How the banks create money

[tkmikkelsen]

Um, if there were only a single 100 money NOTE, the example would still work exactly as laid out, so how is there 1100?

Money is very different from money notes. There is never enough money notes to pay out all the money in the world. Most money only exist as a number.
So the 1100 comes from the fact that we already had 100 floating around, perhaps owned by the shipbuilder. In order for the bank to loan the fisherman 1000 money they have to create them. These money are create against future value generated. This is more or less what credit is. The 1000 money still exist though and therefor there is 1100 money on the island now.

At what point are they not going to have the 5 money to give you? Every day you give back the five against what you already owed, so he still has it. At what point does the back look in it's drawer and say, "Oh, ****, we don't have 5 money left!"? Because I can't see any point at which that would happen.

Ok, maybe it is bad to say that the bank buys the fish as that clouds things a bit, because the bank has the money that the shipbuilder deposited. Which is actually only 1000. They give the fisherman 5 money every week for his fish and fisherman pays off a 5 money every week. Until he have done so for 240 weeks and paid back 1200 money to the bank. The bank still only holds 1000 money and there is a 100 money somewhere else on the Island, so 1200 money is paid back, but the island only have 1100 money. So the high interest rate is this scenario did not create the imaginary 100 money that interest created. Only thing it did was to ensure that the fisherman had spend some extra weeks paying off his debt. They didn't create more value, because in the end there is still only 1100 money on the island and not 1200 money as the bank wanted back.

Now add a few more people and another bank and quickly you get to the point where this is so clouded that it is not easy to look through, but as long as you use this model there will always be a portion of money that is simply hot air. The more people banks you enter into the fray the more hot air money you create.

 

[bluesjnr]

God forbid if two people on the island wanted to spend 100 money at the same time.

 

[AvalonXQ]

Money is very different from money notes. There is never enough money notes to pay out all the money in the world. Most money only exist as a number.
So the 1100 comes from the fact that we already had 100 floating around, perhaps owned by the shipbuilder. In order for the bank to loan the fisherman 1000 money they have to create them. These money are create against future value generated. This is more or less what credit is. The 1000 money still exist though and therefor there is 1100 money on the island now.

Read drkitten's set up again. There is only $100 on the island; the bank has it. His example works without ever increasing beyond that $100.

 

[drkitten]

Money is very different from money notes. There is never enough money notes to pay out all the money in the world. Most money only exist as a number.
So the 1100 comes from the fact that we already had 100 floating around, perhaps owned by the shipbuilder. In order for the bank to loan the fisherman 1000 money they have to create them. These money are create against future value generated. This is more or less what credit is. The 1000 money still exist though and therefor there is 1100 money on the island now.

No. As soon as I pay back the loan, the money that was created via lending disappears.

So at the end of the period, there's 300 money on the island. There's the original 100 money, and there's the 200 money that was created as "wealth" via the lending process. And, of course, the island as a whole is also wealthier by one boat and one deep-sea fisherman, which gives the island access to more and different fish.

Ok, maybe it is bad to say that the bank buys the fish as that clouds things a bit, because the bank has the money that the shipbuilder deposited.

Well, that's the whole point. I can pay off the loan by trading "wealth" for "money," just as I used the loan itself by trading "money" for "wealth. I used the bank's money to increase my wealth (the boat), I use the boat to produce more wealth (the fish I can catch with it), and then I trade my newfound wealth for money which I use to retire the debt.

The system works as long as I can continue to produce wealth. If instead of building a fishing boat, I had built a pleasure yacht, then I would indeed be in trouble -- the bank would eventually have repossessed my yacht, but it would still be out the money it created as clients asked for their deposits back. Of course, that also assumes a certain degree of stupidity both on my part and on the bank's; I should never have applied for that loan and the bank certainly shouldn't have approved it.

 

[drkitten]

Sorry, my bad got inflation and economic growth mixed up in my head.

Inflation = A general increase in prices on goods and services.

Economic Growth = Increase in the amount of money being produced.

They are 2 different things and I was using them wrong, my bad and I apologize.

No. Economic growth is an increase in the amount of wealth produced, which is entirely different from the amount of money. Again, economic growth is deflationary, because if I find a way to make twice as much bread from the same amount of ingredients, that increases the supply of bread and lowers the price.

