source roubles to pay for their oil and gas, and roubles can only be sourced in quantity at Russian banks.  By effectively transferring the venue of exchange from western controlled to Russian-controlled banks, Russia effectively limited the potency of the bank sanctions.  The West cannot now further escalate the sanctions to all Russian banks, as this would effectively cut Europe’s ability to source these needed commodities from Russia.  They can, but at great risk tom causing prolonged recession in their home economies, and potentially weakening their domestic political clout.

By transacting sales in roubles going forward, this will create new greater demand for roubles that was not there before. Whereas before, Russia was content to just accumulate dollars and euros, occasionally converting them to roubles as domestic transactions required it, while hoarding the rest as global reserve, now it’s the western nations who will need to accumulate roubles, so that they can continue buying Russian commodities.

This can be viewed as an increase in international value of the rouble, and decline in the use of the dollar and euro.

Background on dollar’s rise as global reserve currency

The dollars rise to global reserve status is widely accepted to start from the end of World War 2, when due to the widespread destruction of European economies and industry during the war, only  US manufacturing prowess remained intact, and the US had the financial capability to supply much of Europe’s and the world’s, needs.  This resulted in countries’ increased demand for the currency, demand which continued to rise even as Europe started to become resilient again. 

Much of the world’s trade was done in dollars, or were quoted in dollars, because for a long time, the US was the only country with a stable enough financial system, that it became a self-reinforcing condition to conduct international trade in dollars. As more trade was done in dollars, this created more demand for dollars, which resulted in the dollar being preferred for more trades.

Because the dollar was the default currency for most global trade, it then logically also became the default reserve currency preference of most nations.  In lieu of accumulating gold, as the global consensus for acquiring wealth, acquiring dollars became the norm for many countries that started to accumulate surpluses from trade.

 

2008 onwards

The most serious threat to the global acceptance of the US dollar as default reserve currency was during the 2008 crisis, as widely covered at the time on this blog.  When large financial institutions in the US started blowing up, the US had to respond by propping up measures such as quantitative easing and the fall of interest rate to the zero bound.   This resulted in a lot of people speculating that the US will print the dollar til it loses all value.  I argued, against such, assertions on this blog, and so far, until now, 14 years later, the dollar has not yet to lose value like Zimbabwe’s currency, despite rolling out the largest stimulus ever in history in 2020. 

Since 2008 however, this widespread speculation contributed to many trends, including the rise of Bitcoin and cryptocurrencies; the hunt for alternative currencies that can diversify central banks’ reserve baskets; and greater speculation in ‘scarce’ assets that will increase in value when valued in the dollar losing value.

Many speculated that the Chinese yuan could take the place of the dollar as the default standard, given China’s meteoric rise in global trade.   But since China continues to control the supply of yuan, and maintains its peg to the dollar, the yuan has not been the threat to the dollar as some have thought.

 

Where China and Russia still fall short

This is I believe is the quagmire Russia will find itself in.  Will they allow the rouble to be freely available anywhere in the world, and allow it to feely float, as the US does the dollar?  What happens when a rising rouble makes their exports more expensive, or a falling rouble makes imports too costly for local consumers? Will they allow market forces to dictate, or will they intervene heavily, as China does?  

A further competitive advantage the US has, that allows them to freely float the dollar globally, is that the US had a large domestic market, which decreases their reliance on exports, lower than other countries’ level of reliance to theirs.   The US has also always been an innovative economy, that always had a lot of things to sell, and by the time a rising dollar was making the exports of yesteryear highly expensive, they were already on to their next exporting star, and gladly outsourced production of expensive goods elsewhere.

So what’s next?

Businesses will continue to adapt.  This recent spate of sanctions is a test case whether the dollar will fall as default reserve currency. However, since there has been no difference in the economic preferences and bargaining positions of countries with regard to global trade and investment since a decade ago, my bet is on the US dollar to continue its reign for the foreseeable time.

Short intro from the author

Let's take a short detour to introduce this site.

“Conventional approaches, unconventional conclusions” on the global finance and economic issues of the day.  That’s the theme of this blog with the seemingly smug and sarcastic title of Rogue Economist Rants, wherein I blogged from May 2008 up to May 2012.  Hello, dear reader, and welcome to my blog. I blog pseudonymously as Rogue Econ or Rogue Economist.

