How the banks create money

[Tippit]

This isn't necessarily true; the independence of the Fed is much more important when we're talking about setting the price of money (and other areas like regulation but we'll ignore that for now).

I don't presume the price of money should be "set" (another word for manipulation).

The Fed's independence is largely irrelevant to its role as the government's deficit enabler, because the central bank will always provide as much as the government wants. It just makes sense to include this responsibility with all the others that the Fed manages, in the same way it makes sense for any other government agency to have authority over areas of similarity. As you correctly point out, Treasury could perform the same function.

So, without the Fed, Congress runs out of money and is forced to stop spending. With the Fed, endless supply of money. Hardly irrelevant.

The point though is what difference would it make?*

The difference is who decides where the money goes. Private bankers, or politicians. Not only does the Fed monetize government debt, but every single loan it makes to a private bank is monetized as well. So we have a private entity making private loans against the public's bottomless checkbook, using monetary inflation.

*Additionally, since you're so obsessed with currency devaluation, exactly what do you think happens to the confidence in, and value of currency if a country just prints more money to fund its deficits, without any obligation to later pay that money back? In essence, you're basically advocating a system that is more akin to, say, Zimbabwe than the US?

In truth, I am not advocating such a system. I only use it as an example to point out how preposterous it is to give a private entity the power to issue money. Politicians have and would abuse this power as well, but at least they are presumed to be transparent and accountable. I advocate a strong commodity standard (probably gold, or bi-metallic), which must be coupled with statutes that strictly limit the amount of money creation to zero. Any standard which intends to limit the issuance of money based solely on the idea that the currency is redeemable will fail, just like the gold standard failed in the roaring twenties.

 

[drkitten]

So, without the Fed, Congress runs out of money and is forced to stop spending. With the Fed, endless supply of money.

Evidently in Tippit-land, Congress couldn't pass a law directing the Treasury to print more money.

Evidently in Tippit-land, Congress can pass a law directing the Treasury not to print money (that's what he's advocating in his commodity standard), but Congressional authority only goes so far....

 

[Sceptic-PK]

I don't presume the price of money should be "set" (another word for manipulation).

So, you think politicians should “decide where the money goes” but that the government shouldn’t be allowed to influence the price of money to keep an upper limit on inflation?

So, without the Fed, Congress runs out of money and is forced to stop spending. With the Fed, endless supply of money. Hardly irrelevant.

How so? What’s stopping Congress from printing as much money as it wants via any other agency, such as the Treasury which you yourself pointed out?

The difference is who decides where the money goes. Private bankers, or politicians. Not only does the Fed monetize government debt, but every single loan it makes to a private bank is monetized as well. So we have a private entity making private loans against the public's bottomless checkbook, using monetary inflation.

The decisions made by the Fed are made by the board, which is a government agency. Private bankers don’t conduct monetary policy, the government does. I know you know this and are just trying to be difficult.

In truth, I am not advocating such a system. I only use it as an example to point out how preposterous it is to give a private entity the power to issue money. Politicians have and would abuse this power as well, but at least they are presumed to be transparent and accountable. I advocate a strong commodity standard (probably gold, or bi-metallic), which must be coupled with statutes that strictly limit the amount of money creation to zero. Any standard which intends to limit the issuance of money based solely on the idea that the currency is redeemable will fail, just like the gold standard failed in the roaring twenties.

Again, the Fed is not a private entity. I know you don’t support a Zimbabwe-like currency issuing model, I just thought it strange that you would criticise the US system from that position. Doesn’t make any sense, given your obsessions with inflation/currency devaluation.

 

[Sceptic-PK]

Doesn't Zimbabwe have fractional reserve banking?

How is that relevant?

 

[drkitten]

Doesn’t make any sense, given your obsessions with inflation/currency devaluation.

It makes perfect sense, from a metalogical point of view.

There are no rational arguments against the Federal Reserve, fiat currency, and fractional reserve banking. It's the most robust and stable method of controlling the currency supply ever tried in practice or even proposed in theory; historically, it is a clear winner over every competitor that's been tried, which is why it's almost universally used, and the countries that don't use it are economic cesspits. There's a certain amount of cause-effect confusion there; the countries that switch to any variant lunatic model end up driving themselves into a ditch in fairly short order, but by the same token, any country that would even consider moving to any other system is already demonstrably broken and so the ditch isn't too far away in the first place.

