How the banks create money

[Tippit]

I didn't think I needed to. Anyone who didn't just fall out of a tree knows that the money supply was expanding as mining operations took gold out of the ground and put it into coinage. If you have just fallen out of a tree, look at the history of gold mining in Alaska for a single instance. Of course, the US was also able to buy substantial amounts from the South African gold fields as well.

The California gold rush lasted from 1848 to 1855, which gold rush are you talking about? In any case I find it interesting that you are willing to differentiate between monetary and price inflation - only when it suits you.

That's right. Without substantial monetary inflation, the amount of goods in circulation from the second industrial revolution would have been much more than 33% over baseline, which would have produced the net deflation that you yourself admit caused the Great Depression and would have stopped the second industrial revolution in its tracks.

So in other words, according to you, we should believe that massive productivity gains which increase economic output and result in lower prices for everyone is a cause of major depressions. We are further supposed to believe that if it weren't for some fictional increase in the money supply during that period that you have yet to document, the 2nd industrial revolution would have actually resulted in a depression. This, instead of the phenomenal 4-to-6 percent per annum output growth that actually occured over twenty-five years.

You fail to distinguish between the natural price deflation that occurs given productivity gains resulting in increased real output, and the massive economic shock that occurs when the money supply is artificially contracted, resulting in the widespread destruction of credit. The latter is the cause of depressions, not the former. Just ask your pal Ben Bernanke, who apologized for it.

My reading comprehension is just fine; if you think that there was no monetary inflation while output more than doubled,..... well, "magic pixies" doesn't begin to touch it.

I'm not aware of any monetary inflation during the period, but I welcome any evidence you have. What we do have evidence of is long term price deflation and robust economic growth, which flies in the face of the notion that falling prices are economic anathema - the weak justification for inflationary monetary policy. Or, as I like to call it, the imposition of the inflation tax.

Your failure to understand how real output can grow without monetary inflation is because you can't conceive of how the aggregate of goods and services could possibly increase despite a mostly static money supply. Here's a hint, if you adjust output for deflation, it can reveal a positive rate of output growth, just like real output is lower than nominal output, adjusted for inflation.

 

[psionl0]

You fail to distinguish between the natural price deflation that occurs given productivity gains resulting in increased real output, and the massive economic shock that occurs when the money supply is artificially contracted, resulting in the widespread destruction of credit.

Are you sure that you have correctly distinguished between the two? The price of many consumer items like white goods and electronic items goes down by the month - mainly because they are being imported (on credit) from countries with cheap labour costs. On the other hand, it now takes two people working to keep one roof over their head and many services such as education and medicine are being priced out of the reach of ordinary people.

Overall deflation can't be good. Once money increases in value, it becomes an investment all by itself. That encourages people to hold back on spending or even investing money (since the value of an investment is likely to go down in dollar terms) resulting in a downward spiral.

 

[Tippit]

Are you sure that you have correctly distinguished between the two? The price of many consumer items like white goods and electronic items goes down by the month - mainly because they are being imported (on credit) from countries with cheap labour costs. On the other hand, it now takes two people working to keep one roof over their head and many services such as education and medicine are being priced out of the reach of ordinary people.

The price of electronic goods deflates because of incredible productivity gains that drive input costs lower and lower, and that result in higher quality products that drive older ones into quick obsolesence. The electronics industry is no more labor intensive than any other industry. The problems you are describing with housing, education and medicine are inflationary, not deflationary, so I'm not sure what the point you're trying to make is.

Overall deflation can't be good. Once money increases in value, it becomes an investment all by itself. That encourages people to hold back on spending or even investing money (since the value of an investment is likely to go down in dollar terms) resulting in a downward spiral.

