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Old 23rd July 2017, 09:12 AM   #1
Saggy
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The insanity of our banking system .....

I finally (I made a months long effort a couple of years ago and failed miserably) figured it out. I'm reading a book, Tradgedy and Hope 101, a synopsis of Quigley's book, and the author does a good job of explaining what money is up to a point. So, he lists historically the types of money ...
Barter
Commodity money
Receipt money
Fractional money
Fiat money
Debt money

All is clear thru fiat money, but the jump to debt money remained a mystery to me. And, I've made a concerted effort in the past to understand the objections to debt money, but ... never could get it. Now I see that in most explanations there are missing steps, and now I see what they are and understand the problem, and I'll explain it here ...

Debt money - here we will bypass the book's write up and do our own - with fiat money the govt. prints the money and then uses it to buy goods and services, so it finances itself and creates money and puts it into the economy at the same time. The money derives its value by govt. fiat.

Now we ask ourselves how does 'debt money' get created ...

Debt money type 1 - simple:
What if the govt. printed money and then, instead of using it to buy goods, loaned it to the economy, i.e. persons, businesses. The govt. could charge interest, if it wanted, money would be in the economy, and the govt. would be holding a collection of I.O.U.s.

Debt money type 2 - twisted:
It doesn't at first blush make sense for the govt. to instead of loaning money into the economy, to create money by borrowing money from the economy. Yet that is the basis for our current system. Here is how it works.... the govt. wants money so it issues a govt. bond to borrow from the economy. Drawback #1 - the govt. has to pay interest on the money. The govt. sells the bond to a bank. The bank takes money from its vault and pays the govt. So far, money has been taken out of the economy. But, the bank counts the bond as an asset, and using fractional banking, can loan money into the economy equal to say ten times the bond face value. Thus, the bank loans money equal to ten times the bond value into the economy, creating new money, and profits handsomely for its efforts. What an unbelievable racket !

Edit - even here there is a missing subtlety, when the bank buys the bond its vault money goes down by the face value of the bond, while its bond holdings go up. So, its net assets remain unchanged. However, there is a distinction in the types of assets banks hold, with the bond representing a type 1 asset that the bank can use as the basis for fractional lending, where as the vault cash is a type 2 asset that doesn't serve as a basis for fractional lending. !!!
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Old 23rd July 2017, 09:19 AM   #2
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If you want to understand money, you are better off reading

Debt: The First 5,000 Years, by David Graeber
https://www.goodreads.com/book/show/...om_search=true

hint: all money is Debt money. It can't be any other way.
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Old 23rd July 2017, 09:29 AM   #3
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Originally Posted by The Great Zaganza View Post
If you want to understand money, you are better off reading

Debt: The First 5,000 Years, by David Graeber
https://www.goodreads.com/book/show/...om_search=true

hint: all money is Debt money. It can't be any other way.
I'm more interested in a discussion of my analysis, criticism, hosannas, whatever, as opposed to a reading list.
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Old 23rd July 2017, 10:36 AM   #4
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Originally Posted by Saggy View Post
I'm more interested in a discussion of my analysis, criticism, hosannas, whatever, as opposed to a reading list.
Barter economy is a fiction: there has never been a case in all of Anthropology were a culture that practices barter for daily things has been documented.
It's a very old story, but has no basis in reality.

All forms of money are, by definition, replacements for future things to buy, and therefore a debt.
It is only a question where the debt is coming from.

The brilliance of finance is that the debt is coming from the future, which allows people to borrow (in theory) infinite amounts

Of course, the most important rule of debt is that it can be forgiven: historically, this happened more or less automatically every seven years.
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Old 23rd July 2017, 05:30 PM   #5
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Originally Posted by Saggy View Post
I finally (I made a months long effort a couple of years ago and failed miserably) figured it out.
No you didn't.