I chose economics as my specific area of conversation because of its relevance to current world problems. (More background here). And ever since I read Joseph Stiglitz’ Globalization and its Discontents, I have come to realize that what we sometimes know to be correct prescriptions to economic problems could actually be, if you think about it, making problems worse. His book convinced me that we really don’t know enough about economics for anyone to be a fool-proof prescriptive policy adviser. Each case is different, and requires a specific inquiry into its own circumstances.

And that is why I strove to see the unconventional in the conventional. I also strove to determine whether, even when using conventional approaches, if this can lead to unconventional conclusions.  And in economics, focusing on different sets of data, or analyzing events from different starting points, even when using the same approach, does lead to different conclusions.  Hopefully, my body of posts demonstrates this over-riding intent sufficiently to readers.  

The key take away of the posts I made in 2011-2012 can be summarized around the following basic tenets, as laid out in my sidebar since 2011:

3 QUESTIONS TEST OF WHETHER IT IS WORTH THE PUBLIC SPENDING

1. Does this create productive jobs for those who would be otherwise unemployed?
2. Will the newly hired workers have meaningful income that they can spend back in the economy?
3. Is the output of the jobs adding to capacity of goods/services demanded?

If it generates income for the unemployed, aggregate demand will go up. If it adds to demanded capacity, there will be no inflation. If the output is demanded by people, there will be no wastage.

I consider myself an economic realist. My views lean towards free market, but I appreciate Keynesian prescriptions to jumpstart stalled demand. I am sympathetic with Post-Keynesians, but draw the line on  calls for permanent government intervention.

I also have another minor blog in Tumblr, which I treated as a baby blog platform, and which I considered a good one-stop location for comments I made on other people's blogs and websites outside of this main blog.  Very often, these comments were the germ of ideas that eventually formed into full blog posts over here. Also, it is worthwhile to mention, some full-blown posts were also developed from comment discussions that happened at Seeking Alpha, which syndicated some of my blog posts from here, as chosen by that site’s curators. 

I stopped blogging for the next ten years after 2012, because I did not want to just end up repeating myself on topics I've already covered. However, let's see if every now and then, a topic or raging issue of the day compels me to come back and cover it with a new blog post here. Meantime, I'm occassionally on twitter. 

Once again, this is Rogue Economist, wishing that you, the reader, will get some food for thought from reading this blog.

Why NGDP targeting?

These days I keep reading about NGDP targeting, as it keeps being mentioned more and more everywhere. It seems to be another zombie idea taking on more life of its own. It's basically the idea that the current crisis will permanently be solved by the Fed credibly communicating to the people that it will start targeting 4-5% annual growth in nominal GDP level, from here on.

Wow. Imagine, business planners and executives will have no more compunctions about claiming to their investors that they will attain at least 5% nominal revenue growth year in year out.  If they don't achieve it via additional sales volume, the Fed is going to make sure they achieve their targets via inflation. Recessions will be a thing of the past.  Woohoo! There will be NGDP growth year after year, courtesy of the Fed,  regardless of overall business sentiment. Nobody will ever lose again on a business investment, provided everyone invests their money in the most entrenched TBTF companies.

And business investors themselves will have no more worries about their subpar investing prowess. 5% NGDP growth means at least a positive return on their investments, no matter if they put their money in companies run by incompetent managers. If the Fed will work to ensure 5% NGDP growth every year, it wouldn't really mater if the return comes via aggregate demand growth. It can very easily be achieved by asset price appreciation. So fire away, investors. If you don't get the price appreciation via normal market forces, the Fed will come in and goose it up for you.

Now, how again is the Fed supposed to attain this yearly NGDP growth? Via monetary policy? Quantitative easing, Operation twist, swapping Treasuries for reserves? Hasn't this been largely ineffective in reviving demand for the last 2 years? Exactly how is confiscating government treasury assets from the private sector going to make them want to spend more money? And in keeping rates low, or causing more inflation, how is the Fed supposed to convince savers to stop saving, rather than doubling up on saving to make up for the lost yield?