Of course it can. When you consider that the current financial crisis was caused by asset inflation in the housing market, courtesy of the Fed, you quickly realize that not all investments are sound. Financial asset inflation has resulted in the arbitrary transfer of wealth to lucky home flippers and bankers, from everyone else. Business returns, even in a deflationary environment, will always have higher returns than cash, and real returns will obviously be higher. The fact that inflation causes people to consume or invest more than they otherwise need or want in order to escape cash or anemic bank returns is not a good thing. Finally, why do you assume that mild deflation must result in a spiral of doom, where mild inflation doesn't? What makes inflation different? The period 1875-1900 obviously proves that this propaganda is untrue.

 

[Francesca R]

Finally, why do you assume that mild deflation must result in a spiral of doom, where mild inflation doesn't? What makes inflation different?

Mild deflation is a considerably less stable equilibrium. You don't always have productivity growing at a 3% clip or whatever and you don't always have real final sales chugging along at something similar. There are demand and supply shocks. And when there are negative shocks, it is harder to respond via monetary policy with mild deflation.

But you know this because it has been argued extensively before.

 

[Tippit]

Mild deflation is a considerably less stable equilibrium. You don't always have productivity growing at a 3% clip or whatever and you don't always have real final sales chugging along at something similar. There are demand and supply shocks. And when there are negative shocks, it is harder to respond via monetary policy with mild deflation.

But you know this because it has been argued extensively before.

It's not a "less stable" equilibrium. Once again, 1875-1900 bears this out. I don't know of anyone who is making an argument for deflation in the context of lower productivity. If we're producing less, prices should rise, naturally. The argument is against activist monetary policy at all, because it represents a thinly disguised (and massive) transfer of wealth.

 

[psionl0]

Once again, 1875-1900 bears this out.

Isn't that about the time that silver was "demonetized"? I don't see how that helps your case.

The massive contraction of the supply of money during the latter half of the 19th century caused major hardships for sure. We both know that this is a case against giving banks the power to create money but you have not convinced me that "freezing" the supply of money will not put a dampener on productivity.

 

[Tippit]

Isn't that about the time that silver was "demonetized"? I don't see how that helps your case.

The massive contraction of the supply of money during the latter half of the 19th century caused major hardships for sure. We both know that this is a case against giving banks the power to create money but you have not convinced me that "freezing" the supply of money will not put a dampener on productivity.

How are you not convinced? Did you read the paper by Fed bank president James Bullard? Here is a link, although you can only access the cover page without subscribing:

Deflation and Economic Growth

The economy grew rapidly during the period in question, while prices fell. According to the inflationists, this is impossible, as we would have a "deflationary spiral", and economic calamity. You claim there was a massive contraction in the money supply, drkitten claims there was an expansion in the money supply. Neither have provided evidence. I am not aware of any reliable money supply stats from that period, but I'm willing to look at them. What we do know, is prices fell, and the economy grew. Silver was demonetized in the Coinage act of 1873, which would certainly be contractionary, and certainly helps explain the 1% deflation per year from 1875 to 1900. In any case, the economy grew. My point isn't to advocate for a gold or silver standard, it's to make people aware of the fact that the premise behind why we supposedly need central banks is false, and that monetary policy that targets inflation represents a regressive transfer of wealth, which is disguised by productivity gains. These gains and more end up being effectively confiscated by bankers and politicians.

 

[Sceptic-PK]

I like the graph that shows that every time the economy grew, inflation did as well. And inflation only went down when growth went down.

 

[webb5]

It is possible to have economic growth with declining prices. If the fall in prices is the direct result from improvements in productivity through advances in technology. This is particularly true when technological innovation boosts productivity faster than prices are falling, so that profit margins are not negatively affected.

The rapid expansion of the rail roads in the late 1800's would of further decreased these costs with cheaper transportation. New industries with mass production further decreased prices.

 

[webb5]

Deflation caused by the banks is a completly different thing! Recessions and depressions is the end result.

Our politicians mostly do not seem to understand the facts of money creation. Most government economic and banking advisers belong to the bank oriented school of thought which has plunged much of the world into unrepayable and rapidly escalating debt. Many owe their employment to going along with the iniquitous system.