But given that there's no rational argument -- none -- that can be made against it, it follows that Tippit and his fellow lunatics are forced to rely on irrational arguments, including cherry picking data, quoting out of context, and most importantly simply making stuff up. (I'm fairly confident that his response to this message will include at least two of those three rhetorical flourishes -- I'd like my million in a cashier's check please, Mr. Randi.) This is because, when there are no rational arguments against something, all arguments against it are by definition irrational and specious.

But once you've understood that everything Tippit says is irrational and specious, then you understand why what he writes doesn't make sense.

Now, it would be nice, I admit, if any of the anti-Fed proponents or goldbugs could argue their stance from a consistent point of view. Just because someone is irrational doesn't mean they must be inconsistent, I agree. But there's no particular reason to expect that someone that strongly irrational is even capable of recognizing the inconsistency in their position, since consistency is typically a property defined in logical/rational terms.....

 

[drkitten]

How is that relevant?

I think he's pointing out that countries without fractional reserve banking can't devalue their currency, and therefore the difference between Zimbabwe and the United States can't be attributed to the use in the United States of fractional reserve banking.

He's wrong at several levels, of course. Countries without fractional reserve banking can easily devalue their currency by simply cranking up the printing presses.

Basically, there are several issues (mistakes of fact) going on.

1) Currencies based on commodities are better than fiat money.
--- this is simply wrong, and we have good historical examples both of depressions caused by a lack of sufficient commodity money, and of runaway inflation caused by too much commodity money. Since the amount of any given commodity money varies with the amount of the commodity and not with any controllable economic number, the money supply swings randomly and harmfully. Which is why countries gave up commodity money in the first place.

2) Well, if you're going to have fiat currency, put the money supply in the hands of the government instead of the Evil Bankerz.
--- No. The track record of governments to take the long view of the needs of the economy isn't good enough, and much worse than the track record of independent banks. The difference between the US Federal Reserve, especially in the recession of the early 1980s, and of modern Zimbabwe, shows the difference. Politicians are less likely to take the necessary hard decisions.


3) Well, if you're going to have fiat currency created by banks, it should still be based on a full-reserve system.
--- No. That will simply destroy the lending industry because no one will be able to use money that's locked in a banker's vault, but that will also destroy the economy unless the government steps in to print money directly in order to create new money to stimulate investment. The problem with this is that money once printed is difficult to pull out of circulation (as opposed to money created via lending and implicitly destroyed when the loan is repaid), so we end up with all the problems of a directly government-controlled money supply plus a few others as well.

4) But an increasing money supply makes the money in my mattress worth less! I'm being taxed to death!
-- Yes, if you invest like an idiot you'll lose money. Stop investing like an idiot. The world economy does not have training wheels.


I think I got all the nutcase arguments covered there, but I'm sure that someone will come along with something breathtakinging inane in response anyway.

 

[Sceptic-PK]

A pleasure as always drkitten.

Just because someone is irrational doesn't mean they must be inconsistent, I agree.

Haha!

 

[respect]

I don't presume the price of money should be "set" (another word for manipulation).



So, without the Fed, Congress runs out of money and is forced to stop spending. With the Fed, endless supply of money. Hardly irrelevant.



The difference is who decides where the money goes. Private bankers, or politicians. Not only does the Fed monetize government debt, but every single loan it makes to a private bank is monetized as well. So we have a private entity making private loans against the public's bottomless checkbook, using monetary inflation.



In truth, I am not advocating such a system. I only use it as an example to point out how preposterous it is to give a private entity the power to issue money. Politicians have and would abuse this power as well, but at least they are presumed to be transparent and accountable. I advocate a strong commodity standard (probably gold, or bi-metallic), which must be coupled with statutes that strictly limit the amount of money creation to zero. Any standard which intends to limit the issuance of money based solely on the idea that the currency is redeemable will fail, just like the gold standard failed in the roaring twenties.