You get inflation when the supply of money increases faster than the economy grows. (Or when production shrinks and the supply of money doesn't, as in the 1970s.) Left to itself, a fixed money supply will almost always be deflationary because the general tendency of the economy is to grow; deflation will also end up restricting economic growth because it retards the investment that drives economic growth.

Which is why a sensible government tries to increase the money supply to keep up with growth. The easiest and safest way to do this is via the banks, because the banks that supply investment capital can also supply new money to keep the two quantities roughly in-line. The alternative would be to have a bunch of out-of-touch research economists at the Mint decide how much to increase the money supply.....

 

[drkitten]

Read drkitten's set up again. There is only $100 on the island; the bank has it. His example works without ever increasing beyond that $100.

No, tk's correct that the loan creates new money. The IOU I signed to get the loan is itself an asset that the bank can trade or sell for something valuable. if the bank needs to buy land near the soon-to-be-built fish market, the banker could simply sign the IOU over to the builder as payment.

Of course, the IOU is worth something only as long as I am paying it off. The value in the IOU is created when I take out the loan, and systematically destroyed as I pay it off. 240 days from now, when I've paid it off, it's just a piece of waste paper.

 

[marplots]

Now add a few more people and another bank and quickly you get to the point where this is so clouded that it is not easy to look through, but as long as you use this model there will always be a portion of money that is simply hot air. The more people banks you enter into the fray the more hot air money you create.

Now you've hit on it. All money is hot air. I have money in my wallet that says, "this note is legal tender for all debts, public and private" which is as tautological as the Bible being true because it says it is true. So, yeah. It's all hot air.

On the other hand, a great deal of what we think of as firm and fixed is also hot air. The system of laws in the U.S. is, in the end, just an agreement we have in place to follow the rules -- pretty much like money, marriage, and a hundred other conceits. Not as big a deal as some make it out to be.

 

[drkitten]

Now you've hit on it. All money is hot air. I have money in my wallet that says, "this note is legal tender for all debts, public and private" which is as tautological as the Bible being true because it says it is true. So, yeah. It's all hot air.

Yup, even gold -- beloved of the anti-bank conspiracists -- is hot air. It has value only because I think I can give this lump of soft, shiny, useless metal to someone else in exchange for something I actually want, like food or shelter or a new car. If no one else wanted the soft useless metal, it's of no use to me either.

 

[GreyArea]

It has value only because I think I can give this lump of soft, shiny, useless metal to someone else in exchange for something I actually want, like food or shelter or a new car. If no one else wanted the soft useless metal, it's of no use to me either.

I thought that many societies chose to prefer gold because it doesn't tarnish. It's good for crowns. Later we found out it's a good conductor, too, so I wouldn't say it's completely useless.

 

[drkitten]

I thought that many societies chose to prefer gold because it doesn't tarnish. It's good for crowns.

Yes, but follow that path a little longer.

Gold is valuable because it's shiny, so the king wants to make his crown out of it.

So the king wants your gold.

Who's the person who's going to be the king (and get to wear the shiny gold crown)? Historically, the kind of person who becomes the king is not the king of person who would simply ask "pretty please, may I have some of your gold?"

 

[marplots]

Historically, the kind of person who becomes the king is not the kind of person who would simply ask "pretty please, may I have some of your gold?"

You are right, that other person is the Pope.

 

[Skeptic Ginger]

An interesting story about the latest 600 billion the Fed is infusing into the banking system:

New $600B Fed Stimulus Fuels Fears of US Currency War

It's this economist's opinion [former Wall Street economist and University of Missouri professor Michael Hudson] that the fed desires to increase the money supply so the banks will lend it and stabilize the housing market. Instead, the banks are buying foreign currency speculating the dollar will fall and the banks can then reap a profit. China will no doubt see it as an attempt to decrease the cost of exports and increase the cost of imports.

the Fed has said, we want to give the banks so much money that they will lend it out so you can begin to bid up prices on real estate again and pull the banks out of the real estate negative equity that it’s in. So the purpose, according to the Fed, is to raise the price of real estate, to inflate asset prices. But that’s not happening. The actual banks have lent less today than they did in 2007. So the money is going abroad. And it’s going abroad not really to buy foreign companies so much, but to speculate in currency.