The thing is, monetary policy has overstayed its usefulness as a countercyclical policy. You can only use it so many times to revive an economy from recession. If you don't tighten it back to previous levels, you eventually get to the zero bound, which is where we are.  The Fed can't increase rates, but neither can it decrease them below zero.  So monetarists have been convincing the fed to buy up other types of financial assets, to lower rates on any and all instruments that are NOT YET at the zero bound.  Eventually, where does this take us? They're already proposing the Fed buy up stocks, commodities, and other financial assets.

See, despite all these market distorting moves the Fed has already done, economists are still arguing Bernanke is not doing enough.  They continue to encourage him to communicate to the market - that he will do whatever he can to induce inflation until  the people do it themselves. The thing is, Chuck Norris may continue promising the people he will beat them up unless they do as he wants, but if Chuck has no arms and legs, people are just going to wonder how he's going to make good on his promise.

And if asset substitution, or buying up financial assets, or further monetary loosening still doesn't work in increasing NGDP? Perhaps the fed can just target inflation directly by regular currency depreciation. The US will then be just another currency manipulator.  Will that really get people to start spending their money in the domestic economy, or will it encourage those who can to flee the currency? 

It's the height of futility to insist that the Fed be run on autopilot, based on an automatic rule - "Do we have 5% NGDP level growth already? No, buy more assets, yes, stop, higher than 5% already, sell." The thing is, if we insist policymakers to stop thinking and analyzing the economy, and just follow these policy rules automatically, what we'll have is not a clean, well-functioning economy. We'll have instead the economic equivalent or a runaway car whose speed only varies with the slope of the road it's on. It will still go faster and slower, but it won't care who or what is in its path.  

PS. That time again. No more posts for me till maybe later this year. Don't worry, the zombies will still be there.

Why Nations Fail, a review

"Why Nations Fail" is different from a lot of development books. It neither focuses on specific policy proposals, and neither does it focus on specific micro or macroeconomic theories that lead lead a nation towards economic development.  Quite simply, this book wants to tell you why the same specific sets of policies will work in one nation, and lead nowhere in another. It wants to tell you how you know which nations can run with a specific set of development actions, and end up achieving their objectives.

This book is also different from your regular pseudo-cultural economics books which explain away economic development in successful countries to their specific cultural, anthropological, sociological, or religious makeup. Neither does it barrage you with pseudo-explanations that attribute success to geographical location as the differentiating factor. And neither does it shirk by merely pointing out that successful countries just had the luck of having a really brilliant leader who knew what to do. Yes, these can be big factors that certainly help, but the book in fact explains how each of these common success theories fall short. After all, how many times have we seen countries located strategically next to emerging economies, and led by seemingly smart and charismatic leaders, that still fall short of economic progress, while their neighbours, with seemingly less resources, more run of the mill leaders that come and go, leap into the industrialized world?

No, this is a book that focus on institutions.  It distinguishes between institutions that can be considered extractive from those that are more inclusive.  It then explains how inclusive institutions create the right incentives for local people to invest, to strive, and to take initiative, and how extractive ones discourage them.  If you've been with me on this blog for some time, you know I have a great deal of respect for institutional explanations, and how these institutions create very concrete transmission channels and mechanisms for economic policy. You can have the right policy, but it you do not have the right institutions for it, then no amount of effort will result in successful implementation. To have the right institutions, you need to know how it aligns its objectives with people's incentives and helps them overcome their constraints.

At the macroeconomic level, before you even think of specific goals and policies, you need to ask whether people can see themselves getting more prosperous if they work harder, invest their savings, and take risks with new ways of doing things.  Do they see that rewards go to those who make the effort and investment, or do they risk losing the fruits of their labour to an extractive regime that expropriates and gives everything to someone else more closely connected to the ruling elite? Do they know for a fact that they will have a voice going forward, to ensure that their economic interests are protected and represented, or will they lose out to an elite that's suddenly given a monopoly on their industry?