Do you realize that your argument rests on you not understanding what the word "private" means?

 

[psionl0]

I think he's pointing out that countries without fractional reserve banking can't devalue their currency, and therefore the difference between Zimbabwe and the United States can't be attributed to the use in the United States of fractional reserve banking.

Way off! Sceptic-PK implied that the money system in Zimbabwe is somehow different to the US. It is still the same principle - the government prints new money and the banks multiply it. This is what makes printing money risky when FRB is in place.

As for the 4 points claim are made by anti-FRB advocates, I only advocate point 3). Of course your criticism is based on the false claim that everybody will keep their money in a zero interest trading account. It is more likely that at least half will be in "investment" accounts of which there would be various types depending on the amount of risk the saver was prepared to take. If that isn't enough for lending purposes, there are several options the government has for increasing the money supply - the simplest being to put money itself into investment accounts (a very effective money supply control mechanism). It wouldn't come to that initially because in the transition, debt based money in trading accounts would be replaced by government issued fiat money and the money on loan would not change.

 

[Tippit]

Do you realize that your argument rests on you not understanding what the word "private" means?

No, I'm afraid you're the one who doesn't understand.

http://en.wikipedia.org/wiki/U.S._Federal_Reserve_Bank

"The responsibilities of the central bank are divided into several separate and independent parts, some private and some public."

"Thus the Federal Reserve has both private and public aspects."

"Agrarian and progressive interests, led by William Jennings Bryan, favored a central bank under public, rather than banker, control. But the vast majority of the nation's bankers, concerned about government intervention in the banking business, opposed a central bank structure directed by political appointees.
The legislation that Congress ultimately adopted in 1913 reflected a hard-fought battle to balance these two competing views and created the hybrid public-private, centralized-decentralized structure that we have today."

Clearly, the Fed is quasi-private. Rest assured, when the Fed provides credit to a fully-private member bank, the BoG isn't consulted.

 

[Sceptic-PK]

Way off! Sceptic-PK implied that the money system in Zimbabwe is somehow different to the US. It is still the same principle - the government prints new money and the banks multiply it. This is what makes printing money risky when FRB is in place.

Of course the monetary system is different in the US. In the US the Fed sells bonds to raise capital in order to fund spending. Nobody was buying Zimbabwe bonds, they were simply printing more and more money.

If FRB is so risky why have there been so few issues with it since the advent of central banking?

As for the 4 points claim are made by anti-FRB advocates, I only advocate point 3). Of course your criticism is based on the false claim that everybody will keep their money in a zero interest trading account. It is more likely that at least half will be in "investment" accounts of which there would be various types depending on the amount of risk the saver was prepared to take. If that isn't enough for lending purposes, there are several options the government has for increasing the money supply - the simplest being to put money itself into investment accounts (a very effective money supply control mechanism). It wouldn't come to that initially because in the transition, debt based money in trading accounts would be replaced by government issued fiat money and the money on loan would not change.

How would this address the fact that hardly anyone (certainly no average people) would be able to afford to borrow money anymore, because they couldn’t afford the huge amounts of interest that full reserve requirements would create?

 

[Sceptic-PK]

No, I'm afraid you're the one who doesn't understand.



Clearly, the Fed is quasi-private. Rest assured, when the Fed provides credit to a fully-private member bank, the BoG isn't consulted.

The only part of the Fed that really matters as far as policy-making goes, is the board, which is a government agency with appointments by Congress. There is very little difference in practice between the Fed and other central banks around the world, regardless of whether they’re government or quasi-government agencies.

 

[Tippit]

So, you think politicians should “decide where the money goes” but that the government shouldn’t be allowed to influence the price of money to keep an upper limit on inflation?

Since the inflation tax rate is entirely arbitrary, and technically unlimited, monetary inflation should be outlawed, which would require politicians to use only direct (and more progressive) forms of taxation. The inflation tax is practically limited by what the population will endure without becoming wise to the scam, i.e., as long as they are willing to be fooled, for example, that food inflation is due to increased demand, or inclement weather affecting supply.