There are only two types of money: commodity money and debt money. (Barter is just a fictional hypothesis written by Adam Smith and considered to be gospel ever since). Substances like gold or grain are valued in their own right and were usually accepted in exchange for other goods or services thus not creating a debt.

Everything else is a debt - a record that somebody owes somebody else a debt. If the debt is transferable and recorded on a portable instrument then it becomes "money".

Fiat currency? Simply IOUs written by the government. The "fiat" aspect comes from the government decreeing that these IOUs must be accepted by a creditor to settle a debt. Since the government accepts them for taxes, this is how the government honours its debt.

Incidentally, the most likely origin of the use of money as a unit of accounting seems to come from the chiefs and high priests of the early societies. They decreed that the villagers owed them some of their produce (or owed it to the gods but we will look after it for them wink wink). Since different people produced different things, a set of exchange rates needed to be set up so that each person paid the right amount. The repositories set up for the collection of these taxes also became places where people could exchange their surplus produce for other produce.
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Old 23rd July 2017, 06:15 PM   #6
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Originally Posted by psionl0 View Post
No you didn't.
Good grief. I'm an engineer, not a philosopher, so I'm interested in the mechanisms, not the deep meanings. So, there may never have been a barter economy. No problem. Gold coins are, by definition, coins made of gold. Gold coins are not debt money, at least according to the book, and according to my thinking. And, whether or not gold coins are 'debt money' is an academic argument for the professors that doesn't particularly concern me.

I'm perfectly happy with the books accounting of all types of money up to debt money, i.e., the current system.

What does concern me is trying to understand money creation in our current system, and that said, the version in the OP needs to be amended ....

Now, with references, and trying to get it right....

The balance sheet of the Fed is principally ..

http://web.mit.edu/14.02/www/krugman/0923LEC.pdf

"Assets - Bonds
Liabilities - high powered money, i.e. reserve deposits of the member banks."

Money creation ...

http://thismatter.com/money/banking/money-supply.htm

'When the Federal Reserve purchases a $1 million Treasury from a primary dealer, which is a bank, it simply increments the banks reserve account at the Federal Reserve by $1 million. No other account is debited. Hence, money is created rather than transferred.'

The Fed has 19 primary dealers, these are commercial banks.

When the Fed buys a let's say $100,000 face value Treasury from commercial bank A, The Fed gets the bond, and dealer A, a member bank, gets a reserve deposit at the Fed of $100,000.

Let's say the reserve requirement is 10%.

Now A can create and loan $1,000,000,000, i.e. 10 x 100,000.

https://en.wikipedia.org/wiki/Money_multiplier

"In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system.[1] Most often, it measures an estimate of the maximum amount of commercial bank money that can be created, given a certain amount of central bank money. That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) is equal to an amount which is a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier."

And there you have it.

The $100,000 Treasury, representing a loan of the economy to the govt., becomes $1,000,000 that the banks can loan and collect interest on.

It is just an unbelievable scam.
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Old 23rd July 2017, 06:23 PM   #7
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duplicate post
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Old 23rd July 2017, 06:26 PM   #8
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Originally Posted by Saggy View Post
The $100,000 Treasury, representing a loan of the economy to the govt., becomes $1,000,000 that the banks can loan and collect interest on.

It is just an unbelievable scam.
This is not a scam. It's a service rendered to the public at large that greases the cogs of civilization. Compare to bitcoin.

It might feel "scammy" if you don't own a bank. Thankfully, you can buy shares and participate yourself.
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Old 23rd July 2017, 06:35 PM   #9
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Originally Posted by marplots View Post
It's a service rendered to the public at large that greases the cogs of civilization.
It has certainly done that, so, it has to be evaluated in terms of pluses and minuses.

And, I'm not the first to note the problem of banks, e.g. Thomas Jefferson " I sincerely believe with you, that banking establishments are more dangerous than standing armies;"
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Old 23rd July 2017, 06:40 PM   #10
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Originally Posted by Saggy View Post
It has certainly done that, so, it has to be evaluated in terms of pluses and minuses.