In my mind these are the questions that must run in the minds of the multitude of people who ultimately make the difference between a nation taking off and a nation not making it.  Steve Waldman posts that depression is a revealed preference, as a polity, and we are choosing continued depression because we prefer it to the alternatives. In the same vein, nations can choose slavery, apartheid, or pluralism, rule by absolute royal decree or rule of law, upward mobility for newcomers or stable representation for incumbents, openness to creative destruction or loyalty to existing regimes. these revealed preferences often also reveal whose interests are most given importance in society. Whether these interests are those of one person, a few elites, or the greater multitude makes all the difference for a nation's rise, and it continued stay up there.

The book provides enough stories and anecdotes from history to make this  view of development vivid.  Soviet Russia, ancient Rome, Maya city states, sub-saharan Africa, medieval China and Japan, medieval England, Spain and Europe, even the neolithic age, as are a bunch of other historical places and times make it to this thick book as examples. it's like reading history all over again, but with the end of analyzing why one people or nation makes it, while others don't, and still others fall. Highly recommended for both history and economics buffs.

Written by Daron Acemoglu, MIT professor of Economics; and James Robinson, Harvard professor of Government.

Natural rate brain twisters

Mike Sankowski has a good primer over at MMR on the fallacies about the 'natural rate'. His main points:

1. The NRoI doesn’t exist
2. If the NRoI does exist, it’s not stable
3. Then, even if it does exist and is stable, it’s power is so weak it’s not useful to consider it in policy.
4. Then, even if it does have a powerful impact on our economy, we have such a problem measuring it and observing it and knowing it in real time, we shouldn’t consider using it as any sort of guide for policy.
5. Then, even if we can observe and measure it and consider using it as a policy guide, the NRoI is focusing on the wrong goal and should not be used as a policy guide

I'll just add that it boggles me how economists purport to be able to calculate the ‘natural rate’ or the ‘equilibrium rate of interest’ in the ‘absence of the capital markets’. Since everything is linked to the capital market, how are they able to compute for the natural rate without it, and how do they at all know it is the ‘equilibrium’? Furthermore, what is the conceptual significance of a rate of interest in the absence of a capital market? 

The natural rate means something different for everyone, even for economists, so there can never be one objective measure for it. Personally, I have my own personal ‘natural rate of interest’, but that is personal to me. I’m sure the ‘natural’ rate would be different for you, and different for the next person. Furthermore, the ‘natural’ rate would be different for me tomorrow, and different again next week. It depends on a lot of personal factors that affect how I value whether or not to take out that next loan or make the next investment. Kind of like the risk premium, it’s going to be a different value for everyone, and its value would change as their personal circumstances change. 

There’s no economy-wide risk premium, and there’s no economy-wide natural rate.  Averaging out everyone’s natural rates to get at one overall natural rate to target still ends up with people with higher than average personal natural rates who still end up misallocating funds (and ending up affecting everybody else’s natural rate). I tend to equate the natural rate with risk premium. Having said that, even economists who argue about the merits of calculating a natural rate will calculate the risk premium as exogenous to the interest rate set by the central bank. So how can something calculated exogenously to the natural rate also be endogenous to it?

Are you still with me? Maybe not. That's how convoluted it gets when you start thinking of an economy's so-called natural rate. Mike is right - to calculate it is to focus on the wrong goal and it should not be used as a policy guide.

Some limits to bank printing 'out of thin air'

In this post I want to highlight an interesting discussion I had over at MNE with other commenters about banks and their ability to print money for their acquisitions. An anonymous commented said:

Bank credit money is also created when banks make asset purchases or payments on their own account, not only when they make loans." to which Matt Franko added "imo they must be able to buy the property and construction of their branches by crediting bank accounts of the landowners and contractors.

I was at first resistant to Matt's assertion that banks can print every time they want to make an acquisition. But thinking it through, that's almost about right, but I wanted to add a clarification, based on my own understanding, that not all payments banks make, though they’re paid as credits to accounts, are new money. That credit will result in a debit, and sometimes the debit is to their equity.  For example, if they buy their office supplies, pay their workers, or settle their utility bills, it does not add new money to the economy. If the bank uses its earnings (part of its equity) which is money received from elsewhere, it is not money created at the point of credit. Anonymous commenter says: 

Whenever they spend or lend they do so with their own privately created credit. They only use reserves to settle with each other or with the central bank and treasury (or when they borrow/lend reserves from/to each other,)or cash when people withdraw it. Everything else is done with the 'inside money' they create themselves. ..