How so? What’s stopping Congress from printing as much money as it wants via any other agency, such as the Treasury which you yourself pointed out?

Nothing, which is why I don't support fiat money at all, whether it's controlled by politicans, bankers, or some unholy alliance between the two as it is now. If we're forced to use fiat money, however, its issuance should be solely in the hands of politicians and not bankers, for obvious reasons (hint: bankers aren't electable, and thus, aren't accountable).

The decisions made by the Fed are made by the board, which is a government agency. Private bankers don’t conduct monetary policy, the government does. I know you know this and are just trying to be difficult.

The BoG doesn't micro-manage every aspect of the Fed, it merely oversees policy. The Fed is a quasi-private bank, as are most central banks. For each regional Fed bank, 6 of the 9 board members are elected by private member banks, and private member banks are paid a 6% dividend from Fed profits. While the regional bankers don't conduct monetary policy per se, they extend inflationary credit to whomever they want, without approval.

Again, the Fed is not a private entity. I know you don’t support a Zimbabwe-like currency issuing model, I just thought it strange that you would criticise the US system from that position. Doesn’t make any sense, given your obsessions with inflation/currency devaluation.

I'm obsessed with inflation and currency devaluation because I recognize how incredibly important the issue is, how vast the scope is, and how misunderstood the effects are (some of us here still fail to understand that it is a regressive tax, amazingly enough, which is why I repeat that fact ad nauseum.) The only meaningful difference between the Reserve Bank of Zimbabwe, and the Federal Reserve, is that the Federal Reserve has stolen vastly more purchasing power which has been disguised by the incredibly productive power of the US economy.

 

[Tippit]

Of course the monetary system is different in the US. In the US the Fed sells bonds to raise capital in order to fund spending. Nobody was buying Zimbabwe bonds, they were simply printing more and more money.

Uh, in the US the Fed buys government bonds in order for the government to raise capital. The only difference between what the Fed does, and what Mugabe does, is that bondholders get a huge subsidy by the Fed, and Mugabe subsidizes himself.

If FRB is so risky why have there been so few issues with it since the advent of central banking?

Lol. Not risky at all. The "only" issues were the Great Depression, numerous recessions, and the Global Financial Crisis.

How would this address the fact that hardly anyone (certainly no average people) would be able to afford to borrow money anymore, because they couldn’t afford the huge amounts of interest that full reserve requirements would create?

Interestingly enough, they wouldn't need to mortgage their lives because without fiat money, monetary inflation-induced asset bubbles would be obsolete. Homes and cars would actually be affordable. Credit would still exist, it would merely reflect a realistic price, and it would only go to credit-worthy borrowers (thus precluding calamities like the current GFC.)

 

[psionl0]

Of course the monetary system is different in the US. In the US the Fed sells bonds to raise capital in order to fund spending. Nobody was buying Zimbabwe bonds, they were simply printing more and more money.

Details. Since the Fed buys most of the government bonds, the government is effectively printing money.

If FRB is so risky why have there been so few issues with it since the advent of central banking?

Your historical sources are very different to mine.

How would this address the fact that hardly anyone (certainly no average people) would be able to afford to borrow money anymore, because they couldn’t afford the huge amounts of interest that full reserve requirements would create?

The cost of borrowing money (interest rate) is simply a function of the amount of money that is available for borrowing. If the amount of money on loan doesn't change, then why would the interest rate?

 

[Sceptic-PK]

Details. Since the Fed buys most of the government bonds, the government is effectively printing money.

So, why did Zimbabwe reach a zillion % inflation rate but the rest of the world that prints money has not?

Your historical sources are very different to mine.

They must be, because the two greatest economic collapses in the time we're talking were not caused by FRB.

The cost of borrowing money (interest rate) is simply a function of the amount of money that is available for borrowing. If the amount of money on loan doesn't change, then why would the interest rate?

Eh? How on earth would the amount of money on loan remain the same? There would be a huge drop in loans, because banks would be prevented from loaning any reserves. Even with your idealistic "investment deposit accounts", where clients can choose to invest their money in an account which is then loaned out, the amount of available loans would never be able to satisfy the demand for loans.