And, I'm not the first to note the problem of banks, e.g. Thomas Jefferson " I sincerely believe with you, that banking establishments are more dangerous than standing armies;"
Dangerous for whom?
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Old 23rd July 2017, 07:18 PM   #11
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Let's try to remember that fractional reserve banking is responsible for creating ... everything.
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Old 23rd July 2017, 07:29 PM   #12
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Originally Posted by Saggy View Post
Gold coins are, by definition, coins made of gold. Gold coins are not debt money, at least according to the book, and according to my thinking.
Didn't I say that?

Originally Posted by Saggy View Post
When the Fed buys a let's say $100,000 face value Treasury from commercial bank A, The Fed gets the bond, and dealer A, a member bank, gets a reserve deposit at the Fed of $100,000.

Let's say the reserve requirement is 10%.

Now A can create and loan $1,000,000,000, i.e. 10 x 100,000.

<yadda> <yadda> <yadda>
Don't make this so complicated. When a bank makes a loan it accepts an IOU (which may or may not be backed by collateral) from the borrower and in return gives the borrower an IOU of its own (increases the borrower's bank account balance). It is just a simple exchange of liabilities.

We call bank accounts "money" simply because we can transfer balances to third party accounts via check or electronic banking.

Originally Posted by Saggy View Post
It is just an unbelievable scam.
It's not a scam, just a not very good way of going about it.
  • It makes the money supply pro-cyclical.
  • It requires massive deposit insurance since banks can't pay out all of their deposit liabilities at once.
  • It makes regulation of the money supply difficult.

If we were to insist that checkable deposits operated on a full reserve basis then regulation of the money supply becomes much easier. Banks would no longer be able to create new deposits. They would only be able to lend money that was deposited into savings accounts (thus putting money back into circulation that had been removed). Other than that, they would have to borrow the money from the Fed which can say "yea" or "nay" depending on whether the economy benefits.
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Old 24th July 2017, 03:46 AM   #13
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Originally Posted by Saggy View Post
Good grief. I'm an engineer, not a philosopher, so I'm interested in the mechanisms, not the deep meanings. So, there may never have been a barter economy. No problem. Gold coins are, by definition, coins made of gold. Gold coins are not debt money, at least according to the book, and according to my thinking. And, whether or not gold coins are 'debt money' is an academic argument for the professors that doesn't particularly concern me.

I'm perfectly happy with the books accounting of all types of money up to debt money, i.e., the current system.

What does concern me is trying to understand money creation in our current system, and that said, the version in the OP needs to be amended ....

Now, with references, and trying to get it right....

The balance sheet of the Fed is principally ..

http://web.mit.edu/14.02/www/krugman/0923LEC.pdf

"Assets - Bonds
Liabilities - high powered money, i.e. reserve deposits of the member banks."

Money creation ...

http://thismatter.com/money/banking/money-supply.htm

'When the Federal Reserve purchases a $1 million Treasury from a primary dealer, which is a bank, it simply increments the banks reserve account at the Federal Reserve by $1 million. No other account is debited. Hence, money is created rather than transferred.'

The Fed has 19 primary dealers, these are commercial banks.

When the Fed buys a let's say $100,000 face value Treasury from commercial bank A, The Fed gets the bond, and dealer A, a member bank, gets a reserve deposit at the Fed of $100,000.

Let's say the reserve requirement is 10%.

Now A can create and loan $1,000,000,000, i.e. 10 x 100,000.

https://en.wikipedia.org/wiki/Money_multiplier

"In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system.[1] Most often, it measures an estimate of the maximum amount of commercial bank money that can be created, given a certain amount of central bank money. That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) is equal to an amount which is a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier."

And there you have it.

The $100,000 Treasury, representing a loan of the economy to the govt., becomes $1,000,000 that the banks can loan and collect interest on.