Economics is not a profession, such as engineering is where faiure to produce the desired results would result in discredit and the sack. Government advisers, whose advice has led to disastrous results in the past, still hold influential positions. If they ran private businesses many would now be bankrupt.

For those who still do not understand how the present banking system works by fraudently creating money, need to see this link.
http://www.michaeljournal.org/myth.htm

 

[Sceptic-PK]

Nobody cares.

 

[drkitten]

Nobody cares.

Not true. Lots of people care deeply. The problem is that webb5's misstatements and wrong ideas have already been refuted.

Check post #13.

 

[Arthur Mann]

"At the end, of the original $100 in our economy, Art has $99, the Bank has $1 and Chuck has $0." (Money divided).

That's a pretty fair description of our monetary system, but you left out one part: interest.

In your example, let's say the bank charged Chuck 10% interest, a reasonable rate for a loan. Now Chuck owed $55, and remember, we still only have $100 in this little economy. So Chuck gets his $55 together and pays the bank. The bank subtracts $50 from Chuck's debt and pockets the $5. Now the score is

• Art $100
• Bank $5
• Chuck $0

So now we have $105 in the economy. The bank invented and gave itself the "interest". Where did that come from? The bank keeps all the ledgers, so eventually they're going to drop that $5 bomb on somebody. Can't do it to Chuck (unless he borrows again). Can't do it to Art (unless he borrows), he can claim his $100 at any time. The Federal Reserve, responsible for all our currency, operates in exactly the same fashion, by the way.

How does the bank handle the fact that they merely invented this $5 for themselves? They ignore it, until it's time to start reeling in all the currency. The banks stop loaning out money, debts start to get paid off, the money supply vanishes. No new loans mean lots of people are left holding the bag, unable to pay back their loans. There was never enough "real" money in the system to pay off the loans plus the interest.

Banks that didn't claw their way off the bottom sink and the rest get bailed out and the game is reset. The banks also incestuously intertwine their finances with the insurance monolith, so when the dominoes stop falling and the next round of government currency floods in, they can all lean on each other and get back up.

This cycle has been repeated over and over again in my lifetime. It shouldn't take people this long to get wise to it.

 

[Sceptic-PK]

Not true. Lots of people care deeply. The problem is that webb5's misstatements and wrong ideas have already been refuted.

Check post #13.

Well yeah, that’s what I meant. Webb is merely bumping his thread with more fallacious nonsense that nobody cares about because it’s the same fallacious nonsense that was posted last time, and the time before that.

 

[Sceptic-PK]

That's a pretty fair description of our monetary system, but you left out one part: interest.

In your example, let's say the bank charged Chuck 10% interest, a reasonable rate for a loan. Now Chuck owed $55, and remember, we still only have $100 in this little economy. So Chuck gets his $55 together and pays the bank. The bank subtracts $50 from Chuck's debt and pockets the $5. Now the score is

• Art $100
• Bank $5
• Chuck $0

So now we have $105 in the economy. The bank invented and gave itself the "interest". Where did that come from? The bank keeps all the ledgers, so eventually they're going to drop that $5 bomb on somebody. Can't do it to Chuck (unless he borrows again). Can't do it to Art (unless he borrows), he can claim his $100 at any time. The Federal Reserve, responsible for all our currency, operates in exactly the same fashion, by the way.

How does the bank handle the fact that they merely invented this $5 for themselves? They ignore it, until it's time to start reeling in all the currency. The banks stop loaning out money, debts start to get paid off, the money supply vanishes. No new loans mean lots of people are left holding the bag, unable to pay back their loans. There was never enough "real" money in the system to pay off the loans plus the interest.

Banks that didn't claw their way off the bottom sink and the rest get bailed out and the game is reset. The banks also incestuously intertwine their finances with the insurance monolith, so when the dominoes stop falling and the next round of government currency floods in, they can all lean on each other and get back up.