When a bank purchases something or pays someone they credit an account, as they do when they make a loan. The credit is typed into existence through a computer keyboard. This adds to the bank's overall liabilities. Banks have to maintain a *ratio* of capital and or reserves. That ratio has to "come from somewhere" in the case of said purchases/payments, but it's only a fraction of the overall credit/deposit money credited by the bank. If the created deposit is then transferred to another bank then of course settlement takes place with reserves, as always.

Not much I really disagree with. I just would add that loans and branch locations are two different animals. When a bank buys a branch property, it has to be funded by a corresponding liability - its own equity, a loan from somewhere else, or via deposits. But when a bank buys a loan, it expects a positive income from the spread between the loan and the cost of the liability that results from it. Then when a bank buys property for a branch, or a computer printer, there's usually no income assumption, as they’re an expense outlay for the bank.  While it is true that purchases or payments are created as an accounting entry by the bank, if they result in net equity outflow, that outflow cannot be compensated by the bank by printing reserves into existence. One has to distinguish whether that payment is for an expense or for funding a loan. Anything that is considered an expense outlay is not new money created by the bank. And any net cost that results from that purchase is not funded with new money, as is the case with equity capital that has to be raised to maintain the ratio. That’s why, as Tom Hickey said, "the bulk of horizontal money creation comes from credit extension, not asset purchases or payments on their own account". Tom also mentions in the discussion. 

When a bank creates bank money to purchase assets other than loans or fund expenses, it is in effect borrowing at the price of reserves, since it is creating deposits that have to clear (after netting). Even if a bak uses its own excess reserves, that's interest it is losing on lending in the interbank market. Banks can create money but not "for nothing." But it is true that banks borrow at a much lower rate than non-banks in the sense that they don't have the spread to deal with.

This is also why, I believe, a bank that has no earnings or no equity cannot continue spending just because it can create money out of thin air by crediting an account. If the spending is going to be funded by liabilities, then the bank incurs greater liquidity and insolvency risk.  As Dan Kervick also adds: 

But the money they create to buy stuff for themselves is just as much a liability as money they create in the process of making a loan. They create an account for the seller of the goods and credit that account. If the seller of the goods then writes a check on that account to someone whose account is at another bank, the first bank will have to make a payment to that other bank that is settled and cleared through the banks' reserve accounts at the central bank. And if the seller comes into the bank and decides to withdraw the total amount in the account, the bank will have to hand him a bunch of vault cash. Clonal also adds: 

I believe the fact that revenue is recognized immediately on making the loan is where all the problems are coming from. More money than the amount of the loan is created at the time of the inception of the loan. The excess money is then capitalized after accounting for things like provisions for loan losses etc.

To which I acknowledge, I could be referring to an outmoded banking model. As far as I know, if a bank keeps the loan in its books, revenue is recognized as and when it receives interest income, not when the loan is made. Of course, if a bank securitizes everything or most of the loans it makes, revenue will be recognized when the loan is sold, even if it's at the point the loan is made.

P.S. I add in comment discussion that Basel rules further limit this printing.

Bartering in the Greek Euro odyssey

I want to highlight in this post the flourishing barter system in Greece. It is one that grew out of necessity, due to the lack of circulating income within the country, which is then the result of three years of austerity measures. What do people do when insufficient money is going around, and each has less income to buy his needs, yet still has his demands, as does his neighbour? Last year the New York Times reported on the Greek Volos network:

Part alternative currency, part barter system, part open-air market, the Volos network has grown exponentially in the past year, from 50 to 400 members. It is one of several such groups cropping up around the country, as Greeks squeezed by large wage cuts, tax increases and growing fears about whether they will continue to use the euro have looked for creative ways to cope with a radically changing economic landscape.
“Ever since the crisis there’s been a boom in such networks all over Greece,” said  George Stathakis, a professor of political economy and vice chancellor of the University of Crete. In spite of the large public sector in Greece, which employs one in five workers, the country’s social services often are not up to the task of helping people in need, he added. “There are so many huge gaps that have to be filled by new kinds of networks,” he said. Here in Volos, the group’s founders are adamant that they work in parallel to the regular economy, inspired more by a need for solidarity in rough times than a political push for Greece to leave the euro zone and return to the drachma.