It is just an unbelievable scam.
What, in your opinion, bequeaths gold with intrinsic value? After all, it is just a metal of little utility.
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Old 24th July 2017, 05:33 AM   #14
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Originally Posted by Loss Leader View Post
Let's try to remember that fractional reserve banking is responsible for creating ... everything.
Let also try to remember that fractional reserve banking means that banks lend a fraction of their deposits, not a multiple of their deposits as Saggy believes.

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Old 24th July 2017, 05:57 AM   #15
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Originally Posted by theprestige View Post
Let also try to remember that fractional reserve banking means that banks lend a fraction of their deposits, not a multiple of their deposits as Saggy believes.

This signature is intended to irradiate people.
Given that the money they loan out most likely ends up deposited in another bank (or maybe even the same bank), the total amount loaned ends up being many many times greater than the original amount of "real" money.

If the required fraction the banks have to keep on deposit was 50% then the original amount of money could, at most, be doubled - but the usual reserve requirements are much lower - often 10% or less. With a 10% reserve requirement the amount of money in circulation can be multiplied by ten by the banks.

Originally Posted by John Kenneth Galbraith
The process by which banks create money is so simple the mind is repelled.

Last edited by ceptimus; 24th July 2017 at 06:13 AM.
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Old 24th July 2017, 06:01 AM   #16
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Originally Posted by ceptimus View Post
Given that the money they loan out most likely ends up deposited in another bank (or maybe even the same bank), the total amount loaned ends up being many many times greater than the original amount of "real" money.
Nope.
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Old 24th July 2017, 06:19 AM   #17
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Originally Posted by The Great Zaganza View Post
Nope.
I don't know why you misunderstand, but you are wrong.

A google search on money creation or fractional reserve banking would allow you to educate yourself.
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Old 24th July 2017, 06:22 AM   #18
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You are mixing things up.
One is leveraging the capital of the bank , the other is fractional reserve banking, which is limited by the deposits of its customers .
Fractions of Fractions of Fractions converge on a fix value, no matter how many times you repeat the process: it doesn't increase exponentially.
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Old 24th July 2017, 06:32 AM   #19
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Originally Posted by psionl0 View Post
Don't make this so complicated.
I'm not making it complicated, it is complicated.

And, to the point, I see that my previous explanation is still lacking.

According to reference, the Fed buys treasuries from a 'primary dealer', and there are 23 designated govt. primary dealers.

https://en.wikipedia.org/wiki/Primary_dealer

So primary dealers acquire Fed deposits, i.e. reserves, when they sell to the Fed.

But, what about commercial banks. According to the ref above only the primary dealers deal directly with the Fed. So how do typical commercial banks get Fed deposits, i.e. reserves?
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Old 24th July 2017, 09:37 AM   #20
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Originally Posted by The Great Zaganza View Post
You are mixing things up.
One is leveraging the capital of the bank , the other is fractional reserve banking, which is limited by the deposits of its customers .
Fractions of Fractions of Fractions converge on a fix value, no matter how many times you repeat the process: it doesn't increase exponentially.
It doesn't increase exponentially, but the total loaned is increased by the 'money multiplier'.

https://en.wikipedia.org/wiki/Money_multiplier

"In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system.[1] Most often, it measures an estimate of the maximum amount of commercial bank money that can be created, given a certain amount of central bank money. That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) is equal to an amount which is a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier."


According to this, the commercial bank just creates out of thin air an amount of money equal to the reciprocal of the reserve ratio times its reserves money.

I've also seen it explained as follows: the bank gets a $100 deposit and the reserve ratio is 10%, so it deposits $10 in reserves, and lends the $90. The borrower of the $90 deposits it in a bank, and the process repeats, that is, the bank deposits $9 in reserves and loans $81, and so on. The first loan, $90 = (1 - .1)*100, the second loan is $81 = (1 - .1)*(1 - .1)*100, the 3rd is (1 - .1)*(1 - .1)*(1 - .1)*100, and so on. With y = 1-x, the amounts loaned are (y + y*y + y*y*y+....)*100, etc, and 1+y+y*y+... is a geometric series, and (1 / (1 - y)) = 1+y+y*y+ ... as you can see by multiplying both sides by 1-y. So the multiplier is (almost) 1 / (1 - y) = 1 / (1 - 1 + x) = 1/x where x is the reserve ratio, that is, the reciprocal of the reserve ratio.