Now, the Fed and the Congress, two weeks ago, said, "We want China to raise its currency by 20 percent." This would create billions and billions of dollars of bonanza for Wall Street banks, and it would enable them to earn their way out of debt by essentially looting the China central bank, the Brazilian central bank, the Turkish central bank and the other central banks, because you can now borrow money in America at one percent. So you’d put down, let’s say, a billion dollars of your own—a million dollars of your own money, borrow $99 million of the bank’s money—that’s $100 million. You would buy Chinese currency, RMB, for $100 million. You then say, "Raise your currency by 20 percent," which is what the Fed has asked them to do. That means that your million dollars now has turned into a $20 million gain, because $100 million is now worth $120 million. You’ve made a 200 percent profit. And for Wall Street, they deal in billions, not millions. And so, this would enable the banks to make up their money by buying out, essentially, foreign currency. They’re doing the same in Australia. It’s currency gamble.

What a tangled web they weave....

 

[drkitten]

An interesting story about the latest 600 billion the Fed is infusing into the banking system:

You say "interesting," I say "line-your-hat-with-tinfoil wrong." Potato, poTAHto, I guess.

Just a few of the gems in it:

• Turning $1 million into $20 million is a 200 percent profit.
• Increasing the money supply will have a deflationary effect
• Easy credit will force people to buy houses at exorbitant prices (I guess because there's nothing else available for people to buy?)
• Easy credit will raise interest rates (I guess he's repealed the law of supply and demand?)
• The Asian currency crisis was engineered by George Soros

 

[timhau]

It's this economist's opinion [former Wall Street economist and University of Missouri professor Michael Hudson] ...

I've seen more impressive credentials than "former Wall Street economist" and "U. of Missouri professor" slapped on people who were dead wrong.

 

[Skeptic Ginger]

You say "interesting," I say "line-your-hat-with-tinfoil wrong." Potato, poTAHto, I guess.

Just a few of the gems in it:

• Turning $1 million into $20 million is a 200 percent profit.
• Increasing the money supply will have a deflationary effect
• Easy credit will force people to buy houses at exorbitant prices (I guess because there's nothing else available for people to buy?)
• Easy credit will raise interest rates (I guess he's repealed the law of supply and demand?)
• The Asian currency crisis was engineered by George Soros

I listened to the interview and that's not even close to what I heard. There could be a typo on the 200%, I don't know. And people do misspeak, that doesn't mean they can't do basic math.

The mechanisms for the rest was explained and you've ignored the mechanisms involved in what looks counterintuitive.


As for the professor's qualifications, (timhau's post), let's look instead of guessing. Here's his CV and I suspect he's more qualified than anyone posting in this thread. Correct me if any of you are PhD economists.

I do not claim to know if Dr Hudson's opinion is correct. It's my understanding well qualified economists have trouble agreeing with each other. I did, however, find the interview very interesting. Of course the fact he worked with Dennis Kucinich and is being interviewed on Democracy Now means certain people will dismiss his opinions without any thought. But I don't have that issue.

 

[Skeptic Ginger]

Re "the Asian currency crisis engineered by George Soros", Hudson said:

Yes, there is only one country that did that, and that was Malaysia under Prime Minister Tun Mohamad Mahathir. He would not sell the domestic currency to the foreign speculators, so George Soros and the others who sold the currency short, hoping that the central bank would use all of its money just to defend its currency and then be emptied out, they couldn’t cover their position, so they were squeezed. But countries like Korea, where the meetings, the G20 meetings, are this week—the IMF went and said, "You owe money you can’t pay. George Soros has raided you. You have to sell Americans your electric companies. You have to sell Americans your car companies." And this was a grab that, in the past, in past centuries, there would have had to be a military invasion to take over. And now they’re doing it financially. And they’re angry over there.

Do you have evidence this description of events is not correct?

It's not like the IMF does not take these kinds of actions. "Confessions of an Economic Hitman" has corroborating revelations in the book. It seems to be a common practice to manipulate third world countries via economic extortion.

 

[Francesca R]

Re "the Asian currency crisis engineered by George Soros", Hudson said. Do you have evidence this description of events is not correct?

Sure, some people think Soros and other "western speculators" engineered the East Asian crisis. For a while Soros's Quantum Fund was blamed for forcing the British pound out of the pre-Euro exchange rate mechanism. But it was quite a short while, and it did not take long to get re-cast as rescuing the economy from the most doomed policy of John Major's government.