In essence, a 100% reserve requirement would mean banks would only lend to those of ample means (ie those guaranteed to pay everything back) and would charge a premium amount of interest due to the fact that loans would be so much harder to get.

 

[Sceptic-PK]

Uh, in the US the Fed buys government bonds in order for the government to raise capital.

Yes, and they also sell them as well.

Lol. Not risky at all. The "only" issues were the Great Depression, numerous recessions, and the Global Financial Crisis.

And you repeatedly ignore the role of the Gold Standard in the Great Depression so I can't really take you seriously on that topic. FRB certainly didn't cause the GFC, though may have exacerbated it, but if you believe there's some magical monetary system that is immune to market failure, then I would like some of what you're smoking. Of note, you also mentioned only 2 real economic calamaties in ~90 years, which is pretty good compared to the time periods you seem to think were eras of economic bliss.

Interestingly enough, they wouldn't need to mortgage their lives because without fiat money, monetary inflation-induced asset bubbles would be obsolete. Homes and cars would actually be affordable. Credit would still exist, it would merely reflect a realistic price, and it would only go to credit-worthy borrowers (thus precluding calamities like the current GFC.)

There are far more components in the cost of assets than just monetary inflation. This has been demonstrated to you on JREF by far more capable posters than I, so I won't waste either your time or mine attempting to do so again.

 

[Sceptic-PK]

For each regional Fed bank, 6 of the 9 board members are elected by private member banks, and private member banks are paid a 6% dividend from Fed profits.

I'll just correct this point, because I have to run. The banks don't receive 6% dividends from Fed profits, they receive 6% dividends based on the stock they are (usually) required to purchase in the Federal Reserve system. This is compensation for the opportunity cost of the capital they invest. The member banks do not receive higher dividend payments if the Fed's "profits" are higher, they receive their standard 6% on the stock they own.

 

[psionl0]

So, why did Zimbabwe reach a zillion % inflation rate but the rest of the world that prints money has not?

Zimbabwe prints more money than the rest of the world. Everybody knows that unbridled money printing will cause hyper inflation but the Zimbabwe government isn't interested in the well being of its people.

They must be, because the two greatest economic collapses in the time we're talking were not caused by FRB.

If the contraction of the money supply caused by a tightening of credit has no economic impact then you might be right.

Eh? How on earth would the amount of money on loan remain the same? There would be a huge drop in loans, because banks would be prevented from loaning any reserves.

You're not thinking again. Existing loans are not about to be recalled or destroyed. As these loans are repaid, the money becomes available for lending again (regardless of what is in trading accounts) just like today when the money supply is at the limit as set by the reserve ratio.

As a matter of fact, the amount of money available for lending would tend to increase as banks entice their customers to put money into their investment accounts.

 

[Tippit]

Yes, and they also sell them as well.

No, the Fed doesn't sell bonds in order for the government to raise capital. I didn't claim the Fed doesn't sell bonds, I was pointing how how your claim in its entirety was wrong.

And you repeatedly ignore the role of the Gold Standard in the Great Depression so I can't really take you seriously on that topic. FRB certainly didn't cause the GFC, though may have exacerbated it, but if you believe there's some magical monetary system that is immune to market failure, then I would like some of what you're smoking. Of note, you also mentioned only 2 real economic calamaties in ~90 years, which is pretty good compared to the time periods you seem to think were eras of economic bliss.

The gold standard failed to prevent the monetary inflation that caused the roaring twenties, it merely caused an outflow of gold. This is because while the US dollar was redeemable, there was no statuatory requirement to maintain parity. The dislocations caused by the roaring twenties, coupled with the sharp contraction in the supply of (fiat) money by the Fed caused the Great Depression, not gold. Gold was merely the scapegoat. This is obvious when you recognize that the Fed tightening continued through 1937, four years after Roosevelt declared gold bankruptcy in 1933.

There are far more components in the cost of assets than just monetary inflation. This has been demonstrated to you on JREF by far more capable posters than I, so I won't waste either your time or mine attempting to do so again.

The price of assets has to do with the supply and demand of money, and the supply and demand of assets, with no preference to either.