So, both versions give the same end result, my guess is that the wiki explanation is a shorthand.
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Old 24th July 2017, 11:22 AM   #21
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Originally Posted by Saggy View Post
But, what about commercial banks. According to the ref above only the primary dealers deal directly with the Fed. So how do typical commercial banks get Fed deposits, i.e. reserves?
Obviously primary dealers have bank accounts. When they sell a bond to the Fed, the Fed adds to the bank's reserves (new base money) and the bank credits the primary dealer's bank account.

Originally Posted by Saggy View Post
I've also seen it explained as follows: the bank gets a $100 deposit and the reserve ratio is 10%, so it deposits $10 in reserves, and lends the $90.
<... remainder of incorrect explanation snipped ...>
In the real world, the bank gets $100 and can make a $90 loan. It does so by crediting the borrower's account so the bank now has $100 in reserves and $190 in deposit liabilities. If the borrower doesn't withdraw the money or have it transferred to a different bank (maybe they made a payment to somebody who has an account with the same bank) then the bank can lend a further 90% of $90 (= $81) meaning that it still has $100 in reserves but $271 in deposit liabilities. If the money gets transferred to another bank then it is the other bank that gets to loan the $81 in the same way. This process can continue until the multiplier limit has been reached.

Note that currently banks are nowhere near lending the allowable limits. They have a lot more than 10% in reserves.
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Old 24th July 2017, 01:35 PM   #22
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Originally Posted by psionl0 View Post
Obviously primary dealers have bank accounts. When they sell a bond to the Fed, the Fed adds to the bank's reserves (new base money) and the bank credits the primary dealer's bank account.


In the real world, the bank gets $100 and can make a $90 loan. It does so by crediting the borrower's account so the bank now has $100 in reserves and $190 in deposit liabilities. If the borrower doesn't withdraw the money or have it transferred to a different bank (maybe they made a payment to somebody who has an account with the same bank) then the bank can lend a further 90% of $90 (= $81) meaning that it still has $100 in reserves but $271 in deposit liabilities. If the money gets transferred to another bank then it is the other bank that gets to loan the $81 in the same way. This process can continue until the multiplier limit has been reached.

Note that currently banks are nowhere near lending the allowable limits. They have a lot more than 10% in reserves.

Yep

https://fred.stlouisfed.org/series/EXCSRESNS
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Old 24th July 2017, 02:51 PM   #23
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Originally Posted by psionl0 View Post
Obviously primary dealers have bank accounts. When they sell a bond to the Fed, the Fed adds to the bank's reserves (new base money) and the bank credits the primary dealer's bank account.
The primary dealer has an account at the Fed, no problem. But what about commercial banks? According to the ref above only primary dealers deal directly with the Fed. (wiki: primary dealer - In the United States, a primary dealer is a bank or securities broker-dealer that is permitted to trade directly with the Federal Reserve System )

Now, what are 'reserves'? Reserves are vault cash and deposits at the Fed. wiki:Bank reserves - are a commercial banks' holdings of deposits in accounts with a central bank (for instance the European Central Bank or the applicable branch bank of the Federal Reserve System, in the latter case including federal funds), plus currency that is physically held in the bank's vault ("vault cash").

So, to get reserves a commercial bank has to make a deposit in the Fed unless someone deposits cash. But according to the ref. cited earlier wiki: primary dealers, only primary dealers deal directly with the Fed.