Back in 2008, I mused whether there could be a private sector solution to the aggregate demand problem. Back then, austerity was already being trumpeted by many policymakers and opinion makers as the necessary solution to the economic crisis, while rejecting Keynesian solutions as wasteful and 'crowds out' private sector investment. (Pundits who believed that people stopped spending because of too much government waste rather than because people with the money started hoarding them out of fear, or because of escalated debt calls and investment writedowns). 

Back in 2008, in the similar situation of less transactions, and less income going around, bartering also seemed to me the circuit breaker to this vicious cycle of fear and recession.  "Could the private sector solution involve local companies engaging in quasi-barter trade with each other? Or paying via in-kind currencies? For example, we can have businesses paying employees via credits that can be used by consumers to buy/pay for services of other local producers. So in essence, in an economic downturn where actual cash flow is scarce, demand is created by empowering cash-starved businesses to pay employees and suppliers in some 'credit principle' that other businesses will then consider acceptable form of payment. I don’t really know how this type of arrangement can be made to work, but if it can, it will work only if enough businesses participate. The world is now more globalized than ever before, and this solution would again only be possible if an economy has enough industry diversity to be self-sustaining on its own, otherwise the arrangement will need to be global in scope."

What's happening in Greece shows us that despite the constraints caused by policymakers that are both literally and figuratively distanced from the problems and challenges of regular people, life still has to go on.  I would still expect that this situation (in Greece and in all of the Eurozone) be finally resolved properly, as bartering remains a short-term solution. It gets bogged down by the constant requirement of a double coincidence of wants, and results in far less efficiency and productivity than when commerce is done with a state-backed currency.  Still, for what it's worth, for now this development is a triumph of the human spirit over outsize constraints, of necessity over adversity.

A phenomenon that loanable funds theory can't explain

Mainstream economists believe that since for every buyer there is a seller, they take this logic to the notion of bank lending, and assume that for every borrower, there is a lender, with banks just bringing them together. And they further assume that when a borrower needs to increase his consumption, a lender needs to curtail his, to provide the necessary funds.

Paul Krugman recently asks:  "If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend; but Keen seems to be saying something else, and I’m not sure what. I think it has something to do with the notion that creating money = creating demand, but again that isn’t right in any model I understand."

This image of lending is outdated, and does not explain why banks trip over themselves to provide lines of credit to creditworthy customers. Just imagine, you have all those banks that have issued you credit cards, with varying line amounts, whether you actually asked for the card or not. Why did they do it? Because they have tons of unlent funds that they have to lend out? What good is it to them if you don't use your card, if they've already issued you one? They've given you an open commitment to provide you up to your line limit, but it's your option whether to you use it, not use it, partially use it, or use it then pay it down quickly.  

If you don't use it, the bank doesn't earn interest from you. If they did secure loanable funds prior to you drawing your line, then what happens to the poor schmuck who provided that loanable fund? No interest income for him. Is there really a schmuck standing ready to not consume by the exact amount that you draw your line with, month after month, and stands ready to forego his interest income once you pay it back?  Did the bank promise him something in order to secure his funds? If the loanable funds theory of banking is correct, then credit cards have got to be the most uneconomical bank product ever invented.  Any banker worth his salt will push to sell you an actual loan rather than a miserable line of credit.  As far as the logic of loanable funds theory is concerned,  it's a losing proposition for any bank. So why do banks provide this product, often to people who don't even want it? Does the loanable funds theory have an explanation for this?

Krugman tries to explain why banks do it: "As I (and I think many other economists) see it, banks are a clever but somewhat dangerous form of financial intermediary, one that exploits the law of large numbers to offer a better tradeoff between liquidity and returns, but does so at the cost of taking on very high leverage, with all the risks that entails.The super-high leverage of banks, and the role of bank deposits as a key form of liquid assets, means that banks broadly defined are usually central players in financial crises. But that’s a quantitative thing, not a qualitative thing."

Banks risking insolvency for an uncertain income stream? Does the loanable funds theory have an explanation for this?