Asia has done rather well since its large FX devaluations of the 1990s. Politically as well as economically in Indonesia's case (getting rid of Suharto).

(PS--Mahathir Mohammed is not really someone to rush to the defence of)

 

[drkitten]

I listened to the interview and that's not even close to what I heard. There could be a typo on the 200%, I don't know. And people do misspeak, that doesn't mean they can't do basic math.

The mechanisms for the rest was explained and you've ignored the mechanisms involved in what looks counterintuitive.

I haven't ignored them. They're simply wrong.

Here's the explanation provided.

The idea is to flood the economy with credit so the banks will lend out more debt. And if the Fed’s policy works, then housing prices are going to go back up so high that most consumers are going to have to pay 40 percent of their income for housing. They’re going to have to pay more money for credit card debt. The purpose is to help the banks make money at the expense of the economy. It’s not to help the economy at all. That’s the really important thing. When they say the economy, they mean—the Fed means its constituency: the banks. And the banks’ product is debt. And that’s what they’re trying to produce.

[...] It will inflate asset prices. It won’t inflate consumer prices. It’s actually deflationary for consumer prices, because if you’re an American consumer and you spend 40 percent of your income for housing, 15 percent for debt service to the bank, 11 percent goes out in your FICA wage withholding, and about ten to 15 percent in actual income taxes, that means that the average American has maybe one-third or a quarter of their salary to actually spend on goods and services. So they have to spend so much on debt service and finance and insurance and real estate that there’s no money to buy goods and services, so that’s why so many stores are closing throughout the cities on the big shopping streets.

The idea is, with debt cheap, people will pay more for their housing and have nothing left over for consumer goods. The problem, of course, is that that exact same argument suggests that, with debt cheap, people will pay more for consumer goods and have nothing left over for housing. Flooding the market with credit makes credit cheaper, which in turn encourages spending of all types. The idea that cheap credit makes consumer spending drop is not just counterintuitive.

It's tinfoil-hat wrong.

I do not claim to know if Dr Hudson's opinion is correct.

Then why are you defending it?

Of course the fact he worked with Dennis Kucinich and is being interviewed on Democracy Now means certain people will dismiss his opinions without any thought.

Believe me, his association with Kucinich is not the reason I dismissed his opinion as wrong.

 

[webb5]

You don't under stand do you. I will try to explain it this way.

Every single dollar in existence has been created as debt, and this must be paid back with interest. So say at 10% interest how much money would you have paid the banks after 10 years? The money you pay back to the banks must come from some one else such as your employer. Guess where this money comes from.

If the banks stop creating money right now the economy would collapse as there is not enough money in circulation. The interest part that the banks charge reduces the money supply. In ten years time at 10% interest the money supply would be zero if all borrowing was stopped. So we must continue to borrow an ever growing amount of debt to maintain enough money in the system.

When the banks reduce the money supply we have recessions and even depressions. We are at the mercy of the banks.

Ever played the monopoly game? In real life you borrow at the start of the game just like all the other players and each time you pass go you pay interest. The money supply that each player borrowed at the start of the game will dwindle each time they pass go as yearly interest is paid. Each player can earn money from other players but this from the money already owed. What ever the players do the game will end before the players go round the board 10 times. The bank is the winner here.

This is how the world runs right now. You and just every one else in this world has been conned! You are talking about a fairy tale I'm talking about a real night mare. Poverty in this world is getting worse. People are dying every day from poverty.

There is a solution, but it means people must wake up. The private banks must be replaced by people banks that control the supply of money. It can work, Australia used this system before it was shut down by the private banks. I have a website that explains all this, unfortunately I cannot link this site here. Please do some research on this very important subject.

 

[drkitten]

Every single dollar in existence has been created as debt, and this must be paid back with interest. So say at 10% interest how much money would you have paid the banks after 10 years?

About $3.00 per dollar borrowed.

But if I've created $8.00 in wealth with that borrowed dollar, I'm still better off than I was before -- and better off even than the bank is from the money I borrow.

The money you pay back to the banks must come from some one else such as your employer. Guess where this money comes from.

From the wealth I've created through my work, via the employer.

That seems to be your basic problem; you don't understand the difference between creating money and creating wealth.