That's what I don't understand. (Note: possible explanation - a commercial bank can have an account at the Fed but can't sell it Treasuries. However, the Fed's assets as per above MIT ref consist of govt. bonds (this was before the meltdown), but if a commercial bank deposited money at the Fed that money would be an asset ? And the FED can print money, so why would it want more?)

Originally Posted by psionl0 View Post
In the real world, the bank gets $100 and can make a $90 loan. It does so by crediting the borrower's account so the bank now has $100 in reserves and $190 in deposit liabilities.
No, it doesn't have any reserves until it makes a deposit in the Fed, at least per above. My 'explanation' assumed that it could make the deposit in the Fed, but I don't understand how.
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Old 24th July 2017, 04:05 PM   #24
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Basically, the primary dealers are a useful mechanism to make all the trading easier. They aren't fundamental to the money creation process. Think of it this way. A bank could sell a treasury bill to a primary dealer. The primary dealer then sells it to the Fed. The Primary dealer gets paid by the Fed, turning the payment over to the bank.

The Fed paid in reserves at the Fed, which are now in the account of the bank.
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Old 24th July 2017, 04:42 PM   #25
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Originally Posted by Saggy View Post
It doesn't increase exponentially, but the total loaned is increased by the 'money multiplier'.

https://en.wikipedia.org/wiki/Money_multiplier

"In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system.[1] Most often, it measures an estimate of the maximum amount of commercial bank money that can be created, given a certain amount of central bank money. That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) is equal to an amount which is a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier."


According to this, the commercial bank just creates out of thin air an amount of money equal to the reciprocal of the reserve ratio times its reserves money.
Money multipliers aren't money created out of thin air. They're derived estimates of the overall economic activity enabled by fractional reserve banking, given a certain amount of deposits and a certain fraction of deposits in reserve.

Money deposited in a vault somewhere doesn't contribute much to a community's overall economic activity. On the other hand, if a fraction of the deposit is lended out again, that loan *does* contribute to the community's overall economic activity. How much does it contribute? Money multipliers are part of calculating the answer to that question. Bank loans don't create more money, they enable more activity. You're confusing economic activity for actual money. Money is just a unit of measurement for calculating economic activity. Basketball players don't create more inches out of thin air just by being measured in inches. Bakers don't create more dozens out of thin air whenever they put cakes in a box.

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Old 24th July 2017, 04:47 PM   #26
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Originally Posted by theprestige View Post
Money multipliers aren't money created out of thin air. They're derived estimates of the overall economic activity enabled by fractional reserve banking, given a certain amount of deposits and a certain fraction of deposits in reserve.
To get technical, money multipliers aren't estimates of overall economic activity. They're estimates of how much public money, M1 for example, can be created from a given amount of central bank reserves.
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Old 24th July 2017, 04:50 PM   #27
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Originally Posted by Saggy View Post
Good grief. I'm an engineer....
...who makes us other engineers look bad.
http://rationalwiki.org/wiki/Salem_Hypothesis

Originally Posted by abaddon View Post
What, in your opinion, bequeaths gold with intrinsic value? After all, it is just a metal of little utility.
It looks pretty, can be found in pure form in the wild, doesn't tarnish, and is easy to work because of its terrible mechanical properties. Why, yes, I'm an engineer too.
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Old 24th July 2017, 05:54 PM   #28
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I like to think of fractional reserve banking as borrowing from the future. A factory, let's say, borrows money to make capital improvements that are greater than the price of the money. I don't understand why anybody except Polonius would have a problem with this (and he dies in Act Three).
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Old 24th July 2017, 07:08 PM   #29
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And the reason gold looks pretty, is relativistic effects of the electrons.

https://en.wikipedia.org/wiki/Relati...ntum_chemistry
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Old 24th July 2017, 08:19 PM   #30
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Originally Posted by theprestige View Post
Bank loans don't create more money, they enable more activity.
You are operating under the erroneous assumption that only Federal Reserve notes are money.