This cycle has been repeated over and over again in my lifetime. It shouldn't take people this long to get wise to it.

LOL.

 

[marplots]

That's a pretty fair description of our monetary system, but you left out one part: interest.

In your example, let's say the bank charged Chuck 10% interest, a reasonable rate for a loan. Now Chuck owed $55, and remember, we still only have $100 in this little economy. So Chuck gets his $55 together and pays the bank. The bank subtracts $50 from Chuck's debt and pockets the $5. Now the score is

• Art $100
• Bank $5
• Chuck $0

So now we have $105 in the economy. The bank invented and gave itself the "interest". Where did that come from?

This is what puzzles me when the claim "the banks create money" is bandied about. Yes, I agree that in your version of my example there is more value in the economy than before and the same amount of currency -- a mismatch.

What I don't see is why the banks become the bad guy here.
1) The bank provided a service and was compensated for the service.
2) Chuck created the money he used to pay back the bank (maybe carved a picnic table out of granite and sold it to a guy in Japan).
3) Value is added to the marketplace all the time -- "out of thin air".

Again, I can see why the bank might end up holding the virtual value and require new currency to match that value, but this seems neither nefarious nor odd.

Since, before this subject came up here at JREF I was largely ignorant of it, I would be happy to find out where I have mischaracterized the situation.

 

[Arthur Mann]

Yes, I agree that in your version of my example there is more value in the economy than before and the same amount of currency -- a mismatch.

That's just it, there isn't more value in the economy, just more invented money. Money represents debt, not resources, but let's pretend it represents resources. There is a finite amount of resources, and $100 to represent it all. The bank has none of the resources, just the $100 deposited, the customer owns the $100. The bank invents an extra $5 that goes in its pocket, now there is $105 representing all the resources, the bank owns $5, the customer owns $100. Now the bank for some reason has a claim on 1/25th of the wealth. Even if part of it goes back to the customer as interest, let's say $4, or 4% interest, the bank then gets a claim on 1/105th of the resources. As this cycle repeats, the bank's portion of the wealth steadily and only ever increases. The bank can not lose. They've stacked the deck the same way Vegas has.

1) The bank provided a service and was compensated for the service.

That's just it, the banks provide no service, other than keeping track of (their) money. Banks are parasites on the economy, their sole purpose is to siphon wealth from many and put it in the hands of the few. It's not even really about money, they invent money as they need it, they're after "real" property, with their invented money and claims on collateral property enforced at gunpoint by governments.

 

[Sledge]

So don't use a bank. Problem solved.

 

[Sceptic-PK]

That's just it, there isn't more value in the economy, just more invented money.

Says who? Maybe I borrowed that money to build a widget factory and start selling widgets? I am adding value to the economy by building something "out of thin air".

Money represents debt

No, it doesn't. It may, but it also may not. This mistake is repeated over and over by anti-banking CTs, and it is completely wrong. Any country's central bank can create money for free, and do whatever it likes with it. This has nothing to do with debt.

not resources

Again, it may.

The bank invents an extra $5 that goes in its pocket

How and for what?

The bank can not lose.

Missed 2008 did we?

That's just it, the banks provide no service, other than keeping track of (their) money.

So, when I go to the bank and they give me money so I can buy a car or a house (years before I would be able to save enough), that isn't providing a service?

Banks are parasites on the economy, their sole purpose is to siphon wealth from many and put it in the hands of the few.

With an attitude like that you will be forever poor. Not your fault of course, those evil banks are responsible.

 

[marplots]

(much clipped from original)
That's just it, the banks provide no service, other than keeping track of (their) money.

I'm really trying to understand this. If banks provide no service, why do we use banks? I can think of the reasons I use banks, and it does seem to me like they are providing a service, but I think you mean something more general.

Can you explain?