In fact, most money is ledger money and most payments are done by making bookkeeping entries (debit one account in the ledger and credit another).
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Old 24th July 2017, 08:37 PM   #31
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Originally Posted by Saggy View Post
The primary dealer has an account at the Fed, no problem. But what about commercial banks? According to the ref above only primary dealers deal directly with the Fed. (wiki: primary dealer - In the United States, a primary dealer is a bank or securities broker-dealer that is permitted to trade directly with the Federal Reserve System )
Simples. If the primary dealer is a bank then the Fed credits the dealer's reserve account directly. Otherwise, it has a bank account and the dealer's bank gets the reserves as above.

Originally Posted by Saggy View Post
... but if a commercial bank deposited money at the Fed that money would be an asset ? And the FED can print money, so why would it want more?
Reserves are an asset for the commercial bank but a liability for the Fed. It is thusly for all debt instruments. There is always a creditor for whom the instrument is an asset and a debtor for whom the instrument is a liability.

Originally Posted by Saggy View Post
No, it doesn't have any reserves until it makes a deposit in the Fed, at least per above. My 'explanation' assumed that it could make the deposit in the Fed, but I don't understand how.
Assuming that the Fed has a "no common banks past our doors" policy, bank A could always take the cash, deposit it at bank B and then instruct bank B to transfer the money in its account to an account in bank A (bank A's equity account). The Fed would then make the necessary changes in each bank's reserve account.
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Old 25th July 2017, 06:27 AM   #32
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Originally Posted by psionl0 View Post
Simples. If the primary dealer is a bank then the Fed credits the dealer's reserve account directly. Otherwise, it has a bank account and the dealer's bank gets the reserves as above.

Reserves are an asset for the commercial bank but a liability for the Fed. It is thusly for all debt instruments. There is always a creditor for whom the instrument is an asset and a debtor for whom the instrument is a liability.


Assuming that the Fed has a "no common banks past our doors" policy, bank A could always take the cash, deposit it at bank B and then instruct bank B to transfer the money in its account to an account in bank A (bank A's equity account). The Fed would then make the necessary changes in each bank's reserve account.

Let's take this step by step.

I walk in and make out a check to open an account in commercial bank A, not a primary dealer.

As a result, bank A has an asset the money I've deposited, and has a liability, my account, i.e. my ability to draw money from the bank.

However, at this point bank A has not increased its reserves, because ....

[wiki : Bank reserves are a commercial banks' holdings of deposits in accounts with a central bank (for instance the European Central Bank or the applicable branch bank of the Federal Reserve System, in the latter case including federal funds), plus currency that is physically held in the bank's vault ("vault cash").]

and bank A has not made a deposit in a central bank and its vault cash has not increased.

Now, bank A wants to convert some of the deposit I made into reserves, so it must make a deposit at the Fed. But, it cannot do so ...

[wiki : In the United States, a primary dealer is a bank or securities broker-dealer that is permitted to trade directly with the Federal Reserve System ("the Fed"). The number of primary dealers grew to 46 in 1988, declined to 21 by 2007 and stands at 23]

So, how does bank A, not a primary dealer, acquire reserves ? I.e., where is the error in the above line of reasoning?
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Old 25th July 2017, 07:42 AM   #33
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You wrote the check on bank B. When the check clears, bank B transfers some of its reserves at the Fed to bank A. (Neither total reserves nor total money in the system changes.)
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Old 25th July 2017, 07:45 AM   #34
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Originally Posted by Saggy View Post
So, how does bank A, not a primary dealer, acquire reserves ? I.e., where is the error in the above line of reasoning?
The word "check" is where you go astray.

In the first place, bank A is not going to credit your account until the check clears. And how does it clear? There is a process for the bulk clearing of checks but basically, the check will make its way to the bank of the person who wrote the check. Once the bank verifies that the check is genuine, it will debit the drawer's account and instruct the Fed to transfer money from its reserve account to bank A's reserve account.

Now that bank A has its reserves, it credits your account with the deposit and everybody is happy again.

ETA ninja'd by Startz
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Old 25th July 2017, 08:09 AM   #35
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Originally Posted by psionl0 View Post
The word "check" is where you go astray.

In the first place, bank A is not going to credit your account until the check clears. And how does it clear? There is a process for the bulk clearing of checks but basically, the check will make its way to the bank of the person who wrote the check. Once the bank verifies that the check is genuine, it will debit the drawer's account and instruct the Fed to transfer money from its reserve account to bank A's reserve account.

Now that bank A has its reserves, it credits your account with the deposit and everybody is happy again.

ETA ninja'd by Startz
Son of a gun. So, each commercial bank has a reserve account at the Fed, and when a check clears funds are transferred from the reserve account of the payer's bank to the reserve account of the payee's bank.

And, the reserve requirement means that a bank is free to print and loan money up to the money multiplier (reciprocal of the reserve ratio) times the amount in its reserve account.

Thanks, I think I got it ! Hey, you were right, it is simple, after all.
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Old 25th July 2017, 09:20 AM   #36
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Originally Posted by Saggy View Post
And, the reserve requirement means that a bank is free to print and loan money up to the money multiplier (reciprocal of the reserve ratio) times the amount in its reserve account.
Ordinary banks don't print money - not in the sense that they print banknotes. They create money out of thin air, but most money isn't in the form of cash these days.

The physical representation of most money is just some magnetic imprints on some spinning discs located on some of the bank's computer servers. When they make you a loan they just flip a few bits on a disc debiting one account and flip a few more bits crediting your account.

Even if you take your loan in cash that just comes from a cash store - the banks are confident that the cash will soon get spent and deposited back in a bank so the amount of actual cash on the planet only needs to be a small fraction of the amount of money. As people get more and more dependent on credit cards and now contact-less payment systems, sometimes using a cell phone rather than a card, the cash:money ratio is becoming smaller and smaller.
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Old 25th July 2017, 09:21 AM   #37
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Originally Posted by Saggy View Post
So, there may never have been a barter economy. No problem. Gold coins are, by definition, coins made of gold. Gold coins are not debt money, at least according to the book, and according to my thinking. And, whether or not gold coins are 'debt money' is an academic argument for the professors that doesn't particularly concern me.
Gold coins are only money if everyone aggress to treat them as such. They suffer from too many limitations to be viable as money for a modern economy and are not free from the issue described above. In fact, the process was first noted by gold dealers back when gold coins were the primary form of money.
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Old 25th July 2017, 09:50 AM   #38
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Originally Posted by theprestige View Post
Money multipliers aren't money created out of thin air. They're derived estimates of the overall economic activity enabled by fractional reserve banking, given a certain amount of deposits and a certain fraction of deposits in reserve.
Money multiplies are a function of economic conditions and are not something that can be definitively set. Asset and cash reserve requirements are there to place limits on them, but in a slowing economy the multipliers shrink and you cant force them to be higher. To avoid the overall money supply shrinking with them the central bank increases the base money supply instead.
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Old 25th July 2017, 10:02 AM   #39
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Originally Posted by Saggy View Post
Thanks, I think I got it ! Hey, you were right, it is simple, after all.
It's always nice to deal with a quick study.

Just remember that "print" is a euphemism for "make bookkeeping entries". Some people think CT when they see the expression "print money" even if they are actually creating money.
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Old 25th July 2017, 10:07 AM   #40
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Originally Posted by lomiller View Post
Money multiplies are a function of economic conditions and are not something that can be definitively set. Asset and cash reserve requirements are there to place limits on them, but in a slowing economy the multipliers shrink and you cant force them to be higher. To avoid the overall money supply shrinking with them the central bank increases the base money supply instead.
Actually, in the United States until the Great Recession excess reserves were very close to zero so the money multiplier was not terribly much affected by economic conditions. (Not true today, obviously.)
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